Hiscox
Annual Report 2007

Plain-text annual report

2007 Hiscox Ltd Report and Accounts Contents Corporate highlights Chairman’s statement Chief Executive’s report Business overview Business structure At a glance Hiscox locations Hiscox products Claims at Hiscox The Hiscox brand The people at Hiscox Insurance carriers Managing the Group’s assets Group financial performance Cash flow and liquidity Risk management Corporate responsibility Board of Directors Corporate governance Directors’ remuneration report Directors’ report Report of the independent registered public accounting firm Consolidated income statement Consolidated balance sheet Consolidated statement of changes in equity Consolidated cash flow statement Notes to the financial statements Five year summary Glossary Credits 2 4 8 16 17 18 20 21 22 26 30 34 38 39 42 44 48 50 52 54 60 61 62 63 64 65 66 106 107 108 Hiscox Ltd Report and Accounts 2007 Contents 1 “Our ambition remains to be a highly respected international specialist insurance and reinsurance company, built on a balance between volatile international catastrophe business and more steady local and regional business.” Robert Hiscox Chairman 2 Corporate highlights Hiscox Ltd Report and Accounts 2007 Corporate highlights Financial Record pre-tax profits up 18% to £237.2m (2006: £201.1m) Gross premiums written up 6.5% to £1,198.9m (2006: £1,126.2m) Group combined ratio improves to 84.4% (2006: 89.1%) Earnings per share on profit after tax up 16.1% to 48.4p (2006: 41.7p) Final dividend 8p per share (2006: 7p) making 12p for the full year, an increase of 20% (2006: 10p) Return on equity 28.8% (2006: 28.9%) Active capital management Operational Excellent year for Hiscox Global Markets – profits increased to £155.6m (2006: £90.7m) Hiscox UK and Hiscox Europe – good top line growth of 13.7% to £302.3m (2006: £265.8m) with profits of £21.8m (2006: £33.1m) despite the impact of Windstorm Kyrill and the UK floods Hiscox International – another successful year with profits up 33.2% to £69.1m (2006: £51.9m) Hiscox USA – acquired American Live Stock, a major milestone towards building a strong US domestic business Regional business relatively stable in the softening market with good growth prospects Group key performance indicators Gross premiums written (£m) Net earned premiums (£m) Profit before tax (£m) Earnings per share (p) Total dividend per share for year (p) Net asset value per share (p) Shareholders’ equity (£m) Group combined ratio (%) Return on equity (%) 20% increase in dividend 12p dividend for 2007 2007 1,198.9 965.2 237.2 48.4 12.0 209.5 824.3 84.4 28.8 2006 1,126.2 888.8 201.1 41.7 10.0 173.2 682.1 89.1 28.9 Hiscox Ltd Report and Accounts 2007 Corporate highlights 3 Chairman’s statement 4 Chairman’s statement Hiscox Ltd Report and Accounts 2007 After a record result in 2006, I am delighted to announce a further record in 2007. We took full advantage of the strong rates for international reinsurance in London and Bermuda, added some gearing from our sidecar ‘Panther’, and with disciplined underwriting, skilful avoidance of various market losses and some help from Mother Nature, were handsomely rewarded. Our regional businesses in the UK, Europe and the USA continued to grow, with the UK making a good profit despite the storms and floods. Our strategy of growing stable regional businesses will now become more valuable as some international rates fall following two years with relatively light catastrophes. Results The result for the year ended 31 December 2007 was a record profit of £237.2 million (2006: £201.1 million). Gross written premium income increased 6.5% to £1,198.9 million (2006: £1,126.2 million) with net earned premium increasing 8.6% to £965.2 million (2006: £888.8 million). This was despite a weak dollar exchange rate persisting throughout 2007. The combined ratio was 84.4% (2006: 89.1%). Earnings per share on profit after tax increased 16.1% to 48.4p (2006: 41.7p) and net assets per share rose 21% to 209.5p per share (2006: 173.2p). Return on equity was 28.8% (2006: 28.9%). £237.2m record profit before tax Dividend and capital management In March 2007, the Board proposed a total dividend of 12p for 2007. Subject to shareholders’ approval, we will pay a final dividend of 8p (2006: 7p) making a total distribution for the year of 12p (2006: 10p) an increase of 20%. This will be paid on 17 June 2008 to shareholders on the register on 16 May 2008. Our dividend policy going forward is to increase the dividend year-on-year as we believe a growing income is well received by shareholders and a main plank of equity investment. This year’s record result has generated additional capital at a time when we have reduced the 2008 capacity of our Lloyd’s Syndicate 33 by 20%. On top of the annual dividend of around £50 million, we have announced a buy-back of our shares to treasury of up to £50 million and repayment of debt of £50 million, making an effective capital repayment of £150 million. Our business needs capital to support underwriting and to build the network of regional businesses. We have made regular small Hiscox Ltd Report and Accounts 2007 Chairman’s statement 5 Chairman’s statement continued Dividend and capital management continued acquisitions but prices have been driven very high. If the sub-prime crisis and the competitive insurance conditions reduce the profitability and the expectations of some attractive businesses we will need capital to be able to buy if the right opportunity arises. Review of the year Our ambition remains to be a highly respected international specialist insurance and reinsurance company, built on a portfolio balanced between volatile international catastrophe business and more steady local and regional business. During the last year we made significant progress in strengthening the Group. As usual I will highlight some salient points of the year under review and leave Bronek Masojada to report in more detail. 2007 was another cracking year for the international catastrophe exposed business. It always sounds easy in retrospect to write a book of catastrophe business when the catastrophes have not occurred, but it isn’t. It requires extremely careful analysis of exposures and sensible purchase of reinsurance, combined with the ability to secure shares of the most attractive business. This the Global Markets team in London and the Bermuda team did extremely well. handling combined with slick operations to build a profitable book such as ours. Our direct business which offers household and small commercial policies, is nearing critical mass and profitability. The income rose by 72% and the number of policies to 54,000, aided by the advertising campaigns which also helped sell policies through brokers and strengthen the brand. Hiscox Europe increased premium income by 25% and had a third year of profit despite losses from Windstorm Kyrill which bodes well for the future as we increase our product range. Hiscox USA established a firm foothold and the acquisition of the American Live Stock Insurance Company, now renamed Hiscox Insurance Company Inc., will give us the ability to market our policies on an admitted basis in addition to the surplus lines basis using Hiscox Syndicate 33 at Lloyd’s. Hiscox Guernsey had another brilliant year. The market The insurance cycle is alive and definitely kicking and it would appear that some insurers are, as usual, suffering from rapid and severe memory loss. (How can they forget 2005 when years of premiums were wiped out?) Rates are reducing rapidly in obvious Our strategy of growing stable regional businesses will now become more valuable. 2007 was a year of good progress on the regional side of the business. Hiscox UK made a profit despite being assaulted by Windstorm Kyrill in January and floods in June and July. The household book lost money but enhanced its reputation by excelling in the management of claims. Household insurance is thought by the majority of buyers to be a commodity purchase – all policies are the same so it is only price that matters. It is extraordinary that people who would normally never buy the cheapest will cover the risk of losing their most precious assets with a cheap and often unread policy. Well you find out how good your policy is when you have a claim, and we set out to prove that a Hiscox policy is altogether better – and I believe that we succeeded. The commercial side of Hiscox UK showed the benefit of balance and its superb underwriting profits kept UK profitable. It has built up an excellent book in the small professional businesses area with intelligent cover and efficient processes. There is less competition for small risks which require a distinct skill in underwriting and claims areas where there are large premiums to be competed for and the lust for non-catastrophe exposed business is turning underwriting discipline to jelly. I sometimes wonder whether underwriters who have made a 10% profit and then reduce rates by 10% think they are going to make 9%, instead of the obvious NIL. Any management, including the management of Lloyd’s, who sees a rising income in an area of falling rates ought to ask serious questions. It was disappointing to see the capacity of Lloyd’s reducing only 2% for 2008 (an actual increase at constant exchange rates) when most of the seasoned underwriters like us were reducing by 20%. Sub-prime crisis After a period of grace during which the banks had re-established a reputation for financial discipline, control of risk and expertise in passing that risk off to others (and insurers were widely assumed to have taken the risk off them), there is a measure of schadenfreude in their current turmoil. Critics have wondered why the insurance industry has been unable to quantify its losses almost immediately after major catastrophes, telling us that the banks can 6 Chairman’s statement Hiscox Ltd Report and Accounts 2007 mark to market every night and know their exact exposure at any time. Not so, it would appear. It is a serious crisis, the full extent of which I do not think we have yet seen. In our underwriting books we have a very limited exposure which we have reserved fully. I comment on our investment portfolios below. Investments The end of 2007 (and the beginning of 2008) has been a challenging period for investing. However, our policy of focusing on high quality, short duration bonds has kept us away from the structured products that have done so much damage in the financial world. We have a negligible exposure to certain sub-prime securities, all of which remain AAA rated. Our regional businesses are showing healthy growth. We believe that we have demonstrated that our household policies give superior cover backed by great service. Our specialist commercial policies have a strong following in their markets and have much further to go. We have built many advantages into our business over the last few years which will benefit us greatly in the years to come. Our residence in Bermuda gives us considerable strategic advantages and a more global perspective. Our international spread of offices lead to business opportunities not available to us before, and give our staff increased choices in their careers. We have a great group of people with a wide range of skills in international and regional business with a network of offices and contacts throughout the world. The market may be testing in the next few years but we have been building towards this moment and I am confident that we will prosper. At the end of last year we reduced our equity exposure from 10% of overall funds to 7.8% and that has helped during the weak market in early 2008. We expect opportunities to emerge from the current turbulence and a more normal relationship between risk and reward to return. Robert Hiscox Chairman 3 March 2008 People We have continued to seek, recruit, train and motivate the best people. There is a spirit which pervades throughout all our offices which is made up of a desire to do an excellent job with drive, Direct to customer income up by 72% efficiency and integrity. I think that because of this customers want to do business with Hiscox. I am very grateful to everyone at Hiscox for what they have built over the last few years culminating in the excellent results over the last two. The future We are building a long-term business and our senior management have experience of several down-cycles. We have spent 15 years investing considerable money in building an international network to distribute our specialist products. This will mitigate the effect of this part of the cycle. Our Global Markets and Bermuda businesses are most affected by the cycle and they will let those with short memories take the business off them if the price is not right. There is still plenty of good business at fair prices so they have budgeted to make a good profit in 2008. Reinsurance prices are relatively firm, so those who are reducing insurance premiums to unrealistic levels will be squeezed by expensive reinsurance and less income to pay losses. Hiscox Ltd Report and Accounts 2007 Chairman’s statement 7 Chief Executive’s report 8 Chief Executive’s report Hiscox Ltd Report and Accounts 2007 Our Chairman Robert Hiscox has always advised us to ‘advance to the sound of gunfire, retreat when the Sirens call’. In 2007 we followed this advice. Significant parts of our business advanced, particularly in reinsurance in London and Bermuda, but also in our smaller ticket businesses in the UK, USA and Europe. The result of this has been a record level of controlled gross written premium, record profits on both an absolute and per share basis and a 20% increase in dividend per share. We are also hearing the Sirens of a market in downturn and in 2008 we will retreat tactically. Across the Group market conditions are becoming tougher but with variability in pricing trends by line of business. Our business strategy has long been set to take account of this environment. We are shrinking significantly in the areas such as international big ticket business where we see most pressure on pricing, shrinking moderately in areas like reinsurance which are less affected, and expanding in the US, UK and European domestic markets where our specialist focus protects us from the extremes of market competition. Group performance The pre-tax profit for the year was £237.2 million (2006: £201.1 million). Gross written premium grew to £1,198.9 million, an increase of 6.5% (2006: £1,126.2 million), which equals £3.04 per share (2006: £2.86). Earnings per share are 48.4p (2006: 41.7p). Return on equity was 28.8% (2006: 28.9%). Dividends per share have increased 20% to 12p per share (2006: 10p). This excellent performance was achieved despite losses of £68 million from the catastrophes which affected our business. Hiscox is most well known for its expertise in the high net worth arena, but it is our balance of business that gave us the flexibility to deliver this record result while still investing in the future. The decision to expand in reinsurance in both London and Bermuda, combined with a strong performance in big ticket international business, generated record returns and we invested in both our UK direct business and the USA. 84.4% Group combined ratio £1,198.9m Gross premiums written up by 6.5% Hiscox Ltd Report and Accounts 2007 Chief Executive’s report 9 Chief Executive’s report continued Building a balanced business Gross premiums written at 100% level (£m) 1476 1407 1111 1105 1083 941 780 603 514 480 422 413 403 370 379 378 244 190 132 100 1,600 1,400 1,200 1,000 800 600 400 200 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Hiscox Bermuda Syndicate 33 London Market Syndicate 33 Retail Hiscox Insurance Company Retail 10 Chief Executive’s report Hiscox Ltd Report and Accounts 2007 Hiscox Global Markets Hiscox Global Markets underwrites a mix of bigger ticket international business where the Lloyd’s licences provide market access, and smaller ticket specialty business which comes to London for both historic and relationship reasons. Richard Watson led it to a stunning year. Gross written premiums were £676.5 million (2006: £709.1 million) and profits surged to £155.6 million (2006: £90.7 million). The combined ratio improved to 81.7% (2006: 90.1%). The growth in profits was due to an excellent performance by the reinsurance, property and specialty teams. Our marine and global errors and omissions (E&O) teams all made solid contributions. The reinsurance area expanded significantly in the year, with the added capacity of a special purpose re-insurer Panther Re, which was capitalised by WL Ross & Co. Growth in a year that turned out to have very few insured natural catastrophes has been a major contributor to the Group’s growth in profits. In October last year Panther Re and Syndicate 33 agreed that their successful reinsurance partnership covering the 2007 year of account would not be renewed for 2008. We commuted our contract with Panther Re in January 2008 in a deal which brought benefits to both parties. In place of Panther Re we created the smaller Cougar Syndicate at Lloyd’s which is capitalised by a mix of individual and Corporate Names. Initially set up for one year, Cougar Syndicate has a capacity of £34.6 million. Although we expect our reinsurance writings to reduce as rates are easing, we will write enough well-rated business to satisfy both Cougar and ourselves. The property team underwrite all of our catastrophe exposed primary property and property binder business. They had a good year as modest expansion and few losses led to a significant profit contribution. We have moved the reinsurance protections of this business towards a quota share structure, creating partnerships to share both risk and reward. Under the specialty banner we bring together a range of areas such as bloodstock, contingency, kidnap and ransom, terrorism, personal accident and political risks. The division had an almost static top line but improved combined ratios led to a good performance. Hiscox Global Markets rating index Index level (%) £155.6m Hiscox Global Markets pre-tax profit 900 800 700 600 500 400 300 200 100 0 8 9 n a J 8 9 c e D o t 8 9 l u J 9 9 n u J o t 9 9 n a J 9 9 c e D o t 9 9 l u J 0 0 n u J o t 0 0 n a J 0 0 c e D o t 0 0 l u J 1 0 n u J o t 1 0 n a J 1 0 c e D o t 1 0 l u J 2 0 n u J o t 2 0 n a J 2 0 c e D o t 2 0 l u J 3 0 n u J o t 3 0 n a J 3 0 c e D o t 3 0 l u J 4 0 n u J o t 4 0 n a J 4 0 c e D o t 4 0 l u J 5 0 n u J o t 5 0 n a J 5 0 c e D o t 5 0 l u J 6 0 n u J o t 6 0 n a J 6 0 c e D o t 6 0 l u J 7 0 n u J o t 7 0 n a J 7 0 c e D o t Specialty Syndicate Reinsurance Property Global E&O Marine and Energy Hiscox Ltd Report and Accounts 2007 Chief Executive’s report 11 Chief Executive’s report continued £69.1m Hiscox International pre-tax profit It is the specialty division which provides a fair degree of balance of non-correlated business to Hiscox Global Markets and the Group, so it is an area we will cherish as market conditions deteriorate. The marine area saw a reduction in overall premium written as we responded to declining rates, particularly in upstream energy. Combined ratios remained good, but the smaller level of income led to slightly lower profitability overall. Our global errors and omissions division was created from the merger of our technology, media and telecommunications teams and our global professional indemnity teams. Bigger ticket professional indemnity is an area where many catastrophe-focused players are expanding – seeking illusory ‘non-correlating’ business – forgetting that it is only worth doing if it remains profitable. The division has shown great discipline, shrinking in those areas where rates are under most pressure, allowing it to deliver a good result. We remain committed to the area, particularly its more specialist niches, and will expand when the rates return to better levels. Hiscox Global Markets has invested in building underwriting teams outside London. We have established hubs in Paris and in New York to give brokers greater choice in the way they access Hiscox. As well as business which comes to London, we can also serve those brokers who, for whatever reason, decide to place their business in their local market. At Hiscox we have regarded front line underwriters as our ‘fighter pilots’; but just like real pilots, their tools are becoming ever more sophisticated and a greater range of skills need to be brought to bear before a risk is underwritten. Over the last several years we have invested significantly in our modelling capability with a focus on both aggregate management and risk pricing. This year we recruited a further three pricing actuaries to expand our strong analytical team. We believe that the enhanced transparency and greater understanding that the analytics give us, when combined with real management action, will make us more effective in dealing with the softer market that lies ahead. As announced in late 2007, we expect Hiscox Global Markets to shrink by at least 20% in 2008 as we remain committed to our goal of seeking profit over volume. Hiscox International Hiscox International comprises our business in Bermuda, the USA and Guernsey. It had another successful year. Gross written premium grew to £220.2 million (2006: £151.3 million) and the combined ratio 75.4% (2006: 62.7%). Profits grew to £69.1 million (2006: £51.9 million). This improvement was driven by a good performance in each business. Hiscox Bermuda had a great year. Robert Childs led his team to expand their external reinsurance book by 60% to £148.7 million (2006: £93.0 million). This expansion, coupled with a year of low loss frequency, generated a combined ratio of 56.7% and allowed the profits to flow. In 2008 we expect the business to shrink as the team shows the same discipline in softer markets as it did in expanding at the right time. Hiscox Guernsey had another good year under the leadership of Steve Camm and Rob Davies. Gross written premium remained virtually flat at £49.1 million (2006: £48.6 million). Profits remained strong. Our Guernsey team continues to drive the expansion of our worldwide kidnap and ransom business. During the year we acquired a portfolio of this business from AON, which is made up of Latin American risks from third party intermediaries. We also recruited another team based in New York. These two teams will build our relationships with local retail brokers – injecting a stronger growth element into this business. Hiscox USA had a step change in size this year. Led by Ed Donnelly, premiums grew 130% to £22.4 million (2006: £9.7 million). Our team expanded to 88 people. During the year we acquired the American Live Stock Insurance Company. It contributed £3 million to this year’s business. Hiscox Global Markets Hiscox International Gross premiums written Net premiums earned Profit before tax Combined ratio 2007 £m 676.4 552.2 155.6 2006 £m 709.1 567.5 90.7 81.7% 90.1% Gross premiums written Net premiums earned Profit before tax Combined ratio 2007 £m 220.2 164.6 69.1 2006 £m 151.3 93.5 51.9 75.4% 62.7% 12 Chief Executive’s report Hiscox Ltd Report and Accounts 2007 Hiscox UK and Hiscox Europe rating index Index level (%) 160 150 140 130 120 110 100 90 80 0 0 b e F 1 0 n a J o t 0 0 g u A 1 0 l u J o t 1 0 b e F 2 0 n a J o t 1 0 g u A 2 0 l u J o t 2 0 b e F 3 0 n a J o t 2 0 g u A 3 0 l u J o t 3 0 b e F 4 0 n a J o t 3 0 g u A 4 0 l u J o t 4 0 b e F 5 0 n a J o t 4 0 g u A 5 0 l u J o t 5 0 b e F 6 0 n a J o t 5 0 g u A 6 0 l u J o t 6 0 b e F 7 0 n a J o t 6 0 g u A 7 0 l u J o t 7 0 b e F 8 0 n a J o t UK Personal lines incl. DPD UK Pl Europe Personal Lines We have renamed it Hiscox Insurance Company Inc. and will use it as our admitted market platform for the USA. This represents a major milestone in our desire to build a strong US domestic platform. We will retain its profitable animal mortality business and will continue to use the American Live Stock brand in this specialist area. We now have four offices supporting our USA domestic operations in Armonk, Chicago, Manhattan and Geneva, Illinois. In time, we aim to acquire additional businesses or teams who can support the growth of our US domestic business. Hiscox UK and Hiscox Europe Despite challenging conditions our businesses in both the UK and Europe delivered good top line growth with gross premiums written increasing by 13.7% to £302.3 million (2006: £265.8 million). Aggregate profits fell to £21.8 million (2006: £33.1 million), and the combined ratio was 98.2% (2006: 96.2%) reflecting the impact of Windstorm Kyrill and the UK floods. Hiscox UK, led by Steve Langan, produced profits despite several catastrophe events. It has grown gross written premiums 10.7% to £229.2 million (2006: £207.1 million) though profits have fallen to £17.2 million (2006: £32.4 million). The decline has been due to the impact of Windstorm Kyrill, the UK floods in June and July and further investment in our UK marketing campaign. UK property rates had been low for some time and, in part due to the impact of the floods, we are now seeing rates firm. Our marketing campaign continues to show returns. Brand awareness almost trebled in 18 months and customer numbers for the direct business grew to 54,000. The professions and specialty commercial area focuses on knowledge-based businesses employing 250 or fewer staff. Over several years we have developed specific products for firms active in this sector and are building our market presence. This year we began marketing these liability and property products to firms employing ten or fewer staff via the internet. These smaller firms increasingly use the internet to purchase insurance and Hiscox is able to serve their specialist needs. One of the consequences of the UK floods and Windstorm Kyrill has been the need to restructure Hiscox UK’s reinsurance programme as it is no longer economic to continue unchanged. In 2008 we have decided to increase the deductible on our catastrophe programme to £10 million from its previous level of £1million. Hiscox Europe, led by Marc van der Veer, produced a fourth year of profits and growth. Gross written premiums grew 24.5% to reach £73.1 million (2006: £58.7 million) and profits increased to £4.6 million (2006: £0.7 million). The profit improvement includes the benefit of a stronger Euro exchange rate, but even excluding this we are ahead year-on-year. This was achieved despite some serious losses as a result of Windstorm Kyrill. During the year we opened an office in Hamburg and in 2008 we opened another in Bordeaux. We remain committed to growth in the territories where we are currently active. Europe has very good loss ratios, and it is through growth and efficiency gains that we expect profits to improve. Hiscox Ltd Report and Accounts 2007 Chief Executive’s report 13 Chief Executive’s report continued £17.2m Hiscox UK pre-tax profit £4.6m Hiscox Europe pre-tax profit £100.8m Investment return Hiscox UK and Hiscox Europe Gross premiums written Net premiums earned Profit before tax Combined ratio Claims Two years ago we appointed Jeremy Pinchin as Group Claims Director. Since then, Jeremy has been working in a systematic way with the senior claims team to enhance our claims promise. We have been investing in the operational and technical robustness of our claims function given the growth of key business areas and increased geographic spread. The claims team’s work was put to the test this year and they passed with flying colours. In the UK, we received many plaudits for the outstanding service which we gave to many policyholders following the UK floods. Across the Group, claims staff often work in tough situations to return our policyholders to normality as soon as possible. They enhance our reputation of paying valid claims fast. Operations and IT As our business grows and develops our IT infrastructure becomes ever more central to our operations. In order to increase our operational resilience to external physical events we moved all the Group’s core infrastructure to external data centres in suburban London and Paris during 2007. During 2008 we will begin a significant project to migrate our systems onto a new operating platform allowing us to discard older technologies and move to a single system across the Group. The project, which will take around three years and cost £25 million, will enhance operational efficiencies by providing easier access to risk data. The system is designed to support any future growth the Group may experience. UK 229.2 190.3 17.2 2007 £m Europe 73.1 58.0 4.6 UK 207.1 178.3 32.4 2006 £m Europe 58.7 49.5 0.7 98.8% 96.2% 92.0% 106.6% Investments Invested assets in the Group grew to £2.05 billion (2006: £1.74 billion). Investment income grew to £100.8 million (2006: £78.5 million), a return of 5.4% (2006: 4.6%) on average funds. We have managed to avoid the worst damage from the sub-prime crisis affecting the world. We remain predominantly invested in cash and short duration bonds and have more than sufficient liquidity to meet most eventualities. As the world faces this unprecedented situation we are certain that opportunities will arise. We have made an initial investment in corporate bonds with lower credit ratings than our customary AAA,with a duration of up to five years. We are prepared to hold the bonds purchased to maturity accepting the mark to market volatility as we believe the returns will be more attractive with this approach. During the course of the year we accepted an offer from the management of Hiscox Investment Management to purchase a majority of the shares of this business. They have renamed themselves HIM Capital and we wish them well in their venture. We retain access to the knowledge of Alec Foster, HIM Capital’s Chairman and the overseer of our Group funds for many years, under a consultancy contract. David Astor has succeeded Alec as our in-house overseer of the third party fund managers who have day-to-day responsibility for investing our funds. 14 Chief Executive’s report Hiscox Ltd Report and Accounts 2007 600 500 400 300 200 100 0 Boxplot and whisker diagram of Hiscox Ltd net loss (USD) Hiscox Ltd losses (millions USD) s s o l t e k r a m n b 2 5 $ w e r d n A e n a c i r r u H d o i r e p n r u t e r r a e y 9 2 s s o l t e k r a m n b 9 3 $ a n i r t a K e n a c i r r u H d o i r e p n r u t e r r a e y 8 1 s s o l t e k r a m n b 0 1 $ e k a u Q e g d i r h t r o N d o i r e p n r u t e r r a e y 6 1 s s o l t e k r a m n b 3 $ e k a u Q a t e i r P a m o L d o i r e p n r u t e r r a e y 7 Q E P J Q E S U S W U E U H S U Q E P J Q E S U S W U E U H S U Q E P J Q E S U S W U E U H S U Q E P J Q E S U S W U E U H S U Q E P J Q E S U S W U E U H S U 5–10 year 10–25 year 25–50 year 50–100 year 100–250 year The chart above shows the variability in net loss the Group expects from individual losses of a given industry loss size. Industry loss return period and peril Upper 95% Mean Lower 5% Balance sheet Net assets per share grew to 209.5p per share (2006: 173.2p) and tangible net assets grew to 199.3p per share (2006: 164.8p). On the financing front we had a quiet year. We considered issuing longer term debt but the market turmoil that began in the summer made this inadvisable. Our healthy profits and measured growth have led us to consider our own optimal balance sheet structure. The need to have a taut balance sheet has to be balanced against the inevitable increase in exposure to external shocks as the insurance pricing cycle turns. We believe we have struck the right balance in the £100 million capital management programme which we announced in December. £50 million will be spent buying back shares in the market and a further £50 million will be spent repaying debt. In addition, we will be returning almost £50 million to shareholders this year through our dividend. At the end of February 2008 we have spent £14.1 million buying back 5.4 million shares into treasury. The average price paid was 258.7p per share. People Hiscox’s performance is the result of the efforts of all of our staff. My thanks go to them all, including underwriters and business developers who grew our business at the right price, claims staff who deliver our promise and IT and operations who hold the business together (sometimes with few resources and dated systems). Many went the extra mile to make this result a reality. relationship management to the market and continuing with our leadership development programmes. We feel that if our staff have the best skills, they will deploy them to their own and the business benefit. Current trading In our planning process we assumed that rates in the big ticket area would be most under pressure, followed by reinsurance with the specialty and retail businesses being least affected.These assumptions caused us to announce an anticipated 20% reduction in premiums underwritten by Hiscox Global Markets,with Hiscox Bermuda following this lead. To date, renewals have largely met our initial price expectations other than in large property and energy risks. Here price reductions have exceeded our plans and we have revised down our expectations in these areas. We have seen good progress in our retail business areas. Conclusion Over the past decade we have built Hiscox from a largely Lloyd’s- and London-focused insurance business to a global business with a specialty focus active in multiple regions of the world. This achievement stands us in good stead as we enter a tougher pricing environment. We will continue to balance our retail and volatile risks, giving us the resilience and firepower to respond to the crises and opportunities which will inevitably emerge, to the benefit of the business and its owners. Hiscox is committed to continue to equip our staff with the skills required for the changing times. In the year ahead there will be greater emphasis on training for underwriting in a soft market, adapting broker Bronek Masojada Chief Executive 3 March 2008 Hiscox Ltd Report and Accounts 2007 Chief Executive’s report 15 Business overview Hiscox is now an international insurance Group with a spread of global and regional businesses. 16 16 Business overview Hiscox Ltd Report and Accounts 2007 Business structure Hiscox Ltd Hiscox Global Markets Hiscox International Hiscox UK and Europe Hiscox Bermuda Hiscox Guernsey Hiscox USA Hiscox UK Hiscox Europe Four locations One location One location Four locations Eight locations Twelve locations Reinsurance Reinsurance Art and private client PI and specialty commercial Art and private client Art and private client Group capital support Property Marine and energy Specialty Technology and media Aerospace Kidnap and ransom Regional technology and media PI and specialty commercial PI and specialty commercial Animal mortality Regional technology and media Regional technology and media Direct Hiscox Ltd Report and Accounts 2007 Business structure 17 At a glance Hiscox Global Markets Hiscox Global Markets underwrites insurance and reinsurance business across the world. It uses Lloyd’s broker network, licences and coinsurance capability to share in some of the world’s largest and most complex risks. Hiscox Global Markets has also developed distribution through hub offices in Paris, New York and San Francisco to access smaller or more sophisticated specialist risks in their local markets such as technology, media and kidnap and ransom. Hiscox UK and Hiscox Europe Hiscox UK and Hiscox Europe underwrite local specialty insurance from 20 different regional centres across Europe. Business is sourced mainly through local brokers. There are two main product streams covering: the personal property of wealthy individuals, including fine art; and the liability and property of professional or advisory and service-led businesses. Hiscox UK also underwrites executive household, small professional risks and event cover marketed direct to the consumer. Highlights Highlights Pre-tax profit £155.6 million (2006: £90.7 million) and a combined ratio of 81.7% (2006: 90.1%) Panther Re – successful sidecar transaction Continued focus on risk selection, pricing and aggregation Security Syndicate 33 has an A (Excellent) from A.M. Best and uses Lloyd’s security, A+ (Strong) from Standard & Poor’s and A (Excellent) from A.M. Best. Profit despite UK floods £21.8 million (2006: £33.1 million) Excellent claims performance during floods enhanced brand with customers Hiscox UK good top line growth in core areas: Art and Private Client, Professions and Specialty Commercial, Technology Media and Telecoms and Direct 25% growth in Hiscox Europe Security Hiscox Insurance Company Limited has an A- (Excellent) from A.M. Best and A- (Strong) from Standard & Poor’s. Syndicate 33 has an A (Excellent) from A.M. Best and uses Lloyd’s security, A+ (Strong) from Standard & Poor’s and A (Excellent) from A.M. Best. Richard Watson Managing Director, Hiscox Global Markets Joined Hiscox in 1986 as a Political Risk Underwriter. Appointed Managing Director of Hiscox Global Markets in October 2005. Steve Langan Managing Director, Hiscox UK Joined in 2005 as Managing Director of UK Retail and Group Marketing Director. Previously Managing Director of Diageo’s Italian subsidiary. Marc van der Veer Managing Director, Hiscox Europe Joined in May 2005. Previously headed up directors and officers’ liability underwriting, Continental Europe for XL Capital. 18 At a glance Hiscox Ltd Report and Accounts 2007 Hiscox International Hiscox International consists of Hiscox Guernsey, Hiscox Bermuda and Hiscox USA. Highlights £69.1 million pre-tax profit (2006: £51.9 million) and a combined ratio of 75.4% (2006: 62.7%) Milestone for Hiscox USA, acquisition of American Live Stock gives access to admitted licences Hiscox Bermuda had an excellent year despite Windstorm Kyrill, UK floods and California fires Hiscox Bermuda Hiscox Bermuda opened in 2005 and underwrites a significant property reinsurance account, predominantly catastrophe and risk excess of loss business and some internal reinsurances. Hiscox Guernsey Hiscox Guernsey has been operating since 1998 and offers a range of products including fine art insurance and kidnap and ransom protection. Security Hiscox Insurance Company (Bermuda) Limited has an A- (Excellent) from A.M. Best. Security Hiscox Insurance Company (Guernsey) Limited has an A- (Excellent) from A.M. Best. Hiscox USA Hiscox USA opened in March 2006 and underwrites errors and omissions, kidnap and ransom and terrorism for smaller to medium-sized businesses. American Live Stock Insurance Company underwrites animal mortality insurance. Security Syndicate 33 has an A (Excellent) rating from A.M. Best and uses Lloyd’s security, A+ (Strong) from Standard & Poor’s and A (Excellent) from A.M. Best. Robert Childs Chief Underwriting Officer Chief Executive Officer of Hiscox Bermuda Chairman of Hiscox USA Joined Hiscox in 1986. Active Underwriter of Syndicate 33 from 1993 to 2005. Chief Underwriting Officer of the Group for seven years. Steve Camm Managing Director, Hiscox Guernsey Joined Hiscox in 1994 as a Kidnap and Ransom Underwriter. Appointed Underwriting Director of Hiscox Guernsey in December 1998. Ed Donnelly President, Hiscox USA Joined Hiscox in 2005. Previously Senior Vice President at Professional Indemnity Agency, a subsidiary of HCC Insurance Company. Hiscox Ltd Report and Accounts 2007 At a glance 19 Hiscox locations Hiscox has 27 offices in 13 countries. Most of these offices service local businesses and individuals with local Hiscox products. These smaller premium products include insurance for higher value homes as well as specialist liability and property risks for professional businesses. Customers from all parts of the globe place their more complicated or larger business with Hiscox through the Lloyd’s and Bermudian insurance markets. In these markets we underwrite a variety of risks from reinsurance and terrorism to contingency. As local insurance providers become more sophisticated, more business is being underwritten locally. In order to improve broker access to our products, Hiscox Global Markets have opened new offices in New York, Paris and San Francisco. These offices use existing relationships and underwriting expertise to access business that would not be placed in the traditional markets. Creation of the Hiscox offices 1901 1993 1994 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 London Paris Munich Guernsey, Leeds Amsterdam Birmingham, Glasgow Brussels, Dublin Maidenhead Colchester Madrid Bermuda Armonk, Bristol, Cologne, Lisbon, Lyon, Manhattan, San Francisco, Stockholm Chicago, Geneva, Hamburg, Manchester 2008 Bordeaux UK Birmingham Bristol Colchester Glasgow Leeds London Maidenhead Manchester Europe Amsterdam Bordeaux Brussels Cologne Dublin Guernsey Hamburg Lisbon Lyon Madrid Munich Paris Stockholm USA Armonk Chicago Geneva Manhattan San Francisco Bermuda Hamilton 20 Hiscox locations Hiscox Ltd Report and Accounts 2007 Hiscox products 2007 Total Group controlled premium £1,476 million Year-on-year growth +27.1% £496m +7.1% £199m -10.5% £186m +3.8% £184m Kidnap and ransom Contingency Terrorism Bloodstock Specie Personal accident Political risks High value household and content Fine art Aviation war Classic cars Aerospace Non marine reinsurance Marine reinsurance Whole account reinsurance +15.0% £156m -13.2% £133m -22.7% £122m Managing general agents Commercial property Onshore energy USA homeowners Professional liabilities Errors and omissions Commercial office Professional indemnity Directors and officers’ liability Technology E&O Media E&O Marine hull Energy liability Upstream- midstream energy Reinsurance Art and Private Client Specialty Property Local E&O and Commercial Global E&O Marine and Energy Hiscox Ltd Report and Accounts 2007 Hiscox products 21 Claims at Hiscox We are determined to make our claims service better than the competition. 22 Claims at Hiscox Hiscox Ltd Report and Accounts 2007 Since 2005 the claims team has been working in a systematic way to build upon the operational and technical robustness of our claims function. This has allowed us to maintain high standards given the growth of key business areas and increased geographical spread. Focus on UK floods The UK floods in June and July were devastating for those affected and it was a huge event for the industry. Hiscox’s claims volume doubled during July, testing our service levels and that of our suppliers. Our claims underwriters, loss adjusters and disaster recovery specialists pulled out all the stops, responding to our clients’ difficulties with speed and sensitivity. The ABI predicted the industry would settle 40% of flood claims by the end of 2007. Hiscox had settled over 59% of claims. We expect to have less than ten open claims by July 2008. Fast and effective It took 13 minutes for flood waters to rise from three inches to two feet in our customer’s Georgian house in North Hampshire. The deluge was beyond the capacity of nearby drains and the failure of the area’s pumping station complicated matters. Sewage flooded our customer's kitchen, conservatory, study and the ground floor of an office. Hiscox’s loss adjuster arrived the next morning to assess the damage, with the disaster recovery company arriving in the afternoon to remove carpets, sanitise hard areas and start the important drying process with industrial blowers. Our customer said: “ We were very impressed with the service – a loss adjuster was appointed promptly and spent a lot of time on our property. Decisions were made quickly, which I think is important because the longer it takes, the worse the damage will be.” Hiscox pays valid claims fast £452m paid out in claims in 2007 Hiscox Report and Accounts 2007 Claims at Hiscox 23 Flood risk – a Climatologists view “ We recognise climate change is likely to increase flood risk and our business is preparing for this with increased analysis and modelling of potential risks. We have seen the massive impact that flood has on our customers and the economy. Sadly, some of it could be prevented. The Government needs to raise flood plain management in its list of priorities.” Matthew Swann Hiscox Climatologist Claims at Hiscox continued Feedback on Hiscox from customers affected by the UK floods “The total service was very professional, very prompt and eased the trauma we felt. Many thanks.” “The floods brought us great distress. Life became quite fraught and the only salvation in all this was Hiscox. Within 24 hours we were in the hands of a professional team, your staff, the loss adjuster and the salvage team. We soon realised that help and advice was only a phone call away.” “Best insurance process I have ever been through.” “Courteous staff. Prompt processing of claim. Fast payment. Very pleased with service.” Those few Hiscox customers who were still out of their houses at Christmas were sent a hamper. One customer responded with a poem. “ When life takes a turn for the dampers, When house dwellers turn into campers, When your council has brains, As clogged as its drains, Thank God for Hiscox’s hampers.” 24 Claims at Hiscox Hiscox Ltd Report and Accounts 2007 “Hiscox had faith in me and were determined to fight this to the end.” Graeme McLagan “ We felt the High Court had erred in the case. We could also see that there was an important point of law to be defended and winning would have a positive impact on all of our clients engaged in investigative journalism.” Andrew Sellers Head of UK and International Technology and Media Claims at Hiscox Focus on technology and media claims The Hiscox approach to technology and media claims sets us apart from the competition. Our claims underwriters aim to get under the skin of our customers’ business. The team uses its in-depth knowledge of industry risks to help prevent or minimise any problems before they arise. This partnership approach means our claims staff often go beyond the policy commitment to help the insured. Standing by our policyholders When freelance journalist Graeme McLagan wrote his book Bent Coppers:The Inside Story of ScotlandYard’s Battle Against Police Corruption, he and his publishers knew it would be controversial. They were not expecting to be in court for the next four years facing accusations of libel from an ex-police officer backed by the Police Federation. When others would have walked away, Hiscox provided expertise and encouragement. Working with specialist media lawyers, the team was determined to stand by the publisher. The result: The Orion Publishing Group won a landmark ruling in the law of libel by the Court of Appeal which ruled that journalist Graeme McLagan acted responsibly when he researched and wrote the book. Hiscox Ltd Report and Accounts 2007 Claims at Hiscox 25 The Hiscox brand We want customers to reach for a Hiscox policy and be confident that we will deliver great service when they need it most. 26 The Hiscox brand Hiscox Ltd Report and Accounts 2007 Ambition: Great underwriting Superb service Powerful brand “ We understand our customers and know they are sophisticated and demanding. The message behind the Hiscox brand is that we will always try to exceed those demands with exceptional service.” Steve Langan Managing Director, Hiscox UK Group Marketing Director Over the last two years Hiscox has spent £23 million on marketing, promoting Hiscox as an insurer you can have confidence in by focusing on our claims record. The resulting campaigns have been highly regarded and set Hiscox among international brands like Proctor and Gamble, British Airways and Tesco. Winners of the Brand Extension category at the 2007 Marketing Society Awards ‘Best Use of Data for a Financial Product’ in the 2007 Data Strategy Awards ‘Best Financial’ and ‘Innovation’ awards in the 2006 Direct Response Intelligence Awards Hiscox Ltd Report and Accounts 2007 The Hiscox brand 2727 The Hiscox brand continued Hiscox Direct Direct marketing cost per sale (CPS), total awareness growth and policy count Index (%) 300 250 200 150 100 50 0 Live policy count 60,000 50,000 40,000 30,000 20,000 10,000 0 o t n a J 6 0 r a M o t r p A 6 0 n u J o t l u J 6 0 p e S o t t c O 6 0 c e D o t n a J 7 0 r a M o t r p A 7 0 n u J o t l u J 7 0 p e S o t t c O 7 0 c e D Home Direct policy count Commercial Direct policy count Awareness index CPS index Hiscox has a 5* rating (the highest possible) from Defaqto, the independent market researchers, for the most comprehensive cover for its 505 and 506 UK home and contents policies. Our 606 home and contents policy has a Premier rating (the highest possible) from Defaqto for high net worth products. In 2007 Hiscox was the recipient of the following broker voted awards for the Insurance Times: Personal Lines Insurer of the Year Commercial Lines Insurer of the Year Lloyd’s Syndicate of the Year AWA R D S 2 0 0 7 W I N N E R PERSONAL LINES INSURER OF THE YEAR AWA R D S 2 0 0 7 W I N N E R COMMERCIAL LINES INSURER OF THE YEAR Certainty Stills from television advert x3 Brand awareness in the UK almost trebled in two years The people at Hiscox We want our customers to experience Hiscox as: Intelligent not intellectual, bold not arrogant, thought provoking not patronising, different not standard, straightforward not users of jargon, positive not pushy, contemporary not stuffy, sophisticated not superior. 30 The people at Hiscox Hiscox Ltd Report and Accounts 2007 ]“ The behaviour and performance of Hiscox employees is what will set us apart from other insurers. Our ambition is to attract and develop extraordinary people.” Amanda Brown Group Human Resources Director 90% of staff, in an independent employee survey, said they were proud to work at Hiscox Hiscox Ltd Report and Accounts 2007 The people at Hiscox 31 31 The people at Hiscox continued We have three principles that drive our people strategy Total hired in 2007 245 Recruit the best Where possible, Hiscox aims to recruit internally. In 2007 one third of new appointments were internal promotions or referrals from current employees. Hiscox has an extremely thorough recruitment process. The average number of candidates seen per hire in 2007 was eight. Head count growth Total number of staff as at 31 December 1,000 800 600 853 715 601 506 463 400 376 421 399 200 0 2000 2001 2002 2003 2004 2005 2006 2007 “ Hiscox is a demanding, challenging client who embraces ‘out of box ’ thinking and as a result is able to attract and integrate the best candidates regardless of background. This is not a wood-panelled or long-lunch environment but one which is open, meritocratic, robust, challenging, fast moving and fun.” Andrew Simpson Partner and Head of Financial Services Practice Whitehead Mann LLP 32 32 The people at Hiscox Hiscox Ltd Report and Accounts 2007 Develop excellence Hiscox has a unique underwriting training As the business grows the leadership challenge is being shared with more and more people. programme developed by very experienced Hiscox underwriters. The training aims to reinforce Hiscox’s underwriting standards and covers: profitable underwriting; learning the lessons of history; and approaching every risk with a restless curiosity. 198 underwriters completed this core training programme during 2007. This includes 81% of underwriters from our new businesses in Bermuda and the US. It is a special focus of Hiscox to develop the right kind of leadership skills using and sharing the wealth of experience that exists in the Group. During 2007, 45 people completed the extraordinary leadership training programme. “During training, it isalways interesting and useful to speak to people from other countries. We learn a lot. I guess it is one of Hiscox’s advantages.” David Viera Special Risks Underwriter Hiscox France Motivate Having attracted and trained the best people we can find, it is then essential to keep them motivated and thriving in their various roles. The Hiscox Partnership One of the motivators to senior people who have contributed significantly to the success of the Group is to be appointed a Hiscox Partner. The Hiscox Partnership is comprised of up to 5% of the total number of staff. The Partnership is informed of all the strategic decisions and facts and figures of the Group, which enables those senior people to influence the direction and performance of the Group. In 2007 nine new partners joined the team. Hiscox staff with more than ten years’ service 11% Hiscox Ltd Report and Accounts 2007 The people at Hiscox 33 33 Insurance carriers Syndicate 33 Hiscox can trace its origins in the Lloyd’s Market to 1901. Today, Hiscox Syndicate 33 is one of the largest composite syndicates at Lloyd’s, and has an A.M. Best syndicate rating of A (Excellent). Syndicate 33 underwrites a mixture of reinsurance, major property and energy business, as well as a range of specialty lines including contingency, technology and media risks among others. The business is mainly property-related short-tail business; there is little exposure to aviation or motor business. Syndicate 33 trades through the Lloyd’s worldwide licences and rating. It also benefits from the Lloyd’s brand. Lloyd’s has an A (Excellent) rating from A.M. Best and A+ (Strong) from Standard & Poor’s. The geographical and currency splits are shown on the right. One of the main advantages of trading through Lloyd’s is the considerably lower capital ratios that are available due to the diversification of business written in Syndicate 33 and in Lloyd’s as a whole. Syndicate 33 has a capital requirement ratio of approximately 50% of Syndicate capacity. The size of the Syndicate is increased or reduced according to the strength of the insurance environment in its main classes. At present, Hiscox owns approximately 72.6% of the Syndicate, with 27.4% being owned by third party Lloyd’s Names. Hiscox receives a fee and a profit commission of approximately 17.5% on the element it does not own. The chart below shows the performance of Syndicate 33 for the last seven years. Syndicate 33 2007 Gross premiums written geographical split (%) 9 % U K 3 % 5 0 % A s i a N o rt h A m e ri c a Rest of world 27% E u r o p e 1 1 % Syndicate 33 Gross premiums written and combined ratio (%) 1,200 1,000 800 722 600 567 400 200 827 844 830 120 1024 994 100 80 60 40 20 0 2001 2002 2003 2004 2005 2006 2007 0 Gross premiums written Combined ratio 34 Insurance carriers Hiscox Ltd Report and Accounts 2007 Panther Re In December 2006, Hiscox announced a market-leading sidecar transaction, which broke new ground within the Lloyd’s Market. Hiscox, in conjunction with WL Ross as lead investor, and Goldman Sachs as financial adviser and lead arranger, created the sidecar, Panther Re, which was the first sidecar in the Lloyd’s market. A ‘sidecar’ is a limited-life insurance company, formed to give its investors access to the insurance market, and its cedants access to capital. The quota share arrangement that Syndicate 33 entered into with Panther Re enabled Syndicate 33 to write more of the favourably rated reinsurance business available during 2007. Panther Re’s sole activity is the quota share arrangement it entered into with Syndicate 33 for 2007, under which it took a 40% pro-rata share of the Syndicate’s property catastrophe reinsurance business. In return Syndicate 33 received a ceding commission and a profit commission. $360 million was raised in conjunction with Goldman Sachs and WL Ross to capitalise Panther Re. Hiscox has no equity interest in Panther Re. Panther Re wrote gross premiums of approximately $160 million in 2007. The sidecar is not controlled by the Group and is not consolidated in the Group’s financial statements. Panther Re and Hiscox Syndicate 33 have agreed that the successful reinsurance partnership between Panther Re and Syndicate 33 covering the 2007 year of account will not be renewed for the 2008 year of account. Cougar Syndicate Cougar Syndicate has been set up for 2008 with a capacity of £34.6 million and is wholly backed by external Names. The Syndicate is taking a pure year account quota share of Syndicate 33’s international property catastrophe reinsurance account under a limited tenancy agreement initially for a one-year period only. Management is provided by Hiscox Syndicates Ltd. Syndicate 33 Capacity and Hiscox ownership (£m) 8 4 2 4 8 5 2 6 4 8 7 8 4 7 8 2 3 8 4 7 7 5 3 6 4 0 6 7 4 5 0 5 5 0 5 5 5 3 0 0 7 8 0 5 1,000 800 600 400 200 1 0 2 4 0 5 0 6 3 1 9 1 7 7 2 0 2001 2002 2003 2004 2005 2006 2007 2008 Capacity Hiscox ownership Qualifying Quota Share 9 % E U R 4 % C A D 1 2 % G B P 75% USD Syndicate 33 2007 Gross premiums written currency split (%) Hiscox Ltd Report and Accounts 2007 Insurance carriers 35 Insurance carriers continued Hiscox Insurance Company Hiscox purchased Hiscox Insurance Company Limited in 1996, in keeping with its aim of diversifying its activities outside of Lloyd’s and writing a focused book of regional specialist risks. The Group has reshaped the Company’s original portfolio to concentrate on high value household and smaller premium professional indemnity business. Hiscox Insurance Company has licences throughout Europe. It is the primary insurance vehicle used by the UK and mainland Europe offices for their business. The success of the reshaped portfolio can be seen in the chart below. Hiscox Insurance Company Limited has achieved average compound growth in gross premiums written of 14.2% from 1997 to 2007, despite discontinuing almost all of its original business. It has also significantly improved its combined ratio. 76% UK Hiscox Insurance Company Limited continues to be rated A- (Excellent) by A.M. Best and A- (Strong) by Standard & Poor’s. At the end of 2007, net assets exceeded £126 million. Hiscox Insurance Company (Guernsey) Formed by Hiscox in 1998, Hiscox Insurance Company (Guernsey) Limited writes mainly kidnap and ransom and fine art insurance. Its gross premiums written since inception are shown in the chart opposite. Hiscox Guernsey has an A-(Excellent) rating from A.M. Best. Hiscox Insurance Company Limited Gross premiums written geographical split by origin (%) 3 % N e t 2 % B e l g i 7 % G e r m h e r l a u m a n n y d s 3 % O t h e r E u r o p e 9 % Fra n c e Hiscox Insurance Company Limited Gross premiums written (£m) and combined ratio (%) 300 250 200 150 100 50 0 23 52 47 43 63 35 121 146 84 43 43 30 1997 1998 1999 2000 2001 2002 Core Non-core Combined ratio 228 233 242 196 284 120 100 80 60 40 20 23 2003 3 2004 2005 2006 2007 0 36 Insurance carriers Hiscox Ltd Report and Accounts 2007 Hiscox Insurance Company (Bermuda) Limited Gross premiums written by class (%) 4 0 % I n t e r n a l Q S C atastro p he 3 4 % Proportional 13% N o n - p r o p o r t i o n a l 1 3 % Hiscox Insurance Company (Bermuda) Formed by Hiscox in late 2005, Hiscox Insurance Company (Bermuda) Limited completed its first full year of business in 2006. Initially capitalised at $500 million, it has access to reinsurance business shown to the growing Bermudian market and has also become a vehicle for intergroup reinsurance. Hiscox Bermuda has an A- (Excellent) rating from A.M. Best. At the end of 2007, net assets were $760.7 million. American Live Stock In July 2007 the Group announced the acquisition of ALTOHA, Inc. an insurance holding company and its subsidiaries American Live Stock Insurance Company, the premier live stock insurer in the US, and Harding & Harding, Inc. the affiliated insurance agency. ALTOHA and its subsidiaries are based in Geneva, Illinois and have 25 staff. American Live Stock Insurance Company is an admitted insurance company with licences in all 50 US states. Its insurance is also available internationally in Australia and South Africa. Its main business is animal mortality insurance for cattle and horses, although farmowners cover is also provided in certain areas. American Live Stock Insurance Company has changed its name to Hiscox Insurance Company Inc. An affiliated agency, Harding & Harding, Inc. has changed its name to American Live Stock Inc. and places all of its business with Hiscox Insurance Company Inc. Hiscox Insurance Company (Guernsey) Limited Gross premiums written ($m) 100 80 60 40 20 0 98 89 79 61 62 66 68 47 38 1999 2000 2001 2002 2003 2004 2005 2006 2007 Hiscox Ltd Report and Accounts 2007 Insurance carriers 37 Managing the Group’s assets Invested assets in the Group grew to £2.05 billion (2006: £1.74 billion). The investment returns, excluding derivative positions, grew by 28% to £100.8 million (2006: £78.5 million) in the last year due in part to an increase in the Group assets as a result of positive cash flows. Investment policy The investment policy is designed to maximise returns within the overall risk appetite of the Group. The overriding philosophy with the Group’s assets is not to lose money or to put at risk the Group’s capacity to underwrite. Hiscox has a policy of focusing on high quality, short duration bonds. This has reduced the impact of market volatility witnessed in the second half of the year. We have negligible direct exposure to sub- prime residential mortgage backed securities, which lie at the root of the current market dislocation and all of which remained AAA rated at 31st December 2007. Despite the market conditions, the collateral underlying the mortgage backed and asset backed securities in our US dollar portfolio continues to perform in line with expectations. Similarly our holdings of corporate bonds have seen spreads widen but we expect to recoup any mark to market losses by holding the bonds to maturity. Indeed, we see good value in certain areas of the corporate bond market and expect to add to our holdings. In the last quarter of 2007 we reduced our equity exposure from 10% of overall funds to 7.8% and that has helped during the weak market in early 2008. Technical funds, the investments held for the payment of future claims, are primarily invested in high quality bonds and cash. The high quality and short duration of these funds allows the Group to meet its aim of paying valid claims quickly. These funds are maintained in the currency of the insurance policy to reduce foreign exchange risk. Due to the short tail nature of the Group’s insurance liabilities, the aim is not to match the duration of the assets and liabilities precisely. Benchmarks are instead set for the fixed income fund managers which approximate the payment profile of the claims as well as providing the managers with some flexibility to enhance returns. A proportion of the Group’s assets are allocated to riskier assets, principally equities. Here, it is the Group’s philosophy to take a long- term view in search of acceptable risk adjusted returns. The proportion of the Group’s funds invested in risk assets will depend on the outlook for investment and underwriting markets. An allocation within the risk assets is made to less volatile, absolute return strategies. This balances the desire to enhance returns against the need to ensure capital is available to support underwriting throughout any downturn in financial markets. 38 Managing the Group’s assets Hiscox Ltd Report and Accounts 2007 Group financial performance The Group achieved a profit before tax of £237.2 million in 2007 (2006: £201.1 million). Earnings per share were 48.4p (2006: 41.7p). The post-tax return on shareholders’ equity was 28.8% (2006: 28.9%). The underwriting performance of each reporting segment is detailed below. The net asset value grew to £824.3 million from £682.1 million driven by profitable contributions from each of the segments. Net asset value per share grew to 209.5p from 173.2p. 28.8% Post-tax return on equity Hiscox Global Markets performance Hiscox Global Markets comprises the results of Syndicate 33, excluding Syndicate 33’s fine art, UK regional events coverage, non-US household business and the underwriting result of Hiscox Inc. It includes the results of the larger retail technology and media (TMT) business written by Hiscox Insurance Company Limited. Gross premiums written decreased by 4.6% on the prior year. The weaker Dollar to Pound Sterling translation rate obscures real underlying growth in gross premiums written activity of approximately 2%. Global Market’s reinsurance outwards costs have grown by approximately £46.2 million. This is attributable to the Panther Re sidecar arrangement which has taken cedings from the Group of approximately £54 million. Net premiums written decreased to £524.7 million from £603.6 million. Investment income increased to £46.6 million (2006: £33.1 million) as continued strong cash generation led to a rise in the average level of assets under management in the Syndicate and interest rates remained at good levels. The strong profit before tax increased to £155.6 million (2006: £90.7 million) following the benign hurricane season experienced this year. The combined ratio fell to 81.7% (2006: 90.1%). Group financial performance Global Markets 2007 UK and Europe 2007 International 2007 Corporate Centre 2007 Total 2007 Global Markets 2006 UK and Europe 2006 International 2006 Corporate Centre 2006 Total 2006 Gross premiums written (£m) 676.4 Net premiums written (£m) 524.7 Net premiums earned (£m) 552.2 Investment result (£m) 46.6 Profit/(loss) before tax (£m) 155.6 Claims ratio (%) Expense ratio (%) Combined ratio (%) 44.3 37.4 81.7 302.3 265.0 248.3 18.4 21.8 45.6 52.6 98.2 220.2 185.2 164.6 23.9 69.1 40.1 35.3 75.4 Financial assets and cash excluding derivative assets (£m) Other assets (£m) Total assets (£m) Net assets (£m) Net asset value per share (p) Net tangible asset value per share (p) Adjusted number of shares in issue (m) – – – 10.8 1,198.9 974.9 965.2 99.7 (9.3) 237.2 – – – 44.0 40.4 84.4 2007 2,050.6 849.7 2,900.3 824.3 209.5 199.3 393.4 709.1 603.6 567.5 33.1 90.7 55.7 34.4 90.1 265.8 234.4 227.8 19.3 33.1 41.3 54.9 96.2 151.3 137.4 93.5 16.4 51.9 17.5 45.2 62.7 – – – 36.7 25.4 – – – 1,126.2 975.4 888.8 105.5 201.1 49.3 39.8 89.1 2006 1,743.1 914.9 2,658.0 682.1 173.2 164.8 393.7 Hiscox Ltd Report and Accounts 2007 Group financial performance 39 Group financial performance continued Hiscox UK and Hiscox Europe Gross premiums written (£m) Net premiums written (£m) Net premiums earned (£m) Investment result (£m) Profit before tax (£m) Claims ratio (%) Expense ratio (%) Combined ratio (%) Hiscox UK performance Hiscox UK comprises business written by Hiscox Insurance Company Limited in the UK and Ireland. It also includes the results of Syndicate 33’s fine art, UK regional events coverage and non-US household business, together with income and expenses arising from the Group’s retail agency activities in the UK. It excludes the results of the larger retail TMT business written by Hiscox Insurance Company Limited and the Irish surety business. Gross premiums written increased by 10.7% due to increased income from all core lines of business, especially in the direct business and professional and specialty commercial lines. Net premiums written increased by 10.9% from £182.8 million to £202.8 million. Investment income remained steady at £15.9 million (2006: £15.4 million). Exposure to equity holdings has weighed slightly on relative performance this year versus last. Profit before tax of £17.2 million (2006: £32.4 million) was lower than the prior period following the additional marketing and growth related expenses and also due to losses from Windstorm Kyrill and the UK floods. The net claims ratio increased to 45.5% (2006: 39.0%). The June and July floods, although well covered by low-level reinsurance coverages, still cost the business approximately £7.5 million net. The expense ratio increased to 53.3% (2006: 53.0%) in part due to increased marketing costs. The combined ratio increased to 98.8% (2006: 92.0%) due mainly to the effects of the UK floods. UK 2007 229.2 202.8 190.3 15.9 17.2 45.5 53.3 98.8 Europe 2007 73.1 62.2 58.0 2.5 4.6 45.2 51.0 96.2 Total 2007 302.3 265.0 248.3 18.4 21.8 45.6 52.6 98.2 UK 2006 207.1 182.8 178.3 15.4 32.4 39.0 53.0 92.0 Europe 2006 58.7 51.6 49.5 3.9 0.7 50.2 56.4 106.6 Total 2006 265.8 234.4 227.8 19.3 33.1 41.3 54.9 96.2 Hiscox Europe performance Hiscox Europe comprises business written in mainland Europe by Hiscox Insurance Company Limited and the Irish surety business. It also includes the results of Syndicate 33’s European fine art, European regional events coverage and European household business, together with the income and expenses arising from the Group’s retail agency activities in Continental Europe. Europe’s gross premiums written has grown by 24.5% as a result of good underlying growth in all established European territories, most notably Holland and France, together with an increase in activity though emergent offices in Portugal, Sweden and Spain. A focus on specialty commercial and TMT business is beginning to augment renewals of the traditional household accounts. Net premiums written increased by 20.5% from £51.6 million to £62.2 million. Investment income has reduced to £2.5 million (2006: £3.9 million) due a change in the Group investments attributed to the European division. The Irish surety business continued its excellent performance in the year. Profit before tax increased to £4.6 million (2006: £0.7 million) following moderate net losses but including an exchange gain. Europe’s net claims ratio of 45.2% represents a 5% improvement on the prior year despite moderate net losses early in the year from Windstorm Kyrill (estimated at approx. £1.5 million) together with a number of medium sized losses during the first half, particularly in the Netherlands and Germany. The expense ratio decreased to 51.0% (2006: 56.4%). The combined ratio improved to 96.2% (2006: 106.6%), primarily driven by favourable loss ratios in France and the Netherlands as well as in the new areas of European development. 40 Group financial performance Hiscox Ltd Report and Accounts 2007 Hiscox International performance International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Insurance Company (Bermuda) Limited, Hiscox Inc. and Hiscox Insurance Company Inc. Bermuda gross premiums written increased by 45.5% to £220.2 million from £151.3 million. Bermuda grew gross premiums written so as to benefit from the strong underwriting rates on external catastrophe exposed business. Bermuda gross premiums written growth of approximately 60% was achieved despite the adverse foreign exchange effects of the weaker US Dollar. The US division has grown its gross premiums written by approximately 130% on the prior year. Underlying organic growth of approximately 90% (in translated Pound Sterling terms) has been augmented with approximately £2.9 million of new premiums contributed by the acquired Hiscox Insurance Company Inc. business. Net premiums written increased by 34.8% to £185.2 million, driven by growth in gross premiums written. Investment income increased to £23.9 million (2006: £16.4 million). The Bermuda investment income surpassed the 2006 level as continued strong cash generation led a rise in the average level of assets under management and US interest rates remained high. Profit before tax increased to £69.1million (2006: £51.9 million) with strong profits from Hiscox Bermuda and Guernsey due to a favourable claims and rating environment. The claims ratio was 40.1% (2006: 17.5%) following a benign hurricane season. The expense ratio improved to 35.3% (2006: 45.2%). A number of one-off set-up costs were incurred in the prior year. The combined ratio increased to 75.4% from 62.7%. Hiscox Corporate Centre performance Corporate Centre comprises the investment return and administration costs associated with the Company and other Group management activities. These non-underwriting entities capture the majority of the Group’s funding costs. Underlying investment income decreased to £10.8 million (2006: £36.7 million), mainly due to a one-off derivative gain of £27 million in 2006. Finance costs decreased to £8.1 million (2006: £9.1 million) due a 9% average weakening in the US dollar exchange rate in 2007 plus $26 million higher borrowings for the first seven months of 2006. The change in average interest rates during the year was mildly negative. Loss before tax was £9.3 million (2006 profit: £25.4 million). Group investment performance The investment return benefited from the increase in funds under management together with higher interest rates, though the rates in Europe remained relatively low. Bond portfolios in all currencies had short durations to protect the underlying assets against the changing interest rates in the US and UK. The Group’s equity weighting was increased to 10% in the early part of the year, with a defensive and more globally diversified portfolio which included some absolute return funds. The equity weighting was reduced to 8% in the last quarter of 2007. Group investment performance Bonds £ US$ Other Bonds total Equities Deposits and cash equivalents Total return Group invested assets 31 December 2007 31 December 2006 Asset allocation % Return % Return £000 Asset allocation % 10.1 50.6 9.7 70.4 7.8 21.8 17.7 31.7 10.5 59.9 8.1 32.0 5.5 5.8 3.7 5.5 4.1 5.4 5.4 70,688 6,959 23,140 100,787 £2,050.6m Return % 4.0 4.4 2.2 4.0 Return £000 42,095 10.6 13,517 4.6 4.6 22,904 78,516 £1,743.1m Hiscox Ltd Report and Accounts 2007 Group financial performance 41 Cash flow and liquidity The Group’s cash flows originate from multiple sources. Core cash inflows include insurance premium remittances, which are typically received from policyholders in advance of providing risk coverage, losses recovered from reinsurance partners and net investment returns. After allowing for the payment of acquisition costs and other short-term expense requirements, surplus cash balances arising are invested in an optimal mix of assets, concentrated mainly on high quality debt and fixed income securities of short duration. In general, the investment portfolio produces relatively steady cash returns during periods of interest rate stability. Where interest rates are lower for sustained periods, investment income typically reduces, as the proceeds from higher-yielding securities are reinvested in securities offering coupon payments at lower prevailing market rates. However, it is still possible to realise a partial cash flow benefit in a low interest rate environment, since the underlying market value of the investments tends to increase, leading to higher realised cash gains from their eventual sale. Other cash inflows result from the sale and redemption of investments, investment management fees and underwriting agency commissions. Aside from investing activities and the payment of acquisition and operating costs, the Group’s principal cash requirements are primarily for the settlement of insurance claims, to pay for reinsurance cover, to settle fiscal tax liabilities, to service and reduce borrowings and to distribute dividends to shareholders. The Group’s cash flow is impacted to a large extent by the results of Syndicate 33. Until 2005, the Group had in general only received cash from the Syndicate following the closure of a year of account at the end of three years, except when Lloyd’s allowed early profit distributions subject to solvency requirements. However, from 2006 onwards, syndicate cash distribution has been determined on a one- year accounting basis, although still subject to solvency requirements. Cash flows for 2007 Cash flows from operating activities A net cash outflow arose from operations during the year of £162.7 million (2006: inflow of £157.4 million) principally as a result of the Group making a net cash investment of £489.7 million (2006: £1.3 million disinvestment) into holdings of slightly longer dated financial assets that do not qualify for presentation as cash equivalents. The underlying positive cash conversion from operations of £327 million (2006: £156.1 million) was strong once again. The £170.9 million improvement on the prior year reflects the profitable growth in gross underwriting activity together with good collections of outstanding amounts from reinsurance partners. In addition, substantial payouts were made in the prior year in relation to large hurricane related catastrophe losses suffered in 2005. Investment revenue receipts excluding derivative transactions increased by over 28% or almost £20 million on the prior year to £90.2 million, partially as a result of the larger portfolio generated from the growth in premiums collected and higher shareholder funds and also due to higher interest rates prevailing for much of the current year under review. Interest payments of £8.2 million (2006: £9.4 million) were made during the year in respect of the Group’s US$182 million borrowings and assets held under finance leases. The reduction on the prior year is mainly attributable to the relative weakness in the US Dollar exchange rate during 2006 and $26 million of principal repayments being made in July 2006. Current tax payments increased to £42.8 million (2006: £36.4 million) mainly in anticipation of the higher attributable UK based profits falling due to be taxed and paid. £327m positive cash conversion from operations 28% increase in investment revenue receipts 42 Cash flow and liquidity Hiscox Ltd Report and Accounts 2007 Relationship between cash flow statement and income statement The Group’s premium income can only be earned as the risk coverage period to which it relates elapses. Consequently whilst the cash flow statement reports on actual funds received in the year from premiums written, the income statement is influenced by the exclusion of newer premium inflows relating to future risk coverage periods. Likewise much of the cash outflows made during 2007 relate to claim liabilities recognised in prior income statements. Liquidity of debt and fixed income securities The availability of funds at short notice is a prerequisite for any insurance business with short tail exposure to catastrophic events. The Group retains a deliberate level of debt and fixed income securities in instruments with imminent maturity dates which can be liquidated rapidly for cash as required. Notwithstanding the contractual maturity profile of these securities, the Group is able to realise cash from its investment portfolios in a reasonable manner as and when required. Cash flows from investing activities 2007 was a year of significant investment activities involving cash outflows. In July the Group announced the acquisition of the ALTOHA Inc. Group in the USA which involved a net outflow of cash of £11.1 million. The Group also experienced a net cash outflow of £0.9 million on the disposal of Hiscox Investment Management Limited in December. Three new associate companies were purchased during the year which required net cash payments of £1.3 million. Capital expenditure on fixed assets grew by £2.3 million to £7.8 million reflecting the start of a major IT transformation project in the Group. £2.5 million cash was also spent acquiring intangible customer relationship assets during the year (2006: £0.3 million). Cash flows from financing activities The net cash outflow from financing activities rose by £8.6 million to £50 million, primarily due to an additional £13 million of dividends and £11.3 million in respect of shared buy-backs offset by £14 million of debt repayment in 2006. £54.9 million (2006: £30.4 million) was returned to shareholders during 2007 comprising dividend payments of £43.6 million (2006: £30.4 million) and share repurchases of £11.3 million. £5.2 million (2006: £3.2 million) cash was received in respect of share options exercised during the year. £0.3 million (2006: £0.1 million) was paid in respect of finance lease obligations during the year. None of the Group’s borrowings fell due for repayment during 2007 (2006: net payment of £14.2 million). It is management’s intention that net debt will be reduced by approximately £50 million during 2008 excluding letters of credit. Investment income generated on the proceeds of borrowings largely offsets the interest obligations. However, such interest income is reported separately with operating activities in the cash flow statement. £489.7m net cash investment into financial assets £54.9m cash returned to shareholders Hiscox Ltd Report and Accounts 2007 Cash flow and liquidity 4343 Risk management Risk management framework The risk management framework extends to all aspects of risk including insurance risk, market risk, credit risk, operational risk, liquidity, social, environmental and ethical risk. The core business of Hiscox is dealing with risk. The understanding of risk is intrinsic to every level of decision-making in the Group. The risks associated with the core business represent some of the greater exposures, however the Group is exposed to a number of other risks and has developed systems and procedures to identify and manage them. Risk appetite is set by the main Board and cascaded down into the Group’s operations through management and specialist committees. These latter committees have terms of reference that assign specific areas of focus, and oversee activities such as underwriting, loss modelling, reinsurance purchase and security, broker credit risk, investments, claims reserving and business continuity. Senior management responsibilities are clearly identified together with their reporting lines and the execution of delegated responsibility is closely monitored by reporting to the Board and its committees. This monitoring, supported by financial and non-financial management information, covers performance against agreed targets and objectives, as well as the risks to achieving these objectives and the effectiveness of the measures in place to manage these risks. In parallel with these direct risk management processes, there is a dedicated risk management function which, in conjunction with Internal Audit, monitors and reviews the effectiveness of risk management throughout the organisation and reports to the Board. These functions are organised centrally to assist in the integration of best practice throughout the Group. Risk management tools allow individual Group businesses to assess their own risks locally whilst feeding into weighted global reports at Group level. Major risks The major risks that the Group faces are presented below. A number of these factors are common to all insurance businesses, while others are relevant to Hiscox specifically. For a discussion of the major risks and uncertainties impacting the Group’s financial statements, see note 3 to the financial statements. Catastrophe and systemic insurance losses Like other insurers,the Group’s earningscanbe affectedby unpredictable events and circumstances. These may include, but are not limited to, conditions such as natural and other catastrophes,legal developments, social change and the emergence of latent risks. Such events could create significant levels of losses if the Group’s underwriting models, aggregation tools and policy wordings do not prevent unplanned concentrations of risk, both in geographical regions and types of policy. The failure to manage concentrations of exposure is therefore the single greatest risk to Hiscox. The Group continues to underwrite significant risks in geographical regions that are prone to natural peril. This business remains a compelling proposition for the Group, since it is capable of returning impressive margins over the medium- to long-term as the occurrence of catastrophes averages out. The portfolio of risks is actively managed to maintain a balanced and diversified book. This is supported by the use of exposure aggregation and scenario modelling tools and by the purchase of a reinsurance programme designed to cap losses from concentrations of risks. Policy wordings are reviewed regularly in the light of legal developments to ensure that the Group’s exposure is restricted, where possible, to those risks identified at the time of policy issuance. The modelling and monitoring tools are used both in the underwriting process and by independent risk specialists. They are used to design the insurance and reinsurance programmes and control the business underwritten to ensure that the risk profiles of contracts match the exposures for which the programmes were devised. Aggregation and modelling resources are shared across the Group. Management at Hiscox insurance subsidiaries worldwide are therefore The core business of Hiscox is dealing with risk. The understanding of risk is intrinsic to every level of decision- making in the Group. able to adopt the Group’s existing methodologies and models, albeit tailored to the intricacies of that particular market. Hiscox also runs realistic disaster scenario projections for each Group entity and for the Group as a whole. The Group’s maximum net retentions based on the estimated losses from these scenarios are outlined in note 3.1 to the financial statements. The Group’s performance relative to the unprecedented impact of catastrophes on the industry in recent years highlights the ability of its models to suggest precise and logical reinsurance placements. It also shows the distinctive benefits that Hiscox derives from its diversification in coverage and geography. By writing a well-diversified book with a large focus on uncorrelated retail business, Hiscox is able to offset losses on its more volatile accounts. Competition and the insurance cycle Hiscox is continuing to grow its regional presence in the UK, Europe and USA. In all of these markets around the world, Hiscox competes against major international groups with very similar offerings. At times, a minority of these groups may choose to underwrite for cash flow or market share purposes and at prices that sometimes fall short of the suggested break-even technical price. By its nature, this business requires that underwriting staff exercise the greatest possible levels of foresight. The Group has developed robust risk management and mitigation techniques in preparation for the challenges that these risks present. These techniques are designed to shield the core capital base of the Group against unexpected, repeat clusters of all but the most destructive of events. The Group is firm in its resolve to reject business that is unlikely to generate underwriting profits. Accepting insurance risk below the technical price is detrimental to the industry’s prospects, since it drives the prevailing rates in the market lower to the point where business failures occur, insurers’ capital is destroyed, customers receive sub-optimal service and the industry suffers from negative 44 Risk management Hiscox Ltd Report and Accounts 2007 publicity. As capacity levels in the market fall, prices inevitably rise until the point where the cycle of irrational pricing may begin again. In common with all insurers, the Group is exposed to this price volatility. Prolonged periods of low premium rating levels or high levels of competition in the insurance markets are likely to have a negative impact on the Group’s financial performance. Pricing levels are monitored on a continuous basis with monthly reports showing both current levels and trends over the past 12 months throughout a wide range of products. To counter this, Hiscox alters its appetite for the lines of business and the layers it writes within them in response to market conditions and the risk appetite of the Group. The Group’s cycle management strategy and related modelling and monitoring are essential to ensure that it controls any accumulating adverse effects of changes. Hiscox is continuing to grow its regional presence in the UK, Europe and USA. As the Group frequently acts as the lead insurer in the complex co-insurance programmes required to cover significant high value assets, it has some ability to set market rates rather than follow them. Mutualisation is a related risk arising from the phenomenon of pricing cycles in the industry. The Group is required to contribute towards obligations of other insurers who fail. Syndicate 33 contributes to the New Central Fund operated by the Council of Lloyd’s, and in the UK certain Hiscox entities contribute to the Financial Services Compensation Scheme (FSCS). Should the level of failures escalate, the Group could be subject to additional or special levies by Lloyd’s and/or the FSCS. The Group participates in many industry bodies, associations and task-force initiatives in order to monitor developments and influence their strategic direction. In particular, the involvement of the Group’s executives in the reshaping of the Lloyd’s market underscores that commitment. Other business areas where the Group is to some extent reliant on the timely and effective supply of services from third parties include back office policy processing, data entry and cash collection. Although the Group manages these relationships to ensure continuity and quality of service, events could occur beyond its control that could affect these third parties and in turn impact on the Group’s performance. The Group selects its agents and business partners carefully. Significant areas of outsourcing undergo a rigorous tendering process, where numerous attributes other than just price competitiveness are given due consideration. All third parties operate within the terms of formal service level agreements, with repercussions for underperformance. Credit risk with reinsurance counterparties The Group purchases reinsurance protection to contain its exposure to single claims and the aggregation of claims from catastrophic events. The Group places reinsurance with companies that it believes are strong financially and operationally. The limits on reinsurance counterparty risk are recommended by the Reinsurance Security Committee, which meets regularly under the chairmanship of the Group Finance Director. Evaluation criteria include financial strength, trading record, payment history, outlook and organisational structures. Information is drawn from the following sources: public information produced by the company; the Group’s experience with the reinsurer and knowledge of their behaviour in the marketplace; analysis from a reinsurance consultant; rating agency commentary and gradings. Sidecars have continued to be popular vehicles for acquiring additional capacity. These are reinsurance companies which participate in the business of another insurer, but which are separately capitalised or offer security or both. These companies may offer very high levels of reinsurance but are often vehicles of only a limited and very short-term duration and their attractiveness is highly dependent upon the amount and quality of collateralisation offered. Some reinsurance transactions have been entered into with these vehicles but each has been individually approved. There remains a risk that in the event of this shorter-term capacity being withdrawn following large losses it may be more difficult to replace in the conventional market. During the year the Group was the sole client of Panther Re, a Bermudian reinsurer that takes a 40% share of certain property catastrophe reinsurance lines written by Syndicate 33. This arrangement was not renewed for 2008 and was in part replaced by the new Cougar Syndicate. The Group’s experience of bad debt losses arising from its reinsurance arrangements has been minimal. Claims volatility The Group establishes provisions for unpaid claims, defence costs and related expenses to cover its ultimate liability in respect of both reported claims and incurred but not reported (IBNR) claims. These provisions take into account both the Group’s and the industry’s experience of similar business, historical trends in reserving patterns, loss payments and pending levels of unpaid claims and awards. Binding authorities and other outsourcing Hiscox writes a considerable amount of premium income through agents to whom binding authority is given to accept risks on behalf of Hiscox Group insurance vehicles. Binder management exists as a separate discipline outside of the underwriting process at Hiscox. All delegations are strictly controlled through tight underwriting guidelines and limits and extensive vetting, monitoring, and auditing of the agencies. However, as there is no absolute guarantee that an agent will comply with the terms of its authority, Hiscox could be exposed to unanticipated losses. Reserve estimates are subject to regular reviews. Adjustments are made to take into account management’s latest view of the probable ultimate liability, based on claims and other developments and new data. Yet there can be no absolute guarantee that the ultimate losses will not differ materially from the provisions the Group has established. It is particularly difficult to estimate IBNR claims and those arising from large catastrophes. Note 24 to the financial statements provides information on the Group’s estimation of ultimate claim costs over recent years. Additional information is provided in note 3 to the financial statements. Hiscox Ltd Report and Accounts 2007 Risk management 45 Risk management continued Business continuity It is critical for Hiscox that the key resources required to support insurance underwriting and other essential business activities continue to be available. The Group has taken significant steps to mitigate the impact of business interruptions that may result from a variety of events, including the loss of key individuals and facilities such as premises, computer networks and communications. The Group’s business could be affected adversely if staff were to be prevented from using its major premises for any reason. The Group’s staff are widely distributed with offices around the UK, Europe, USA, Bermuda and Guernsey. This geographical dispersion reduces the Group’s exposure to natural, operationaland terrorist events that could prevent access to its premises. The business also relies on IT and telecommunications systems. Whilst the Group considers its systems to be resilient, their failure or impairment, or the inability to transfer data onto any new systems introduced, could cause a loss of business and/or damage to the reputation of the Hiscox Group, as well as remedial costs. The most difficult continuity risk for Hiscox to manage is the loss of key staff. The recruitment and retention of high quality people is of fundamental importance to Hiscox and the Group takes the risk of losing such assets very seriously. To maintain the loyalty of staff, the Group provides competitive remuneration packages and benefits as well as extensive training and support and a unique culture that embraces the individual and their aspirations. More information about Hiscox’s investment in its people can be found on pages 30 to 33. In the event that key staff do leave, the Group’s contingency plans ensure continuity of service both internally and to policyholders. These include cross-training and rotation of duties to ensure that staff can perform multiple roles. Most staff work in teams rather than in isolation, which lessens the impact of normal staff turnover on the business. Hiscox has a formal disaster recovery plan that addresses its premises and technology related risks. Robust contingency strategies are in place for both workspace recovery and back-up of data centres and communications. In the event of an outage,these procedures will enable the Group to move operations to alternative facilities within very short periods of time. The alternative facilities are supplied by separate localised utility grids and telecommunications carriers. The disaster recovery plan is tested regularly and the Group also performs disaster simulations. Currency fluctuations The US Dollar is the Group’s largest underwriting currency. A significant proportion of the Group’s US Dollar insurance liabilities are supported by investments held in the same currency. However, as a significant proportion of the Group’s operational cost base is located in the UK and Europe, movements in foreign exchange rates may have a material adverse effect on its financial performance and position. Further details of the Group’s investment profile and its management of currency risks are provided in notes 3, 18 and 20 to the financial statements. Investment returns The Group’s entities hold significant portfolios of investments to support their obligations, including their insurance liabilities, and their profits depend in part upon the returns that these achieve. Changes in interest rates, equity returns and other economic variables can therefore affect the Group’s financial performance substantially. A fall in the capital value of their investments could result in a reduction in the level of business that each entity is able to underwrite. In addition, a major insurance loss or unexpected sequence of attritional losses could result in a sustained cash outflow that might require the early realisation of investments on unfavourable terms. The Group’s investment strategy seeks to minimise the concentration of investment risk in any one particular sector. Regulation The Group’s entities are incorporated and transact business in a variety of countries and states, all of which require strong levels of accountability to the local regulatory authorities. The various Hiscox businesses operating in the UK are subject to high levels of regulation from the FSA and the Council of Lloyd’s. The numerous regulatory bodies that oversee the Group’s international operations include the Guernsey Financial Services Commission, the Bermuda Monetary Authority and individual state insurance departments in the USA. These bodies all have significant powers of intervention including the ultimate sanction of removing the authorisation to carry on insurance business. Robust contingency strategies are in place for both workspace recovery and back up of data centres and communications. Regulatory action could affect the Group’s results and position in numerous ways. For example, it could be required to allocate inefficient levels of capital around the Group in order to overcome minimum regulatory hurdles, or bear the costs of implementing new compliance or sophisticated computer modelling systems. Continual changes in, or inappropriate levels of, regulation in the Group’s markets could also result in their becoming uncompetitive or unattractive to customers, which might lead them to place their insurance business in alternative markets in which the Group has no presence. Hiscox devotes considerable resources throughout the Group to meet its regulatory obligations. The senior management of each Hiscox business maintains constructive, productive and valuable relationships with all of the regulatory bodies in their respective territories. Furthermore, the Group debates all current regulatory issues and encourages the development of new initiatives in areas such as risk management and reporting that will help safeguard the future of the industry. Rating agencies The ability of the Group’s insurance operations to write certain classes of business, including reinsurance, may be affected by a change in the financial strength or credit rating issued by an accredited rating agency such as A.M. Best, Moody’s or Standard & Poor’s. 46 Risk management Hiscox Ltd Report and Accounts 2007 Syndicate 33 has its own rating and also benefits from the Lloyd’s global rating. The Lloyd’s rating could be affected by matters outside of the Group’s influence or control. Hiscox Insurance Company Limited, Hiscox Insurance Company (Guernsey) Limited and Hiscox Insurance Company (Bermuda) Limited have their own ratings from accredited agencies. A downgrading of any of the rated entities could have a material adverse impact. The Group might cease to meet the security criteria of brokers, resulting in a loss of new business, policy cancellations and non-renewals. The Group’s borrowing facilities might also be subject to review. The Group maintains an excellent relationship with the agencies that rate its entities. The Group’s investment strategy seeks to minimise the concentration of investment risk in any one particular sector. Group senior management holds several meetings with representatives from the agencies each year and gives due consideration to the likelihood of rating consequences before executing any significant strategic action. Hiscox Ltd Report and Accounts 2007 Risk management 47 Corporate responsibility Fundamental to corporate and social responsibility is honest and fair dealing in all activities of the Company. Hiscox has alwaysbeenextremelyconsciousofitsreputation. Management has always believed that a reputation for integrity and decent behaviour in all dealings, be they within the Group or with those from outside who come in contact with the Group, will be good for morale and for the results of the business. Communication and participation Employees are kept informed of business developments through formal briefings, team meetings, intranet bulletins, video conferences and informal routes. Management takes these opportunities to listen to staff and involve them in taking the business forward. A monthly staff e-zine provides updates on issues and social events. Robert Hiscox Hiscox’s commitment to responsible business practices is reflected: In the marketplace Dealing with customers Hiscox UK is dedicated to advising customers on risk management to prevent burglary and fire in the home and other distressing losses. Should a loss occur, the Hiscox UK philosophy is that insurance is a promise to pay, and the claims service aims to support customers and make them whole as soon as possible. For more information about Claims at Hiscox see pages 22 to 25. Dealing with business partners Insurance brokers are an important Hiscox stakeholder, and Hiscox endeavours to have good relationships with them to create a competitive advantage in the marketplace. Clear communication is key to good relations and a quarterly Hiscox broker magazine keeps brokers informed of developments at Hiscox and in the insurance industry. Dealing with investors In keeping with its policy of open and transparent communication, Hiscox reports both its half and full year results to its investors via a series of presentations as well as ensuring all relevant Group financial information is available from its website. In addition, senior management and key performers meet investors and analysts to explain and take questions on the Group financial performance and business strategy. In the workplace Hiscox wants to employ the best people and provide them with the means and the motivation to excel. This is achieved with fair rewards and by providing staff with an environment in which they can enjoy their work and reach their full potential. Hiscox recognises how important it is for employees to maintain a healthy work/life balance and gives staff the option of flexible and home working wherever possible. Equal opportunities Hiscox is committed to providing equal opportunities to all employees and potential employees in all aspects of employment regardless of disability, sex, race, religion, sexual inclination or background. Rewards and benefits Hiscox encourages employees to identify with the success of the Group through performance-related pay and bonus schemes, savings- related share option schemes and executive share option schemes. Competitive benefits packages contain health, fitness, flexible working and career break opportunities. Salary packages are benchmarked by Watson Wyatt against the financial services industry as a whole and against the Lloyd’s market specifically, where applicable. Training and development Hiscox is committed to training and developing its employees to help them maximise their potential. Each permanent member of staff is provided with a tailored personal development programme. Training and development needs are reviewed twice a year, along with performance, against clearly set objectives. Culture The Hiscox culture is underpinned by a set of core values that determine the standard of behaviour expected of employees. These core values – challenge convention, integrity, respect, courage, quality and excellence in execution – guide everything that Hiscox does in its business. By conducting its business with these core values in mind, the Group recognises that it is more likely to achieve business success and create value for its shareholders. Hiscox strives for the highest standards of corporate governance while being in essence a non-bureaucratic organisation. An effective and firm system of internal controls ensures that risks are managed within acceptable limits, but not at the expense of innovation or speed of response. The Group believes that it has got this balance right and that it is one of its greatest strengths. The Group’s policies ensure that it continues to follow a best practice approach to managing its people and remains a fair and professional employer. In the unlikely event of an employee having a material concern relating to the operations of the business, a whistleblowing policy explains to staff how they can confidentially raise their misgivings. Hiscox also subscribes to Public Concern at Work, which provides free legal advice to any employee with a concern about possible danger or malpractice in the workplace. In the community In total, Hiscox donated £616,572 to charities in 2007. As the Group expands throughout the world, it aims to recruit local staff wherever possible to help develop a rapport with the local community and make a direct contribution to the local economy. The Group has maintained its involvement in its local communities with the strong support of its employees. In Bermuda, Hiscox supports the Bermuda Sunshine League which is a transitional living facility for children removed from unstable living environments and gives employees the opportunity to contribute their time and effort to children who require adult role models and a semblance of stability. Hiscox is a member of the Lloyd’s Community programme, which supports local initiatives concerning education, training, enterprise and regeneration. In London for example, the Reading Partners scheme has continued, through which staff assist pupils at the Elizabeth Selby Infants School in Tower Hamlets. Employees also mentor students at Morpeth School in Tower Hamlets. Supporting the arts The Group continues to support the Bermuda Masterworks Foundation, which aims to repatriate artworks by Bermudian artists or featuring Bermuda landscapes/seascapes. Hiscox Art Projects, a contemporary exhibition space situated in the London office with free entry to the public, continues to provide artists with an opportunity to exhibit their talents. The Hiscox Foundation The Hiscox Foundation, a charity funded by an annual donation from Hiscox, has been set up to give donations to deserving causes. It gives priority to any charity in which a member of staff is involved with the aim of encouraging and developing such activity. Hiscox staff also continued their six year long support of the Richard House Hospice, raising over £30,000 through various initiatives during 2007. One such initiative was the Ardéche challenge, where 24 people took part in a canoe race through the Ardéche Gorge 48 Corporate responsibility Hiscox Ltd Report and Accounts 2007 in South Eastern France raising over £12,000 for the charity. Money was also raised through book sales and a Christmas raffle. In the environment The way customers conduct their business is of paramount importance to the Group. Hiscox’s approach to underwriting their risks will take into account customers’ attitudes to all aspects of their business, including care of the environment. As part of its approach, Hiscox has joined Climatewise, an insurance industry initiative which aims to reduce the economy’s and society’s long-term risk from climate change. Hiscox is developing a strategy to support the principles of Climatewise and is encouraged by the actions taken by Lloyd’s to assist the market to meet the majority of the principles. The Group’s direct environmental impact is mainly from the energy it uses and the emissions and waste it generates from its premises. In accordance with the Group’s Environmental Policy, consumables are recycled and reused wherever possible. The Group is taking steps to reduce the amount of raw materials used in business processes and by staff, particularly through the extensive use of computerisation and communications technology. During 2007, Hiscox upgraded its IT data centre and reduced the number of servers required by the Group. Programmes for recycling batteries, mobile phones, lamps and CDs continued during the year. A Hiscox representative attends meetings organised by the City of London Corporation to keep abreast of environmental best practice and exchange ideas with other like-minded companies. Hiscox Ltd Report and Accounts 2007 Corporate responsibility 49 Board of Directors Executive Directors Robert Ralph Scrymgeour Hiscox Chairman (Aged 65) Robert Hiscox joined Hiscox in1965 and has been Chairman of the main holding company of Hiscox since its incorporation in 1973. He was Deputy Chairman of Lloyd’s between 1993 and 1995. He is a Non Executive Director of Grainger Trust plc. Bronislaw Edmund Masojada Chief Executive (Aged 46) Bronek Masojada joined Hiscox in 1993. From 1989 to 1993 he was employed by McKinsey and Co. Bronek served as a Deputy Chairman of Lloyd’s from 2001 to 2007 and as Chairman of the Lloyd’s Underwriting Agents Association from 1998 to 2001. He was a Non Executive Director of Ins-sure Holdings Limited from 2002 to 2006 and is a past president of The Insurance Institute of London. He is Chairman of the Lloyd's Tercentenary Foundation, a charity which supports research in areas of interest to the insurance industry. Stuart John Bridges Group Finance Director (Aged 47) Stuart Bridges joined Hiscox in 1999. He is a chartered accountant and has held posts in various financial service companies in the UK and US, including Henderson Global Investors. He was a member of the Financial Reporting Council’s review group on The Turnbull Guidance on Internal Control. Robert Simon Childs Chief Underwriting Officer Chief Executive Officer of Hiscox Bermuda and Chairman of Hiscox USA (Aged 56) Robert Childs joined Hiscox in1986, served as the Active Underwriter of the Hiscox Lloyd’s Syndicate 33 between 1993 and 2005, and is the Group’s Chief Underwriting Officer. Robert was Chairman of the Lloyd’s Market Association from January 2003 to May 2005. Independent Non Executive Directors Carol Franklin Engler Non Executive Director (Aged 56) Carol Franklin Engler joined Hiscox in1999. She is the Ombudsman for the Swiss telecommunication industry and the Executive Chairman of Forests for Friends Ltd and The Tree Partner Company in Switzerland. Carol was the Chief Executive Officer of the World Wide Fund for Nature in Switzerland from 1999 to 2002. From 1979 to 1999 she was employed by Swiss Re in a variety of roles including Head of the Aviation Department and Head of Human Resources. Board of Directors Hiscox Ltd Report and Accounts 2007 Secretary Robin Mehta Registered office Wessex House 45 Reid Street Hamilton HM 12 Bermuda Registered number 38877 Auditors KPMG Crown House 4 Par-la-Ville Road Hamilton HM 08 Bermuda Solicitors Appleby Hunter Bailhache Canon’s Court 22 Victoria Street PO Box HM 1179 Hamilton HMEX Bermuda Bankers Bank of Bermuda – HSBC 6 Front Street Hamilton HM 11 Bermuda Stockbrokers UBS Limited 1 Finsbury Avenue London EC2M 2PP Registrars Capita Registrars (Jersey) Limited PO Box 532 St Helier Jersey JE4 5UW Member of the Audit Committee Member of the Conflict Committee Member of the Remuneration and Nomination Committee Chairman of Committee is highlighted in solid Independent Non Executive Directors continued Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 65) Daniel Healy joined Hiscox in 2006. He was appointed Executive Vice President and Chief Financial Officer of North Fork Bancorporation in 1992 and a member of its Board of Directors in 2000. He was a partner with KPMG LLP before joining North Fork. He was the Managing Partner of the San José, California and Long Island, New York offices and held other positions in that firm during his tenure. He holds Board positions with KBW, Inc. and Harlem RBI, a not for profit organisation. He is also a senior adviser to Permira Advisers LLC an international private equity firm. Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 69) Dr James King joined Hiscox in 2006. He chairs Keytech Limited, The Bermuda Telephone Company Ltd, the Argus Group of Companies, Grotto Bay Properties Ltd and the Establishment Investment Trust, a UK listed company. He was chairman of the Bank of N.T. Butterfield & Son Limited until 19 April 2007. He is a Trustee of the Bermuda Institute of Ocean Sciences and a Director of Castle Harbour Limited. Dr King is a fellow of the Royal College of Surgeons, Canada and the American College of Surgeons. Sir Mervyn Pedelty Senior Independent Director and Chairman of the Remuneration and Nomination Committee (Aged 59) Sir Mervyn Pedelty joined Hiscox in 2005. He was previously the Chief Executive and an Executive Director of The Co-operative Bank plc (from 1997 until his retirement in 2004) and also of Co-operative Financial Services Limited and the Co-operative Insurance Society Limited (from 2002 to 2004). He was a Director of the Association of British Insurers (from 2002 to 2004) and is a former Council Member of the British Bankers’ Association. Sir Mervyn is a Chartered Accountant and a Chartered Banker. His other current appointments include: independent Director of Friends Provident plc, Chairman of the FTSE4 Good Policy Committee, a Director of Performances Birmingham Limited and a Senior Adviser to Permira Advisers LLP. Andrea Sarah Rosen Non Executive Director (Aged 53) Andrea Rosen joined Hiscox in 2006. She was appointed as a Director of Alberta Investment Management Corporation in October 2007 and is a Director of Emera Inc. She was previously Vice Chair of TD Financial Group and President of the TD Canada Trust from 2002 to 2005. Prior to this she held various positions within the TD Financial Group from 1994 to 2002, including Executive Vice President of TD Commercial Banking and Vice Chair of TD Securities. She was Vice President of Varity Corporation from 1991 to 1994 and held various positions with Wood Gundy Inc. from 1981 to 1990. Dirk Arie Stuurop Non Executive Director (Aged 59) Dirk Stuurop joined Hiscox in 2006. He is managing partner of Lighthouse Holdings LLC. In 2004 he was appointed Vice Chairman of the Board of RAM Holdings Limited, a Bermudian domiciled financial guaranty reinsurance operation. From 1999 to 2006, Dirk was President of Stuurop & Company, a privately owned firm providing strategic advice to executive managements and boards of directors. In 1999 he retired as Chairman of Global Financial Institutions at Merrill Lynch where he worked from 1982. He served as Chairman of Worldinsure Ltd, from 2000 to 2002 and as Senior Executive Director to Banc of America Securities in 2003. Hiscox Ltd Report and Accounts 2007 Board of Directors Corporate governance Overview and basis of reporting Hiscox Ltd (‘the Company’) is a Bermudian domiciled holding company for the Group. The Company is listed on the London Stock Exchange’s main market for listed securities. The corporate governance framework for companies registered in Bermuda is established by the Company’s constitution together with Companies Act legislation. During 2007, and up to the date of this report and accounts, the Group has complied with the provisions of the Combined Code in all material respects. The Board of Directors The Board comprises four Executive Directors and six independent Non Executive Directors, including a Senior Independent Director. Biographical details for each member of the Board are provided on pages 50 to 51. The roles and activities of the Chairman and Chief Executive are distinct and separate. The Chairman is responsible for running an effective Board and overall strategy, and the Chief Executive has responsibility for running the Group’s business. In accordance with the Company’s Bye-Laws all Directors are required to submit themselves for re-election at least every three years. All Directors are entitled to seek independent professional advice at the Company’s expense. A copy of the advice is provided to the Company Secretary who will circulate it to all Directors. No such advice was sought during the year. The Board meets at least four times a year and operates within established Terms of Reference. It is supplied with appropriate and timely information to enable it to review business strategy, trading performance, business risks and opportunities. The Board of Hiscox Ltd met five times during the year. The Board considers all the Non Executive Directors to be independent within the meaning of the Combined Code as there are no relationships or circumstances which would interfere with the exercise of their independent judgement. The Board’s Terms of Reference include a Schedule of Matters Reserved for Board Decision, a copy of which can be found on the Group’s website: www.hiscox.com. The Board retains ultimate authority for high level strategic and management decisions including: setting Group strategy, approving significant mergers or acquisitions, approving the financial statements, declaration of the interim dividend and recommendation of the final dividend, approving Group business plans and budgets, approving major new areas of business, approving capital raising, approving any bonus or rights issues of share capital, setting Group investment guidelines, approving the Directors’ remuneration, approving significant expenditure or projects, and approving the issue of share options. The Board has, however, authorised the boards of the trading entities and business divisions to manage their respective operational affairs, to the extent that Company Board level approval is not required. The Board’s committees The Board has appointed and authorised a number of committees to manage aspects of the Group’s affairs. Each committee operates within established written terms of reference and each committee Chairman reports directly to the Board. The Group Executive Committee The Group Executive Committee, comprised of the Executive Directors, meets monthly to raise and discuss topics such as Group strategy (subject always to Board approval), approval of senior appointments and remuneration (other than Board appointments), management of the Group’s trading performance, mergers and acquisitions (which are not significant to the Group), significant issues raised by the London and International executive committees and approval of exceptional spend within the limits established by the Board. The London Executive Committee considers day-to-day issues arising from the Group’s UK and mainland Europe businesses. The International Executive Committee considers issues arising from the Group’s Bermuda, Guernsey and US businesses. The Audit Committee The Audit Committee of Hiscox Ltd comprises Daniel Healy as Chairman of the Committee together with Carol Franklin Engler, Dirk Stuurop, Andrea Rosen and Dr James King. The Audit Committee meets at least four times a year to assist the Board on matters of financial reporting, risk management and internal control. The Audit Committee monitors the scope, results and cost effectiveness of the internal and external audit functions, the independence and objectivity of the external auditors, and the nature and extent of non-audit work undertaken by the external auditors together with the level of related fees. The internal and external auditors have unrestricted access to the Audit Committee. All non-audit work undertaken by the Group’s external auditors with fees greater than £50,000 must be pre-approved by the Audit Committee. KPMG has confirmed to the Audit Committee that in its opinion it remains independent. The Committee is satisfied that this is the case. The Remuneration and Nomination Committee The Remuneration and Nomination Committee is chaired by Sir Mervyn Pedelty and comprises Carol Franklin Engler, Dirk Stuurop, Daniel Healy, Andrea Rosen and Dr James King. It meets a minimum of two times a year to deal with appointments to the Board and to recommend a framework of executive remuneration. The Directors’ remuneration report is presented on pages 54 to 59. The Conflicts Committee The Group has a Conflicts Committee which is comprised of independent Non Executive Directors from within the Group, and chaired by Dr James King. It meets as and when required. Conflicts of interest may arise from time to time because Syndicate 33 and Cougar Syndicate are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.4% of the Names on Syndicate 33 are third parties with 72.6% of Syndicate 33 owned by a Hiscox Group company. 100% of Cougar Syndicate is owned by third parties. The Conflicts Committee serves to protect the interests of the third party Syndicate Names. Should such a potential conflict of interest arise, there is a formal procedure to refer the matter to this Committee. Risk Committees There are a number of committees within the Group which have been established to oversee key risk areas, including committees covering reinsurance credit risk, liquidity risk, broker credit risk, business continuity risk and investment risk. These committees are comprised of Directors within the Group companies and relevant senior employees. 52 Corporate governance Hiscox Ltd Report and Accounts 2007 Performance evaluation During the year, the Chairman led a review of the performance of the Board as a whole. The Non Executive Directors met with the Chairman to discuss a wide range of issues, including the performance of the Executive Directors of the Board and senior management. In addition the Non Executives met without the Chairman and the Executive Directors during the year. The performance of the Executive Directors and the Chairman was discussed. No major issues regarding the performance of the Board were raised in these discussions. The Chief Executive held one-to-one meetings with each of the Executive Directors to discuss their performance over the year and to set targets for the year ahead. Shareholder communications The Executive Directors communicate and meet directly with shareholders and analysts throughout each year, and do not limit this to the period following the release of financial results or other significant announcements. All Directors endeavour to attend the Annual General Meeting. The Company commissions independent research on feedback from shareholders and analysts on a regular basis following the Company’s results announcements. This research together with the analysts’ research notes are copied to the Non Executive Directors in full. The Chairman attends a number of meetings with shareholders as well as speaking at the analysts’ presentations. In addition, any specific items covered in letters received from major shareholders are reported to the Board. Major shareholders are invited to request meetings with the Senior Independent Director and/or the other Non Executive Directors, and they have been given the contact details of the Senior Independent Director. An alert service is available on www.hiscox.com to notify any stakeholder of new stock exchange announcements. Accountability and internal control The Directors are responsible for maintaining a sound system of internal control to safeguard the investment made by shareholders and the Company’s assets, and for reviewing its effectiveness. The risk management systems are set out in detail in the Risk management report on pages 44 to 47. The Board has reviewed the effectiveness of internal controls during 2007, including financial, operational and compliance controls. The Board confirms there is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company, which has been in place throughout the year and up to the date of approval of the Annual Report and Accounts and accords with the guidance in the document ‘Internal Control: Guidance for Directors on the Combined Code’. The head of each business area is responsible for implementing the risk management programme in their area of operations. The Risk team collates risk management information and the Head of Risk works with the risk committees to monitor significant risks and movements, and review the relevant internal controls. The Group also has an Internal Audit function which has direct access to the Audit Committee and reports to each meeting. The Board acknowledges that it is neither possible, nor desirable, to eliminate risk completely. The system is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable and not absolute assurance against material misstatement or loss. The constant aim is to be fully aware of the risks to which the business is exposed and to manage these risks to acceptable levels. Meetings and attendance table Director RRS Hiscox BE Masojada SJ Bridges RS Childs C Franklin Engler DM Healy Dr J King Sir Mervyn Pedelty AS Rosen DA Stuurop Hiscox Ltd Report and Accounts 2007 Corporate governance Ltd Board Audit Committee Remuneration and Nomination Committee Attended Attended Attended 5/5 5/5 5/5 5/5 4/5 5/5 5/5 4/5 5/5 4/5 n/a n/a n/a n/a 3/4 4/4 4/4 n/a 4/4 3/4 n/a n/a n/a n/a 1/2 2/2 2/2 2/2 2/2 2/2 53 53 Directors’ remuneration report This report sets out the remuneration policy for the Group’s senior executives. This policy is consistent with the overall reward approach across the Group. The sections of this report entitled ‘Remuneration of Executive Directors’, ‘Annual cash incentives’, ‘Share incentive schemes’ and ‘Pensions’ have been audited by KPMG. The remainder of the report is unaudited. Remuneration and Nomination Committee The Remuneration and Nomination Committee meets at least twice a year. Details of the members can be found on pages 50 to 51. The Remuneration and Nomination Committee makes recommendations to the Board on the overall frameworkand cost of remuneration for Hiscox and determines the specific remuneration packages for the Executive Directors. None of the Committee has any personal financial interest (other than as shareholders) or conflicts of interest arising from cross-directorships or day-to-day involvement in running the business. No Director plays any part in any discussion about his or her own remuneration. Advice on specific topics is provided by Towers Perrin Remuneration Consultants. Remuneration policy The remuneration philosophy within Hiscox is to provide rewards which attract and retain quality staff and encourage and reward superior performance. The Remuneration and Nomination Committee believes that pay should be competitive but that superior reward should be driven by superior business results. Remuneration of Executive Directors The remuneration received by each person who served as an Executive Director during the year is set out in the table below. Remuneration elements There are four main elements of the remuneration packages in Hiscox: base salary and benefits, annual cash incentives (bonuses), share incentives and pensions. The proportions of salary, cash incentives and share incentive schemes in the overall reward for Executive Directors are detailed below: RRS Hiscox BE Masojada RS Childs SJ Bridges vv 24% 15% 14% 23% 61% 67% 72% 56% 15% 18% 14% 21% Base Annual cash incentive Share incentive scheme ‘Base’ refers to base salary for the year. ‘Annual cash incentive’ is the annual amount allocated from the profit bonus pool. ‘Share incentive scheme’ is the estimated value at award of the Performance Share Plan awards made during the year. Base salary and benefits Base salaries within the Group are reviewed annually. The Remuneration and Nomination Committee considers the overall budget and approach for the review, taking into account economic and operational conditions. Individual salaries are then reviewed using the Watson Wyatt Financial Services Salary Survey as a benchmark. Individual skills, experience and performance are also taken into account when setting salaries. When approving Executive Director’s pay increases the Remuneration and Nomination Committee takes into account rates of inflation, Watson Wyatt data, other publicly available reports and comparable companies’ pay structures as appropriate. Watson Wyatt is an independent remuneration consultant who provides ad hoc information to the Remuneration and Nomination Committee and does not provide any other services to the Company. Annual cash incentives (bonuses) Hiscox’s remuneration policy is underpinned by the belief that a significant portion of total remuneration should be attained through incentive awards, therefore linking rewards directly with performance. The expectation is that successful performance should enable individuals to achieve upper quartile total remuneration. The table on page 55 shows the payment of annual cash incentives to Executive Directors over the past ten years and illustrates the alignment between business performance and reward. Incentives are awarded by setting an overall bonus pool and then allocating individual awards from that pool based on personal performance ratings. Two bonus pools are operated: the Personal Performance Bonus (PPB) and the Profit Related Bonus (PRB). The PPB is only available to junior and mid-level staff and is based on individual performance. It is designed to ensure that staff in these roles continue to be motivated to perform and the benefit is up to 10% of relevant salaries. Remuneration of Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges As from 1 January 2007, certain benefits were rolled into basic salary. 2007 Basic salary £000 2007 Benefits £000 297 405 336 307 2 2 90 2 2007 Bonus £000 750 1,750 1,750 750 2007 Total £000 2006 Basic salary £000 2006 Benefits £000 1,049 2,157 2,176 1,059 268 326 308 268 17 15 13 14 2006 Bonus £000 600 800 2006 Total £000 885 1,141 1,200 1,521 600 882 54 Directors’ remuneration report Hiscox Ltd Report and Accounts 2007 All employees, including Executive Directors, are eligible for the Profit Related Bonus. The PRB scheme is triggered when the business profits of the Group, based on the year’s pre-tax operating result, exceed a Return on Equity (ROE) linked to the longer term rate of return (‘Hurdle Rate’). The minimum Hurdle Rate has previously been set at a 10% pre-tax return on allocated equity with the bonus pool comprising 15% of profits in excess of that. Bonus pools are then calculated for each major business division based on the performance of that division against the Hurdle Rate of return for the division’s allocated equity. Once the overall bonus pool has been established, individual bonuses, including those for Executive Directors, are calculated based on the results of each business area and individual performance. The Remuneration and Nomination Committee determines the bonuses to be paid to the Executive Directors based on the performance of the Group and an assessment of individual performance. In this way, the bonus scheme aligns the interests of Executive Directors and employees with shareholders. The payment of larger bonuses is deferred over a three-year period as follows. to further align employee interests with those of the shareholder. The following share incentive schemes are operated by Hiscox: the Hiscox Approved Share Option Scheme, the Hiscox Unapproved Share Option Scheme (the ‘Share Option Schemes’), the Performance Share Plan and a Save as You Earn (SAYE) scheme. Options and awards that were granted under the share incentive schemes established by Hiscox plc were rolled over into Hiscox Ltd shares at the time of the re-domicile. Hiscox Ltd has established share incentive schemes which are substantially the same as those previously operated by Hiscox plc and since the re-domicile all options and awards have been granted under the Hiscox Ltd schemes. Performance conditions In order to ensure that these schemes are aligned with shareholders’ interests, the Remuneration and Nomination Committee regularly reviews the terms and conditions of the grants, including the performance measure. The Remuneration and Nomination Committee believes that using ROE as the long-term performance condition better aligns the interests of employees with shareholders because: Bonus of £50,000/$100,000/ €75,000 and below Entire bonus taken in cash in year one Bonus above £50,000/$100,000/ £50,000/$100,000/€75,000 €75,000 and below £100,000/ $200,000/€150,000 taken in cash in year one Remainder of bonus split 50% in year two, 50% in year three Bonus above £100,000/$200,000/ 50% of bonus taken in year one €150,000 25% taken in year two 25% taken in year three Share ownership is encouraged amongst senior personnel by allowing the deferred element of the annual bonus to be used, without deferral,for: payment of the exercise price on the exercise of share options; payment of tax on the exercise of share options; purchase of shares; and payment of debt due on share purchases. Executive Directors’ cash incentives and ROE Pre-tax return on equity % Average bonus as a percentage of salary % ROE captures the efficiency with which the Company is using shareholder funds to generate earnings, whereas EPS growth gives no indication of the level of return on the investment required to generate those additional earnings; the Company operates in a highly cyclical business where earnings can fluctuate considerably, which can have a distorting effect on EPS growth. Where EPS is used as a performance condition this can introduce an element of luck as to when in the cycle share grants are made which can operate to the disadvantage of both employees and shareholders. The Remuneration and Nomination Committee believes that an average ROE performance requirement over the three-year period smoothes out the cyclical fluctuations in earnings and ensures that over any given period shareholders will receive a minimum return on equity before awards granted to employees will vest. For the Special Awards (see below) and subsequent performance share awards ROE has been calculated as profit after tax and goodwill amortisation divided by shareholders’ funds at the beginning of each year. The ROE for the option award granted in 2005 has been calculated as profit before tax and goodwill amortisation divided by shareholders’ funds at the beginning of each year. The ROE will be calculated for each of the three financial years constituting the performance period and then averaged. 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 16 0 3 (24) 13 30 28 19 35 36 73 The performance conditions for each scheme are described below. 0 0 0 90 202 173 54 274 372 Share Option Schemes Awards are made to Executive Directors, senior managers and other staff at the discretion of the Remuneration and Nomination Committee. No grants were made during 2007, or up until the date of this report and accounts. The exercise of options granted since 22 June 2004 are subject to the following performance conditions: an option will vest as to 100% of their shares if the Group’s pre-tax ROE average is 10% over the three-year performance period (the ‘maximum target’); an option will not vest at all unless the Group’s pre-tax ROE average over the period equals or exceeds 8%, at which point the options will vest as to 40% of the shares (the ‘minimum target’); and an option will vest on a straight line basis if the Group’s pre-tax ROE average is between the minimum target and the maximum target. Share incentive schemes The Remuneration and Nomination Committee believes strongly in the value of employee participation in long-term share schemes in order Hiscox Ltd Report and Accounts 2007 Directors’ remuneration report 55 Directors’ remuneration report continued Performance Share Plan Restricted share awards are made to Executive Directors, senior managers and all other staff under the Performance Share Plan at the discretion of the Remuneration and Nomination Committee. Awards under this plan were made in 2007 and the Remuneration and Nomination Committee has also agreed to make awards under this plan in 2008. Awards under this plan are subject to the same testing conditions that were applied to the special awards granted in 2006 (described below). In 2005, following the Rights Issue, we received shareholder approval to grant special awards to individuals within the Company of over up to five million shares, of which a maximum of 20% were available for Executive Directors (‘Special Award’). These awards vest after three years subject to the following performance conditions: 25% of the award vests if the Company achieves an average ROE of 10% post- tax over the three years and 100% vests if the average return exceeds 17.5% post-tax. Vesting will occur on a straight-line basis between these points. Awards were granted of over 2,771,500 shares on 26 March 2007 and 52,000 shares on 2 October 2007 which were subject to the same testing performance conditions as the Special Awards, and it is also the current intention that future awards will be subject to those conditions. The Remuneration and Nomination Committee has agreed the following changes to the Performance Share Plan: Dividends (or amounts equal to dividends) on shares granted under the Performance Share Plan (including in respect of the 2006 and 2007 grants) will roll up in the form of shares between the grant and vesting. At the end of the performance period the employee would have options over the proportion of the share grant which vests by reference to the satisfaction of the applicable performance target as well as over the number of shares representing the ‘rolled up’ dividends on those shares. After vesting but before exercise, the employee would then receive ‘shadow dividends’ (i.e. amounts equal to dividends paid) on the total number of shares remaining under option up to a maximum of 200,000 shares per employee. These amounts would be paid in cash, twice yearly, at the same time as dividends are paid to shareholders, until the option is exercised (which could be for up to a futher seven years, when the option expires). Total shareholder return (%) Above 200,000 shares under option, the dividends would be re-invested into shares within an employee benefit trust. Executive Directors, however, would have the entire dividend re-invested in shares within the trust. The Remuneration and Nomination Committee believes that this change better aligns senior management with shareholders by focusing employees on ROE and dividends and therefore Total Shareholder Return. It also encourages employees to retain the shares which is consistent with our wish to create high levels of employee shareholding. Details of this change will be included in the Notice of the Annual General Meeting. Save as You Earn The sharesave scheme and international sharesave scheme are offered to all employees and currently have a 53% participation. The table at the end of the Remuneration report details Directors’ interests in the long-term incentive plans. Pensions The final salary pension scheme (the Scheme) was closed for future accrual on 31 December 2006. All active members, including SJ Bridges and BE Masojada, transferred to the Group Personal Pension arrangement (the GPP), a defined contribution arrangement on 1 January 2007. As compensation for the closure of the Scheme, Transitional Allowances were made. The amount was fixed in April 2007, payable over three years and could be taken as cash or paid into the GPP. In 2007 the payment made to BE Masojada was £33,600 and to SJ Bridges was £39,800. RRS Hiscox, a pensioner member, retired on 3 January 2003 and RS Childs who left the Scheme on 31 December 2005, is an existing deferred member. The pension entitlement from the Scheme is shown opposite. This is the benefit that would be paid annually on retirement, based on service to date of deferment and then increased to 31 December 2007. The increase in the accrued pension for the year excludes any increase for inflation. However, figures for RRS Hiscox are based on his actual pension in payment. The transfer values have been calculated on the basis of actuarial advice in accordance with version 9 Actuarial Guidance Note GN 11: Retirement Benefit Schemes – Transfer Values. 150 120 90 60 30 0 -30 2 0 c e D 3 0 b e F 3 0 r p A 3 0 n a J 3 0 g u A 3 0 t c O 3 0 c e D 4 0 b e F 4 0 r p A 4 0 n u J 4 0 g u A 4 0 t c O 4 0 c e D 5 0 b e F 5 0 r p A 5 0 n u J 5 0 g u A 5 0 t c O 5 0 c e D 6 0 b e F 6 0 r p A 6 0 n u J 6 0 g u A 6 0 t c O 6 0 c e D 7 0 b e F 7 0 r p A 7 0 n u J 7 0 g u A 7 0 t c O 7 0 c e D Hiscox F TSE Non life insurance 56 Directors’ remuneration report Hiscox Ltd Report and Accounts 2007 Executive Directors’ service contracts Directors’ service contracts are on a rolling basis and the unexpired term shown in the following table is therefore the same as the notice period. The Remuneration and Nomination Committee believes that these notice periods provide an appropriate balance and provide sufficient protection to the Company, having regard to prevailing market conditions and current practice amongst public companies. None of the contracts include any provision for compensation payments on early termination. Service contract table Director RRS Hiscox BE Masojada RS Childs SJ Bridges C Franklin Engler D Healy Dr J King Sir Mervyn Pedelty A Rosen D Stuurop Effective date of Hiscox Ltd contract 12 Dec 2006 12 Dec 2006 12 Dec 2006 12 Dec 2006 11 Oct 2006 11 Oct 2006 11 Oct 2006 11 Oct 2006 11 Oct 2006 11 Oct 2006 Unexpired term and notice period 12 months 6 months 6 months 6 months 3 months 3 months 3 months 3 months 3 months 3 months External Non Executive Directorships No external appointment may be accepted by an Executive Director where such appointment may give rise to a conflict of interest. The consent of the Chairman is required in any event. During the year RRS Hiscox was a Non Executive Director of Grainger Trust plc and was paid £35,000 for his services and AGICM Ltd for which he received no fees. BE Masojada was Deputy Chairman of Lloyd’s until 31 January 2007 and the fees were remitted to the Group for his service. Neither SJ Bridges nor RS Childs held Non Executive Director positions during the year. Remuneration of Non Executive Directors Non Executive Directors receive an annual fee in respect of their Board appointments together with additional compensation for their further duties in relation to Board committees. All amounts are denominated in US Dollars. The structure of the fees paid are detailed below: The fees in relation to Hiscox Ltd for the year were: C Franklin Engler D Healy Dr J King Sir Mervyn Pedelty A Rosen D Stuurop Hiscox Ltd Board $000 Committees $000 75 75 75 75 75 75 25 35 30 50* 25 25 Total 2007 $000 100 110 105 125 100 100 Total 2006 $000 6 24 23 10 22 22 The Pound Sterling equivalent of the total was £321,000 (2006: £55,000). *Sir Mervyn Pedelty receives £10,000 for serving on a UK subsidiary board. The comparative amounts for the prior year reflect the fees paid in relation for the period from appointment to 31 December 2006. The fees are reviewed annually but not necessarily increased. Fees are set at a level to attract individuals with a broad range of relevant skills and experience. The Non Executive Directors receive no other benefits. Pensions RRS Hiscox BE Masojada RS Childs SJ Bridges Increase in accrued pension during the year £000 9 2 9 1 Total accrued annual pension at 31 Dec 07 £000 Transfer value of increase in accrued pension £000 Transfer value of accrued pension at 1 Jan 07 £000 Transfer value of accrued pension at 31 Dec 07 £000 195 36 209 28 43 4 30 2 4,213 4,301 479 533 3,867 4,258 337 378 Increase/ (decrease) in transfer value of accrued benefit during the year £000 88 54 391 41 This table relates to the closed final salary pension scheme. Hiscox Ltd Report and Accounts 2007 Directors’ remuneration report 57 Directors’ remuneration report continued Share options The conditions of exercise of the Approved and Unapproved share options are described on pages 55 and 56. RRS Hiscox BE Masojada RS Childs SJ Bridges Other employees Number of options at 1 January 2007 90,237 56,396 56,398 51,526 51,526 51,526 357,609 90,237 112,797 169,195 78,958 140,997 206,104 206,104 206,104 206,104 1,416,600 90,238 112,797 169,197 78,958 140,997 206,104 206,104 206,103 206,104 1,416,602 84,597 112,797 56,398 140,997 180,341 154,578 154,578 154,578 1,038,864 127,452 317,948 348,523 728,240 118,436 95,039 491,768 947,487 1,455,371 1,714,800 2,308,336 2,457,753 11,111,153 Total 15,340,828 Number of options granted Number of options lapsed Number of options exercised Number of options at 31 December 2007 90,237 56,396 56,398 51,526 51,526 51,526 357,609 90,237 112,797 169,195 78,958 140,997 206,104 206,104 206,104 206,104 1,416,600 90,238 112,797 – 78,958 – 206,104 206,104 206,103 206,104 – – – – – – – – – – – – – – – – – – – (169,197) – (140,997) – – – – (310,194) 1,106,408 (22,559) (1,073) – (100,000) – – – – 62,038 111,724 56,398 40,997 180,341 154,578 154,578 154,578 (123,632) 915,232 – (127,452) 245,891 (72,057) 170,315 (178,208) 453,719 (274,521) – (118,436) 95,039 – 350,778 (140,990) 627,297 (320,190) 1,007,099 (448,272) (662,102) 1,052,698 1,777,628 (530,708) (121,083) 2,233,618 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – (103,052) (103,052) (2,994,019) 8,014,082 (103,052) (3,427,845) 11,809,931 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Exercise price £ Market price at date of exercise £ 1.574 1.020 1.755 1.465 1.514 1.499 1.574 1.281 1.020 1.755 0.806 1.252 1.465 1.514 1.499 1.574 1.281 1.020 1.755 0.806 1.252 1.465 1.514 1.499 1.281 1.020 1.755 0.806 1.252 1.465 1.514 1.499 1.702 1.574 1.281 1.020 1.001 1.685 1.755 0.806 1.252 1.465 1.514 1.499 – – – – – – – – – – – – – – – – – 3.01 – 3.01 – – – – 3.01 3.01 – 3.01 – – – – 2.60-3.01 2.61-3.01 2.64-3.01 2.60-3.01 2.64-3.01 – 2.62-3.01 2.60-2.97 2.62-2.97 2.62-2.91 2.62-3.01 2.67-3.01 Date from which exercisable 20 Oct 01 15 Jun 03 03 May 04 02 Apr 06 13 Jul 07 06 Apr 08 20 Oct 01 13 Oct 02 15 Jun 03 03 May 04 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 20 Oct 01 13 Oct 02 15 Jun 03 03 May 04 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 13 Oct 02 15 Jun 03 03 May 04 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 17 Dec 00 20 Oct 01 13 Oct 02 15 Jun 03 09 Nov 03 14 Feb 04 03 May 04 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 Expiry date 19 Oct 08 14 Jun 10 02 May 11 01 Apr 13 12 Jul 14 05 Apr 15 19 Oct 08 12 Oct 09 14 Jun 10 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 19 Oct 08 12 Oct 09 14 Jun 10 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 12 Oct 09 14 Jun 10 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 16 Dec 07 19 Oct 08 12 Oct 09 14 Jun 10 08 Nov 10 13 Feb 11 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 58 Directors’ remuneration report Hiscox Ltd Report and Accounts 2007 Share options The interests of the Directors and employees under the UK and International Sharesave Schemes of the Group are set out below: UK Sharesave Scheme RRS Hiscox BE Masojada RS Childs SJ Bridges Other employees Number of options at 1 January 2007 5,932 7,168 – 7,544 – 84,328 525,550 317,903 – – Number of options granted Number of options lapsed Number of options exercised – – 4,343 – 4,256 – – – 436,125 410,609 – – – – – – (7,510) (40,931) (49,455) (7,088) – (7,168) – (7,544) – (84,328) (470,450) (9,837) (1,530) – Number of options at 31 December 2007 5,932 – 4,343 – 4,256 – 47,590 267,135 385,140 403,521 948,425 855,333 (104,984) (580,857) 1,117,917 Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date – 01 Dec 08 31 May 09 1.576 2.61 01 Dec 07 31 May 08 1.322 – 01 Dec 10 31 May 11 2.210 2.80 01 Dec 06 31 May 07 1.223 2.220 – 01 May 10 31 Oct 10 1.223 2.64-2.83 01 Dec 06 31 May 07 1.322 2.63-2.91 01 Dec 07 31 May 08 1.576 2.67-2.89 01 Dec 08 31 May 09 2.220 2.61-2.74 01 May 10 31 Oct 10 – 01 Dec 10 31 May 11 2.210 International Sharesave Scheme RS Childs Other employees – 8,136 24,021 37,868 – – – 4,147 – – – 179,720 7,363 63,965 – – (3,709) (3,243) (3,451) – – – (8,136) (5,729) – – – – 4,147 – 14,583 34,625 176,269 7,363 63,965 70,025 255,195 (10,403) (13,865) 300,952 2.220 1.223 1.322 1.576 2.220 2.220 2.210 – 01 May 10 31 Oct 10 2.99 01 Dec 06 31 May 07 2.64 01 Dec 07 31 May 08 – 01 Dec 08 31 May 09 – 01 May 10 31 Oct 10 – 01 Jul 10 31 Dec 10 – 01 Dec 10 31 May 11 The aggregate gain made by the Directors on exercise of the above options (based on market price at date of exercise less the exercise price) was £929,045 (2006: £25,568). The market price of Hiscox Ltd shares at 31 December 2007 was 286.5p (2006: 280.25p). The highest and lowest prices of Hiscox shares during 2007 were 304.5p and 246.75p (2006: 280.25p and 193.75p). Performance share plan RRS Hiscox BE Masojada RS Childs SJ Bridges Other employees Number of options at 1 January 2007 Number of awards granted Number of awards lapsed Number of awards exercised Number of awards at 31 December 2007 Market price at date of exercise £ Date from which released 100,000 – 260,000 – 250,000 – 215,000 – 3,383 3,337,500 25,000 190,000 – 80,000 – 200,000 – 150,000 – 120,000 – – – – – 2,221,500 52,000 – – – – – – – – – – (197,500) – (20,000) (95,000) – – – – – – – – – (3,383) 100,000 80,000 260,000 200,000 250,000 150,000 215,000 120,000 – – 3,140,000 25,000 – 170,000 – – 2,126,500 52,000 – – 12 Jan 09 – 26 Mar 10 – 12 Jan 09 – 26 Mar 10 – 12 Jan 09 – 26 Mar 10 – 12 Jan 09 – 26 Mar 10 2.58 01 Apr 05 – 12 Jan 09 – 13 Mar 09 – 05 Oct 09 – 26 Mar 10 – 02 Oct 10 Total 4,380,883 2,823,500 (312,500) (3,383) 6,888,500 By order of the Board Andrea Rosen Acting Chairman of the Remuneration and Nomination Committee Wessex House, 45 Reid Street, Hamilton HM 12, Bermuda 3 March 2008 Hiscox Ltd Report and Accounts 2007 Directors’ remuneration report 59 Directors’ report The Directors have pleasure in submitting their Annual Report and financial statements for the year ended 31 December 2007. Principal activity and business review The Company is a holding company for subsidiaries involved in the business of insurance in Bermuda, the US, the UK and Europe. An analysis of the development and performance of the business can be found within the Chief Executive’s report on pages 8 to 15. A description of the major risks can be found in the Risk management section on pages 44 to 47. Financial results The Group achieved a pre-tax profit for the year of £237.2 million (2006: £201.1 million). Detailed results for the year are shown in the consolidated income statement on page 62, and also within the Group financial performance section on pages 39 to 41. Share capital Details of the structure of the Company’s share capital and changes in the share capital during the year are disclosed in note 22 to the consolidated financial statements. Directors The names and details of the individuals who served as Directors of the Company during the year are set out on pages 50 to 51. Robert Hiscox, Dr James King and Andrea Rosen retire by rotation in accordance with the Bye-Laws of the Company and they have each submitted themselves for re-election at the second Annual General Meeting of the Company. A copy of the Company’s Bye-Laws is available for inspection at the Company’s registered office. Political and charitable contributions The Group made no political contributions during the Going concern After making enquiries, the Directors have a reasonable year (2006: £nil). expectation that the Company and the Group have 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. Directors’ responsibility The Board is responsible for ensuring the maintenance of proper accounting records which disclose with reasonable accuracy the financial position of the company. It is required to ensure that the financial statements present a fair view for each financial period. Dividends An interim dividend of 4p (net) per share (2006: 3p (net)) was paid on 1October 2007 by Hiscox Ltd in respect of the year ended 31 December 2007. Charitable donations totalled £616,572 (2006: £567,000) of which £550,000 (2006: £500,000) was donated to the Hiscox Foundation, a UK registered charity. The policy of the Hiscox Foundation is to assist and improve education, the arts and independent living for disabled and disadvantaged members of society. Further information concerning the Group’s charitable activities is contained in the report on Corporate responsibility on pages 48 to 49. Major interests in shares The Company has been notified of the following shareholdings of 5% or more in the ordinary shares of the Company as at 3 March 2008: Invesco Limited Jupiter Asset Management Number of shares % of total 59,434,439 25,210,566 15.1 6.4 The Directors recommend the payment of a final dividend of 8p (net) per share (2006: 7p (net)). If approved this will be paid on 17 June 2008 to shareholders on the register at the close of business on 16 May 2008, provided that such dividend will not be paid to those shareholders who, prior to 16 May 2008, have made an election to participate in the Company’s Dividend Access Plan if Hiscox plc subsequently declares a dividend for the purposes of such Dividend Access Plan prior to the payment date of such dividend. If Hiscox Ltd has declared a dividend, those shareholders who have elected to participate in the Dividend Access Plan will receive payment of that dividend on 17 June 2008. Annual General Meeting The notice of Annual General Meeting, to be held at the Elbow Beach Hotel, 60 South Shore Road, Paget PG04, Bermuda on 4 June 2008 at 10am (2pm BST), is contained in a separate circular to shareholders enclosed with this report. By order of the Board Robin Mehta Secretary Wessex House, 45 Reid Street, Hamilton HM 12, Bermuda 3 March 2008 Directors’ interests Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges Non Executive Directors C Franklin Engler D Healy Dr J King Sir Mervyn Pedelty A Rosen D Stuurop 5p Ordinary Shares 31 December 2007 31 December 2007 31 December 2006 31 December 2006 5p Ordinary Shares number of shares non-beneficial 5p Ordinary Shares number of shares number of shares non-beneficial 5p Ordinary Shares number of shares beneficial beneficial 9,398,065 2,710,070 1,703,805 592,053 560,237 9,395,065 – 2,702,902 – 1,386,067 – 468,421 570,237 – – – 23,288 55,000 – 18,000 – 50,000 – – – – – – 23,288 50,000 – – – – – – – – – – 60 Directors’ report Hiscox Ltd Report and Accounts 2007 Report of the independent registered public accounting firm to the Board of Directors and the shareholders of Hiscox Ltd In addition to our audit of the consolidated financial statements, the Directors have engaged us to review their Corporate Governance Statement as if the Company were required to comply with the Listing Rules of the Financial Services Authority in relation to those matters. We review whether the Corporate Governance Statement reflects the Company’s compliance with the nine provisions of the 2006 Combined Code specified for our review by those rules, and we report if it does not. We are not required by the terms of our engagement to consider whether the Board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures. We also read the other information contained in the Report and Accounts and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information. Opinion In our opinion: the consolidated financial statements give a true and fair view of the consolidated financial position of the Company as at 31 December 2007, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards; and the part of the Directors’ remuneration report which we were engaged to audit has been properly prepared in accordance with Schedule 7A to the UK Companies Act 1985, as if those requirements were to apply to the Company. KPMG Hamilton Bermuda 3 March 2008 We have audited the accompanying consolidated financial statements of Hiscox Ltd (‘the Company’) on pages 62 to 105 which comprise the consolidated balance sheet as at 31 December 2007, and the consolidated income statement, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes. In addition to our audit of the consolidated financial statements, the Directors have engaged us to audit the information in the Directors’ remuneration report that is described as having been audited, which the Directors have decided to prepare as if the Company were required to comply with the requirements of Schedule 7A to the UK Companies Act 1985. Management’s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatements, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit and, under the terms of our engagement letter, to audit the part of the Directors’ remuneration report that is described as having been audited. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with relevant ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements and the part of the Directors’ remuneration report to be audited are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements and the part of the Directors’ remuneration report to be audited. The procedures selected depend on our judgement, including the assessment of the risks of material misstatement of the financial statements and the part of the Directors’ remuneration report to be audited, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements and the part of the Directors’ remuneration report to be audited in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting principles used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and the part of the Directors’ remuneration report to be audited. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Hiscox Ltd Report and Accounts 2007 Report of the independent registered public accounting firm to the Board of Directors and the shareholders of Hiscox Ltd 61 Consolidated income statement For the year ended 31 December 2007 Income Gross premiums written Outward reinsurance premiums Net premiums written Gross premiums earned Premiums ceded to reinsurers Net premiums earned Investment result Other revenues Revenue Expenses Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Administration expenses Other expenses Total expenses Results of operating activities Finance costs Share of profit of associates after tax Profit before tax Tax expense Profit for the year (all attributable to equity shareholders of the Company) Earnings per share on profit attributable to equity shareholders of the Company Basic Diluted The notes on pages 66 to 105 are an integral part of these consolidated financial statements. Note 2007 £000 2006 £000 4 1,198,949 (224,039) 1,126,164 (150,767) 4 974,910 975,397 1,179,444 1,033,585 (214,254) (144,757) 965,190 888,828 99,677 19,044 105,550 15,692 1,083,911 1,010,070 4 6 9 24.2 8 9 (423,365) (264,570) (76,813) (73,868) (382,341) (235,797) (76,533) (104,943) (838,616) (799,614) 245,295 (8,177) 81 210,456 (9,404) 10 237,199 (45,951) 201,062 (37,216) 191,248 163,846 48.4p 46.8p 41.7p 40.5p 11 16 26 29 29 62 Consolidated income statement Hiscox Ltd Report and Accounts 2007 Consolidated balance sheet At 31 December 2007 Assets Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Loans and receivables including insurance receivables Reinsurance assets Cash and cash equivalents Total assets Equity and liabilities Shareholders’ equity Share capital Share premium Contributed surplus Other reserves Retained earnings Total equity (all attributable to equity shareholders of the Company) Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities carried at fair value Current tax Trade and other payables Total liabilities Total equity and liabilities Note 2007 £000 2006 £000 15 14 16 40,452 19,378 1,502 123,081 33,212 13,821 28 117,115 8 18 1,747,827 1,241,910 446,272 302,772 502,871 385,222 280,088 302,742 19 21 17, 24 2,900,292 2,658,001 22 22 22 23 23 19,898 4,955 398,834 (43,265) 443,882 19,694 – 442,425 (40,396) 260,362 824,304 682,085 28 – 9,751 3,801 8,467 27 24 1,713,887 1,594,101 93,929 20,793 254,825 91,764 24,711 235,875 25 18 2,075,988 1,975,916 2,900,292 2,658,001 The notes on pages 66 to 105 are an integral part of these consolidated financial statements. The consolidated Group financial statements were approved by the Board of Directors on 3 March 2008 and signed on its behalf by: RRS Hiscox Chairman SJ Bridges Group Finance Director Hiscox Ltd Report and Accounts 2007 Consolidated balance sheet 63 Consolidated statement of changes in equity Share capital £000 Share premium £000 Contributed surplus £000 Balance at 1 January 2006 Currency translation differences Net expense recognised directly in equity Profit for the year Note 13 Total recognised income/(expense) for year Employee share options: Equity settled share based payments Deferred tax release on share based payments Proceeds from shares issued Transfer on reverse acquisition Change in own shares held in treasury Dividends to external shareholders 30 22 22 19,570 – 401,365 – – – – – – 124 – – – – – – – – 2,829 (404,194) – – Balance at 31 December 2006 19,694 Currency translation differences Net investment hedge 13 Net expense recognised directly in equity Profit for the year Total recognised income/(expense) for year Employee share options: Equity settled share based payments Deferred tax transfer on share based payments Proceeds from shares issued Change in own shares held in treasury Dividends to external shareholders 30 22 – – – – – – – 204 – – – – – – – – – 264 442,161 – – 442,425 – – – – – – – – – – – – – 4,955 – – – – – – (43,591) Merger reserve £000 4,723 – – – – – – – (4,723) – – Currency translation reserve £000 822 (41,218) (41,218) – (41,218) Capital redemption reserve £000 Retained earnings £000 Total £000 33,244 – 118,289 – 578,013 (41,218) – – – – 163,846 (41,218) 163,846 163,846 122,628 – – – – – – – – – (33,244) – – 5,238 3,367 – – 50 (30,428) 5,238 3,367 3,217 – 50 (30,428) – – – – – – – – – – – – (40,396) (4,269) 1,400 (2,869) – (2,869) – – – – – (43,265) – – – – – – – – – – – – 260,362 682,085 – – (4,269) 1,400 – 191,248 (2,869) 191,248 191,248 188,379 5,689 (2,074) – (11,343) – 5,689 (2,074) 5,159 (11,343) (43,591) 443,882 824,304 Balance at 31 December 2007 19,898 4,955 398,834 The notes on pages 66 to 105 are an integral part of these consolidated financial statements. 64 Consolidated statement of changes in equity Hiscox Ltd Report and Accounts 2007 Consolidated cash flow statement For the year ended 31 December 2007 Profit before tax Adjustments for: Interest and equity dividend income Interest expense Net (gains)/losses on financial investments derivatives and borrowings Non-cash movement in retirement benefit obligation Depreciation Charges in respect of share based payments Other non-cash movements Changes in operational assets and liabilities: Insurance and reinsurance contracts Financial assets Other assets and liabilities Cash flows from operations Interest received Equity dividends received Interest paid Current tax paid Net cash flows from operating activities Cash outflow from the acquisition of subsidiary Cash outflow from the sale of subsidiary Cash outflow from acquisition of associates Cash flows from the purchase of property, plant and equipment Cash flows from the purchase of intangible assets Net cash flows from investing activities Proceeds from the issue of ordinary shares Cash flows from the purchase of own shares including those arising on share buy-back programme Dividends paid to Company’s shareholders Repayments of borrowings and financial liabilities Net cash flows from financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at 1 January Net increase in cash and cash equivalents Effect of exchange rate fluctuations on cash and cash equivalents Cash and cash equivalents at 31 December Note 2007 £000 2006 £000 237,199 201,062 15 10 31 32 16 14 22 22 30 (90,205) 8,177 687 (3,801) 4,917 5,689 (641) 133,951 (489,745) 31,112 (162,660) 85,435 4,770 (8,243) (42,823) (70,243) 9,404 (9,422) (12,876) 3,898 5,238 1,551 45,426 1,311 (17,953) 157,396 68,644 1,599 (9,416) (36,363) (123,521) 181,860 (11,133) (936) (1,273) (7,789) (2,500) – – – (5,452) (300) (23,631) (5,752) 5,159 (11,343) (43,591) (272) 3,217 50 (30,428) (14,334) (50,047) (41,495) (197,199) 134,613 502,871 (197,199) (2,930) 413,759 134,613 (45,501) 21 302,742 502,871 The purchase, maturity and disposal of financial assets is part of the Group’s insurance activities and is therefore classified as an operating cash flow. The purchase, maturity and disposal of derivative contracts is also classified as an operating cash flow. Included within cash and cash equivalents held by the Group are balances totalling £53,336,000 (2006: £41,304,000) not available for immediate use by the Group outside of the Lloyd’s Syndicate within which they are held. The notes on pages 66 to 105 are an integral part of these consolidated financial statements. Hiscox Ltd Report and Accounts 2007 Consolidated cash flow statement 65 Notes to the financial statements 1 General information The Hiscox Group, which is headquartered in Hamilton, Bermuda, comprises Hiscox Ltd (the parent Company, referred to herein as the ‘Company’) and its subsidiaries (collectively, the ‘Hiscox Group’ or the ‘Group’). For the period under review the Group provided insurance, reinsurance and investment management services to its clients worldwide. It has operations in Bermuda, the UK, Europe, and USA and employs over 800 people. The Company is registered and domiciled in Bermuda and on 12 December 2006 its ordinary shares were listed on the London Stock Exchange. As such it is required to prepare financial information in accordance with the Bermuda Companies Act 1981, which permits the Group to prepare financial statements which comprise the consolidated income statement, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 36 in accordance with International Financial Reporting Standards (‘IFRS’). Accordingly, the financial information has been prepared in accordance with Bermuda Law. The consolidated financial statements for the year ended 31 December 2007 include all of the Group’s subsidiary companies and the Group’s interest in associates. All amounts relate to continuing operations. The financial statements were approved for issue by the Board of Directors on 3 March 2008. 2 Significant accounting policies The principal accounting policies applied in the preparation of these consolidated Group financial statements are set out below. The most critical individual components of these financial statements that involve the high degree of judgement or significant assumptions and estimations are identified at note 2.23. 2.1 Statement of compliance The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards and in accordance with the provisions of the Bermuda Companies Act 1981. Since 2002, the standards adopted by the International Accounting Standards Board (IASB) have been referred to as IFRS. The standards from prior years continue to bear the title ‘International Accounting Standards’ (IAS). Insofar as a particular standard is not explicitly referred to, the two terms are used in these financial statements synonymously. Compliance with IFRS includes the adoption of interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC). In March 2004, the IASB issued IFRS 4 Insurance Contracts which specifies the financial reporting for insurance contracts by an insurer. The standard is only the first phase in the IASB’s insurance contract project and as such is only a stepping stone to phase II, introducing limited improvements to accounting for insurance contracts. Accordingly, to the extent that IFRS 4 does not specify the recognition or measurement of insurance contracts, transactions reported in these consolidated financial statements have been prepared in accordance with another comprehensive body of accounting principles for insurance contracts, namely accounting principles generally accepted in the UK. 2.2 Basis of preparation The financial statements are presented in Pounds Sterling and are rounded to the nearest thousand unless otherwise stated. They are compiled on a going concern basis and prepared on the historical cost basis except that pension scheme plan assets included in the measurement of the employee retirement benefit obligation, and financial instruments including derivative instruments and financial liabilities at fair value through profit or loss, are measured at fair value. Employee retirement benefit obligations are determined using actuarial analysis. The balance sheet of the Group is presented in order of increasing liquidity. The accounting policies have been applied consistently by all Group entities, to all periods presented, solely for the purpose of producing the consolidated Group financial statements. The comparative amounts reported herein for the year ended 31 December 2006 have been extracted from the previously published report for that period, but have beenadjusted for reclassification of certain minor overseas agency underwriting expenses and commissions from‘other expenses’and‘other revenues’ to‘expenses for the acquisition of insurance contracts’, and for the Group’s revised presentation of segment information (note 4).The effect of the reclassification of the aforementioned expensesandcommissions is to increase the previously reported ‘expenses for the acquisition of insurance contracts’ for the year ended 31 December 2006 by £9,948,000. Simultaneous identical reductions have been made in total to ‘other expenses’ and ‘other revenues’. These presentational adjustments have no impact on the Group’s previously reported result from operating activities, profit before tax or shareholders’ equity. The Directors believe that the amended classification of these expenses and commissions provides a more appropriate presentation of their operating nature. The Group elected to apply the transitional arrangements contained in IFRS 4 that permitted the disclosure of only five years of data in claims development tables, in the year ended 31 December 2005 which was the year of adoption. The number of years of data presented was increased from six in the prior year, to seven in the current financial year, and will be increased in each succeeding additional year up to a maximum of ten years if material outstanding claims exist for such periods. As detailed in note 3 the Group adopted IFRS 7 Financial Instruments: Disclosures, and a corresponding amendment to IAS 1 Presentation of Financial Statements – Capital Disclosures on 1 January 2007. The adoption of IFRS 7 and the amendments to IAS 1 impacted the type and amount of disclosures made in these financial statements, but had no impact on the reported profits or financial position of the Group. In accordance with the transitional requirements of the standards, the Group has provided full comparative information. The consolidated financial statements also reflect the early adoption of IFRS 8 Operating Segments from that date. IFRS 8 is a disclosure standard concerning the designation and presentation of operating segment information and therefore has no impact on the reported primary financial statements or financial position of the Group. Four IFRIC interpretations became effective for financial reporting purposes during the year under review, however their adoption has not resulted in any changes to the Group’s stated accounting policies. The Directors have considered recently published IFRS, new interpretations and amendments to existing standards that are mandatory to the Group’s accounting periods commencing on or after 1 January 2008 and which have not been subject to early adoption. With the exception of recent revisions to IFRS 3 Business Combinations, which generally require transaction costs on business combinations to be accounted for separately as period costs by way of an immediate charge to the income statement rather than being capitalised as part of the overall cost of combination for goodwill purposes, the Directors’ current assessment is that the adoption of these changes will necessitate minor presentational changes only. 2.3 Change of holding company in prior year On 12 December 2006 Hiscox Ltd replaced Hiscox plc as the Group’s holding company by way of a share for share exchange. 66 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 2 Significant accounting policies continued 2.3 Change of holding company in prior year continued Hiscox Ltd was incorporated under the laws of Bermuda on 6 September 2006. Details of the share for share exchange transaction and its effects are disclosed in note 22. For the period from incorporation to 12 December 2006, Hiscox Ltd was a shell company with no material revenues or assets and did not constitute a ‘business’ as defined by IFRS 3 Business Combinations. Consequently, due to the relative values of both Companies, the shareholders of Hiscox plc immediately before the share exchange acquired, in effect, 100% of the enlarged share capital of Hiscox Ltd on completion of the transaction. In order to appropriately reflect the substance of the transaction outlined above, the new holding Company was accounted for using the reverse acquisition principles outlined in IFRS 3. Consequently, Hiscox plc was deemed to be the acquirer for accounting purposes and the legal parent Company, Hiscox Ltd, was treated as a subsidiary whose identifiable assets and liabilities are incorporated into the Group at fair value. The Group’s consolidated financial statements are issued in the name of the legal parent Company, Hiscox Ltd. However, as a consequence of applying reverse acquisition accounting, the results for the year ended 31 December 2006 represented a continuation of the consolidated activities of Hiscox plc for the year ended 31 December 2006 plus those of Hiscox Ltd from 12 December 2006. In accordance with Bermuda law the Group’s previously reported share premium, merger reserve and capital redemption reserve were presented as contributed surplus at 31 December 2006. Contributed surplus is a distributable reserve. 2.4 Basis of consolidation (a) Subsidiaries Subsidiaries are those entities controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Generally this occurs when the Group obtains a shareholding of more than half of the voting rights of an entity. In assessing control, potential voting rights that are currently exercisable or convertible are taken into account. The consolidated financial statements include the assets, liabilities and results of the Group up to 31 December each year. The financial statements of subsidiaries are included in the consolidated financial statements only from the date that control commences until the date that control ceases. Hiscox Dedicated Corporate Member Limited underwrites as a corporate member of Lloyd’s on the main syndicate managed by Hiscox Syndicates Limited (the ‘main managed syndicate’). In view of the several but not joint liability of underwriting members at Lloyd’s for the transactions of syndicates in which they participate, the Group’s attributable share of the transactions, assets and liabilities of this main Syndicate has been included in the financial statements. The Group uses the purchase method of accounting to account for the acquisition of subsidiaries. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement. (b) Associates Associates are those entities in which the Group has significant influence but not control over the financial and operating policies. Significant influence is generally identified with a shareholding of between 20% and 50% of an entity’s voting rights. The consolidated financial statements include the Group’s share of the total recognised gains and losses of associates on an equity accounted basis from the date that significant influence commences until the date that significant influence ceases. The Group’s share of its associates’ post-acquisition profits or losses after tax is recognised in the income statement each period, and its share of the movement in the associates’ net assets is reflected in the investments’ carrying values in the balance sheet. When the Group’s share of losses equals or exceeds the carrying amount of the associate, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associate. (c) Transactions eliminated on consolidation Intragroup balances, transactions and any unrealised gains arising from intragroup transactions are eliminated in preparing the consolidated financial statements. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Unrealised gains arising from transactions with associates are eliminated to the extent of the Group’s interest in the entity. Unrealised gains arising from transactions in associates are eliminated against the investment in the associate. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment. 2.5 Foreign currency translation (a) Functional and presentational currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The functional currency of all individual entities in the Group is deemed to be Sterling with the exception of the entities operating in France, Germany, the Netherlands and Belgium whose functional currency is Euros, those entities operating from the USA and Bermuda whose functional currency is US Dollars, and Hiscox Insurance Company (Guernsey) Limited whose functional currency is also US Dollars. (b) Transactions and balances Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the retranslation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when deferred in equity as qualifying net investment hedges. Non-monetary items carried at historical cost are translated in the balance sheet at the exchange rate prevailing on the original transaction date. Non-monetary items measured at fair value are translated using the exchange rate ruling when the fair value was determined. (c) Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet (ii) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the date of the transactions) Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 67 Notes to the financial statements continued 2 Significant accounting policies continued 2.5 Foreign currency translation continued (c) Group companies continued (iii) all resulting exchange differences are recognised as a separate component of equity. When a foreign operation is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale. Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as the foreign entity’s assets and liabilities and are translated at the closing rate. 2.6 Property, plant and equipment Property, plant and equipment are stated at historical cost less depreciation and any impairment loss. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance items are charged to the income statement during the financial period in which they are incurred. Land and artwork assets are not depreciated as they are deemed to have indefinite useful economic lives. The cost of leasehold improvements is amortised over the unexpired term of the underlying lease or the estimated useful life of the asset, whichever is shorter. Depreciation on other assets is calculated using the straight-line method to allocate their cost or revalued amounts, less their residual values, over their estimated useful lives. The rates applied are as follows: 50 years 3 years Buildings Vehicles Leasehold improvements including fixtures and fittings Furniture, fittings and equipment 10–15 years 3–15 years The assets’ residual values and useful lives are reviewed at each balance sheet date and adjusted if appropriate. An asset’s carrying amount is written down immediately to its recoverable amount if the asset’s carrying amount is greater than its estimated recoverable amount. Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the income statement. 2.7 Intangible assets (a) Goodwill Goodwill represents amounts arising on acquisition of subsidiaries and associates. In respect of acquisitions that have occurred since 1 January 2004, goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the acquisition date. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. (b) Syndicate capacity The cost of purchasing the Group’s participation in the Lloyd’s insurance syndicates is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. Having considered the future prospects of the London insurance market, the Board believe that the Group’s ownership of syndicate capacity will provide economic benefits over an indefinite number of future periods. (c) State authorisation licences State authorisation licences acquired in business combinations are recognised initially at their fair value. The asset is not amortised, as the Board considers that economic benefits will accrue to the Group over an indefinite number of future periods, but is tested annually for impairment, and any accumulated impairment losses recognised are deducted from the historical cost amount to produce the net balance sheet carrying amount. (d) Rights to customer contractual relationships Costs directly attributable to securing the intangible rights to customer contract relationships are recognised as an intangible asset where they can be identified separately and measured reliably and it is probable that they will be recovered by directly related future profits. These costs are amortised on a straight-line basis over the useful economic life which is deemed to be 20 years and are carried at cost less accumulated amortisation and impairment losses. (e) Computer software Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring into use the specific software. These costs are amortised over the expected useful life of the software of between three and five years on a straight-line basis. Internally developed computer software is only capitalised where the cost can be measured reliably, the Group intends to and has adequate resources to complete development and where the computer software will yield future economic benefits in excess of the costs incurred. 2.8 Financial assets including loans and receivables The Group has classified financial assets as a) financial assets designated at fair value through profit or loss, and b) loans and receivables. Management determines the classification of its financial investments at initial recognition. The decision by the Group to designate all financial investments, comprising debt and fixed income securities, equities and shares in unit trusts and deposits with credit institutions, at fair value through profit or loss reflects the fact that the investment portfolios are managed, and their performance evaluated, on a fair value basis. Regular way purchases and sales of investments are accounted for at the date of trade. Financial assets are initially recognised at fair value. Subsequent to initial recognition financial assets are measured as described below. In respect of acquisitions prior to this date, goodwill is included on the basis of its deemed cost, which represents the amount recorded under previous GAAP. Financial assets are de-recognised when the right to receive cash flows from them expires or where they have been transferred and the Group has also transferred substantially all risks and rewards of ownership. Goodwill on acquisition of subsidiaries is included in intangible assets. Goodwill on acquisition of associates is included in investments in associates. Goodwill is not amortised but is tested annually for impairment and carried at cost less accumulated impairment losses. The impairment review process examines whether or not the carrying value of the goodwill attributable to individual cash generating units exceeds its implied value. Any excess of goodwill over the recoverable amount arising from the review process indicates impairment. Fair value for securities quoted in active markets is the bid price exclusive of transaction costs. For the minority of instruments where no active market exists, fair value is determined by referring to recent transactions and other valuation factors including the discounted value of expected future cash flows. Fair value changes are recognised immediately within the investment result line in the income statement. 68 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 2 Significant accounting policies continued 2.8 Financial investments including loans and receivables continued (a) Financial assets at fair value through profit or loss A financial asset is classified into this category at inception if it is managed and evaluated on a fair value basis in accordance with documented strategy, if acquired principally for the purpose of selling in the short-term, or if it forms part of a portfolio of financial assets in which there is evidence of short-term profit taking. (b) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted on an active market. Receivables arising from insurance contracts are included in this category and are reviewed for impairment as part of the impairment review of loans and receivables. Loans and receivables are carried at amortised cost less any provision for impairment in value. 2.9 Cash and cash equivalents The Group has classified cash deposits and short-term highly liquid investments as cash and cash equivalents. These assets are readily convertible into known amounts of cash and are subject to inconsequential changes in value. Cash equivalents are financial investments with less than three months to maturity at the date of acquisition. 2.10 Impairment of assets Assets that have an indefinite useful life are not subject to amortisation and are tested annually or whenever there is an indication of impairment. Assets that are subject to amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Non-financial assets Objective factors that are considered when determining whether a non-financial asset (such as goodwill, an intangible asset or item of property, plant and equipment) or group of non-financial assets may be impaired include, but are not limited to, the following: adverse economic, regulatory or environmental conditions that may restrict future cash flows and asset usage and/or recoverability; the likelihood of accelerated obsolescence arising from the development of new technologies and products; and the disintegration of the active market(s) to which the asset is related. Financial assets Objective factors that are considered when determining whether a financial asset or group of financial assets may be impaired include, but are not limited to, the following: negative rating agency announcements in respect of investment issuers, reinsurers and debtors; significant reported financial difficulties of investment issuers, reinsurers and debtors; actual breaches of credit terms such as persistent late payments or actual default; the disintegration of the active market(s) in which a particular asset is traded or deployed; and adverse economic or regulatory conditions that may restrict future cash flows and asset recoverability. Impairment loss An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. For the purpose of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash generating units). Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior periods. A reversal of an impairment loss is recognised as income immediately. Impairment losses recognised in respect of goodwill are not subsequently reversed. 2.11 Derivative financial instruments Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently valued at their fair value at each balance sheet date. Fair values are obtained from quoted market values and, if these are not available, valuation techniques including option pricing models as appropriate. The method of recognising the resulting gain or loss depends on whether the derivative is designated as a hedging instrument and, if so, the nature of the item being hedged. For derivatives not formally designated as a hedging instrument, fair value changes are recognised immediately in the income statement. Changes in the value of derivative and other financial instruments formally designated as hedges of net investments in foreign operations are recognised in the currency translation reserve to the extent they are effective; gains or losses relating to the ineffective portion of the hedging instruments are recognised immediately in the consolidated income statement. The Group had no derivative instruments designated for hedge accounting during the current and prior financial year (see note 2.18). 2.12 Own shares Where any Group company purchases the parent Company’s equity share capital (own shares), the consideration paid, including any directly attributable incremental costs (net of income taxes), is deducted from equity attributable to the Company’s equity shareholders. Where such shares are subsequently sold, reissued or otherwise disposed of, any consideration received is included in equity attributable to the Company’s equity shareholders, net of any directly attributable incremental transaction costs and the related tax effects. 2.13 Revenue Revenue comprises insurance premiums earned on the rendering of insurance protection, net of reinsurance, together with profit commission, investment returns, agency fees and other income inclusive of foreign exchange gains on instruments not formally designated for hedge accounting treatment. The Group’s share of the results of associates is reported separately. The accounting policies for insurance premiums are outlined below. Profit commission, investment income and other sources of income are recognised on an accruals basis net of any discounts and amounts such as sales based taxes collected on behalf of third parties. 2.14 Insurance contracts (a) Classification The Group issues short-term casualty and property insurance contracts that transfer significant insurance risk. Such contracts may also transfer a limited level of financial risk. (b) Recognition and measurement Gross premiums written comprise premiums on business incepting in the financial year together with adjustments to estimates of premiums written in prior accounting periods. Estimates are included for pipeline premiums and an allowance is also made for cancellations. Premiums are stated before the deduction of brokerage and commission but net of taxes and duties levied. Premiums are recognised as revenue (earned premiums) proportionally over the period of coverage. The portion of premium received on in-force contracts that relates to unexpired risks at the balance sheet date is reported as the unearned premium liability. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 69 Notes to the financial statements continued 2 Significant accounting policies continued 2.14 Insurance contracts continued (b) Recognition and measurement continued Claims and associated expenses are charged to profit or loss as incurred based on the estimated liability for compensation owed to contract holders or third parties damaged by the contract holders. They include direct and indirect claims settlement costs and arise from events that have occurred up to the balance sheet date even if they have not yet been reported to the Group. The Group does not discount its liabilities for unpaid claims. Liabilities for unpaid claims are estimated using the input of assessments for individual cases reported to the Group and statistical analysis for the claims incurred but not reported, and an estimate of the expected ultimate cost of more complex claims that may be affected by external factors e.g. court decisions. (c) Deferred acquisition costs (‘DAC’) Commissions and other direct and indirect costs that vary with and are related to securing new contracts and renewing existing contracts are capitalised as deferred acquisition costs. All other costs are recognised as expenses when incurred. DAC are amortised over the terms of the policies as premium is earned. (d) Liability adequacy test At each balance sheet date, liability adequacy tests are performed by each segment of the Group to ensure the adequacy of the contract liabilities net of related DAC. In performing these tests, current best estimates of future contractual cash flows and claims handling and administration expenses, as well as investment income from assets backing such liabilities, are used. Any deficiency is immediately charged to profit or loss initially bywriting-off DAC and by subsequently establishing a provision for losses arising from liability adequacy tests (‘the unexpired risk provision’). Any DAC written-off as a result of this test cannot subsequently be reinstated. (e) Outwards reinsurance contracts held Contracts entered into by the Group, with reinsurers, under which the Group is compensated for losses on one or more insurance or reinsurance contracts and that meet the classification requirements for insurance contracts, are classified as insurance contracts held. Contracts that do not meet these classification requirements are classified as financial assets. The benefits to which the Group is entitled under outwards reinsurance contracts are recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers (classified within loans and receivables) as well as longer-term receivables (classified as reinsurance assets) that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Reinsurance liabilities primarily comprise premiums payable for ‘outwards’ reinsurance contracts. These amounts are recognised in profit or loss proportionally over the period of the contract. Receivables and payables are recognised when due. The Group assesses its reinsurance assets on a regular basis and if there is objective evidence, after initial recognition, of an impairment in value, the Group reduces the carrying amount of the reinsurance asset to its recoverable amount and recognises the impairment loss in the income statement. (f) Receivables and payables related to insurance contracts Receivables and payables are recognised when due. These include amounts due to and from agents, brokers and insurance contract holders. accordingly and recognises the impairment loss in profit or loss. (g) Salvage and subrogation reimbursements Some insurance contracts permit the Group to sell property acquired in settling a claim (i.e. salvage). The Group may also have the right to pursue third parties for payment of some or all costs (i.e. subrogation). Estimates of salvage recoveries are included as an allowance in the measurement of the insurance liability for claims and salvage property is recognised in other assets when the liability is settled. The allowance is the amount that can reasonably be recovered from the disposal of the property. Subrogation reimbursements are also considered as an allowance in the measurement of the insurance liability for claims and are recognised in other assets when the liability is settled. The allowance is the assessment of the amount that can be recovered from the action against the liable third party. 2.15 Deferred tax Deferred 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 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 tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets are recognised to the extent that it is probable that the future taxable profit will be available against which the temporary differences can be utilised. Deferred 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. 2.16 Employee benefits (a) Pension obligations The Group operated a defined contribution arrangement for all active employees during the year under review. The defined benefit scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of the defined contribution arrangement from 1 January 2007. A defined contribution arrangement is one under which the Group pays fixed contributions into a separate entity and has no further obligation beyond the agreed contribution rate. A defined benefit scheme is a pension scheme that defines an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors such as age, years of service and compensation. For the defined contribution arrangement, the Group pays contributions to a privately administered pension insurance plan on a contractual basis. The contributions are recognised as an employee benefit expense when they are due. The liability recognised in the balance sheet in respect of the defined benefit pension scheme is the present value of the defined benefit obligation at the balance sheet date less the fair value of plan assets, together with adjustments for unrecognised actuarial gains or losses and past service costs. Scheme assets exclude any insurance contracts issued by the Group. On curtailment, all unrecognised actuarial gains or losses are recognised in the income statement where relevant. If there is objective evidence that the insurance receivable is impaired, the Group reduces the carrying amount of the insurance receivable Adjustments either from or to other parties participating in the Lloyd’s Syndicate regarding the defined benefit scheme are recognised as a 70 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 2 Significant accounting policies continued 2.16 Employee benefits continued (a) Pension obligations continued component of the income statement charge or credit and within receivables on the balance sheet in accordance with the policies outlined at 2.8 (b) above. (b) Other long-term employee benefits The Group provides sabbatical leave to employees on completion of a minimum service period of ten years. The present value of the expected costs of these benefits is accrued over the period of employment. In determining this liability, consideration is given to future increases in salary levels, experience with employee departures and periods of service. (c) Share based compensation The Group operates a number of equity settled share based employee compensation plans. These include both the approved and unapproved share option schemes, and the Group’s performance share plans, outlined in the Directors’ remuneration report together with the Group’s save as you earn (‘SAYE’) schemes. The fair value of the employee services received, measured at grant date, in exchange for the grant of the awards is recognised as an expense with the corresponding credit being recorded in retained earnings within equity. The total amount to be expensed over the vesting period is determined by reference to the fair value of the awards granted, excluding the impact of any non-market vesting conditions (e.g. profitability or net asset growth targets). Non-market vesting conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period. When the terms and conditions of an equity settled share based employee compensation plan are modified, and the expense to be recognised increases as a result of the modification, then the increase is recognised evenly over the remaining vesting period. When a modification reduces the expense to be recognised, there is no adjustment recognised and the pre-modification expense continues to be applied. The proceeds received net of any directly attributable transaction costs are credited to share capital and share premium when the options are exercised. In accordance with the transitional arrangements of IFRS 2 only share based awards granted or modified after 7 November 2002, but not yet vested at the date of adoption of IFRS are included in the calculations. (d) Termination benefits Termination benefits are payable when employment is terminated before the normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Group recognises termination benefits when it is demonstrably committed to either: terminating the employment of current employees according to a detailed formal plan without possibility of withdrawal; or providing termination benefits as a result of an offer made to encourage voluntary redundancy. (e) Profit sharing and bonus plans The Group recognises a liability and an expense for bonuses and profit sharing, based on a formula that takes into consideration the profit attributable to the Company’s shareholders after certain adjustments. The Group recognises a provision where a contractual obligation to employees exists or where there is a past practice that has created a constructive obligation. (f) Accumulating compensation benefits The Group recognises a liability and an expense for accumulating compensation benefits (e.g. holiday entitlement), based on the additional amount that the Group expects to pay as a result of the unused entitlement accumulated at the balance sheet date. 2.17 Borrowings Borrowings are financial liabilities and are designated on inception as being held at fair value through profit or loss if they are managed and evaluated on a fair value basis in accordance with a documented strategy or if they eliminate or significantly reduce a measurement or recognition inconsistency. Borrowings are initially measured at fair value with all incremental transaction costs immediately expensed. Borrowings are then consequently measured at fair value at each balance sheet date thereafter, using observable market interest rate data for similar instruments, with all changes in value from one accounting period to the next reflected in the income statement unless they form part of a designated hedge accounting relationship in which case certain changes in value are recognised directly in equity, (see notes 2.18 and 18). 2.18 Net investment hedge accounting In order to qualify for hedge accounting, the Group is required to document in advance the relationship between the item being hedged and the hedging instrument. The Group is also required to document and demonstrate an assessment of the relationship between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an ongoing basis. This effectiveness testing is re-performed at each period end to ensure that the hedge remains highly effective. The Group hedges elements of its net investment in certain foreign entities through foreign currency borrowings that qualify for hedge accounting; accordingly gains or losses on retranslation are recognised in equity to the extent that the hedge relationship is effective. Accumulated gains or losses are recycled to the income statement only when the foreign operation is disposed of. The ineffective portion of any hedge is recognised immediately in the income statement. 2.19 Finance costs Finance costs consist of interest charges accruing on the Group’s borrowings and bank overdrafts together with commission fees charged in respect of letters of credit. Arrangement fees in respect of financing arrangements are charged over the life of the related facilities. 2.20 Provisions The Group is subject to various insurance related assessments and guarantee fund levies. Provisions are recognised where there is a present obligation (legal or constructive) as a result of a past event that can be measured reliably and it is probable that an outflow of economic benefits will be required to settle that obligation. 2.21 Leases (a) Hiscox as lessee Leases in which significantly all of the risks and rewards of ownership are transferred to the Group are classified as finance leases. At the commencement of the lease term, finance leases are recognised as assets and liabilities at the lower of the fair value of the asset and the present value of the minimum lease payments. The minimum lease payments are apportioned between finance charges and repayments of the outstanding liability, finance charges being charged to each period of the lease term so as to produce a constant rate of interest on the outstanding balance of the liability. All other leases are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 71 Notes to the financial statements continued 2 Significant accounting policies continued 2.21 Leases continued (a) Hiscox as lessee continued are charged to the income statement on a straight-line basis over the period of the lease. (b) Hiscox as lessor Rental income from operating leases is recognised on a straight-line basis over the term of the relevant contractual agreement. 2.22 Dividend distribution Dividend distribution to the Company’s shareholders is recognised as a liability in the Group’s financial statements in the period in which the dividends are approved. 2.23 Use of critical estimates and assumptions The Directors consider the accounting policies for determining insurance liabilities, amounts denominated in foreign currencies, the valuation of investments, the valuation of retirement benefit scheme obligations and the determination of current and deferred tax assets and liabilities as being most critical to an understanding of the Group’s result and position. The inherent uncertainty of insurance risk requires the Group to make estimates and assumptions that affect the reported amounts of insurance and reinsurance assets and liabilities at the balance sheet date. This is the most significant area of potential uncertainty in the Group’s financial statements. There are several sources of uncertainty that need to be considered in the estimation of the insurance liabilities that the Group will ultimately pay for valid claims. These include but are not restricted to: inflation; changes in legislation; changes in the Group’s claims handling procedures; and discordant judicial opinions which extend the Group’s coverage of risk beyond that envisaged at the time of original policy issuance. The Group seeks to gather corroborative evidence from all relevant sources before making judgements as to the eventual outcome of claims, particularly those under litigation, which have occurred and been notified to the Group but remain unsettled at the balance sheet date. Estimates are continually evaluated based on entity specific historical experience and contemporaneous developments observed in the wider industry, and are also updated for expectations of prospective future developments. Although the possibility exists for material changes in insurance liabilities estimates to have a critical impact on the Group’sreported performance and financial position,it is anticipated that the scale and diversity of the Group’s portfolio of insurance business considerably lessens the likelihood of this occurring. Note 24 to consolidated financial statements provides a greater analysis of the main methods used by the Group when formulating estimates of the insurance claims liabilities at each balance sheet date. With regard to employee retirement benefit scheme obligations, the assets, liabilities and changes disclosed in these consolidated financial statements are sensitive to assumptions regarding mortality, inflation, investment returns and interest rates on corporate bonds, the latter of which has been subject to specific recent volatility. Legislation concerning the determination of taxation assets and liabilities is complex and continually evolving. In preparing the Group’s financial statements, the Directors estimate taxation assets and liabilities after taking appropriate professional advice. The determination and finalisation of agreed taxation assets and liabilities may not occur until several years after the balance sheet date and consequently the final amounts payable or receivable may differ from those presently recorded in these financial statements. 2.24 Reporting of additional performance measures The Directors consider that the claims ratio, expense ratio and combined ratio measures reported in respect of operating segments and the Group overall at note 4 provide useful information regarding the underlying performance of the Group’s businesses. These measures are widely recognised by the insurance industry and are consistent with internal performance measures reviewed by senior management including the chief operating decision maker. However, these three measures are not defined within the IFRS framework and body of standards and interpretations and therefore may not be directly comparable with similarly titled additional performance measures reported by other companies. 3 Management of risk Overview of risk The Group enters into contracts that directly accept and transfer insurance risk, which in turn necessarily creates exposure to financial and other classes of risk. Consequently, Hiscox is fundamentally concerned with the identification and management of all significant risks. The Group’s overall appetite for accepting and managing varying classes of risk is defined by the Group’s Board. The Board has developed a governance framework and set Group-wide risk management policies and procedures which cover specific areas such as risk identification, risk management and mitigation, and risk reporting. The objective of these policies and procedures is to protect the Group’s shareholders, policyholders and other stakeholders from negative events that could hinder the Group’s delivery of its contractual obligations and its achievement of sustainable profitable economic and social performance. The Board exercises oversight over the development and operational implementation of its risk management policies and procedures, and ongoing compliance therewith, partially through its own enquiries but primarily through a dedicated internal audit function, which has operational independence, clear terms of reference influenced by the Board’s Non Executive Directors and a clear upwards reporting structure back into the Board. The main sources of risk relevant to the Group’s operations and its financial statements fall into two broad categories: insurance risk and financial risk. Note 3.1 details the Group’s approach to managing insurance risk specifically whilst note 3.2 onwards outlines the Group’s sensitivity to financial risk generally. Additional information is also provided in the Corporate governance and Risk management sections of this Report and Accounts. 3.1 Insurance risk Insurance risk is transferred to the Group by contract holders through the underwriting process. The Group’s exposure to insurance risk arises from the possibility that an insured event occurs, and a claim is subsequently submitted by the insured for payment. Management of insurance risk on a day-to-day basis is the responsibility of the Chief Underwriting Officer, who receives assistance from the management information and risk modelling departments. The Board sets the Group’s underwriting strategy for accepting and managing insurance risk prospectively, seeking to exploit identified opportunities and taking cognisance of other relevant anticipated market conditions. Specific underwriting objectives such as aggregation limits, reinsurance protection thresholds, geographical disaster event risk exposures and line of business diversification parameters are prepared and reviewed by the Chief Underwriting Officer in order to translate the Board’s summarised underwriting strategy into specific measurable actions and targets. These actions and targets are reviewed and approved by the Board in advance of each underwriting year. The Board continually reviews its underwriting strategy throughout each underwriting year in light of the evolving 72 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 3 Management of risk continued 3.1 Insurance risk continued market pricing and loss conditions and as opportunities present themselves. The Board requires all underwriters to operate within an overall Group appetite for individual events. This defines the maximum exposure that the Group is prepared to retain on its own account for any one potential catastrophe event or disaster. The Group’s underwriting risk appetite seeks to ensure that it should not lose more than one years profit plus 15% of core capital as a result of a 1 in 250 bad year. Realistic disaster scenarios are extreme, hypothetical events selected by Lloyd’s to represent major events occurring in areas with large insured values. They also reflect the areas that represent significant exposures for Hiscox. The Group compiles estimates of losses arising from realistic disaster events using statistical models alongside input from its underwriters. The selection of realistic disaster scenario events is adjusted each year and they are not therefore necessarily directly comparable from one year to the next. The events are extreme and as yet untested, and as such these estimates may prove inadequate as a result of incorrect assumptions, model deficiencies, or losses from unmodelled risks. This means that should a realistical disaster actually eventuate, the Group’s final ultimate losses could materially differ from the current estimates presented below. Estimates of the Group’s maximum loss exposure to a selection of realistic disaster scenarios are shown in the first table below. The Group’s estimated concentration of insurance risk, determined in relation to the broad categories of insurance liabilities reserved on the balance sheet, is summarised in the tables on page 74. The Group’s underwriters and management consider insurance risk at an individual contract level, and also from a portfolio perspective where the risks assumed in similar classes of policies are aggregated and the exposure evaluated in light of historical portfolio experience and prospective factors. To assist with the process of pricing and managing insurance risk the Group routinely performs a wide range of activities including the following: regularly updating the Group’s risk models; documenting, monitoring and reporting on the Group’s strategy to manage risk; developing systems that facilitate the identification of emerging issues promptly; utilising sophisticated computer modelling tools to simulate catastrophes and measure the resultant potential losses before and after reinsurance; monitoring legal developments and amending the wording of policies when necessary; regularly aggregating risk exposures across individual underwriting portfolios and known accumulations of risk; examining the aggregated exposures in advance of underwriting further large risks; and developing processes that continually factor market intelligence into the pricing process. The delegation of underwriting authority to specific individuals, both internally and externally, is subject to regular review. All underwriting staff and binding agencies are set strict parameters in relation to the levels and types of business they can underwrite, based on individual levels of experience and competence. These parameters cover areas such as the maximum sums insured per insurance contract, maximum gross written premiums and maximum aggregated exposures per geographical zone and risk class. Monthly meetings are held between the Chief Underwriting Officer and a specialist central analysis and review team in order to monitor claim development patterns and discuss individual underwriting issues as they arise. The Chief Underwriting Officer also holds weekly video conference meetings with this team to discuss interim underwriting matters. The Group’s insurance contracts include provisions to contain losses such as the ability to impose deductibles and demand reinstatement premiums in certain cases. In addition, in order to manage the Group’s exposure to repeated catastrophic events, relevant policies frequently contain payment limits to cap the maximum amount payable from these insured events over the contract period. One tool for managing insurance risk is reinsurance. Reinsurance protection such as excess of loss cover is purchased at an entity level and is also considered at an overall Group level to mitigate the effect of catastrophes and unexpected concentrations of risk. However, the scope and type of reinsurance protection purchased may change depending on the competitiveness of cover available in the market. Estimated sensitivity to realistic disaster scenarios at 1 January 2008 Gross loss £m Net loss £m Gross loss as a % of GWP Net loss as a % of NWP Net loss as a % of insurance industry loss Industry loss size £ billion Japan Earthquake Gulf of Mexico Windstorm Florida Windstorm European Windstorm San Francisco Earthquake 164 484 333 250 336 109 187 92 104 93 14 40 28 21 28 11 19 9 11 10 0.4 0.3 0.2 0.7 0.5 25 65 58 15 20 Estimated sensitivity to realistic disaster scenarios at 1 January 2007 Gross loss £m Net loss £m Gross loss as a % of GWP Net loss as a % of NWP Net loss as a % of insurance industry loss Industry loss size £ billion Japan Earthquake Gulf of Mexico Windstorm Florida Windstorm European Windstorm San Francisco Earthquake 151 376 321 341 269 101 139 88 147 78 13 33 29 30 24 10 14 9 15 8 0.2 0.2 0.2 0.9 0.4 42 64 58 17 20 Return period* years 100 115 105 60 120 Return period* years 190 100 90 80 120 *A return period relates to the annual probability of a loss from an individual event for a particular peril exceeding a given amount. For example if industry underwriting models suggests that there is a 1% chance per year of a Japanese earthquake generating an insured loss to the industry exceeding £25 billon, then the return period for a £25 billion Japanese earthquake would commonly be described as 100 years. Similarly a 250 year return period suggests a level of insured loss to the industry with a 0.4% probability of exceedance. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 73 Notes to the financial statements continued 3 Management of risk continued 3.1 Insurance risk continued Estimated concentration of gross and net insurance liabilities on balance sheet by territory coverage of premium written 31 December 2007 UK and Ireland Europe United States Other territories Multiple territory coverage Total 31 December 2006 UK and Ireland Europe United States Other territories Multiple territory coverage Total Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Types of insurance risk in Group Reinsurance inwards £000 47,633 40,498 43,751 41,167 111,008 87,937 34,163 31,292 103,081 88,419 Property – Marine and major assets £000 7,200 6,841 22,367 16,918 26,390 15,270 96,391 74,946 81,095 61,345 Property – Other assets £000 122,967 101,690 47,799 41,764 92,012 90,686 53,664 52,564 18,364 18,165 Casualty – Professional indemnity £000 263,869 199,573 66,758 53,523 131,466 129,457 75,478 61,171 1,808 1,101 Casualty – Other risks £000 1,332 1,235 11,662 9,022 18,083 16,495 58,735 43,920 48,576 32,842 Other* £000 Total £000 28,446 17,307 15,340 10,194 13,095 10,406 37,827 49,650 33,527 28,401 471,447 367,144 207,677 172,588 392,054 350,251 356,258 313,543 286,451 230,273 339,636 233,443 334,806 539,379 138,388 128,235 1,713,887 289,313 175,320 304,869 444,825 103,514 115,958 1,433,799 Types of insurance risk in Group Reinsurance inwards £000 74,176 49,679 32,039 26,751 67,037 58,556 17,147 14,990 74,750 64,024 Property – Marine and major assets £000 5,889 5,226 17,757 15,250 69,949 59,135 58,868 50,949 112,707 85,621 Property – Other assets £000 87,420 80,863 45,372 37,801 113,768 98,274 45,701 39,698 17,027 14,709 Casualty – Professional indemnity £000 237,914 188,166 40,539 32,995 188,770 152,688 13,558 10,475 125 100 Casualty – Other risks £000 9,722 9,431 1,975 1,583 27,734 20,756 42,543 30,151 43,105 33,548 Other* £000 Total £000 44,525 22,091 6,451 5,257 17,652 13,269 43,482 41,718 36,399 27,575 459,646 355,456 144,133 119,637 484,910 402,678 221,299 187,981 284,113 225,577 265,149 265,170 309,288 480,906 125,079 148,509 1,594,101 214,000 216,181 271,345 384,424 95,469 109,910 1,291,329 *Includes a diverse mix of certain specialty lines such as kidnap and ransom, terrorism, bloodstock and other risks which contain a mix of property and casualty exposures. Frequency and severity of claims The specific insurance risks accepted by the Group fall broadly into four main categories: reinsurance inwards, marine and major property risks, other property risks and casualty insurance risks. These specific categories are defined for risk review purposes only and are not exclusively aligned to any specific reportable segment in the Group’s operational structure or the primary internal reports reviewed by the chief operating decision maker. A discussion of the frequency and severity of claims for each of those categories is given below. The Group has no significant exposure to asbestos risks or life insurance business. Reinsurance inwards The Group’s reinsurance inwards acceptances are primarily focused on large commercial property, homeowner and marine exposures held by other insurance companies predominantly in North America and other developed economies. This business is characterised more by large claims arising from individual events or catastrophes than the high frequency, low severity attritional losses associated with certain other business written by the Group. Multiple insured losses can periodically arise out of a single natural or man-made occurrence. The main circumstances that result in claims against the reinsurance inwards book are conventional catastrophes, such as earthquakes or storms, and other events including fires and explosions. The occurrence and impact of these events is very difficult to model over the short-term which complicates attempts to anticipate loss frequencies on an annual basis. In those years where there is a low incidence of severe catastrophes, loss frequencies on the reinsurance inwards book can be relatively low. A significant proportion of the reinsurance inwards business provides cover on an excess of loss basis for individual events. The Group agrees to reimburse the cedant once their losses exceed a minimum level. Consequently the frequency and severity of reinsurance inwards’ claims is related not only to the number of significant insured events that occur but also to their individual magnitude. If numerous catastrophes occurred in any one year but the cedant’s individual loss on each was below the minimum stated, then the Group would have no liability under such contracts. Maximum gross line sizes and aggregate exposures are set for each type of programme. Property risks – Marine and major assets The Group directly underwrites a diverse range of property risks. The risk profile of the property covered under marine and major asset policies is different to that typically contained in the other classes of property (such as private households and contents insurance) covered by the Group. Typical property covered by marine and other major property contracts include fixed and moveable assets such as ships and other vessels, cargo in transit, energy platforms and installations, pipelines, other 74 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 3 Management of risk continued 3.1 Insurance risk continued Property risks – Marine and major assets continued subsea assets, satellites, commercial buildings and industrial plants and machinery. These assets are typically exposed to a blend of catastrophic and other large loss events, and attritional claims arising from conventional hazards such as collision, flooding, fire and theft. Climatic changes may give rise to more frequent and severe extreme weatherevents(forexampleearthquakes,windstorms and river flooding etc.) andit may be expected that their frequency will increase over time. For this reason the Group accepts major property insurance risks for periods of mainly one year so that each contract can be re-priced on renewal to reflect the continually evolving risk profile. The most significant risks covered for periods exceeding one year are certain specialist lines such as marine and offshore construction projects which can typically have building and assembling periods of between three and four years. These form a small proportion of the Group’s overall portfolio. Marine and major property contracts are normally underwritten by reference to the commercial replacement value of the property covered. The cost of repairing or rebuilding assets, of replacement or indemnity for contents and time taken to restart or resume operations to original levels for business interruption losses are the key factors that influence the level of claims under these policies. Other property risks The Group provides home and contents insurance, together with cover for art work, antiques, classic cars, jewellery, collectables and other assets held by affluent individuals. Events which can generate claims on these contracts include burglary, acts of vandalism, fires, flooding and storm damage. Losses can be predicted with a greater degree of certainty as there is a rich history of actual loss experience data and the locations of the assets covered, and the individual levels of security taken by owners, are relatively static from one year to the next. The losses associated with these contracts tend to be of a higher frequency and lower severity than the marine and other major property assets covered above. The Group’s home and contents insurance contracts are exposed to weather and climatic risks such as floods and windstorms and their consequences. As outlined earlier the frequency and severity of these losses do not lend themselves to accurate prediction over the short-term. Contract periods are therefore not normally more than one year at a time to enable risks to be regularly re-priced. Contracts are underwritten by reference to the commercial replacement value of the properties and contents insured, and claims payment limits are always included to cap the amount payable on occurrence of the insured event. Casualty insurance risks The casualty underwriting strategy attempts to ensure that the underwritten risks are well diversified in terms of type and amount of potential hazard, industry and geography. However, the Group’s exposure is more focused towards marine and professional and technological liability risks rather than human bodily injury risks, which are only accepted under limited circumstances. Claims typically arise from incidents such as errors and omissions attributed to the insured, professional negligence and specific losses suffered as a result of electronic or technological failure of software products and websites. The provision of insurance to cover allegations made against individuals acting in the course of fiduciary or managerial responsibilities, including directors’ and officers’ insurance, is one example of a casualty insurance risk. However the Group’s specific exposure to this specific risk category is relatively limited. The Group’s casualty insurance contracts mainly experience low severity attritional losses. The Group’s pricing strategy for casualty insurance policies is typically based upon historical claim frequencies and average claim severities, adjusted for inflation and extrapolated forwards to incorporate projected changes in claims patterns. In determining the price of each policy an allowance is also made for acquisition and administration expenses, reinsurance costs, investment returns and the Group’s cost of capital. Sources of uncertainty in the estimation of future claim payments The Group’s procedures for estimating the outstanding costs of settling insured losses at the balance sheet date, including those not yet notified by, or apparent to, the insured, are detailed in note 24. The majority of the Group’s insurance risks are short tail and, based on past history, significant claims are normally notified and settled within 12 to 24 months of the insured event occurring. Those claims taking the longest time to develop and settle typically relate to casualty risks where legal complexities occasionally develop regarding the insured’s alleged omissions or negligence. The majority of the Group’s casualty exposures are written on a claims made basis. However the final quantum of these claims may not be established for a number of years after the event. Consequently a significant proportion of the casualty insurance amounts reserved on the balance sheet may not be expected to settle within 24 months of the balance sheet date. Certain marine and property insurance contracts such as those relating to subsea and other energy assets, and the related business interruption risks, can also take longer than normal to settle. This is because of the length of time required for detailed subsea surveys to be carried out and damage assessments agreed together with difficulties in predicting when the assets can be brought back into full production. 3.2 Financial risk Overview The Group is exposed to financial risk through its ownership of financial assets including loans and receivables, financial liabilities and reinsurance assets. These items collectively represent a significant element of the Group’s net shareholder funds. The key financial risk for the Group is that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance contracts and financial liabilities.The most important entity and economic variables that could result in such an outcome relate to risk factors such as equity price risk, interest rate risk, credit risk, liquidity risk and currency risk. The Group’s policies and procedures for managing exposure to these specific categories of risk are detailed below. (a) Equity price risk The Group is exposed to equity price risk through its holdings of equity and unit trust investments. However this is limited to a small and controlled proportion of the overall investment portfolio and the equity and unit trust holdings involved are well diversified over a number of companies and industries. The fair value amounts held at the balance sheet date may be analysed as follows: Nature of equity and unit trust holdings Directly held equity securities Units held in funds – traditional long only Units held in funds – long and short and special strategies Geographic focus Specific UK mandates Global mandates 2007 % weighting 2006 % weighting 3 77 20 40 60 1 92 7 59 41 Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 75 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (a) Equity price risk continued The allocation of equity risk is not heavily confined to any one market index so as to reduce the Group’s exposure to individual sensitivities. A 10% downward correction in equity prices at 31 December 2007 would have been expected to reduce Group equity and profit after tax for the year by approximately £11.6 million (2006: £9.9 million). A 10% upward movement is estimated to have an equal but opposite effect. Reliability of fair values The Group has elected to carry all financial investments at fair value through income as they are managed and evaluated on a fair value basis in accordance with a documented strategy. With the exception of unquoted equity investments, all of the financial investments held by the Group trade in public markets and the Group therefore determines fair value by reference to published price quotations in the most active financial markets in which the assets trade. The Group determines the fair value of financial assets primarily with reference to their closing bid market prices at the balance sheet date. The ability to obtain quoted bid market prices may be reduced in periods of diminished liquidity, such as those prevailing for certain categories of asset-backed and mortgage-backed fixed income instruments affected by the continued market dislocation that commenced during the second half of 2007. In such instances fair values may be determined using other observable market inputs such as prices provided by market makers such as dealers and brokers, and prices achieved in the most recent regular transaction of identical or closely related instruments occurring before the balance sheet date but updated for relevant perceived changes in market conditions. At 31 December 2007, the Group holds asset-backed and mortgage- backed fixed income instruments in its investment portfolio but has minimal direct exposure to sub-prime asset classes. All such instruments with sub-prime exposure held by the Group were independently rated AAA by at least one of the major rating agencies at 31 December 2007. Together with the Group's investment managers, management continues to monitor the potential for any adverse development associated with this investment exposure through the analysis of relevant factors such as credit ratings, collateral, subordination levels and default rates in relation to the securities held. Valuation of these securities will continue to be impacted by external market factors including default rates, rating agency actions, and liquidity. The Company will make adjustments to the investment portfolio as appropriate as part of its overall portfolio strategy, but its ability to mitigate its risk by selling or hedging its exposures may be limited by the market environment. The Company’s future results may be impacted, both positively and negatively, by the valuation adjustments applied to these securities, however management does not feel that this will have a material impact on the Group's results, cash flows or reported financial position. The Group currently expects all such instruments to mature as expected on their pre-determined contractual terms. The fair value of unquoted equity investments is determined by reference to recent observable market transactions and other valuation factors including the discounted value of expected future cash flows. The carrying value of unquoted equity investments included in the Group’s balance sheet at 31 December 2007 was £4,151,000 (2006: £976,000), representing less than 1% of the total financial assets carried at fair value. (b) Interest rate risk investment portfolio of debt and fixed income securities is inversely correlated to movements in market interest rates. If market interest rates fall, the fair value of the Group’s debt and fixed income investments would tend to rise and vice versa. Debt and fixed income assets are predominantly invested in high quality corporate, government and asset backed bonds. The investments typically have relatively short durations and terms to maturity. The portfolio is managed to minimise the impact of interest rate risk on anticipated Group cash flows. The fair value of debt and fixed income assets in the Group’s balance sheet at 31 December 2007 was £1,445million (2006: £1,044 million). These may be analysed as follows: 31 December 2007 % weighting 31 December 2006 % weighting Nature of debt and fixed income holdings Government issued bonds and instruments Asset backed securities (all AAA rated) Mortgage backed instruments – Agency (all AAA rated) Mortgage backed instruments – Non-agency (all AAA rated) Corporate bonds Lloyd’s and money market deposits 35 16 7 13 27 2 45 18 3 14 18 2 One method of assessing interest rate sensitivity is through the examination of duration-convexity factors in the underlying portfolio. Using a duration-convexity based sensitivity analysis, if market interest rates had risen by 100 basis points at the balance sheet date, the fair value might have been expected to decrease by £22 million (2006: decrease of £13 million). Insurance contract liabilities are not directly sensitive to the level of market interest rates, as they are undiscounted and contractually non-interest-bearing. The Group’s debt and fixed income assets are further detailed at note 18. The Group’s major borrowing facility at 31 December 2007 totalled £91,764,000 (2006: £92,852,000). The Group agreed an interest rate margin at the commencement of the borrowing term in November 2005 and the applicable base interest rate element is reset to applicable LIBOR market rates at periodic intervals dependent on the Group’s perception of interest rate outlook. The overall interest charge associated with these borrowings is currently fixed at 6.12% until 30 June 2008. The Group has no other significant borrowings or other assets or liabilities carrying interest rate risk, other than the facilities and Letters of Credit outlined in note 33. (c) Credit risk The Group has exposure to credit risk, which is the risk that a counterparty will suffer a deterioration in perceived financial strength or be unable to pay amounts in full when due. Key areas of exposure to credit risk include: reinsurers’ share of insurance liabilities; amounts due from reinsurers in respect of claims already paid; amounts due from insurance contract holders; and counterparty risk with respect to cash and cash equivalents, and investments including deposits and derivative transactions. Fixed income investments represent a significant proportion of the Group’s assets and the Board continually monitors investment strategy to minimise the risk of a fall in the portfolio’s market value which could affect the amount of business that the Group is able to underwrite or its ability to settle claims as they fall due. The fair value of the Group’s The Group’s maximum exposure to credit risk is represented by the carrying values of monetary assets and reinsurance assets included in the consolidated balance sheet. The Group does not use credit derivatives or other products to mitigate maximum credit risk exposures. The Group structures the levels of credit risk accepted by placing limits 76 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 3 Management of risk continued 3.2 Financial risk continued (c) Credit risk continued also receives details of recent payment history and the status of any ongoing negotiations between Group companies and these third parties. This information is used to update the reinsurance purchasing strategy. on their exposure to a single counterparty, or groups of counterparties, and having regard to geographical locations. Such risks are subject to an annual or more frequent review. There is no significant concentration of credit risk with respect to loans and receivables, as the Group has a large number of internationally dispersed debtors with unrelated operations. Reinsurance is used to contain insurance risk. This does not, however, discharge the Group’s liability as primary insurer. If a reinsurer fails to pay a claim for any reason, the Group remains liable for the payment to the policyholder. The creditworthiness of reinsurers is therefore continually reviewed throughout the year. The Group Reinsurance Security Committee assesses the creditworthiness of all reinsurers by reviewing credit grades provided by rating agencies and other publicly available financial information detailing their financial strength and performance. The financial analysis of reinsurers produces an assessment categorised by Standard & Poor’s (S&P) rating (or equivalent when not available from S&P). The Committee considers the reputation of its reinsurance partners and Individual operating units maintain records of the payment history for significant brokers and contract holders with whom they conduct regular business. The exposure to individual counterparties is also managed by other mechanisms, such as the right of offset where counterparties are both debtors and creditors of the Group. Management information reported to the Group’s Board includes details of provisions for impairment on loans and receivables and subsequent write-off. Exposures to individual intermediaries and groups of intermediaries are collected within the ongoing monitoring of the controls associated with regulatory solvency. The Group also mitigates credit counterparty risk by concentrating debt and fixed income investments in high quality instruments, including a particular emphasis on government gilts issued mainly by European Union and North American countries. An analysis of the Group’s major exposures to counterparty credit risk excluding loans and receivables, based on Standard & Poor’s or equivalent rating, is presented below: As at 31 December 2007 Debt and fixed income securities Reinsurance assets Cash and cash equivalents Deposits with credit institutions Derivative financial assets/(liabilities) Total Note AAA £000 AA £000 A £000 17 18 1,116,903 15,309 97,816 35,911 – 18 21 18, 20 106,754 134,475 173,755 501 – 158,157 120,536 31,166 107,462 – Other/ not rated £000 Total £000 62,718 1,444,532 280,088 9,768 302,742 5 143,874 – – – 1,265,939 415,485 417,321 72,491 2,171,236 Amounts attributable to largest single counterparty 252,875 96,909 17,984 4,996 The largest counterparty exposure within AAA rating is with the US Treasury. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2007 are supported by letter of credit guarantees issued by financial institutions with Standard & Poor’s or equivalent credit or financial strength ratings of A or better. As at 31 December 2006 Debt and fixed income securities Reinsurance assets Cash and cash equivalents Deposits with credit institutions Derivative financial assets/(liabilities) Total Note 18 17 21 18 18, 20 AAA £000 AA £000 A £000 742,964 20,892 115,661 – – 72,210 130,155 242,980 – 608 140,634 121,261 144,228 54,715 – Other/ not rated £000 Total £000 87,861 1,043,669 302,772 30,464 502,871 2 54,715 – 608 – 879,517 445,953 460,838 118,327 1,904,635 Amounts attributable to largest single counterparty 215,745 46,600 23,649 17,209 The largest counterparty exposure within the AAA rating is with the US Treasury. The largest counterparty exposure under other ratings is a reinsurance asset that is supported by Letter of Credit guarantees rated A or better. At 31 December 2007 the Group held no material debt and fixed income assets that were past due or impaired beyond their reported fair values, either for the current period under review or on a cumulative basis (2006: £nil). For the current and prior periods under review, all of the Group’s maturing financial instruments settled on their original contractual terms and payment dates, and the Group therefore experienced no losses of, or delays in recovering, principal amounts invested. (d) Liquidity risk The Group is exposed to daily calls on its available cash resources mainly from claims arising from insurance contracts. Liquidity risk is the risk that cash may not be available to pay obligations when due at a reasonable cost. The Board sets limits on the minimum level of cash and maturing funds available to meet such calls and on the minimum level of borrowing facilities that should be in place to cover at unexpected levels of claims and other cash demands. A significant proportion of the Group’s investments are in highly liquid assets which could be converted into cash in a prompt fashion and at minimal expense. The deposits with credit institutions largely comprise short dated certificates for which an active market exists and which the Group can easily access. The Group’s exposure to equities is concentrated on shares and funds that are frequently traded on internationally recognised stock exchanges. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 77 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (d) Liquidity risk continued The main focus of the investment portfolio is on high quality short duration debt and fixed income securities, and cash. There is no significant holdings of investments with specific repricing dates. Notwithstanding the regular interest receipts and also the Group’s ability to liquidate these securities and its other financial instrument assets, for cash in a prompt and reasonable manner, the contractual maturity profile of the fair value of these securities at 31 December was as follows: Fair values at balance sheet date analysed by contractual maturity Less than one year Between one and two years Between two and five years Over five years Sub-total Debt and fixed income securities £000 176,432 374,869 563,052 282,110 Cash and cash equivalents £000 302,742 – – – Deposits with credit institutions £000 132,757 11,117 – – 2007 Total £000 2006* Total £000 611,931 385,986 563,052 282,110 783,477 257,883 307,325 192,890 1,396,463 302,742 143,874 1,843,079 1,541,575 Perpetual notes and other non-dated instruments 48,069 – – 48,069 60,288 Total 1,444,532 302,742 143,874 1,891,148 1,601,863 *Included in amounts receivable in ‘less than one year’ are derivative balances at 31 December 2007 of £nil (2006: £608,000). The Group’s equities and shares in unit trusts and perpetual notes and other non-dated instruments have no contractual maturity terms but could also be orderly liquidated for cash in a prompt and reasonable timeframe within one year of the balance sheet date if so required. Average contractual maturity analysed by denominational currency of investments Pound Sterling US Dollar Euro Canadian Dollar 2007 Years 4.69 9.42 4.11 1.83 2006 Years 3.56 7.76 3.99 1.47 The following is an analysis by liability type of the estimated timing of net cash flows based on the net claims liabilities held. The Group does not discount claims liabilities. The estimated phasing of settlement is based on current estimates and historical trends and the actual timing of future settlement cash flows may differ materially from that disclosure below. Liquidity requirements to settle estimated profile of net claim liabilities on balance sheet Reinsurance inwards Property – marine and major assets Property – other assets Casualty – professional indemnity Casualty – other risks Other* Total Liquidity requirements to settle estimated profile of net claim liabilities on balance sheet Reinsurance inwards Property – marine and major assets Property – other assets Casualty – professional indemnity Casualty – other risks Other* Total Within one year £000 Between one and two years £000 95,083 53,458 108,740 104,889 26,851 14,965 71,981 53,688 50,832 121,326 32,324 13,062 Between two and five years £000 20,058 15,932 16,618 87,778 15,355 4,518 Over five years £000 21,404 7,947 6,369 34,188 12,462 3,387 2007 Total £000 208,526 131,025 182,559 348,181 86,992 35,932 403,986 343,213 160,259 85,757 993,215 Within one year £000 Between one and two years £000 Between two and five years £000 57,103 51,151 85,524 106,976 28,405 12,000 52,221 56,694 44,636 105,249 27,570 11,420 21,183 17,690 15,204 77,332 11,482 4,163 Over five years £000 23,864 8,519 6,074 25,095 10,360 3,341 2006 Total £000 154,371 134,054 151,438 314,652 77,817 30,924 341,159 297,790 147,054 77,253 863,256 * Includes a diverse mix of certain specialty lines such as kidnap and ransom, terrorism, bloodstock and other risks which contain a mix of property and casualty exposures. Details of the payment profile of other Group liabilities is given in notes 18 and 25. (e) Currency risk The Group operates internationally and its exposures to foreign exchange risk arise primarily with respect to the US Dollar and the Euro. The assets of the Group’s Bermudian, US and European insurance businesses are generally invested in assets denominated in the same currencies as their insurance and investment liabilities. The Group has financed a portion of its net investment in its Bermudian and Guernsey based operations, which have US Dollar functional currencies, using US Dollar denominated borrowings, to which net investment hedge accounting has applied for the vast majority of the year under review, 78 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued (see note18). The Group also entered into foreign currency derivative transactions during the current and prior years under review, details of which are given in note 20. All foreign currency derivative transactions are managed centrally by designated individuals, delegated thresholds are set and Board approval is required in advance of all significant individual and aggregated positions being taken. Included in the tables below are net non-monetary liabilities of £233 million (2006: £231million) which are denominated in foreign currencies. The profile of the Group’s assets and liabilities, categorised by currency at their translated carrying amount is as follows: At 31 December 2007 Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Loans and receivables including insurance receivables Reinsurance assets Cash and cash equivalents Total assets Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities carried at fair value Current tax Trade and other payables Total liabilities At 31 December 2006 Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Loans and receivables including insurance receivables Reinsurance assets Cash and cash equivalents Total assets Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities carried at fair value Current tax Trade and other payables Total liabilities Sensitivity analysis Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 35,369 17,281 986 47,637 5,083 1,499 – 56,001 411,908 1,130,080 168,889 158,151 166,436 87,963 130,634 116,780 – 598 516 15,204 165,258 48,280 19,912 44,606 40,452 – 19,378 – 1,502 – 4,239 123,081 40,581 1,747,827 385,222 280,088 302,742 9,902 5,777 10,722 876,075 1,658,622 294,374 71,221 2,900,292 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 – 9,751 – – 491,339 1,015,832 91,764 – 114,521 – 24,711 51,390 – – 167,302 – – 54,219 – – – 9,751 39,414 1,713,887 91,764 24,711 235,875 – – 15,745 577,191 1,222,117 221,521 55,159 2,075,988 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 33,212 12,222 28 53,503 478,159 152,076 83,325 69,219 – 1,088 – 52,463 580,028 242,823 192,657 392,644 – 511 – 10,276 147,386 41,588 20,758 33,273 – – – 873 33,212 13,821 28 117,115 36,337 1,241,910 446,272 302,772 502,871 9,785 6,032 7,735 881,744 1,461,703 253,792 60,762 2,658,001 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 3,801 8,467 441,619 297 20,793 114,428 – – 984,763 93,555 – 99,382 – – 132,912 77 – 35,432 – – 3,801 8,467 34,807 1,594,101 93,929 20,793 254,825 – – 5,583 589,405 1,177,700 168,421 40,390 1,975,916 A 10% strengthening or weakening of the following currencies against Pound Sterling at 31 December 2007 would be estimated to have (decreased)/increased equity and profit or loss before tax by the approximate amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. The analysis is performed on the same basis for 2006. Effect on equity £m Effect on profit before tax £m 31 December 2007 US Dollar Euro 31 December 2006 US Dollar Euro Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 51.3 6.9 40.6 7.3 32.2 9.9 15.5 10.4 79 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued Sensitivity analysis continued A 10% weakening of the Pound Sterling against the above currencies at 31 December would have been expected to result in equal but opposite effect on the above currencies to the amounts shown above, on the basis that all other variables remain constant. (f) Limitations of sensitivity analysis The sensitivity information given in notes (a) to (e) above demonstrates the impact of a change in a major input assumption while other assumptions remain unchanged. In reality, there is normally significant levels of correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation and taking other protective action. 3.3 Capital risk management The Group’s primary objectives when managing its capital position are: to safeguard its ability to continue as a going concern, so that it can continue to provide long-term growth and progressive dividend returns for shareholders; to provide an adequate return to the Group’s shareholders by pricing its insurance products and services commensurately with the level of risk; the attainment of an efficient cost of capital; and to comply with all regulatory requirements by a significant margin. The Group sets the amount of capital required in its funding structure in proportion to risk. The Group then manages the capital structure and makes adjustments to it in the light of changes in economic conditions and the risk characteristics of the underlying assets. In order to obtain or maintain an optimal capital structure the Group may adjust the amountofdividends paid to shareholders, returncapital to shareholders, issue new shares, assume debt, or sell assets to reduce debt. The Group’s activities are funded by a mixture of capital sources including issued equity share capital, retained earnings, Letters of Credit, bank debt and other third party insurance capital. The Board ensures that the use and allocation of capital are given a primary focus in all significant operational actions. With that in mind, the Group has developed and embedded sophisticated capital modelling tools within its business. These join together short-term and long-term business plans and link divisional aspirations with the Group’s overall strategy. The models provide the basis of the allocation of capital to different businesses and business lines, as well as the regulatory and rating agency capital processes. There were no changes in the Group’s approach to capital risk management during the current or prior year under review. Gearing The Group currently utilises short-to medium-term gearing as an additional source of funds to maximise the opportunities from strong markets and to reduce the risk profile of the business when the rating environment shows a weaker model for the more volatile business. The Group’s gearing is obtained from a number of sources, including: Letters of Credit – in November 2005, the Group secured a £137.5 million facility from a syndicate of banks at a margin of 1.1%; term and revolving loan facility – also in November 2005, the Group secured a $225 million facility at 1.3% margin of which $182 million remains available; external Names – 27.4% of Syndicate 33’s capacity is capitalised by third parties paying a profit share of approximately 17.5%; sidecar – in December 2006, Syndicate 33 entered into a limited tenacy quota share reinsurance arrangement with Panther Re, whose sole activity was to participate in the 2007 year property catastrophe reinsurance business of its only client, Syndicate 33. Panther Re was capitalised at $360 million and all risks underwritten were fully collateralised; Cougar Syndicate at Lloyd’s – with a capacity of £34.6 million, this syndicate is wholly backed by external members and will take a pure 2008 year of account quota share of Syndicate 33’s international property catastrophe reinsurance account; gearing quota shares – historically the Group has used reinsurance capital to fund its capital requirement for short-term expansions in the volume of business underwritten by the Syndicate; and qualifying quota shares – these are reinsurance arrangements that allow the Group to increase the amount of premium it writes in hard markets. The funds raised through Letters of Credit and loan facilities have been applied to support both the 2008 year of account for Syndicate 33 and the capital requirements of Hiscox Insurance Company (Bermuda) Limited, formed in 2005. Financial strength Standard & Poor’s and A.M. Best’s ratings of the financial strength of the Group’s UK insurance company subsidiary, Hiscox Insurance Company Limited, remained at A- (Excellent) during the year. Similarly Hiscox Insurance Company (Bermuda) Limited and Hiscox Insurance Company (Guernsey) Limited retained their A- (Excellent) ratings from A.M. Best. Syndicate 33 benefits from an A.M. Best rating of A (Excellent) and the Lloyd’s ratings of A (Excellent) from A.M. Best and A+ (Strong) from Standard & Poor’s. Capital performance The Group’s main capital performance measure is the achieved Return on Equity (ROE). This marker best aligns the aspirations of employees and shareholders. As variable remuneration, the vesting of options and longer-term investment plans all relate directly to ROE, this concept is embedded in the workings and culture of the Group. The Group maintains its cost of capital levels and its debt to overall equity ratios in line with others in the non-life insurance industry. Capital modelling and regulation The capital requirements of an insurance group are determined by its exposure to risk and the solvency criteria established by management and statutory regulations. In 2005, the Financial Services Authority (FSA) and Lloyd’s introduced a new capital regime that enables insurance companies the chance to calculate their own capital requirements through Individual Capital Assessments (ICA). Hiscox Insurance Company Limited and Syndicate 33 maintain ICA models in accordance with this regime. The models are concentrated specifically on the particular product lines, market conditions and risk appetite of each entity. If the FSA considers an ICA to be inadequate, it can require the entity to maintain an increased 80 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 3 Management of risk continued 3.3 Capital risk management continued Capital modelling and regulation continued capital safeguard. The Directors are also required to certify that the Group has complied, in all material aspects, with the provisions of the Interim Prudential Sourcebook: Insurers (IPRU(INS)), the Integrated Prudential Sourcebook for Insurers (INSPRU) and General Prudential Sourcebook (GENPRU) when completing the ICA return. The Group used its own integrated modelling expertise to produce the ICA calculations. The results mirrored those driving the existing internal capital setting process. The assessed capital requirement for the business placed through Hiscox Insurance Company Limited is driven by the level of resources necessary to maintain an A-rating.The Group’s internal work on the ICA of Hiscox Insurance Company for regulatory purposes has produced results that also support the level of capital required by the rating agencies. For Syndicate 33, the ICA process produces a result that is uplifted by Lloyd’s to identify the capital required to hold the A rating. The strong control and risk management environment, together with the sophistication of the modelling, have produced a capital ratio below that suggested under the previous risk-based capital regime. Another key area of capital modelling for Hiscox is to identify which insurance vehicle produces the best return on capital employed for the Group, given certain restraints from licences, reinsurance and the regulatory environment. This modelling takes into account transactional costs and tax, in addition to the necessary capital ratios. It proves the capital efficiency of Lloyd’s, despite a tax disadvantage against offshore entities, and the cost advantage of processing smaller premium business outside of Lloyd’s. In addition to the ICA modelling process, the EU Insurance Group’s Directive of 1998, as amended by the Financial Group’s Directive (FGD), compels insurance companies that are members of a group to consider the solvency margin of their ultimate parent company. This consideration must refer to the surplus assets of the ultimate parent’s related insurers, reinsurers, intermediate holding companies andother regulated entities. The FGD has been applied in the UK through INSPRU and GENPRU. In accordance with these provisions, the parent company’s solvency margin consideration became a minimum capital requirement for the Group from 31 December 2006 onwards. The estimated regulatory capital position of the Group under FGD at 31 December 2007 was a surplus of £536 million (2006: surplus of £435 million), which is calculated as below. The final regulatory capital position will be submitted to the FSA before 30 April 2008 in accordance with the required regulatory timetable. In the Group’s other geographical territories, including the USA, its subsidiaries underwriting insurance business are required to operate within broadly similar risk-based externally imposed capital requirements when accepting business. Estimated Group capital position At 31 December Group capital resources Group capital resources requirement Surplus 2007 £m 738 (202) 536 2006 £m 617 (182) 435 Group capital resources are less than the Group’s total equity value primarily as a result of the inadmissability of certain assets including intangible assets for regulatory purposes. 4 Operating segments The Group adopted IFRS 8 Operating Segments with effect from 1 January 2007. The Group also made minor changes to the structure of its internal organisation during the year under review. As a consequence of both events, minor changes have occurred in the identification of the Group’s reportable segments from the prior year. Previously IAS 14 Segment Reporting (the predecessor standard to IFRS 8) resulted in the Group identifying and reporting disaggregated primary statement information for two sets of reportable segments, whose designation was based on the dissimilarity of risks and rewards in the Group’s operations and geographical location. Segment information is now required to be presented with singular reference to the basis of those regular internal reports about the separate components of the Group that inform the chief operating decision maker and which are used in the assessment of financial performance and allocation of resources. Management have identified the Group’s operating segments in line with its internal organisation, which recognises the differences in products and services, customer groupings and geographical areas in addition to the discrete major legal entities of the Group. The Group’s four operating segments arising on the adoption of IFRS 8 are therefore identified as follows: Global Markets comprises the results of Syndicate 33, excluding Syndicate 33’s fine art, UK regional events coverage, non-US household business and underwriting result of Hiscox Inc. It includes the results of the larger retail TMTbusinesswritten by Hiscox Insurance Company Limited. UK and Europe comprises the results of Hiscox Insurance Company Limited, the results of Syndicate 33’s fine art, UK regional events coverage and non-US household business, together with the income and expenses arising from the Group’s retail agency activities in the UK and in continental Europe. It excludes the results of the larger retail TMT business written by Hiscox Insurance Company Limited. International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Inc., Hiscox Insurance Company (Bermuda) Limited and the ALTOHA sub-group. Corporate Centre comprises the investment return, finance costs and administrative costs associated with Group management activities. Corporate Centre forms a reportable segment due to its investment activities which earn significant external revenues. The four reportable segments identified above, and the under noted financial information related thereto, differ from the three primary business segments disclosed in the prior year, in three main ways: The Group’s central functions are now separately identified as the ‘Corporate Centre’ segment, with a greater proportionofcentral revenues and expenses now being allocated to individual operating segments where appropriate. Previously all central revenues and expenses were included with the Global Markets business within a single segment. This is a change arising from the adoption of IFRS 8. The Group’s specie business, all of which is written in Syndicate 33, is now presented within the Global Markets segment and not within the UK and Europe segment as previously reported. This is a change arising from minor amendments made to the Group’s internal organisation during the year. The Global Markets segment also now includes all of the Group’s larger TMT risks. In prior years, those risks underwritten by Hiscox Insurance Company Limited were reported in the UK and Europe segment. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 81 Notes to the financial statements continued 4 Operating segments continued This is a change arising from minor amendments made to the Group’s internal organisation during the year. Information regarding the Group’s operating segments is presented below. The comparative amounts for the prior year have been restated to conform to the requirements of IFRS 8. The comparative amounts have also been restated to reflect the re-classification of certain agency commissions and expenses outlined at note 2.2 above. All amounts reported below represent transactions with external parties only, with all inter-segment amounts eliminated. Performance is measured based on each reportable segments profit before tax. (a) Profit before tax by segment Gross premiums written Net premiums written Net premiums earned Investment result including interest revenues* Other revenues Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Year to 31 December 2007 Year to 31 December 2006 676,464 302,273 220,212 524,683 265,001 185,226 552,205 248,348 164,637 – 1,198,949 709,080 265,778 151,306 – 974,910 603,562 234,414 137,421 – 965,190 567,490 227,865 93,473 – 1,126,164 – 975,397 – 888,828 46,617 11,996 18,343 2,672 23,915 1,216 10,802 3,160 99,677 19,044 33,123 6,878 19,327 4,931 16,449 421 36,651 105,550 15,692 3,462 Revenue 610,818 269,363 189,768 13,962 1,083,911 607,491 252,123 110,343 40,113 1,010,070 Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Administration expenses Other expenses (246,876) (115,032) (61,457) – (423,365) (271,120) (95,317) (15,904) – (382,341) (157,718) (65,423) (27,822) (37,399) (22,830) (29,692) (41,429) (11,592) (6,104) – (264,570) (145,458) – (76,813) (37,001) (15,242) (73,868) (62,933) (62,861) (31,360) (29,473) (27,478) (8,172) (6,878) – (235,797) (76,533) – (5,659) (104,943) Total expenses (455,246) (247,546) (120,582) (15,242) (838,616) (516,512) (219,011) (58,432) (5,659) (799,614) Results of operating activities Finance costs including interest expense Share of profit of associates after tax 155,572 21,817 69,186 (1,280) 245,295 90,979 33,112 51,911 34,454 210,456 – – – – (82) (8,095) (8,177) (312) – 81 81 – – – (36) (9,056) (9,404) – 10 10 Profit before tax 155,572 21,817 69,104 (9,294) 237,199 90,667 33,112 51,875 25,408 201,062 *Interest revenues total £85,435,000 (2006: £68,644,000). The following charges are included within the consolidated income statement: Depreciation Amortisation of intangible assets Year to 31 December 2007 Year to 31 December 2006 Global Markets £000 975 40 UK and Europe £000 3,303 137 International £000 Corporate Centre £000 599 41 40 5 Total £000 4,917 223 Global Markets £000 1,412 40 UK and Europe £000 2,276 135 International £000 170 – Corporate Centre £000 40 12 Total £000 3,898 187 The Group’s wholly owned subsidiary, Hiscox Syndicates Limited, oversees the operation of Syndicate 33 at Lloyd’s. The Group’s percentage participation in Syndicate 33 can fluctuate from year to year and consequently, presentation of the results at the 100% level removes any distortions arising therefrom. 100% ratio analysis Claims ratio (%) Expense ratio (%) Combined ratio (%) Year to 31 December 2007 Year to 31 December 2006 Global Markets 44.3 37.4 81.7 UK and Europe 45.6 52.6 98.2 International Corporate Centre 40.1 35.3 75.4 – – – Total 44.0 40.4 84.4 Global Markets 55.7 34.4 90.1 UK and Europe 41.3 54.9 96.2 International Corporate Centre 17.5 45.2 62.7 – – – Total 49.3 39.8 89.1 In calculating the claims and expense ratios the Group has applied an estimated allocation of the foreign exchange gains and losses to each category. The impact on profit before tax of a 1% change in each component of the segmental combined ratios is: At 100% level (note 4b) 1% change in claims or expense ratio At Group level 1% change in claims or expense ratio Year to 31 December 2007 Year to 31 December 2006 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 7,660 2,598 1,695 5,522 2,483 1,646 – – 7,865 2,400 948 5,675 2,279 935 – – 82 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 4 Operating segments continued (b) 100% operating result by segment Gross premiums written Net premiums written Net premiums earned Investment result Other revenues Claim and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Administration expenses Other expenses Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Year to 31 December 2007 Year to 31 December 2006 932,251 316,017 227,576 722,209 276,967 191,219 765,959 259,841 169,465 – 1,475,844 – 1,190,395 827,424 247,891 – 1,195,265 786,471 240,039 971,174 281,038 154,999 141,114 94,794 – 1,407,211 – 1,216,429 – 1,121,304 64,552 2,665 19,161 2,672 23,915 500 10,802 118,430 8,997 3,160 54,207 – 19,886 4,931 16,449 1,480 36,651 3,462 127,193 9,873 (345,318) (118,418) (67,938) – (531,674) (377,006) (99,047) (16,597) – (492,650) (222,965) (69,428) (42,375) (11,913) (5,596) (34,640) (38,079) (22,858) (29,350) – (334,768) (204,579) – (84,632) (43,798) (15,242) (73,046) (83,135) (67,259) (31,872) (32,783) (27,763) (8,172) (6,878) – (299,601) (83,842) – (5,659) (128,455) Results of operating activities 207,395 26,399 66,058 (1,280) 298,572 132,160 33,895 53,313 34,454 253,822 Segment results at the 100% level presented above differ from those presented at the Group’s share at note 4(a) solely as a result of the Group not owning 100% of the capacity of Syndicate 33 at Lloyd’s. (c) Segmental analysis of assets and liabilities The segment assets and liabilities at 31 December and the capital expenditure for the year then ended are as follows: Financial assets Reinsurance assets Intangible assets Deferred acquisition costs Other assets Total assets Insurance liabilities Other liabilities Total liabilities Capital expenditure Financial assets Reinsurance assets Intangible assets Deferred acquisition costs Other assets Total assets Insurance liabilities Other liabilities Total liabilities Capital expenditure Global Markets £000 UK and Europe £000 954,701 162,516 25,275 56,231 456,515 271,572 102,137 2,985 36,087 248,366 International £000 385,091 28,691 7,543 24,792 222,796 Corporate Centre £000 Intragroup items and eliminations £000 31 December 2007 Total £000 137,965 – 4,649 – 658,318 – 1,749,329 (13,256) 280,088 40,452 123,081 707,342 – 5,971 (878,653) 1,655,238 661,147 668,913 800,932 (885,938) 2,900,292 1,081,287 419,549 407,332 166,858 229,481 51,859 – 158,760 (434,926) (4,213) 1,713,887 362,100 1,500,836 574,190 281,340 158,760 (439,139) 2,075,987 9,409 190 3,375 167 13,141 Global Markets £000 UK and Europe £000 746,900 237,165 25,315 68,895 497,321 328,871 78,929 3,120 29,225 152,693 International £000 16,848 4,679 – 20,414 380,751 Corporate Centre £000 Intragroup items and eliminations £000 31 December 2006 Total £000 149,319 – 4,777 – 504,007 – 1,241,938 302,772 33,212 117,115 (571,808) 962,964 (18,001) – (1,419) 1,575,596 592,838 422,692 658,103 (591,228) 2,658,001 1,167,765 323,279 354,720 158,832 89,617 16,486 – 127,139 (243,921) (18,001) 1,594,101 381,815 1,491,044 513,552 106,103 127,139 (261,922) 1,975,916 4,330 230 1,159 231 5,950 Segment assets and liabilities primarily consist of operating assets and liabilities, which represent the majority of the balance sheet. Intragroup assets and liabilities that cross segments are presented under the separate category heading ‘Intragroup items and eliminations’. Capital expenditure comprises expenditure on intangible assets (note 14) other than goodwill, and additions to property, plant and equipment (note 15), but excluding assets acquired on business combinations. (d) Geographical information The Group’s operational segments underwrite business fromlocations inthe UK and Ireland, and also through its branch network inGuernsey, France, Germany, Belgium, the Netherlands, Spain, Portugal and Sweden. In addition, the Group commenced underwriting and agency operations in Bermuda and the USA in 2006. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 83 Notes to the financial statements continued 4 Operating segments continued (d) Geographical information continued The following table provides an analysis of the Group’s gross premium revenues earned by material geographical location of external parties: Gross premium revenues earned from external parties Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Global Markets £000 UK and Europe £000 Year to 31 December 2007 UK and Ireland Europe United States Rest of World 9,095 85,441 202,703 77,171 69,956 19,913 2,006 101,485 310,892 62,050 3,924 234,808 – 297,239 99,006 183,834 – 167,040 64,459 82,129 – 414,383 347,000 3,774 – 300,782 137,369 4,703 International £000 5,361 11,518 48,565 45,867 701,097 285,804 192,543 – 1,179,444 665,504 256,770 111,311 Year to 31 December 2006 Corporate Centre £000 Total £000 – 288,201 – 158,106 – 399,339 187,939 – – 1,033,585 The Group’s largest external policyholder contributed less than 2% of total gross Group premium revenues earned and the details thereof are not disclosed on the grounds of materiality. The Group has not reported segmental details of non-current assets excluding financial instruments and including loans and receivables, rights and obligations under insurance and reinsurance contracts, investments in associates and subsidiaries on the grounds of the relevance of these items to the Group’s operations and the usefulness of such information to users. 5 Net asset value per share Net asset value Net tangible asset value Net asset value (total equity) £000 824,304 783,852 2007 NAV per share pence 209.5 199.3 Net asset value (total equity) £000 682,085 648,873 2006 NAV per share pence 173.2 164.8 The net asset value per share is based on 393,386,041 shares (2006: 393,725,396), being the adjusted number of shares in issue at 31 December. There is no impact on the comparative amount for the application of reverse acquisition accounting in the prior year (note 2.3). 6 Investment result The total result for the Group before taxation comprises: Investment income including interest receivable Net realised gains/(losses) on financial investments at fair value through profit or loss Net fair value gains on financial investments at fair value through profit or loss Return on financial investments and financial liabilities (note 7) Fair value gains/(losses) on derivative instruments and borrowings Total result Investment expenses are presented within other expenses (note 9). 7 Analysis of return on investments The return on investments for the year by currency was: Sterling US Dollar Other 2007 £000 2006 £000 90,259 10,105 423 100,787 (1,110) 75,526 (5,731) 8,721 78,516 27,034 99,677 105,550 2007 % 4.9 5.5 3.6 2006 % 5.4 4.8 2.2 The return on financial investments and financial liabilities by asset class for the year was: Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions/cash and cash equivalents Global Markets UK and Europe International Corporate Centre 2007 Total £000 % £000 % £000 43,802 – 2,815 46,617 5.2 – 4.9 5.2 9,599 1,131 7,613 18,343 5.6 1.3 5.5 4.6 11,553 2,181 10,181 23,915 % 6.1 9.1 5.2 5.9 £000 5,734 3,647 2,531 11,912 % 6.1 6.4 6.5 6.3 £000 70,688 6,959 23,140 100,787 % 5.5 4.1 5.4 5.4 84 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 7 Analysis of return on investments continued Global Markets UK and Europe International Corporate Centre 2006 Total £000 % £000 % £000 % £000 % £000 % Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions/cash and cash equivalents 30,518 194 2,411 33,123 4.2 9.9 3.8 4.2 7,601 6,994 4,732 19,327 3.3 9.9 4.2 4.6 323 1,014 15,112 16,449 2.6 17.6 4.9 5.1 3,653 5,315 649 9,617 4.0 10.4 42,095 13,517 3.9 5.8 22,904 78,516 8 Deferred acquisition costs Gross £000 Reinsurance £000 2007 Net £000 Gross £000 Reinsurance £000 4.0 10.6 4.6 4.6 2006 Net £000 Balance deferred at 1 January Acquisition costs incurred in relation to insurance contracts written Acquisition costs expensed to the income statement 117,115 284,071 (278,105) 110,586 (6,529) 106,747 271,426 (12,645) 253,271 13,535 (264,570) (242,303) (2,496) (11,139) 7,106 104,251 242,132 (235,797) Balance deferred at 31 December 123,081 (5,639) 117,442 117,115 (6,529) 110,586 The deferred amount of insurance contract acquisition costs attributable to reinsurers of £5,639,000 (2006: £6,529,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 25). The amounts expected to be recovered before and after one year are estimated as follows: Within one year After one year 9 Other revenues and expenses Agency related income Profit commission Other income Other revenues Managing agency expenses Overseas underwriting agency expenses Connect agency expenses Net foreign exchange (gains)/losses Investment expenses Other Group expenses including depreciation and amortisation Other expenses 10 Employee benefit expense The aggregate remuneration and associated costs were: Wages and salaries, including holiday pay and sabbatical leave charges Social security costs Share based payments cost of options granted to Directors and employees Pension costs – defined contribution Pension costs – net expense/(credit) arising on defined benefit schemes 2007 £000 2006 £000 117,442 – 110,586 – 117,442 110,586 2007 £000 4,626 10,468 3,950 2006 £000 4,861 5,332 5,499 19,044 15,692 28,870 23,811 14,492 (8,401) 1,250 13,846 17,258 22,033 12,547 38,354 1,306 13,445 73,868 104,943 Note 13 14, 15 Note 2007 £000 2006 £000 22 28 68,135 8,909 5,689 7,256 (3,801) 58,568 7,512 5,238 1,689 12,180 86,188 85,187 The average monthly number of staff employed by the Group was 804 (2006: 637) comprising 301underwriting and 503 administrative staff (2006: 270 and 367 respectively). Of the total remuneration shown above, an amount of £19,838,000 (2006: £20,780,000) was recharged to the syndicate managed by Hiscox Syndicates Limited. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 85 Notes to the financial statements continued 11 Finance costs Interest and expenses associated with bank borrowings carried at fair value Interest and charges associated with Letters of Credit Interest charges arising on finance leases Note 18 33 2007 £000 6,278 1,845 54 8,177 2006 £000 7,325 2,038 41 9,404 12 Auditors’ remuneration Fees payable to the Group’s main external auditor KPMG, its member firms and its associates (exclusive of VAT) include the following amounts recorded in the consolidated income statement: Group Fees payable to the Company’s auditor for the audit of the Group’s consolidated financial statements Fees payable to the Company’s auditor and its associates for other services: The audit of subsidiaries pursuant to legislation Other services pursuant to legislation All other services* Fees in respect of the defined benefit pension scheme: Audit Total auditors’ remuneration expense 2007 £000 201 345 50 93 689 12 701 2006 £000 110 321 30 307 768 9 777 *Other fees relate primarily to corporate advisory and financial reporting consulting services (2006: Group’s Scheme of Arrangement and the listing of Hiscox Ltd on the London Stock Exchange). Non-audit services with fees greater than £50,000 must be pre-approved by the Audit Committee which is composed solely of independent Non Executive Directors. The full audit fee payable for the Syndicate audit has been included above, although an element of this is borne by the third party participants in the Syndicate. Fees payable to other external auditors in respect of the Company’s subsidiaries in the United States pursuant to legislation during 2007 were £51,000 (2006: £nil). 13 Net foreign exchange gains/(losses) The net foreign exchange gains/(losses) for the year include the following amounts: Exchange gains/(losses) recognised in the consolidated income statement Exchange losses classified as a separate component of equity** 2007 £000 2006 £000 8,401 (38,354) (2,869) (41,218) This excludes profits or losses on foreign exchange derivative contracts which are included within the investment result and are outlined in note 20. Overall impact of foreign exchange related items Consolidated income statement Derivative gains/(losses) on foreign exchange contracts included within investment return Unearned premiums and deferred acquisition costs adjustment Foreign exchange gains on borrowings for economic hedging of Hiscox Insurance Company (Bermuda) Limited Other foreign exchange losses Impact of foreign exchange related items on consolidated income statement Note 6, 20 2007 £000 2006 £000 (1,110) 27,034 14,438 – (6,037) (25,511) 14,121 (26,964) 8,401 (38,354) 7,291 (11,320) **Foreign exchange differences recognised directly in equity during 2007 include £1,400,000 of losses arising on the retranslation of a portion of the Group’s net investment in its Bermudian and Guernsey subsidiaries, which are entirely offset by corresponding gains of the same amount on the retranslation of certain foreign currency borrowings designated for hedge accounting (2006: £nil recognised in equity on foreign currency borrowings). Further details are provided at note 18 to these financial statements. 86 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 14 Intangible assets At 1 January 2006 Cost Accumulated amortisation and impairment Net book amount Year ended 31 December 2006 Opening net book amount Other additions Amortisation and impairment charge Closing net book amount At 31 December 2006 Cost Accumulated amortisation and impairment Net book amount Year ended 31 December 2007 Opening net book amount Additions in year on business combinations Other additions Disposal on sale of subsidiary Amortisation charges Closing net book amount At 31 December 2007 Cost Accumulated amortisation and impairment Net book amount Goodwill £000 Syndicate capacity £000 State authorisation licences £000 Other £000 Total £000 8,547 (2,442) 24,505 – 6,105 24,505 6,105 – – 6,105 24,505 – – 24,505 8,547 (2,442) 24,505 – 6,105 24,505 6,105 – – (39) – 24,505 – – – – 6,066 24,505 8,496 (2,430) 24,505 – 6,066 24,505 – – – – – – – – – – – 5,083 – – – 5,083 5,083 – 5,083 2,670 (181) 35,722 (2,623) 2,489 33,099 2,489 300 (187) 33,099 300 (187) 2,602 33,212 2,970 (368) 36,022 (2,810) 2,602 33,212 2,602 – 2,500 (81) (223) 33,212 5,083 2,500 (120) (223) 4,798 40,452 5,361 (563) 43,445 (2,993) 4,798 40,452 The Group’s intangible asset relating to syndicate capacity has been allocated, for impairment testing purposes, to one individual cash generating unit being the active Lloyd’s corporate member entity. The Group has considered the recoverable amount from the active Lloyd’s corporate member entity on a value in use basis. This calculation uses cash flow projections based on financial forecasts approved by management covering a five-year period. Cash flows beyond the five-year period are extrapolated based on an average level of return and annual growth estimated at 2% consistent with the industry long term average. A pre-tax discount factor of 7% has been applied to projected cash flows as part of the exercise. The results of this exercise indicate that the recoverable amount exceeds the intangible’s carrying value. The Group’s weighted average cost recognised on the balance sheet is approximately 10 Pence per Pound of syndicate capacity held, which is significantly below the average open market price of 26 Pence per Pound witnessed in the recent Lloyd’s of London Syndicate 33 capacity auctions in Autumn 2007. The Group has recognised intangible assets of £5,083,000 relating to insurance authorisation licences for 50 US states acquired in the business combination of ALTOHA Inc. (note 31). This intangible asset has been allocated for impairment testing purposes to one individual cash generating unit being the Group’s North American underwriting businesses. The Group has considered the recoverable amount of this cash generating unit on a consistent basis to the active Lloyd’s corporate member entity outlined above. Other intangibles primarily relate to the costs of acquiring rights to customer contractual relationships, and at 31 December 2006 also included a limited level of capitalised software costs. The additions during 2006 primarily comprised the Group’s acquisition of the customer relationships of Global Flying Insurance Services. The additions during 2007 primarily relate to the costs of acquiring rights to customer contractual relationships held previously by AON Limited. The amortisation charge for the year includes £40,000 (2006: £40,000) relating to capitalised software costs. The net book value of capitalised software costs at 31 December 2007 was £nil (2006: £40,000). There are no charges for impairment during the current or prior financial year. The Group had no internally generated intangible assets at 31 December 2007 (2006: £nil). Goodwill is allocated to the Group’s cash generating units (‘CGUs’) identified according to country of operation and business segment. At 31 December 2007 and 2006 the Group’s goodwill net book amount is all attributable to UK based operations. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 87 Notes to the financial statements continued 15 Property, plant and equipment Land and buildings £000 Leasehold improvements £000 At 1 January 2006 Cost Accumulated depreciation Net book amount Year ended 31 December 2006 Opening net book amount Additions Disposals Depreciation charge Closing net book amount At 31 December 2006 Cost Accumulated depreciation Net book amount Year ended 31 December 2007 Opening net book amount Additions Additions on business combinations Disposals Depreciation charge Closing net book amount At 31 December 2007 Cost Accumulated depreciation Net book amount 2,985 (80) 2,905 2,905 – – (40) 2,865 2,985 (120) 2,865 2,865 – – – (40) 2,825 2,985 (160) 2,825 Furniture, fittings and equipment and art £000 Total £000 24,925 (16,184) 28,563 (16,435) 8,741 12,128 8,741 4,973 (4) (3,655) 12,128 5,650 (59) (3,898) Vehicles £000 647 (171) 476 476 169 (55) (125) 465 10,055 13,821 679 (214) 29,894 (19,839) 34,072 (20,251) 465 10,055 13,821 465 260 18 (31) (116) 10,055 10,119 10 (263) (4,629) 13,821 10,641 127 (294) (4,917) 596 15,292 19,378 6 – 6 6 508 – (78) 436 514 (78) 436 436 262 99 – (132) 665 1,044 (379) 896 (300) 34,978 (19,686) 39,903 (20,525) 665 596 15,292 19,378 The Group’s land and buildings assets relate to freehold property in the United Kingdom. At 31 December 2006 part of the buildings were occupied by third parties under separate operating lease arrangements (note 34). Assets with a net book value of £510,000 were held under finance leases (2006: £465,000). The total depreciation charge for the year in respect of assets held under finance leases was £106,000 (2006: £125,000). At 31 December 2007 there were £2,336,000 of assets under construction, upon which no depreciation has yet been charged (2006: £nil). 16 Investments in associates Year ended 31 December At beginning of year Additions during the year Share of post-tax profit recognised for the period At end of year The Group’s interests in its principal associates, all of which are unlisted, were as follows: 2007 £000 28 1,393 81 1,502 2006 £000 18 – 10 28 Name Blyth Valley Ltd Total at the end of 2006 Blyth Valley Ltd Plexstar Insurance Services Limited Barta & Partner GmbH HIM Capital Holdings Ltd Total at the end of 2007 % interest held at 31 December Country of incorporation 25.2 UK 25.2 49.0 25.0 40.0 UK UK Austria UK Entity 100% pro-forma information for year ended 31 December 2007 Assets £000 192 192 565 769 1,232 300 2,866 Liabilities £000 Revenues £000 83 83 179 579 1,074 – 1,832 784 784 1,325 573 1,064 – 2,962 Profit £000 40 40 192 98 310 – 600 88 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 16 Investments in associates continued The additions during the current year relate to equity investments made in Plexstar Insurance Services Limited, Barta & Partner GmbH and HIM Capital Holdings Ltd. Cash consideration of £1,273,000 was paid. The equity interests held by the Group in respect of associates do not have quoted market prices and are not traded regularly in any active recognised market. The associates concerned have no material impact on the results or assets of the Group. No impairments were identified during the current or prior financial year under review. 17 Reinsurance assets Reinsurers’ share of insurance liabilities Provision for non-recovery and impairment Reinsurance assets Note 2007 £000 2006 £000 283,414 (3,326) 306,550 (3,778) 24 280,088 302,772 The amounts expected to be recovered before and after one year, based on historical experience, are estimated as follows: Within one year After one year 147,987 132,101 136,790 165,982 280,088 302,772 Amounts due from reinsurers in respect of outstanding premiums and claims already paid by the Group are included in loans and receivables (note 19). The Group recognised a gain during the year of £452,000 (2006: £4,094,000) in respect of impaired balances. 18 Financial assets and liabilities carried at fair value Financial assets and liabilities are measured at their bid price fair values and ask price fair values respectively, with all changes from one accounting period to the next being recorded through the income statement, except in the case of unlisted equity investments, and borrowing instruments that formed part of a designated hedge accounting relationship from 1January 2007 as provided for by IAS 39. Note 2007 Cost £000 2007 Fair value £000 2006 Cost £000 2006 Fair value £000 Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Total investments Derivative instrument assets 1,435,373 1,444,532 1,046,009 1,043,669 141,841 54,715 135,427 143,852 159,421 143,874 117,457 54,800 1,714,652 1,747,827 1,218,266 1,240,225 20 – – – 1,685 Total financial investments at fair value through profit or loss 1,714,652 1,747,827 1,218,266 1,241,910 Borrowings from credit institutions (see below) Derivative instrument liabilities 2007 Cost £000 91,457 – 2007 Fair value £000 91,764 – 2006 Cost £000 2006 Fair value £000 92,857 – 92,852 1,077 Note 20 Total financial liabilities at fair value through profit or loss 91,457 91,764 92,857 93,929 An analysis of the credit risk and contractual maturity profiles of the Group’s debt and fixed income securities is given in notes 3.2(c) and 3.2(d). The Group has no material exposure to financial assets not actively traded on recognised markets. The Group’s borrowings from credit institutions at 31 December 2006 and 2007 are denominated in US Dollars, half fall due for repayment in 2008 and half fall due for repayment in 2009. The movement in fair value of financial liabilities during 2007 includes no net principal repayments, £1,400,000 of foreign exchange gains recognised directly in equity (see note 13 and below) and £302,000 of fair value losses (2006: £14,212,000 of net principal repayments, £14,121,000 of foreign exchange gains and £5,000 of fair value gains). The amounts recognised as fair value gains and losses are attributable to changes in applicable benchmark interest rates. The amount of financial liabilities payable on maturity is not materially different to the cost disclosed above. Included in financial liabilities at 31 December 2007 are foreign currency borrowings from credit institutions totalling US$182,000,000 (2006: US$nil) that were designated as a hedging instrument in a net investment hedge relationship. The hedged item was the foreign currency spot retranslation risk associated with the first US$182,000,000 of the Group’s net investment in its Bermudian and Guernsey subsidiaries. The hedging relationship commenced on 3 January 2007 and was entirely effective throughout the entire period up until the balance sheet date. Investments at 31 December are denominated in the following currencies at their fair value: Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 89 Notes to the financial statements continued 18 Financial assets and liabilities carried at fair value continued Debt and fixed income securities Sterling US Dollars Euro and other currencies Equities and shares in unit trusts Sterling US Dollars Euro and other currencies Deposits with credit institutions Sterling US Dollars Euro and other currencies Total investments The table below illustrates the movements in financial assets during the year: At 1 January Net additions/(disposals) into investment portfolio Net fair value gains At 31 December 19 Loans and receivables including insurance receivables Gross receivables arising from insurance and reinsurance contracts Less provision for impairment Net receivables arising from insurance and reinsurance contracts Due from contract holders, brokers, agents and intermediaries Due from reinsurance operations Prepayments and accrued income Other loans and receivables: Net profit commission receivable Accrued interest Right to reimbursement of defined benefit obligation Share of Syndicate’s other debtors’ balances Other debtors including related party amounts Total loans and receivables including insurance receivables The amounts expected to be recovered before and after one year are estimated as follows: Within one year After one year 2007 £000 2006 £000 206,357 1,038,412 199,763 308,914 552,015 182,740 1,444,532 1,043,669 102,196 51,148 6,077 114,530 26,328 983 159,421 141,841 95,541 48,333 – 143,874 54,715 – – 54,715 1,747,827 1,240,225 2007 £000 2006 £000 1,240,225 1,237,778 (6,274) 8,721 507,179 423 1,747,827 1,240,225 Note 2007 £000 2006 £000 329,156 (1,392) 356,354 (875) 327,764 355,479 28 201,157 126,607 280,694 74,785 327,764 355,479 9,562 6,746 13,850 9,003 – 12,705 12,338 14,443 6,065 1,163 44,316 18,060 385,222 446,272 381,639 3,583 446,272 – 385,222 446,272 There is no significant concentration of credit risk with respect to loans and receivables, as the Group has a large number of internationally dispersed debtors. The Group has recognised a loss of £517,000 (2006: gain of £143,000) for the impairment (and subsequent recovery) of receivables during the year ended 31 December 2007. 90 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 20 Derivative financial instruments Derivative financial instruments are used on occasion to hedge certain economic relationships including the foreign exchange volatility arising from translating the net investments in, and results of, subsidiary companies with different functional currencies, and the foreign exchange impact of insurance business dominated in foreign currencies. During the current and prior financial year, the Group has not elected to denominate any derivative contracts as formal hedging instruments and, as a consequence, has not applied the hedge accounting provisions of IAS 39 in respect of these contracts. At 31 December 2007 the Group had no derivative exposure on foreign exchange cylinder option contracts (2006: financial asset with net fair value of £1,685,000). The Group recognised gains totalling £317,000 in respect of these contracts in the current year (2006: gain of £6,577,000). No expenses or charges were incurred in the acquisition of the derivative contracts (2006: £nil). The Group also entered into conventional foreign exchange forward and option contracts during the current and prior year primarily in order to manage the net investment in the Bermudian operation and currency exposures related to the proceeds raised from the Rights Issue. The contract outstanding at the prior balance sheet date required the Group to sell US $293,000,000 at an agreed future rate to Pound Sterling at a fixed date within one year of the balance sheet date. At 31 December 2007, this contract had been closed out and a gain recognised of £732,000. Other contracts opened and closed during the current year resulted in a loss of £2,159,000 being recognised. The Group had no outstanding derivative exposures at 31 December 2007. Foreign exchange cylinder option contracts expiring: Within one year Between one and five years Total at 31 December Foreign exchange forward contract expiring: Within one year Total at 31 December 2007 Contract notional amounts $000 Fair value of assets £000 Fair value of liabilities £000 – – – – – – – – – – – – – – – Contract notional amounts $000 50,000 – 50,000 Fair value of assets £000 1,700 – 1,700 2006 Fair value of liabilities £000 15 – 15 293,000 293,000 – – 1,077 1,077 The Group had the right and intention to settle all contracts on a net basis at 31 December 2006. Consequently, only the net balance was recognised in the 2006 balance sheet as detailed in note 18. 21 Cash and cash equivalents Cash at bank and in hand Short-term bank deposits 22 Share capital Group Issued share capital 2007 £000 2006 £000 236,417 66,325 142,200 360,671 302,742 502,871 31 December 2007 31 December 2006 Number of shares Share capital £000 Number of shares Share capital £000 397,938,305 19,898 393,915,738 19,694 The amounts presented in the equity structure of the Group above relate to Hiscox Ltd, the legal parent Company. In accordance with the reverse acquisition provisions of IFRS 3 Business Combinations, the amount of issued share capital included in the consolidated balance sheet reflects that of Hiscox plc, the Group’s former legal parent company, up until the date of the reverse acquisition on 12 December 2006 together with that issued subsequently by Hiscox Ltd, the new legal parent, up until each respective balance sheet date. Changes in Group share capital At 1 January 2006 Employee share option scheme – proceeds from shares issued Transfers on reverse acquisition At 31 December 2006 Employee share option scheme – proceeds from shares issued Dividends to shareholders At 31 December 2007 Note 2.3 Ordinary share capital £000 19,570 124 – 19,694 204 – Share premium £000 Contributed surplus £000 401,365 2,829 (404,194) – 264 442,161 – 442,425 4,955 – – (43,591) 19,898 4,955 398,834 Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 91 Notes to the financial statements continued 22 Share capital continued In accordance with Bermuda law, an amount of £442,161,000 was reclassified as contributed surplus on completion of the reverse acquisition of Hiscox Ltd. Included in this amount are balances of £4,723,000 and £33,244,000 relating to the previously reported merger reserve and capital redemption reserve respectively. Equity structure of Hiscox Ltd At 1 January Issue of ordinary shares to original subscriber at par value on incorporation Issue of ordinary shares on scheme of arrangement Employee share option scheme – ordinary shares issued Redemption of subscriber’s shares At 31 December Number of 5p ordinary shares in issue (thousands) 2007 393,916 – – 4,022 – Number of 5p ordinary shares in issue (thousands) 2006 – 140 393,707 209 (140) 397,938 393,916 At the date of incorporation of the Company (6 September 2006) the authorised share capital of £7,000 comprised 140,000 ordinary shares of 5p each. On 21 September 2006 the authorised share capital was increased to £30,000,000 comprising 600,000,000 ordinary shares of 5p each. No further changes occurred during the current year under review. The redemption of the original subscriber’s shares was at par value. 393,707,089 shares were issued at fair value to the members of Hiscox plc on 12 December 2006 in consideration for the cancellation of their shareholdings in that company. All issued shares are fully paid. Share options and performance share plan awards Share options and performance share plan awards are granted to Directors and to senior employees. The exercise price of the granted options is equal to the closing mid-market price of the shares on the day before the date of the grant. No exercise price is attached to performance plan awards, although their attainment is conditional on the employee completing three year’s service (the vesting period) and the Group achieving targeted levels of returns on equity. Share options are also conditional on the employee completing three years’ service (the vesting period) or under exceptional circumstances (death, disability, retirement or redundancy). The options are exercisable starting three years from the grant date only if the Group achieves its targets of profitability; the options have a contractual option term of ten years. The Group has no legal or constructive obligation to re-purchase or settle the options in cash. In accordance with IFRS 2 the Group recognises an expense for the fair value of share option and performance share plan award instruments issued to employees, over their vesting period through the income statement. The expense recognised in the Consolidated Income Statement during the year was £5,689,000 (2006: £5,238,000). This comprises charges of £4,352,000 (2006: £2,828,000) in respect of performance share plan awards and £1,337,000 (2006: £2,410,000) in respect of share option awards. The amount expensed in the prior year includes £930,000 in respect of modification arising in January 2006, pursuant to the Group’s Rights Issue in November 2005. The Group has applied the principles outlined in the Black-Scholes option pricing model when determining the fair value of each share option instrument and discounted cash flow methodology in respect of performance share plan awards. The forfeiture of expected dividends during the vesting period was taken into account when determining the fair value measurement of performance share plan awards. The range of principal Group assumptions applied in determining the fair value of share based payment instruments granted during the year under review are: Assumptions affecting inputs to fair value models Annual risk free rates of return and discount rates (%) Long-term dividend yield (%) Expected life of options (years) Implied volatility of share price (%) Weighted average share price (p) 2007 2006 5.5 4.75 3.25 26 268.5 3.5-5.0 2.0-4.0 3.25-7.5 32-49 149.5 The weighted average fair value of each share option granted during the year was 67.9p (2006: 95.9p). The weighted average fair value of each performance share plan award granted during the year was 232.8p (2006: 210.0p). Movements in the number of share options during the year and details of the balances outstanding at 31 December 2007 are shown in the Directors’ remuneration report. The implied volatility assumption is based on historical data for periods of between five and ten years immediately preceding grant date. For options issued after 1 January 2006 the assumptions regarding long-term dividend yield have been aligned to the progressive dividend policy announced during the 2005 Rights Issue. Additional details on the Group’s share option schemes are shown in the Directors’ remuneration report accompanying these financial statements. 92 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 23 Retained earnings and other reserves Currency translation reserve Total other reserves at 31 December Retained earnings at 31 December 2007 £000 2006 £000 (43,265) (40,396) (43,265) (40,396) 443,882 260,362 The currency translation reserve comprises foreign exchange differences arising from the translation of the financial statements of, and investments in, foreign operations. 4,365,305 ordinary shares of 5p each were purchased by Hiscox Ltd in open market transactions during the current year (2006: nil) and are held in treasury. Retained earnings have been reduced by £11,343,000 being the consideration paid. Included within this amount are transaction cost expenses of £23,000 directly related to the purchases. The highest price paid per share was 265p, the lowest price paid was 247.75p and the average price paid was 259.4p per share. At 31 December 2007 Hiscox Ltd held 4,365,305 shares in treasury. Additional details are shown in note 35 to these financial statements in respect of additional Hiscox Ltd shares held by subsidiaries. Included within Group retained earnings is an amount of £21,578,000 (2006: £20,578,000), which is not distributable and is held to meet solvency capital requirements to maintain an equalisation provision. The amounts in the equalisation provision are realised when particular entities in the Group have suffered insurance losses in excess of levels set out in the relevant solvency capital regulations. 24 Insurance liabilities and reinsurance assets Gross Claims reported and loss adjustment expenses Claims incurred but not reported Unearned premiums Total insurance liabilities, gross Recoverable from reinsurers Claims reported and loss adjustment expenses Claims incurred but not reported Unearned premiums Total reinsurers’ share of insurance liabilities Net Claims reported and loss adjustment expenses Claims incurred but not reported Unearned premiums Total insurance liabilities, net The amounts expected to be recovered and settled before and after one year, based on historical experience, are estimated as follows: Within one year After one year Note 2007 £000 2006 £000 642,252 573,635 498,000 703,159 425,170 465,772 1,713,887 1,594,101 137,868 84,804 57,416 214,148 50,925 37,699 17 280,088 302,772 504,384 488,831 440,584 489,011 374,245 428,073 1,433,799 1,291,329 844,570 589,229 685,409 605,920 1,433,799 1,291,329 The gross claims reported, the loss adjustment expenses liabilities and the liability for claims incurred but not reported are net of expected recoveries from salvage and subrogation. The amounts for salvage and subrogation at the end of 2007 and 2006 are not material. 24.1 Insurance contracts assumptions (a) Process used to decide on assumptions The risks associated with insurance contracts and in particular with casualty insurance contracts are complex and subject to a number of variables that complicate quantitative sensitivity analysis. For all risks, the Group uses several statistical methods to incorporate the various assumptions made in order to estimate the ultimate cost of claims. The reserves for outstanding claims are actuarially estimated primarily by using both the Chain Ladder and Bornhuetter-Ferguson methods. There is close communication between the actuaries involved in the estimation process and the Group’s underwriters to ensure that, when applying both estimation techniques, both parties are cognisant of all material factors relating to outstanding claims, and allowance is also made for the rating environment. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 93 (b) Claims development tables The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The Group analyses actual claims development compared with previous estimates on an accident year basis. This exercise is performed to include the liabilities of Syndicate 33 at the 100% level regardless of the Group’s actual level of ownership, which has increased significantly over the last six years. Analysis at the 100% level is required in order to avoid distortions arising from reinsurance to close arrangements which subsequently increase the Group’s share of ultimate claims for each accident year three years after the end of that accident year. The top half of each table, on the following pages, illustrates how estimates of ultimate claim costs for each accident year have changed at successive year ends. The bottom half reconciles cumulative claim costs to the amounts still recognised as liabilities. A reconciliation of the liability at the 100% level to the Group’s share, as included in the Group balance sheet, is also shown. Notes to the financial statements continued 24 Insurance liabilities and reinsurance assets continued 24.1 Insurance contracts assumptions continued (a) Process used to decide on assumptions continued The Chain Ladder method is adopted for mature classes of business where sufficient claims development data is available in order to produce estimates of the ultimate claims and premiums by actuarial reserving Group and underwriting year or year of account for the managed Syndicate.This methodology produces optimal estimates when a large claims development history is available and the claims development patterns throughout the earliest years are stable. Where losses in the earliest underwriting years or years of account have yet to fully develop, a ‘tail’ arises on the reserving data, i.e. a gap between the current stage of development and the fully developed amount. The Chain Ladder methodology is used to calculate average development factors which, by fitting these development factors to a curve, allows an estimate to be made of the potential claims development expected between the current and the fully developed amount, known as a ‘tail reserve’. This tail reserve is added to the current reserve position to calculate the total reserve required. 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 this historical pattern. The selected development factors are then applied to cumulative claims data for each accident year that is not yet fully developed to produce an estimated ultimate claims cost for each accident year. Chain Ladder techniques are less suitable in cases in which the insurer does not have developed claims history data for a particular class of business (e.g. in relation to more recent underwriting years or years of account). In these instances the Group’s actuaries make reference to the Bornhuetter-Ferguson method. The Bornhuetter-Ferguson method is based on the Chain Ladder approach but utilises estimated ultimate loss ratios. This 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 has been used in situations in which developed claims experience was not available for the projection (recent accident years or new classes of business). In exceptional cases the required provision is calculated with reference to the actual exposures on individual policies. Adjustments are made within the claims reserving methodologies to remove distortions in the historical claims development patterns from large or isolated claims not expected to re-occur in the future. In addition, the reserves determined for the managed Syndicate are converted to annually accounted figures using earnings patterns that are consistent with those for the underlying Syndicate business. The choice of selected results for each accident 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 combinations of techniques have been selected for individual accident years or groups of accident years within the same class of business. 94 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 24 Insurance liabilities and reinsurance assets continued 24.1 Insurance contracts assumptions continued (b) Claims development tables continued Insurance claims and claims expenses reserves – gross at 100% Accident year Estimate of ultimate claims costs as adjusted for foreign exchange* at end of accident year one year later two years later three years later four years later five years later six years later 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 Total £000 582,662 567,633 625,822 645,088 681,204 678,172 675,393 355,086 376,185 382,234 368,115 364,306 345,767 – 394,954 402,951 379,055 389,528 383,093 – – 588,662 954,388 649,510 1,053,059 619,682 1,057,875 – 584,437 – – – – – – 505,750 488,644 – – – – – 685,965 4,067,467 – 3,537,982 – 3,064,668 – 1,987,168 – 1,428,603 – 1,023,939 675,393 – Current estimate of cumulative claims Cumulative payments to date 675,393 (550,166) 345,767 (289,047) 383,093 (298,855) 584,437 1,057,875 (735,891) (434,005) 488,644 (261,989) 685,965 4,221,174 (153,523)(2,723,476) 125,227 56,720 84,238 150,432 321,984 226,655 532,442 1,497,698 Liability recognised at 100% level Liability recognised in respect of prior accident years at 100% level Total gross liability to external parties at 100% level Reconciliation of 100% disclosures above to Group’s share – gross Accident year 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 Total £000 Current estimate of cumulative claims Less: Attributable to external Names 675,393 (172,846) 345,767 (72,228) 383,093 (88,261) 584,437 1,057,875 (274,629) (137,166) 488,644 (96,871) 685,965 4,221,174 (971,039) (129,038) Group share of current ultimate claims estimate 502,547 273,539 294,832 447,271 783,246 391,773 556,927 3,250,135 Cumulative payments to date Less: Attributable to external Names (550,166) 137,450 (289,047) 57,683 (298,855) 66,166 (434,005) 105,140 (735,891) 192,672 (261,989) 49,447 (153,523)(2,723,476) 632,118 23,560 Group’s share of cumulative payments (412,716) (231,364) (232,689) (328,865) (543,219) (212,542) (129,963)(2,091,358) 89,831 42,175 62,143 118,406 240,027 179,231 426,964 1,158,777 Liability for 2001 to 2007 accident years recognised on Group’s balance sheet Liability for accident years before 2001 recognised on Group’s balance sheet Total Group liability to external parties included in balance sheet – gross** Insurance claims and claims expenses reserves – net at 100% Accident year 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 Total £000 Estimate of ultimate claims costs as adjusted for foreign exchange* at end of accident year one year later two years later three years later four years later five years later six years later 287,895 323,583 381,384 413,320 404,236 392,112 388,403 237,401 258,930 265,650 251,537 245,892 235,466 – 307,137 322,020 297,150 307,699 298,719 – – 492,147 535,338 515,172 481,864 – – – 572,367 653,704 649,302 – – – – 450,018 447,659 – – – – – 593,001 2,939,966 – 2,541,234 – 2,108,658 – 1,454,420 948,847 – 627,578 – 388,403 – Current estimate of cumulative claims Cumulative payments to date 388,403 (302,120) 235,466 (183,245) 298,719 (229,114) 481,864 (350,961) 649,302 (398,400) 447,659 (241,053) 593,001 3,094,414 (133,857)(1,838,750) 86,283 52,221 69,605 130,903 250,902 206,606 459,144 1,255,664 Liability recognised at 100% level Liability recognised in respect of prior accident years at 100% level Total net liability to external parties at 100% level *The foreign exchange adjustment arises from the retranslation of the estimates at each date using the exchange rate ruling at 31 December 2007. ** This represents the claims element of the Group’s insurance liabilities. 73,845 1,571,543 57,110 1,215,887 34,156 1,289,820 Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 95 Notes to the financial statements continued 24 Insurance liabilities and reinsurance assets continued 24.1 Insurance contracts assumptions continued (b) Claims development tables continued Reconciliation of 100% disclosures above to Group’s share – net Accident year 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 Total £000 Current estimate of cumulative claims Less: Attributable to external Names 388,403 (93,570) 235,466 (47,506) 298,719 (67,445) 481,864 (114,287) 649,302 (160,471) 447,659 (90,264) 593,001 3,094,414 (687,180) (113,637) Group’s share of current ultimate claims estimate 294,833 187,960 231,274 367,577 488,831 357,395 479,364 2,407,234 Cumulative payments to date Less: Attributable to external Names (302,120) 69,063 (183,245) 33,405 (229,114) 48,666 (350,961) 84,617 (398,400) 96,884 (241,053) 46,210 (133,857)(1,838,750) 399,936 21,091 Group’s share of cumulative payments (233,057) (149,840) (180,448) (266,344) (301,516) (194,843) (112,766) (1,438,814) Liability for 2001 to 2007 accident years recognised on Group’s balance sheet Liability for accident years before 2001 recognised on Group’s balance sheet Total net liability to external parties included in the balance sheet* *This represents the claims element of the Group’s insurance liabilities and reinsurance assets. 24.2 Movements in insurance claims liabilities and reinsurance claims assets 61,776 38,120 50,826 101,233 187,315 162,552 366,598 968,420 24,795 993,215 Year ended 31 December Total at beginning of year Claims and claims adjustment expense for year Cash paid for claims settled in the year Exchange differences and other movements Gross £000 Reinsurance £000 2007 Net £000 Gross £000 Reinsurance £000 2006 Net £000 (1,128,329) (498,568) 452,235 (41,225) 265,073 (863,256) 75,203 (423,365) (131,505) 320,730 (27,324) 13,901 (1,322,493) (395,497) 504,656 85,005 467,800 (854,693) 13,156 (382,341) 311,129 62,649 (193,527) (22,356) Total at end of year (1,215,887) 222,672 (993,215) (1,128,329) 265,073 (863,256) Notified claims Incurred but not reported Total at end of year (642,252) (573,635) 137,868 (504,384) 84,804 (488,831) (703,159) (425,170) 214,148 50,925 (489,011) (374,245) (1,215,887) 222,672 (993,215) (1,128,329) 265,073 (863,256) The insurance claims expense reported in the consolidated income statement is comprised as follows: Current year claims and loss adjustment expenses (Under)/over provision in respect of prior year claims and loss adjustment expenses Gross £000 Reinsurance £000 2007 Net £000 Gross £000 Reinsurance £000 2006 Net £000 (562,223) 78,953 (483,270) (353,895) 3,275 (350,620) 63,655 (3,750) 59,905 (41,602) 9,881 (31,721) Total claims and claims handling expense (498,568) 75,203 (423,365) (395,497) 13,156 (382,341) 96 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 25 Trade and other payables Creditors arising out of direct insurance operations Creditors arising out of reinsurance operations Obligations under finance leases Share of Syndicate’s other creditors’ balances Social security and other taxes payable Other creditors Reinsurers’ share of deferred acquisition costs Accruals and deferred income Total The amounts expected to be settled before and after one year are estimated as follows: Within one year After one year Note 2007 £000 2006 £000 34 8 30,353 114,317 33,473 126,319 144,670 159,792 457 2,681 4,067 13,704 442 15,481 5,846 8,049 20,909 29,818 5,639 64,657 6,529 58,686 235,875 254,825 234,828 1,047 252,298 2,527 235,875 254,825 The amounts expected to be settled after one year of the balance sheet date primarily relate to finance leases and the Group’s provision of sabbatical leave employee benefits. 26 Tax expense The amounts charged in the consolidated income statement comprise the following: Current tax expense Deferred tax expense Note 27 2007 £000 2006 £000 26,891 19,060 45,951 8,770 28,446 37,216 The tax expense on the Group’s profit before tax differs from the theoretical amount that would arise using the average tax rate applicable to profits of the consolidated companies as follows: Profit before tax Tax calculated at the standard corporation tax rate applicable in the UK* of 30% (2006: 30%)** Effects of: Expenses not deductible for tax purposes Income not subject to tax Group entities subject to overseas tax at lower rates Tax losses for which no deferred tax asset is recognised Other items Change of deferred tax rate Prior year tax adjustments Tax charge for the period *The principal charge to current tax arises in respect of the Group’s UK subsidiaries. **The UK corporation tax rate will be changed from 30% to 28% from April 2008. 27 Deferred tax Deferred tax assets Deferred tax liabilities Total net deferred tax liability All material tax assets and liabilities relate to the same tax authority. 2007 £000 2006 £000 237,199 201,062 71,160 60,319 (1,296) – (24,843) 1,092 (2,064) (1,374) 3,276 652 (10,264) (18,121) 4,351 (75) – 354 45,951 37,216 2007 £000 2006 £000 40,153 (49,904) 24,945 (33,412) (9,751) (8,467) Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 97 Notes to the financial statements continued 27 Deferred tax continued The movement on the total net deferred tax liability is as follows: At 1 January Income statement charge Transfer from deferred tax to current tax (Charge to)/released from equity At 31 December The applicable rate for deferred tax from April 2008 is 28%. (a) Group deferred tax assets analysed by balance sheet headings At 31 December Tangible assets Trade and other payables Retirement benefit obligations Losses Other items Total deferred tax assets 2006 £000 1,344 8,991 6,876 – 7,734 Income statement (charge)/credit £000 (121) 6,471 2,600 4,151 4,181 24,945 17,282 2007 £000 2006 £000 (8,467) (19,060) 19,850 (2,074) (15,193) (28,446) 31,805 3,367 (9,751) (8,467) Transfer to current tax £000 Transfer from equity £000 2007 £000 1,223 15,462 9,476 4,151 9,841 – – – – (2,074) (2,074) 40,153 (b) Group deferred tax liabilities analysed by balance sheet headings and Syndicate participation At 31 December Intangible assets Investment in associated enterprises Financial assets Insurance contracts – equalisation provision* Other items Open years of account and Section 107 disclaimers Total deferred tax liabilities Transfer to current tax £000 Transfer from equity £000 2006 £000 (377) (191) (3,785) (6,064) (3,654) Income statement (charge)/credit £000 25 13 (2) 21 3,654 (14,071) (19,341) 3,711 (40,053) – 19,850 (33,412) (36,342) 19,850 2007 £000 (352) (178) (3,787) (6,043) – (10,360) (39,544) (49,904) – – – – – – – – – – – – – – – – – – – *The solvency regulations in the UK require certain entities within the Group to establish an equalisation provision, to be utilised against abnormal levels of future losses in certain lines of business. The regulations prescribe that the provision is increased every year by an amount that is calculated as a percentage of net premiums written for those lines of business during the financial year subject to a maximum percentage. The amount of each annual increase is a deductible expense for tax purposes, and the equalisation provision is taxed when released. The entities within the Group that are affected by this requirement continue to prepare their individual financial statements, for statutory filing and tax purposes, in accordance with UK GAAP which permits the recognition of equalisation provisions on the balance sheet. Equalisation provisions are not permitted under IFRS which therefore results in the temporary difference for tax purposes. Deferred income tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through the future taxable profits is probable. During the period, management revised its assumptions about the recoverability of carried forward unused tax losses to be recognised as deferred tax assets. Management’s assessment is that it is now probable that enough taxable profit will be available to allow part of the benefit to be utilised. Part of the balance has therefore now been provided. The Group has not provided for deferred tax assets totalling £8,104,000 (2006: £7,023,000) in relation to losses in overseas companies of £23,667,000 (2006: £20,064,000). The aggregate amount of temporary differences associated with investments in subsidiaries and associates for which no deferred tax liability has been recognised is £nil (2006: £73,855,000). This is as a result of the transfer of these subsidaries to Hiscox Ltd from Hiscox plc. In accordance with IAS 12, all deferred tax assets and liabilities are classified as non-current. 28 Employee retirement benefit obligations The Company’s subsidiary, Hiscox plc, operates a defined benefit pension scheme based on final pensionable salary. The scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of a defined contribution scheme from 1 January 2007. The funds of the defined benefit scheme are controlled by the trustee and are held separately from those of the Group. The gross amount recognised in the Group balance sheet in respect of the defined benefit scheme is determined as follows: Present value of funded obligations Fair value of scheme assets Present value of unfunded obligations Unrecognised net actuarial gains Unrecognised surplus deemed irrecoverable Gross liability in the balance sheet 2007 £000 2006 £000 106,793 (127,576) 137,461 (133,660) (20,783) 18,817 1,966 – 3,801 – – 3,801 The unrecognised net actuarial gains are the net cumulative gains and losses on both the scheme’s obligations and underlying assets. 98 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 28 Employee retirement benefit obligations continued Included within loans and receivables for the Group (note 19) at 31 December 2006 was a right to reimbursement of £1,163,000 recoverable from third party Names in Syndicate 33, representing their contribution to funding the defined benefit scheme obligation (2007: £nil). The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit acturial cost method. A formal full actuarial valuation is performed on a triennial basis, most recently at 31 December 2005, and updated at each intervening balance sheet date by the actuaries. The present value of the defined benefit obligation is determined by discounting the estimated future cash flows using interest rates of AA rated corporate bonds that have terms to maturity that approximate to the terms of the related pension liability. The plan assets are invested as follows: At 31 December Equities Debt and fixed income assets Cash 2007 £000 2006 £000 57,716 69,702 158 98,738 10,098 24,824 127,576 133,660 During the current year under review a series of changes to the scheme’s investment mix were executed by Trustees so as to achieve a greater degree of protection against interest rate volatility following the scheme’s recent closure. These changes resulted in the majority of the scheme’s debt and fixed income assets at 31 December 2007 now being held through the ownership of equity units in liability managed credit funds issued by Standard Life Assurance Limited which invest in a broad spread of high quality corporate bonds with derivatives used in controlled conditions to extend durations in some cases. The amounts recognised in the Group’s income statement are as follows: Current service cost Interest cost Expected return on scheme assets Net actuarial losses including curtailment charges recognised Past service cost Settlement gain recognised Effect of deemed irrecoverability of surplus Total included in staff costs The reduction in current service cost is attributable to the scheme’s closure to future accrual on 31 December 2006. The actual return on scheme assets was £7,786,000 (2006: £12,911,000). The movement in liability recognised in the Group’s balance sheet is as follows: At beginning of year Total expense charged/(credited) in the income statement of the Group Contributions paid At end of year A reconciliation of the fair value of the scheme assets is as follows: Opening fair value of scheme assets Expected return on scheme assets Difference between expected and actual return on scheme assets Contributions by the employer Settlements with scheme members Benefits paid Closing fair value of scheme assets Note 2007 £000 2006 £000 200 6,657 (7,711) – – (4,913) 1,966 4,191 6,397 (6,431) 7,355 668 – – 10 (3,801) 12,180 Note 10 2007 £000 2006 £000 3,801 (3,801) – 16,677 12,180 (25,056) – 3,801 2007 £000 2006 £000 133,660 7,711 75 – (11,687) (2,183) 101,409 6,431 6,480 25,056 – (5,716) 127,576 133,660 Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 99 Notes to the financial statements continued 28 Employee retirement benefit obligations continued A reconciliation of the present value of funded obligations of the scheme is as follows: Benefit obligation at beginning of year Current service cost Interest cost Actuarial gains Benefits paid from scheme Curtailments and amendments Settlements with scheme members Closing present value of funded obligations A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme liabilities Experience gains on scheme assets 2007 £000 2006 £000 137,461 200 6,657 (18,742) (2,183) – (16,600) 137,533 4,191 6,397 (5,917) (5,716) 973 – 106,793 137,461 2007 £000 2,783 75 2006 £000 2005 £000 (3,310) 6,480 (1,223) 10,764 2004 £000 992 1,316 Assumptions regarding future mortality experience are set based on professional advice, published statistics and actual experience. The average life expectancy in years of a pensioner retiring at age 60 on the balance sheet date is as follows: Male member Female member The average life expectancy in years of a pensioner retiring at 60,15 years after the balance sheet date is as follows: Male member Female member Other principal acturial assumptions are as follows: Discount rate Expected return on plan assets Future salary increases Inflation assumption Pension increases 2007 years 24.5 27.6 2007 years 25.6 28.6 2007 % 5.80 6.09 4.60 3.60 3.60 2006 years 24.5 27.6 2006 years 25.6 28.6 2006 % 5.10 6.09 4.30 3.30 3.30 During the year the Group made no contributions to the defined benefit scheme (2006: contribution rate of 33.3% of pensionable salaries). No additional contributions were paid during 2007 (2006: £20,570,000 ). The Group has agreed that further additional contributions will be made if necessary although no contributions are currently expected to be made in 2008 given the current level of underlying scheme surplus. 61% of the deficit calculated is recharged or refunded to Syndicate 33. The expected return on scheme assets is based on historical data and management’s expectations of long-term future returns. 29 Earnings per share Basic earnings per share is calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of shares in issue during the year, excluding ordinary shares purchased by the Group and held in treasury as own shares. Basic Profit attributable to the Company’s equity holders (£000) Weighted average number of ordinary shares (thousands) Basic earnings per share (pence per share) Diluted 2007 2006 191,248 395,308 163,846 392,558 48.4p 41.7p Diluted earnings per share is calculated adjusting for the assumed conversion of all dilutive potential ordinary shares. The Company has one category of dilutive potential ordinary shares, share options and awards. For the share options, a calculation is made to determine the number of shares that could have been acquired at fair value (determined as the average annual market share price of the Company’s shares) based on the monetary value of the subscription rights attached to outstanding share options. The number of shares calculated as above is compared with the number of shares that would have been issued assuming the exercise of the share options. 100 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 29 Earnings per share continued Diluted continued Profit attributable to the Company’s equity holders (£000) Weighted average number of ordinary shares in issue (thousands) Adjustments for share options (thousands) Weighted average number of ordinary shares for diluted earnings per share (thousands) Diluted earnings per share (pence per share) 2007 2006 191,248 163,846 395,308 13,530 392,558 12,449 408,838 405,007 46.8p 40.5p Diluted earnings per share has been calculated after taking account of 13,014,000 (2006: 11,806,000) options and awards under employee share option and performance plan schemes and 516,000 (2006: 643,000) options under SAYE schemes. 30 Dividends paid to external shareholders Interim dividend for the year ended: 31 December 2007 of 4.0p (net) per share 31 December 2006 of 3.0p (net) per share Final dividend for the year ended: 31 December 2006 of 7.0p (net) per share 31 December 2005 of 4.75p (net) per share 2007 £000 2006 £000 15,868 – 27,723 – – 11,789 – 18,639 43,591 30,428 A final dividend in respect of 2007 of 8p per share, amounting to a total dividend of 12p for the year, is to be proposed at the Annual General Meeting on 4 June 2008. These financial statements do not reflect this final dividend as a distribution or liability in accordance with IAS 10 Events after the Balance Sheet Date. 31 Acquisitions during the financial year On 16 August 2007, the Group acquired 100% of the share capital of ALTOHA Inc. in the USA. The total consideration was £29,052,000 which includes contingent consideration of £7,530,000 as outlined below. No goodwill arose on acquisition. Intangible assets of £5,083,000 have been recognised in respect of the US State authorisation licences held by ALTOHA Inc.’s consolidated operations. Identifiable assets and liabilities acquired Investments Intangible assets Cash and cash equivalents Other assets Insurance contract liabilities Other liabilities Net identifiable assets Cash consideration paid on business combination including acquisition related transaction costs of £197,000 Contingent cash consideration on business combination paid into escrow facility Goodwill on acquisition Book value 2007 £000 Adjustments 2007 £000 Fair value 2007 £000 18,942 – 17,919 4,473 (4,617) (3,710) – 5,083 – – – (9,038) 33,007 (3,955) 18,942 5,083 17,919 4,473 (4,617) (12,748) 29,052 (21,522) (7,530) – The adjustments made to book values recognise an additional pre-acquisition dividend payable to the former shareholders, and the recognition of intangible assets in the form of US State authorisation licences. If the acquisition had occurred on 1 January 2007, Group net revenue for the year would have increased by £6,895,000 and Group profit after tax for the year would have increased by £1,373,000. The total consolidated profit after tax of the acquired entity since the acquisition date included in the Group’s profit or loss for the period was £472,000. The intangible assets shown above arose from the licences held by the acquired group which strengthens the Group’s market position in targeted business segments. The contingent consideration with regard to ALTOHA Inc. is provisional and dependent on certain criteria including the non-emergence of any material unidentified pre-acquisition liabilities over a period of two years from the date of acquisition up to 16 August 2009. Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 101 exists for 2008. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required. (e) As Hiscox Bermuda is not an admitted insurer or reinsurer in the US, the terms of certain US insurance and reinsurance contracts require Hiscox to provide Letters of Credit or other terms of collateral to clients. On 1 December 2006, Hiscox entered into a Letter of Credit Reimbursement and Pledge Agreement with Citibank for the provision of a Letter of Credit facility in favour of US ceding companies. The agreement was a three year secured facility that allowed Hiscox to request the issuance of up to US$300 million in Letters of Credit. Letters of Credit issued under these facilities are collateralised by pledged cash and cash equivalents of Hiscox Bermuda. Letters of Credit under this facility totalling approximately US$38 million were issued with an effective date of 31 December 2007. 34 Capital and lease commitments Capital commitments The Group’s capital expenditure contracted for at the balance sheet date but not yet incurred for property, plant and equipment was £165,000 (2006: £161,000). Operating lease commitments The Group acts as both lessee and lessor in relation to various offices in the UK and overseas which are held under non-cancellable operating lease agreements. The leases have varying terms, escalation clauses and renewal rights. The Group also has payment obligations in respect of operating leases for certain items of office equipment. Operating lease rental expenses for the year totalled £4,691,000 (2006: £4,859,000). Operating lease rental income for the year totalled £468,000 (2006: £675,000). Notes to the financial statements continued 32 Disposals during the financial year The Group’s wholly owned subsidiary, Hiscox Investment Management Limited was sold on 5 December 2007. This business did not constitute a discontinued operation as defined by IFRS 5 Non Current Assets Held for Sale and Discontinued Operations due to its relative insignificance to the Group and the fact that it did not represent a major line of business or operating segment. Cash consideration of £300,000 was received in respect of this disposal. The Group also received a 40% equity stake in the acquiror, HIM Capital Holdings Ltd, which is incorporated on the Group’s balance sheet at 31 December 2007 as an equity accounted associate, as part of the consideration. The fair value of this holding at the date of transaction approximated to the Group’s retained interest in 40% of the pre-transaction carrying values of Hiscox Investment Management Limited’s tangible net assets. The total fair value of the consideration received was £420,000. The net assets disposed at the date of sale totalled £420,000 and included cash and cash equivalents of £1,236,000. No profit or loss therefore arose on this transaction. 33 Contingencies and guarantees The Group’s subsidiaries are like most other insurers, continuously involved in legal proceedings, claims and litigation in the normal course of business. The Group does not believe that such actions will have a material effect on its profit or loss and financial condition. The Group is subject to insurance solvency regulations in all the territories in which it issues insurance contracts, and it has complied with all the local solvency regulations. There are no contingencies associated with the Group’s compliance or lack of compliance with these regulations. The following guarantees have also been issued: (a) Hiscox plc has entered into a deed of covenant in respect of its corporate member subsidiary, Hiscox Dedicated Corporate Member Limited, to meet the subsidiaries’ obligations to Lloyd’s. The total guarantee given by the Company under this deed of covenant (subject to limited exceptions) amounts to £118,831,798 (2006: £118,831,798). The obligations in respect of this deed of covenant are secured by a fixed and floating charge over certain of the investments and other assets of the Company in favour of Lloyd’s. Lloyd’s has a right to retain the income on the charged investments in circumstances where it considers there to be a risk that the covenant might need to be called and may be met in full. (b) Hiscox plc has an agreement with Lloyds TSB Bank, an agent for a syndicate of banks, for a £137,500,000 irrevocable standby Letter of Credit Facility and a US$225,000,000 Term and Revolving Credit Facility. Commencing 7 November 2005 £137,500,000 was drawn down on the Letter of Credit Facility to support part of the Group’s underwriting activities. The Group has given a fixed and floating charge over certain assets as a guarantee to the group of banks led by Lloyds TSB Bank in connection with their Letter of Credit. At 31 December 2007, US$182,000,000 of the term and revolving credit facility was available and fully drawn (2006: US$182,000,000). (c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2006: £325,000) with NatWest Bank plc to support its consortium activities with Lloyd’s. (d) The managed syndicate is subject to the New Central Fund annual contribution, which is an annual fee calculated on capacity for 2007 and on gross premiums written for 2008. This fee was 1.0% for 2007 and 0.5% for 2008. 0.75% was loaned to the central fund for 2007 which was repaid during the year. No loan 102 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 34 Capital and lease commitments continued Operating lease commitments continued The aggregate minimum lease payments required by the Group under non-cancellable operating leases, over the expected lease terms, are as follows: No later than one year Land and buildings Office equipment Later than one year and no later than five years Land and buildings Office equipment Later than five years Land and buildings 2007 £000 2006 £000 4,705 141 4,553 129 14,032 199 14,687 246 19,714 22,917 38,791 42,532 The total future aggregate minimum lease rentals receivable by the Group as lessor under non-cancellable operating property leases are as follows: No later than one year Later than one year and no later than five years Later than five years 2007 £000 468 1,872 117 2,457 2006 £000 513 1,974 1,027 3,514 Obligations under finance leases It is the Group’s policy to lease certain of its motor vehicles under finance lease arrangements. The leases have a typical term of three years and are on a fixed repayment basis with a final lump sum component at the end of each agreement should the Group decide to acquire ownership of the vehicle. Interest rates are fixed at the contract commencement date. The Group’s obligations under leases are secured by the lessors’ charges over the leased assets. Finance lease interest expense for the year totalled £54,000 (2006: £41,000). The finance lease obligations to which the Group is committed include the following minimum lease payments: Current liabilities due for settlement within one year Non-current liabilities due for settlement after one year and no later than five years Less: future finance lease interest charges The present value of the minimum lease payments is not materially different to the currently disclosed obligation. 2007 £000 246 261 507 (50) 457 2006 £000 233 273 506 (64) 442 Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 103 Notes to the financial statements continued 35 Principal subsidiary companies of Hiscox Ltd at 31 December 2007 Company Nature of business Country Hiscox plc* Hiscox Insurance Company Limited Hiscox Insurance Company (Guernsey) Limited* Hiscox Inc. Hiscox Holdings Inc. ALTOHA Inc. American Live Stock Inc. Hiscox Insurance Company Inc. Hiscox ASM Limited Hiscox Insurance Company (Bermuda) Limited* Hiscox Dedicated Corporate Member Limited Hiscox Select Insurance Fund PLC Hiscox Select Holdings Limited Hiscox Select A to J Limited Hiscox Holdings Limited** Hiscox Insurance Holdings Limited Hiscox Assurances Services SARL Hiscox International Holdings B.V. Hiscox Syndicates Limited Hiscox Underwriting Ltd Hiscox AG Hiscox Overseas Holdings B.V.* Hiscox bv Hiscox Connect Limited Hiscox Underwriting Group Services Limited Hiscox NV Hiscox Trustees Limited† Hiscox Pension Trustees Limited Hiscox Qualifying Employees Share Ownership Trustees Limited Holding company General insurance General insurance Underwriting agent Insurance holding company Holding company Underwriting agent General insurance Underwriting agent General insurance and reinsurance Lloyd’s corporate Name Insurance holding company Insurance holding company Lloyd’s corporate Names Insurance holding company Insurance holding company Underwriting agent Insurance holding company Lloyd’s managing agent Underwriting agent Underwriting agent Holding company Underwriting agent Online intermediary Service company Underwriting agent Corporate trustee Pension trustee Share scheme trustee Great Britain Great Britain Guernsey USA (Delaware) USA (Delaware) USA (Delaware) USA (Illinois) USA (Illinois) Great Britain Bermuda Great Britain Great Britain Great Britain Great Britain Great Britain Great Britain France Netherlands Great Britain Great Britain Germany Netherlands Netherlands Great Britain Great Britain Belgium Great Britain Great Britain Great Britain *Held directly. **Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2006: 54,560) at 31 December 2007. †Hiscox Trustees Limited is the trustee of the Hiscox Employee Share Ownership Plan (ESOP). The ESOP owned 132,399 shares in Hiscox Ltd (2006: 135,782) at 31 December 2007. The shares have been purchased by the ESOP for future use in employee share option schemes and are held as own shares. None of these shares are currently under option to employees, nor have any been conditionally gifted to them. All companies are wholly owned. The proportion of voting rights of subsidiaries held is the same as the proportion of equity shares held. 36 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 54 to 59. A number of the Group’s key personnel hold insurance contracts and investment management agreements with the Group, all of which are on normal commercial terms and are not material in nature. The following transactions were conducted with related parties during the year. (a) Syndicate 33 at Lloyd’s Hiscox Syndicates Limited, a wholly owned subsidiary of the Company, received management fees and profit commissions for providing a range of management services to Syndicate 33 in which Hiscox Dedicated Corporate Member Limited, and in the prior year the corporate member subsidiaries of Hiscox Select Insurance Fund PLC also participated. Value of services provided by Hiscox Syndicates Limited to Syndicate 33 Amounts receivable from Syndicate 33 at 31 December excluding profit commission (b) Transactions with associates 2007 £000 2006 £000 41,466 19,877 1,402 1,695 Certain companies within the Group conduct insurance and other business with associates. These transactions arise in the normal course of obtaining insurance business through brokerages, and are based on arm’s length arrangements. Total 2007 £000 Gross premium income achieved through associates Commission expense charged by associates Amounts payable to associates at 31 December Amounts receivable from associates at 31 December Details of the Group’s associates are given in note 16. 7,290 1,342 120 47 Total 2006 £000 2,325 503 48 16 104 Notes to the financial statements Hiscox Ltd Report and Accounts 2007 36 Related-party transactions continued (c) Internal reinsurance arrangements During the current and proceeding year, there were reinsurance arrangements between Hiscox Dedicated Corporate Member Limited, Hiscox Insurance Company Limited, Hiscox Insurance Company (Guernsey) Limited and Hiscox Insurance Company (Bermuda) Limited. (d) Other Blyth Valley Ltd was the Group’s sole associate during the prior year. BE Masojada was a non-executive Director of Ins-sure Holdings Limited and its subsidiaries throughout the prior year until resignation on 31 December 2006. These companies operate in a joint venture between Lloyd’s, the International Underwriting Association (IUA) and Xchanging. These companies provide policy issuance, premium collection, claims settlement and clearing services to Lloyd’s and the London insurance company markets. Hiscox Underwriting Group Services Limited received the annual fee of £nil (2006: £20,000) in relation to this directorship. The balance due at 31 December 2007 was £nil (2006: £20,000). BE Masojada was also Deputy Chairman of Lloyd’s in the prior year. Hiscox Underwriting Group Services Limited received the annual fee of £nil (2006: £46,250) in relation to his services. There were no amounts outstanding at 31 December 2007 (2006: £nil). Hiscox Ltd Report and Accounts 2007 Notes to the financial statements 105 Five year summary Results Gross premiums written Net premiums written Net premiums earned Results of operating activities Profit for the year after tax Assets employed Intangible assets Financial assets carried at fair value Cash and cash equivalents Insurance liabilities and reinsurance assets Other net assets Net assets Net asset value per share (p) Key statistics Basic earnings per share (p) Diluted earnings per share (p) Combined ratio (%) Return on equity (%) Dividends per share (p) Share price – high* (p) Share price – low* (p) *Closing mid market prices. 2007 £000 2006 £000 2005 £000 2004 £000 2003 £000 1,198,949 974,910 965,190 245,295 191,248 1,126,164 975,397 888,828 201,062 163,846 861,174 681,236 693,299 70,221 48,630 816,609 704,085 714,852 89,522 63,948 797,380 660,966 547,451 83,408 60,491 40,452 33,212 33,099 1,747,827 1,241,910 1,237,778 413,759 502,871 29,989 980,731 119,563 (1,433,799) (1,291,329) (1,216,624)(1,008,032) 246,575 302,742 195,421 167,082 110,001 21,753 773,289 52,945 (845,450) 327,300 824,304 682,085 578,013 368,826 329,837 209.5 173.2 147.7 125.7 113.5 48.4 46.8 84.4 28.8 41.7 40.5 89.1 28.9 12.00 10.00 15.6 15.1 96.0 12.8 7.00 21.3 21.0 92.6 20.6 5.00 20.9 20.6 87.2 21.7 4.20 304.5 246.75 280.25 193.75 234.5 152.25 180.5 143.5 170.5 137.0 The amounts and ratios for 2003 are those previously published on a UK GAAP basis, the Group’s primary reporting framework at that time. The figures reported for 2004 to 2007 are prepared in accordance with IFRS. 106 Five year summary Hiscox Ltd Report and Accounts 2007 Glossary Binder (or binding authority) PSC 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. Cedant An insurer that transfers insurance risk to another insurer under a reinsurance contract. Professions and Specialty Commercial division (commercial lines). Qualifying quota share reinsurance (QQS) These are quota share reinsurance policies, which Lloyd’s allow in certain circumstances, that enable a syndicate to write gross premium in excess of its authorised stamp capacity. Quota shares Claims ratio Net claims incurred, including IBNR, as a percentage of net earned premiums. Where insurance risks are re-insured on a proportional basis, premiums and claims are divided in the same proportions between the insurer and re-insurer. Combined ratio The total of the claims and expenses ratios. E&O Re-domicile The establishment of a new parent company for the Hiscox Group, based in Bermuda. Errors and omissions, liability insurance for businesses. Return on Equity (ROE) Expense ratio Net operating expenses as a percentage of net earned premiums. Net profit after tax expressed as a percentage of adjusted opening equity. This percentage measures profitability by expressing the efficiency of the Group’s utilisation of shareholders’ funds. Gross premiums written Premiums contracted for before any deductions. Incurred loss ratio Paid and outstanding losses as a percentage of premiums. Gross incurred loss ratio is before deducting any reinsurance; the net loss ratio is after deducting reinsurance. Individual capital assessments Risk-based calculations of the capital required by each FSA- authorised insurance entity in accordance with FSA regulations. Long-tail A term used to describe an insurance risk that has the potential for claims development or new claims to be reported a number of years after expiry of the term of the policy. Member or Lloyd’s Member An underwriting member of Lloyd’s. Members collectively accept insurance risks through a Lloyd’s syndicate. Members are required to meet certain Lloyd’s solvency requirements and are responsible for their share of any losses made by the syndicates on which they participate, and are entitled to an equivalent share of any profits. Names Individual Members of Lloyd’s. Net premiums written Premiums received after the cost of reinsurance and adjustment for unearned premium. Unearned premium covers the future period of risk of an insurance policy. Net written premium Premiums received after the cost of reinsurance. Open year A year of account of a syndicate which has not been closed by reinsurance to close (‘RITC’). RITC usually occurs at the end of the third year. A year of account can be left open beyond the third year if the extent of the future liability cannot be accurately quantified. Reinsurance to Close (RITC) The reinsurance to close of a syndicate comprises a premium payable by the closing year to the members on the next open year of account and a contract which transfers the liability for all claims in respect of the closing year to the next open year. Short-tail A term used to describe an insurance risk where claims are expected to arise near to the dates on which a policy was current. Sidecar A limited lifespan insurance company formed to give its investors access to the insurance market, and its cedants access to capital. Specie The line of business that covers cash and valuables in vaults, premises or transit. Stamp capacity or syndicate capacity The maximum amount of business that a syndicate in Lloyd’s can write per year, aggregated from all its members. Syndicate A grouping of Lloyd’s underwriters. Each syndicate has an active underwriter who is authorised to accept business on behalf of each underwriting member participating therein. A member of a syndicate is still a principal in his own right and is personally liable for his agreed share of each risk that is accepted by the syndicate. He is not liable for the debts of other syndicate members and thus the liability is several but not joint. Year of account The year to which risk is allocated and to which all premiums and claims in respect of that risk are attributed. The year of account of a risk is determined by the calendar year in which it incepts. A syndicate year of account is normally closed by reinsurance at the end of 36 months. Hiscox Ltd Report and Accounts 2007 Glossary 107 Credits All paper used in the production of this report is recyclable and bio-degradable. The cover and pages 1 to 60 have been manufactured to ISO14001 environmental standards with pulp bleached using a Totally Chlorine Free (TCF) process. Pages 61 to 108 contain material sourced from responsibly managed and sustainable forests, certified in accordance with the Forest Stewardship Council (FSC) and have been manufactured to ISO14001and ISO 9001 environmental standards with pulp bleached using an Elemental Chlorine Free (ECF) process. Design by Browns Print by St Ives Westerham Press Photography (Chairman/Chief Executive) by John Ross Photography (portraits) by John Ross and Stephen Raynor 108 Credits Hiscox Ltd Report and Accounts 2007 Hiscox Ltd 4th Floor Wessex House 45 Reid Street Hamilton HM 12 Bermuda T +1 441 278 8300 F +1 441 278 8301 E enquiries@hiscox.bm www.hiscox.com 

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