Hiscox_AR08_Cover_4pp_AW:Layout 1 16/3/09 19:07 Page 1 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 i H s c o x L t d R e p o r t a n d A c c o u n t s 2 0 0 8 Hiscox Ltd Report and Accounts 2008 1 2 3 5 12 16 22 28 30 32 35 43 44 45 46 46 47 48 49 50 96 Contents Corporate highlights Business structure Chairman’s statement Chief Executive’s report Insurance carriers Group financial performance Risk management Corporate responsibility Board of Directors Corporate governance Directors’ remuneration report Directors’ report Directors’ responsibilities statement Report of the independent registered public accounting firm Consolidated income statement Consolidated statement of comprehensive income Consolidated balance sheet Consolidated statement of changes in equity Consolidated cash flow statement Notes to the financial statements Five year summary Hiscox_AR08_Cover_4pp_AW:Layout 1 16/3/09 19:07 Page 2 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 To request a copy of the 2008 Hiscox brochure visit www.hiscox.com Design: Browns Print: St Ives Westerham Press Photography: Portraits © John Ross, Peter Marlow (Magnum Photos), Kit Noble and Stephen Raynor Front and back cover © Getty Images This report is printed on recycled paper containing 100% post consumer waste and manufactured at a mill accredited with ISO14001 environmental management standard. The pulp used in this product is bleached using a Totally Chlorine Free process (TCF). FSC certified. 100% Corporate highlights 23.2% Increase in net asset value per share Group key performance indicators Gross premiums written (£m) Net premiums earned (£m) Profit before tax (£m) Profit before tax and certain foreign currency items* (£m) Earnings per share (p) Total dividend per share for year (p) Net asset value per share (p) Group combined ratio (%) Group combined ratio excluding foreign exchange (%) Return on equity (%) Return on equity excluding certain foreign currency items* (%) Net asset value £m Net asset value £m 951.0 951.0 824.3 824.3 2007 2007 2008 2008 2008 2007 1,147.4 1,198.9 953.0 105.2 156.2 18.8 12.75 258.1 76.1 91.9 9.2 16.4 965.2 237.2 237.2 48.4 12.0 209.5 84.4 85.5 28.8 28.8 Financial highlights Net asset value p per share Profit before tax £105.2m (2007: £237.2m) Profit before tax excluding certain foreign currency items* £156.2m (2007: £237.2m) Total dividend for the year increased by 6.25% to 12.75p (2007: 12.0p) Net assets per share increased by 23.2% to 258.1p (2007: 209.5p) Excellent combined ratio of 76.1% (2007: 84.4%) or 91.9% (2007: 85.5%) excluding foreign exchange Investment return of -1.3% (2007: 5.4%) Return on equity of 9.2% (2007: 28.8%) or 16.4% (2007: 28.8%) excluding certain foreign currency items* Strong balance sheet after share repurchases of £63m at average price 221.7p 258.1 258.1 209.5 209.5 2007 2008 Operational highlights Rates increasing in reinsurance, marine and energy, and stable elsewhere Expansion in the USA: five new offices opened and 43 additional staff recruited since September Capacity of Syndicate 33 increased to £750m (2008: £700m) New wholly owned Syndicate 3624 created with £80m capacity Good opportunities to continue to grow a balanced business internationally *excludes foreign currency items on economic hedges and intragroup borrowings. Corporate highlights Hiscox Ltd Report and Accounts 2008 1 Business structure Hiscox Ltd Hiscox Global Markets Hiscox International Hiscox Bermuda Hiscox Guernsey Hiscox USA Hiscox UK and Europe Hiscox UK Hiscox Europe 2 Business structure Hiscox Ltd Report and Accounts 2008 Richard Watson Managing Director, Hiscox Global Markets, Active Underwriter, Syndicate 33 Reinsurance; property; marine and energy; specialty; technology and media; aerospace. Robert Childs Chief Underwriting Officer, Chairman of Hiscox USA, Chief Executive Officer, Hiscox Bermuda Reinsurance; Group capital support. Steve Camm Managing Director, Hiscox Guernsey Art and private client; kidnap and ransom. Ed Donnelly President, Hiscox USA PI and specialty commercial; regional technology and media; animal mortality. Steve Langan Managing Director, Hiscox UK Art and private client; PI and specialty commercial; regional technology and media; direct. Michael Gould Chairman of Hiscox European Steering Group, Chief Operating Officer Art and private client; PI and specialty commercial; regional technology and media. Robert Hiscox Chairman Chairman’s statement 2008 was a year that will be written about for decades to come, and it was a good year for Hiscox to show the robustness of its business. Global Markets’ underwriting was tested by the third most expensive hurricane on record but the reinsurance account still made a decent profit; the regional business continued to grow in size and profitability, and the worldwide financial collapse stress tested our investment portfolio beyond any expert forecast and a very small investment loss was a fair result, with currency movements adding substantially to our profits and assets. In the 2008 interim report I wrote that it seemed surreal to be announcing record profits when the share price was so low. Our sector was subsequently re-rated, and the appraisal was valid. We had not followed the banks into speculating heavily on borrowed money, and we had continued to price risk and to monitor our liabilities to the best of our ability, using the best models available but aware of their frailty. We had in our corporate memory the agonies Lloyd’s suffered in the early 1990s from the spiral of reinsurance liabilities and the seemingly unquantifiable liabilities from asbestosis and pollution, and we had learnt. A great asset of the insurance industry is that feast always follows famine. After big losses there is a shortage of capital and supply so we can put rates up and recoup our losses. Conversely, the curse of the industry is the ease of entry, with an instant inflow of capital when we get the rates into profit territory. The last quarter of 2008 saw a firming in rates in some of our key areas (particularly reinsurance which is a third of our book) and a stabilisation in others, but this time there is a global shortage of capital, which means we should be able to charge the right rate for some time to come. Results The result for the year ended 31 December 2008 was a profit of £105.2 million (2007: £237.2 million) on a gross written premium income of £1,147.4 million (2007: £1,198.9 million). The combined ratio was 76.1% (2007: 84.4%). Earnings per share on profit after tax were 18.8p (2007: 48.4p) and net assets per share increased by 23% to 258.1p (2007: 209.5p). Return on equity was 9.2% (2007: 28.8%). Dividend and capital management The Board proposes a final dividend of 8.5p (2007: 8p) making a total dividend for the year of 12.75p (2007: 12p), an increase of 6.25%. This will be paid on 16 June 2009 to shareholders on the register at the close of business on 15 May 2009. We have always advocated a progressive dividend policy and being able to cover an increased dividend after such a difficult year is extremely satisfying. During 2008 we bought in 28,300,742 shares for a total of £62,866,000 (an average price of 221.7p per share). Our balance sheet is strong and sufficient for our current plans. We like to use our capital as fully as is prudent to keep the returns to shareholders as high as possible. Interestingly, we last raised capital through a rights issue in 2005 raising £170 million net, since when we have returned £207 million to shareholders through dividends and share buy-backs. The current state of the market The market overall is solid and healthy. There is comment that rates are not rising fast everywhere, but much as I enjoy surging rates following a big loss, underwriters do tend to push prices too high which attracts new capital. And if rates are pushed too high, they have to come down and the momentum of the insurance cycle starts to swing down. Rates are being put up selectively, capital is tight, our current combined ratio is 91.9% stripping out currency distortions, so market conditions are profitable and improving. The better underwriters can make good money at these rates so we do not want to push them up faster which will just help the weaker ones. The current state of our business I leave it to Bronek, our inestimable CEO who runs the company with remarkable passion and ability, to comment on the business in detail. Conditions at Hiscox are better than good. Our time honoured strategy has been to write internationally traded big ticket and catastrophe business (through Global Markets and Bermuda principally), and balance it with regional, smaller business in the UK, Europe and the USA. The Global Markets division has recently expanded in the US with the acquisition of some highly talented people and new offices have been opened. We have long abandoned the Lloyd’s business model of sitting in the Room waiting for business to come from around the world which is no longer sustainable. Bermuda has a bigger share of the world reinsurance Chairman’s statement Hiscox Ltd Report and Accounts 2008 3 Our balance sheet is strong and sufficient for our current plans. The future All areas of the company have good possibilities of profitable growth and there is a great feeling of dynamism throughout. We have taken on some excellent new people. I would like to thank them for joining us, and also thank the existing staff in all areas of the business for making Hiscox an exciting and constantly challenging environment. Change is the price of survival, and the change at Hiscox over the last decade from a Lloyd’s agency to a group of international insurance companies has been dramatic. We have a balanced business both geographically and in our products; we have a dominant position in many of our specialisms; we are building a strong brand, and most important, we have first class people devoted to doing first class business in a first class way. We will continue to build on our strong foundations during the forthcoming very difficult economic conditions, and then should flourish enormously when the world comes out of recession. Robert Hiscox Chairman 9 March 2009 Chairman’s statement continued market than London, and our operation here in Bermuda showed us the viability and efficiency of underwriting electronically, even on a small island 600 miles from anywhere. Bermuda benefits from advantageous tax and regulatory regimes, and also from being closer to the USA. Human relationships and proximity remain a key factor in doing business, so we have opened, or are opening, offices selectively across the USA, in addition to our Global Markets presence in London and Paris. Those offices will also be used to increase the distribution of our regional businesses which are growing strongly in the USA, having also attracted new talented people. The regional businesses in the UK and mainland Europe have built on their strong foundations, had a good year and should continue to be a growing asset with the potential of steady profits. Our direct household and small commercial business in the UK had good growth in 2008 and will be helped this year by our new marketing campaign. Investments An investment return of -1.3% is a fair one, even a good one, in the circumstances of the worst year on record for most types of investment. Our staple diet consists of bonds, and trying to squeeze an extra point or two of yield could have led us into the toxic products that have done so much damage. However, we have only had one insolvency so far, a relatively small investment in Lehman Brothers bonds; otherwise we have marked to market, and as low as some of those valuations are, the instruments are all paying their coupons and heading for redemption. The Board Carol Franklin Engler retired from the Board during the year having served nine years. Carol brought an underwriter’s eye to our deliberations with an uncanny talent for pricking balloons. She also had human resources experience, which together with her other outside activities made her an extremely effective Director. I would like to thank her for her valuable contribution through a period of great change. We have been joined by Gunnar Stokholm and Ernst Jansen, both of whom have vital experience of building international insurance businesses. They bring considerable underwriting knowledge as well as international business experience to our strategic planning and Board discussions. 4 Chairman’s statement Hiscox Ltd Report and Accounts 2008 Chief Executive’s report Strategic focus Total Group controlled income for 2008 100% = £1,390m In 2008 our strategy of building balance paid off for the business and for shareholders. A rigorous approach to underwriting saw us shrink our international big ticket and reinsurance product lines. At the same time we continued to invest in our domestic market businesses in the UK, Europe and USA. These actions allowed us to generate sufficient underwriting profit which together with our foreign exchange gains, have produced a good result, despite the ravages of the toughest investment environment in living memory. We now see opportunity ahead of us. Recent market turbulence has severely affected some of our competitors and we have seized the opportunity to attract good staff – particularly in the US. Bronek Masojada Chief Executive i 3 0 % R e n s u r a n c e m ercial13 % co m o missions and d n a s r r o r e d i a d m e n a h c Localerrors and T e 6 % s n s i o o m i s y t p r o p e r 5 % L a r g e m is sio n s, o –terrorism,specie, G lo b al errors a n d offi c ers politicalrisks,aerospace dire ctors a n d Specialty 5 % % 3 y erg n e d n a e arin M % 8 A rt a n d b k l i o d o n d a s p t o a c n k d , r p a e n r s s o o n m a , l c a S o c n p c t e i i d n c i e g a n e l t t n y 8 c – y % , S m a l l p r o p e r t y 5 % priv ate clie nt 1 7 % Chief Executive’s report Hiscox Ltd Report and Accounts 2008 5 Chief Executive’s report continued Group performance The pre-tax profit for the year was £105.2 million (2007: £237.2 million). Gross written premium shrank to £1,147.4 million (2007: £1,198.9 million). Earnings per share are 18.8p (2007: 48.4p). Return on equity was 9.2% (2007: 28.8%) and net asset value per share increased to 258.1p (2007: 209.5p). Net tangible assets increased to 244.9p (2007: 199.3p). Dividends increase to 12.75p (2007: 12p). These results were achieved despite a very challenging investment environment, which saw investment returns on financial assets falling to a loss of £27.6 million, in contrast to a positive contribution of £100.8 million in 2007. The significant appreciation in net asset value reflects both our profit and the impact of the Dollar strengthening. At the end of the year, £603 million of shareholders’ funds were held in US Dollars. Hiscox Global Markets Hiscox Global Markets underwrites a mix of big ticket international and reinsurance business, and specialty business where deep expertise in specific product lines draws the business to London. All of these lines take advantage of the Lloyd’s brand and licence network. During the year Global Markets showed exceptional discipline in shrinking in almost all its areas, rather than writing business at the wrong price. Hiscox Global Markets 2008 £m Gross premiums written 586.5 Net premiums earned 477.8 Underwriting profit Investment result Foreign exchange Other income/expenses Profit before tax Combined ratio 41.6 (5.8) 108.5 (3.8) 140.5 68.5% 2007 £m 676.5 552.2 119.8 46.6 4.5 (15.3) 155.6 81.7% Combined ratio excluding foreign exchange 94.5% 82.5% Hiscox Global Markets rating index Index level (%). 12 month rolling period Specialty Reinsurance Property Global E&O Marine and energy 900 800 700 600 500 400 300 200 100 0 Jan 98 to Dec 98 Jan 99 to Dec 99 Jan 00 to Dec 00 Jan 01 to Dec 01 Jan 02 to Dec 02 Jan 03 to Dec 03 Jan 04 to Dec 04 Jan 05 to Dec 05 Jan 06 to Dec 06 Jan 07 to Dec 07 Jan 08 to Dec 08 6 Chief Executive’s report Hiscox Ltd Report and Accounts 2008 £1,147.4m Gross premiums written Growth and activity in the US has not diminished our commitment to the London Market and we will seek to expand in both areas. The rewards of this approach are shown in its ability to generate a profit despite losses from Hurricanes Ike and Gustav. At a trading level Global Markets benefited from the strength in the US Dollar. This was an advantage this year but could present a future challenge if Sterling strengthens. Our reinsurance area had a great year despite the run of large risk losses which affected the market in the first half and the impact of Hurricanes Ike and Gustav into the second half. The team’s performance benefited from the commutation of the Panther Re sidecar, which saw Hiscox assuming the risk of all losses occurring after 31 January 2009. We replaced Panther with a Lloyd’s sidecar Cougar Syndicate 6104 and other reinsurances. January renewals saw an increase in the rates in the US. We have expanded our writings slightly but expect to expand further as the year develops, as we expect rates to rise generally as the year progresses. The property team underwrites our catastrophe exposed primary property business, together with some international homeowner and small business insurance. The team suffered in the hurricanes but delivered a positive result overall, helped by releases on older years, including some arising out of the positive settlement of claims relating to the events of September 11, 2001. We are pursuing our subrogation actions relating to these and other claims with vigour. Our global errors and omissions business was created this year to bring together our expertise in the technology and media fields with that in the broader error and omission field. The team had a difficult year as they dealt with a series of large claims. Rates in this area need to rise – and until they do we will continue to take a very cautious approach. The specialty division, which brings together political risks, aviation war, terrorism, contingency, kidnap and ransom and bloodstock, had a good year. Hiscox’s deep expertise attracts business. The key challenge for this team is to continue to draw business into London as businesses – including Hiscox – build their capability in domestic markets. Marine and energy, unsurprisingly, had an unprofitable year. They were in the front line for both Hurricanes Ike and Gustav. The losses sustained were within our expectations. Rates in the Gulf will have to rise significantly if the class is to be underwritten profitably there. In addition to disciplined underwriting, the Global Markets team has recognised that business no longer flows to London as a right, and in 2007 invested in creating teams who were located mainly in Paris and New York. Since September, Global Markets has taken advantage of the disruption caused by the financial crises by recruiting people and working with our USA business to open new offices in Boston, Kansas City, Lexington and Miami. We expect to open a further office in Los Angeles this year. This expanded footprint will enable us to underwrite our specialist lines locally in the US domestic market. The growth of the business outside London brings with it inevitable conflict with those brokers, and indeed those underwriters, who are entirely London centric. Growth and activity in the US has not diminished our commitment to the London Market and we will seek to expand in both areas. The key to success in London is a continued investment by Hiscox, and the market as a whole, in efficiency and improving infrastructure. In 2008 Global Markets worked on a project to replace its core underwriting system. The project was due to be delivered in the second half of the year but, as seems inevitable when dealing with projects of this scale and complexity, completion is now expected in the first half of 2009. Once this new system is in place, we will be investing in connecting to the newly announced Lloyd’s Exchange, as we believe that over time it is in everyone’s interest that underwriting moves to a more electronic environment. If the London Market as a whole is able to achieve this it is our belief that it will continue to be the vibrant centre of the international insurance industry. When planning for Global Markets in 2009 we initially announced a reduction in the size of Syndicate 33, however in response to market changes we have reconsidered our plans. We have increased the size of Syndicate 33 to £750 million (2008: £700 million) and renewed the Cougar Syndicate 6104 which is supported entirely by third-party capital at the increased level of £43 million (2008: £34 million). In addition we created Syndicate 3624 with a capacity of £80 million which is completely capitalised by Hiscox. Syndicate 3624 will provide capacity for all the new lines of business which we are planning to underwrite in the US, most of the business already generated by Hiscox USA and 50% of the technology and media business. These structures introduce an element of complexity into our business, but give us greater flexibility in planning our business expansion. Hiscox UK and Hiscox Europe Our commitment to growing our domestic businesses in the UK and mainland Europe paid off in 2008. We saw strong growth in both divisions and much stronger underwriting performance. Looking at each in turn: Hiscox UK saw growth of 14.3% to £261.9 million (2007: £229.2 million). Growth was strong in all areas, but we are particularly Chief Executive’s report Hiscox Ltd Report and Accounts 2008 7 Chief Executive’s report continued pleased with developments in our specialty commercial area and the new motor business which was launched in 2008. The successful launch of our luxury motor product demonstrates that people value quality insurance. We have continued to invest in the UK Direct business, which has made good progress. The brand building which has supported this business has had benefits not only here, but for the Group as a whole. The high net worth team have done well to increase rates and consequently profitability during the year. The progress in top and bottom line by Hiscox UK was achieved despite the decision to put the broker channel mid net worth household product into run-off. Our personal lines strategy is to serve the richest 10% of the population in their personal insurance needs, with the bulk of the richest 5% being served through the broker market and the rest dealing with Hiscox direct if they wish. We believe this strategy makes good sense for customers, our broker partners and us. Hiscox Europe saw growth of 12.0% in the year as a whole and a strong improvement in underwriting profit in local currency. France and Belgium continued to deliver good profits and Germany and the Hiscox UK 2008 £m Gross premiums written 261.9 Net premiums earned Underwriting profit Investment result Foreign exchange Other income/expenses Profit/(loss) before tax 227.3 36.8 (2.8) 9.3 (14.4) 28.9 2007 £m 229.2 190.4 16.0 15.9 0.7 (15.4) 17.2 Combined ratio 85.0% 98.8% Hiscox UK and Hiscox Europe rating index Index level (%). 12 month rolling period UK commercial lines UK personal lines Europe personal lines 160 150 140 130 120 110 100 90 80 Feb 00 to Jan 01 Aug 00 to Jul 01 Feb 01 to Jan 02 Aug 01 to Jul 02 Feb 02 to Jan 03 Aug 02 to Jul 03 Feb 03 to Jan 04 Aug 03 to Jul 04 Feb 04 to Jan 05 Aug 04 to Jul 05 Feb 05 to Jan 06 Aug 05 to Jul 06 Feb 06 to Jan 07 Aug 06 to Jul 07 Feb 07 to Jan 08 Aug 07 to Jul 08 8 Chief Executive’s report Hiscox Ltd Report and Accounts 2008 Hiscox Europe 2008 €m Gross premiums written 120.3 Net premiums earned 110.8 Underwriting profit Investment result Foreign exchange Other income/expenses Profit/(loss) before tax 25.1 (11.6) 0.1 (19.8) (6.2) 2007 €m 107.4 91.5 21.8 3.6 (0.2) (22.6) 2.6 Combined ratio 95.6% 100.9% Hiscox International 2008 £m Gross premiums written 206.0 Net premiums earned 172.8 Profit before tax Combined ratio 0.9 94.2% 75.4% 2007 £m 220.2 164.6 69.1 Netherlands made substantial improvements to their performance year on year. The progress of the business reflects our decision to focus our efforts in those countries where we already have offices in order to drive economies of scale. To drive this point home we have set a target of a gap of 10% between the rate of growth of expenses and revenues. We achieved this in 2007 and came close in 2008. Of particular note in Europe is the turnaround in Germany. Some tough decisions were made to end relations with brokers who had produced poor quality business, allowing the team to focus on more productive relationships. The Netherlands has seen a real growth in scale with very little increase in expense, with consequent positive impact on the bottom line. Spain has new leadership in place. Hiscox International Hiscox International comprises our businesses in Bermuda, Guernsey and the domestic USA team. Each business faced quite different challenges in the year and I review them in turn below: Hiscox Bermuda faced difficult market conditions affecting the reinsurance market. Their response, rightly, was to shrink their top line significantly. Third-party reinsurance reduced to $211.7 million (2007: $297.3 million). The team also had to deal with the impact of Hurricanes Ike and Gustav. Despite this the business had a positive underwriting result. During the year we began a specialty reinsurance business centred in Bermuda. The financial crises and improving market meant our capital could be better employed elsewhere and regrettably the business was closed during December. Charles Dupplin, currently Chairman of Hiscox’s Art and Private Client division and Director of Mergers and Acquisitions, will succeed Robert Childs as Chief Executive of Hiscox Bermuda. Charles will take up this new role in April 2009, subject to regulatory approval. As previously announced, Robert Childs will return to the UK towards the end of April 2009. He will continue in his roles as Group Director of Underwriting and Chairman of Hiscox USA and he will also serve as an internal Non Executive of Hiscox Bermuda. In the last three years our team in Bermuda, led by Robert, has built a vibrant business from nothing. I would like to thank Robert for his leadership. With Charles at the helm, I am confident that our Bermuda business will continue to develop. Hiscox Guernsey had another good year. It grew its core kidnap and ransom and fine art accounts and responded rapidly with new products to the piracy threat on the Horn of Africa. It is this fast response to market conditions which sets this team apart from its competitors. We have a great business development team based in London and have now created a Miami office as a gateway to South America. Opportunities abound. Hiscox USA continued on its journey to build a specialist business in the USA. Top line grew 32% to $59.2 million (2007: $44.7 million) and the result was close to break even. The team continues to gain scale and build reputation amongst brokers. It has also taken advantage of the financial market turmoil to recruit new staff. New team members joined in New York and Lexington (where we have now opened an office) and members of the current team will relocate to Miami and the West Coast this year to build our local presence. The key constraint in the USA is the time taken to get rate and forms approved by the state regulators. We currently have 15 products going through this process. Claims Effective claims management is essential to provide good customer service. As we expand we have been careful to make sure that our claims standards are preserved. We have continued to invest in claims operations, including the strengthening of complex claims management capability for big ticket businesses in Global Markets and Bermuda and in developing our service culture to our policyholders in our retail operations. In the UK we settle 10% of our UK property claims in one day and 45% in 30 days. In 2008, our claims teams settled our two largest historic outstanding claims. This required long and sensitive discussions with the assureds and it is to the team's credit that this was achieved while still retaining positive relationships with those clients. Operations and IT With the relentless advance of technology, operations and IT are now central to the business. Ten years ago if our IT collapsed we could continue to trade, but this is no longer the case. Our core infrastructure is based in the UK and France, removing the Group’s dependence for communications on our London office. The resilience of these new arrangements was tested during 2008 and our systems worked well. We have also significantly improved our online response times and service in the UK which is critical to the direct customer experience. We appointed Michael Gould as Chief Operating Officer during the year and he has already improved operating disciplines. This includes more rigour in prioritising and managing projects, as well as developing consistent operational measures to track the Group’s performance. Chief Executive’s report Hiscox Ltd Report and Accounts 2008 9 Chief Executive’s report continued Investments 2008 was the year of investment challenges. We achieved a return across the portfolio of -1.3%. There is no need to comment on the global crisis as many more informed commentators are busy doing so at length elsewhere. Suffice to say, I am delighted that even though we have a small negative return, we still enter 2009 with 98.7% of our funds intact and, thanks to good relative investment performance and a great underwriting performance, our balance sheet is unimpaired. Many of our competitors can only dream of being in this position. This provides a stable foundation on which we can build the underwriting business in 2009. In addition to the upheaval and volatility in the financial market, 2008 saw equivalent volatility in the currency exchange market and in the course of the year the US Dollar fluctuated from 1.99 opening to 1.44 closing. Hiscox holds assets to match its insurance liabilities in original currencies, thereby reducing the impact of volatile exchange rates and making active use of shareholders funds. The majority of the net assets are in US Dollars and as the Dollar strengthened during the year, the decision was made to lock in some of the resulting gains by entering into economic hedge contracts to protect against further fluctuations. As the year progressed the Dollar strengthened further and the additional underlying gain was offset by the cost of the hedge. As a result of accountancy rules, this cost of £42.5 million was taken through the profit and loss account, while the underlying gain of £151.2 million was taken directly to the balance sheet. Further FX gains arose in the trading accounts during the course of 2008. Together these contributed £57 million to our reported profits (2007: £7 million) net of foreign exchange on economic hedges and intragroup borrowings. Balance sheet and ratings Total shareholders’ funds grew to £951.0 million (2007: £824.3 million). On a per share basis this is equal to net assets per share of 258.1p (2007: 209.5p) and net tangible assets per share of 244.9p (2007: 199.3p). We continue to see building per share asset value as a key performance metric as we think that over time it is the most important factor driving our share price. In 2008 loss reserves grew to £1.8 billion (2007: £1.2 billion). This includes our loss estimates of net $175 million for Hurricanes Ike and Gustav. Total reserve releases during the course of the year amounted to £123 million (2007: £60 million). This release is larger than previous years as two of our biggest outstanding historic claims were settled during the period. During the course of the year Hiscox has benefited from a series of positive rating agency decisions. On 18 September 2008 A.M. Best announced an upgrade to the financial strength rating of Hiscox Insurance Company (Bermuda) Limited, Hiscox Insurance Company (UK) Limited and Hiscox Insurance Company (Guernsey) Limited to A (Excellent) from A- (Excellent). It has also affirmed a financial strength rating of A for Hiscox Syndicate 33 and Hiscox Insurance Company Inc. The outlook for the rating is stable. In December Standard & Poor’s also upgraded their rating for the Hiscox Insurance Company Ltd to A (Strong). These rating actions reflect the strength of Hiscox’s diversified global portfolio and give us a competitive benefit in the new, more cautious world in which we operate. A key to retaining this balance is the need to balance the rewards from underwriting with the risks. We plan to continue to run our business so that it can survive a 1 in 250 catastrophic year. Of course we measure this by drawing on our extensive modelling capability, but as recent events show, models are inevitably flawed and we will continue to supplement the model output with instinct and pragmatic business judgement. Capturing opportunities In the middle of the year we thought the market would continue to soften and that Hiscox would continue to invest in its regional business to offset the planned reduction of the big ticket insurance and reinsurance businesses. The financial crises which broke in mid September changed our view. Overnight we went from defence to offence. We expanded our US domestic presence through the recruitment of 43 staff and the opening of five new offices. Our ambition is to build Hiscox into a top ten surplus lines market and a respected specialist player in the US admitted market. In addition to the domestic US opportunities, we believe that there will be material benefits to our London operations as insureds re-discover the benefits of the subscription market where risks are shared between many participants. Our levels of expertise mean that Hiscox is a ‘must visit’ business in London – and we aim to keep it that way. We see these opportunities continuing for some time as the global capital shortage means that there is unlikely to be a flood of new capital into the industry. In addition many capital raisings will be focused on repairing damage to balance sheets with little net additional capital entering the industry. People Insurance continues to be a business where the 10 Chief Executive’s report Hiscox Ltd Report and Accounts 2008 key ingredient to success is the people within the business. Our staff have had a great year. There is inevitable nervousness when so much turmoil abounds, but they stuck to their knitting and delivered great business development, underwriting, investment and operations performance. What is also pleasing is the way individuals have chosen to move and travel in order to build the business. Many members of staff spend huge proportions of their time on the road travelling to see brokers and producers both within their home countries and around the world. Others are learning new languages in order to be more effective and others are volunteering to move temporarily – and in some cases permanently – to help Hiscox take advantage of new opportunities. It is these attitudes, sacrifices and day to day performance which gives Hiscox the strength and agility to respond to challenging markets. I am deeply grateful to all of our staff for this. Conclusion 2008 will be remembered as one of the most challenging in history for the world economy, and 2009 is shaping up in the same vein. I hope I am not tempting fate by saying that whilst we are acutely aware of the dangers in this crisis, we believe that there are good opportunities ahead for Hiscox and that success in capturing them will bring considerable benefits to policyholders, staff and shareholders. Bronek Masojada Chief Executive 9 March 2009 Hiscox locations Bermuda Hamilton *new office Europe Amsterdam Bordeaux Brussels Cologne Dublin Guernsey Hamburg Lisbon Lyon Madrid Munich Paris Stockholm UK Birmingham Colchester Glasgow Leeds London Maidenhead Manchester USA Armonk (New York) Boston Chicago Geneva (Illinois) Kansas City (Missouri) Lexington (Kentucky) Los Angeles* New York City Miami San Francisco Chief Executive’s report Hiscox Ltd Report and Accounts 2008 11 Insurance carriers Syndicate 3624 Syndicate 3624 is a new wholly owned syndicate with an initial underwriting capacity of £80 million. The Syndicate was approved by Lloyd’s during the last quarter of 2008 and began underwriting for the 2009 year of account. No business was written in the Syndicate in 2008. Panther Re The reinsurance contract with Panther Re was not renewed for the 2008 year of account and the 2007 year of account was successfully commuted during 2008. 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 ratings. It also benefits from the Lloyd’s brand. Lloyd’s has an A (Excellent) rating from A.M. Best, an A+ (Strong) from Standard & Poor’s, and an A+ (Strong) rating from Fitch. The geographical and currency splits are shown to 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 45.6% 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 72.5% of the Syndicate, with 27.5% being owned by third party Lloyd’s Names. Hiscox receives a fee and a profit commission of approximately 17.5% of profit on the element it does not own. The chart to the right shows the performance of Syndicate 33 for the last eight years. 12 Insurance carriers Hiscox Ltd Report and Accounts 2008 120 100 80 60 40 20 0 Syndicate 33 Gross premiums written (£m) and combined ratio (%) Gross premiums written Combined ratio 1024 994 885 827 844 830 722 567 1,200 1,000 800 600 400 200 0 2001 2002 2003 2004 2005 2006 2007 2008 Syndicate 33 2008 Gross premiums written geographical split (%) 5 % U K 7 % E u r o p e 3 % 4 7 % A sia N orth A m eric a R e s t o f w o rl d 3 8 % Cougar Syndicate Cougar Syndicate was set up for the 2008 year of account with a capacity of £34 million and is wholly backed by external Names. The Syndicate takes a pure year account quota share of Syndicate 33’s international property catastrophe reinsurance account under a limited tenancy agreement. This was initially for a one-year period only. Cougar Syndicate 6104 is managed by Hiscox Syndicates Limited. The arrangement was extended for the 2009 year of account and Cougar Syndicate 6104’s capacity was increased to £43 million. In addition Hiscox has put in place reinsurance with a number of conventional reinsurers on a similar basis to the Cougar and Panther arrangements. Syndicate 33 2008 Gross premiums written currency split (%) 9 % E U R 3 % C A D 1 0 % G B P 78% USD Syndicate 33 Capacity and Hiscox ownership (£m) Capacity Hiscox ownership Qualifying Quota Share 8 4 2 4 8 5 2 6 4 8 2 3 8 4 7 7 7 4 5 0 5 5 0 5 5 7 8 4 7 8 5 3 6 4 0 6 3 5 0 5 7 4 3 0 0 7 4 4 5 8 0 5 1,000 800 600 400 200 0 1 0 2 4 0 5 7 7 2 0 6 3 1 9 1 2001 2002 2003 2004 2005 2006 2007 2008 2009 Insurance carriers Hiscox Ltd Report and Accounts 2008 13 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% from 1997 to 2008, despite discontinuing almost all of its original business. It has also significantly improved its combined ratio. In September A.M. Best upgraded the rating of Hiscox Insurance Company Limited to A (Excellent). In December Standard & Poor’s upgraded its rating to A (Strong). At the end of 2008, net assets exceeded £151 million (2007: £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. During the year, A.M. Best upgraded the rating of Hiscox Guernsey to A (Excellent). At the end of 2008, net assets exceeded $23.1 million (2007: $20.6 million). Hiscox Insurance Company Limited Gross premiums written geographical split by origin (%) 3% Other Europe 2% Belgium 4% Netherlands 7 % G e r m a n y 11 % France 7 3 % U K Hiscox Insurance Company Limited Gross premiums written (£m) and combined ratio (%) Core Combined ratio Gross premiums written 350 300 250 200 150 100 50 0 164 176 127 90 98 75 325 284 219 231 233 242 Combined ratio 140 120 100 80 60 40 20 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 14 Insurance carriers Hiscox Ltd Report and Accounts 2008 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 $502 million, it has access to reinsurance business shown to the growing Bermuda market and has also become a vehicle for intragroup reinsurance. During the year A.M. Best upgraded the rating of Hiscox Bermuda to A (Excellent). At the end of 2008, net assets were $803.8 million (2007: $760.7 million). Hiscox Insurance Company Inc. Hiscox Insurance Company Inc. was acquired by the Group in July 2007 through the purchase of the then parent holding company ALTOHA, Inc. It is rated A (Excellent) by A.M. Best. Hiscox Insurance Company Inc. is based in Geneva, Illinois and is an admitted insurance company with licences in all 50 US states. Its insurance is also available internationally in Australia and South Africa. Its main business is animal mortality insurance for cattle and horses. Hiscox Insurance Company (Guernsey) Limited Gross premiums written ($m) 120 100 80 60 40 20 0 110 98 89 79 61 62 66 68 47 38 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Hiscox Insurance Company (Bermuda) Limited Gross premiums written ($m) External business 350 300 250 200 150 100 50 0 297 212 171 2006 2007 2008 Insurance carriers Hiscox Ltd Report and Accounts 200815 15 Group financial performance 9.2% Post-tax return on equity Earnings per share fell to 18.8p (2007: 48.4p). The revival of the US Dollar during the second half of the year generated material exchange gains, which combined with good underwriting profits, assisted in growing overall net asset value per share by 23% to 258.1p (2007: 209.5p). Gross premiums written reduced by 4.3% as the Global Markets and Bermuda businesses contracted on rates. This was offset by growth in all other business units. The Group achieved a profit before tax of £105.2 million in 2008 (2007: £237.2 million). The post-tax return on shareholders’ equity was 9.2% (2007: 28.8%). Total dividend for the year increased by 6.25% to 12.75p (2007: 12.0p). The reduction in profit before tax reflects the twin challenges of the unprecedented volatile investment markets and increased catastrophe losses prevalent during 2008. The Group’s investment portfolio negotiated difficult market conditions reasonably well however the protracted influence on valuations from widening credit spreads and the greater worldwide intolerance of equity risk assets outweighed the coupon returns from fixed Group financial performance Global Markets 2008 UK and Europe 2008 International 2008 Corporate Centre 2008 Total 2008 Global Markets 2007 UK and Europe 2007 International 2007 Corporate Centre 2007 Gross premiums written (£m) 586.5 354.9 206.0 – 1,147.4 676.4 302.3 220.2 Net premiums written (£m) Net premiums earned (£m) 425.1 328.7 176.7 477.8 302.4 172.8 – – 930.5 524.7 265.0 185.2 953.0 552.2 248.3 164.6 – – – Total 2007 1,198.9 974.9 965.2 Investment result – financial assets (£m) (5.8) (11.9) (8.1) (1.8) (27.6) 46.6 18.4 23.9 11.9 100.8 Investment result – derivatives (£m) – (10.5) – (42.5) (53.0) – – – (1.1) (1.1) 134.5 31.6 0.9 (10.9) 156.2 155.6 21.8 69.1 (9.3) 237.2 Profit/(loss) before tax and certain foreign currency items (£m) Foreign currency items on economic hedges and intragroup borrowings (£m) Profit/(loss) before tax (£m) Claims ratio (%) Expense ratio (%) Foreign exchange impact (%) Combined ratio (%) – (57.0) (51.0) – 0.9 (67.9) 105.2 155.6 51.1 40.8 45.1 37.4 – 21.8 45.6 54.3 – 69.1 40.1 36.8 6.0 140.5 57.8 36.7 – 31.6 41.9 50.3 (26.0) (10.7) 68.5 81.5 43.0 38.8 12.4 94.2 – – – – – – (9.3) 237.2 – – – – 44.5 41.0 (1.1) 84.4 2007 2,050.6 849.7 2,900.3 824.3 209.5 199.3 393.4 (15.8) (0.8) (1.7) (1.5) 76.1 81.7 98.2 75.4 2008 2,522.4 1,214.9 3,737.3 951.0 258.1 244.9 368.5 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) 16 Group financial performance Hiscox Ltd Report and Accounts 2008 12.75p Dividend for 2008 increased by 6.25% income securities. Consequently, the underlying investment performance before the impact of derivative items was £27.6 million negative (2007: £100.8 million positive). Although disappointing, this remains a creditable result in an exceptional year and a significant portion represents unrealised fair value adjustments which may be expected to reverse over the medium term as the affected assets mature. The Group’s reported profit before tax includes foreign currency items of £51 million in relation to foreign currency hedging contracts and foreign currency losses on intragroup borrowings. The hedging contracts were used to hedge part of the Group’s net investment in its Bermuda and Guernsey insurance operations and the £42.5 million of charges incurred are therefore economically linked to the underlying currency translation gains of £151.2 million recognised directly in equity. Not withstanding the fact that a formal hedge accounting treatment for this net investment relationship could not be achieved with these hedging contracts, the Group believes they are the most economically sound means of shielding foreign exchange movements in the investments’ value to an acceptable range. £8.5 million of foreign exchange losses on intercompany positions again are inseparable from similar and opposite gains recognised in the balance sheet. The underwriting performance of each reporting segment is detailed below. 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 13.3% on the prior year as the business continued to strategically retreat from inadequately priced risks in certain lines of business which were increasingly contested during the year. This shrinkage was partially offset by the impact of reinstatement premiums on reinsurance business following Hurricane Ike and favourable exchange rate movements during the second half of the year. The percentage of reinsurance purchased by the Global Markets segment was 27.5% (2007: 22.4%). The reinsurance partnership with Panther Re was successfully commuted in January 2008 and the business utilised the quota share arrangement with the Cougar Syndicate and reinsurance contracts with commercial reinsurers on similar terms throughout 2008 in return for ceding and profit commissions. Net premiums written and earned fell representing in part the reduction in business volume. Investment income reduced to £5.8 million negative (2007: £46.6 million positive) as widening spreads in fixed income markets compounded the effects of lower prevailing cash interest rates. The business incurred significant net catastrophe losses, mainly in respect of Hurricanes Ike and Gustav, in contrast to the relatively benign loss experience in 2007. The expense ratio declined to 36.7% (2007: 37.4%) as lower employee compensation costs offset the increased investment made in a number of operational areas. Profit before tax was consequently lower at £140.5 million (2007: £155.6 million). The combined ratio was 68.5% (2007: 81.7%), having been impacted by positive foreign exchange movements. 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 over 10% for the second year running. Management successfully expanded underwriting activity across all core lines of retail business, especially in the direct product offerings and for the professional and specialty commercial risks. Reinsurance outwards costs reduced by £7.7 million to £18.7 million (2007: £26.4 million) as the UK business retained additional aggregate exposure as comparable cover to the prior year became prohibitively expensive. The business also avoided any need for reinstatement premiums on its reinsurance programme unlike 2007 when £2.2 million was incurred subsequent to the summer flood events. The widespread de-leveraging in equity markets during 2008 resulted in all dividend income returns being more than erased by significant unrealised fair value losses in valuations. The claims ratio reduced to 39.8% (2007: 45.6%), reflecting the absence of significant catastrophe losses in contrast to the prior year which was characterised by multiple unusual large loss events including Windstorm Kyrill and the UK summer flooding incidents. Group financial performance Hiscox Ltd Report and Accounts 2008 17 Group financial performance continued Improved expense management and economies of scale accompanied the favourable prior year claims experience such that the combined ratio improved to 85.0% (2007: 98.8%). 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 grew by 27% to £93.0 million (2007: £73.1 million) as a result of strong underlying growth in all countries except for Ireland, where demand for surety bond insurance was constrained by the slowdown in the construction market. The strengthening Euro offered support to the reported top line. In common with the UK business, reinsurance outwards costs fell to £7.5 million (2007: £10.9 million) mainly as a result of less low level reinsurance cover being purchased. Investment income declined due to the effects of unrealised losses on fixed income assets and equities. A relatively benign current loss environment resulted in a claims ratio of 48.6% (2007: 45.2%). The expense ratio decreased for the second year running to 52.4% (2007: 56.2%) as the business continued to unlock scale benefits of premium growth outstripping expenses which grew more sparingly. There was an exchange gain of £23.2 million, partially offset through derivative losses, to manage the exposure to Euros. The combined ratio therefore improved overall to 70.6% (2007: 96.2%), primarily driven by exchange gains and favourable loss ratios across most European regions and product lines. Profit before tax was therefore reduced to £2.7 million (2007: £4.6 million). 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. The reduction in gross premiums written of £14 million is wholly attributable to the strategic contraction of the Bermudian external reinsurance business in response to softer market conditions. A reduction of 23% of the Bermuda premium was offset by organic growth of 21% achieved in Guernsey where we experienced increased demand for our specialised products, and 43% growth in the USA which benefited from organic growth and the inclusion of one full year of business from the ALTOHA Inc. Group which was acquired in August 2007. Exchange rate movements also had a beneficial impact. The reinsurance outwards spend was slightly lower in 2008 reflecting the lower underwriting activity in Bermuda which more than offset the impact of the reinstatement premiums incurred after Hurricanes Ike and Gustav. £75.8m Net positive cash flow Hiscox UK and Hiscox Europe Gross premiums written (£m) Net premiums written (£m) Net premiums earned (£m) Investment result – financial assets (£m) Investment result – derivatives (£m) Profit before tax (£m) Claims ratio (%) Expense ratio (%) Foreign exchange impact Combined ratio (%) UK 2008 261.9 243.2 227.3 (2.8) – 28.9 39.8 49.7 (4.5) 85.0 Europe 2008 93.0 85.5 75.1 (9.1) (10.5) 2.7 48.6 52.4 (30.4) 70.6 Total 2008 354.9 328.7 302.4 (11.9) (10.5) 31.6 41.9 50.3 (10.7) 81.5 UK 2007 229.2 202.8 190.3 15.9 – 17.2 45.6 53.7 (0.5) 98.8 Europe 2007 73.1 62.2 58.0 2.5 – 4.6 45.2 56.2 (5.2) 96.2 Total 2007 302.3 265.0 248.3 18.4 – 21.8 45.6 54.2 (1.6) 98.2 18 Group financial performance Hiscox Ltd Report and Accounts 2008 Investment income reduced to £8.1 million negative (2007: £23.9 million positive) mainly attributed to adverse interest rate movements in addition to the unusually challenging market conditions outlined above. The claims ratio was 43.0% (2007: 40.1%) as catastrophe losses in Bermuda accrued from the more active 2008 hurricane season, and other large risk losses in the first half of the year. This dampened good loss conditions in Guernsey and the USA. The expense ratio was up at 38.8% (2007: 36.8%). This is as a result of a full year of ALTOHA Inc. Group and expansion costs to take advantage of opportunities in the US. Profit before tax therefore reduced to £0.9 million (2007: £69.1 million). 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 £1.8 million negative (2007: £11.9 million positive). Derivative charges of £42.5 million were incurred in protecting £47.6 million of the currency translation gains recognised directly in equity (2007: £nil), made prior to the execution of these contracts. This was far outweighed by the £151.2 million translation gains recognised in equity. Finance costs decreased markedly to £4.7 million (2007: £8.1 million) as the Group repaid its $182 million term loan facility early in May 2008. Expenses decreased by 20.7%. Loss before tax was £67.9 million (2007: £9.3 million). Cash and liquidity The Group’s primary source of liquidity is generated from premium income and interest income received on investments. Funds received are used predominantly to pay claims, increase investments and pay dividends and taxes. The Group maintains relationships with a limited selection of banks who are monitored for their credit status and ability to meet the day-to-day banking requirements of the Group. There were no impairments recorded against cash or cash equivalents and no recoverability issues have been identified on such assets. Net cash inflows from operating activities during the year were £200.9 million (2007: outflow of £123.5 million). The cash inflow was mainly as a result of the strong underwriting result together with continued favourable collection and settlement of outstanding amounts from reinsurance partners. In addition, the Group’s investment in the current year in financial assets which do not qualify for presentation as cash equivalents reduced to £284.1 million compared with £489.7 million during 2007. The Group includes the purchase, maturity and disposal of financial assets as part of its insurance activities and as such they are classified as operating cash flows. During the latter half of the year, the Group experienced defaults of £6 million on debt securities held with one financial institution. Net cash outflows from investing activities for the year were £16.7 million (2007: outflow £23.6 million). During the year the Group acquired Amershill Limited for a consideration of £2 million. Amershill is a wholly owned subsidiary and acts as an underwriting agent for the Group. The Group also purchased a holding in two new associate companies for total consideration of £5.4 million. £2.5bn Invested assets Group investment performance Bonds £ US$ Other Bonds total Equities Deposits and cash equivalents Total return Group invested assets Asset allocation % 11.6 54.7 10.2 76.5 5.0 18.5 31 December 2008 31 December 2007 Return £000 Asset allocation % Return % 5.3 (2.5) 3.1 (0.3) (4,027) (28.4) (38,267) 3.7 (1.3) 14,662 (27,632) £2,522.4m 10.1 50.6 9.7 70.4 7.8 21.8 Return % 5.5 5.8 3.7 5.5 4.1 5.4 5.4 Return £000 70,688 6,959 23,140 100,787 £2,050.6m Group financial performance Hiscox Ltd Report and Accounts 2008 19 Away from cash and treasuries, which will be maintained at an appropriate level to provide liquidity, we see good opportunities in investment grade corporate bonds and would expect to increase our allocation there. During the year we reduced our exposure to equities which further mitigated the overall impact of the weak markets. In turn our risk assets outperformed the broader indices helped by our modest allocation to hedge funds which, as intended, provided a helpful buffer to our long only managers. We have investments with four hedge fund managers totalling £40 million (2007: £30 million) all of whom are essentially stock pickers and none of whom employ any leverage. In light of recent scandals and events, the maxim of keeping it simple has found new relevance and still lies at the heart of our philosophy. Group financial performance continued The increased outflow was driven primarily by cashflows on the purchase of own shares as part of the share buy-back programme of £62.9 million (2007: £11.3 million) and £2.2 million for purchases held in trust. Net cash outflows from financing activities for the year were £108.5 million (2007: outflow £50.0 million). The Group repaid $182 million being the full amount of its loan facility during the year. In May the Group refinanced its bank facilities with a £350 million secured syndicated loan facility at a 1% margin. The £200 million cash element of this is a five year revolving facility. As at the year end £137.5 million of the Letter of Credit and £90.3 million of debt was drawn. Group assets The Group’s invested assets grew to £2.52 billion (2007: £2.05 billion) with steady cash flow and the effect of a strong Dollar. The investment return, excluding derivative positions, declined to £27.6 million negative (2007: £100.8 million positive) in the last year. Hiscox has a policy of focussing on high quality short duration bonds and this has held us in good stead during what has been a traumatic time for most investors. Despite our conservative stance the portfolio suffered from the extreme weakness in equity markets and the widening of spreads on non Government bonds. The complete lack of liquidity in most areas of the bond markets has led to many discounted mark to market valuations. This has been most pronounced in the US Dollar bond portfolio where the valuations of some of the mortgage backed securities have suffered. The underlying securities, however, continue to pay down interest and principal in line with expectations and remain highly rated. Indeed cashflow from our bond portfolios is being generated at the rate of approximately £100 million a quarter which, together with undrawn bank facilities, provides us with ample liquidity. By the end of the year, 18.5% of the total portfolio was represented by cash. Government and Government supported assets accounted for 52% of the debt securities, with 94.6% of the debt securities being rated A or higher. Our ability to hold the discounted securities to maturity will benefit the Group’s investment return in the coming years at a time when interest rates in general are likely to be low. 20 Group financial performance Hiscox Ltd Report and Accounts 2008 High quality and well diversified portfolio Investment portfolio: £2,522m Asset allocation Bond credit quality 3.0% BBB 2.4% BB and below 1 8 . 5 % C a s h 9 . 0 % A 9.3 % A A 76.3% AAA 5.0% Riskassets 76.5% Bonds Bond currency split 2.3% CAD 7 1 . 5 % U S D % 1 5.2 P B G EUR 11.0% Group financial performance Hiscox Ltd Report and Accounts 2008 2121 Incentives ensure that underwriting staff make sound and objective judgements that are aligned with the Group’s overall strategic objectives. Risk management Risk management framework The risk management framework extends to all aspects of risk including insurance, market, credit, operational, liquidity, environmental, ethical and strategic risks. 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 systems and procedures to identify and manage them. These procedures are regularly reviewed and improved in the light of the changing risk environment and best practices. Risk appetite is set by the main Board and cascaded down into the Group’s global operations as part of the business planning cycle and through various risk and operational committees. These committees have terms of reference that assign specific areas of focus, such as underwriting, loss modelling, reinsurance purchase and security, liquidity, broker credit risk, investments, claims reserving and business continuity. Senior management responsibilities are clearly defined 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 and Group risk committees, monitors and reviews the effectiveness of risk management activities throughout the organisation and reports to the Board. These functions are organised centrally to assist in the integration of best practice throughout the Group. A range of risk 22 Risk management Hiscox Ltd Report and Accounts 2008 management tools are used to assess and manage risk both at business unit level and on a Group-wide basis. Major risks The major risks that the Group faces are presented below. Detailed information on the major risks and uncertainties impacting the Group’s financial statements, is set out in note 3 to the financial statements. Insurance Catastrophe and systemic insurance losses 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 good margins over the medium- to long-term as the occurrence of catastrophes averages out. As with similar insurers, the Group’s earnings are affected by unpredictable external events such as natural and other catastrophes, legal developments, social and economic change and the emergence of latent risks. Such events can create significant levels of underwriting losses. The Group manages its exposure to these risks through having a clearly defined risk appetite which dictates the business plan and is realised through disciplined underwriting, close and continuous monitoring of exposures and aggregations and a prudent and disciplined reinsurance purchase programme to cap losses from risk concentrations. Of critical importance is the quality of our underwriting models and risk aggregation capability. Incentives ensure that underwriting staff make sound and objective judgements that are aligned with the Group’s overall strategic objectives. Clear authority limits are also in place that are regularly reviewed and monitored. Policy wordings are reviewed regularly by specialists and legal experts in the light of legal developments to ensure that the Group’s exposure is restricted, as far as 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. Subsidiaries and locations worldwide therefore employ the same sophisticated standard of modelling tools tailored to the characteristics of each specific market. We also run realistic disaster scenario projections on a subsidiary and consolidated basis in order to estimate the potential loss across all books of business following a range of specific events. We adjust our business plan, target products and reinsurance programme indicated that it will not demand any principal repayments in the next three years. 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 continued involvement of the Group’s executives in the reshaping of the Lloyd’s market underscores that commitment. Reserving 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, as well as any potential changes in historic rates arising from market or economic conditions. Details of the actuarial and statistical methods and assumptions used to calculate reserves are set out in note 26 to the financial statements. The provision estimates are subject to rigorous review and challenge by senior management from all areas of the business and the final provision is approved by the reserving committees. The provision is set above the expected or mean reserve requirement to minimise the risk that actual claims exceed the amount provided. Binding authorities Hiscox writes a considerable amount of premium income through agents to whom binding authority is given to accept risks on behalf of Hiscox Group carriers. All binding authorities are strictly controlled through tight underwriting guidelines and limits and extensive vetting, monitoring, and auditing of compliance. Agents to whom binding authorities are granted are regularly examined to ensure they meet the Group’s minimum standards. These checks are performed by staff independent of the underwriting function and the process is overseen by a committee comprising both underwriters and non-underwriters from the senior management team and the Group Head of Internal Audit. to deliver a well-diversified book of uncorrelated business. This enables us to maximise expected risk/return on the portfolio as a whole and offset potential losses on the more volatile accounts. Competition and the insurance cycle We have continued to increase our presence in the USA and in Europe. In these markets, Hiscox competes against major international groups with similar offerings. At times, a minority of these groups may choose to underwrite for cash flow or market share purposes at prices that sometimes fall short of the break-even technical price. 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 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. To manage this risk, Hiscox alters its appetite for the lines of business and the layers it writes in response to market conditions and the risk appetite of the Group. Pricing levels are monitored on a continuous basis with detailed monthly reports showing current prices relative to exposure, trends over the past 12 months, and projections to the year end. The Group’s cycle management strategy and related modelling and monitoring are essential to ensure that it quickly identifies and controls any accumulating adverse effects of changes. 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 the obligations of other financial institutions who fail. Syndicates 33 and 3624 contribute 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). Insurance companies have not yet been asked to fund the recent claims on the FSCS from the banking industry, currently funded by the Treasury. Any such requests will depend on the final level of claims from deposit-holders (net of asset recoveries), the period of repayment demanded by the Treasury and the ability of the banks to make such repayments. The Treasury has We adjust our business plan, target products and reinsurance programme to deliver a well- diversified book with a large focus of uncorrelated business. Risk management Hiscox Ltd Report and Accounts 2008 23 Risk management continued Credit Reinsurance counterparties The Group purchases reinsurance protection to limit 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. Credit exposures to these companies are closely managed by the Reinsurance Security Committee (RSC), which is chaired by the Group Finance Director. All reinsurers used must be approved by the RSC following an internal assessment of the companies’ financial strength, trading record, payment history, outlook and organisational structure, in addition to credit ratings granted by external agents. Approved reinsurers are monitored continuously to identify potential deteriorations as early as possible. Monitoring procedures include consideration of public information produced by reinsurers; the Group’s experience of the reinsurers and their behaviour in the marketplace; analysis from external consultants and from rating agencies. Credit limits are set for approved reinsurers both at a Hiscox Group level and for each underwriting subsidiary based on a defined risk appetite. The Group’s experience of bad debts arising from its reinsurance arrangements has been minimal. Operational and other key risks Business continuity The Group has taken significant steps to minimise the impact of business interruption that could result from a major external event. A formal disaster recovery plan is in place for both workspace recovery and retrieval of communications, IT systems and data. In the event of a major event, these procedures will enable the Group to move the affected operations to alternative facilities within very short periods of time. The disaster recovery plan is tested regularly and includes disaster simulation tests. Staff are widely distributed throughout the UK, Europe, USA, Bermuda and Guernsey. This geographical dispersion reduces the Group’s exposure to natural or terrorist events that could prevent access to premises or loss of staff. In the event of a loss of staff, for example as a result of a pandemic, a plan is in place to re-assign key responsibilities and transfer resources to ensure key business functions can continue to operate. Hiscox credit rating The external ratings granted to the Group and its subsidiaries are essential to maintaining profitability, particularly in relation to our reinsurance business and managing the costs of financing and access to capital. We have identified the key aspects of our business which are critical to maintaining our ratings and closely manage these to minimise the risk of an event which might jeopardise any rating and to ensure that we respond appropriately to unforeseen external events. We maintain regular and open communication with our rating agencies to ensure that we continue to meet their expectations and that careful consideration is given to the potential impact on a rating of any significant decision. Emerging risks Being able to identify and plan for unexpected events has become an increasingly important component of our business cycle management. Emerging risk identification and control is therefore a core part of risk management activities in relation to all aspects of our business, including underwriting, operational and strategic. Significant efforts are made, including obtaining external expertise, to try to identify any threats to the business either actual of potential. For example, a change in US legislation may result in unintended risks being underwritten, or may require us to cease business in certain US States. We take all reasonable steps to minimise the likelihood and impact of such events and to be prepared for their occurrence. Capital The Group manages capital rigorously in order to maximise its return on capital whilst maintaining sufficient levels of financial resources to absorb unexpected losses and meet the requirements of regulators and rating agencies. Accurate measurement of potential losses under various scenarios is a critical aspect of our business planning and capital management cycle. Potential losses are calculated regularly using the most sophisticated modelling techniques available supported by stress and scenario assessments. We invest heavily in the most up to date risk management techniques and expert staff to ensure our procedures and analyses remain second to none. 24 Risk management Hiscox Ltd Report and Accounts 2008 Emerging risk identification and control is a core part of risk management activities in relation to all aspects of our business, including underwriting, operational and strategic. Foreign exchange The US Dollar is the Group’s largest underwriting currency. The Group’s policy is to match US Dollar insurance liabilities with investments held in the same currency in order to minimise the effect of currency fluctuations. Whilst the Group’s functional and reporting currency is Sterling, a significant proportion of the Group’s operational cost base is located in the USA and Europe, and movements in foreign exchange rates may have a material adverse effect on its financial performance and position. In addition the capital base of the Bermuda, Guernsey and US insurance companies are in US Dollars. Net currency positions are closely monitored and currency hedging transactions are entered into where this is considered advantageous in the light of anticipated movements in exchange rates. Further details of the Group’s investment profile and its management of currency risks are provided in notes 3, 20 and 22 to the financial statements. Investments and foreign exchange Investment policy The investment policy is designed to maximise returns within the overall risk appetite of the Group which stipulates a one in 100 year loss tolerance. The overriding philosophy with the Group’s assets is not to lose money or to put at risk the Group’s capacity to underwrite. In this regard 2008 by most measures, will be viewed as a one in 100 year event. These turbulent times have not diminished the Group’s capacity to underwrite due to our conservative investment policy. 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. Risk management Hiscox Ltd Report and Accounts 2008 25 Risk management continued Liquidity Liquidity risk is the risk of being unable to meet liabilities to customers or other creditors as they fall due, or the risk of incurring excessive costs in selling assets or having to raise finance in a very short period. The majority of the Group’s cash inflows and outflows are routine and can be forecast well in advance. The primary source of inflows is insurance premiums whilst outflows are to policyholders for claims made. Cash flow is forecast on rolling daily, weekly, monthly and quarterly basis depending on the source, and, in the event of a major catastrophe, such forecasting may be up to three years in advance. Free cash is invested according to the Group’s investment policy and cash requirements can normally be met through regular income streams (i.e. premiums or investment income), existing cash balances or realising investments that have reached maturity. The Group’s liquidity risk arises from large, unplanned cash demands and the principal source of risk is a major catastrophe resulting in a high value of claims. This could be exacerbated if we had to fund claims pending recovery from a reinsurance partner. We plan for this risk through a number of measures. First, we run stress tests to estimate the size and timing of claims that might have to be paid in the event of a number of major catastrophes all occurring within a short period of time. We also run scenario analyses that consider the impact on liquidity of a range of adverse events happening simultaneously; for example, an economic downturn and declining investment returns combined with unusual levels of insurance losses. Second, taking into account the stress and scenario analyses, we maintain extensive borrowing facilities. These are held with a diverse range of major international banks in order to minimise the risk of one or more being unable to honour their commitments. Third, our investment policy recognises that some investments may need to be realised before maturity or at short notice and hence a high proportion of investments must be held in liquid assets. This minimises the risk of loss in the event of having to sell assets quickly. Using these measures we believe the likelihood of being unable to meet our liabilities, or of incurring excessive costs in doing so, to be extremely remote. 26 Risk management Hiscox Ltd Report and Accounts 2008 Boxplot and whisker diagram of Hiscox Ltd net loss (USD) Upper 95%/lower 5% Mean Hiscox Ltd loss ($m) s s o l t e k r a m 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 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 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 d o i r e p n r u t e r r a e y 7 s s o l t e k r a m b 5 7 1 $ e k . I e n a c i r r u H 800 600 400 200 0 s s o l t e k r a m 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 JP EQ US EQ EU WS US HU JP EQ US EQ EU WS US HU JP EQ US EQ EU WS US HU JP EQ US EQ EU WS US HU JP EQ US EQ EU WS US HU 5–10 year 10–25 year 25 –50 year 50 –100 year 100–250 year Industry loss return period and peril The chart above shows the variability in net loss the Group expects from individual losses of a given industry loss size. Risk management Hiscox Ltd Report and Accounts 2008 27 Hiscox strives for the highest standards of corporate governance while being in essence a non-bureaucratic organisation. Corporate responsibility Fundamental to corporate and social responsibility is honest and fair dealing in all activities of the Group. Hiscox has always been extremely conscious of its reputation. 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. Robert Hiscox Hiscox’s commitment to responsible business practices is reflected: In the marketplace Dealing with customers Hiscox 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. 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. Packages are also considered on a country-by-country basis. 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. 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. 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. With this conduct, 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 28 Corporate responsibility Hiscox Ltd Report and Accounts 2008 support HART (Humanitarian Aid Relief Trust) over a three year period. The charity helps some of the poorest and most abused people in the world. As part of the purchase of American Live Stock, Hiscox has taken over a small charitable foundation based in Illinois, USA. Four Hiscox employees have been appointed to the Board of the Foundation. The Foundation, which formerly supported animal charities, will now broaden its scope to support relevant causes in the US. 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. 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 continues to take 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. Programmes for recycling batteries, mobile phones, lamps and CDs continued during the year. The Group’s efforts were rewarded by a Clean City Award from the City of London Corporation, which aims to promote good waste management practices and encourage waste minimisation, reuse and recycling. Hiscox is a member of Climatewise, an insurance industry initiative which aims to reduce the economy’s and society’s long-term risk from climate change. Hiscox supports 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. During 2008 Hiscox UK conducted an audit of its impact on the environment and with Corporate Citizenship, calculated the carbon footprint of the UK business. Hiscox UK aims to be Carbon Neutral by the end of 2009 by reducing greenhouse gas emissions, engaging employees to modify their behaviours and seeking to offset unavoidable carbon emissions. More detailed information relating to the actions Hiscox is taking to meet each of the Climatewise Principles will be published on Hiscox.com in June 2009. 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 Hiscox donated £717,000 to charities in 2008. As the Group expands internationally, 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, 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. Hiscox has started a two year programme of support for the Whitechapel Art Gallery in London. 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 continued their seven year long support of the Richard House Hospice, raising over £25,000 during 2008. The foundation has committed to Corporate responsibility Hiscox Ltd Report and Accounts 2008 29 Board of Directors Executive Directors Robert Ralph Scrymgeour Hiscox Chairman (Aged 66) Robert Hiscox joined Hiscox in 1965 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 and AGICM Ltd. Bronislaw Edmund Masojada Chief Executive (Aged 47) 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. 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 48) 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 is Chairman of the Business Advisory Board of the Institute of Chartered Accountants in England and Wales, a member of the Financial Regulation and Taxation Committee of the Association of British Insurers and Vice-chairman of the Lloyd’s Market Association Finance Committee. Robert Simon Childs Chief Underwriting Officer and Chief Executive Officer of Hiscox Bermuda and Chairman of Hiscox USA (Aged 57) Robert Childs joined Hiscox in 1986, 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. Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 66) 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 is Chairman of Herald National Bank and 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. Ernst Robert Jansen Non Executive Director (Aged 60) Ernst Jansen joined Hiscox on 20 November 2008. He held several Managing Director positions in the European chemical industry between 1980 and 1990. He was an Executive Director then Vice Chairman of Eureko B.V. between 1992 and 2007. Following retirement he became an adviser to the Executive Board and is a member of the Supervisory Board of a number of Eureko operating companies. Independent Non Executive Directors 30 Board of Directors Hiscox Ltd Report and Accounts 2008 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 Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 70) 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 60) 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 Acting Senior Independent Director and Acting Chairman of the Remuneration and Nomination Committee (Aged 54) 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 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. Gunnar Stokholm Non Executive Director (Aged 59) Gunnar Stokholm joined Hiscox on 20 November 2008. He worked for Zurich Financial Services between 1995 and 2004, in a number of roles including CEO for Australia and Asian markets. He spent the majority of his career at Topdanmark Insurance and held the position of Managing Director of Topdanmark Holding from 1986 to 1995. Dirk Arie Stuurop Non Executive Director (Aged 60) Dirk Stuurop joined Hiscox in 2006. He is managing partner of Lighthouse Holdings LLC. From 2004 to 2009 he was 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. Board of Directors Hiscox Ltd Report and Accounts 2008 31 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 2008, 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 seven independent Non Executive Directors, including a Senior Independent Director. Biographical details for each member of the Board are provided on pages 30 to 31. The Board continues to believe in the need for an Executive Chairman. The roles and activities of the Chairman and Chief Executive are distinct and separate. The Chairman is responsible for running an effective Board including oversight of corporate governance and overall strategy. 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. The appointment and removal of the Company Secretary is a matter for the Board as a whole. 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 four 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 is chaired by Daniel Healy and comprises Ernst Jansen, Dr James King, Andrea Rosen, Gunnar Stokholm and Dirk Stuurop. Daniel Healy and Dr James King are considered by the Board to have 32 Corporate governance Hiscox Ltd Report and Accounts 2008 recent and relevant financial experience. The Audit Committee meets at least three 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 comprises Andrea Rosen as acting chair in Sir Mervyn Pedelty’s absence together with Daniel Healy, Ernst Jansen, Dr James King, Gunnar Stokholm and Dirk Stuurop. It meets a minimum of two times a year to deal with appointments to the Board and to recommend a framework of executive remuneration. A succession planning review identified the requirement for additional Non Executive Directors. An evaluation of the skills, knowledge and experience of the Board was undertaken in order to achieve the desired level of diversity across the Board. Spencer Stuart were appointed to conduct an executive search. Following consultation with the members of the Remuneration and Nomination Committee, the Chairman and Chief Executive interviewed prospective candidates. The Remuneration and Nomination Committee recommended to the Board the appointment of Ernst Jansen and Gunnar Stokholm. The Directors’ remuneration report is presented on pages 35 to 42. 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, Syndicate 3624 and Syndicate 6104 are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.4% of the Names on Syndicate 33 are third parties and 72.6% of Syndicate 33 is owned by a Hiscox Group company. 100% of Syndicate 3624 is owned by a Hiscox Group company. 100% of Syndicate 6104 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 specific risk areas, including underwriting, reserving, reinsurance credit, liquidity, broker credit, business continuity and investments. A Group risk committee ensures risk management activities are effective and integrated. These committees are comprised of Directors of the Company and its subsidaries and relevant senior employees. Meetings and attendance table Director RRS Hiscox BE Masojada SJ Bridges RS Childs C Franklin Engler1 DM Healy ER Jansen2 Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm2 DA Stuurop 1 Resigned 20 November 2008. 2 Appointed 20 November 2008. Ltd Board Audit Committee Remuneration and Nomination Committee Attended Attended Attended 4/4 4/4 4/4 3/4 3/3 4/4 1/1 3/4 0/4 4/4 1/1 3/4 n/a n/a n/a n/a 3/3 3/3 1/1 2/3 n/a 3/3 1/1 2/3 n/a n/a n/a n/a 2/2 2/2 1/1 1/2 0/2 2/2 1/1 2/2 Corporate governance Hiscox Ltd Report and Accounts 2008 33 The Board has reviewed the effectiveness of internal controls during 2008, 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 function collates risk management information and 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. Corporate governance continued 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. 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. With the exception of the unavoidable absence of Sir Mervyn Pedelty, all Directors attended 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 22 to 27. 34 Corporate governance Hiscox Ltd Report and Accounts 2008 The Committee focuses on: the overall remuneration strategy, policy and cost for the Group; the determination of levels and make up of remuneration for the four Executive Directors; and the award of sizable bonuses to individuals. 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. The Committee is provided with data and has access to advice from Towers Perrin, independent remuneration consultants, who provide no other services to the Company. Remuneration policy The remuneration philosophy is to provide rewards that are competitive in every country in which Hiscox operates and that are consistent with our overall reward principles: competitive base pay; benefits which encourage health and security for the individual and their family but are not excessive and are consistent at all levels of the organisation; an annual bonus scheme which enables employees to earn attractive bonuses for generating good levels of return on equity; to encourage share ownership at all levels of the organisation and require it at senior levels; and contracts and notice periods that are in line with acceptable market practice but limit severance payments made on termination. 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 in this report entitled ‘Annual cash incentives’, ‘Share incentive schemes’, ‘Remuneration of Executive Directors’ 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. The members of the Committee for 2008 were Sir Mervyn Pedelty (Chairman), Andrea Rosen (Acting Chairman), Carol Franklin Engler, Daniel Healy, Dr James King and Dirk Stuurop. Ernst Jansen and Gunnar Stokholm joined the Committee on 20 November 2008. Total shareholder return (%) Hiscox FTSE Non life insurance 150 120 90 60 30 0 -30 Dec 03 Feb 04 Apr 04 Jun 04 Aug 04 Oct 04 Dec 04 Feb 05 Apr 05 Jun 05 Aug 05 Oct 05 Dec 05 Feb 06 Apr 06 Jun 06 Aug 06 Oct 06 Dec 06 Feb 07 Apr 07 Jun 07 Aug 07 Oct 07 Dec 07 Feb 08 Apr 08 Jun 08 Aug 08 Oct 08 Dec 08 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 35 Directors’ remuneration report continued As a business Hiscox is focused on generating strong pre-tax return on equity and long-term shareholder returns, therefore our reward structure is aligned with this. Remuneration elements The elements of remuneration at Hiscox are; fixed reward (base salary, benefits and retirement benefits) and variable reward (annual cash incentives (bonuses) and share incentive schemes). Fixed reward Fixed reward is made up of base salary, benefits and retirement benefits. Base salary Base salaries are reviewed annually. The Remuneration and Nomination Committee takes into account inflation rate movements by country, market data provided by it’s own consultants, Towers Perrin and the competitive position of Hiscox salaries (using Watson Wyatt salary reports) in order to set the overall salary budget. Individual salaries are set by taking into account all of the above as well as individual performance and skills. When approving Executive Directors salaries, the Remuneration and Nomination Committee takes into account rates of inflation, performance and competitive positioning of salaries as informed by Watson Wyatt data and other publicly available reports. The 2009 salary increases for Executive Directors will be a cost of living increase of 2%. Benefits Benefits are set within agreed principles but reflect normal practice for each country. Hiscox benefits include health insurance, life insurance and long-term disability schemes. Retirement benefits These also vary by local country practice. With the exception of Holland, all Hiscox retirement schemes are based on defined contributions. In Holland, we closed the defined benefit scheme to new members from July 2008. We will introduce a defined contribution scheme in 2009 and transition all current employees into this scheme from 2010. Variable reward 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, thereby linking rewards directly with performance. The expectation is that successful performance (company and individual) should enable employees to achieve upper quartile total remuneration. 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 entirely on individual performance ratings. It is designed to ensure that employees in these roles continue to be motivated to perform and the benefit is up to 10% of relevant salaries. 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 is currently 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. The Hurdle Rate for the 2008 bonus was reviewed. On balance the conclusion was for the Hurdle Rate to remain unchanged for 2008 but will continue to be reviewed for subsequent years depending on changes in the longer-term rate of return. 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. It has historically been Hiscox’s practice to base bonuses on operating profits, increasing the Group’s focus on generating underwriting profit. Operating profit is determined using a normalised investment return which has been set at 4% on bonds and 6% equities for the last few years. In 2007 actual investment return exceeded the normalised return. In view of the unprecedented market volatility the Remuneration Committee has decided that in future bonuses should be based on pre-tax profit which is determined using actual investment return. In 2008 the actual investment return was substantially below the normalised investment return. In order to provide a fair transition to this retrospective change in bonus approach in favour of the interests of shareholders it was decided that 2008 bonuses for junior employees 36 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 should be determined using profits based on the normalised investment return, mid-level employees assuming a 0% investment return and for senior employees based on the pre-tax profits which reflects the actual investment return of -1.3%. In 2009 bonuses for all staff will be based on the actual investment return. Additionally for the calculation of bonuses, foreign exchange gains or losses arising on intercompany loans and on balance sheet hedging contracts that are accounted through the profit and loss account with the equal gain or loss in the balance sheet are excluded from the calculation. Executive Directors’ cash incentives and ROE Pre-tax return on equity % Average bonus as a percentage of salary % 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 16 0 3 (24) 13 30 28 19 35 36 14 73 0 0 0 90 202 173 54 274 372 53 The payment of larger bonuses is deferred over a three-year period as follows. Bonus of £50,000, €75,000, $100,000 and below Entire bonus taken in cash in year one Bonus above £50,000 and below £100,000 Bonus above €75,000 and below €150,000 Bonus above $100,000 split 50% in year two, and 50% in year three and below $200,000 £50,000, €75,000, $100,000 taken in year one Balance of bonus Bonus above £100,000 50% of bonus taken Bonus above €150,000 in year one Bonus above $200,000 Balance of bonus split 50% in year two, and 50% 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. Early payment of deferred bonuses for reasons other than the above can only be made with the agreement of the Chief Executive (and the Remuneration and Nomination Committee in the case of Executive Directors). Share Incentive Schemes The Remuneration and Nomination Committee believes that employees should be encouraged to own Hiscox shares so that they are aligned to the long-term success of the company. Hiscox operates a Performance Share Plan for senior managers, a UK Save as You Earn scheme and an International Save as You Earn Scheme. Performance Share Plan Restricted share awards or nil cost option awards (depending on the appropriate practice by country) are made to Executive Directors and other senior managers at the discretion of the Remuneration and Nomination Committee. Awards under this plan were made in 2008 and the Remuneration and Nomination Committee has also agreed to make awards under this plan in 2009. The maximum annual award to an individual under the Performance Share Plan is a value of 200% of basic salary. The highest actual grant awarded in 2008 was 115% of basic salary. Dividend payments In order to better align senior managers with Total Shareholder Return, the concept which is applied to the Performance Share Plan awards is that the recipient is provided with the equivalent of the dividend either in shares or cash. This specifically works as follows: dividends (or amounts equal to dividends) on shares granted under the Performance Share Plan (including in respect of the 2006 and 2007 grants) 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; and for UK based employees only, 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 under option per individual, 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 further seven years, when the option expires). Above 200,000 shares under option, the ‘shadow dividends’ would be re-invested into shares within the trust. Executive Directors, however, would have the entire ‘shadow dividend’ re-invested in shares within an employee benefit trust. Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 37 Directors’ remuneration report continued Performance conditions Performance conditions for the Performance Share Plan are as follows: 25% of the award vests if the Company achieves an average ROE of 10% post-tax for each of the three years; 100% vests if the average three-year return exceeds 17.5% post-tax; and vesting will occur on a straight-line basis between these points. The Remuneration and Nomination Committee believes that using ROE as the long-term performance condition better aligns the interests of employees with shareholders because: 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; and 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. ROE has been calculated as profit after tax and goodwill amortisation divided by shareholders funds at the beginning of each year, excluding foreign currency items on economic hedges and intragroup borrowings. Save as You Earn The sharesave scheme and international sharesave scheme are offered to all employees and currently have a 60% participation. Shareholding guidelines We strongly believe that senior managers within Hiscox should be aligned with Hiscox shareholders by owning a reasonable number of Hiscox shares. Formal shareholding guidelines have been introduced this year which mean that within five years of becoming an Executive Director, Hiscox Partner (the top 5% of employees in the company) or a member of a subsidiary board, the employee will be expected to own Hiscox shares valued at 100% of salary for Hiscox Partners and members of subsidiary boards and 150% of salary for Executive Directors. The Special Award In 2005, following the Rights Issue, we received shareholder approval to grant special awards to individuals within the Company of up to five million shares, of which a maximum of 20% are available for Executive Directors (‘Special Award’). These awards have the same performance conditions as described above for the Performance Share Plan. The post tax ROE over the three-year performance period was 22.7%. The performance conditions for this grant have therefore been met and the shares have vested in full. The table at the end of the remuneration report details Directors’ interests in the long-term incentive plans. Executive Director Reward Executive Directors’ reward packages are consistent with the rest of the business. The actual compensation paid to the four Executive Directors in 2008 is outlined in the table below. Details of their contractual notice periods, is contained in the table opposite. RS Childs SJ Bridges 31% 18% 32% 18% BE Masojada 33% 15% 51% 50% 52% RRS Hiscox 51% 29% 20% 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. 38 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 Remuneration of Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges 2008 Basic salary £000 308 428 348 318 2008 Benefits £000 2 2 221 2 2008 Bonus £000 175 200 200 175 2008 Total £000 485 630 769 495 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 1,049 2,157 2,176 1,059 As from 1 January 2007, certain benefits were rolled into basic salary. At the request of the Group, RS Childs will be returning from assignment in Bermuda in April, 2009. In that circumstance, the Committee has agreed that bonus payments from financial years 2007 and 2008, which have been disclosed as bonuses in the relevant years and parts of which remain outstanding, will be paid early in 2009. The amounts involved are £437,500 in respect of 2007 and £100,000 in respect of 2008. As a condition of early payment RS Childs has signed an agreement requiring him to repay these amounts in full, should he leave/resign from the Group before the dates in 2010 and 2011 when these payments would normally have been made. External Non Executive Directorships No external appointments 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 has been a Non Executive Director of Grainger Trust plc and was paid £35,000 for his services and AGICM Ltd and was paid £10,000. SJ Bridges, BE Masojada and RS Childs did not hold any Non Executive Director positions during the year. Service contract table Director RRS Hiscox BE Masojada RS Childs SJ Bridges C Franklin Engler DM Healy ER Jansen Dr J King Sir Mervyn Pedelty AS Rosen G Stockholm DA 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 20 Nov 2008 11 Oct 2006 11 Oct 2006 11 Oct 2006 20 Nov 2008 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 3 months 3 months Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 39 Directors’ remuneration report continued 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 DM Healy ER Jansen Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm DA Stuurop Hiscox Ltd Board $000 Committees $000 78 78 9 78 78 78 9 78 27 37 3 32 52* 35 3 27 Total 2008 $000 105 115 12 110 130 113 12 105 Total 2007 $000 100 110 – 105 125 100 – 100 The Pound Sterling equivalent of the total was £391,000 (2007: £321,000). *Sir Mervyn Pedelty receives £10,000 for serving on a UK subsidiary board. Pensions RRS Hiscox BE Masojada RS Childs SJ Bridges Increase in accrued pension during the year £000 10 1 11 1 Total accrued annual pension at 31 Dec 08 £000 Transfer value of increase in accrued pension £000 Transfer value of accrued pension at 1 Jan 08 £000 Transfer value of accrued pension at 31 Dec 08 £000 205 37 220 29 (2) – – – 4,301 533 4,258 378 4,772 681 5,127 459 Increase/ (decrease) in transfer value of accrued benefit during the year £000 471 148 869 81 40 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 Share options The conditions of exercise of the approved and unapproved share options are described on pages 37 and 38. Number of options granted Number of options lapsed Number of options exercised SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Number of options at 1 January 2008 62,038 111,724 56,398 40,997 180,341 154,578 154,578 154,578 915,232 90,238 112,797 78,958 206,104 206,104 206,103 206,104 1,106,408 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 1,416,600 245,891 170,315 453,719 95,039 350,778 627,297 1,007,099 1,052,698 1,777,628 2,233,618 8,014,082 Total 11,809,931 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Number of options at 31 December 2008 62,038 – 56,398 – 180,341 154,578 154,578 154,578 – (111,724) – (40,997) – – – – (152,721) 762,511 (90,238) – – – – – – – 112,797 78,958 206,104 206,104 206,103 206,104 (90,238) 1,016,170 (90,237) (56,396) – – – – – – 56,398 51,526 51,526 51,526 (146,633) 210,976 (90,237) – – – (140,997) – – – – – 112,797 169,195 78,958 – 206,104 206,104 206,104 206,104 (231,234) 1,185,366 (245,891) – (69,930) 100,385 (127,422) 326,297 (95,039) – (58,650) 292,128 (191,975) 435,322 (252,476) 754,623 (209,373) 843,325 (474,032) 1,303,596 (656,944) 1,576,674 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date 1.281 1.020 1.755 0.806 1.252 1.465 1.514 1.499 1.574 1.281 1.755 1.252 1.465 1.514 1.499 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 – 2.5825 13 Oct 02 15 Jun 03 12 Oct 09 14 Jun 10 – 03 May 04 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 2.5825 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 – – – – 20 Oct 01 13 Oct 02 19 Oct 08 2.4225 – 12 Oct 09 – 03 May 04 02 May 11 18 Nov 12 – 01 Apr 13 – 12 Jul 14 – 05 Apr 15 – 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 2.4025 2.3625 20 Oct 01 15 Jun 03 19 Oct 08 14 Jun 10 – 03 May 04 02 May 11 01 Apr 13 – 12 Jul 14 – 05 Apr 15 – 02 Apr 06 13 Jul 07 06 Apr 08 20 Oct 01 13 Oct 02 15 Jun 03 2.365 19 Oct 08 – 12 Oct 09 14 Jun 10 – – 03 May 04 02 May 11 26 Sep 11 18 Nov 12 01 Apr 13 12 Jul 14 05 Apr 15 2.365 27 Sep 04 19 Nov 05 02 Apr 06 13 Jul 07 06 Apr 08 – – – – 20 Oct 01 13 Oct 02 15 Jun 03 14 Feb 04 19 Oct 08 1.574 2.148-2.585 12 Oct 09 1.281 2.387-3.457 14 Jun 10 1.020 2.193-3.457 1.685 13 Feb 11 3.508 1.755 2.405-3.408 03 May 04 02 May 11 26 Sep 11 0.806 2.370-3.508 27 Sep 04 18 Nov 12 19 Nov 05 1.252 2.415-3.457 01 Apr 13 02 Apr 06 1.465 2.408-3.500 12 Jul 14 13 Jul 07 1.514 2.387-3.517 05 Apr 15 06 Apr 08 1.499 2.145-3.457 – (2,381,732) 5,632,350 – (3,002,558) 8,807,373 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 41 Directors’ remuneration report continued 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 SJ Bridges RRS Hiscox BE Masojada Other employees Number of options at 1 January 2008 4,256 5,932 – 4,343 47,590 267,135 385,140 403,521 – – Number of options granted Number of options lapsed Number of options exercised – – 4,907 – – – – – 604,468 388,607 – – – – (2,866) (16,772) (162,541) (259,964) (63,828) (1,373) – (5,932) – – (44,724) (250,363) (4,406) – – – Number of options at 31 December 2008 4,256 – 4,907 4,343 – – 218,193 143,557 540,640 387,234 Total 1,117,917 997,982 (507,344) (305,425) 1,303,130 International Sharesave Scheme RS Childs Other employees 4,147 14,583 34,625 176,269 7,363 63,965 – – – – – – – – 215,679 62,464 – – (3,283) (80,653) – (40,256) (17,623) – – (14,583) (29,729) – – – – – 4,147 – 1,613 95,616 7,363 23,709 198,056 62,464 Total 300,952 278,143 (141,815) (44,312) 392,968 Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date – – 01 May 10 31 Oct 10 2.220 3.012 01 Dec 08 31 May 09 1.576 01 Dec 11 31 May 11 1.956 2.210 01 Dec 10 31 May 11 1.322 2.378-2.445 01 Dec 07 31 May 08 1.576 2.378-3.108 01 Dec 08 31 May 09 2.220 2.378-3.410 01 May 10 31 Oct 10 01 Dec 10 31 May 11 2.210 1.982 31 Oct 10 01 Dec 11 31 May 12 1.956 – – 01 May 11 – – 01 May 10 31 Oct 10 2.220 1.322 2.460 01 Dec 07 31 May 08 1.576 3.013-3.108 01 Dec 08 31 May 09 31 Oct 10 2.220 31 Dec 10 2.220 01 Dec 10 31 May 11 2.210 1.982 31 Oct 11 01 Dec 11 31 May 12 1.956 – 01 May 10 01 Jul 10 – – – 01 May 11 – Performance share plan SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Number of awards at 1 January 2008 215,000 120,000 – 250,000 150,000 – 100,000 80,000 – 260,000 200,000 – 3,140,000 25,000 170,000 2,126,500 52,000 – Number of awards granted – – 110,000 – – 140,000 – – 75,000 – – 175,000 – – – – – 1,616,500 Number of awards lapsed – – – – – – – – – – – – (10,000) – – (25,000) – (10,000) Number of awards exercised Number of awards at 31 December 2008 Market price at date of exercise £ – – – – – – – – – – – – 215,000 120,000 110,000 250,000 150,000 140,000 100,000 80,000 75,000 260,000 200,000 175,000 (40,000) 3,090,000 25,000 – 170,000 – 2,101,500 – – 52,000 – 1,606,500 – – – – – – – – – – – – 2.225 – – – – – Date from which released 12 Jan 09 26 Mar 10 7 April 11 12 Jan 09 26 Mar 10 7 April 11 12 Jan 09 26 Mar 10 7 April 11 12 Jan 09 26 Mar 10 7 April 11 12 Jan 09 13 Mar 09 05 Oct 09 26 Mar 10 02 Oct 10 7 April 11 Total 6,888,500 2,116,500 (45,000) (40,000) 8,920,000 42 Directors’ remuneration report Hiscox Ltd Report and Accounts 2008 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 16 June 2009. 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 24 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 30 to 31. Ernst Jansen and Gunnar Stokholm were appointed as Non Executive Directors on 20 November 2008 and have submitted themselves for election at the Annual General Meeting. Carol Franklin Engler resigned on 20 November 2008. Bronek Masojada, Daniel Healy and Dirk Stuurop retire by rotation in accordance with the Bye-Laws of the Company and they have each submitted themselves for re-election at the 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 year (2007: £nil). Charitable donations totalled £717,000 (2007: £616,572) of which £500,000 (2007: £550,000) 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 page 29. 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 9 March 2009: Number of shares % of total Invesco Limited 38,254,927 10.4 Jupiter Asset Management 25,210,566 6.4 Legal and General 18,591,533 5.05 Directors’ report The Directors have pleasure in submitting their Annual Report and financial statements for the year ended 31 December 2008. 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, Guernsey and Europe. An analysis of the development and performance of the business can be found within the Chief Executive’s report on pages 5 to 11. A description of the major risks can be found in the risk management section on pages 22 to 27. Financial results The Group achieved a pre-tax profit for the year of £105.2 million (2007: £237.2 million). Detailed results for the year are shown in the consolidated income statement on page 46, and also within the Group financial performance section on pages 16 to 21. Going concern After making enquiries, the Directors have a reasonable 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. Dividends An interim dividend of 4.25p (net) per share (2007: 4p (net)) was paid on 29 September 2008 by Hiscox Ltd in respect of the year ended 31 December 2008. The Directors recommend the payment of a final dividend of 8.5 (net) per share (2007: 8p (net)). If approved this will be paid on 16 June 2009 to shareholders on the register at the close of business on 15 May 2009, provided that such dividend will not be paid to those shareholders who, prior to 16 May 2009, have made an election to participate in the Company’s Dividend Access Plan if Hiscox plc subsequently declares a dividend Directors’ report Hiscox Ltd Report and Accounts 2008 43 Directors’ report continued 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 3 June 2009 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 HM12, Bermuda 9 March 2009 Directors’ interests Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges Non Executive Directors DM Healy ER Jansen1 Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm1 DA Stuurop 1 Appointed 20 November 2008. 31-Dec-2008 5p Ordinary Shares number of shares beneficial 31-Dec-2008 5p Ordinary Shares number of shares non-beneficial 31-Dec-2007 5p Ordinary Shares number of shares beneficial 31-Dec-2007 5p Ordinary Shares number of shares non-beneficial 6,327,050 550,000 9,398,065 560,237 2,941,304 10,081,500 2,710,070 1,794,043 744,774 55,000 – – 18,000 – – 50,000 – – – – – – – – – 1,703,805 592,053 55,000 n/a – 18,000 – n/a 50,000 – – – – n/a – – – n/a – Directors’ responsibilities statement 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. We confirm that to the best of our knowledge: the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and the Directors’ report includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. The Directors responsible for authorising the responsibility statement on behalf of the Board are the Chairman, RRS Hiscox and the Group Finance Director, SJ Bridges. The statements were approved for issue on 9 March 2009. 44 Directors’ report/Directors’ responsibilities statement Hiscox Ltd Report and Accounts 2008 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 2008, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the EU; 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 9 March 2009 Report of the independent registered public accounting firm to the Board of Directors and the shareholders of Hiscox Ltd We have audited the accompanying consolidated financial statements of Hiscox Ltd (‘the Company’) on pages 46 to 95 which comprise the consolidated balance sheet as at 31 December 2008, and the consolidated income statement, consolidated statement of comprehensive income, 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 (in addition to that required to be prepared) 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 as adopted by the EU. 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. 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. Report of the independent registered public accounting firm to the Board of Directors and the shareholders of Hiscox Ltd Hiscox Ltd Report and Accounts 2008 45 Consolidated income statement For the year ended 31 December 2008 Note 2008 Results excluding 2008 Foreign currency foreign currency items on economic hedges and intragroup borrowings (note 14) £000 items on economic hedges and intragroup borrowings £000 2008 Total £000 2007 Total £000 Income Gross premiums written Outward reinsurance premiums Net premiums written Gross premiums earned Premiums ceded to reinsurers Net premiums earned Investment result – financial assets Investment result – derivatives Other revenues Revenue Expenses Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Administration expenses Other expenses Foreign exchange gains/(losses) 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 owners of the Company) Earnings per share on profit attributable to owners of the Company Basic Diluted 4 1,147,364 (216,900) – 1,147,364 1,198,949 (224,039) – (216,900) 4 930,464 – 930,464 974,910 1,171,511 (218,491) 953,020 – 1,171,511 1,179,444 (214,254) – (218,491) – 953,020 965,190 (27,632) (10,438) 19,858 – (42,540) – (27,632) (52,978) 19,858 100,787 (1,110) 19,044 934,808 (42,540) 892,268 1,083,911 4 7 7 9 26.2 18 9 (479,380) (252,868) (83,198) (76,499) 118,218 – – – – (8,463) (479,380) (252,868) (83,198) (76,499) 109,755 (423,365) (264,570) (76,813) (82,269) 8,401 (773,727) (8,463) (782,190) (838,616) 161,081 (5,158) 260 156,183 (30,255) (51,003) – – (51,003) (4,117) 110,078 (5,158) 260 245,295 (8,177) 81 105,180 (34,372) 237,199 (45,951) 125,928 (55,120) 70,808 191,248 11 17 28 31 31 18.8p 18.1p 48.4p 46.8p 2008 Total £000 2007 Total £000 Consolidated statement of comprehensive income For the year ended 31 December 2008, after tax Note 2008 Results excluding 2008 Foreign currency foreign currency items on economic hedges and intragroup borrowings (note 14) £000 items on economic hedges and intragroup borrowings £000 Profit for the year Other comprehensive income Currency translation differences (net of tax of £nil (2007: £nil)) Net investment hedge (net of tax £(238,000) (2007: £420,000)) Total other comprehensive income 125,928 (55,120) 70,808 191,248 71,008 (597) 80,171 – 151,179 (597) 13 70,411 80,171 150,582 (4,269) 1,400 (2,869) Total comprehensive income recognised (all attributable to owners of Company) 196,339 25,051 221,390 188,379 In order to permit a fuller understanding of the current year’s results and specifically the impact of certain foreign currency items, the Group has elected to present additional columns on the consolidated income statement and the consolidated statement of comprehensive income. No material items of this nature arose in the prior year and the comparative 2007 results are therefore unaffected (note 14). The notes on pages 50 to 95 are an integral part of these consolidated financial statements. 46 Consolidated income statement/Consolidated statement of comprehensive income Hiscox Ltd Report and Accounts 2008 Consolidated balance sheet At 31 December 2008 Assets Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Reinsurance assets Loans and receivables including insurance receivables Current tax Cash and cash equivalents Total assets Equity and liabilities Shareholders’ equity Share capital Share premium Contributed surplus Currency translation reserve Retained earnings Total equity (all attributable to owners of the Company) Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities Current tax Trade and other payables Total liabilities Total equity and liabilities Note 2008 £000 2007 £000 17 16 15 48,557 19,668 7,200 131,130 40,452 19,378 1,502 123,081 18 20 2,081,772 1,747,827 280,088 385,222 – 302,742 487,720 494,315 26,289 440,622 23 21 19, 26 3,737,273 2,900,292 24 24 24 25 25 20,067 9,418 352,078 107,317 462,146 19,898 4,955 398,834 (43,265) 443,882 951,026 824,304 30 – 68,649 – 9,751 29 26 2,277,416 1,713,887 91,764 24,711 235,875 143,350 – 296,832 27 20 2,786,247 2,075,988 3,737,273 2,900,292 The notes on pages 50 to 95 are an integral part of these consolidated financial statements. The consolidated Group financial statements were approved by the Board of Directors on 9 March 2009 and signed on its behalf by: RRS Hiscox Chairman SJ Bridges Group Finance Director Consolidated balance sheet Hiscox Ltd Report and Accounts 2008 47 Consolidated statement of changes in equity Balance at 1 January 2007 Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) Employee share options: Equity settled share based payments Proceeds from shares issued Purchase of own shares held in treasury Deferred tax Dividends paid to owners of the Company Balance at 31 December 2007 Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) Employee share options: Equity settled share based payments Excess tax benefit on share based payments Proceeds from shares issued Purchase of own shares held in treasury Purchase of own shares held in trust Deferred tax Dividends paid to owners of the Company Note Share capital £000 Share premium £000 Contributed surplus £000 Currency translation reserve £000 Retained earnings £000 Total £000 19,694 – – 204 – – – – – 442,425 (40,396) 260,362 682,085 – (2,869) 191,248 188,379 – 4,955 – – – – – – – (43,591) – – – – – 5,689 – (11,343) (2,074) – 5,689 5,159 (11,343) (2,074) (43,591) 19,898 4,955 398,834 (43,265) 443,882 824,304 – – – 169 – – – – – – 150,582 70,808 221,390 – – 4,463 – – – – – – – – – – (46,756) – – – – – – – 5,269 883 – (62,866) (2,200) 6,370 – 5,269 883 4,632 (62,866) (2,200) 6,370 (46,756) 24 32 24 32 Balance at 31 December 2008 20,067 9,418 352,078 107,317 462,146 951,026 The notes on pages 50 to 95 are an integral part of these consolidated financial statements. 48 Consolidated statement of changes in equity Hiscox Ltd Report and Accounts 2008 Consolidated cash flow statement For the year ended 31 December 2008 Profit before tax Adjustments for: Interest and equity dividend income Interest expense Net fair value 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 Effect of exchange rate fluctuations on cash presented separately 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 subsidiaries Cash outflow from the 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 owners of the Company Net repayments of borrowings and financial liabilities Net cash flows from financing activities Net increase/(decrease) 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 Note 2008 £000 2007 £000 105,180 237,199 16 10 33 34 17 15 24 25 32 20 (92,227) 5,158 180,085 – 5,323 5,269 (766) (62,086) (90,205) 8,177 687 (3,801) 4,917 5,689 (3,571) 2,930 281,633 (284,069) (10,474) 133,951 (489,745) 31,112 133,026 89,608 2,619 (5,327) (18,982) (162,660) 85,435 4,770 (8,243) (42,823) 200,944 (123,521) (3,137) (42) (5,438) (4,521) (3,530) (11,133) (936) (1,273) (7,789) (2,500) (16,668) (23,631) 4,632 (65,066) (46,756) (1,292) 5,159 (11,343) (43,591) (272) (108,482) (50,047) 75,794 (197,199) 302,742 75,794 62,086 502,871 (197,199) (2,930) Cash and cash equivalents at 31 December 23 440,622 302,742 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 £47,094,000 (2007: £53,336,000) not available for immediate use by the Group outside of the Lloyd’s Syndicate within which they are held. The notes on pages 50 to 95 are an integral part of these consolidated financial statements. Consolidated cash flow statement Hiscox Ltd Report and Accounts 2008 49 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 and reinsurance services to its clients worldwide. It has operations in Bermuda, the UK, Europe, and USA and employs over 950 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 its annual audited financial information in accordance with Section 4.1 of the Disclosure and Transparency Rules and the Listing Rules, both issued by the Financial Services Authority (FSA), in addition to the Bermuda Companies Act 1981. The first two pronouncements issued by the FSA require the Group to prepare financial statements which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 38 in accordance with International Financial Reporting Standards (‘IFRS’) as adopted by the European Union. The consolidated financial statements for the year ended 31 December 2008 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 9 March 2009. 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 highest degree of judgement or significant assumptions and estimations are identified at note 2.22. 2.1 Statement of compliance The consolidated financial statements have been prepared in accordance with IFRS as adopted by the European Union and in accordance with the provisions of the Bermuda Companies Act 1981. Since 2002, the standards adopted by the International Accounting Standards Board 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 assets included in the measurement of the employee retirement benefit obligation, and certain financial instruments including derivative instruments 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 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 seven in the prior year, to eight 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. The consolidated financial statements reflect the early adoption of IFRS 8 Operating Segments, which was first adopted in the prior year. IFRS 8 is a disclosure standard concerning the designation and presentation of operating segment information and therefore had no impact on the reported primary financial statements or financial position of the Group. The Group has financial assets of over £2.5 billion. The portfolio is predominantly invested in liquid short dated bonds and cash to ensure significant liquidity to the Group and to reduce risk from the financial markets. In addition the Group has significant borrowing facilities. The Group writes a balanced book of insurance and reinsurance business spread by product and geography. The Directors believe that the current reinsurance and insurance markets are favourable and that the Group is well placed to trade in these markets whilst successfully managing its business risks. After making enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts. Standards and interpretations relevant to the Group published and effective or early adopted at 1 January 2008 IAS 1 Presentation of financial statements The IASB published the revised IAS 1 Presentation of financial statements on September 6, 2007 with an effective date of 1 January 2009. The Group early adopted on 1 January 2008. The revised standard is as a result of Phase A of the IASB’s financial statement presentation 50 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 2 Significant accounting policies continued 2.2 Basis of preparation continued project, the objective of which is to enhance the usefulness of information presented in a complete set of financial statements. The main change required by the revised standard is the introduction of ‘total comprehensive income’ which requires the presentation of changes in non-owner equity in either one statement, the statement of comprehensive income, or two statements, the income statement and a statement showing the profit or loss and all components of other comprehensive income. The revised standard also requires other minor changes in the presentation of financial statements. The Group has not presented a consolidated balance sheet at the beginning of the earliest comparative accounting period, 1 January 2007, as no retrospective restatements, reclassifications, or changes in accounting policy have occurred. IFRIC 14, IAS 19 The Limit on Defined Benefit Asset, Minimum Funding Requirements and their Interaction The International Financial Reporting Interpretations Committee (IFRIC) published IFRIC 14, IAS 19 The Limit on Defined Benefit Asset, Minimum Funding Requirements and their Interaction on 5 July 2007 with an effective date for annual periods beginning on or after 1 January 2008. The interpretation clarifies when refunds or reductions in future contributions in relation to defined benefit assets are available and also provides guidance on the impact of minimum funding requirements on such assets. The Group has applied the interpretation from 1 January 2008 with no impact on the carrying amount of the defined benefit pension scheme asset or on the financial results of the Group. Amendments to IFRS 2 Share-based Payment Amendments to IFRS 2 Share-based Payment were published on 17 January 2008 with an effective date of 1 January 2009 with early application permitted. The amended standard clarifies the definition of vesting conditions and introduces the term of ‘non-vesting’ conditions which are conditions which are other than service or performance conditions. Non-vesting conditions are reflected in the measurement of the grant date fair value of the awards. There is no requirement to reflect a true up for any differences arising between expected and actual outcome due to failure to meet non-vesting conditions. The amendment has no material impact on the Group’s financial results. Standards and interpretations published but not yet effective Amendments to IAS 23 Borrowing Costs Amendments to IAS 23 Borrowing Costs, was published on 29 March 2007 and are applicable from 1 January 2009. The amendment makes it compulsory to capitalise borrowing costs relating to qualifying assets and removes the option to expense such costs. The amendment excludes eligible assets measured at fair value from the revised standard’s scope of application. The amendment has no material impact on the Group’s financial results. Amendments to IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements – Puttable Financial Instruments and Obligations Arising on liquidation Amendments to IAS 32 and IAS 1 were published on 14 February 2008 and are effective for annual periods beginning on 1 January 2009. The amendment to IAS 32 will exempt some financial instruments, which would usually be considered equity, from the financial liability classification. The exemption is available to financial instruments that have particular features and meet specific conditions. The application of the amended standard will have limited impact on the Group. 2.3 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. Management also exercise significant judgement about any actual or perceived control acquired indirectly, through normal commercial dealings with entities of a special purpose nature. The Group does not undertake any such arrangements with such entities where control of that entity would be acquired. 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 Syndicates managed by Hiscox Syndicates Limited (the ‘main managed Syndicates’ numbered 33 and, commencing 1 January 2009, 3624). 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 have been included in the financial statements. The Group manages the underwriting of, but does not participate as a member of, Syndicate 6104 at Lloyd’s which provides reinsurance to Syndicate 33 on a normal commercial basis. Consequently, aside from the receipt of managing agency fees and defined profit commissions as appropriate, the Group has no share in the assets, liabilities or transactions of Syndicate 6104, nor is it controlled. The position and performance of that Syndicate is therefore not included in the Group’s financial statements. The Group uses the acquisition 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, together with directly attributable transaction costs, equity instruments issued and liabilities incurred or assumed at the date of exchange. 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 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 51 Notes to the financial statements continued 2 Significant accounting policies continued 2.3 Basis of consolidation continued (b) Associates continued 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. In accordance with IAS 21, foreign currency gains and losses on intragroup monetary assets and liabilities may not fully eliminate on consolidation when the intragroup monetary item concerned is transacted between two Group entities that have different functional currencies. 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 with 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. 2.4 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 subsidiary 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 IAS 39 effective net investment hedges or when the underlying balance is deemed to form part of the Group’s net investment in a subsidiary operation and is unlikely to be settled in the forseeable future. 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) (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. 2.5 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: Buildings Vehicles Leasehold improvements including fixtures and fittings Furniture, fittings and equipment 50 years 3 years 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. 2.6 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. 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 generally accepted accounting principles. 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 52 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 2 Significant accounting policies continued 2.6 Intangible assets continued (a) Goodwill continued development and where the computer software will yield future economic benefits in excess of the costs incurred. at amortised cost less any provision for impairment in value. 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. 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 2.7 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. 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. Fair value for securities quoted in active markets is the bid price exclusive of transaction costs. For 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. (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 2.8 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. 2.9 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. (a) 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. (b) 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; adverse economic or regulatory conditions that may restrict future cash flows and asset recoverability; and the withdrawal of any guarantee from statutory funds or sovereign agencies implicity supporting the asset. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 53 Notes to the financial statements continued 2 Significant accounting policies continued 2.9 Impairment of assets continued (c) 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. 2.10 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 2.17). 2.11 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 owners on consolidation. Where such shares are subsequently sold, reissued or otherwise disposed of, any consideration received is included in equity attributable to the Company’s owners, net of any directly attributable incremental transaction costs and the related tax effects. 2.12 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 fair value movements on derivative 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. 2.13 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. Overrider and profit commissions earned on ceded reinsurance are also included within premiums. Premiums are stated before the deduction of brokerage and commission but net of taxes and duties levied. Premiums are recognised as revenue (premiums earned) proportionally over the period of coverage except where time does not approximate to the pattern of risk, where previous claims information and other factors determine revenue recognition. 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. 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 insurance contracts as the related 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 by writing-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. 54 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 2 Significant accounting policies continued 2.13 Insurance contracts continued (e) Outwards reinsurance contracts held continued 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. If there is objective evidence that the insurance receivable is impaired, the Group reduces the carrying amount of the insurance receivable 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. 2.14 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. 2.15 Employee benefits (a) Pension obligations The Group operated both defined contribution and defined benefit pension schemes 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 scheme from 1 January 2007. balance sheet when it is probable that future economic benefits will be recovered by the scheme sponsor in the form of refunds or reduced future contributions. The Group is not currently required to make ongoing, regular contributions and does not forsee future refunds with sufficient probability for the scheme’s current reported surplus to be recognised as an asset on the balance sheet. Actuarial gains and losses are only recognised when the net cumulative unrecognised actuarial gains and losses for each individual plan at the end of the previous accounting period exceeds 10% of the higher of the defined benefit obligation and the fair value of the plan assets at that date. Such actuarial gains or losses falling outside of this 10% corridor are charged or credited to income over the employees’ expected average remaining working lives. Past service costs are recognised immediately in income, unless the changes to the pension plan are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over the vesting period. A defined contribution plan is a pension plan under which the Group pays fixed contributions into a separate entity and has no further obligation beyond the agreed contribution rate. A defined benefit plan is a pension plan 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. (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. For defined contribution plans, the Group pays contributions to publicly or privately administered pension insurance plans on a contractual basis. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in future payments is available. (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 amount recognised in the balance sheet in respect of defined benefit pension plans 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. Plan assets exclude any insurance contracts issued by the Group. To the extent that a surplus emerges on the defined benefit obligation, it is only recognisable on the asset side of the 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 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 55 Notes to the financial statements continued a past practice that has created a constructive obligation. 2 Significant accounting policies continued 2.15 Employee benefits continued (c) Share based compensation continued 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 (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. 2.16 Financial liabilities Financial liabilities are initially measured at fair value. The Group’s borrowings are financial liabilities and were previously designated on inception as being held at fair value through profit or loss if they were 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. In the prior year and up to 6 May 2008 (when all existing borrowings were repaid in full), borrowings were consequently remeasured at fair value at each balance sheet date 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 formed part of a designated hedge accounting relationship in which case certain changes in value were recognised directly in equity, (see notes 2.17 and 20). All borrowings drawn after 6 May 2008 are now remeasured at amortised cost at each balance sheet date thereafter using the effective interest method. Any difference between the remeasured amortised cost carrying amount and the ultimate redemption amount is recognised in the income statement over the period of the borrowings. 2.17 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 hedged elements of its net investment in certain foreign entities through foreign currency borrowings that qualified for hedge accounting from 3 January 2007 until their replacement on 6 May 2008; accordingly gains or losses on retranslation are recognised in equity to the extent that the hedge relationship was effective during this period. Accumulated gains or losses will be 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. 2.18 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. 2.19 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. 2.20 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) 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. 2.21 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. 56 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 2 Significant accounting policies continued 2.22 Use of critical estimates, judgements and assumptions The preparation of financial statements requires the use of significant estimates, judgements and assumptions. The Directors consider the accounting policies for determining insurance liabilities, 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, judgements 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 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 when relevant, 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’s reported 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 26 to the 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. The Group carries its financial investments at fair value through profit or loss with fair value determined using published price quotations in the most active financial markets in which the assets trade. During periods of economic distress and diminished liquidity, the ability to obtain quoted bid prices may be reduced and as such as a greater degree of judgment is required in obtaining the most reliable source of valuation. Note 3.2 to the financial statements discusses the reliability of the Group’s fair values. With regard to employee retirement benefit scheme obligations, the amounts disclosed in these consolidated financial statements are sensitive to judgemental assumptions regarding mortality, inflation, investment returns and interest rates on corporate bonds, many of which have been subject to specific recent volatility. This complex set of economic variables may be expected to influence the liability obligation element of the reported net balance amount to a greater extent than the reported value of the scheme assets element. For example, if the recent cuts in official UK interest rates are replicated with lower yields emerging in UK corporate bond indices, a significant uplift may occur in the reported net scheme deficit through the reduced effect of discounting outweighing any expected appreciation in asset values. A sensitivity analysis is given at note 30. 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. 2.23 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. Net asset value per share and return on equity measures, disclosed at notes 5 and 6, are likewise considered to be additional performance measures. 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 unaudited information is also provided in the corporate governance and risk management sections of this Report and Accounts. The Group, in common with the non-life insurance industry generally, is fundamentally driven by a desire to originate, retain and service insurance contracts to maturity, rather than engaging in mass distribution of the risks assumed through large scale securitisation. The Group’s business is therefore fundamentally different to other types of financial institutions in that its cash flows are funded mainly through advance premium collections rather than assuming cash deposits, and the timing of such Notes to the financial statements Hiscox Ltd Report and Accounts 2008 57 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 extent and competitiveness of cover available in the market. Notes to the financial statements continued 3 Management of risk continued premium inflows is reasonably predictable. In addition, the majority of material cash outflows are typically triggered by the occurrence of insured events non- correlated to financial markets, and not by the inclination or will of policyholders. Consequently, as the Group therefore has the capacity to invest and hold a significant proportion of assets to maturity if required, it has the ability for many of its ultimate cash flows to remain relatively immune to short-term, technically driven accounting losses in fair value terms. 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 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 year’s profit plus 15% of core capital as a result of a 1 in 250 year event. 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 realistic disaster actually eventuate, the Group’s final ultimate losses could materially differ from those unaudited estimates modelled by management. 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 59. 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. 58 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 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 2008 UK and Ireland Europe United States Other territories Multiple territory coverage Total 31 December 2007 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 Property – Marine and major assets £000 8,900 8,163 5,370 4,097 50,252 36,889 15,736 13,510 183,410 130,813 Property – Other assets £000 Casualty – Professional indemnity £000 141,470 139,135 75,624 70,269 168,770 118,909 28,459 23,470 38,615 31,325 223,181 177,272 44,932 41,082 338,150 306,694 37,062 34,746 3,990 3,756 Casualty – Other risks £000 3,100 2,610 9,219 7,478 46,713 33,186 7,118 5,840 154,195 106,023 Reinsurance inwards £000 51,386 43,742 27,922 22,546 249,389 143,826 81,258 69,570 124,552 90,170 Other* £000 Total £000 13,887 11,807 11,447 9,615 20,352 15,554 62,779 49,580 50,178 38,019 441,924 382,729 174,514 155,087 873,626 655,058 232,412 196,716 554,940 400,106 534,507 263,668 452,938 647,315 220,345 158,643 2,277,416 369,854 193,472 383,108 563,550 155,137 124,575 1,789,696 Types of insurance risk in Group 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 Casualty – Professional indemnity £000 122,967 101,690 47,799 41,764 92,012 90,686 53,664 52,564 18,364 18,165 263,869 199,573 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 Reinsurance inwards £000 47,633 40,498 43,751 41,167 111,008 87,937 34,163 31,292 103,081 88,419 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 *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 and crop 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. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 59 Notes to the financial statements continued 3 Management of risk continued 3.1 Insurance risk continued 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 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 weather events (for example earthquakes, windstorms and river flooding etc.) and it 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. The Group’s exposure to commodity price risk in relation to insurance contracts is very limited, given the controlled extent of business interruption cover offered in the areas prone to losses of asset production. Other property risks The Group provides home and contents insurance, together with cover for art work, antiques, classic cars, jewellery, collectables and other assets typically held by affluent individuals. The Group also extends cover to reimburse certain policyholders when named insureds or insured assets are seized for kidnap and a ransom demand is subsequently met. Events which can generate claims on these contracts include burglary, kidnap, seizure of assets, acts of vandalism, fires, flooding and storm damage. Losses on most classes 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 26. 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 length of time required to obtain definitive legal judgements and make eventual settlements exposes the Group to a degree of reserving risk in an inflationary environment. 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. 60 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 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. Reliability of fair values The Group has elected to carry all financial investments at fair value through profit or loss 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 are available to trade in public markets and the Group therefore seeks to determine fair value by reference to published price quotations in the most active financial markets in which the assets trade. The Group seeks to determine 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 addition, those quoted prices that may be available may represent an Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Derivative instrument assets Total unrealistic proportion of market holdings or individual trade sizes that could not be readily available to the Group. In such instances fair values may be determined or partially supplemented 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. Throughout 2008 the Group has witnessed substantial declines in observable market values for many fixed income assets such as corporate, municipal and asset backed bonds. In some cases the extent and duration of declines witnessed appears to arise as a response to global macroeconomic and liquidity concerns and not as a result of specific issuer events or credit concerns. At 31 December 2008, 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. 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 Group 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 Group’s future results may be impacted, both positively and negatively, by the valuation adjustments applied to these securities. In October 2008, the IASB issued an Exposure Draft on Improving Disclosures about Financial Instruments, Proposed amendments to IFRS 7. The Exposure Draft was in response to the requirement by users of financial statements to enhance the disclosures over the fair value measurement of financial instruments. This was particularly relevant in light of the current market conditions. On 5 March 2009, the IASB issued the amendments to IFRS 7 with an effective date for annual periods beginning on or after 1 January 2009. One amendment to enhance the disclosure of fair value measurements is based on a three level fair value hierarchy similar to that issued by the US Financial Accounting Standard Board in SFAS 157. The fair value hierarchy classifies financial instruments into Level 1 to Level 3 based on the significance of the inputs used in measuring their fair value with Level 1 being the most reliable. The levels within the fair value hierarchy are defined as follows: Level 1 – Quoted prices in active markets for the same instrument. Level 2 – Quoted prices in active markets for similar assets or liabilities or other valuation techniques for which all significant inputs are based on observable market data. Valuation techniques for which any significant input is not based on observable market data. Level 3 – The Group will adopt the amended standard from its effective date and endorsement by the EU. Given the instability of the global markets in the fourth quarter of 2008, the Group has classified its financial investments as at 31 December 2008 using the above proposed fair value hierarchy in order to present useful information on the inputs used to measure fair value. Level 1 £000 Level 2 £000 Level 3 £000 Total £000 605,222 1,323,377 122,282 – – 2,043 22,392 – – 1,928,599 124,864 28,269 40 539 5,877 40 629,657 1,445,659 6,456 2,081,772 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 61 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued Reliability of fair values continued The level within the hierarchy that a financial instrument is placed is based on the lowest level of any input that is significant to its fair value measurement. Where a valuation technique is used, the Group selects inputs using the most reliable source of data and where possible observable market data. The models used to measure fair value in these cases may not be the same across the industry and as such fair value measurements may differ. 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 2008 was £539,000 (2007: £4,151,000), representing less than 1% of the total financial assets carried at fair value. (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: 2008 % weighting 2007 % weighting 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 – 68 32 29 71 3 77 20 40 60 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 2008 would have been expected to reduce Group equity and profit after tax for the year by approximately £10.0 million (2007: £11.6 million) assuming that the only area impacted was equity financial assets. A 10% upward movement is estimated to have an equal but opposite effect. (b) Interest rate risk 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 investment portfolio of debt and fixed income securities is normally 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 if credit spreads remained constant. 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 2008 was £1,929 million (2007: £1,445 million). These may be analysed as follows: Nature of debt and fixed income holdings 31 December 2008 % weighting 31 December 2007 % weighting Government issued bonds and instruments Agency and Government supported debt Asset backed securities Mortgage backed instruments – Agency Mortgage backed instruments – Non-agency Corporate bonds Lloyd’s and money market deposits 35 17 10 8 8 20 2 26 9 16 7 13 27 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 £31 million (2007: decrease of £22 million) assuming that the only balance sheet area impacted was debt and fixed income financial assets. Duration is the weighted average length of time required for an instrument’s cashflow stream to be recovered, where the weightings involved are based on the discounted present values of each cashflow. A closely related concept, modified duration, measures the sensitivity of the instrument’s price to a change in its yield to maturity. Convexity measures the sensitivity of modified duration to changes in the yield to maturity. Using these three concepts, scenario modelling derives the above estimated impact on instruments' fair values for a 100 basis point change in the term structure of market interest rates. 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 20. The $182 million facility drawn down at 31 December 2007 was fully repaid in the year. The Group negotiated a new loan facility with its primary lender for £350 million. At 31 December 2008, $130 million was drawn on this facility. 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 35. (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. The concentrations of credit risk exposures held by insurers may be expected to be greater than those associated with other industries, due to the specific nature of reinsurance markets and the extent of investments held in financial markets. In both markets, the Group interacts with a number of counterparties who are engaged in similar activities with similar customer profiles, and often in the same geographical areas and in industry sectors. Consequently, as many of these counterparties are themselves exposed to similar economic characteristics, one single localised or macroeconomic change could severely disrupt the ability of a significant number of counterparties to meet the Group’s agreed contractual terms and obligations. 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. 62 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 3.2 Financial risk continued (c) Credit risk continued The Group’s maximum exposure to credit risk is represented by the carrying values of financial 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 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). Despite the rigorous nature of this assessment exercise, and the resultant restricted range of reinsurance counterparties with acceptable strength and credit credentials that emerges therefrom, some degree of credit risk concentration remains inevitable. The Committee considers the reputation of its reinsurance partners and 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. 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 reports detail 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 2008 Debt and fixed income securities Deposits with credit institutions Derivative financial assets Reinsurance assets Cash and cash equivalents Total Note AAA £000 AA £000 A £000 Other/ not rated £000 Total £000 20, 22 20 20 1,471,797 4,146 – 6,896 54,227 23 19 179,416 11,800 40 278,685 330,246 172,832 12,323 – 175,756 56,010 104,554 1,928,599 28,269 40 487,720 440,622 – – 26,383 139 1,537,066 800,187 416,921 131,076 2,885,250 Amounts attributable to largest single counterparty 415,429 271,991 15,508 8,103 The largest counterparty exposure within AAA rating is with the US Treasury. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2008 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 2007 Debt and fixed income securities Deposits with credit institutions Derivative financial assets Reinsurance assets Cash and cash equivalents Total Note AAA £000 AA £000 A £000 20, 22 20 20 1,116,903 35,911 – 15,309 97,816 23 19 106,754 501 – 134,475 173,755 158,157 107,462 – 120,536 31,166 Other/ not rated £000 Total £000 62,718 1,444,532 143,874 – 280,088 302,742 – – 9,768 5 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 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. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 63 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (c) Credit risk continued At 31 December 2008 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 (2007: £nil). For the current period under review, the Group experienced defaults on debt securities with one financial institution. The total market value of those securities is negligible to the overall portfolio. No defaults occurred in investments during the prior year. The available headroom of working capital is monitored through the use of a detailed Group cash flow forecast which is reviewed by management monthly or more frequently as required. (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 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 to 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 traded on internationally recognised stock exchanges. The main focus of the investment portfolio is on high quality short duration debt and fixed income securities, and cash. There are 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 the majority of 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 Perpetual notes and other non-dated instruments Debt and fixed income securities £000 196,839 593,371 669,819 407,273 Deposits with credit institutions £000 28,269 – – – 1,867,302 28,269 61,297 – Derivative financial assets £000 Cash and cash equivalents £000 2008 Total £000 2007 Total £000 40 – – – 40 – 440,622 – – – 665,770 593,371 669,819 407,273 611,931 385,986 563,052 282,110 440,622 2,336,233 1,843,079 – 61,297 48,069 Total 1,928,599 28,269 40 440,622 2,397,530 1,891,148 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 2008 Years 4.85 6.95 5.10 2.45 2007 Years 4.69 9.42 4.11 1.83 64 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 3.2 Financial risk continued (d) Liquidity risk continued 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 Between two and five years £000 136,718 71,590 143,891 109,421 60,526 34,985 75,744 41,561 44,696 109,516 47,281 15,742 53,762 39,787 30,918 185,154 49,774 14,220 Over five years £000 8,859 6,630 3,826 41,266 11,912 3,646 2008 Total £000 275,083 159,568 223,331 445,357 169,493 68,593 557,131 334,540 373,615 76,139 1,341,425 Within one year £000 Between one and two years £000 Between two and five 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 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 *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 20 and 27. (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. These exposures may be classified in two main categories: 1) 2) Operational foreign exchange risk through routinely entering into insurance, investment and operational contracts, as a Group of Structural foreign exchange risk through taking net investments in subsidiaries with different functional currencies to the Group; and international insurance entities serving international communities, where rights and obligations are denominated in currencies other than each respective entities’ functional currency. The Group’s exposure to structural foreign exchange risk primarily relates to the US Dollar net investments made in its domestic operation in Bermuda and its overseas operation in Guernsey and the US. Other structural exposures also arise on a smaller scale in relation to net investments made in European operations. The Group’s risk appetite permits the acceptance of structural foreign exchange movements within defined aggregate limits and exchange rate parameters which are monitored centrally. Exchange rate derivatives are used when appropriate to shield the Group against significant movements outside of the defined range. At a consolidated level, the Group is exposed to foreign exchange gains or losses on balances held between group companies where one party to the transaction has a functional currency other than Pound Sterling. To the extent that such gains or losses are considered to relate to economic hedges and intragroup borrowings, they are disclosed separately in order for users of the financial statements to obtain a fuller understanding of the Group’s financial performance (note 14). In the prior year and up to 6 May 2008 the Group financed a portion of its net investment in the Bermuda and Guernsey insurance operations using US Dollar borrowings to which hedge accounting was applied for the vast majority of the periods under review (see note 20). The Group has the ability to draw on its current borrowing facility in any currency requested, enabling the Group to match its funding requirements with the relevant currency. Operational foreign exchange risk is controlled within the Group’s operations. The assets of the Group’s overseas operations are generally invested in the same currencies as their underlying insurance and investment liabilities producing a natural hedge. Due attention is paid to local regulatory solvency and risk based capital requirements. Details of all foreign currency derivative contracts entered into with external parties are given in note 22. All foreign currency derivative transactions with external parties are managed centrally. Included in the tables below are net non-monetary liabilities of £225m (2007: £233m) which are denominated in foreign currencies. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 65 Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued The currency profile of the Group’s assets and liabilities is as follows: At 31 December 2008 Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Reinsurance assets Loans and receivables including insurance receivables Current tax Cash and cash equivalents Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 42,249 16,378 6,504 40,263 6,308 2,404 – 66,462 370,043 1,430,712 389,121 290,523 – 229,165 63,782 127,702 26,289 127,881 – 886 696 20,094 236,066 24,769 64,748 – 75,109 – – – 4,311 48,557 19,668 7,200 131,130 44,951 2,081,772 487,720 10,048 494,315 11,342 26,289 – 440,622 8,467 Total assets 821,091 2,414,695 422,368 79,119 3,737,273 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities Current tax Trade and other payables Total liabilities At 31 December 2007 Intangible assets Property, plant and equipment Investments in associates Deferred acquisition costs Financial assets carried at fair value Reinsurance assets Loans and receivables including insurance receivables Cash and cash equivalents – 68,649 – – 455,606 1,570,090 132,818 – 108,627 – – 143,627 – – 206,228 10,532 – 40,680 – – – 68,649 45,492 2,277,416 143,350 – 296,832 – – 3,898 667,882 1,811,535 257,440 49,390 2,786,247 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 5,083 35,369 1,499 17,281 – 986 47,637 56,001 411,908 1,130,080 166,436 87,963 168,889 158,151 130,634 116,780 – 598 516 15,204 165,258 19,912 48,280 44,606 – – – 4,239 40,452 19,378 1,502 123,081 40,581 1,747,827 280,088 385,222 302,742 5,777 9,902 10,722 Total assets 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 Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities Current tax Trade and other payables Total liabilities 66 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued Sensitivity analysis The Group performs sensitivity analysis before and after the impact of US Dollar derivative contracts. The estimated impact of a 10% strengthening or weakening of the following currencies against Pound Sterling occurring on 31 December 2008 on total equity and profit before tax is shown below. This analysis assumes that all other variables, in particular interest rates, remain constant and that the underlying valuation of assets and liabilities in their base currency is unchanged. The process of deriving the undernoted estimates takes account of the linear retranslation movements of foreign currency monetary assets and liabilities together with the impact on the retranslation of those Group entities with non-sterling functional currency financial statements. Cognizance is also paid to non-linear estimated changes in the valuation of certain foreign currency linked derivative contracts. No account is taken of potential management actions such as the instigation of stop loss procedures on foreign currency derivative contracts that would have been contemplated if a change towards the actual scenarios had actually arisen. At 31 December 2008 Strengthening of US Dollar Weakening of US Dollar Strengthening of Euro Weakening of Euro Effect on equity excluding the impact of US Dollar derivative contracts £m Effect on profit before tax excluding the impact of US Dollar derivative contracts £m Effect on equity including the impact of US Dollar derivative contracts £m Effect on profit before tax including the impact of US Dollar derivative contracts £m 71.8 (59.8) 20.6 (11.6) 19.5 (15.9) 28.7 (16.2) 21.7 (24.7) 20.6 (11.6) (30.6) 19.3 28.7 (16.2) The sensitivity analysis performed as at 31 December 2007 showed an impact on equity of £58.2 million and an impact on profit of £42.1 million based on the US Dollar and Euro strengthening by 10% against Pound Sterling. (f) Limitations of sensitivity analysis The sensitivity information given in notes (a) to (e) above demonstrates the estimated 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 same limitations exist in respect to the retirement benefit scheme sensitivities presented at note 30 to these financial statements. Furthermore, estimates of sensitivity may become less reliable in unusual market conditions such as instances when risk free interest rates fall towards zero. 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 amount of dividends paid to shareholders, return capital 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. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 67 Notes to the financial statements continued 3.3 Capital risk management continued During the year the Group was in compliance with capital requirements imposed by regulators in each jurisdiction where the Group operates. 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: Letter of Credit and revolving credit facility – the Group's main facility currently in place is for a total of £350 million which may be drawn as cash (under a revolving credit facility) or letter of credit or a combination thereof, providing that the cash portion does not exceed £200 million. This facility was secured during 2008 by the Company’s subsidiary Hiscox plc. The Letter of Credit availability period ends on 31 December 2009. This enables the Group to utilise the Letter of Credit as Funds at Lloyd’s to support underwriting on both the 2009 and 2010 years of account. Subject to agreement by the banks, the Group is able to extend the Letter of Credit availability period to 2011, which would provide Fund’s at Lloyd’s cover up to and including the 2012 year of account. The revolving credit facility has a maximum five year contractual period for repayment. At 31 December 2008 £137,500,000 was drawn by way of Letter of Credit to support the Funds at Lloyd's requirement and a further US$130,000,000 by way of cash to support general trading activities; external Names – 27.5% of Syndicate 33’s capacity is capitalised by third- parties paying a profit share of approximately 17.5%; Syndicate 6104 at Lloyd’s – with an approximate capacity of £43 million (2007: £34 million). This Syndicate is wholly backed by external members and takes a pure 2009 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 2009 year of account for Syndicate 33 and the capital requirements of Hiscox Insurance Company (Bermuda) Limited, formed in 2005. Financial strength The financial strength ratings of the Group’s insurance company subsidiaries is outlined below: A.M. Best Fitch Standard & Poor’s Hiscox Insurance Company Limited Hiscox Insurance Company (Bermuda) Limited Hiscox Insurance Company (Guernsey) Limited Hiscox Insurance Company Inc. A (Excellent) A A (Strong) A (Excellent) A (Excellent) A (Excellent) A A A – – – Syndicate 33 benefits from an A.M. Best rating of A (Excellent). In addition, the Syndicate also benefits from 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 UK Financial Services Authority (FSA) and Lloyd’s introduced a new capital regime that requires insurance companies 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 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. 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 and other 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 2008 was 68 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 3.3 Capital risk management continued a surplus of £638 million (2007: surplus of £536 million), which is calculated as below. The final regulatory capital position will be submitted to the FSA before 30 April 2009 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 2008 £m Group capital resources 829 Group capital resources requirement Surplus (191) 638 2007 £m 738 (202) 536 Group capital resources are less than the Group’s total equity value primarily as a result of the inadmissibility of certain assets including intangible assets for regulatory purposes. 4 Operating segments The Group’s four operating segments are: 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 TMT business written 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. In respect of the current year under review, Corporate Centre also includes the majority of foreign currency items on economic hedges and intragroup borrowings. These relate to certain foreign currency items on economic hedges and intragroup borrowings, further details of which are given at note 14. Corporate Centre forms a reportable segment due to its investment activities which earn significant external coupon revenues. All amounts reported below represent transactions with external parties only, with all inter-segment amounts eliminated. Performance is measured based on each reportable segment’s profit before tax. (a) Profit before tax by segment 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 2008 Year to 31 December 2007 Gross premiums written Net premiums written Net premiums earned 586,458 354,899 206,007 425,056 328,744 176,664 172,788 477,814 302,418 – 1,147,364 676,464 302,273 220,212 – 930,464 524,683 265,001 185,226 – 953,020 552,205 248,348 164,637 – 1,198,949 – 974,910 – 965,190 Investment result – financial assets* Investment result – derivatives Other revenues (5,785) – 15,606 (11,935) (10,483) 2,929 (8,114) – 1,323 (1,798) (42,495) – (27,632) (52,978) 19,858 46,617 – 11,996 18,343 – 2,672 23,915 – 1,216 11,912 100,787 (1,110) (1,110) 19,044 3,160 Revenue 487,635 282,929 165,997 (44,293) 892,268 610,818 269,363 189,768 13,962 1,083,911 Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition (137,379) of insurance contracts (23,157) Administration expenses (19,149) Other expenses Foreign exchange gains/(losses) 108,536 (275,679) (129,889) (73,812) – (479,380) (246,876) (115,032) (61,457) – (423,365) (74,625) (46,228) (33,042) 32,507 (40,864) (13,813) (14,112) (22,291) – (252,868) (83,198) – (10,196) (76,499) (8,997) 109,755 (157,718) (27,822) (27,292) 4,462 (65,423) (37,399) (33,509) 3,817 (41,429) (11,592) (8,613) 2,509 – (264,570) (76,813) – (82,269) (12,855) (2,387) 8,401 Total expenses (346,828) (251,277) (164,892) (19,193) (782,190) (455,246) (247,546) (120,582) (15,242) (838,616) Results of operating activities Finance costs including interest expense Share of profit of associates after tax 140,807 31,652 1,105 (63,486) 110,078 155,572 21,817 69,186 (1,280) 245,295 (273) (35) (186) (4,664) (5,158) – – – 260 260 – – – – (82) (8,095) (8,177) – 81 81 Profit before tax 140,534 31,617 919 (67,890) 105,180 155,572 21,817 69,104 (9,294) 237,199 *Interest revenues included total £89,608,000 (2007: £85,435,000). Notes to the financial statements Hiscox Ltd Report and Accounts 2008 69 Notes to the financial statements continued 4 Operating segments continued (a) Profit before tax by segment continued The following charges are included within the consolidated income statement: Depreciation Amortisation of intangible assets Global Markets £000 1,348 – UK and Europe £000 3,007 135 International £000 921 123 Corporate Centre £000 47 1 Total £000 5,323 259 Global Markets £000 975 40 UK and Europe £000 3,303 137 International £000 599 41 Corporate Centre £000 40 5 Total £000 4,917 223 Year to 31 December 2008 Year to 31 December 2007 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. Year to 31 December 2008 Year to 31 December 2007 100% ratio analysis Claims ratio (%) Expense ratio (%) Combined ratio excluding foreign exchange impact (%) Foreign exchange impact (%) Combined ratio (%) Global Markets 57.8 36.7 94.5 (26.0) 68.5 UK and Europe 41.9 50.3 92.2 (10.7) 81.5 International Corporate Centre 43.0 38.8 81.8 12.4 94.2 – – – – – Total 51.1 40.8 91.9 (15.8) 76.1 Global Markets 45.1 37.4 82.5 (0.8) 81.7 UK and Europe 45.6 54.3 99.9 (1.7) 98.2 International Corporate Centre 40.1 36.8 76.9 (1.5) 75.4 – – – – – Total 44.5 41.0 85.5 (1.1) 84.4 The combined ratio is an underwriting ratio and as such the costs of the Corporate Centre are not included in the total combined ratio calculation. 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 (b) 100% operating result by segment Year to 31 December 2008 Year to 31 December 2007 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 6,531 3,168 1,793 4,778 3,024 1,728 – – 7,660 2,598 1,695 5,522 2,483 1,646 – – 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 2008 Year to 31 December 2007 Gross premiums written Net premiums written Net premiums earned 803,189 371,511 215,040 580,806 344,101 183,798 653,090 316,791 179,340 – 1,389,740 932,251 316,017 227,576 191,219 – 1,108,705 722,209 276,967 – 1,149,221 765,959 259,841 169,465 – 1,475,844 – 1,190,395 – 1,195,265 (7,933) – 23 Investment result – financial assets Investment result – derivatives Other revenues Claim and claim adjustment expenses, net of reinsurance Expenses for the acquisition (188,724) of insurance contracts (31,245) Administration expenses (19,531) Other expenses Foreign exchange gains/(losses) 169,713 (11,970) (10,483) 2,929 (8,149) (1,798) – (42,495) – 35 (29,850) (52,978) 2,987 64,552 – 2,665 19,161 – 2,672 23,915 – 500 11,912 119,540 (1,110) (1,110) 8,997 3,160 (377,626) (132,838) (77,038) – (587,502) (345,318) (118,418) (67,938) – (531,674) (79,474) (46,933) (33,042) 34,152 (41,868) (14,082) (13,589) (22,291) (310,066) (222,965) – (34,640) (92,260) – (10,196) (76,358) (28,739) (8,997) 172,577 5,881 (69,428) (38,079) (33,510) 4,160 (42,375) (11,913) (8,105) 2,509 – (334,768) (84,632) – (12,855) (83,209) (2,387) 10,163 Results of operating activities 197,767 39,132 2,358 (63,486) 175,771 207,395 26,399 66,058 (1,280) 298,572 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. 70 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 4 Operating segments continued (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: Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Intragroup items and eliminations £000 Total £000 31 December 2008 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 1,175,492 320,776 460,804 120,543 2,850 41,102 486,926 231,224 30,507 55,158 471,676 121,028 – 107,011 6,555 8,645 – 35,352 (200,638) – (482) 525,984 742,713 (1,005,953) – 2,088,972 487,720 48,557 131,130 980,894 2,208,887 716,495 1,148,668 870,296 (1,207,073) 3,737,273 1,553,432 436,949 219,317 560,451 487,176 – 100,916 196,041 (200,141) 2,277,416 (567,894) 508,831 2,113,883 656,266 588,092 196,041 (768,035) 2,786,247 8,622 337 934 220 10,113 31 December 2007 Global Markets £000 UK and Europe £000 International £000 Corporate Centre £000 Intragroup items and eliminations £000 Total £000 271,572 954,701 102,137 162,516 2,985 25,275 36,087 56,231 456,515 248,366 385,091 137,965 – 4,649 – 222,796 658,318 28,691 7,543 24,792 – (13,256) – 5,971 (878,653) 1,749,329 280,088 40,452 123,081 707,342 1,655,238 661,147 668,913 800,932 (885,938) 2,900,292 1,081,287 407,332 419,549 166,858 229,481 – 51,859 158,760 (4,213) 1,713,887 362,101 (434,925) 1,500,836 574,190 281,340 158,760 (439,138) 2,075,988 9,409 190 3,375 167 13,141 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 15) other than goodwill, and additions to property, plant and equipment (note 16), but excluding assets acquired on business combinations. (d) Geographical information The Group’s operational segments underwrite business domestically in Bermuda and from locations in the UK and Ireland, the USA, Guernsey, France, Germany, Belgium, the Netherlands, Spain, Portugal, Sweden and Austria. The following table provides an analysis of the Group’s gross premium revenues earned by material geographical location of external parties: Year to 31 December 2008 Year to 31 December 2007 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 International £000 Corporate Centre £000 Total £000 UK and Ireland Europe United States Rest of World 36,204 220,213 84,776 52,722 308,818 232,044 9,878 18,914 4,567 124,450 55,390 23,535 9,095 85,441 202,703 – 266,295 19,913 77,171 69,956 – 156,412 2,006 101,485 – 437,835 310,892 62,050 3,924 – 310,969 234,808 – 297,239 167,040 – – 414,383 – 300,782 629,788 333,091 208,632 – 1,171,511 701,097 285,804 192,543 – 1,179,444 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. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 71 Notes to the financial statements continued 5 Net asset value per share Net asset value Net tangible asset value Net asset value (total equity) £000 2008 NAV per share pence Net asset value (total equity) £000 951,026 902,469 258.1 824,304 244.9 783,852 2007 NAV per share pence 209.5 199.3 The net asset value per share is based on 368,477,595 shares (2007: 393,386,041), being the adjusted number of shares in issue at 31 December. Net tangible assets comprise total equity excluding intangible assets. 6 Return on equity Profit for the period Opening shareholders’ equity Adjusted for the time weighted impact of: – Distribution and other movements in capital Adjusted opening shareholders’ equity Annualised return on equity (%) 2008 £000 2007 £000 70,808 191,248 824,304 682,085 (55,700) (18,029) 768,604 664,056 9.2 28.8 Profit for the period excluding foreign currency items on economic hedges and intragroup borrowings Annualised return on equity excluding foreign currency items on economic hedges and intragroup borrowings (%) 125,928 191,248 28.8 16.4 7 Investment result The total result for the Group before taxation comprises: Investment income including interest receivable Net realised gains on financial investments at fair value through profit or loss Net fair value (losses)/gains on financial investments at fair value through profit or loss Investment result – financial assets Fair value gains/(losses) on derivative instruments and borrowings Total result Investment expenses are presented within other expenses (note 9). 8 Analysis of return on financial investments (i) The weighted average return on financial investments for the year by currency was: Sterling US Dollar Other (ii) Investment yields Note 2008 £000 2007 £000 94,678 4,743 (127,053) 90,259 10,105 423 8 20, 22 (27,632) 100,787 (1,110) (52,978) (80,610) 99,677 2008 % (0.1) (2.5) 0.4 2007 % 4.9 5.5 3.6 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 2008 Total £000 % £000 % £000 % £000 % £000 % (8,288) – (0.9) – 7,367 (25,529) 3.4 (41.9) (7,490) (5,552) (2.3) (16.2) 4,384 (7,186) 5.4 (18.0) (4,027) (38,267) (0.3) (28.4) 2,503 4.2 6,227 5.0 4,928 2.8 1,004 2.6 14,662 (5,785) (0.6) (11,935) (3.0) (8,114) (1.5) (1,798) (1.1) (27,632) 3.7 (1.3) 72 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 8 Analysis of return on financial investments continued Global Markets UK and Europe International Corporate Centre 2007 Total £000 Debt and fixed income securities 43,802 Equities and shares in unit trusts – Deposits with credit institutions/ cash and cash equivalents 2,815 46,617 % 5.2 – 4.9 5.2 £000 9,599 1,131 7,613 18,343 % 5.6 1.3 5.5 4.6 £000 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 £000 70,688 6,959 6.5 23,140 6.3 100,787 % 5.5 4.1 5.4 5.4 9 Other revenues and expenses Agency related income Profit commission Other income Other revenues Managing agency expenses Overseas underwriting agency expenses Connect agency expenses Investment expenses Other Group expenses including central overheads 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 Note 2008 £000 2007 £000 5,324 14,382 152 4,626 10,468 3,950 19,858 19,044 19,513 28,787 13,343 1,899 12,957 28,870 23,811 14,492 1,250 13,846 76,499 82,269 15, 16 Note 2008 £000 2007 £000 79,048 10,468 5,269 5,794 – 68,135 8,909 5,689 7,256 (3,801) 100,579 86,188 24 30 The average monthly number of staff employed by the Group was 914 (2007: 804) comprising 335 underwriting and 579 administrative staff (2007: 301 and 503 respectively). Of the total remuneration shown above, an amount of £21,053,000 (2007: £19,838,000) was recharged to Syndicate 33. 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 20 35 36 2008 £000 3,201 1,922 35 5,158 2007 £000 6,278 1,845 54 8,177 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 73 Notes to the financial statements continued 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 2008 £000 262 519 75 75 931 12 943 2007 £000 201 345 50 93 689 12 701 *Other fees relate primarily to corporate advisory and financial reporting consulting services. 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 2008 were £23,000 (2007: £51,000). 13 Net foreign exchange gains/(losses) The net foreign exchange gains/(losses) for the year include the following amounts: Exchange gains recognised in the consolidated income statement Exchange gains/(losses) classified as a separate component of equity Total exchange gains reported for the year 2008 £000 2007 £000 109,755 8,401 150,582 (2,869) 260,337 5,532 The above excludes profits or losses on foreign exchange derivative contracts which are included within the investment result and are outlined in note 22. Overall impact of foreign exchange related items before tax Consolidated income statement Derivative losses on foreign exchange contracts included within investment return Net unearned premiums and deferred acquisition costs adjustment† Foreign exchange losses on intragroup borrowings (note 14) Other foreign exchange gains/(losses) 2008 Economic hedges and intragroup borrowings £000 Note 2008 Other £000 2008 £000 2007 £000 7, 22 (42,540) (10,123) (52,663) (1,110) – (8,463) – 50,525 – 67,693 50,525 (8,463) 67,693 (8,463) 118,218 109,755 14,438 – (6,037) 8,401 7,291 Impact of foreign exchange related items in consolidated income statement (51,003) 108,095 57,092 †Net unearned premiums and deferred acquisition cost adjustment arises as a result of a foreign exchange mismatch caused by those items being translated only at the historical exchange prevailing at the original transaction date and not retranslated again at the year end rate. 74 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 14 Foreign currency items on economic hedges and intragroup borrowings The Group has highlighted two separate charges on the consolidated income statement to enable readers to obtain a fuller understanding of their impact and that of related amounts recognised directly in other comprehensive income: Consolidated income statement 2008 £000 Consolidated statement of comprehensive income 2008 £000 Total impact on equity 2008 £000 Unrealised losses on foreign currency derivative contracts used to manage retranslation risk associated with the net investment in Bermuda and Guernsey insurance operations (42,540) – (42,540) Retranslation gain on managed net investment in Bermuda and Guernsey insurance operations – 67,591 67,591 Unrealised translation (losses)/gains on intragroup borrowings Total (losses)/gains recognised (12,580) 12,580 – (55,120) 80,171 25,051 The Group recorded unrealised losses of £42,540,000 before and after tax in respect of US Dollar currency option collar contracts which were contracted in September and October 2008 to serve as informal hedges of part of the Group’s net investment in its Bermuda and Guernsey insurance operations. The translated Pound Sterling value of the US Dollar capital held in these operations appreciated significantly during the year generating currency translation gains. The collar contracts acquired enabled the Group to largely protect approximately £47,568,000 of 2008 foreign exchange gains earned up to the dates at which the contracts were effected, at zero initial cost. The US Dollar continued to strengthen subsequent to the purchase of the derivatives generating further translation gains of £67,591,000. The unrealised losses are therefore viewed by the Directors as economically linked to the underlying currency translation gains recognised separately within total comprehensive income. Formal hedge accounting designation was not achievable due to the specific effectiveness requirements of IAS 39. Foreign exchange losses of £8,463,000 before tax (£12,580,000 after tax) were recorded on certain loan arrangements, denominated in US Dollars, between Group companies. In most cases, as one party to each arrangement has a functional currency other than the US Dollar, foreign exchange losses arise which are not eliminated through the income statement on consolidation. Implicit offsetting gains are reflected instead on retranslation of the counterparty company’s closing balance sheet through other comprehensive income and into the Group’s currency translation reserve within equity. 15 Intangible assets At 1 January 2007 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 Year ended 31 December 2008 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 2008 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 – – – 2,970 (368) 36,022 (2,810) 2,602 33,212 6,105 – – (39) – 24,505 – – – – 6,066 24,505 8,496 (2,430) 24,505 – 6,066 24,505 6,066 1,909 – – – 24,505 – – – – 7,975 24,505 10,405 (2,430) 24,505 – 7,975 24,505 – 5,083 – – – 5,083 5,083 – 5,083 5,083 1,225 – – – 6,308 6,308 – 6,308 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 4,798 – 5,230 – (259) 40,452 3,134 5,230 – (259) 9,769 48,557 10,591 (822) 51,809 (3,252) 9,769 48,557 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 75 Notes to the financial statements continued 15 Intangible assets continued Goodwill is allocated to the Group’s cash generating units (‘CGUs’) identified according to country of operation and business segment. At 31 December 2008 and 2007 the Group’s goodwill net book amount is all attributable to UK based operations. Accumulated amortisation and impairment of goodwill relates to the amortisation charged prior to the Group’s adoption of IFRS. 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% (2007: 2%) consistent with the industry long-term average. A pre-tax discount factor of 7% (2007: 7%) has been applied to projected cash flows as part of the exercise. The results of this exercise indicate that the recoverable amount significantly exceeds the intangible’s carrying value and would not be sensitive to reasonably possible changes in assumptions. The Group’s weighted average cost recognised on the balance sheet is significantly below the average open market price witnessed in the recent Lloyd’s of London Syndicate 33 capacity auctions in Autumn 2008. In 2007 and 2008, the Group recognised intangible assets totalling £6,308,000 relating to insurance authorisation licences for 50 US states acquired in the business combination of ALTOHA Inc. (note 33). 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 intangible additions during 2007 primarily relate to the costs of acquiring rights to customer contractual relationships held previously by AON Limited, the additions during 2008 relate to software licence and development costs. The amortisation charge for the year includes £nil (2007: £40,000) relating to capitalised software costs and is included in other expenses in the income statement. The net book value of capitalised software costs at 31 December 2008 was £5,230,000 (2007: £nil). There are no charges for impairment during the current or prior financial year. At 31 December 2008 there were £5,230,000 of assets under construction on which no amortisation has been charged (2007: £nil). 76 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 16 Property, plant and equipment At 1 January 2007 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 Year ended 31 December 2008 Opening net book amount Additions Additions on business combinations Disposals Depreciation charge Foreign exchange movements Closing net book amount At 31 December 2008 Cost Accumulated depreciation Net book amount Land and buildings £000 Leasehold improvements £000 Vehicles £000 Furniture, fittings and equipment and art £000 Total £000 2,985 (120) 2,865 2,865 – – – (40) 2,825 2,985 (160) 2,825 2,825 – – – (40) – 2,785 2,985 (200) 2,785 514 (78) 436 436 262 99 – (132) 665 1,044 (379) 665 665 257 – – (222) 254 954 1,700 (746) 954 679 (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 19,378 896 (300) 34,978 (19,686) 39,903 (20,525) 596 15,292 19,378 596 145 – (47) (144) – 15,292 4,450 – (23) (4,917) 577 19,378 4,852 – (70) (5,323) 831 550 15,379 19,668 968 (418) 40,413 (25,034) 46,066 (26,398) 550 15,379 19,668 The Group’s land and buildings assets relate to freehold property in the United Kingdom. Assets with a net book value of £582,000 were held under finance leases (2007: £510,000). The total depreciation charge for the year in respect of assets held under finance leases was £116,000 (2007: £106,000) and is included in other expenses. At 31 December 2008 there were £3,106,000 of assets under construction, upon which no depreciation has yet been charged (2007: £2,336,000). 17 Investments in associates Movement in carrying value 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 2008 £000 1,502 5,438 260 7,200 2007 £000 28 1,393 81 1,502 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 77 Notes to the financial statements continued 17 Investments in associates continued The Group’s interests in its principal associates, all of which are unlisted, were as follows: 2008 Associates incorporated in the UK Associates incorporated in Europe Total at the end of 2008 2007 Associates incorporated in the UK Associates incorporated in Europe Total at the end of 2007 % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profit after tax £000 100% results From 25.2% to 49% 25% 11,981 2,066 8,809 1,289 14,047 10,098 6,214 1,483 7,697 877 268 1,145 100% results % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profit after tax £000 From 25.2% to 49% 25% 1,634 1,232 2,866 758 1,074 1,832 1,898 1,064 2,962 290 310 600 The additions during the current year relate to equity investments made in Senior Wright Indemnity Ltd and Media Insurance Brokers. Cash consideration of £5,438,000 (2007: £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. 18 Deferred acquisition costs Gross £000 Reinsurance £000 2008 Net £000 Gross £000 Reinsurance £000 2007 Net £000 Balance deferred at 1 January Acquisition costs incurred in relation to insurance contracts written Acquisition costs expensed to the income statement 123,081 270,126 (262,077) (5,639) 117,442 117,115 (8,564) 261,562 284,071 (278,105) 9,209 (252,868) (6,529) 110,586 (12,645) 271,426 13,535 (264,570) Balance deferred at 31 December 131,130 (4,994) 126,136 123,081 (5,639) 117,442 The deferred amount of insurance contract acquisition costs attributable to reinsurers of £4,994,000 (2007: £5,639,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 27). The amounts expected to be recovered before and after one year are estimated as follows: Within one year After one year 19 Reinsurance assets Reinsurers’ share of insurance liabilities Provision for non-recovery and impairment Reinsurance assets 2008 £000 2007 £000 126,136 – 117,442 – 126,136 117,442 Note 2008 £000 2007 £000 495,251 (7,531) 283,414 (3,326) 26 487,720 280,088 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 238,472 249,248 147,987 132,101 487,720 280,088 78 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 19 Reinsurance assets continued Amounts due from reinsurers in respect of outstanding premiums and claims already paid by the Group are included in loans and receivables (note 21). The Group recognised a loss during the year of £4,205,000 (2007: gain of £452,000) in respect of impaired balances. 20 Financial assets and liabilities Financial assets are measured at their bid price values, 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 3 January 2007 to 6 May 2008 as provided for by IAS 39. Note 2008 Cost £000 2008 Fair value £000 2007 Cost £000 2007 Fair value £000 Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Total investments Derivative instrument assets Total financial assets carried at fair value Borrowings from credit institutions (see below) Derivative instrument liabilities Total financial liabilities 1,993,551 1,928,599 1,435,373 1,444,532 159,421 143,874 155,399 28,219 124,864 28,269 135,427 143,852 2,177,169 2,081,732 1,714,652 1,747,827 22 40 40 – – 2,177,209 2,081,772 1,714,652 1,747,827 2008 Cost £000 90,278 – 2008 Fair value £000 90,278 53,072 2007 Cost £000 91,457 – 2007 Fair value £000 91,764 – Note 22 90,278 143,350 91,457 91,764 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’s borrowings from credit institutions at 31 December 2008 and 2007 are denominated in US Dollars. The entire amount from December 2007 was repaid during the year and the amount outstanding at 31 December 2008 is all expected to be repaid within one year of the balance sheet date. The movement in fair value of financial liabilities during 2008 includes net principal repayments of £3,508,000, £835,000 of foreign exchange gains recognised directly in equity (see note 13 and below), £2,022,000 foreign exchange losses and £nil of fair value losses (2007: £nil of net principal repayments, £1,400,000 of foreign exchange gains and £302,000 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 were foreign currency borrowings from credit institutions totalling US$182,000,000 that were designated as a hedging instrument in a net investment hedge relationship. The hedged item was 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 6 May 2008. Investments at 31 December are denominated in the following currencies at their fair value: 2008 £000 2007 £000 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 293,697 206,357 1,378,167 1,038,412 199,763 256,735 1,928,599 1,444,532 55,011 45,611 24,242 102,196 51,148 6,077 124,864 159,421 21,335 6,934 – 95,541 48,333 – 28,269 143,874 2,081,732 1,747,827 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 79 Notes to the financial statements continued 21 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 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 2008 £000 2007 £000 441,752 (560) 329,156 (1,392) 441,192 327,764 274,470 166,722 201,157 126,607 441,192 327,764 7,948 9,562 11,959 9,480 13,546 10,190 13,850 9,003 12,705 12,338 494,315 385,222 491,529 2,786 381,639 3,583 494,315 385,222 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 gain of £832,000 (2007: loss of £517,000) for the impairment of receivables during the year ended 31 December 2008. 22 Derivative financial instruments The Group entered into both exchange-traded and over the counter derivative contracts for a number of purposes during 2008. The Group had the right and intention to settle all contracts on a net basis. The assets and liabilities of these contracts at 31 December 2008 all mature within one year of the balance sheet date and are detailed below: Derivative contract assets included on balance sheet Event linked future contracts Derivative contract assets included on balance sheet Foreign exchange option collar contracts Foreign exchange forward contracts The Group had no derivative assets or liabilities at 31 December 2007. Gross contract notional amount 000 US$80 Gross contract notional amount 000 US$600,000 €68,680 Fair value of assets £000 474 Fair value of assets £000 Fair value of liabilities £000 Net balance sheet position £000 434 40 Fair value of liabilities £000 Net balance sheet position £000 – – – 42,540 10,532 42,540 10,532 53,072 53,072 80 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 22 Derivative financial instruments continued Foreign exchange option collar contracts During 2008 the Group’s capital benefited from a significant uplift in net asset value due to the appreciation of the US Dollar to Pound Sterling exchange rate which increased the translated values of its net investments in the Bermuda and Guernsey insurance operations. During September and October 2008 the US Dollar fluctuated significantly and in order to protect the majority of the exchange gains earned to date the Group progressively hedged the risk of subsequent US Dollar weakness impacting this capital by entering into a series of currency option collar contracts. These over the counter instruments have no initial purchase cost and consist of covered call and protective put options which essentially protect the Group against material downside movements in US Dollar to Pound Sterling exchange rate whilst at the same time limiting further participation in material US Dollar strengthening beyond an upper cap. The Group made a loss on these contracts of £42,540,000 (2007: £1,842,000) as included in notes 7 and 14. The related exchange gain earned on the retranslation of the portion of underlying net investments concerned was £67,591,000 and is included within the overall gain of £151,179,000 recognised in other comprehensive income (note 13). Foreign exchange forward contracts During 2008 the Group entered into a series of conventional over the counter forward contracts in order to secure translation gains made on Euro denominated monetary assets which had been subject to significant appreciation in value since 31 December 2007. The contracts required the Group to forward sell a fixed amount of Euros for Pound Sterling at pre-agreed future exchange rates. The Group made a loss on these forward contracts of £10,123,000 (2007: gain of £732,000) as included in note 7. An opposite exchange gain of £10,163,000 was earned on the retranslation of the underlying assets concerned. There was no initial purchase cost associated with these instruments. Event linked future contracts In June 2008 the Group commenced trading event linked future contracts which are transacted on Chicago Climate Futures Exchange. The contracts have fixed maturity dates and are structured such that cash inflows are binary in nature and are triggered by the occurrence of specific natural events in specific geographical zones which cause pre-determined losses to the insurance industry in excess of a specified amount. The Group itself does not have to suffer losses to receive a payment once the industry loss strike amount on each contract has been reached. Consequently the contracts are not accounted for as insurance contracts in accordance with IFRS 4. The Group made a gain on event linked future contracts of £45,000 (2007: £nil) as included in note 7. Interest rate future contracts In August 2008 the Group commenced short selling a number of Pound Sterling government bond futures and Euro sovereign futures to informally hedge substantially all of the interest rate risk on a specific long portfolio of Sterling and Euro denominated corporate bonds. All positions taken were closed out before maturity using offsetting trades and no closing assets or liabilities existed at 31 December 2008. The contracts are exchange traded. The Group made a loss on these futures contracts of £360,000 (2007: £nil) as included in note 7. 23 Cash and cash equivalents Cash at bank and in hand Short-term bank deposits 2008 £000 2007 £000 353,542 87,080 236,417 66,325 440,622 302,742 The Group holds its cash deposits with a well diversified range of banks and financial institutions. Cash and cash equivalents include amounts of US$17,775,000 (2007: US$14,985,000) held in escrow to settle deferred consideration on acquisitions. 24 Share capital Group Issued share capital 31 December 2008 31 December 2007 Share capital £000 Number of shares Share capital £000 Number of shares 20,067 401,330,601 19,898 397,938,305 The amounts presented in the equity structure of the Group above relate to Hiscox Ltd, the legal parent Company. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 81 Notes to the financial statements continued 24 Share capital continued Changes in Group share capital and contributed surplus At 1 January 2007 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2007 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2008 Ordinary share capital £000 19,694 204 – Share premium £000 – 4,955 – Contributed surplus £000 442,425 – (43,591) 19,898 4,955 398,834 169 – 4,463 – – (46,756) 20,067 9,418 352,078 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. Contributed surplus is a distributable reserve and arose on the reverse acquisition of Hiscox plc on 12 December 2006. Equity structure of Hiscox Ltd At 1 January Employee share option scheme – ordinary shares issued At 31 December All issued shares are fully paid. Number of 5p ordinary shares in issue (thousands) 2008 Number of 5p ordinary shares in issue (thousands) 2007 397,938 393,916 3,393 4,022 401,331 397,938 Share options and performance share plan awards Performance share plan awards are granted to Directors and to senior employees. Up until 2005, share options were also granted. 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 less 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 return on equity; 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 £5,269,000 (2007: £5,689,000). This comprises charges of £4,960,000 (2007: £4,352,000) in respect of performance share plan awards and £309,000 (2007: £1,337,000) in respect of share option awards. 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 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) 2008 2007 3.2-5.6 4.75 3.25 27-30 247.9 5.5 4.75 3.25 26 268.5 The weighted average fair value of each share option granted during the year was 60.5p (2007: 67.9p). The weighted average fair value of each performance share plan award granted during the year was 213.4p (2007: 232.8p). 82 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 24 Share capital continued Share options and performance share plan awards continued Movements in the number of share options during the year and details of the balances outstanding at 31 December 2008 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. 25 Retained earnings and other reserves Currency translation reserve at 31 December Retained earnings at 31 December 2008 £000 2007 £000 107,317 (43,265) 462,146 443,882 The currency translation reserve comprises qualifying net investment gains and losses and foreign exchange differences arising from the translation of the financial statements of, and investments in, foreign operations. 28,300,742 ordinary shares of 5p each were purchased by Hiscox Ltd in open market transactions during the current year (2007: 4,365,305) and are held in treasury. In addition, 1,000,000 ordinary shares of 5p each were purchased and held in trust. Retained earnings have been reduced by £65,066,000 being the consideration paid for these transactions. Included within this amount are transaction cost expenses of £125,000 (2007: £23,000) directly related to the purchases. The highest price paid per share was 260p, the lowest price paid was 191.5p and the average price paid was 221.7p per share. At 31 December 2008 Hiscox Ltd held 32,666,047 shares in treasury. Additional details are shown in note 37 to these financial statements in respect of additional Hiscox Ltd shares held by subsidiaries. Included within Group retained earnings is an amount of £23,932,000 (2007: £21,578,000), 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. 26 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 Note 2008 £000 2007 £000 885,905 881,823 509,688 642,252 573,635 498,000 2,277,416 1,713,887 180,406 245,897 61,417 137,868 84,804 57,416 19 487,720 280,088 705,499 635,926 448,271 504,384 488,831 440,584 1,789,696 1,433,799 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 995,454 794,242 844,570 589,229 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 2008 and 2007 are not material. 1,789,696 1,433,799 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 83 Notes to the financial statements continued 26 Insurance liabilities and reinsurance assets continued 26.1 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. Delays in the notification of claims necessitate the holding of significant reserves for liabilities that may only emerge a number of accounting periods later. The impact of inflation on ultimate claim estimates is therefore significant. In addition a greater level of risk may be inherent in reserving estimates for newer types of insurance products where there is a lack of past historical development experience. 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. 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. (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. 84 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 26 Insurance liabilities and reinsurance assets continued 26.1 Insurance contracts assumptions continued (b) Claims development tables continued Insurance claims and claims expenses reserves – gross at 100% Accident year 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 2008 £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 seven years later 749,648 727,993 810,021 836,914 881,684 877,676 876,086 877,941 Current estimate of cumulative claims 877,941 (780,967) Cumulative payments to date 437,736 463,447 472,577 455,747 451,206 423,579 419,824 – 419,824 (359,868) 493,451 507,499 477,146 491,699 487,718 475,401 – – 475,401 (399,294) 748,759 1,253,261 831,151 1,387,438 793,273 1,399,169 749,948 1,378,982 – 753,543 – – – – – – 753,543 1,378,982 (594,416) (1,114,832) 643,855 616,072 593,856 – – – – – 593,856 (409,844) 864,188 1,210,449 6,401,347 – 5,307,705 774,105 – 4,546,042 – – 3,913,290 – – 2,574,151 – – 1,776,656 – – 1,295,910 – 877,941 – – 774,105 1,210,449 6,484,101 (274,981)(4,319,016) (384,814) 96,974 59,956 76,107 159,127 264,150 184,012 389,291 935,468 2,165,085 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 2008 £000 Total £000 Current estimate of cumulative claims 877,941 Less: Attributable to external Names (218,191) 419,824 (86,594) 475,401 (106,885) 753,543 1,378,982 (346,205) (174,815) 593,856 (123,730) 774,105 1,210,449 6,484,101 (240,694) (1,447,568) (150,454) Group’s share of current ultimate claims estimate 659,750 333,230 368,516 578,728 1,032,777 470,126 623,651 969,755 5,036,533 (780,967) Cumulative payments to date Less: Attributable to external Names 192,092 (359,868) 71,607 (399,294) 87,967 (594,416) (1,114,832) 282,694 139,519 (409,844) 83,531 (384,814) 63,755 (274,981)(4,319,016) 965,197 44,032 Group’s share of cumulative payments (588,875) (288,261) (311,327) (454,897) (832,138) (326,313) (321,059) (230,949)(3,353,819) Liability for 2001 to 2008 accident years recognised on Group’s balance sheet 70,875 Liability for accident years before 2001 recognised on Group’s balance sheet Total Group liability to external parties included in balance sheet – gross** 44,969 57,189 123,831 200,639 143,813 302,592 738,806 1,682,714 109,247 2,274,332 85,014 1,767,728 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 2008 £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 seven years later 358,257 403,105 483,139 526,027 513,333 497,218 490,038 492,765 Current estimate of cumulative claims 492,765 (410,138) Cumulative payments to date 296,566 323,581 335,648 306,962 299,838 283,553 277,270 – 277,270 (232,148) 391,129 413,586 374,738 385,991 377,204 370,818 – – 370,818 (302,448) 626,722 685,423 657,714 616,453 617,474 – – – 617,474 (478,701) 731,748 841,506 839,043 811,585 – – – – 811,585 (594,658) 569,946 562,952 544,493 – – – – – 544,493 (375,785) 748,640 680,514 – – – – – – 680,514 (317,957) 837,864 4,560,872 – 3,910,667 – 3,234,775 – 2,647,018 – 1,807,849 – 1,151,589 767,308 – 492,765 – 837,864 4,632,783 (232,079)(2,943,914) 82,627 45,122 68,370 138,773 216,927 168,708 362,557 605,785 1,688,869 Liability recognised at 100% level Liability recognised in respect of prior accident years at 100% level 45,329 1,734,198 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 2008. **This represents the claims element of the Group’s insurance liabilities. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 85 Notes to the financial statements continued 26 Insurance liabilities and reinsurance assets continued 26.1 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 2008 £000 Total £000 Current estimate of cumulative claims 492,765 Less: Attributable to external Names (116,349) 277,270 (54,903) 370,818 (82,082) 617,474 (143,775) 811,585 (195,548) 544,493 (114,412) 680,514 (133,508) 837,864 4,632,783 (165,857)(1,006,434) Group’s share of current ultimate claims estimate 376,416 222,367 288,736 473,699 616,037 430,081 547,006 672,007 3,626,349 Cumulative payments to date Less: Attributable to external Names (410,138) 93,966 (232,148) 43,464 (302,448) 64,586 (478,701) 112,341 (594,658) 142,587 (375,785) 77,956 (317,957) 54,658 (232,079)(2,943,914) 624,185 34,627 Group’s share of cumulative payments (316,172) (188,684) (237,862) (366,360) (452,071) (297,829) (263,299) (197,452)(2,319,729) Liability for 2001 to 2008 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. 26.2 Movements in insurance claims liabilities and reinsurance claims assets 60,244 33,683 50,874 107,339 163,966 132,252 283,707 474,555 1,306,620 34,805 1,341,425 Year ended 31 December Total at beginning of year Claims and loss adjustment expenses for year Cash paid for claims settled in the year Exchange differences and other movements Gross £000 Reinsurance £000 2008 Net £000 (1,215,887) (698,471) 549,106 (402,476) (993,215) 222,672 219,091 (479,380) (117,582) 431,524 102,122 (300,354) Gross £000 Reinsurance £000 2007 Net £000 (1,128,329) (498,568) 452,235 (41,225) 265,073 75,203 (131,505) 13,901 (863,256) (423,365) 320,730 ( 27,324) Total at end of year (1,767,728) 426,303 (1,341,425) (1,215,887) 222,672 (993,215) Claims reported and loss adjustment expenses Claims incurred but not reported (885,905) (881,823) 245,897 180,406 (705,499) (635,926) (642,252) (573,635) 137,868 84,804 (504,384) (488,831) Total at end of year (1,767,728) 426,303 (1,341,425) (1,215,887) 222,672 (993,215) The insurance claims expense reported in the consolidated income statement is comprised as follows: Year ended 31 December Current year claims and loss adjustment expenses (Under)/over provision in respect of prior year claims and loss adjustment expenses Gross £000 Reinsurance £000 2008 Net £000 Gross £000 Reinsurance £000 2007 Net £000 (828,940) 226,808 (602,132) (562,223) 78,953 (483,270) 130,469 (7,717) 122,752 63,655 (3,750) 59,905 Total claims and claims handling expense (698,471) 219,091 (479,380) (498,568) 75,203 (423,365) 86 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 27 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 2008 £000 2007 £000 35,089 175,134 30,353 114,317 210,223 144,670 439 2,714 10,919 9,493 457 2,681 4,067 13,704 23,565 20,909 4,994 58,050 5,639 64,657 296,832 235,875 36 18 284,892 11,940 234,828 1,047 296,832 235,875 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. 28 Tax expense The Company and its subsidiaries are subject to enacted tax laws in the jurisdictions in which they are incorporated and domiciled. The principle subsidiaries of the Company and the country in which they are incorporated are listed in note 37. The amounts charged in the consolidated income statement comprise the following: Current tax (credit)/expense Deferred tax expense Note 29 2008 £000 2007 £000 (32,341) 66,713 26,891 19,060 34,372 45,951 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 28.5% (2007: 30%)** Effects of: Expenses not deductible for tax purposes 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 changed from 30% to 28% on 1 April 2008. 29 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. Note 2008 £000 2007 £000 105,180 29,976 237,199 71,160 (1,259) 14,771 260 1,480 (653) (10,203) (1,296) (24,843) 1,092 (2,064) (1,374) 3,276 34,372 45,951 2008 £000 2007 £000 27,747 (96,396) 40,153 (49,904) (68,649) (9,751) Notes to the financial statements Hiscox Ltd Report and Accounts 2008 87 Notes to the financial statements continued 29 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 Release from/(charge to) equity At 31 December The applicable rate for deferred tax from 1 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 Intangible assets – Syndicate capacity Other items Total deferred tax assets 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 2008 £000 2007 £000 (9,751) (66,713) 1,445 6,370 (8,467) (19,060) 19,850 (2,074) (68,649) (9,751) Transfer to equity £000 – – – – 4,715 1,655 2008 £000 863 4,050 – 5,996 4,715 12,123 6,370 27,747 2008 £000 53 (17) (922) (6,703) – (7,589) (88,807) (96,396) – – – – – – – – Income statement (charge)/credit £000 Transfer to current tax £000 2007 £000 1,223 15,462 9,476 4,151 – 9,841 (360) (11,412) (9,476) 1,681 – 627 40,153 (18,940) 2007 £000 (352) (178) (3,787) (6,043) – Income statement (charge)/credit £000 405 161 2,865 (660) – – – – 164 – – 164 – – – – – (10,360) (39,544) 2,771 (50,544) (49,904) (47,773) – 1,281 1,281 Transfer to current tax £000 Transfer to equity £000 (b) Group deferred tax liabilities analysed by balance sheet headings and Syndicate participation *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 £7,628,000 (2007: £8,104,000) in relation to losses in overseas companies of £21,230,000 (2007: £23,667,000). This is as a result of the transfer of these subsidiaries to Hiscox Ltd from Hiscox plc. In accordance with IAS 12, all deferred tax assets and liabilities are classified as non-current. 88 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 30 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 2008 £000 2007 £000 101,615 (115,166) 106,793 (127,576) (13,551) 9,767 3,784 (20,783) 18,817 1,966 – – As the fair value of scheme assets exceeds the present value of funded obligations and unrecognised net actuarial gains, the scheme reports a surplus. However, the surplus arising on the pension scheme is not recognised on the Group’s balance sheet due to uncertainty of recoverability. The unrecognised net actuarial gains are the net cumulative gains and losses on both the scheme’s obligations and underlying assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit actuarial 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 triennial actuarial value at 31 December 2008 is currently being completed. 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 scheme assets are invested as follows: At 31 December Equities Debt and fixed income assets Cash 2008 £000 2007 £000 43,316 71,670 180 57,716 69,702 158 115,166 127,576 During the prior 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 and 2008 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 gain recognised Settlement gain recognised Effect of deemed irrecoverability of surplus Total included in staff costs The actual return on scheme assets was a loss of £10,387,000 (2007: positive return of £7,786,000). 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 Note 2008 £000 2007 £000 200 6,135 (7,720) (433) – 1,818 200 6,657 (7,711) – (4,913) 1,966 10 – (3,801) Note 10 2008 £000 2007 £000 – – – – 3,801 (3,801) – – Notes to the financial statements Hiscox Ltd Report and Accounts 2008 89 Notes to the financial statements continued 30 Employee retirement benefit obligations continued 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 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 Settlements with scheme members Closing present value of funded obligations 2008 £000 2007 £000 127,576 7,720 (18,107) – – (2,023) 133,660 7,711 75 – (11,687) (2,183) 115,166 127,576 2008 £000 2007 £000 106,793 200 6,135 (9,490) (2,023) – 137,461 200 6,657 (18,742) (2,183) (16,600) 101,615 106,793 A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme liabilities Experience gains/(losses) on scheme assets 2008 £000 – (18,107) 2007 £000 2,783 75 2006 £000 2005 £000 (3,310) 6,480 (1,223) 10,764 2004 £000 992 1,316 Additional memorandum information at the end of the current and previous four accounting periods is presented below: Present value of funded obligations Fair value of scheme assets Present value of unfunded obligations 2008 £000 2007 £000 2006 £000 2005 £000 2004 £000 101,615 (115,166) 106,793 (127,576) 137,461 (133,660) 137,533 (101,409) 99,229 (65,020) (13,551) (20,783) 3,801 36,124 34,209 Gross liability recognised on balance sheet – – 3,801 16,677 34,718 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 actuarial assumptions are as follows: Discount rate Expected return on scheme assets Inflation assumption Pension increases 90 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 2008 years 24.5 27.6 2008 years 25.6 28.6 2008 % 6.70 6.90 3.00 3.00 2007 years 24.5 27.6 2007 years 25.6 28.6 2007 % 5.80 6.09 3.60 3.60 30 Employee retirement benefit obligations continued During the year the Group made no contributions to the defined benefit scheme (2007: £nil). The Group has agreed that further additional contributions will be made if necessary but none are currently expected to be made in 2009 given the current level of underlying scheme surplus. 61% of any scheme surplus or 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. While management believes that the actuarial assumptions are appropriate, any significant changes to those could affect the balance sheet and income statement. Whilst an additional one year of life expectancy for all scheme members might be expected to reduce the present value of unfunded obligations at 31 December 2008 by approximately £3m, the Group considers that the most sensitive and judgmental assumptions are the discount rate and inflation. The Group has estimated the sensitivity of the net obligation recognised in the consolidated balance sheet to isolated changes in these assumptions at 31 December 2008 as follows: Present value of unfunded obligations before change in assumption £000 Present value of unfunded obligations after change £000 (Increase) /decrease in obligation recognised on balance sheet £000 Effect of a change in discount rate Use of discount rate of 6.45% Effect of an increase in inflation Use of inflation assumption of 3.25% (13,551) (8,859) (13,551) (11,810) – – 31 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) 2008 2007 70,808 377,506 18.8p 191,248 395,308 48.4p Diluted 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. 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) 2008 2007 70,808 191,248 377,506 13,351 395,308 13,530 390,857 408,838 18.1p 46.8p Diluted earnings per share has been calculated after taking account of 13,003,000 (2007: 13,014,000) options and awards under employee share option and performance plan schemes and 348,000 (2007: 516,000) options under SAYE schemes. 32 Dividends paid to owners of the Company Interim dividend for the year ended: 31 December 2008 of 4.25p (net) per share 31 December 2007 of 4.0p (net) per share Final dividend for the year ended: 31 December 2007 of 8.0p (net) per share 31 December 2006 of 7.0p (net) per share 2008 £000 2007 £000 15,615 – – 15,868 31,141 – – 27,723 46,756 43,591 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 91 Notes to the financial statements continued 32 Dividends paid to owners of the Company continued A final dividend in respect of 2008 of 8.5p per share, amounting to a total dividend of 12.75p for the year, is to be proposed at the Annual General Meeting on 3 June 2009. These financial statements do not reflect this final dividend as a distribution or liability in accordance with IAS 10 Events after the reporting period. 33 Acquisitions On 30 September 2008, the Group acquired 100% of the issued share capital of Amershill Limited. Cash consideration of £2,000,000 was paid and goodwill of £1,909,000 was recognised. The fair value of the identifiable net assets acquired was £91,000. The effect on the Group’s income statement would have not been materially different if the acquisition had occurred on 1 January 2008. 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 included contingent consideration of £7,530,000. No goodwill arose on acquisition. Intangible assets of £5,083,000 were initially recognised in respect of the US State authorisation licences held by ALTOHA Inc.’s consolidated operations. During 2008, further cash consideration of £1,225,000 was paid in finalisation of their ultimate purchase value. 34 Disposals The Group disposed of its Hiscox Select A to J Limited subsidiaries on 3 November 2008. The fair value of the net assets were £nil and a cash payment and loss on disposal of £42,000 was incurred. These entities were all non-trading corporate capital vehicles. 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. 35 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. 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 Ltd and Hiscox Insurance Company (Bermuda) Limited have entered into a deed of covenant in respect of a subsidiary, Hiscox Dedicated Corporate Member Limited, to meet the subsidiaries’ obligations to Lloyd’s. The total guarantee given by these companies under this deed of covenant (subject to limited exceptions) amounts to £138,831,798 (2007: £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) During 2008 Hiscox plc negotiated a new Letter of Credit and revolving credit facility with Lloyds TSB Bank, for a total of £350 million which may be drawn as cash (under a revolving credit facility) or Letter of Credit or a combination thereof, providing that the cash portion does not exceed £200 million. In addition, the terms also provide that upon request the facility may be drawn in foreign currency. At 31 December 2008 £137.5 million (2007: £137.5 million on previous facility) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further US$130 million by way of cash (2007: US$182 million on previous facility repaid in full during the current year). (c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2007: £50,000) 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 gross premiums written. This fee was 0.5% for 2008 and 2009. 0.75% was loaned to the central fund for 2007 which was repaid during 2007. No loan exists for 2008 or 2009. 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 Insurance Company (Bermuda) Limited 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$83 million were issued with an effective date of 31 December 2008 (2007: US$38 million). 92 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 36 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 £225,000 (2007: £165,000). 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 £5,499,000 (2007: £4,691,000). Operating lease rental income for the year totalled £468,000 (2007: £468,000). 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 Later than one year and no later than five years Later than five years Land and buildings Office equipment Land and buildings Office equipment Land and buildings 2008 £000 2007 £000 5,621 144 17,913 99 17,497 4,705 141 14,032 199 19,714 41,274 38,791 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 2008 £000 468 1,521 – 1,989 2007 £000 468 1,872 117 2,457 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 £35,000 (2007: £54,000). 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. 2008 £000 246 223 469 (30) 439 2007 £000 246 261 507 (50) 457 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 93 Notes to the financial statements continued 37 Principal subsidiary companies of Hiscox Ltd at 31 December 2008 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 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 Amershill Limited Holding company General insurance General insurance Underwriting agent Insurance holding company Holding company Underwriting agent General insurance Insurance intermediary General insurance and reinsurance Lloyd’s corporate Name Insurance holding company Insurance holding company 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 Underwriting agent 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 France Netherlands Great Britain Great Britain Germany Netherlands Netherlands Great Britain Great Britain Belgium Great Britain Great Britain Great Britain Great Britain *Held directly. **Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2007: 54,560) at 31 December 2008. †Hiscox Trustees Limited is the trustee of the Hiscox Employee Share Ownership Plan (ESOP). The ESOP owned 132,399 shares in Hiscox Ltd (2007: 132,399) at 31 December 2008. 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. 38 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 35 to 42. A number of the Group’s key personnel hold insurance contracts 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 accrued 2008 £000 2007 £000 55,947 41,466 745 1,402 94 Notes to the financial statements Hiscox Ltd Report and Accounts 2008 38 Related-party transactions continued (b) Transactions with associates 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. 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 17. Total 2008 £000 20,443 4,974 – 128 Total 2007 £000 7,290 1,342 120 47 (c) Internal reinsurance arrangements During the current and prior 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. The related results of these transactions have been eliminated on consolidation. Notes to the financial statements Hiscox Ltd Report and Accounts 2008 95 2008 £000 2007 £000 2006 £000 2005 £000 2004 £000 1,147,364 1,198,949 974,910 930,464 965,190 953,020 237,199 105,180 191,248 70,808 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 33,212 48,557 40,452 33,099 2,081,772 1,747,827 1,241,910 1,237,778 413,759 29,989 980,731 119,563 502,871 (1,789,696) (1,433,799) (1,291,329) (1,216,624) (1,008,032) 246,575 195,421 440,622 302,742 110,001 169,771 167,082 951,026 824,304 682,085 578,013 368,826 258.1 209.5 173.2 147.7 125.7 18.8 18.1 76.1 9.2 48.4 46.8 84.4 28.8 41.7 40.5 89.1 28.9 12.75 12.00 10.00 15.6 15.1 96.0 12.8 7.00 21.3 21.0 92.6 20.6 5.00 361.00 194.75 304.50 246.75 280.25 193.75 234.50 152.25 180.50 143.50 Five year summary Results Gross premiums written Net premiums written Net premiums earned Profit before tax 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. 96 Five year summary Hiscox Ltd Report and Accounts 2008 Hiscox_AR08_Cover_4pp_AW:Layout 1 16/3/09 19:07 Page 2 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 To request a copy of the 2008 Hiscox brochure visit www.hiscox.com Design: Browns Print: St Ives Westerham Press Photography: Portraits © John Ross, Peter Marlow (Magnum Photos), Kit Noble and Stephen Raynor Front and back cover © Getty Images This report is printed on recycled paper containing 100% post consumer waste and manufactured at a mill accredited with ISO14001 environmental management standard. The pulp used in this product is bleached using a Totally Chlorine Free process (TCF). FSC certified. 100% Hiscox_AR08_Cover_4pp_AW:Layout 1 16/3/09 19:07 Page 1 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 i H s c o x L t d R e p o r t a n d A c c o u n t s 2 0 0 8 Hiscox Ltd Report and Accounts 2008 1 2 3 5 12 16 22 28 30 32 35 43 44 45 46 46 47 48 49 50 96 Contents Corporate highlights Business structure Chairman’s statement Chief Executive’s report Insurance carriers Group financial performance Risk management Corporate responsibility Board of Directors Corporate governance Directors’ remuneration report Directors’ report Directors’ responsibilities statement Report of the independent registered public accounting firm Consolidated income statement Consolidated statement of comprehensive income Consolidated balance sheet Consolidated statement of changes in equity Consolidated cash flow statement Notes to the financial statements Five year summary