Hiscox_AR09_Cover_AW:Layout 1 11/3/10 10:57 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 9 Hiscox Ltd Report and Accounts 2009 1 2 3 5 12 14 15 20 21 26 28 32 34 37 45 46 47 48 48 49 50 51 52 100 Contents Corporate highlights Why invest in Hiscox? Chairman’s statement Chief Executive’s report Hiscox at a glance People Group financial performance Group investments Risk management Corporate responsibility Insurance carriers 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 statement of cash flows Notes to the consolidated financial statements Five year summary Hiscox_AR09_Cover_AW:Layout 1 11/3/10 10:57 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 2009 Hiscox brochure visit www.hiscox.com Design: Browns www.brownsdesign.com Print: St Ives Westerham Press Photography: Portraits © John Ross and Matthew Septimus Front and back cover © Beat Glanzmann/Corbis This brochure is printed on recycled paper containing 100% post-consumer waste, manufactured at a mill that has been awarded the ISO14001 certificate for environmental management. The pulp is bleached using a Totally Chlorine Free process. Corporate highlights 30.1% Return on equity Group key performance indicators Gross premiums written (£m) Net premiums earned (£m) Profit before tax (£m) Profit after tax (£m) Earnings per share (p) Total dividend per share for year (p) – increased by 17.6% Net asset value per share (p) – increased by 15.9% Group combined ratio excluding foreign exchange (%) Group combined ratio (%) Return on equity (%) Investment return (%) 2009 2008 1,435.4 1,147.4 Gross premiums written £m 1,098.1 320.6 280.5 75.2 15.0 299.2 82.2 86.0 30.1 7.2 928.1 105.2 70.8 18.8 12.75 258.1 91.6 75.3 9.2 (1.3) 1,435.4 1,147.4 2008 2009 Operational highlights Net asset value p per share Insurance rates broadly stable and still very attractive in reinsurance Retail and specialty businesses continue to grow Ongoing investment in UK marketing benefits Group 299.2 258.1 2008 2009 Corporate highlights Hiscox Ltd Report and Accounts 2009 1 Why invest in Hiscox? We are a leading specialist insurer with: balance that creates opportunity throughout the cycle strong financial performance a transparent approach to risk specialist expertise that is valued by our customers. Our business Our expertise A balanced portfolio that creates opportunity throughout a cyclical market Hiscox’s strategy is to balance the more volatile catastrophe-exposed insurance and reinsurance with steady local specialty insurance. Our diversity by product and geography gives us great flexibility, particularly in a tough commercial environment. We are able to grow and shrink the catastrophe- exposed lines according to market conditions. Currently, rates for reinsurance, which makes up almost a third of our income, are close to an all-time high, and we are therefore making the most of this opportunity. However, we have the flexibility to shrink this side of the business when rates are no longer favourable. Our local specialty insurance business tends to be steadier throughout the insurance cycle and we have successfully grown our retail lines by 10% year-on-year over the last five years. Our performance Strong financial performance Hiscox has a strong record of top-line growth with a focus on ROE. Performance highlights between 2005 and 2009 include: nearly doubled in size to produce gross written premiums of over £1.4 billion healthy combined ratio averaging 86.2% delivered average ROE of 22% maintained a progressive dividend policy with compound growth of 16.5%. A transparent approach to risk The very business of insurance is managing risk. The understanding of risk is intrinsic to every level of decision-making in the Group. We devote a great deal of expertise to understanding the impact of global events and model these rigorously. We also draw on over 100 years of history in insurance to assess these risks. Catastrophes such as hurricanes and earthquakes could hit at any time, and naturally would have an impact on our business. Therefore twice a year, in our analysts’ presentations and on our website, we publish estimates of what the Group’s losses would be should such a catastrophe occur. Our people Specialist expertise that is valued by our customers We are market leaders in many of our specialist areas and our customers value the expertise and cover we provide. What our UK customers said:* 96% of business insurance customers were satisfied that we spoke to them in a clear way and avoided using financial jargon 99% of home insurance customers were satisfied that we answered their questions and provided the information they needed today over 90% of our home insurance customers surveyed were satisfied with the way we settled their claim. In a 2009 award voted for by independent brokers, Hiscox UK was named Insurance Times’ ‘Commercial Lines Insurer of the Year’ for the third year running. We were also awarded ‘General Insurer of the Year’ at the British Insurance Awards 2009. 2 Why invest in Hiscox? Hiscox Ltd Report and Accounts 2009 * Results from our monthly customer satisfaction survey for customers telephoning one of our UK-based contact centres. Robert Hiscox Chairman Chairman’s statement It is an enormous pleasure to report a gross profit of £320.6 million – three times last year’s profit and considerably higher than the previous record of £237 million in 2007. I know that Mother Nature was kind, but my definition of luck is when preparation meets opportunity, and our catastrophe underwriters did an immense amount of preparation and research to underwrite a carefully controlled exposure which could benefit from a benign catastrophe period, but not hurt us if nature turned vicious. I also believe that the stability of the general insurance industry during the recent banking bubble deserved a reward. The investments yielded a cracking result. And our strategy of growing our specialist retail businesses internationally to balance the catastrophe accounts continued apace. Results The result for the year ending 31 December 2009 was a profit before tax of £320.6 million (2008: £105.2 million) on a gross written premium income of £1,435.4 million (2008: £1,147.4 million). The combined ratio was 86.0% (2008: 75.3%). The combined ratio on a like-for-like basis excluding foreign exchange distortions was 82.2% (2008: 91.6%). Earnings per share on profits after tax were 75.2p (2008: 18.8p), and net assets per share increased to 299.2p (2008: 258.1p). The return on equity was 30.1% (2008: 9.2%). Dividend and capital management The Board proposes to pay a second interim dividend of 10.5p on 29 March 2010 to shareholders on the register on 5 March 2010 in place of a final dividend, making total dividends for the year of 15.0p (2008: 12.75p). We remain prepared to buy back our shares if the share price drops to an unrealistic level. We are pleased we did not do a Rights Issue last year but decided to sweat our capital and avoid dilution. This excellent profit has allowed us to pay an increased dividend, added sufficient capital for our current plans, and enabled us to set aside a buffer of capital to maintain appropriate capital ratios in case of reduced investment income in 2010. The insurance market In my half year statement in 2007 I wrote that it seemed surreal to be announcing record results when our shares were rated so lowly. There was then a re-rating of the general insurance sector, but suspicion and malaise seems to have crept in again. Commentators seem cynical about our prospects and the insurance industry as a whole is valued at less than book value. Hiscox is rated at a small premium to assets and a ridiculously low multiple of earnings. I agree that the general insurance industry has been blighted by poor underwriting in the past when investment profits were easier to make and underwriting didn’t seem to matter too much. In my youth, insurance companies were described as investment trusts with an expensive habit. But the investment market is now offering slim pickings, so underwriting – our basic trade – matters totally, and there are firm signs that managements appreciate that fact. Reinsurance underwriting is dominated by models which we know are not right, but which impose a discipline and are an indispensable guide. The great attraction of the general insurance business is that everyone has to buy it; in fact, more and more so as governments continue to impose countless regulations, any breach of which can lead to litigation. Demand for our products is continuous; it is up to us to price them properly and to supply products which customers want at that price. During 2009 we implemented a new marketing campaign to attract our chosen customers and to continue to strengthen the brand. We want people to reach for a Hiscox policy because they trust it to perform better than standard commodity products. We are differentiating ourselves from the herd which will build value for shareholders. Since I have been at Hiscox we have grown from a premium income of around £3 million to nearly £1.5 billion, and from profits of a few thousand to £300 million. Not in a straight line of either income or profit as the nature of our business is to absorb the unpredictable from others, but I can guarantee you that this business has the determination and talent to continue that profitable growth. The Hiscox businesses As usual, I leave it to the CEO, Bronek Masojada, to report in detail the progress of our spreading but very focused businesses. Chairman’s statement Hiscox Ltd Report and Accounts 2009 3 Outlook As I have said, there is more discipline in our industry than at any time in my long career. It is of course not perfect, but the general insurance industry and Lloyd’s in particular have performed excellently through the financial chaos of the last few years. I just hope that the regulators and Government will appreciate the industry’s conservatism and value, and not wound it with some collateral damage from its current bank bashing. The Hiscox Group has a solid core of profitable businesses which, over the last few years, have enabled us to invest in creating exciting new ventures which will each become core profit earners and bring great value to shareholders. I admire the restless search for new methods of selling our specialist products. The world belongs to the discontented; we will never be satisfied; the profitable growth will continue. Robert Hiscox Chairman 1 March 2010 Chairman’s statement continued In brief, our catastrophe reinsurance underwriting in Bermuda and London was extremely profitable which enabled us to continue to invest in our US start-ups and our direct business. Our UK business demonstrated strong profitable growth, Europe had a tough first half but recovered well in the second, and Guernsey was outstanding as usual. We have made a major investment in the US and it was extremely gratifying to see the core errors and omissions account, which Ed Donnelly joined in 2005 to build, coming into profit. To return to the valuation of insurance companies, I can understand that the volatility of earnings from the catastrophe account makes a valuation based on earnings difficult. Conversely, our strategy of building more stable specialist accounts should be valued much more highly if they can demonstrate sustainable earnings which I believe some have and the others will. In the meantime, we will strive to continue to add to the net assets year-on-year which will inevitably drive the share price up over time. People First I must record our sadness at the recent death of our Senior Independent Non Executive Director, Sir Mervyn Pedelty. He was a huge asset to our business through his knowledge and business acumen, and his warm and humorous personality made him a real pleasure to work with. Life was more fun and interesting when Sir Mervyn was around. Our inestimable CEO, Bronek Masojada, leads an excellent team at the top, and the talent stretches throughout the Company. Over the years we have steadily been able to attract better talent, and the current frailty of the banks and the political attacks on them will help us by making more talent available. We are acutely aware that we are only as good as the people who work here, and it has been gratifying that our conscious efforts to be an employer of choice for the best people continues to be rewarded. We have great teams throughout the Group and I am deeply grateful to them not only for this great profit but for being so inspirational to work with. 4 Chairman’s statement Hiscox Ltd Report and Accounts 2009 Our strategy is to establish operations in Europe, the UK and the US that focus on our core specialty products to balance our more volatile business written in London and Bermuda. This strategy works: in 2005 when Hurricanes Katrina, Rita and Wilma drove some of our competitors deep into the red we made a healthy profit thanks to the contribution of our specialty businesses. The market outlook for 2010 is positive, though with lower expected investment returns and the easing of rates it will probably not be as good a vintage as 2009. We will seek to grow in those specialist areas where margin remains strong and we will maintain our commitment to reinsurance. Chief Executive’s report In 2009 we made a pre-tax profit of £320.6 million – the best result in the Group’s history. Good underwriting and top-class investment management drove this result, helped by the absence of any major catastrophes. Our record profit has not come by sacrificing the future growth of the Group – in 2009 we continued to invest in building our brand in the UK and rapidly expanding our US operations. Strategic focus Total Group controlled income for 2009 100% = £1,713m Bronek Masojada Chief Executive i 3 1 % R e n s u r a n c e 9% mercial com and omissions and errors m edia and errors Local Tech and 4 % o missions Artandprivateclient16% y r t e p p r o e g r a 6 % L 3 % and o missions specie, terrorism, Glo balerrors aerospace Specialty risks, political 5% – y erg n e d n a e arin M % 9 b l o k i d o n d a p s t o a c n k , d p r a e n r s s o o n m a l , c S a o p c n e c i d ti n c i e g a lt e y n t n c – 1 0 y, % S m a l l p r o p e r t y 7 % Chief Executive’s report Hiscox Ltd Report and Accounts 2009 5 Chief Executive’s report continued Group performance In 2009 our pre-tax profit was £320.6 million (2008: £105.2 million). Gross written premium grew by 25.1% to £1,435.4 million (2008: £1,147.4 million). Part of this growth was driven by exchange rate fluctuations and in constant exchange rate terms our gross written premium grew by 5.6%. Return on equity was 30.1% (2008: 9.2%) and our net asset value increased to 299.2p (2008: 258.1p). The dividend has been increased to 15.0p (2008: 12.75p). Over the past five years our dividend has risen by 16.5% compounded, and we have returned £114 million, net of a £176 million capital raising, to investors. I review the individual performance of our business units opposite. Hiscox London Market rating index Index level (%). 12 month rolling period Professional indemnity Property Reinsurance Specialty Marine and energy 1,000 900 800 700 600 500 400 300 200 100 0 9 9 n u J o t 8 9 l u J 9 9 v o N o t 8 9 c e D 0 0 r p A o t 9 9 y a M 0 0 p e S o t 9 9 t c O 1 0 b e F o t 0 0 r a M 1 0 l u J o t 0 0 g u A 1 0 c e D o t 1 0 n a J 2 0 y a M o t 1 0 n u J 2 0 t c O o t 1 0 v o N 3 0 r a M o t 2 0 r p A 3 0 g u A o t 2 0 p e S 4 0 n a J o t 3 0 b e F 4 0 n u J o t 3 0 l u J 4 0 v o N o t 3 0 c e D 5 0 r p A o t 4 0 y a M 5 0 p e S o t 4 0 t c O 6 0 b e F o t 5 0 r a M 6 0 l u J o t 5 0 g u A 6 0 c e D o t 6 0 n a J 7 0 y a M o t 6 0 n u J 7 0 t c O o t 6 0 v o N 8 0 r a M o t 7 0 r p A 8 0 g u A o t 7 0 p e S 9 0 n a J o t 8 0 b e F 9 0 n u J o t 8 0 l u J 9 0 v o N o t 8 0 c e D 6 Chief Executive’s report Hiscox Ltd Report and Accounts 2009 London has recently experienced a renaissance as an insurance market and we see plenty of opportunities to grow our business with London brokers in the years ahead. Hiscox London Market 2009 £m Gross premiums written 663.0 Net premiums earned Underwriting profit Investment result Foreign exchange Profit before tax Combined ratio 453.3 136.0 79.7 (35.8) 179.9 78.8% 2008 £m 545.9 427.8 34.2 (5.5) 108.3 137.0 65.8% Combined ratio excluding foreign exchange 71.0% 94.5% Hiscox UK and Europe 2009 £m Gross premiums written 421.0 Net premiums earned 367.3 Underwriting (loss)/profit (9.3) Investment result Foreign exchange Profit before tax 36.9 (7.1) 20.5 2008 £m 357.1 303.3 21.7 (22.4) 32.5 31.8 Combined ratio 105.1% 81.6% Combined ratio excluding foreign exchange 103.3% 92.3% Hiscox London Market Hiscox London Market was again the main profit generator in the Group, contributing £179.9 million (2008: £137.0 million). This was achieved through underwriting £663.0 million of business (2008: £545.9 million). pressure and we expect to reduce the size of this account significantly. In 2010 this reduction will be partially offset by a scheme to underwrite mechanical equipment – a non-cat area which we expect will serve us well. The London Market business is managed through five divisions whose performance is reviewed below: Reinsurance: Our reinsurance business performed well yet again. Having made a profit in 2008 despite the impact of Hurricane Ike, it is not surprising that it made a very good return in a year largely free of major losses. Our expertise in reinsurance is widely recognised, reflected by the fact that a number of third-party capital providers have chosen us to underwrite on their behalf. In 2009 Syndicate 6104 – a syndicate funded entirely by third-party capital – supported us. This support has been extended into 2010. We have a number of similar arrangements with other insurance companies. Overall, reinsurance prices softened in the January renewals, although I believe that in 2010 we will see rates largely similar to or better than those in 2008 – a year in which we achieved a good result despite the impact of Hurricane Ike. Specialty: This division underwrites a spread of specialist risks: personal accident, bloodstock, kidnap and ransom, terrorism, political risks and aviation war. Good performance across most of these lines was offset by political risk losses, largely due to credit defaults. We took a very cautious approach early in the year in reserving for these claims in view of the continuing fragile state of the global economy. There is a possibility, however, that, as conditions improve, these political risk losses may reduce, which is what we experienced in the last big financial crisis in 1998. In keeping with our belief that you should advance to the sound of gunfire we expect to expand our political risk underwriting this year as client demand and pricing increases due to the turbulent global economic situation. Marine and energy: This division had a good year. Energy rates rose in 2009 following Hurricane Ike. We were able to take advantage of these rates and better terms to write a larger book of business and have been well rewarded for doing so in 2010. Property: Our primary focus is on catastrophe exposed property for global companies, homeowners and small businesses. Rates have been under Casualty: Our London team now focuses on professional indemnity written in Lloyd’s and its results exclude the technology and media book which is now accounted for as part of Hiscox USA. We have shrunk as rates have come under pressure and have taken a cautious reserving approach in view of the economic climate. We have, however, had a net benefit from releases on prior underwriting years. The division saw a change of leadership during the year. Richard Watson got the year off to a great start before moving to the USA to head up our business there. Russell Merrett, who led our reinsurance business for the last four years, was promoted to lead the division. He has settled into the role well. We took advantage of this management change to focus the division on serving those brokers – large and small – who bring business to London, instead of being distracted by opportunities in other regions. London has recently experienced a renaissance as an insurance market and we see plenty of opportunities to grow our business with London brokers in the years ahead. Hiscox UK and Hiscox Europe – specialty retail Our specialist retail businesses in the UK and mainland Europe grew well in 2009. In underwriting terms, the UK had a very good year, while Europe did not. Hiscox UK: In the UK we saw premium growth of 16.1% to £304.0 million (2008: £261.9 million). Growth was particularly strong in fine art due to the acquisition of some global polices insured in London. The professions and specialty commercial business has continued to develop and for the first time it now exceeds the size of the UK focused art and private client business. The UK direct business continued to see strong growth and is near break even net of all its marketing costs. Our substantial marketing investment over the past four years, masterminded by Steve Langan, has turned Hiscox into a recognised consumer brand in the UK, one known not only for the quality of its products but also for its claims management. Of our household claimants 92% reported that they were either ‘satisfied’ or ‘very satisfied’ with the claims service they received. Our success has also been recognised by brokers. In a 2009 award voted for by independent brokers, we were named Insurance Times’ ‘Commercial Chief Executive’s report Hiscox Ltd Report and Accounts 2009 7 Hiscox International 2009 £m Gross premiums written 351.4 Net premiums earned 277.5 Underwriting profit Investment result Foreign exchange Profit before tax Combined ratio 59.5 57.7 7.0 124.2 76.3% 2008 £m 244.4 197.0 34.8 (8.4) (22.1) 4.3 93.1% Combined ratio excluding foreign exchange 78.6% 82.5% Chief Executive’s report continued Insurer of the Year’ for the third year running, and also won the title of ‘General Insurer of the Year’ at the British Insurance Awards. We are not resting on our laurels. In 2010, we will seek to grow our direct business further, pushing it into profit. We foresee a tougher claims environment in some sectors as professional firms get blamed for their customers’ recession-related misfortunes. Prices will have to rise to reflect this. Hiscox Europe: 2009 was a disappointing year for Europe, in spite of premium growth of 6.8% to €131.6 million (2008: €123.2 million). Its underwriting performance in 2009 was significantly worse than 2008, due to a series of unconnected large losses. In 2009, after a few poor years, our German operation succeeded in making a profit through a rigorous re-underwriting of its high net worth book and new focus on expanding in commercial lines. We have been building a business in Europe for the past decade, but we know that the ROE – the return on effort that is – is below expectations. Pierre-Olivier Desaulle, who we appointed Managing Director of Hiscox Europe during the year, will inject new energy into the operation. As MD of Hiscox France since 2000 he grew it six-fold and delivered sustainable profits. The European Management Team is focused on repeating this success across the continent. Hiscox International Hiscox International comprises our businesses located in Bermuda, Guernsey and the US. The businesses faced quite different challenges in 2009: Bermuda: Had a fantastic year. Its primary focus is property catastrophe insurance. After shrinking its top line in 2008, it responded aggressively to the rebounding rates and grew by 24.2% to $262.9 million (2008: $211.7 million). We also created a healthcare insurance and reinsurance team, who will focus on catastrophic exposures in the medical sector. In addition, we are building a small portfolio of catastrophe bonds issued by insurers and others. As this is an alternative route to assuming catastrophe risk we regard this as an extension of our reinsurance underwriting business and consider it when we look at our aggregate exposure to insurance events. During the year Charles Dupplin assumed leadership of Hiscox Bermuda from Robert Childs, its founding CEO. Robert and a small team went to Bermuda in late 2005. Since then Hiscox Bermuda has underwritten $943 million of premium income, generated significant profits and grown the balance sheet from $500 million (of which $200 million was borrowed) to $1 billion before paying a dividend to the Group at the end of 2009. This is a fantastic achievement and one for which we are all very grateful. Hiscox Guernsey: Had another good year. Its focus is on kidnap and ransom, piracy, fine art and terrorism. Premiums grew considerably, particularly in the piracy sector, due to the increased threat around the Horn of Africa. Our success is a reflection of both our risk appetite and our excellent client service. Our team in Guernsey is able to provide a quote, confirm cover, issue a policy and collect the premium in a few hours. This is a testament to the good cooperation between its underwriting and operations teams. Looking forward we see Guernsey continuing to be the leader for the Group in the kidnap and ransom and piracy areas. The Guernsey fine art book saw a small reduction in size due to the reduction in values of insured works. Hiscox USA: Saw a year of dramatic expansion. We took advantage of the broader financial difficulties in 2008 and set out on an ambitious plan to attract quality staff. We were able to hire seasoned experts in inland marine, property, construction, terrorism, kidnap and ransom and media, among other lines. We also opened new offices in Los Angeles, Boston, Miami, Atlanta and Kansas City, and expanded our existing offices in San Francisco, Chicago, New York City and Armonk. In all we recruited 84 people, pushing our total headcount up to 184 people. In order to provide the clarity of focus to accompany our big investment, we created a single US business, merging the New York based London Market activities with our smaller ticket professional lines business. Richard Watson has moved to the US to head up the overall business. Ed Donnelly continues as President of our activities and will drive forward our specialist lines and all of our branch offices. Under Ed’s leadership our smaller ticket professional lines activities reached break even in 2008, and we believe that working together, Ed and Richard will build a very successful business. 8 Chief Executive’s report Hiscox Ltd Report and Accounts 2009 We have also worked hard to develop new products for both the surplus lines and the admitted market. In the surplus lines market there is great flexibility in pricing and wording. In the admitted market, advance approval of rates, forms and underwriting guidelines is required in each US state before launching a new product. Gaining approval has taken far longer than we had anticipated, but we are making steady progress. Although Hiscox USA grew its top line to $162.1 million, up 24.6% (2008: $130.1 million), this growth was less than we had budgeted, as the anticipated upturn in the US domestic market did not occur. Our response has been to call a temporary halt to expanding our product range and to focus in 2010 on marketing those products we have already developed. We are confident this is the right way to improve the underlying financial performance of the business. Investment returns In 2009 we made a tremendous return on our investments. David Astor, our Chief Investment Officer, steered our portfolio very effectively through the financial crisis and kept his nerve when many others panicked. His courage was rewarded with an outstanding investment income result of £182.8 million, a return of 7.2% on invested assets (2008: -£27.6 million; -1.3%). This was achieved by maintaining a well spread portfolio, comprising corporate bonds, quality Hiscox UK and Europe rating index Index level (%). 12 month rolling period UK commercial lines UK personal lines Europe personal lines Europe commercial lines 160 140 120 100 80 60 40 20 0 1 0 c e D o t 1 0 n a J 2 0 r p A o t 1 0 y a M 2 0 g u A o t 1 0 p e S 2 0 c e D o t 2 0 n a J 3 0 r p A o t 2 0 y a M 3 0 g u A o t 2 0 p e S 3 0 c e D o t 3 0 n a J 4 0 r p A o t 3 0 y a M 4 0 g u A o t 3 0 p e S 4 0 c e D o t 4 0 n a J 5 0 r p A o t 4 0 y a M 5 0 g u A o t 4 0 p e S 5 0 c e D o t 5 0 n a J 6 0 r p A o t 5 0 y a M 6 0 g u A o t 5 0 p e S 6 0 c e D o t 6 0 n a J 7 0 r p A o t 6 0 y a M 7 0 g u A o t 6 0 p e S 7 0 c e D o t 7 0 n a J 8 0 r p A o t 7 0 y a M 8 0 g u A o t 7 0 p e S 8 0 c e D o t 8 0 n a J 9 0 r p A o t 8 0 y a M 9 0 g u A o t 8 0 p e S 9 0 c e D o t 9 0 n a J 0 1 r p A o t 9 0 y a M 0 1 g u A o t 9 0 p e S 0 1 c e D o t 0 1 n a J Chief Executive’s report Hiscox Ltd Report and Accounts 2009 9 Chief Executive’s report continued mortgage securities, an allocation to risk assets and a safe allocation to cash and Government bonds. Our caution towards complex products helped us to avoid the worst in 2008 and, as our portfolio recovered in 2009, we saw much better returns. We expect interest rates to remain low for at least the next year. With this in mind, we have reduced the duration of our Government bond portfolio but continue to retain a good allocation to credit, mostly through corporate bonds and to some exposure to mortgage and asset backed products. Whatever we do, we do not expect, in a world of 0.5% to 1.0% returns on short-term Government bonds, to see an investment return this year of the same level that we enjoyed in 2009. Claims In 2009 we handled a higher volume of claims than in 2008, reflecting our growing retail business. In addition to this everyday business, the team has also been working harder on recoveries, subrogating against third-parties and making a major contribution to Hiscox UK’s ‘Get Fit’ efficiency programme. They have achieved all of this while maintaining very high levels of customer satisfaction. In 2010 we will make a significant investment in upgrading our claims handling systems for the London Market. Hiscox is a supporter of the move to electronic claims, but current systems require multiple data entry. We will be addressing this obvious inefficiency. A source of deep concern to us is the new Lloyd’s Claims Transformation Project. We support the move to choice of service provider on more complex claims, but we believe strongly that Lloyd’s customers expect a centralised, coordinated approach to enable their non-complex, standard claims to be paid speedily and efficiently. We fear the new scheme has the potential to create a damaging free-for-all in claims that threatens to tarnish the Lloyd’s brand. We have objected to this aspect of the scheme from inception and we hope that sense will prevail before its final implementation. Operations and IT The future efficiency and competitiveness of this business depends on effective IT and efficient operations. Michael Gould, our Group COO, and his team have replaced our 15 year- old London Market system during 2009. During 2010 we will continue to invest in the new system, to make all of the post-implementation tweaks and improvements that our underwriters and operations people have requested. We are also designing and developing a new system for our retail businesses which will be first tested in Guernsey and then implemented across all our retail activities. This will make it easier to roll out new products and drive down our expense ratio. As part of the development process Michael will be driving us to adopt lean processes – applying manufacturing concepts to the operating approach of our business. Capital management The financial crisis has graphically illustrated how success in financial services depends on balancing expected return against perceived risk, while holding sufficient capital to protect against disaster. The challenge for outsiders is that while insurers’ revenue and capital are very visible, the amount of risk they are taking is not. We have tried to make our risk profile clear to shareholders by publishing our expected losses using Realistic Disaster Scenarios promulgated by Lloyd’s and by publishing a ‘box plot and whisker’ chart on our website. The ‘box plot’ chart gives the likely range of possible losses for Hiscox from major industry events. The individual catastrophic losses are examined alongside an analysis of all the Group’s expected losses, as well as our forecast investment returns and expenses, to arrive at a comprehensive view of our risk profile. This picture of our risk profile enables us to have a debate on our risk appetite, which is then agreed by the Board. Everyone is aware that if our expected underwriting margins fall, or forecast investment returns decrease, we are confronted with a choice: either we are forced to take less risk or we need to have more capital. In 2010 we expect our investment returns are likely to be much lower than in 2009. On the underwriting side we expect prices will remain at attractive levels. Therefore, in order to allow us to continue to take the same risk in 2010 as we did in 2009, we need to hold more capital in the business. This means that in 2010 the level of capital we will hold against our premium income will increase. We look at this balance of expected return, risk and capital every quarter and make minor course adjustments accordingly. Once a year, ahead of the 1 January renewal season, we have a major review of our risk strategy and, if required, make our major course corrections then. People Insurance remains a business in which intellectual capital is as important as financial capital as a prerequisite for success. That we were able to reshuffle our senior management in 2009 without having to look outside to fill any of these roles is a testament to the growing strength of our management cadre. This greater strength is what gives me confidence that we will be able to continue to improve our performance as the Group grows and develops. 10 Chief Executive’s report Hiscox Ltd Report and Accounts 2009 We have continued to invest in training and development and we are always on the lookout for high quality recruits. In 2009 we relaunched our graduate recruitment programme, and, as a result of the meltdown in other parts of the financial sector, we recruited slightly more graduates than we had expected. The programme is continuing in 2010. be as memorable a harvest but has good prospects, despite the continuing fallout from the financial markets crisis and the deepest global recession in living memory. We expect to see modest growth thanks to the expansion of our retail activities in Europe, the UK and the US and, provided major losses fall within our expectations, we expect to continue to deliver good returns for our shareholders and staff. Conclusion and outlook We are optimistic for the year ahead. 2009 was a great year, combining excellent underwriting profits and investment returns. 2010 may not Bronek Masojada Chief Executive 1 March 2010 Hiscox locations Bermuda Hamilton Europe Amsterdam Bordeaux Brussels Cologne Dublin Hamburg Lisbon Lyon Madrid Munich Paris Stockholm Guernsey St Peter Port UK Birmingham Colchester Glasgow Leeds London Maidenhead Manchester USA Armonk (New York) Atlanta Boston Chicago Geneva (Illinois) Kansas City (Missouri) Lexington (Kentucky) Los Angeles Miami New York City San Francisco Chief Executive’s report Hiscox Ltd Report and Accounts 2009 11 Hiscox at a glance Hiscox Ltd Hiscox London Market Hiscox International Hiscox UK and Europe Hiscox London Market Hiscox Bermuda Hiscox Guernsey Hiscox USA Hiscox UK Hiscox Europe Russell Merrett Managing Director Charles Dupplin Chief Executive Officer Steve Camm Managing Director Global reinsurance Group capital support Healthcare insurance Fine art Kidnap and ransom Terrorism Reinsurance Property Marine and energy Specialty Kidnap and ransom Terrorism Political risks Errors and omissions Aerospace Richard Watson Chief Executive Officer Errors and omissions Steve Langan Managing Director Pierre-Olivier Desaulle Managing Director Fine art Fine art Directors and officers’ liability Specialty High-value household Errors and omissions High-value household Errors and omissions Kidnap and ransom Directors and officers' liability Directors and officers' liability Terrorism Technology/ media Property Specialty commercial Specialty commercial Technology/ media Technology/ media Direct to customer household and commercial business Kidnap and ransom Terrorism 12 Hiscox at a glance Hiscox Ltd Report and Accounts 2009 Security Hiscox Insurance Company (Bermuda) Limited has an A (Excellent) rating from A.M. Best and an A (Strong) rating from Fitch. Hiscox Insurance Company (Guernsey) Limited has an A (Excellent) rating from A.M. Best and an A (Strong) rating from Fitch. Hiscox Insurance Company Inc. has an A (Excellent) rating from A.M. Best. Hiscox Bermuda Hiscox Bermuda underwrites a variety of reinsurance business including catastrophe, risk excess of loss, and healthcare insurance, as well as providing Group capital support. Hiscox Guernsey Hiscox Guernsey specialises in fine art, kidnap and ransom, terrorism and piracy insurance. Hiscox USA Hiscox USA opened in 2006 and underwrites a mix of specialty, casualty and property business. Locations Bermuda, Guernsey, USA – Armonk (New York), Atlanta, Boston, Chicago, Geneva (Illinois), Kansas City (Missouri), Lexington (Kentucky), Los Angeles, Miami, New York City, San Francisco. Hiscox UK and Europe Hiscox UK and Europe underwrite local specialty insurance from 20 different regional centres across Europe. Business is sourced mainly through brokers however some household and commercial products are offered directly to the customer via internet and telephone. Gross premiums written (£m) Profit before tax (£m) Combined ratio (%) 421.0 20.5 105.1 Security Hiscox Insurance Company Limited has an A (Excellent) rating from A.M. Best, an A (Strong) rating from Standard and Poor’s, and an A (Strong) rating from Fitch. Locations UK – Birmingham, Colchester, Glasgow, Leeds, London, Maidenhead, Manchester. Europe – Amsterdam, Bordeaux, Brussels, Cologne, Dublin, Hamburg, Lisbon, Lyon, Madrid, Munich, Paris, Stockholm. Hiscox London Market Hiscox London Market underwrites insurance and reinsurance business around the world. It uses the Lloyd’s of London broker network and licenses to participate on some of the world’s largest and most complex risks, as well as the simpler and more traditional ones, that come to Lloyd's. Gross premiums written (£m) Profit before tax (£m) Combined ratio (%) 663.0 179.9 78.8 Security Hiscox Syndicate 33 has an A (Excellent) syndicate rating from A.M. Best. It also benefits from Lloyd’s own ratings, A (Excellent) from A.M. Best, A+ (Strong) from Standard & Poor’s and A+ (Strong) from Fitch. Location London. Capacity Hiscox increased the 2010 capacity for Syndicate 33 to £1 billion (2009: £750 million); Cougar Syndicate 6104 to £45 million (2009: £43 million); and Syndicate 3624, which is a wholly owned syndicate, to £150 million (2009: £80 million). Hiscox International Hiscox International consists of Hiscox Bermuda, Hiscox Guernsey and Hiscox USA. Gross premiums written (£m) Profit before tax (£m) Combined ratio (%) 351.4 124.2 76.3 Hiscox at a glance Hiscox Ltd Report and Accounts 2009 13 experienced underwriters. The training, which aims to reinforce Hiscox’s underwriting standards, includes how to underwrite profitably across the cycle and the importance of learning the lessons of history when assessing risks. We also want to instill in our underwriters a restless curiosity, to challenge convention and not simply to accept a practice because that is the way it has always been done in the past. A total of 338 delegates completed this training programme in 2009. 3. Motivate Having attracted and trained the best people we can find, it is then essential that we keep them motivated and ensure they thrive in their roles. The Hiscox Partnership Senior staff members who have made an important contribution to the Group’s success may be appointed as a Hiscox Partner. The Hiscox Partnership, which numbers up to 5% of the total number of staff, is informed of all the strategic decisions and facts and figures of the Group, which enables them to influence the direction and performance of the Group. They also act as mentors to talented young people and ensure that we are operating in a way which is consistent with our values everywhere in the Group. In 2009 five new Partners were appointed. Employee engagement survey In September, Hiscox conducted its second global employee engagement survey. The survey, which was open to all permanent members of staff, looked at how committed employees feel to Hiscox, their managers, their teams and their role. The idea behind it is simple: if employees feel very engaged they are more likely to stay and deliver their very best for the company. Being able to measure levels of commitment enables Hiscox to identify areas where it can improve performance and boost staff retention. The survey is based on four key measurements: emotional commitment – the extent to which employees value, enjoy and believe in their work, in their manager, team and Hiscox; rational commitment – the extent to which employees believe Hiscox, their managers, and their teams have their best professional and development interests at heart; discretionary effort – employees’ willingness to go above and beyond what is expected of them; and intention to stay. The survey shows Hiscox enjoys high employee engagement and we consistently outscore the global benchmark set against 113 organisations across 58 countries. Our intent to stay rating was better than 95% of other firms. 1,116 Total number of staff at December 2009 Hiscox Partners Stephen Ashwell Global Head, Terrorism David Astor Chief Investment Officer Neil Bolton Head of US Casualty, Hiscox USA Stuart Bridges Chief Financial Officer Amanda Brown Group Human Resources Director David Bruce Deputy Managing Director, Hiscox London Market Head of Specialty, Hiscox London Market Steve Camm Managing Director, Hiscox Guernsey Glenn Caton Director of Marketing, Hiscox UK Head of Direct, Hiscox UK Robert Childs Chief Underwriting Officer Robert Davies Global Head, Kidnap and Ransom Pierre-Olivier Desaulle Managing Director, Hiscox Europe Ed Donnelly President, Hiscox USA Charles Dupplin Chief Executive Officer, Hiscox Bermuda Group Company Secretary Michael Gould Chief Operating Officer Gary Head Chief Underwriter, Hiscox UK David Henderson Branch Manager, Birmingham, Hiscox UK Robert Hiscox Chairman Jason Jones Group Compliance and Audit Director Suzanne Kemble Global Head, Media and Entertainment Kevin Kerridge Head of Direct, Hiscox USA Ian King Reinsurance Underwriter, Hiscox London Market Steve Langan Managing Director, Hiscox UK, and Group Marketing Director Paul Lawrence Head of Property Division, Hiscox London Market Ian Martin Finance Director, Hiscox London Market Bronek Masojada Chief Executive Russell Merrett Managing Director, Hiscox London Market Jeremy Pinchin Group Claims Director Steve Quick Global Head, Broker Relations Robert Read Global Head, Fine Art Bruno Ritchie Head of Aerospace and Global Risks Europe, Hiscox London Market Christopher Sharpe Chief Underwriter, Hiscox Bermuda Nicholas Thomson Retired Chief Underwriting Officer Gavin Watson Chief Financial Officer, Hiscox USA Richard Watson Chief Executive Officer, Hiscox USA Simon Williams Head of Marine and Energy, Hiscox London Market People The quality of our people has been a key ingredient in our success in this highly competitive, cyclical market. Hiscox’s reputation for innovation and dynamism has been built in large part on the energy, commitment and expertise of our employees. A good reputation takes a long time to build, but can be lost very quickly. We place a great emphasis on recruiting the best people, developing their skills and careers and ensuring that they are motivated. Some of the specific actions we take to fulfil each of these principles are described below. The unique personality of Hiscox is expressed through our employees to our clients. We want customers to find us intelligent but not intellectual, bold but not arrogant, thought provoking but not patronising, different while being straight- forward, positive but not pushy, contemporary not stuffy, sophisticated but not superior. 1. Recruit the best Hiscox aims to fill posts by recruiting internally, where possible. Because we strive to attract and retain the best people, we believe we have the ideal candidates for many jobs already working in the firm. We also want to stretch our people so they can reach their full potential. In 2009, 118 new appointments were either internal promotions or recommendations from current employees. When we do recruit talent from outside, we ensure that they go through a thorough assessment. In 2009, we recruited ten graduate trainees into the UK. In 2010, we plan to extend this to Bermuda and continental Europe. This combined with our very successful internship scheme will provide us with another source of talent to fill senior roles in the future. The average number of candidates seen for each job we filled in 2009 was four. 2. Develop excellence Hiscox has a unique underwriting training programme developed by some of our very 14 People Hiscox Ltd Report and Accounts 2009 Group financial performance 30.1% Return on equity Post-tax return on equity increased to 30.1% (2008: 9.2%). Robust underwriting profits combined with a strong investment result assisted in growing the net asset value per share by 15.9% to 299.2p (2008: 258.1p). Gross premiums written increased by 25.1% reflecting an increase in rates for reinsurance and aided by the strong US Dollar. Profit before tax increased to £320.6 million (2008: £105.2 million) resulting in an increase in earnings per share to 75.2p (2008: 18.8p). Total dividend per share for the year increased by 17.6% to 15p (2008: 12.75p). A good underwriting result combined with a strong investment return due to the rally in the investment markets, contributed to the Group’s record profits. Included within the Group’s profits are foreign exchange losses of £25.6 million reversing part of the £109.8 million gain recorded in the prior year. In addition, inherent within the underwriting result is the foreign exchange impact of the non retranslation of non monetary items. This resulted in a loss for the year of £53.2 million (2008: £36.1 million gain). Retranslation of non monetary items at year end rates of exchange Group financial performance London Market UK and Europe International Corporate Centre 2009 Total London Market UK and Europe International Corporate Centre Total 2008 Restated* Gross premiums written (£m) 663.0 421.0 351.4 – 1,435.4 545.9 357.1 244.4 – 1,147.4 Net premiums written (£m) Net premiums earned (£m) 483.6 391.5 281.9 – 1,157.0 363.1 329.1 206.2 453.3 367.3 277.5 – 1,098.1 427.8 303.3 197.0 – – 898.4 928.1 Investment result – financial assets (£m) 80.9 34.9 57.8 9.2 182.8 (5.5) (11.9) (8.4) (1.8) (27.6) Investment result – derivatives (£m) (1.2) 2.0 (0.1) (0.3) 0.4 – (10.5) – (42.5) (53.0) Profit/(loss) before tax (£m) 179.9 20.5 124.2 (4.0) 320.6 137.0 Claims ratio (%) Expense ratio (%) Foreign exchange impact (%) Combined ratio (%) 38.8 32.2 7.8 53.4 49.9 33.0 45.6 1.8 (2.3) 78.8 105.1 76.3 – – – – 31.8 42.2 50.1 61.2 33.3 41.8 40.4 3.8 (28.7) (10.7) 86.0 65.8 81.6 4.3 (67.9) 105.2 44.6 37.9 10.6 93.1 – – – – 52.7 38.9 (16.3) 75.3 *During the year, following a new geographic management structure including new business written through Syndicate 3624, the Group has changed its segmental reporting to provide more effective financial reporting for the evaluation of business segments by the chief operating decision maker to make decisions about future allocation of resources. Accordingly, the 2008 segmental comparatives have been restated in order to enable comparison of results by the user. Financial assets and cash** (£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) **excluding derivative assets and catastrophe bonds. 2009 2,660.6 1,156.8 3,817.4 1,121.3 299.2 285.7 374.8 2008 2,522.4 1,236.9 3,759.3 951.0 258.1 244.9 368.5 Group financial performance Hiscox Ltd Report and Accounts 2009 15 £320.6m Profit before tax Group financial performance continued would result in a 4.3% improvement in the combined ratio (2008: 4.7% decline). The Group also recorded a foreign exchange loss of £69.6 million recognised directly in equity as a result of the retranslation of investments in its US Dollar operations. The underwriting performance for each reporting segment is detailed below. Segmental performance During the year, following a new geographic management structure, the Group changed the way it reports its segments. The comparative information has been adjusted accordingly. Hiscox London Market Hiscox London Market comprises the results of Syndicate 33, excluding the result of fine art, UK regional events coverage and non US household business which is included within the results of UK and Europe. In addition, it excludes the larger TMT business which is allocated to the International segment and an element of kidnap and ransom and terrorism included in UK and Europe. Gross premiums written increased by 21.5% to £663.0 million (2008: £545.9 million) reflecting the strength of the US Dollar exchange rate. In original currency, gross premiums written were comparable with the prior year as rates in reinsurance and marine and energy increased, offset by our deliberate reduction in certain areas where rates were less favourable including US property. The reinsurance outwards spend was comparable to the prior year and reinsurance contracts with commercial reinsurers were renewed during the year with similar terms. The quota share arrangement with the Cougar Syndicate remained in place. A positive investment return of £80.9 million (2008: £5.5 million negative) was recognised as the Group benefited from the rally in the markets. The claims ratio improved significantly to 38.8% compared with 61.2% in the prior year due to a benign year for catastrophe losses and favourable developments in some older years. The resulting combined ratio excluding the impact of foreign currency movements improved to 71.0% (2008: 94.5%). Profit before tax for the year increased by 31.3% to £179.9 million (2008: £137.0 million). Hiscox UK and Europe Hiscox 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 continental Europe. It excludes the results of the larger TMT business written by Hiscox Insurance Company Limited. It also includes an element of kidnap and ransom and terrorism written in Syndicate 33. Gross premiums written increased by 17.9% to £421.0 million (2008: £357.1 million) with growth coming from all core lines especially the direct business and the professional and commercial specialty area. It was aided by the strong Euro exchange rate. Again, the investment result for the year improved significantly and a total return of £34.9 million, excluding derivatives, was achieved (2008: £11.9 million negative). The claims ratio declined by 11.2% to 53.4% due to a number of large unrelated claims in Europe including the impact of Windstorm Klaus and the ‘freeze’ losses experienced early in the year. The combined ratio, before the impact of foreign exchange, also deteriorated by 11% to 103.3%. Profit before tax for the year decreased to £20.5 million (2008: £31.8 million). Hiscox International Hiscox International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Insurance Company (Bermuda) Limited, Syndicate 3624, Hiscox Inc. and Hiscox Insurance Company Inc.. It also includes the results of the larger TMT business written by Hiscox Insurance Company Limited and Syndicate 33. Gross premiums written increased by 43.8% to £351.4 million (2008: £244.4 million). Growth in original currency was 22.0% reflecting increased rates and levels of reinsurance written in Bermuda, increased demand for piracy products in Guernsey and our continued expansion in the US. The investment return increased significantly to £57.8 million profit (2008: £8.4 million loss) consistent with the overall increase in the total investment return for the Group. The claims ratio improved by 11.6% to 33.0% (2008: 44.6%) reflecting a quiet year for catastrophe losses in Bermuda and recognising good loss experience in Guernsey. 16 Group financial performance Hiscox Ltd Report and Accounts 2009 7.2% Investment return The expense ratio deteriorated by 7.7% to 45.6% as a result of continued expansion costs to take advantage of opportunities in the US. Profit before tax increased significantly to £124.2 million (2008: £4.3 million). Hiscox Corporate Centre Hiscox Corporate Centre comprises the investment return, finance costs and administration costs associated Group management activities. Corporate centre also includes the majority of foreign currency items on economic hedges and intragroup borrowings. The investment result improved significantly to £9.2 million profit (2008: £1.8 million loss), an improvement experienced across all segments. Total expenses including certain foreign exchange items have decreased by 54.7% to £8.7 million (2008: £19.2 million). Included within foreign exchange gains of £10.3 million (2008: £9.0 million loss) is the foreign currency impact on certain intragroup loan balances. The resulting loss before tax in Corporate Centre improved significantly to £4.0 million (2008: £67.9 million). In the prior year, the Group recorded a derivative loss of £42.5 million in protecting currency translation gains recognised directly in equity. Cash and liquidity The Group’s primary source of liquidity is generated from premium income and income received on investments. Funds received are used predominantly to pay claims, expenses, reinsurance, increase investments and to pay dividends and taxes. £108.5 million). The inflow is due to an increase in the borrowing facility offset by the payment of dividends. The Group did not enter into any share buy-back programmes in the current year. In 2008 the Group spent £62.9 million for the purchase of shares held in treasury and £2.2 million for the purchase of shares held in trust. 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. The Group has a secured revolving credit facility for a total of £350 million which may be drawn by way of cash or Letter of Credit or a combination thereof providing that the cash portion does not exceed £200 million. The facility may be drawn in any foreign currency at the request of the Group. As at 31 December 2009, $225 million was drawn by way of Letter of Credit and £138 million by way of cash (2008: £137.5 million and $130.0 million respectively). Solvency II Solvency II is the new solvency regime for all EU insurers and reinsurer which is due to come into effect from 2012. The new regime aims to implement solvency requirements that are consistent across all member states and which better reflect the risks that insurers and reinsurers face. The new regime is based on a three-pillar approach as follows: Pillar 1 – Quantitative requirements Pillar 2 – Government and risk management requirements Total net cash outflows for the year were £150.1 million (2008: inflow £75.8 million). Pillar 3 – Disclosure and transparency requirements. The outflow for the year is driven mainly by the settlement of 2008 losses, payment of expenses, the payment of dividends and the settlement of the derivative contracts which were outstanding at the end of 2008. In addition, the decrease also represents the strategic decision by the Group to increase its returns by investing surplus cash balances into its fixed interest portfolio. A working group has been established to lead the implementation of the new regime and a comprehensive implementation plan is in place with performance and execution ongoing. Many of the qualitative requirements already form an integral part of the Group’s risk management framework and a gap analysis has been performed in order to identify those areas which may require small incremental changes. Net cash outflows from investing activities for the year were £11.7 million (2008: £16.7 million). The cash outflow is primarily as a result of the purchase of tangible and intangible assets. The Group did not acquire any new subsidiaries or associates during the year. The Group is seeking approval for its own internal models and is in a firm position to ensure that the Solvency II requirements will be implemented successfully, however uncertainty still exists as the full details of the regime are yet to be confirmed. Net cash inflows from financing activities for the year were £1.6 million (2008: outflow Group financial performance Hiscox Ltd Report and Accounts 2009 17 £2.66bn Invested assets 31 December 2009 31 December 2008 Return £000 Asset allocation % Return % 3.5 9.2 6.8 7.7 152,954 20.7 26,360 0.8 7.2 3,455 182,769 £2,660.6m 11.6 54.7 10.2 76.5 5.0 18.5 Return % 5.3 (2.5) 3.1 (0.3) Return £000 (4,027) (28.4) (38,267) 3.7 (1.3) 14,662 (27,632) £2,522.4m Group financial performance continued Group investment performance £ US$ Other Bonds Bonds total Equities Deposits and cash equivalents Actual return Group invested assets* *excludes derivatives and investment in catastrophe bonds. Asset allocation % 19.1 58.6 7.1 84.8 5.0 10.2 18 Group financial performance Hiscox Ltd Report and Accounts 2009 High quality and well diversified portfolio Investment portfolio: £2,660.6m Asset allocation Bond credit quality . 1 0 2 % C a s h 5.0 % 84.8% Ris k a s s ets Bonds . 6 5 % B B a n d b e o w l 4 . 5 % B B B 1 2 . 7 % A 8.3% AA A A 8 . 0 % A 6 Bond currency split 1.9% CAD 6 9 . 2 % U S D G B P 2 2 . 5 % EUR6.4% Group financial performance Hiscox Ltd Report and Accounts 2009 19 stop prices for subordinated paper being marked down, but our exposure to the lower parts of the capital structure was minimal. With interest rates at low levels and liquidity improving, investors have had more confidence to seek yield. The portfolio, where we continued to increase our exposure to credit during the year, was well positioned for the resulting narrowing of credit spreads. Even modest allocations to high yield and other credit opportunities contributed significantly to our overall returns. Whilst the Group’s allocation to corporate bonds has increased from 20% to 25% during the year, safety and liquidity have remained a high priority and the percentage of the portfolio held in cash and Government supported debt was maintained at around 60%. We are extremely focused on not jeopardising the Group’s capacity to underwrite and pay claims. Our risk assets performed well and added materially to the Group’s investment return. Given the strength of equities since their lows last March we reduced our exposure in the third quarter, maintaining our allocation at 5% of assets. The pace of the recovery, and hence this year’s strong returns, clearly has an impact on the prospects for our portfolio going into 2010. Whilst strong cashflows provided comfort during the crisis they will serve as a drag on yield as they are reinvested at the rates prevailing in the markets. These low rates in turn have a bearing on our risk appetite given our desire not to lose money in any one year. At current market levels any meaningful increase to equities is unlikely in the short-term. Whilst the best of the rally in risk markets may therefore be behind us, we continue to see value in the corporate bond market, but remain wary of the threat of higher interest rates. Government bonds in particular seem over priced, and there is unlikely to be a shortage of supply any time soon. We are keeping the duration of the main bond portfolios correspondingly short. We anticipate that volatility will continue and that patience will be required as Governments remove their support and interest rates move to more normal levels. The price of this patience will be lower investment yields in the immediate future. Group investments The Group’s invested assets increased slightly to £2.66 billion (2008: £2.52 billion) as positive cashflows offset the effect of the decline in the US Dollar against the Pound. The investment return, excluding derivative positions, amounted to £182.8 million (2008: £27.6 million negative). The last two years have witnessed dramatic events in the investment world. Each one, in a very different way, has turned out to be extremely interesting and indeed challenging. Having survived 2008, there was no let up in early 2009, as volatility and uncertainty continued to grip markets. Whilst there was temptation to de-risk further during the periods of greatest uncertainty, the robustness of our balance sheet and the strength of cashflows from the bond portfolio meant that such a move was not required. Additionally, rigorous stress testing and monitoring of the underlying securities confirmed that the prices available in the market for many of our bonds bore little relevance to their fundamental value. Throughout the year payments of principal and interest were as expected. It is therefore pleasing to report that the Group has benefited from holding on to those securities that were heavily discounted in value at the end of 2008 and into the first quarter of 2009. What has been more of a surprise is the speed at which they have returned towards par, making up for most of last year’s losses. This, of course, has been made possible by the extraordinary monetary conditions that have prevailed and the scale of Government measures deployed in order to restore liquidity and confidence in the various markets. As a degree of calm and rationality has been restored, improved valuations for securitised bonds boosted our US Dollar portfolios. Similarly, financial bonds in our Sterling and Euro portfolios recovered once it became clear that the authorities were unlikely to let strategically important banks fail. This did not 20 Group investments Hiscox Ltd Report and Accounts 2009 Risk management 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 are: Risk Committees Underwriting Review Group Reinsurance Purchase Review Group Reinsurance Security Committee Cash Flow Review Group Broker Credit Committee Investment Committee Reserving Committees Business Continuity Committee. These committees are all chaired by either the Chief Executive, Chief Financial Officer or Chief Underwriting Officer and have specific areas of focus, such as underwriting, 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 responsibilities is closely monitored by reporting to the Board and its committees. This monitoring, supported by financial and non-financial management information, assesses 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 the 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 management tools is 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 and risk appetite. 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. Incentives ensure that underwriting staff make sound and objective judgements that are aligned with the Group’s overall strategic objectives. Risk management Hiscox Ltd Report and Accounts 2009 21 We adjust our business plan, target products and reinsurance programme to deliver a well- diversified book. Risk management continued 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 to deliver a well-diversified book. 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 In our 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 may be asked to contribute to the recent claims on the FSCS from the banking industry, currently funded by the Treasury. Any such requests 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 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 27 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. 22 Risk management Hiscox Ltd Report and Accounts 2009 Emerging risk identification and control is a core part of risk management activity in relation to all aspects of our business, including underwriting, operations and strategy. 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 company’s 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; and 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 activity in relation to all aspects of our business, including underwriting, operations and strategy. Significant efforts are made, including obtaining external expertise, to try to identify any threats to the business either actual or 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. The identification of emerging risks is a core agenda item in each Risk Committee. 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 in expert staff to ensure our procedures and analyses remain second to none. 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. Short-term interest rates are likely to remain at historically low levels throughout 2010. As a result the possibility of losing money with a portfolio consisting of any assets other than cash or short-term Government securities is statistically greater than normal. Consequently the Board has agreed, in current market conditions, to set aside extra capital to support the recommended asset allocation and to provide a buffer against possible investment losses during the year. Technical funds, the investments held for the payment of future claims, are primarily invested in high quality bonds and cash. Risk management Hiscox Ltd Report and Accounts 2009 23 Risk management continued 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 is 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. 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 US 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. Where appropriate a percentage of the capital will be held in the currency matching that of the underlying business being written. 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 and 20 to the financial statements. 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 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. 24 Risk management Hiscox Ltd Report and Accounts 2009 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 n b 3 $ e k a u Q a t e i r P a m o L d o i r e p n r u t e r r a e y 7 s s o l t e k r a m n b 5 7. 1 $ e k I 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 7 s s o l t e k r a m n b 0 1 $ e k a u Q e g d i r h t r o N d o i r e p n r u t e r r a e y 6 1 s s o l t e k r a m n b 9 3 $ a n i r t a K e n a c i r r u H d o i r e p n r u t e r r a e y 8 1 s s o l t e k r a m n b 3 . 8 $ J 7 8 9 1 d o i r e p n r u t e r r a e y 5 1 s s o l t e k r a m n b 2 5 $ w e r d n A e n a c i r r u H d o i r e p n r u t e r r a e y 9 2 700 600 500 400 300 200 100 0 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. The return period is the frequency at which an industry insured loss of a certain amount or greater is likely to occur. For example, an event with a return period of 20 years would be expected to occur on average five times in 100 years. Risk management Hiscox Ltd Report and Accounts 2009 25 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 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 Hiscox regularly sends partner brokers updates (electronically or in hard copy) to keep them informed of developments at Hiscox and in the 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 on its website. In addition, senior management and key employees meet investors and analysts throughout the year to explain and take questions on the Group financial performance and business strategy. 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. 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 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 26 Corporate responsibility Hiscox Ltd Report and Accounts 2009 Hiscox strives for the highest standards of corporate governance while being in essence a non-bureaucratic organisation. some of the poorest and most abused people in the world. More details of the charities Hiscox supports can be found on our website www.hiscox.com. 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. In 2009 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 2010 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 www.hiscox.com in June 2010. in essence a non-bureaucratic organisation. An effective and firm system of internal controls ensures that risks are managed within acceptable limits, but not at the expense of innovation or speed of response. The Group believes that it has got this balance right and that it is one of its greatest strengths. The Group’s policies ensure that it continues to follow a best practice approach to managing its people and remains a fair and professional employer. In the unlikely event of an employee having a material concern relating to the operations of the business, a whistleblowing policy explains to staff how they can confidentially raise their misgivings. Hiscox also subscribes to Public Concern at Work, which provides free legal advice to any employee with a concern about possible danger or malpractice in the workplace. In the community Hiscox donated £1,171,000 to charities in 2009. As the Group expands internationally, it has been recruiting local staff wherever possible, developing a rapport with the local community and making 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 has a two-year commitment to support 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 eight year long support of the Richard House Hospice, raising over £34,000 during 2009. The foundation has committed to support HART (Humanitarian Aid Relief Trust) over a three year period. The charity helps Corporate responsibility Hiscox Ltd Report and Accounts 2009 27 Syndicate 3624 Syndicate 3624 is a wholly owned syndicate which began underwriting for the 2009 year of account with an underwriting capacity of £80 million. Syndicate 3624 writes certain business lines including the US E&O account written through the Hiscox underwriting agency in Armonk, New York and a 50% quota share of Syndicate 33’s TMT business written by Hiscox owned underwriting agencies. Syndicate 3624 has a capital requirement ratio of 69% of syndicate capacity. Total underwriting capacity of Syndicate 3624 has been increased to £150 million for the 2010 year of account. Syndicate 33 Gross premiums written (£m) 1,024 994 1,034 885 827 844 830 722 567 1,200 1,000 800 600 400 200 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Syndicate 33 2009 Gross premiums written geographical split (%) 6 % U K 7 % E u r o p e 4 % A sia 55 % North A merica Rest of world 28% Insurance carriers Syndicate 33 Hiscox can trace its origins in the Lloyd’s Market to 1901. Today, Hiscox Syndicate 33 is one of the largest composite syndicates at Lloyd’s, and has an A.M. Best syndicate rating of A (Excellent). Syndicate 33 underwrites a mixture of reinsurance, major property and energy business, as well as a range of specialty lines including contingency, technology and media risks among others. The business is mainly property-related short-tail business; there is little exposure to aviation or motor business. Syndicate 33 trades through the Lloyd’s worldwide licences and 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. For 2010 Syndicate 33 has a capital requirement ratio of approximately 43% 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. For the 2010 year of account, Syndicate 33’s capacity has been increased from £750 million to £1 billion, primarily to reflect the strengthening US Dollar. The chart to the right shows the gross premiums written of Syndicate 33 for the last nine years. 28 Insurance carriers Hiscox Ltd Report and Accounts 2009 Cougar Syndicate 6104 Cougar Syndicate 6104 was set up under a limited tenancy agreement for the 2008 year of account with an initial capacity of £34 million. It is wholly backed by external Names and takes a pure year of account quota share of Syndicate 33’s international property catastrophe reinsurance account. The arrangement was extended for the 2009 year of account and Cougar Syndicate 6104’s capacity was increased to £43 million. The Syndicate will continue for the 2010 year of account and the underwriting capacity has been increased to £45 million. Syndicate 33 2009 Gross premiums written currency split (%) 4 % C A D 1 0 % E U R 1 1 % G B P 75% USD Syndicate 33 Capacity and Hiscox ownership (£m) Capacity Hiscox ownership Qualifying quota share 8 4 2 4 8 5 2 6 4 8 7 8 4 7 8 2 3 8 4 7 7 7 4 5 0 5 5 0 5 5 5 3 6 4 0 6 7 5 0 5 7 4 3 0 0 7 4 4 5 8 0 5 7 5 0 0 0 1, 5 2 7 1,200 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 2010 Insurance carriers Hiscox Ltd Report and Accounts 2009 29 Hiscox Insurance Company (Guernsey) Formed by Hiscox in 1998, Hiscox Insurance Company (Guernsey) Limited writes mainly kidnap and ransom and fine art insurance. Hiscox Guernsey has an A.M. Best rating of A (Excellent). At the end of 2009, net assets exceeded $28 million (2008: $23 million). Hiscox Insurance Company Limited Gross premiums written geographical split by origin (%) 4% Netherlands 3% Belgium 3% Other Europe 8 % G e r m a n y 11% France 7 1 % U K 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 14.5% from 1997 to 2009, despite discontinuing almost all of its original business. It has also significantly improved its combined ratio. Hiscox Insurance Company Limited has an A.M. Best rating of A (Excellent) and a Standard & Poor’s rating of A (Strong). At the end of 2009, net assets exceeded £172 million (2008: £151 million). Hiscox Insurance Company Limited Gross premiums written (£m) 381 325 284 231 233 242 219 400 350 300 250 200 150 100 50 0 164 176 127 90 98 75 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 30 Insurance carriers Hiscox Ltd Report and Accounts 2009 Hiscox Insurance Company (Bermuda) Formed by Hiscox in late 2005, Hiscox Insurance Company (Bermuda) Limited was set up as an expansion of the reinsurance operations of Hiscox and as an internal reinsurer of the Group. It recently employed a new team to underwrite healthcare insurance. Hiscox Bermuda has an A.M. Best rating of A (Excellent). At the end of 2009, net assets were $807 million (2008: $804 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. Hiscox Insurance Company Inc. is based in Geneva, Illinois and is an admitted insurance company with licences in all 50 US states. Its main business is animal mortality insurance for cattle and horses. Hiscox Insurance Company Inc. is rated A (Excellent) by A.M. Best. At the end of 2009, net assets exceeded $56 million (2008: $52 million). Hiscox Insurance Company (Bermuda) Limited Gross premiums written ($m) External business 350 300 250 200 150 100 50 0 297 263 212 171 2006 2007 2008 2009 Insurance carriers Hiscox Ltd Report and Accounts 200931 31 Board of Directors Executive Directors Robert Ralph Scrymgeour Hiscox Chairman (Aged 67) 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 48) 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 49) 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 Chairman of Hiscox USA (Aged 58) 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. He is Non Executive Director of HIM Capital Limited and HIM Capital Holdings Limited. Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 67) 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 61) Ernst Jansen joined Hiscox in 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 32 Board of Directors Hiscox Ltd Report and Accounts 2009 Secretary Charles Dupplin 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 United Kingdom 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 71) 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 (deceased) 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 was a former Council Member of the British Bankers’ Association. Sir Mervyn was a Chartered Accountant and a Chartered Banker. His other recent appointments included: 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 55) 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 60) Gunnar Stokholm joined Hiscox in 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 61) 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 2009 33 Corporate governance Overview and basis of reporting Hiscox Ltd (‘the Company’) is the 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 2009, 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 32 to 33. 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 dividends 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, comprising 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, European and US executive groups and approval of exceptional spend within the limits established by the Board. The London, European and US executive groups provide strategic direction and are a forum for communicating important issues. Below these geographic executive groups, are the local management teams that drive the local 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 34 Corporate governance Hiscox Ltd Report and Accounts 2009 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 Daniel Healy, Ernst Jansen, Dr James King, Andrea Rosen, Gunnar Stokholm, Dirk Stuurop and until his death Sir Mervyn Pedelty. It was chaired, until his death, by Sir Mervyn Pedelty, with Andrea Rosen as alternate, and is now chaired by Andrea Rosen. It meets a minimum of two times a year to deal with appointments to the Board and to recommend a framework of executive remuneration. The Directors’ remuneration report is presented on pages 37 to 44. The Conflicts Committee The Group has a Conflicts Committee which comprises 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. 27.5% of the Names on Syndicate 33 are third parties and 72.5% 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 comprise Directors of the Company and its subsidiaries and relevant senior employees. Performance evaluation Periodically the Chairman reviews the performance of the Board as a whole. He meets with the Non Executive Directors separately and as a body to discuss a wide range of issues including the performance of the Executive Directors. In addition the Non Executives periodically meet without the Chairman and Executive Directors to discuss a similarly wide range of issues concerning the company including as appropriate the performance of the Chairman and the Executive Directors. No major issues concerning Board performance have been raised during the year. 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. Meetings and attendance table Director RRS Hiscox BE Masojada SJ Bridges RS Childs DM Healy ER Jansen Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm DA Stuurop Ltd Board Audit Committee Remuneration and Nomination Committee Attended Attended Attended 4/4 4/4 4/4 4/4 4/4 4/4 3/4 3/4 3/4 4/4 3/4 n/a n/a n/a n/a 3/3 3/3 3/3 n/a 2/3 3/3 2/3 n/a n/a n/a n/a 2/2 2/2 2/2 1/2 2/2 2/2 2/2 Corporate governance Hiscox Ltd Report and Accounts 2009 35 The Board has reviewed the effectiveness of internal controls during 2009, 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 Shareholder communications The Executive Directors communicate and meet directly with shareholders and analysts throughout each year, and do not limit this to the period following the release of financial results or other significant announcements. All Directors attended the Annual General Meeting in 2009. 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. 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 21 to 25. 36 Corporate governance Hiscox Ltd Report and Accounts 2009 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 2009 were Sir Mervyn Pedelty (Chairman), Andrea Rosen (Acting Chairman), Daniel Healy, Dr James King, Dirk Stuurop, Ernst Jansen and Gunnar Stokholm. 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 a shareholder) 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. The Company also uses the Watson Wyatt compensation benchmarking reports. Towers Perrin and Watson Wyatt have now merged to form ‘Towers Watson’. Towers Watson 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 his or her 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. Total shareholder return (%) Hiscox FTSE Non life insurance FTSE All Share 200 150 100 50 0 -50 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 Feb 09 Apr 09 Jun 09 Aug 09 Oct 09 Dec 09 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 37 members from July 2008 and introduced a defined contribution scheme in 2009 into which all current employees will transition from the beginning of 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 2009 bonus was reviewed. On balance the conclusion was that the Hurdle Rate should remain unchanged for 2009 but should 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. Directors’ remuneration report continued As a business Hiscox is focused on generating strong pre-tax returns on equity and long-term shareholder returns, therefore our reward structure is aligned with this. The Remuneration and Nomination Committee regularly reviews our remuneration approach and, particularly in the context of the current remuneration environment, will do so again this year. 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 its own consultants, Towers Perrin, and the competitive position of Hiscox salaries (based on the 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. In 2009, Executive Directors’ salaries increased by 1.6% overall. Executive Directors did not receive a salary increase in the 2010 salary review. 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 the Netherlands, all Hiscox retirement schemes are based on defined contributions. In the Netherlands, we closed the defined benefit scheme to new 38 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 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 2009 16 0 3 (24) 13 30 28 19 35 36 14 34 73 0 0 0 90 202 173 54 274 372 53 287 The payment of larger bonuses is normally 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 performance shares; purchase of shares; and payment of debt due on share purchases. The only exception to this is for US-based employees where, due to the implications of the US Internal Revenue Code, employees are not able to receive the deferred element of their bonuses early in order to purchase shares. 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). The Remuneration and Nomination Committee has decided that bonuses earned in respect of performance in financial year 2009 need not be deferred. Employees will, however, be required to repay a proportion of their bonuses in the event that they leave in circumstances in which they would otherwise have forfeited them. Share Incentive Schemes The Remuneration and Nomination Committee believes that employees should be encouraged to own Hiscox shares so that they are aligned with 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 2009 and the Remuneration and Nomination Committee has also agreed to make awards under this plan in 2010. 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 2009 was 193% 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 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 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 39 Directors’ remuneration report continued the entire ‘shadow dividend’ re-invested in shares within an employee benefit trust. 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 as ROE best captures the efficiency with which the Company is using shareholder funds to generate earnings. The Remuneration and Nomination Committee believes that an average ROE performance requirement over the three-year period smoothes out any 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. 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 are in place 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 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 2009 is outlined in the table below. Details of their contractual notice periods is contained in the table opposite. 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. RRS Hiscox BE Masojada RS Childs SJ Bridges 23% 59% 18% 18% 16% 20% 51% 58% 50% 31% 26% 30% 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. 40 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 Remuneration of Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges 2009 Basic salary £000 2009 Benefits £000 310 436 356 326 2 2 73 2 2009 Bonus £000 800 1,250 1,250 800 2009 Total £000 1,112 1,688 1,679 1,128 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 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. During the year, RS Childs has been a Non Executive Director of HIM Capital Limited and HIM Capital Holdings Limited and did not receive any payment for his services. SJ Bridges and BE Masojada did not hold any Non Executive Director positions during the year. Service contract table Director RRS Hiscox BE Masojada RS Childs SJ Bridges 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 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 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 41 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: DM Healy ER Jansen Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm DA Stuurop Pensions RRS Hiscox BE Masojada RS Childs SJ Bridges Hiscox Ltd Board $000 Committees $000 83 83 83 83 83 83 83 37 27 32 34 34 27 27 Total 2009 $000 120 110 115 117 117 110 110 Total 2008 $000 115 12 110 130 113 12 105 Increase in accrued pension during the year £000 26 2 20 – Total accrued annual pension at 31 Dec 09 £000 Transfer value of increase in accrued pension £000 Transfer value of accrued pension at 1 Jan 09 £000 Transfer value of accrued pension at 31 Dec 09 £000 Increase/ (decrease) in transfer value of accrued benefit during the year £000 231 39 240 29 26 2 24 1 4,772 681 5,127 459 4,701 646 5,387 452 (71) (35) 260 (7) 42 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 Number of options granted Number of options lapsed Share options SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Total Number of options at 1 January 2009 62,038 56,398 180,341 154,578 154,578 154,578 762,511 112,797 78,958 206,104 206,104 206,103 206,104 1,016,170 56,398 51,526 51,526 51,526 210,976 112,797 169,195 78,958 206,104 206,104 206,104 206,104 1,185,366 100,385 326,297 292,128 435,322 754,623 843,325 1,303,596 1,576,674 5,632,350 8,807,373 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Number of options exercised (62,038) – – – – – Number of options at 31 December 2009 – 56,398 180,341 154,578 154,578 154,578 (62,038) 700,473 (112,797) – – – – – – 78,958 206,104 206,104 206,103 206,104 (112,797) 903,373 – (51,526) (51,526) (51,526) 56,398 – – – (154,578) 56,398 (112,797) – – – – – – – 169,195 78,958 206,104 206,104 206,104 206,104 (112,797) 1,072,569 – (100,385) 151,679 (174,618) 244,742 (47,386) 360,947 (74,375) 621,433 (133,190) (212,836) 630,489 (165,186) 1,138,410 1,102,718 (473,956) Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date 1.281 2.943-3.451 1.755 1.252 1.465 1.514 1.499 13 Oct 02 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 1.281 1.755 1.252 1.465 1.514 1.499 1.755 1.465 1.514 1.499 1.281 1.020 1.755 1.252 1.465 1.514 1.499 3.437 13 Oct 02 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 – 03 May 04 02 May 11 01 Apr 13 12 Jul 14 05 Apr 15 02 Apr 06 13 Jul 07 06 Apr 08 2.990 3.028 3.068 13 Oct 02 15 Jun 03 12 Oct 09 3.465 – 14 Jun 10 – 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 13 Oct 02 15 Jun 03 12 Oct 09 1.281 2.910-3.615 1.020 2.895-3.502 14 Jun 10 1.755 3.110-3.607 03 May 04 02 May 11 26 Sep 11 0.806 2.948-3.368 27 Sep 04 18 Nov 12 19 Nov 05 1.252 3.110-3.388 01 Apr 13 02 Apr 06 1.465 3.138-3.527 12 Jul 14 13 Jul 07 1.514 3.030-3.388 05 Apr 15 06 Apr 08 1.499 2.935-3.502 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – (1,381,932) 4,250,418 – (1,824,142) 6,983,231 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 43 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 2009 4,256 4,907 4,343 218,193 143,557 540,640 387,234 – – Number of options granted Number of options lapsed Number of options exercised – – – – – – – 122,827 90,241 – – – (13,837) (6,624) (17,388) (36,998) (3,934) – – – – – (2,234) (1,303) (2,452) – – Number of options at 31 December 2009 4,256 4,907 4,343 204,356 134,699 521,949 347,784 118,893 90,241 Total 1,303,130 213,068 (78,781) (5,989) 1,431,428 Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date – 01 May 10 – – – 01 May 10 2.220 1.956 2.210 2.220 2.210 3.169 1.982 2.948-3.352 01 May 11 1.956 2.975-3.169 2.418 2.752 31 Oct 10 01 Dec 11 31 May 12 01 Dec 10 31 May 11 31 Oct 10 01 Dec 10 31 May 11 31 Oct 11 01 Dec 11 31 May 12 01 Nov 12 01 Dec 12 31 May 13 – 01 May 12 – International Sharesave Scheme RS Childs Other employees 4,147 1,613 95,616 7,363 23,709 198,056 62,464 – – – – – – – – – 54,987 73,180 – – (5,925) – – (36,926) (12,713) (549) – – (1,613) – – (671) – – – – 4,147 – 89,691 7,363 23,038 161,130 49,751 54,438 73,180 2.220 1.576 2.220 2.220 2.210 1.982 1.956 2.418 2.752 Total 392,968 128,167 (56,113) (2,284) 462,738 – 01 May 10 – 01 May 10 01 Jul 10 – 3.375 31 Oct 10 3.367 01 Dec 08 31 May 09 31 Oct 10 31 Dec 10 01 Dec 10 31 May 11 31 Oct 11 01 Dec 11 31 May 12 01 Nov 12 01 Dec 12 31 May 13 – 01 May 11 – – 01 May 12 – Performance Share Plan SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Number of awards at 1 January 2009 Number of awards granted Number of awards lapsed Number of awards exercised Number of awards at 31 December 2009 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 – 3,090,000 25,000 170,000 2,101,500 52,000 1,606,500 22,625 – – 200,000 26,309 – – 225,000 10,523 – – 50,000 27,361 – – 275,000 322,541 2,631 17,100 – – – – 2,991,000 – – – – – – – – – – – – – – – – (237,625) – – – (276,309) – – – (110,523) – – – (287,361) – – – (10,000) (2,492,961) (27,631) (124,338) – (7,500) (75,000) – (53,500) (85,000) 3.007 – – 120,000 – 110,000 – 200,000 2.948 – – 150,000 – 140,000 – 225,000 2.890 – – 80,000 – 75,000 – 50,000 2.898 – – 200,000 – 175,000 – 275,000 909,580 2.890-3.617 2.948 55,262 2.916-2.948 – – – – – – 2,026,500 52,000 – – 1,553,000 – 2,906,000 Date from which released 12 Jan 09 26 Mar 10 07 Apr 11 02 Apr 12 12 Jan 09 26 Mar 10 07 Apr 11 02 Apr 12 12 Jan 09 26 Mar 10 07 Apr 11 02 Apr 12 12 Jan 09 26 Mar 10 07 Apr 11 02 Apr 12 12 Jan 09 13 Mar 09 05 Oct 09 26 Mar 10 02 Oct 10 07 Apr 11 02 Apr 12 Total 8,920,000 4,170,090 (231,000) (3,556,748) 9,302,342 44 Directors’ remuneration report Hiscox Ltd Report and Accounts 2009 Directors’ report The Directors have pleasure in submitting their Annual Report and financial statements for the year ended 31 December 2009. 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 21 to 25. Financial results The Group achieved a pre-tax profit for the year of £320.6 million (2008: £105.2 million). Detailed results for the year are shown in the consolidated income statement on page 48, and also within the Group financial performance section on pages 15 to 19. Going concern A review of the financial performance of the Group is set out on pages 15 to 19. The financial position of the Group, its cash flows and borrowing facilities are included therein. In addition, note 3 to the financial statements provides a detailed discussion on the risks which are inherent to the Group’s business and how those risks are managed. The Group has considerable financial resources and a well balanced book of business. After making enquiries, the Directors have an 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 4.5p (net) per share (2008: 4.25p (net)) was paid on 6 October 2009 by Hiscox Ltd in respect of the year ended 31 December 2009. A second interim dividend of 10.5p (net) per share (2008: final dividend 8.5p (net)) will be paid on 29 March 2010 in respect of the year ended 31 December 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 25 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 32 to 33. Stuart Bridges and Robert Childs 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. One of our Directors, Sir Mervyn Pedelty, died in January 2010. Sir Mervyn had been the Chairman of the Remuneration and Nomination Committee and Senior Independent Director of Hiscox Ltd since redomicile. Political and charitable contributions The Group made no political contributions during the year (2008: £nil). Charitable donations totalled £1,171,000 (2008: £717,000) of which £1,000,000 (2008: £500,000) was donated to the Hiscox Foundation, a UK- registered charity. The policy of the Hiscox Foundation is to assist and improve education, the arts and independent living for disabled and disadvantaged members of society. Further information concerning the Group’s charitable activities is contained in the report on Corporate responsibility on page 27. 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 1 March 2010: Number of shares % of total Invesco Limited 48,909,615 13.04 Jupiter Asset Management 25,210,566 6.4 Standard Life Investments 21,943,914 5.852 Legal & General 18,591,533 5.05 Massachusettes Financial Services Company 23,175,509 5.23 A copy of the Company’s Bye-Laws is available for inspection at the Company’s registered office. Directors’ report Hiscox Ltd Report and Accounts 2009 45 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 9 June 2010 at 10.00am (2.00pm (BST)), is contained in a separate circular to shareholders enclosed with this report. By order of the Board Charles Dupplin, Secretary Wessex House, 45 Reid Street, Hamilton HM12, Bermuda 1 March 2010 Directors’ interests Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges Non Executive Directors DM Healy ER Jansen Dr J King Sir Mervyn Pedelty AS Rosen G Stokholm DA Stuurop 31 December 2009 5p Ordinary Shares number of shares beneficial 31 December 2009 5p Ordinary Shares number of shares non-beneficial 31 December 2008 5p Ordinary Shares number of shares beneficial 31 December 2008 5p Ordinary Shares number of shares non-beneficial 6,600,196 550,000 6,327,050 550,000 3,229,465 10,081,500 2,941,304 10,081,500 1,906,840 1,009,399 55,000 – – 18,000 – – 50,000 – – – – – – – – – 1,794,043 744,774 55,000 – – 18,000 – – 50,000 – – – – – – – – – 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 1 March 2010. 46 Directors’ report/Directors’ responsibilities statement Hiscox Ltd Report and Accounts 2009 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 2009, 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 1 March 2010 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 48 to 99 which comprise the consolidated balance sheet as at 31 December 2009, 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 Section 421 of the UK Companies Act 2006. 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 controls 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 2009 47 Consolidated income statement For the year ended 31 December 2009 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 (losses)/gains 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 2008 Results excluding foreign currency items on economic hedges and intragroup borrowings £000 2008 Foreign currency items on economic hedges and intragroup borrowings (note 14) £000 2009 Total £000 2008 Total £000 Note 4 1,435,401 1,147,364 (248,970) (278,378) 4 1,157,023 898,394 1,363,698 (265,596) 1,171,511 (243,416) 1,098,102 928,095 – 1,147,364 (248,970) – – – – – 898,394 1,171,511 (243,416) 928,095 4 7 7 9 27.2 18 9 11 17 29 32 32 182,769 396 19,498 (27,632) (10,438) 19,858 – (42,540) – (27,632) (52,978) 19,858 1,300,765 909,883 (42,540) 867,343 (463,218) (256,634) (112,627) (116,939) (25,554) (479,380) (227,943) (83,198) (76,499) 118,218 – – – – (8,463) (479,380) (227,943) (83,198) (76,499) 109,755 (974,972) (748,802) (8,463) (757,265) 325,793 (5,293) 118 161,081 (5,158) 260 320,618 (40,121) 156,183 (30,255) (51,003) – – (51,003) (4,117) 110,078 (5,158) 260 105,180 (34,372) 280,497 125,928 (55,120) 70,808 75.2p 72.3p 18.8p 18.1p Consolidated statement of comprehensive income For the year ended 31 December 2009, after tax Profit for the year Other comprehensive income Currency translation differences (net of tax of £nil (2008: £nil)) Net investment hedge (net of tax of £nil (2008: £(238,000))) 2008 Results excluding foreign currency items on economic hedges and intragroup borrowings £000 2008 Foreign currency items on economic hedges and intragroup borrowings (note 14) £000 2009 Total £000 2008 Total £000 Note 280,497 125,928 (55,120) 70,808 (69,589) – 71,008 (597) 80,171 – 151,179 (597) Total other comprehensive (loss)/income 13 (69,589) 70,411 80,171 150,582 Total comprehensive income recognised for the year (all attributable to owners of the Company) 210,908 196,339 25,051 221,390 The presentation of the consolidated income statement for the year ended 31 December 2008 has not been adopted in the current year as the current year amounts are insignificant both to the prior year amounts and overall result of the Group. The notes on pages 52 to 99 are an integral part of these consolidated financial statements. 48 Consolidated income statement/Consolidated statement of comprehensive income Hiscox Ltd Report and Accounts 2009 Consolidated balance sheet At 31 December 2009 Assets Intangible assets Property, plant and equipment Investments in associates Deferred tax 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 2009 £000 2008 £000 17 15 16 30 50,413 22,244 7,318 14,077 141,505 48,557 19,668 7,200 5,996 131,130 18 20 2,413,300 2,081,772 503,794 494,315 26,289 440,622 420,126 488,782 – 259,647 24 21 19, 27 3,817,412 3,759,343 25 25 25 26 26 20,158 11,831 303,465 37,728 748,104 20,067 9,418 352,078 107,317 462,146 1,121,286 951,026 31 – 69,673 – 74,645 30 27 2,122,351 2,277,416 143,350 – 312,906 138,539 26,080 339,483 20 28 2,696,126 2,808,317 3,817,412 3,759,343 The notes on pages 52 to 99 are an integral part of these consolidated financial statements. The consolidated Group financial statements were approved by the Board of Directors on 1 March 2010 and signed on its behalf by: RRS Hiscox Chairman SJ Bridges Group Finance Director Consolidated balance sheet Hiscox Ltd Report and Accounts 2009 49 Consolidated statement of changes in equity Balance at 1 January 2008 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 Balance at 31 December 2008 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 19,898 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) 20,067 9,418 352,078 107,317 462,146 951,026 – – – 91 – – – – – – (69,589) 280,497 210,908 – – 2,413 – – – – – – – – – – (48,613) – – – – – – – 5,260 – – – – 201 – 5,260 – 2,504 – – 201 (48,613) 25 25 33 25 25 30 33 Balance at 31 December 2009 20,158 11,831 303,465 37,728 748,104 1,121,286 The notes on pages 52 to 99 are an integral part of these consolidated financial statements. 50 Consolidated statement of changes in equity Hiscox Ltd Report and Accounts 2009 Consolidated statement of cash flows For the year ended 31 December 2009 Profit before tax Adjustments for: Interest and equity dividend income Interest expense Net fair value (gains)/losses on financial investments and derivatives Depreciation and amortisation 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 carried at fair value Financial liabilities carried at fair value 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 receipts/(repayments) of borrowings Net cash flows from financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at 1 January Net increase in cash and cash equivalents Effect of exchange rate fluctuations on cash and cash equivalents Note 2009 £000 2008 £000 320,618 105,180 (78,298) 5,293 (87,692) 6,046 5,260 (975) 30,844 (92,227) 5,158 180,085 5,323 5,269 (766) (62,086) 15,16 10 (58,366) (338,556) (52,533) 36,560 281,633 (284,069) – (10,474) (211,799) 74,584 3,714 (5,066) (1,463) 133,026 89,608 2,619 (5,327) (18,982) (140,030) 200,944 – – – (8,802) (2,911) (3,137) (42) (5,438) (4,521) (3,530) (11,713) (16,668) 2,504 – (48,613) 47,721 4,632 (65,066) (46,756) (1,292) 1,612 (108,482) (150,131) 75,794 440,622 (150,131) (30,844) 302,742 75,794 62,086 34 35 17 25 26 33 Cash and cash equivalents at 31 December 24 259,647 440,622 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 £31,607,000 (2008: £47,094,000) not available for immediate use by the Group outside of the Lloyd’s syndicate within which they are held. The notes on pages 52 to 99 are an integral part of these consolidated financial statements. Consolidated statement of cash flows Hiscox Ltd Report and Accounts 2009 51 Notes to the consolidated 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 the US and employs over 1,000 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 39 in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. The consolidated financial statements for the year ended 31 December 2009 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 1 March 2010. 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 (IASB) have been referred to as IFRS. The standards from prior years continue to bear the title ‘International Accounting Standards’ (IAS). Insofar as a particular standard is not explicitly referred to, the two terms are used in these financial statements synonymously. Compliance with IFRS includes the adoption of interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC). In March 2004, the IASB issued IFRS 4 Insurance Contracts which specifies the financial reporting for insurance contracts by an insurer. The standard is only the first phase in the IASB’s insurance contract project and as such is only a stepping stone to phase II, introducing limited improvements to accounting for insurance contracts. Accordingly, to the extent that IFRS 4 does not specify the recognition or measurement of insurance contracts, transactions reported in these consolidated financial statements have been prepared in accordance with another comprehensive body of accounting principles for insurance contracts, namely accounting principles generally accepted in the UK. During 2009, the IASB intensified its efforts to complete Phase II of its Insurance Contracts project. There were a number of key decisions made regarding the measurement approaches to be considered for inclusion within the new standard and the IASB is currently deciding on the detailed attributes of each approach. The aim of the IASB is to publish an Exposure Draft in the first half of 2010 and the final standard in 2011. The Group continues to monitor the progress of the project in order to assess any potential impact of the new standard on its results. 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 comparative amounts reported herein for the year ended 31 December 2008, are as per those previously reported for that period, but have been adjusted for the reclassification of acquisition costs on the purchase of reinsurance contracts from ‘Outward reinsurance premiums’ to ‘Expenses for the acquisition of insurance contracts’. The effect of the reclassification for the year ended 31 December 2008 is an increase to ‘Outward reinsurance premiums’ of £32,070,000, a decrease in ‘Net premiums earned’ of £24,925,000 and a decrease in ‘Expenses for the acquisition of insurance contracts’ of £24,925,000. The effect on the balance sheet for 31 December 2008 is an increase to ‘Reinsurance assets’ and an increase to ‘Trade and other payables’ of £16,074,000. The presentational adjustment has no impact on the Group’s previously reported profit before tax, shareholders’ equity or result from operating activities. The Directors’ believe that the amended classification of the expense and commissions provides a more appropriate presentation of their operating nature. The Group also reclassified the prior year comparative for deferred tax assets arising from overseas tax jurisdictions from net deferred tax liabilities to deferred tax assets. The reclassification provides a more appropriate presentation due to the increase of the asset. The effect of the reclassification is an increase to deferred tax assets and deferred tax liabilities of £5,996,000. The presentational adjustment has no impact on the Group’s previously reported profit after tax, shareholders’ equity or results from operating activities. During the year, following a new geographic management structure including new business written through Syndicate 3624, the Group has changed its segmental reporting to provide more effective financial 52 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2 Significant accounting policies continued 2.2 Basis of preparation continued reporting for the evaluation of business segments by the chief operating decision maker to make decisions about future allocation of resources. The prior year segmental results have been restated accordingly. 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 eight in the prior year, to nine in the current financial year, and will be increased in 2010 up to a maximum of ten years if material outstanding claims exist for such periods. The Group has financial assets and cash of over £2.6 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 in place. 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. A review of the financial performance of the Group is set out on pages 15 to 19. The financial position of the Group, its cash flows and borrowing facilities are included therein. In addition, note 3 to the financial statements provides a detailed discussion on the risks which are inherent to the Group’s business and how those risks are managed. The Group has considerable financial resources and a well balanced book of business. The Directors have an 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. The Group early adopted IFRS8 Operating Segments from 1 January 2010. The accounting policies adopted are consistent with those of the previous financial year except as follows: The Group has adopted, for the first time, the following new and amended Standards and Interpretations issued by the IASB and endorsed by the EU as of 1 January 2009. Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures (Amendment) Amendments to IFRS 7 Financial Instruments: Disclosure Amendments to IAS 32 Financial Instrument: Presentation and IAS 1 Presentation of Financial Statements - Puttable Financial Instruments and Obligations Arising on Liquidation Amendments to IAS 23 Borrowing Costs Improvements to IFRS Adoption of the above had no impact on the financial performance or position of the Group. Amendments to IAS 39 Financial Instruments: Recognition and measurement and IFRS 7 Financial Instruments: Disclosures (Amendment) The amendments to IAS 39 and IFRS 7 were issued in response to the global market credit crisis in October 2008. The standard was effective retrospectively from 1 July 2008 to 1 November 2008. Thereafter, retrospective application was not permitted. The amended standard permitted an entity to reclassify certain financial assets out of ‘Held-for-Trading’ if they were no longer held for the purpose of being sold, or repurchased, in the near term. The standard also allowed for those financial assets which are not eligible for classification as loans and receivables to be transferred from ‘Held-for-Trading’ to ‘Available-for- Sale’ or ‘Held-to-Maturity’ only in exceptional circumstances. IFRS 7 was amended to require disclosure of information for any reclassifications of assets described above to include amounts and any gains or losses. The amendment had no impact on the Group’s results. have significant unobservable inputs, Level 3, the amendment requires a reconciliation of the opening and closing balance. In addition, transfers between each level of the hierarchy are to be disclosed. The standard also amends the previous liquidity risk disclosures for non derivative and derivative financial liabilities. The standard is applicable prospectively and no comparatives are required on transition. However, the Group has voluntarily provided comparatives. Amendments to IAS 32 Financial Instrument: Presentation and IAS 1 Presentation of Financial Statements- Puttable Financial Instruments and Obligations Arising on Liquidation The amendments were issued in February 2008 and provide a limited scope exception for puttable financial instruments to be classified as equity if certain specified features are fulfilled. The amendments are effective for financial periods beginning on or after 1 January 2009. There is no impact on the Group’s financial performance as it has not issued such instruments. Amendment to IAS 23 Borrowing Cost 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 had no impact on the Group’s results. Improvements to IFRSs Improvements to IFRSs is an annual process which has been undertaken by the IASB with the view of removing inconsistencies and clarifying wording within the standards. In May 2008, the IASB issued the first in the series of these amendments with separate transitional arrangements for each standard. The following lists the main applicable improvements which have been adopted by the Group from 1 January 2009: Amendments to IFRS 7 Financial Instruments: Disclosure The amendments to the standard enhance the disclosure requirements over fair value measurement and liquidity risk.The standard requires disclosure of those instruments measured at fair value by reference to the source of input used in determining fair value. The instruments are to be categorised using a three-level fair value hierarchy with those instruments with the most reliable method of determining fair value being classified as Level 1. For those instruments which IFRS 7 Financial Instruments: Disclosures: removes the reference to ‘total interest income’ as a component of finance costs. This had no impact on the Group’s accounting policy or financial position as this was already applied. IAS 8 Accounting Policies: clarifies that only implementation guidance that is an integral part of an IFRS is mandatory when selecting accounting policies. This had no impact on the Group’s accounting policy or financial position as this was already applied. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 53 Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.2 Basis of preparation continued IAS 10 Events After the Reporting Period: clarifies that dividends declared after the end of the reporting period are not obligations. This had no impact on the Group’s accounting policy or financial position as this was already applied. IAS 16 Property, Plant and Equipment: replaces the term ‘net selling price’ with ‘fair value less costs to sell’. The Group has amended its accounting policy accordingly which did not result in any change in the financial position. IAS 19 Employee Benefits: revised the definition of ‘past service costs’ to include reductions in benefits related to past services and to exclude the deduction in benefits related to future services that arise from plan amendments. The term ‘return on plan assets’ was revised to exclude plan administration costs if they have already been included in the actuarial assumptions. In addition, the definition of ‘short-term’ and ‘other long-term’ employee benefits was amended to focus on the point in time at which a liability is due to be settled. Finally, the reference to the recognition of contingent liabilities has been deleted. The amendment had no impact on the accounting policy and financial position of the Group as the definitions were consistent with the amendment. Standards and interpretations issued but not yet effective or not yet endorsed by the EU IFRS 9 – Financial Instruments (not endorsed) Part I of the three-part project of the new standard for financial instruments was issued by the IASB in November 2009 and is applicable for accounting periods commencing 1 January 2013 although early adoption is permitted. The two remaining parts of the standard are Part II, Amortised Cost and Impairment and Part III, Hedge Accounting, both of which are expected to be issued in 2010. IFRS 9, Part I reduces the classification and measurement categories of financial instruments to two, being fair value or amortised cost. To classify financial assets as amortised cost they must have basic loan features and be managed on a contractual yield basis. In addition, the classification must also be based on the business model as ‘determined by key management personnel’. The new standard currently does not address how to measure financial liabilities and the IASB are currently considering including credit risk in measuring financial liabilities. It is expected to issue final requirements for this in 2010. IFRS 3 (Revised) Business Combinations and IAS 27 (Amended) Consolidated and Separate Financial Statements (endorsed) The revised standards were issued in January 2008 and are applicable for accounting periods commencing on or after 1 July 2009. IFRS 3 incorporates a number of changes in accounting for business combinations which will impact the amount of goodwill recognised and the results reported in the period of the combination and future reporting periods. IAS 27 requires that a change in the ownership interest of a subsidiary, provided that control is maintained, to be accounted for as an equity transaction. As such, a transaction of this nature will no longer give rise to goodwill nor gain or loss. The Group has not early adopted these standards. 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 these Syndicates has 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 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. 54 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2 Significant accounting policies continued 2.3 Basis of consolidation continued (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 US and Bermuda whose functional currency is US Dollars, Hiscox Insurance Company (Guernsey) Limited and Syndicate 3624 whose functional currency is also US Dollars. 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); and (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. (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. 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 and contingent liabilities assured 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 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. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 55 Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.6 Intangible assets continued (b) Syndicate capacity The cost of purchasing the Group’s participation in the Lloyd’s insurance syndicates is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. Having considered the future prospects of the London insurance market, the Board believe that the Group’s ownership of syndicate capacity will provide economic benefits over an indefinite number of future periods. (c) State authorisation licences State authorisation licences acquired in business combinations are recognised initially at their fair value. The asset is not amortised, as the Board considers that economic benefits will accrue to the Group over an indefinite number of future periods, but is tested annually for impairment, and any accumulated impairment losses recognised are deducted from the historical cost amount to produce the net balance sheet carrying amount. (d) Rights to customer contractual relationships Costs directly attributable to securing the intangible rights to customer contract relationships are recognised as an intangible asset where they can be identified separately and measured reliably and it is probable that they will be recovered by directly related future profits. These costs are amortised on a straight-line basis over the useful economic life which is deemed to be 20 years and are carried at cost less accumulated amortisation and impairment losses. (e) Computer software Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring into use the specific software. These costs are amortised over the expected useful life of the software of between three and five years on a straight-line basis. Internally developed computer software is only capitalised where the cost can be measured reliably, the Group intends to and has adequate resources to complete development, and where the computer software will yield future economic benefits in excess of the costs incurred. 2.7 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. An analysis of fair values of financial instruments and further details as to how they are measured are provided in note 23. (a) Financial assets at fair value through profit or loss A financial asset is classified into this category at inception if it is managed and evaluated on a fair value basis in accordance with documented strategy, if acquired principally for the purpose of selling in the short-term, or if it forms part of a portfolio of financial assets in which there is evidence of short-term profit taking. (b) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted on an active market. Receivables arising from insurance contracts are included in this category and are reviewed for impairment as part of the impairment review of loans and receivables. Loans and receivables are carried at amortised cost less any provision for impairment in value. 2.8 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 implicitly supporting the asset. (c) Impairment loss An impairment loss is recognised for the amount by which the asset’s carrying 56 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2 Significant accounting policies continued 2.9 Impairment of assets continued (c) Impairment loss continued 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 derivatives 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 and reinsurance 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. 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. 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 tests 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. 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 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 57 Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.13 Insurance contracts continued (e) Outwards reinsurance contracts held continued 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. 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. 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. 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 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. 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. (b) Other long-term employee benefits The Group provides sabbatical leave to employees on completion of a minimum service period of ten years. The present value of the expected costs of these benefits is accrued over the period of employment. In determining this liability, consideration is given to future increases in salary levels, experience with employee departures and periods of service. (c) Share based compensation The Group operates a number of equity settled share based employee compensation plans. These include both the approved and unapproved share option schemes, and the Group’s performance share plans, outlined in the Directors’ remuneration report together with the Group’s Save as You Earn (SAYE) schemes. The fair value of the employee services received, measured at grant date, in exchange for the grant of the awards is recognised as an expense with the corresponding credit being recorded in retained earnings within equity. The total amount to be expensed over the vesting period is determined by reference to the fair value of the awards granted, excluding the impact of any non-market vesting conditions (e.g. profitability or net asset growth targets). Non-market vesting conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period. Actuarial gains and losses are only recognised when the net cumulative When the terms and conditions of an equity settled share based employee 58 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2 Significant accounting policies continued 2.15 Employee benefits continued (c) Share based compensation continued compensation plan are modified, and the expense to be recognised increases as a result of the modification, then the increase is recognised evenly over the remaining vesting period. When a modification reduces the expense to be recognised, there is no adjustment recognised and the pre-modification expense continues to be applied. The proceeds received net of any directly attributable transaction costs are credited to share capital and share premium when the options are exercised. In accordance with the transitional arrangements of IFRS 2 only share based awards granted or modified after 7 November 2002, but not yet vested at the date of adoption of IFRS, are included in the calculations. (d) Termination benefits Termination benefits are payable when employment is terminated before the normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Group recognises termination benefits when it is demonstrably committed to either: terminating the employment of current employees according to a detailed formal plan without possibility of withdrawal; or providing termination benefits as a result of an offer made to encourage voluntary redundancy. (e) Profit sharing and bonus plans The Group recognises a liability and an expense for bonuses and profit sharing, based on a formula that takes into consideration the profit attributable to the Company’s shareholders after certain adjustments. The Group recognises a provision where a contractual obligation to employees exists or where there is a past practice that has created a constructive obligation. (f) Accumulating compensation benefits The Group recognises a liability and an expense for accumulating compensation benefits (e.g. holiday entitlement), based on the additional amount that the Group expects to pay as a result of the unused entitlement accumulated at the balance sheet date. 2.16 Financial liabilities All borrowings drawn after 6 May 2008 are now measured 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. Up to 6 May 2008 (when all existing borrowings were repaid in full), borrowings were measured 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). 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. 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 amounts of insurance and reinsurance assets and liabilities reported in the balance sheet date. This includes estimates for losses incurred but not reported. 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 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 59 Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.22 Use of critical estimates, judgements and assumptions continued 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 of insurance liabilities 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 liability 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 27 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 a greater degree of judgement 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 31. 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 of 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 from 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 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 60 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 relevant policies frequently contain payment limits to cap the maximum amount payable from these insured events over the contract period. Another 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. 3 Management of risk continued 3.1 Insurance risk continued 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 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 estimates modelled by management. The Group’s underwriters and management consider insurance risk at an individual contract level, and also from a portfolio perspective where the risks assumed in similar classes of policies are aggregated and the exposure evaluated in light of historical portfolio experience and prospective factors. To assist with the process of pricing and managing insurance risk the Group routinely performs a wide range of activities including the following: regularly updating the Group’s risk models; documenting, monitoring and reporting on the Group’s strategy to manage risk; developing systems that facilitate the identification of emerging issues promptly; utilising sophisticated computer modelling tools to simulate catastrophes and measure the resultant potential losses before and after reinsurance; monitoring legal developments and amending the wording of policies when necessary; regularly aggregating risk exposures across individual underwriting portfolios and known accumulations of risk; examining the aggregated exposures in advance of underwriting further large risks; and developing processes that continually factor market intelligence into the pricing process. The delegation of underwriting authority to specific individuals, both internally and externally, is subject to regular review. All underwriting staff and binding agencies are set strict parameters in relation to the levels and types of business they can underwrite, based on individual levels of experience and competence. These parameters cover areas such as the maximum sums insured per insurance contract, maximum gross written premiums and maximum aggregated exposures per geographical zone and risk class. Monthly meetings are held between the Chief Underwriting Officer and a specialist central analysis and review team in order to monitor claim development patterns and discuss individual underwriting issues as they arise. The Chief Underwriting Officer also holds weekly video conference meetings with this team to discuss interim underwriting matters. The Group’s insurance contracts include provisions to contain losses such as the ability to impose deductibles and demand reinstatement premiums in certain cases. In addition, in order to manage the Group’s exposure to repeated catastrophic events, Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 61 Notes to the consolidated financial statements continued 3 Management of risk continued 3.1 Insurance risk continued Estimated concentration of gross and net insurance liabilities on balance sheet by territory coverage of premium written 31 December 2009 UK and Ireland Europe United States Other territories Multiple territory coverage Total 31 December 2008 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 the Group Reinsurance inwards £000 29,001 26,579 23,650 21,531 188,593 139,688 35,915 34,407 139,843 80,558 Property – Marine and major assets £000 16,993 8,425 5,367 3,659 26,143 22,506 23,506 16,910 162,116 124,264 Property – Other assets £000 Casualty – Professional indemnity £000 133,166 129,114 74,121 69,606 146,842 82,919 43,488 32,924 48,190 37,713 247,222 213,181 53,557 49,691 249,942 233,294 49,656 49,254 12,689 11,289 Casualty – Other risks £000 15,345 10,767 10,549 8,886 20,828 13,689 17,317 6,453 127,781 87,186 Other* £000 Total £000 14,716 9,639 22,992 20,625 15,819 11,294 68,013 57,932 98,991 88,242 456,443 397,705 190,236 173,998 648,167 503,390 237,895 197,880 589,610 429,252 417,002 234,125 445,807 613,066 191,820 220,531 2,122,351 302,763 175,764 352,276 556,709 126,981 187,732 1,702,225 Types of insurance risk in the Group Property – Marine and major assets £000 8,900 8,163 5,370 4,097 50,252 36,889 15,736 13,490 183,410 130,329 Property – Other assets £000 141,470 139,043 75,624 70,241 168,770 118,909 28,459 19,598 38,615 25,670 Casualty – Professional indemnity £000 223,181 177,272 44,932 41,082 338,150 304,037 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 5,829 154,195 105,584 Reinsurance inwards £000 51,386 43,742 27,922 22,546 249,389 143,826 81,258 69,152 124,552 88,940 Other* £000 Total £000 13,887 11,807 11,447 9,615 20,352 15,554 62,779 48,970 50,178 37,461 441,924 382,637 174,514 155,059 873,626 652,401 232,412 191,785 554,940 391,740 534,507 263,668 452,938 647,315 220,345 158,643 2,277,416 368,206 192,968 373,461 560,893 154,687 123,407 1,773,622 *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 including professional indemnity. 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 are 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. 62 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 3 Management of risk continued 3.1 Insurance risk continued Consequently the frequency and severity of reinsurance inwards claims is related not only to the number of significant insured events that occur but also to their individual magnitude. If numerous catastrophes occurred in any one year but the cedant’s individual loss on each was below the minimum stated, then the Group would have no liability under such contracts. Maximum gross line sizes and aggregate exposures are set for each type of programme. Property risks – marine and major assets The Group directly underwrites a diverse range of property risks. The risk profile of the property covered under marine and major asset policies is different to that typically contained in the other classes of property (such as private households and contents insurance) covered by the Group. Typical property covered by marine and other major property contracts include fixed and moveable assets such as ships and other vessels, cargo in transit, energy platforms and installations, pipelines, other 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 27. 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. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 63 Notes to the consolidated financial statements continued 3 Management of risk continued 3.1 Insurance risk continued For the reinsurance lines, there is often a time lag between the establishment and re-estimate of case reserves and reporting to the Group. The Group works closely with clients to ensure timely reporting and also centrally analyses industry loss data to verify the reported reserves. 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. 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 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 appeared to arise as a response to global macroeconomic and liquidity concerns and not as a result of specific issuer events or credit concerns. During 2009, the Group experienced a sharp recovery in those investments which were heavily marked down in 2008. 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, the reliability of fair value measures, 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. At 31 December 2009, 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. 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 markets and the Group therefore seeks to determine fair value by reference to published prices or as derived by pricing vendors using observable 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 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 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. Note 23 provides an analysis of the measurement attributes of the Group’s financial instruments. (a) Equity price risk The Group is exposed to equity price risk through its holdings of equity and unit trust investments. 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 of equity assets in the Group’s balance sheet at 31 December 2009 was £134 million (2008: £125 million). These may be analysed as follows: Nature of equity and unit trust holdings 2009 % weighting 2008 % weighting 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 2 68 30 37 63 – 68 32 29 71 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 2009 would have been expected to reduce Group equity and profit after tax for the year by approximately £11.4 million (2008: £10.0 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 Group may also from time to time, enter into interest rate future contracts in order to minimise the interest rate risk on specific longer duration portfolios. 64 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 3 Management of risk continued 3.2 Financial risk continued (b) Interest rate risk continued The fair value of debt and fixed income assets in the Group’s balance sheet at 31 December 2009 was £2,256 million (2008: £1,929 million). These may be analysed as follows: Nature of debt and fixed income holdings 2009 % weighting 2008 % 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 28 28 6 4 6 26 2 35 17 10 8 8 20 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 £32 million (2008: decrease of £31 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 cash flow stream to be recovered, where the weightings involved are based on the discounted present values of each cash flow. 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. At 31 December 2009, £138 million was drawn on the Group’s borrowing facility (2008: $130 million). 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 36. 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 bonds issued mainly by European Union and North American countries. (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 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, derivative transactions and catastrophe bonds. 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 at any given point in time. The Group does not use credit derivatives or other products to mitigate maximum credit risk exposures on reinsurance assets. 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 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 65 Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (c) Credit risk continued 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 2009 Debt and fixed income securities Deposits with credit institutions Catastrophe bonds Derivative financial instruments Reinsurance assets Cash and cash equivalents Total Note AAA £000 AA £000 A £000 Other/ not rated £000 Total £000 20 20 1,555,636 62 – – 8,120 27,456 24 19 20, 22 198,001 2,860 – – 151,803 136,214 256,120 8,472 – – 230,462 93,999 245,980 2,255,737 11,394 11,310 1,018 420,126 259,647 – 11,310 1,018 29,741 1,978 1,591,274 488,878 589,053 290,027 2,959,232 Amounts attributable to largest single counterparty 308,569 57,859 17,424 10,619 As at 31 December 2008 Debt and fixed income securities Deposits with credit institutions Catastrophe bonds Derivative financial instruments Reinsurance assets Cash and cash equivalents Total Note AAA £000 AA £000 A £000 Other/ not rated £000 Total £000 20 20 1,471,797 4,146 – – 6,926 54,227 24 19 20, 22 179,416 11,800 – 40 281,041 330,246 172,832 12,323 – – 189,444 56,010 104,554 1,928,599 28,269 – 40 503,794 440,622 – – – 26,383 139 1,537,096 802,543 430,609 131,076 2,901,324 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. Catastrophe bonds included within ‘other/not rated’ are rated BB or above. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2009 and 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. At 31 December 2009 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 (2008: £nil). For the current period under review, the Group did not experience any defaults on debt securities (2008: one financial instrument). 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 and reinsurance 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. 66 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 3 Management of risk continued 3.2 Financial risk continued (d) Liquidity risk continued The main focus of the investment portfolio is on high quality short duration debt and fixed income securities, and cash. There 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 Debt and fixed income securities £000 463,526 710,347 668,602 359,094 Deposits with credit institutions £000 7,877 3,517 – – Catastrophe bonds £000 1,878 5,836 3,596 – Derivative financial assets £000 1,018 – – – Cash and cash equivalents £000 259,647 – – – 2009 Total £000 2008 Total £000 733,946 719,700 672,198 359,094 665,770 593,371 669,819 407,273 2,201,569 11,394 11,310 1,018 259,647 2,484,938 2,336,233 Other non-dated instruments 54,168 – – – – 54,168 61,297 Total 2,255,737 11,394 11,310 1,018 259,647 2,539,106 2,397,530 The Group’s equities and shares in unit trusts and other non-dated instruments have no contractual maturity terms but could also be liquidated for cash in a prompt and reasonable timeframe within one year of the balance sheet date. Average contractual maturity analysed by denominational currency of investments Pound Sterling US Dollar Euro Canadian Dollar 2009 Years 1.52 4.89 3.21 1.38 2008 Years 4.85 6.95 5.10 2.45 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 86,533 54,426 115,406 99,372 55,636 56,342 61,120 33,557 42,065 101,486 37,247 30,266 52,478 34,163 32,477 183,597 34,243 27,088 Over five years £000 13,529 10,194 5,234 36,193 8,301 9,480 2009 Total £000 213,660 132,340 195,182 420,648 135,427 123,176 467,715 305,741 364,046 82,931 1,220,433 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 *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 the Group’s borrowings, derivative instruments and other liabilities is given in notes 20 and 28. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 67 Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk The Group operates internationally and its exposures to foreign exchange risk arise primarily with respect to the US Dollar, Pound Sterling and the Euro. These exposures may be classified in two main categories: 1) Structural foreign exchange risk through consolidation of net investments in subsidiaries with different functional currencies within the Group results; and 2) Operational foreign exchange risk through routinely entering into insurance, investment and operational contracts, as a Group of international insurance entities serving international communities, where rights and obligations are denominated in currencies other than each respective entity's 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 a 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). 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 (see note 20). There were no items qualifying for hedge accounting in the current year. 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 £240 million (2008: £225 million) which are denominated in foreign currencies. As a result of the accounting treatment for non monetary items, the Group may also experience volatility in its income statement during a period when movements in foreign exchange rates fluctuate significantly. In accordance with IFRS, non monetary items are recorded at original transaction rates and are not remeasured at the reporting date. These items include unearned premiums, deferred acquisition costs and reinsurers’ share of unearned premiums. Consequently, a mismatch arises in the income statement between the amount of premium recognised at historical transaction rates, and the related claims which are retranslated using currency rates in force at the reporting date. The Group considers this to be a timing issue which can cause significant volatility in the income statements. Further details of the impact of the accounting treatment is provided in note 13. The currency profile of the Group’s assets and liabilities is as follows: At 31 December 2009 Intangible assets Property, plant and equipment Investments in associates Deferred tax 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 44,105 13,678 6,728 – 42,376 6,308 7,893 – 14,077 71,678 580,797 1,623,276 320,424 259,539 – 97,754 54,976 127,361 – 93,096 – 673 590 – 23,125 166,629 27,375 88,480 – 57,998 – – – – 4,326 50,413 22,244 7,318 14,077 141,505 42,598 2,413,300 420,126 17,351 488,782 13,402 – – 259,647 10,799 Total assets 963,117 2,400,949 364,870 88,476 3,817,412 68 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities Current tax Trade and other payables Total liabilities At 31 December 2008 Intangible assets Property, plant and equipment Investments in associates Deferred tax assets 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 – 69,673 – – 486,488 1,361,934 539 138,000 – 26,080 149,005 142,659 – – 220,661 – – 42,766 – – – 69,673 53,268 2,122,351 138,539 26,080 339,483 – – 5,053 862,900 1,511,478 263,427 58,321 2,696,126 Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 42,249 16,378 6,504 – 40,263 6,308 2,404 – 5,996 66,462 370,043 1,430,712 400,727 290,523 – 229,165 66,081 127,702 26,289 127,881 – 886 696 – 20,094 236,066 26,154 64,748 – 75,109 – – – – 4,311 48,557 19,668 7,200 5,996 131,130 44,951 2,081,772 503,794 10,832 494,315 11,342 – 26,289 440,622 8,467 Total assets 823,390 2,432,297 423,753 79,903 3,759,343 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 – 74,645 – – 455,606 1,570,090 132,818 – 120,233 – – 145,926 – – 206,228 10,532 – 42,065 – – – 74,645 45,492 2,277,416 143,350 – 312,906 – – 4,682 676,177 1,823,141 258,825 50,174 2,808,317 Sensitivity analysis As at 31 December 2009, the Group used closing rates of exchange of £1:€1.13 and £1:$1.61 (2008: £1:€1.03 and £1:$1.44). The Group performs sensitivity analysis based on a 10% strengthening or weakening of Pound Sterling against the Euro and US Dollar. 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. During the year, the Group transacted in a number of over the counter forward currency derivative contracts. The impact of these contracts on the sensitivity analysis is negligible. At 31 December 2009 Strengthening of US Dollar Weakening of US Dollar Strengthening of Euro Weakening of Euro Effect on equity after tax £m Effect on profit before tax £m 94.6 (74.8) 10.0 (8.2) 54.2 (41.7) 13.9 (11.4) Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 69 Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (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 are 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 31 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; to maintain of an efficient cost of capital; to comply with all regulatory requirements by a significant margin; and to maintain financial strength ratings of A in each of its insurance entities. 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. 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), 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. The revolving credit facility has a maximum five year contractual period for repayment. 70 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 At 31 December 2009 US$225 million was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further £138 million by way of cash (2008: £137.5 million and US$130 million respectively) 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 for the 2009 year of account (2008 year of account: £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. Financial strength The financial strength ratings of the Group’s insurance company subsidiaries are outlined below: A.M. Best Fitch Standard & Poor’s Hiscox Insurance Company Limited A (Excellent) A A (Strong) Hiscox Insurance Company (Bermuda) Limited Hiscox Insurance Company (Guernsey) Limited A (Excellent) A (Excellent) Hiscox Insurance Company Inc. A (Excellent) 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’s four operating segments are: London Market comprises the results of Syndicate 33, excluding the results of the fine art, UK regional events coverage and non US household business which is included within the results of UK and Europe. In addition, it excludes the larger TMT business which is allocated to the International segment and an element of kidnap and ransom and terrorism included in UK and Europe. 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. It also includes an element of kidnap and ransom and terrorism written in Syndicate 33. International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Insurance Company (Bermuda) Limited, Syndicate 3624, Hiscox Inc. and Hiscox Insurance Company Inc.. It also includes the results of the larger TMT business written by Hiscox Insurance Company Limited and Syndicate 33. Corporate Centre comprises the investment return, finance costs and administrative costs associated with Group management activities. 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. 3 Management of risk continued 3.3 Capital risk management continued 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 Group’s capital requirements are managed both centrally and at a regulated entity level. The assessed capital requirement for the business placed through Hiscox Insurance Company Limited, Hiscox Insurance Company (Bermuda) Limited, Hiscox Insurance Company (Guernsey) Limited and Hiscox Insurance Company Inc., is driven by the level of resources necessary to maintain both regulatory requirements and the capital necessary to maintain financial strength of 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 Group complied with the requirement for the current and prior year. In the Group’s other geographical territories, including the US, its subsidiaries underwriting insurance business are required to operate within broadly similar risk-based externally imposed capital requirements when accepting business. 4 Operating segments The Group’s operating segments consist of four segments which recognise the differences between products and services, customer groupings and geographical areas. Financial information is used in this format by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The format is representative of the management structure of the segments. During the year, following a new geographic management structure including new business written through Syndicate 3624, the Group has changed its segmental reporting to provide more effective financial reporting for the evaluation of business segments by the chief operating decision maker to make decisions about future allocation of resources. Accordingly the 2008 segmental comparatives have been restated in order to enable comparison of results by the user. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 71 Notes to the consolidated financial statements continued 4 Operating segments continued All amounts reported below represent transactions with external parties only, with all inter-segment amounts eliminated which is consistent with the information used by the chief operating decision maker when evaluating the results of the Group. Performance is measured based on each reportable segment’s profit before tax. (a) Profit before tax by segment London Market £000 UK and Europe £000 Gross premiums written Net premiums written Net premiums earned 663,034 483,611 453,281 420,982 391,461 367,326 Year to 31 December 2009 Year to 31 December 2008 Restated Corporate Centre £000 Total £000 London Market £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 – 1,435,401 545,930 363,112 – 1,157,023 427,770 – 1,098,102 357,095 329,117 303,363 244,339 206,165 196,962 – 1,147,364 – 898,394 – 928,095 International £000 351,385 281,951 277,495 Investment result – financial assets* Investment result – derivatives Other revenues 80,901 (1,192) 12,841 34,935 1,967 3,955 57,765 (83) 2,700 9,168 (296) 2 182,769 396 19,498 (5,463) – 15,606 (11,928) (10,483) 2,929 (8,443) – 1,323 (1,798) (42,495) – (27,632) (52,978) 19,858 Revenue 545,831 408,183 337,877 8,874 1,300,765 437,913 283,881 189,842 (44,293) 867,343 Claims and claim adjustment expenses, net of reinsurance (175,823) Expenses for the acquisition of insurance contracts Administration expenses Other expenses Foreign exchange (losses)/gains (101,518) (25,794) (26,384) (35,800) (195,967) (91,428) – (463,218) (261,875) (130,723) (86,782) – (479,380) (87,393) (56,057) (41,136) (67,723) (29,531) (31,597) – (256,634) (112,627) (116,939) (1,245) (17,822) (108,346) (19,622) (19,149) (74,582) (46,250) (33,042) (45,015) (17,326) (14,112) – – (10,196) (227,943) (83,198) (76,499) (7,065) 6,989 10,322 (25,554) 108,345 32,507 (22,100) (8,997) 109,755 Total expenses (365,319) (387,618) (213,290) (8,745) (974,972) (300,647) (252,090) (185,335) (19,193) (757,265) Results of operating activities Finance costs Share of profit of associates after tax 180,512 (616) 20,565 (20) 124,587 (407) 129 325,793 (5,293) (4,250) 137,266 (273) 31,791 (35) 4,507 (186) (63,486) 110,078 (5,158) (4,664) – – – 118 118 – – – 260 260 Profit before tax 179,896 20,545 124,180 (4,003) 320,618 136,993 31,756 4,321 (67,890) 105,180 *Interest revenues included total £74,584,000 (2008: £89,608,000). The following charges are included within the consolidated income statement: Depreciation Amortisation of intangible assets London Market £000 650 635 UK and Europe £000 3,230 135 International £000 1,187 149 Corporate Centre £000 60 – Total £000 5,127 919 London Market £000 1,348 – UK and Europe £000 3,007 135 International £000 921 123 Corporate Centre £000 47 1 Total £000 5,323 259 Year to 31 December 2009 Year to 31 December 2008 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 2009 Year to 31 December 2008 Restated 100% ratio analysis Claims ratio (%) Expense ratio (%) Combined ratio excluding foreign exchange impact (%) Foreign exchange impact (%) Combined ratio (%) Combined ratio excluding non monetary foreign exchange impact (%) International Corporate Centre International Corporate Centre London Market 38.8 32.2 71.0 7.8 78.8 UK and Europe 53.4 49.9 103.3 1.8 105.1 33.0 45.6 78.6 (2.3) 76.3 Total 41.8 40.4 82.2 3.8 86.0 London Market 61.2 33.3 94.5 (28.7) 65.8 UK and Europe 42.2 50.1 92.3 (10.7) 81.6 44.6 37.9 82.5 10.6 93.1 – – – – – – Total 52.7 38.9 91.6 (16.3) 75.3 80.0 – – – – – – 71.5 103.9 76.3 81.7 73.2 82.4 93.1 72 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 4 Operating segments continued (a) Profit before tax by segment continued The claims ratio is calculated as claims and claim adjustment expenses, net of reinsurance, as a proportion of net premiums earned. The expense ratio is calculated as the total of expenses for the acquisition of insurance contracts, administration expenses and other expenses as a proportion of net premiums earned. The foreign exchange impact ratio is calculated as the foreign exchange gains or losses as a proportion of net premiums earned. The combined ratio is the total of the claims, expense and foreign exchange impact ratios. The combined ratio excluding non monetary foreign exchange impact is calculated by adjusting the net premiums earned and the expenses for the acquisition of insurance contracts by the movement arising from retranslating net unearned premiums and net deferred acquisition costs at year end rates of exchange. All ratios are calculated using the 100% results. Costs allocated to the Corporate Centre are non-underwriting related costs and are not included within the combined ratio. 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 2009 Year to 31 December 2008 Restated London Market £000 UK and Europe £000 International £000 Corporate Centre £000 London Market £000 UK and Europe £000 International £000 Corporate Centre £000 6,248 3,824 2,875 4,533 3,673 2,775 – – 5,894 3,179 2,076 4,278 3,034 1,970 – – Year to 31 December 2009 Year to 31 December 2008 Restated London Market £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 London Market £000 UK and Europe £000 International £000 Corporate Centre £000 Total £000 Gross premiums written Net premiums written Net premiums earned 914,072 440,064 666,692 408,037 382,417 624,755 359,297 287,589 287,524 – 1,713,433 – 1,362,318 – 1,294,696 752,593 500,585 589,446 374,254 344,342 317,868 262,893 219,560 207,552 – 1,389,740 – 1,064,487 – 1,114,866 36,428 1,967 2,716 111,446 (1,643) – Investment result – financial assets Investment result – derivatives Other revenues Claims and claim adjustment expenses, net of reinsurance (242,422) (204,330) Expenses for the acquisition of insurance contracts Administration expenses Other expenses Foreign exchange (losses)/gains (139,923) (34,196) (26,858) (92,562) (56,812) (41,136) (48,912) (6,951) 59,297 (83) 677 9,168 (296) 2 216,339 (55) 3,395 (7,525) – 23 (11,960) (10,483) 2,929 (8,567) – 35 (1,798) (42,495) – (29,850) (52,978) 2,987 (94,873) – (541,625) (360,919) (133,983) (92,600) – (587,502) (69,185) (30,427) (31,613) – (301,670) (122,680) (117,429) (1,245) (17,822) (149,755) (26,905) (19,531) (79,357) (46,964) (33,042) (46,599) (18,391) (13,589) – – (10,196) (275,711) (92,260) (76,358) 6,678 10,322 (38,863) 169,393 34,152 (21,971) (8,997) 172,577 Results of operating activities 242,247 21,737 127,995 129 392,108 194,227 39,160 5,870 (63,486) 175,771 Segment results at the 100% level presented above differ from those presented at the Group’s share at note 4(a) solely as a result of the Group not owning 100% of the capacity of Syndicate 33 at Lloyd’s. (c) Segmental analysis of assets and liabilities The segment assets and liabilities at 31 December and the capital expenditure for the year then ended are as follows: 31 December 2009 Intangible assets Deferred acquisition costs Financial assets Reinsurance assets Other assets Total assets Insurance liabilities Other liabilities Total liabilities Capital expenditure London Market £000 UK and Europe £000 32,647 59,741 1,161,612 472,998 369,751 2,715 44,735 365,268 146,435 235,075 International £000 8,522 36,453 604,927 103,630 294,113 Corporate Centre £000 Intragroup items and eliminations £000 Total £000 – 576 6,529 – 75,118 50,413 141,505 213,693 2,420,618 420,126 925,940 (1,040,129) 784,750 – (302,937) 2,096,749 794,228 1,047,645 1,007,587 (1,128,797) 3,817,412 1,326,719 657,956 482,577 185,355 384,186 173,219 – (71,131) 2,122,351 168,193 (610,948) 573,775 1,984,675 667,932 557,405 168,193 (682,079) 2,696,126 1,539 2,245 6,962 275 11,021 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 73 Notes to the consolidated financial statements continued 4 Operating segments continued (c) Segmental analysis of assets and liabilities continued Intangible assets Deferred acquisition costs Financial assets Reinsurance assets Other assets Total assets Insurance liabilities Other liabilities Total liabilities Capital expenditure London Market £000 UK and Europe £000 30,507 52,609 1,175,492 469,971 482,204 2,850 41,102 320,776 120,662 231,224 International £000 8,645 37,901 471,676 113,799 536,702 31 December 2008 Restated Corporate Centre £000 Intragroup items and eliminations £000 Total £000 – (482) 6,555 – 121,028 48,557 131,130 – 2,088,972 – (200,638) 503,794 742,713 (1,005,953) 986,890 2,210,783 716,614 1,168,723 870,296 (1,207,073) 3,759,343 1,541,644 573,752 436,949 498,964 109,566 219,436 – (200,141) 2,277,416 196,041 (567,894) 530,901 2,115,396 656,385 608,530 196,041 (768,035) 2,808,317 8,622 337 934 220 10,113 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 US, 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 from external parties: Gross premium revenues earned from external parties London Market £000 UK and Europe £000 UK and Ireland Europe United States Rest of World 33,028 47,271 324,757 224,878 257,873 111,552 4,440 23,337 Year to 31 December 2009 Corporate Centre £000 Total £000 London Market £000 UK and Europe £000 – – – – 315,199 189,336 519,935 339,228 22,279 51,127 285,796 232,044 220,213 86,371 4,567 23,535 International £000 23,803 18,914 147,472 55,390 International £000 24,298 30,513 190,738 91,013 Year to 31 December 2008 Restated Corporate Centre £000 Total £000 – – – – 266,295 156,412 437,835 310,969 629,934 397,202 336,562 – 1,363,698 591,246 334,686 245,579 – 1,171,511 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 geographical 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. 74 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 5 Net asset value per share Net asset value Net tangible asset value Net asset value (total equity) £000 2009 NAV per share pence Net asset value (total equity) £000 1,121,286 1,070,873 299.2 285.7 951,026 902,469 2008 NAV per share pence 258.1 244.9 The net asset value per share is based on 374,819,025 shares (2008: 368,477,595 shares), 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 year (all attributable to owners of the Company) Opening shareholders’ equity Adjusted for the time weighted impact of capital distributions and issuance of shares Adjusted opening shareholders’ equity Annualised return on equity (%) 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 gains/(losses) on financial investments at fair value through profit or loss Investment result – financial assets Fair value gains/(losses) on derivative financial instruments Total result Investment expenses are presented within other expenses (note 9). 2009 £000 2008 £000 280,497 951,026 (20,429) 70,808 824,304 (55,700) 930,597 768,604 30.1 9.2 Note 2009 £000 2008 £000 94,678 75,740 19,733 4,743 87,296 (127,053) 8 22 182,769 396 (27,632) (52,978) 183,165 (80,610) 8 Analysis of return on financial investments (a) The weighted average return on financial investments for the year by currency, based on monthly asset values, was: Sterling US Dollar Other (b) Investment return 2009 % 4.2 8.5 6.5 2008 % (0.1) (2.5) 0.4 London Market UK and Europe International Corporate Centre 2009 Total £000 Debt and fixed income securities 80,616 Equities and shares in unit trusts – Deposits with credit institutions/ cash and cash equivalents 285 80,901 % 8.0 – 0.7 7.7 19,212 14,769 954 34,935 5.9 28.5 48,887 7,668 1.4 7.8 1,210 57,765 9.2 17.5 0.4 6.8 4,239 3,923 1,006 9,168 3.8 12.3 152,954 26,360 3.3 3,455 5.2 182,769 £000 % £000 % £000 % £000 % London Market UK and Europe International Corporate Centre £000 % £000 % £000 % £000 % £000 % Debt and fixed income securities (7,966) Equities and shares in unit trusts – Deposits with credit institutions/ cash and cash equivalents 2,503 (0.9) – 7,374 (25,529) 3.4 (41.9) (7,819) (5,552) (2.2) (16.2) 4,384 (7,186) 5.4 (18.0) (4,027) (38,267) 4.2 6,227 5.0 4,928 2.8 1,004 2.6 14,662 (5,463) (0.6) (11,928) (3.0) (8,443) (1.5) (1,798) (1.1) (27,632) (0.3) (28.4) 3.7 (1.3) Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 75 7.7 20.7 0.8 7.2 2008 Total Restated Notes to the consolidated financial statements continued 9 Other revenues and expenses Agency related income Profit commission Other underwriting income, catastrophe bonds 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 2009 £000 2008 £000 6,651 12,248 410 189 5,324 14,382 – 152 19,498 19,858 33,051 47,943 11,795 2,690 21,460 19,513 28,787 13,343 1,899 12,957 116,939 76,499 Note 2009 £000 2008 £000 108,626 12,391 5,260 6,510 13,300 25 31 79,048 10,468 5,269 5,794 – 146,087 100,579 The average monthly number of staff employed by the Group was 1,061 (2008: 914) comprising 368 underwriting and 693 administrative staff (2008: 335 and 579 respectively). Of the total remuneration shown above, an amount of £21,555,000 (2008: £21,053,000) was recharged to Syndicate 33. 11 Finance costs Interest and expenses associated with bank borrowings Interest and charges associated with Letters of Credit Interest charges arising on finance leases Note 36 37 2009 £000 2,493 2,780 20 5,293 2008 £000 3,201 1,922 35 5,158 12 Auditors’ remuneration Fees payable to the Group’s main external auditors, 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 auditors for the audit of the Group’s consolidated financial statements Fees payable to the Company’s auditors 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 2009 £000 188 638 90 185 1,101 11 1,112 2008 £000 262 519 75 75 931 12 943 *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. 76 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 12 Auditors’ remuneration continued 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 US pursuant to legislation during 2009 were £52,000 (2008: £23,000). 13 Net foreign exchange (losses)/gains The net foreign exchange (losses)/gains for the year include the following amounts: Exchange (losses)/gains recognised in the consolidated income statement Exchange (losses)/gains classified as a separate component of equity Overall impact of foreign exchange related items on net assets 2009 £000 2008 £000 (25,554) (69,589) 109,755 150,582 (95,143) 260,337 The above excludes profit or losses on foreign exchange derivative financial instruments which are included within the investment result. Net unearned premiums and deferred acquisition costs are treated as non monetary items in accordance with IFRS. As a result, a foreign exchange mismatch arises caused by these items being earned at historical rates of exchange prevailing at the original transaction date whereby resulting claims are retranslated at the end of each period. The impact of this mismatch on the income statement is shown below. Opening balance sheet impact of non retranslation of non monetary items (Loss)/gain included within profit representing the non retranslation of non monetary items Closing balance sheet impact of non retranslation of non monetary items 2009 £000 2008 £000 50,525 (53,732) 14,438 36,087 (3,207) 50,525 14 Foreign currency items on economic hedges and intragroup borrowings In the prior year, the Group 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. The current year comparatives are not significant and as such this presentation has not been applied to the consolidated income statement for the year ended 31 December 2009. The current year comparatives are shown below: Impact as at 31 December 2009 Realised gains on foreign currency derivative contracts used to manage retranslation risk associated with the net investment in Bermuda and Guernsey insurance operations Consolidated income statement 2009 £000 Consolidated other comprehensive income 2009 £000 Total impact on equity 2009 £000 314 – 314 Retranslation loss on managed net investment in Bermuda and Guernsey insurance operations – (5,207) (5,207) Unrealised translation (losses)/gains on intragroup borrowings Total losses recognised Impact as at 31 December 2008 (4,362) 4,362 – (4,048) (845) (4,893) Consolidated income statement 2008 £000 Consolidated other 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 Foreign exchange losses of £6,058,000 before tax (£4,362,000 after tax) (2008: £8,463,000 and £12,580,000 respectively) have been 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. In the prior year the Group entered into 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 (note 22). Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 77 Notes to the consolidated financial statements continued 14 Foreign currency items on economic hedges and intragroup borrowings continued The contracts expired in January 2009 and a gain of £314,000 was recognised for the year ended 31 December 2009. Formal hedge accounting designation was not achievable due to the specific effectiveness requirements of IAS 39. The Group did not enter into any new economic hedging derivative contracts during the current year. 15 Intangible assets At 1 January 2008 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 Amortisation charges Closing net book amount At 31 December 2008 Cost Accumulated amortisation and impairment Net book amount Year ended 31 December 2009 Opening net book amount Other additions Amortisation charges Closing net book amount At 31 December 2009 Cost Accumulated amortisation and impairment Net book amount Goodwill £000 Syndicate capacity £000 State authorisation licences £000 Other £000 Total £000 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 7,975 – – 24,505 – – 7,975 24,505 10,405 (2,430) 24,505 – 7,975 24,505 5,083 – 5,083 5,083 1,225 – – 6,308 6,308 – 6,308 6,308 – – 6,308 6,308 – 6,308 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 9,769 2,775 (919) 48,557 2,775 (919) 11,625 50,413 13,366 (1,741) 54,584 (4,171) 11,625 50,413 Goodwill is allocated to the Group’s cash generating units (CGUs) identified according to country of operation and business segment. Goodwill is considered to have an indefinite life and as such is tested for impairment annually on a value in use basis similar to that described below for the Group's intangible asset relating to Syndicate capacity. 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 CGU 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 2.5% (2008: 2%) consistent with the industry long-term average. A pre-tax discount factor of 1.8% (2008: 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 2009. The Group has previously 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 34). This intangible asset has been allocated for impairment testing purposes to one individual CGU being the Group’s North American underwriting businesses. The Group has considered the recoverable amount of this CGU on a consistent basis to the active Lloyd’s corporate member entity outlined above. 78 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 15 Intangible assets continued Other intangible assets relate to the costs of acquiring rights to customer contractual relationships from AON Limited in 2007, and the additions during 2008 and 2009 relate to software licence and development costs. The amortisation charge for the year includes £660,000 (2008: £nil) 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 2009 was £7,368,000 (2008: £5,230,000). There are no charges for impairment during the current or prior financial year. At 31 December 2009 there were no assets under development on which no amortisation has been charged (2008: £5,230,000). 16 Property, plant and equipment At 1 January 2008 Cost Accumulated depreciation Net book amount Year ended 31 December 2008 Opening net book amount Additions Disposals Depreciation charge Foreign exchange movements Closing net book amount At 31 December 2008 Cost Accumulated depreciation Net book amount Year ended 31 December 2009 Opening net book amount Additions Disposals Depreciation charge Foreign exchange movements Closing net book amount At 31 December 2009 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 (160) 2,825 2,825 – – (40) – 2,785 2,985 (200) 2,785 2,785 3,022 – (59) – 1,044 (379) 665 665 257 – (222) 254 954 1,700 (746) 954 954 2,286 (214) (330) (95) 5,748 2,601 896 (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 19,668 550 – (13) (94) (1) 442 15,379 2,938 (69) (4,644) (151) 19,668 8,246 (296) (5,127) (247) 13,453 22,244 6,007 (259) 3,807 (1,206) 940 (498) 42,732 (29,279) 53,486 (31,242) 5,748 2,601 442 13,453 22,244 The Group’s land and buildings assets relate to freehold property in the UK and US. Assets with a net book value of £398,000 were held under finance leases (2008: £582,000). The total depreciation charge for the year in respect of assets held under finance leases was £56,000 (2008: £116,000) and is included in other expenses. At 31 December 2009 there were £1,906,000 of assets under development upon which no depreciation has yet been charged (2008: £3,106,000). Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 79 Notes to the consolidated financial statements continued 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 The Group’s interests in its principal associates, all of which are unlisted, were as follows: 2009 £000 2008 £000 7,200 – 118 7,318 1,502 5,438 260 7,200 100% results 2009 Associates incorporated in the UK Associates incorporated in Europe Total at the end of 2009 2008 Associates incorporated in the UK Associates incorporated in Europe Total at the end of 2008 % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profit after tax £000 From 25% to 49% up to 25% 11,100 943 7,800 436 8,743 1,379 12,043 8,236 10,122 234 30 264 100% results % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profit after tax £000 From 25% to 49% up to 25% 11,981 2,066 8,809 1,289 14,047 10,098 6,214 1,483 7,697 877 268 1,145 There were no additional investments in associates made during 2009. 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. During the prior year the Group made equity investments in Senior Wright Indemnity Ltd and Media Insurance Brokers. Cash consideration of £5,438,000 was paid. 18 Deferred acquisition costs Gross £000 Reinsurance £000 2009 Net £000 Gross £000 Reinsurance £000 2008 Net £000 Balance deferred at 1 January Acquisition costs incurred in relation to insurance contracts written Acquisition costs expensed to the income statement 131,130 312,705 (302,330) (21,068) (42,212) 45,696 110,062 270,493 (256,634) 123,081 270,126 (262,077) (14,568) (40,634) 34,134 108,513 229,492 (227,943) Balance deferred at 31 December 141,505 (17,584) 123,921 131,130 (21,068) 110,062 The deferred amount of insurance contract acquisition costs attributable to reinsurers of £17,584,000 (2008: £21,068,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 28). The amounts expected to be recovered before and after one year are estimated as follows: Within one year After one year 80 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2009 £000 2008 £000 123,921 – 110,062 – 123,921 110,062 19 Reinsurance assets Reinsurers’ share of insurance liabilities Provision for non-recovery and impairment Reinsurance assets Note 2009 £000 2008 £000 425,572 (5,446) 511,325 (7,531) 27 420,126 503,794 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 217,278 202,848 254,546 249,248 420,126 503,794 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 gain during the year of £2,085,000 (2008: loss of £4,205,000) 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. Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Total investments Catastrophe bonds Derivative financial instruments Total financial assets carried at fair value Borrowings from credit institutions carried at amortised cost* Derivative financial instruments Total financial liabilities *The fair value of borrowings from credit institutions is not considered to be significantly different from the amortised cost. Note 2009 Fair value £000 2008 Fair value £000 2,255,737 1,928,599 124,864 28,269 133,841 11,394 2,400,972 2,081,732 – 40 11,310 1,018 22 2,413,300 2,081,772 2009 Fair value £000 138,000 539 Note 22 2008 Fair value £000 90,278 53,072 138,539 143,350 An analysis of the credit risk and contractual maturity profiles of the Group’s financial instruments is given in notes 3.2(c) and 3.2(d). The Group’s investment in catastrophe bonds consists of £11.3 million, comprising of 12 catastrophe bonds with credit ratings of BB or above. The issuers of these securities have used the proceeds to collateralise certain catastrophe reinsurance obligations mainly in US and European wind and earthquake risks. The investment in these contracts is therefore at risk of loss, in whole or in part if a covered catastrophe occurs. The Group’s borrowings from credit institutions at 31 December 2009 are denominated in Pound Sterling (2008: US Dollars). The entire amount from December 2008 was repaid during the year and the amount outstanding at 31 December 2009 is expected to be repaid in full within one year from the balance sheet date. The movement in fair value of derivative instrument liabilities includes settlements totalling £49,838,000, realised gains of £3,234,000 and unrealised losses of £539,000. From 3 January 2007 until 6 May 2008, the Group designated US$182 million of foreign currency borrowings as hedging instruments in a net investment hedge relationship. The hedging relationship was effective throughout the entire period. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 81 Notes to the consolidated financial statements continued 20 Financial assets and liabilities continued Investments at 31 December are denominated in the following currencies at their fair value: 2009 £000 2008 £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 21 Loans and receivables including insurance receivables Gross receivables arising from insurance and reinsurance contracts 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 508,292 293,697 1,559,673 1,378,167 256,735 187,772 2,255,737 1,928,599 60,549 51,914 21,378 55,011 45,611 24,242 133,841 124,864 11,223 171 – 21,335 6,934 – 11,394 28,269 2,400,972 2,081,732 2009 £000 2008 £000 413,449 (955) 441,752 (560) 412,494 441,192 270,593 141,901 274,470 166,722 412,494 441,192 10,020 7,948 17,758 12,227 20,273 16,010 11,959 9,480 13,546 10,190 488,782 494,315 482,194 6,588 491,529 2,786 488,782 494,315 There is no significant concentration of credit risk with respect to loans and receivables as the Group has a large number of internationally dispersed debtors. The Group has recognised a loss of £395,000 (2008: gain of £832,000) for the impairment of receivables during the year ended 31 December 2009. 82 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 22 Derivative financial instruments The Group entered into both exchange-traded and over the counter derivative contracts for a number of purposes during 2009. The Group had the right and intention to settle each contract on a net basis. The assets and liabilities of these contracts at 31 December 2009 all mature within one year of the balance sheet date and are detailed below: 31 December 2009 Derivative financial instrument assets included on balance sheet Foreign exchange forward contracts Interest rate futures contracts Derivative financial instrument liabilities included on balance sheet Event linked futures contracts 31 December 2008 Derivative financial instrument assets included on balance sheet Event linked futures contracts Derivative financial instrument liabilities included on balance sheet Foreign exchange option collar contracts Foreign exchange forward contracts Gross contract notional amount £000 50,105 21,288 71,393 Fair value of assets £000 180 906 1,086 Fair value of liabilities £000 Net balance sheet position £000 7 61 68 173 845 1,018 Gross contract notional amount US$000 Fair value of assets £000 Fair value of liabilities £000 Net balance sheet position £000 2,400 18 557 539 Gross contract notional amount US$000 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 42,540 10,532 Net balance sheet position £000 42,540 10,532 53,072 53,072 Foreign exchange forward contracts During the current and prior year the Group entered into a series of conventional over the counter forward contracts in order to secure translation gains made on Euro, US Dollar and other non Pound Sterling denominated monetary assets. The contracts require the Group to forward sell a fixed amount of the relevant currency for Pound Sterling at pre-agreed future exchange rates. The Group made a gain on these forward contracts of £769,000 (2008: loss of £10,123,000) as included in note 7. The opposite exchange loss is included within financial investments. There was no initial purchase cost associated with these instruments. Interest rate futures contracts During the year the Group continued short selling a number of Government bond futures and sovereign futures denominated in a range of currencies to informally hedge substantially all of the interest rate risk on specific long portfolios of the matching currencies denominated corporate bonds. All contracts are exchange traded and the Group made a loss on these futures contracts of £78,000 (2008: £360,000) as included in note 7. Event linked future contracts In June 2008 the Group commenced trading event linked future contracts which are transacted on the 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 loss on event linked future contracts of £609,000 (2008: gain of £45,000) as included in note 7. Foreign exchange option collar contracts During the fourth quarter of 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. These contracts settled in 2009 and the Group made a gain of £314,000 (2008: loss of £42,540,000) as included in notes 7 and 14. The related exchange loss recognised on the retranslation of the hedged portion of underlying net investments concerned was £5,207,000 and is included within the overall loss of £69,589,000 recognised in other comprehensive income (note 13). Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 83 Notes to the consolidated financial statements continued 23 Fair value measurements In accordance with the Amendments to IFRS7 Financial Instruments: Disclosures, the fair value of financial instruments based on a three-level fair value hierarchy that reflects the significance of the inputs used in measuring the fair value is provided below. As at 31 December 2009 Financial assets Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Catastrophe bonds Derivative financial instruments Total Financial liabilities Derivative financial instruments As at 31 December 2008 Financial assets Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Catastrophe bonds Derivative financial instruments Total Financial liabilities Derivative financial instruments Level 1 £000 Level 2 £000 Level 3 £000 Total £000 627,702 1,628,035 129,419 – 11,310 1,018 162 11,394 – – – 2,255,737 133,841 11,394 11,310 1,018 4,260 – – – 639,258 1,769,782 4,260 2,413,300 – Level 1 £000 539 Level 2 £000 – 539 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 – 53,072 – 53,072 The levels of the fair value hierarchy are defined by the standard as follows: Level 1 – fair values measured using quoted prices (unadjusted) in active markets for identical instruments; Level 2 – fair values measured using directly or indirectly observable inputs or other similar valuation techniques for which all significant inputs are based on observable market data; Level 3 – fair values measured using valuation techniques for which significant inputs are not based on market observable data. The fair values of the Group’s financial assets are based on prices provided by investment managers who obtain market data from numerous independent pricing services. The pricing services used by the investment manager obtain actual transaction prices for securities that have quoted prices in active markets. For those securities which are not actively traded, the pricing services use common market valuation pricing models. Observable inputs used in common market valuation pricing models include, but are not limited to, broker quotes, credit ratings, interest rates and yield curves, prepayment speeds, default rates and other such inputs which are available from market sources. The fair values of the Group’s investments in catastrophe bonds are based on quoted market prices or, where such prices are not available, by reference to broker or underwriter bid indications. Investments in mutual funds comprise a portfolio of stock investments in trading entities which are invested in various quoted investments. The fair value of shares in unit trusts are based on the net asset value of the fund as reported by independent pricing sources or the fund manager. Included within Level 1 of the fair value hierarchy are Government bonds, Treasury bills and exchange traded equities which are measured based on quoted prices. 84 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 23 Fair value measurements continued Level 2 of the hierarchy contains US Government Agencies, Corporate Securities, Asset Backed Securities and Mortgage Backed Securities and Catastrophe bonds. The fair value of these assets are based on the prices obtained from both investment managers and investment custodians as discussed above. The Group records the unadjusted price provided and validates the price through a number of methods including a comparison of the prices provided by the investment managers with the investment custodians and the valuation used by external parties to derive fair value. Quoted prices for US Government Agencies and Corporate Securities are based on a limited number of transactions for those securities and as such the Group considers these instruments to have similar characteristics of those instruments classified as Level 2. Also included within Level 2 are units held in traditional long funds and long and short special funds and over the counter derivatives. Level 3 contains investments in a limited partnership and unquoted equity securities which have limited observable inputs on which to measure fair value. In the prior year, investments in a mutual fund were included within level 3 as redemptions from the fund were suspended. The fund was redeemed in full in 2009. Unquoted equities are carried at cost, which is deemed to be comparable to fair value. The effect of changing one or more inputs used in the measurement of fair value of these instruments to another reasonably possible assumption would not be significant and no further analysis has been performed. Derivative instruments included within Level 3 in the prior year represented event linked future contracts which are transacted on the Chicago Climate Futures Exchange. During the current year, the classification of these instruments was reviewed and they have been transferred into Level 2 as the valuation of the derivative is based on observable inputs used by the exchange to determine fair value. In certain cases, the inputs used to measure the fair value of a financial instrument may fall into more than one level within the fair value hierarchy. In this instance, the fair value of the instrument in its entirety is classified based on the lowest level of input that is significant to the fair value measurement. During the year, there were no transfers made between Level 1 and Level 2 of the fair value hierarchy. The following table sets forth a reconciliation of opening and closing balances for financial instruments classified under Level 3 of the fair value hierarchy: 31 December 2009 Balance at 1 January Total gains or losses through profit or loss* Purchases Issues Settlements Transfer into Level 2 Closing balance *Total gains/(losses) are included within the investment result in the income statement. 31 December 2008 Balance at 1 January Total gains or losses through profit or loss* Purchases Transfers into Level 3 Settlements Closing balance *Total gains/(losses) are included within the investment result in the income statement. 24 Cash and cash equivalents Cash at bank and in hand Short-term bank deposits Equities and shares in unit trusts £000 Deposits with credit institutions £000 Derivative Instruments £000 5,877 – – – (5,877) – 40 – – – – (40) Total £000 6,456 245 3,353 123 (5,877) (40) – – 4,260 539 245 3,353 123 – – 4,260 Equities and shares in unit trusts £000 Deposits with credit institutions £000 Derivative Instruments £000 – – 539 – – 539 – – – 5,877 – 5,877 – – 40 – – 40 Total £000 – – 579 5,877 – 6,456 2009 £000 2008 £000 166,780 92,867 353,542 87,080 259,647 440,622 The Group holds its cash deposits with a well diversified range of banks and financial institutions. Cash and cash equivalents include amounts of US$334,000 (2008: US$17,775,000) held in escrow to settle deferred consideration on acquisitions. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 85 Notes to the consolidated financial statements continued 25 Share capital Group Issued share capital 31 December 2009 31 December 2008 Share capital £000 Number of shares Share capital £000 Number of shares 20,158 403,148,858 20,067 401,330,601 The amounts presented in the equity structure of the Group above relate to Hiscox Ltd, the legal parent Company. Changes in Group share capital and contributed surplus At 1 January 2008 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2008 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2009 Ordinary share capital £000 19,898 169 – Share premium £000 4,955 4,463 – Contributed surplus £000 398,834 – (46,756) 20,067 9,418 352,078 91 – 2,413 – – (48,613) 20,158 11,831 303,465 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) 2009 Number of 5p ordinary shares in issue (thousands) 2008 401,331 397,938 1,818 3,393 403,149 401,331 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 years’ 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 £5,260,000 (2008: £5,269,000). This comprises charges of £4,972,000 (2008: £4,960,000) in respect of performance share plan awards and £288,000 (2008: £309,000) 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) 86 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 2009 2008 1.4 4.24 3.25 31 310.8 3.2-5.6 4.75 3.25 27-30 247.9 25 Share capital continued Share options and performance share plan awards continued The weighted average fair value of each share option granted during the year was 85.5p (2008: 60.5p). The weighted average fair value of each performance share plan award granted during the year was 308.0p (2008: 213.4p). Movements in the number of share options during the year and details of the balances outstanding at 31 December 2009 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. 26 Retained earnings and other reserves Currency translation reserve at 31 December Retained earnings at 31 December 2009 £000 2008 £000 37,728 107,317 784,104 462,146 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. There were no transactions by the Company in its own shares during the year. During 2008, Hiscox Ltd purchased 28,300,742 of ordinary shares of 5p each in open market transactions. These shares are held in treasury. In addition, during 2008, 1,000,000 ordinary shares of 5p each were purchased and held in trust. Retained earnings reduced by £65,066,000 being the consideration paid for these transactions. Included within this amount were transaction cost expenses of £125,000 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 2009 Hiscox Ltd held 28,142,874 shares in treasury. Additional details are shown in note 38 to these financial statements in respect of additional Hiscox Ltd shares held by subsidiaries. Included within Group retained earnings is an amount of £27,068,000 (2008: £23,932,000), 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. In addition, the Group maintains certain levels of capital to meet minimum solvency requirements for regulatory and rating purposes. 27 Insurance liabilities and reinsurance assets Gross Claims reported and claim adjustment expenses Claims incurred but not reported Unearned premiums Total insurance liabilities, gross Recoverable from reinsurers Claims reported and claim adjustment expenses Claims incurred but not reported Unearned premiums Total reinsurers’ share of insurance liabilities Net Claims reported and claim adjustment expenses Claims incurred but not reported Unearned premiums Total insurance liabilities, net Note 2009 £000 2008 £000 800,307 749,016 573,028 885,905 881,823 509,688 2,122,351 2,277,416 173,987 154,903 91,236 180,406 245,897 77,491 19 420,126 503,794 626,320 594,113 481,792 705,499 635,926 432,197 1,702,225 1,773,622 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 939,565 762,660 979,380 794,242 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 87 1,702,225 1,773,622 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 eight 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. Notes to the consolidated financial statements continued 27 Insurance liabilities and reinsurance assets continued 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 2009 and 2008 are not material. 27.1 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. Catastrophe events which are expected to impact multiple business units in the Group are analysed by the central analysis team. They combine information from underwriters, the claims team and past experience of similar events to produce gross and net estimates of the ultimate loss cost to each part of the Group. These figures are then incorporated by the acturial team into the quarterly reserving exercise. This process ensures that a consistent approach is taken across the Group. 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). 88 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 27 Insurance liabilities and reinsurance assets continued 27.1 Insurance contracts assumptions continued (b) Claims development tables continued 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. Insurance claims and claim adjustment expenses reserves – gross at 100% 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 2008 £000 2009 £000 Total £000 687,619 667,957 740,854 764,878 807,184 803,540 801,393 799,815 805,284 407,142 431,162 439,171 423,316 419,019 394,730 390,836 392,092 – 456,946 468,733 440,712 453,703 448,878 438,322 433,836 – – 688,408 1,147,193 762,649 1,268,711 727,804 1,270,977 687,872 1,252,857 690,802 1,246,928 – 673,061 – – – – – – 595,682 569,356 548,523 517,992 – – – – – 798,296 1,105,836 941,165 715,890 – 679,971 – – – – – – – – – – – – 849,316 6,736,438 – 5,825,623 – 4,848,012 – 4,100,618 – 3,612,811 – 2,309,653 – 1,626,065 – 1,191,907 805,284 – 805,284 392,092 433,836 673,061 1,246,928 517,992 679,971 941,165 849,316 6,539,645 (700,222) (342,993) (381,214) (579,121) (1,089,428) (425,122) (464,969) (507,312) (178,036) (4,668,417) 105,062 49,099 52,622 93,940 157,500 92,870 215,002 433,853 671,280 1,871,228 Total gross 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 2009. Reconciliation of 100% disclosures above to Group’s share – gross 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 2008 £000 2009 £000 Total £000 805,284 392,092 433,836 673,061 1,246,928 517,992 679,971 941,165 849,316 6,539,645 (198,488) (79,763) (96,473) (153,764) (311,634) (107,151) (129,670) (182,655) (149,469) (1,409,067) 606,796 312,329 337,363 519,297 935,294 410,841 550,301 758,510 699,847 5,130,578 (700,222) (342,993) (381,214) (579,121) (1,089,428) (425,122) (464,969) (507,312) (178,036) (4,668,417) 169,966 67,275 83,332 134,861 274,605 86,974 83,412 89,268 23,319 1,013,012 (530,256) (275,718) (297,882) (444,260) (814,823) (338,148) (381,557) (418,044) (154,717) (3,655,405) 76,540 36,611 39,481 75,037 120,471 72,693 168,744 340,466 545,130 1,475,173 95,065 1,966,293 74,150 1,549,323 Total Group liability to external parties included in balance sheet – gross** **This represents the claims element of the Group’s insurance liabilities. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 89 Accident year Estimate of ultimate claims costs as adjusted for foreign exchange* at end of accident year one year later two years later three years later four years later five years later six years later seven years later eight years later Current estimate of cumulative claims Cumulative payments to date Liability recognised at 100% level Liability recognised in respect of prior accident years at 100% level Accident year Current estimate of cumulative claims Less: attributable to external Names Group’s share of current ultimate claims estimate Cumulative payments to date Less: attributable to external Names Group’s share of cumulative payments Liability for 2001 to 2009 accident years recognised on Group’s balance sheet Liability for accident years before 2001 recognised on Group’s balance sheet Notes to the consolidated financial statements continued 27 Insurance liabilities and reinsurance assets continued 27.1 Insurance contracts assumptions continued (b) Claims development tables continued Insurance claims and claim adjustment expenses reserves – net at 100% Accident year Estimate of ultimate claims costs as adjusted for foreign exchange* at end of accident year one year later two years later three years later four years later five years later six years later seven years later eight years later Current estimate of cumulative claims Cumulative payments to date Liability recognised at 100% level Liability recognised in respect of prior accident years at 100% level Accident year Current estimate of cumulative claims Less: attributable to external Names Group’s share of current ultimate claims estimate Cumulative payments to date Less: attributable to external Names Group’s share of cumulative payments Liability for 2001 to 2009 accident years recognised on Group’s balance sheet Liability for accident years before 2001 recognised on Group’s balance sheet 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 2008 £000 2009 £000 Total £000 332,353 373,821 445,270 484,110 473,028 458,392 452,230 454,670 452,892 274,882 299,911 310,031 286,691 280,039 265,680 259,680 265,416 – 360,173 379,825 346,071 357,087 348,250 343,189 339,738 – – 575,992 628,824 603,964 566,162 567,034 552,954 – – – 678,058 778,298 768,654 743,791 733,182 – – – – 528,238 520,805 503,643 460,391 – – – – – 691,257 629,054 609,807 – – – – – – 768,934 687,294 – – – – – – – 686,588 4,896,475 – 4,297,832 – 3,587,440 – 2,898,232 – 2,401,533 – 1,620,215 – 1,051,648 720,086 – 452,892 – 452,892 265,416 339,738 552,954 733,182 460,391 609,807 687,294 686,588 4,788,262 (391,233) (216,919) (290,986) (467,304) (605,267) (374,184) (387,771) (397,569) (154,283)(3,285,516) 61,659 48,497 48,752 85,650 127,915 86,207 222,036 289,725 532,305 1,502,746 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 2009. Reconciliation of 100% disclosures above to Group’s share – net 2001 £000 2002 £000 2003 £000 2004 £000 2005 £000 2006 £000 2007 £000 2008 £000 2009 £000 Total £000 452,892 265,416 339,738 552,954 733,182 460,391 609,807 687,294 686,588 4,788,262 (105,631) (52,130) (74,278) (126,704) (175,504) (95,039) (117,227) (130,913) (117,174) (994,600) 347,261 213,286 265,460 426,250 557,678 365,352 492,580 556,381 569,414 3,793,662 (391,233) (216,919) (290,986) (467,304) (605,267) (374,184) (387,771) (397,569) (154,283)(3,285,516) 88,950 39,665 61,805 109,032 144,904 76,539 72,739 65,647 20,906 680,187 (302,283) (177,254) (229,181) (358,272) (460,363) (297,645) (315,032) (331,922) (133,377)(2,605,329) 44,978 36,032 36,279 67,978 97,315 67,707 177,548 224,459 436,037 1,188,333 42,040 1,544,786 32,100 1,220,433 Total Group liability to external parties included in the balance sheet – net** **This represents the claims element of the Group’s insurance liabilities and reinsurance assets. 90 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 27 Insurance liabilities and reinsurance assets continued 27.2 Movements in insurance claims liabilities and reinsurance claims assets Year ended 31 December Gross £000 Reinsurance £000 2009 Net £000 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 (1,767,728) (508,238) 571,689 154,954 426,303 (1,341,425) (463,218) 460,765 123,445 45,020 (110,924) (31,509) Gross £000 Reinsurance £000 2008 Net £000 (1,215,887) (698,471) 549,106 (402,476) 222,672 219,091 (117,582) 102,122 (993,215) (479,380) 431,524 (300,354) Total at end of year (1,549,323) 328,890 (1,220,433) (1,767,728) 426,303 (1,341,425) Claims reported and loss adjustment expenses Claims incurred but not reported (800,307) (749,016) 173,987 154,903 (626,320) (594,113) (885,905) (881,823) 180,406 245,897 (705,499) (635,926) Total at end of year (1,549,323) 328,890 (1,220,433) (1,767,728) 426,303 (1,341,425) 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 2009 Net £000 Gross £000 Reinsurance £000 2008 Net £000 (725,132) 122,538 (602,594) (828,940) 226,808 (602,132) 216,894 (77,518) 139,376 130,469 (7,717) 122,752 Total claims and claim adjustment expenses (508,238) 45,020 (463,218) (698,471) 219,091 (479,380) 28 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 2009 £000 2008 £000 45,476 157,514 35,089 175,134 202,990 210,223 393 316 15,424 20,448 439 2,714 10,919 9,493 36,581 23,565 17,584 82,328 21,068 58,050 339,483 312,906 37 18 336,383 3,100 300,966 11,940 339,483 312,906 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. 29 Tax expense The Company and its subsidiaries are subject to enacted tax laws in the jurisdictions in which they are incorporated and domiciled. The principal subsidiaries of the Company and the country in which they are incorporated are listed in note 38. The amounts charged in the consolidated income statement comprise the following: Current tax expense/(credit) Deferred tax (credit)/expense Note 30 2009 £000 2008 £000 53,375 (13,254) (32,341) 66,713 40,121 34,372 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 91 Notes to the consolidated financial statements continued 29 Tax expense continued The standard rate of corporation tax in Bermuda is 0% whereas the effective rate of tax for the Group is 12.5% (2008: 32.7%). A reconciliation of the difference is provided below: Profit before tax Tax calculated at the standard corporation tax rate applicable in Bermuda: 0% (2008: 0%) Effects of: Tax on profits arising in the UK at 28% Overseas tax losses for which a deferred tax asset is recognised Other items Other overseas taxes Prior year tax adjustments Tax charge for the period 30 Deferred tax Deferred tax assets Trading losses in overseas entities 2009 £000 2008 £000 320,618 – 105,180 – 47,770 (8,081) (99) (2,706) 3,237 45,790 (1,681) 466 – (10,203) 40,121 34,372 2009 £000 2008 £000 14,077 5,996 The deferred tax asset relates to losses arising in overseas entities and is subject to overseas relief against future profits. Management consider it probable that taxable profits will arise in future in order to utilise the deferred tax asset. Net deferred tax liabilities Deferred tax assets Deferred tax liabilities Total net deferred tax liability 2009 £000 2008 £000 17,658 (87,331) 21,804 (96,449) (69,673) (74,645) Deferred tax assets and deferred tax liabilities relating to the same tax authority are presented net in the Group’s balance sheet. (a) Group deferred tax assets analysed by balance sheet headings At 31 December Trading losses in overseas entities Deferred tax assets At 31 December Tangible assets Trade and other payables Retirement benefit obligations Intangible assets – Syndicate capacity Other items Total deferred tax assets 2008 £000 5,996 5,996 2008 £000 863 4,050 – 4,715 12,176 Income statement (charge)/credit £000 8,081 8,081 Income statement (charge)/credit £000 741 (4,050) 1,310 (485) (1,461) 21,804 (3,945) Transfer to equity £000 – – Transfer to equity £000 – – – – (201) (201) 2009 £000 14,077 14,077 2009 £000 1,604 – 1,310 4,230 10,514 17,658 92 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 30 Deferred tax continued (b) Group deferred tax liabilities analysed by balance sheet headings At 31 December Investment in associated enterprises Financial assets Insurance contracts – equalisation provision* Other items Open years of account Total deferred tax liabilities 2008 £000 (17) (922) (6,703) – (7,642) (88,807) (96,449) Income statement (charge)/credit £000 – 469 (10,270) – (9,801) 18,919 9,118 Transfer to equity £000 – – – – – – – 2009 £000 (17) (453) (16,973) – (17,443) (69,888) (87,331) *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. Equalisation provisions are not permitted under IFRS which therefore results in the temporary difference for tax purposes. Following a change in the legislation at the end of 2008, Lloyd’s Corporate Members are also entitled to a tax deduction for claims equalisation losses although this is not a solvency requirement for Lloyd’s. The Group has provided for the deferred tax liability on its Corporate Members’ claims equalisation reserve during the year. 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. The Group has not provided for deferred tax assets totalling £8,452,000 (2008: £7,628,000) in relation to losses in overseas companies of £22,138,000 (2008: £21,230,000). 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. 31 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 scheme obligations Fair value of scheme assets Deficit/(surplus) for funded plans Unrecognised net actuarial (losses)/gains Past service costs recognised in other creditors Unrecognised surplus deemed irrecoverable Net amount recognised as a defined benefit obligation 2009 £000 2008 £000 140,676 (118,391) 101,615 (115,166) 22,285 (17,648) (11,800) 7,163 (13,551) 9,767 – 3,784 – – As the fair value of scheme obligations exceeds the present value of the scheme assets, the scheme reports a deficit. The Group recognises actuarial gains and losses using the corridor method as defined in the Group’s accounting policy. As a result of a court ruling during the year, past service costs of £11.8 million have been recognised in respect of the equalisation of the scheme obligation for the period between May 1992 and May 1997. The requirement on the scheme to equalise is based on the Barber case in the early 1990s which established that it was unlawful under EU law for retirement ages for men and women to differ. The past service cost has been recognised immediately and has been included within other creditors as payment in full has been agreed by the Group. 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 2008, and updated at each intervening balance sheet date by the actuaries. The present value of the defined benefit obligation is determined by discounting the estimated future cash flows using interest rates of AA rated corporate bonds that have terms to maturity that approximate to the terms of the related pension liability. The scheme assets are invested as follows: At 31 December Equities Debt and fixed income assets Cash 2009 £000 2008 £000 42,488 65,935 9,968 43,316 71,670 180 118,391 115,166 The majority of the scheme’s debt and fixed income assets are held through the ownership of equity units in 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. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 93 Notes to the consolidated financial statements continued 31 Employee retirement benefit obligations continued The amounts recognised in the Group’s income statement are as follows: Current service cost Interest cost Expected return on scheme assets Past service costs Net actuarial gain recognised Effect of deemed irrecoverability of surplus Total included in staff costs The actual return on scheme assets was a gain of £4,221,000 (2008: loss of £10,387,000). The movement in liability recognised in the Group’s balance sheet is as follows: At beginning of year Total expense charged in the income statement of the Group Past service costs recognised in other creditors Contributions paid At end of year A reconciliation of the fair value of 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 scheme obligations of the scheme is as follows: Opening present value of scheme obligations Current service cost Interest cost Actuarial losses/(gains) Past service costs Benefits paid from scheme Settlements with scheme members Closing present value of scheme obligations Note 2009 £000 2008 £000 300 5,720 (7,899) 11,800 – 3,379 200 6,135 (7,720) – (433) 1,818 10 13,300 – Note 10 2009 £000 2008 £000 – 13,300 (11,800) (1,500) – – – – – – 2009 £000 2008 £000 115,166 7,899 (3,678) 1,500 – (2,496) 127,576 7,720 (18,107) – – (2,023) 118,391 115,166 2009 £000 2008 £000 101,615 300 5,720 23,737 11,800 (2,496) – 106,793 200 6,135 (9,490) – (2,023) – 140,676 101,615 A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme obligations Experience (losses)/gains on scheme assets 2009 £000 2008 £000 – (3,678) – (18,107) 2007 £000 2,783 75 2006 £000 2005 £000 (3,310) 6,480 (1,223) 10,764 94 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 31 Employee retirement benefit obligations continued Additional memorandum information at the end of the current and previous four accounting periods is presented below: Present value of scheme obligations Fair value of scheme assets 2009 £000 2008 £000 2007 £000 2006 £000 2005 £000 140,676 (118,391) 101,615 (115,166) 106,793 (127,576) 137,461 (133,660) 137,533 (101,409) Present value of unfunded obligations/(surplus scheme assets) 22,285 (13,551) (20,783) 3,801 36,124 Gross liability recognised on balance sheet – – – 3,801 16,677 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 Female The average life expectancy in years of a pensioner retiring at 60, 15 years after the balance sheet date is as follows: Male Female Other principal actuarial assumptions are as follows: Discount rate Expected return on scheme assets Inflation assumption Pension increases 2009 years 24.5 27.6 2009 years 25.6 28.6 2009 % 5.70 6.50 3.90 3.90 2008 years 24.5 27.6 2008 years 25.6 28.6 2008 % 6.70 6.90 3.00 3.00 The triennial valuation carried out as at 31 December 2008, resulted in a deficit position of £5.1 million and excludes the impact of the equalisation of scheme obligations. The equalisation of scheme obligations has been included in the valuation as at 31 December 2009 and an amount of £11.8 million has been recognised as past service costs. The Group has agreed to fund the £5.1 million deficit paying equal instalments over four years and to pay the full amount relating to the equalisation of obligations in 2010. During the year the Group made the first instalment of £1.5 million to the defined benefit scheme (2008: £nil). 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 believe 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 2009 by approximately £4 million, the Group considers that the most sensitive and judgemental 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 2009 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 5.45% Effect of an increase in inflation Use of inflation assumption of 4.15% (22,285) (30,165) (22,285) (24,454) – – 32 Earnings per share Basic earnings per share are 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 held by the Group and held in treasury as own shares. Basic Profit for the year attributable to the owners of the Company (£000) Weighted average number of ordinary shares (thousands) Basic earnings per share (pence per share) 2009 2008 280,497 372,848 75.2p 70,808 377,506 18.8p Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 95 Notes to the consolidated financial statements continued 32 Earnings per share continued 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 for the year attributable to the owners of the Company (£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) 2009 2008 280,497 70,808 372,848 14,966 377,506 13,351 387,814 390,857 72.3p 18.1p Diluted earnings per share has been calculated after taking account of 14,345,744 (2008: 13,003,000) options and awards under employee share option and performance plan schemes and 619,870 (2008: 348,000) options under SAYE schemes. 33 Dividends paid to owners of the Company Interim dividend for the year ended: 31 December 2009 of 4.5p (net) per share 31 December 2008 of 4.25p (net) per share Final dividend for the year ended: 31 December 2008 of 8.5p (net) per share 31 December 2007 of 8.0p (net) per share 2009 £000 2008 £000 16,834 – 31,779 – – 15,615 – 31,141 48,613 46,756 A second interim dividend in respect of 2009 of 10.5p per share, amounting to a total dividend of 15.0p for the year, was approved by the Board of Directors on 25 February 2010. These financial statements do not reflect this dividend as a distribution or liability in accordance with IAS 10 Events after the reporting period. 34 Acquisitions The Group did not acquire any associates or subsidiaries during the current year. 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. On 16 August 2007, the Group acquired 100% of the share capital of ALTOHA Inc. in the US. 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. 35 Disposals There were no disposals during the current year. 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. 36 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 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. 96 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 36 Contingencies and guarantees continued The following guarantees have also been issued: (a) On 18 November 2009, Hiscox Capital Ltd and Hiscox Ltd entered into a deed of covenant in respect of a fellow subsidiary, Hiscox Dedicated Corporate Member Limited, in order to meet the subsidiary’s obligations to Lloyd’s. The total guarantee given under the deed of covenant (subject to limited exceptions) amounts to US$350 million provided by Hiscox Capital Ltd and £15 million provided by Hiscox Ltd. In the prior year, and up to 18 November 2009, a similar guarantee was provided by Hiscox Ltd and Hiscox Insurance Company (Bermuda) Limited for £138,831,798. 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) In the prior year 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), 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 2009 $225 million (2008: £137.5 million) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further £138 million by way of cash (2008: US$130 million). (c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2008: £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 2009 and 2008. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required. (e) As Hiscox 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 27 February 2009, Hiscox replaced its previous US$300 million facility and 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$450 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$109 million were issued with an effective date of 31 December 2009 (2008: US$38 million). 37 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 £614,000 (2008: £225,000). 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 £5,656,000 (2008: £5,499,000). Operating lease rental income for the year totalled £468,000 (2008: £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 2009 £000 2008 £000 5,683 177 15,730 457 14,501 5,621 144 17,913 99 17,497 36,548 41,274 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 2009 £000 468 1,053 – 1,521 2008 £000 468 1,521 – 1,989 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 97 Notes to the consolidated financial statements continued 37 Capital and lease commitments continued 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 £20,000 (2008: £35,000). The finance lease obligations to which the Group is committed include the following minimum lease payments: Current liabilities due for settlement no later than one year Non-current liabilities due for settlement after one year and no later than five years Less: future finance lease interest charges 2009 £000 226 177 403 (10) 393 2008 £000 246 223 469 (30) 439 The present value of the minimum lease payments is not materially different to the currently disclosed obligation. 38 Principal subsidiary companies of Hiscox Ltd at 31 December 2009 Company Nature of business 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 Hiscox Insurance Services (Guernsey) Limited Hiscox Capital Ltd* Hiscox Agency Ltd* Hiscox Services Ltd* Hiscox Europe Underwriting Limited Hiscox Europe Services 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 Underwriting agent General insurance Underwriting agent Service company Insurance intermediary Service company Country 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 Guernsey Bermuda Bermuda Bermuda Great Britain Great Britain *Held directly. **Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2008: 54,560) at 31 December 2009. †Hiscox Trustees Limited is the trustee of the Hiscox Employee Share Ownership Plan (ESOP). The ESOP owned 132,399 shares in Hiscox Ltd (2008: 132,399) at 31 December 2009. 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. 98 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 38 Principal subsidiary companies of Hiscox Ltd at 31 December 2009 continued All companies are wholly owned. The proportion of voting rights of subsidiaries held is the same as the proportion of equity shares held. 39 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 37 to 44. 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. Value of services provided by Hiscox Syndicates Limited to Syndicate 33 Amounts receivable from Syndicate 33 at 31 December excluding profit commission accrued 2009 £000 2008 £000 50,845 55,947 964 745 (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 2009 £000 Total 2008 £000 18,530 20,443 4,632 4,974 – – – 128 (c) Internal reinsurance arrangements During the current and prior year, there were a number of reinsurance arrangements entered into in the normal course of trade between various Group companies. The related results of these transactions have been eliminated on consolidation. Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009 99 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) 2009 £000 2008† £000 2007 £000 2006 £000 2005 £000 1,435,401 1,147,364 1,198,949 974,910 898,394 1,157,023 965,190 928,095 1,098,102 237,199 105,180 320,618 191,248 70,808 280,497 1,126,164 975,397 888,828 201,062 163,846 861,174 681,236 693,299 70,221 48,630 50,413 40,452 48,557 33,099 2,413,300 2,081,772 1,747,827 1,241,910 1,237,778 413,759 302,742 (1,702,225) (1,773,622) (1,433,799) (1,291,329) (1,216,624) 110,001 167,082 259,647 440,622 153,697 502,871 195,421 100,151 33,212 1,121,286 951,026 824,304 682,085 578,013 299.2 258.1 209.5 173.2 147.7 75.2 72.3 86.0 30.1 18.8 18.1 75.3 9.2 48.4 46.8 84.4 28.8 41.7 40.5 89.1 28.9 15.00 12.75 12.00 10.00 15.6 15.1 96.0 12.8 7.00 362.00 277.00 361.00 194.75 304.50 246.75 280.25 193.75 234.50 152.25 *Closing mid market prices. †The 2008 comparatives have been updated from those previously reported to reflect the reclassification of acquisition costs on the purchase of reinsurance contracts from ‘outward reinsurance premiums’ to ‘expenses for the acquisition of insurance contracts’ (see note 2.2). Earlier year results have not been adjusted. 100 Five year summary Hiscox Ltd Report and Accounts 2009 Hiscox_AR09_Cover_AW:Layout 1 11/3/10 10:57 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 2009 Hiscox brochure visit www.hiscox.com Design: Browns www.brownsdesign.com Print: St Ives Westerham Press Photography: Portraits © John Ross and Matthew Septimus Front and back cover © Beat Glanzmann/Corbis This brochure is printed on recycled paper containing 100% post-consumer waste, manufactured at a mill that has been awarded the ISO14001 certificate for environmental management. The pulp is bleached using a Totally Chlorine Free process. Hiscox_AR09_Cover_AW:Layout 1 11/3/10 10:57 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 9 Hiscox Ltd Report and Accounts 2009 1 2 3 5 12 14 15 20 21 26 28 32 34 37 45 46 47 48 48 49 50 51 52 100 Contents Corporate highlights Why invest in Hiscox? Chairman’s statement Chief Executive’s report Hiscox at a glance People Group financial performance Group investments Risk management Corporate responsibility Insurance carriers 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 statement of cash flows Notes to the consolidated financial statements Five year summary