Hiscox
Annual Report 2010

Plain-text annual report

Hiscox Ltd Report and Accounts 2010 Contents About the Hiscox Group 1 Corporate highlights 2 Why invest in Hiscox? 3 Chairman’s statement 5 Chief Executive’s report 12 Hiscox business structure 13 Hiscox distribution 14 People Financial review 16 Group financial performance 18 Group investments Governance and remuneration 21 Risk management 26 Corporate responsibility Insurance carriers 28 32 Board of Directors 34 Corporate governance 37 Directors’ remuneration report 46 Directors’ report 47 Directors’ responsibilities statement Financial summary 48 Independent auditors’ report 49 Consolidated income statement Consolidated statement of 49 comprehensive income 50 Consolidated balance sheet Consolidated statement 51 of changes in equity Consolidated statement of cash flows Notes to the consolidated financial statements 53 52 100 Five year summary Our ambition is to be a highly respected specialist insurer with a diverse portfolio by product and geography. We believe that building balance between catastrophe-exposed business and less volatile local specialty business gives us opportunities for profitable growth throughout the insurance cycle. Our strategy is: to use our underwriting expertise in London and Bermuda to write high-margin volatile or complex risks; to build our distribution in the UK, Europe and the US for our specialist retail products; to protect and nurture our distinctive culture and ethos by recruiting the best people, and by focusing on organic growth. Strategic focus Total Group controlled income for 2010 31% Reinsurance 4% Large property 4% Global errors and omissions 6% Specialty – terrorism, specie, political risks, aerospace 9% Marine and energy 100% = £1,671m Local errors and omissions and commercial 13% Tech and media errors and omissions 3% Art and private client 17% Specialty – kidnap and ransom, contingency, bloodstock, personal accident 9% Small property 4%  Corporate highlights 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) Net asset value per share (p) Group combined ratio excluding foreign exchange (%) Group combined ratio (%) Return on equity (%) Operational highlights 2010 2009 1,432.7 1,435.4 1,131.2 1,098.1 211.4 178.8 47.2 16.5 320.6 280.5 75.2 15.0 332.7 299.2 89.8 89.3 16.5 82.2 86.0 30.1 Hiscox London Market focused on margin over growth, reducing income by 13.6% and delivering profits of £121.4 million despite catastrophes. Specialist retail businesses in the UK and Europe delivered good growth and doubled profits, again despite catastrophes. Rates still attractive in reinsurance and stable in other specialty lines. The first ‘direct from insurer’ small business offering in the US launched with promising early results. Net asset value p per share Dividend p per share 3.6% Investment return 332.7 16.5 15.0 299.2 2009 2010 2009 2010 Corporate highlights Hiscox Ltd Report and Accounts 2010 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 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 healthy. When these rates are no longer favourable, we have the flexibility to shrink this side of the business. Our local specialty insurance business tends to be steadier throughout the insurance cycle and we have successfully grown our retail lines by 11.3% 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 2006 and 2010 include: increased gross written premiums by 27.2% to over £1.4 billion healthy combined ratio averaging 85.0% delivered average ROE of 22.7% maintained a progressive dividend policy with compound growth of 13.3%. Our expertise 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 experience 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:* 98% of business insurance customers were satisfied that we spoke to them in a clear way and avoided using financial jargon over 90% of our home insurance customers surveyed were satisfied with the way we settled their claim. In Europe, a survey** of our brokers saw Hiscox rated the top insurer for superb service and the best claims service. In 2010 Hiscox UK was awarded Specialist Insurance Provider of the Year by Spears Wealth Management and became a Which? recommended provider for home and contents insurance. On the commercial side, Hiscox UK won Best Small Business Insurance award for the second year running at the Start Your Business Awards 2010. * Results from our monthly customer satisfaction survey for customers telephoning one of our UK-based contact centres. ** Results from a survey of 301 existing household/commercial brokers in Belgium, France, Germany and the Netherlands between November 2010 and January 2011. Building a balanced business Gross premiums written at 100% level (£m) Hiscox Bermuda Hiscox London Market – Volatile Hiscox USA Hiscox Guernsey Hiscox London Market – Retail Hiscox Europe Hiscox UK 1,800 1,600 1,400 1,200 1,000 800 600 400 200 603 514 480 370 379 378 422 403 413 244 1,713 1,671 1,476 1,407 1,390 1,083 1,111 1,105 941 780 2 Why invest in Hiscox? Hiscox Ltd Report and Accounts 2010 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010  Chairman’s statement Robert Hiscox Chairman In our 2010 Interim Statement I said that a half-year profit of £97.2 million was a testament to the strength of our business given the unnatural number of natural catastrophes (and one massive oil spill) during the period. Well, Mother Nature has well and truly tested us further in the second half and a full-year pre-tax profit of £211.4 million is further strong evidence of the resilience of our business. Our long-term strategy has been to build a balanced book of international businesses, retreating from any area when the competition gets foolish and advancing when we can charge the proper price. It seems an immutable rule of insurance that a big loss will hit the area of weakest rates, and this year has proved the rule. We were underweight in Chile, New Zealand and Australia, had declined a significant insured in the oil spill and had pruned our UK household book, as our view was that each area was under-rated for just the catastrophes which have occurred. Results The result for the year ending 31 December 2010 was a profit before tax of £211.4 million (2009: £320.6 million) on a gross written premium of £1,432.7 million (2009: £1,435.4 million). The combined ratio was 89.3% (2009: 86.0%). Earnings per share on profits after tax were 47.2p (2009: 75.2p) and net assets per share increased to 332.7p (2009: 299.2p). The return on equity was 16.5% (2009: 30.1%). Dividend, balance sheet and capital management The Board proposes to pay a final dividend of 11.5p (2009: 10.5p) on 21 June 2011 to shareholders on the register on 13 May 2011, making total dividends for the year of 16.5p (2009: 15.0p) an increase of 10%, in line with our policy of steady dividend growth. Subject to shareholder approval at the forthcoming Annual General Meeting, a scrip dividend alternative to the cash dividend is to be offered to shareholders and the Company’s Dividend Access Plan will be suspended. The balance of profit retained helps to increase the net asset value per share which, combined with dividend growth, underpins the share price. Growth in net assets per share will inexorably drive the share price up whatever rating Mr Market puts on our shares or the sector. New Directors In December we appointed two distinguished and very experienced new Non Executive Directors, Richard Gillingwater and Robert (Bob) McMillan, to the Hiscox Ltd board. Richard Gillingwater is currently the Dean of Cass Business School and brings vital knowledge from his experience in the financial services sector. Richard has now been appointed Senior Independent Director replacing Andrea Rosen who was acting in the role following the death of Sir Mervyn Pedelty in January 2010. Bob McMillan has been a member of our US board since 2007 and his knowledge of retail insurance from his time with the Progressive Insurance Company has proved invaluable. Courage and creativity It takes courage to go against the herd, to pioneer in new areas, or to say no to major suppliers of business. In 1993, when Bronek Masojada joined, we were a simple underwriting agency. It would have been easy to remain so, solely managing syndicates in Lloyd’s. It would have been easy to have expanded through Lloyd’s only, or outside Lloyd’s in the UK only; it would have been easy to accept business only from brokers. As it is, since 1993, we have raised the capital to go from agent to principal, formed insurance companies, opened offices in Bermuda, throughout the UK, Europe and the USA, expanded our distribution channels to include direct offerings, and moved our domicile to Bermuda. Our leading value is courage, and we will continue to develop the business in our own way while watching closely, but not following, the herd. Our emphasis has always been on organic growth and start-ups which are tougher than the instant gratification of acquisitions, but mean that we build what we want. Investing is a word used by politicians to cover expenditure so I am reluctant to use it on our expansion in new areas, but new ventures take time to grow to profitability and I do consider them an excellent investment. We have written off the cost of building businesses against the profits of the day, and those businesses are now in many cases yielding a handsome return. Our UK and European regional offices are now an indispensable and profitable part of our distribution, and I believe our US offices will be so too when they reach critical mass. Our direct business in the UK now makes good money and has enormous growth potential. Our new direct offering in the US – the first direct commercial policy from an insurer – is in pre-marketing phase and showing promise. The insurance cycle General insurance is a great business as there is an insatiable and constantly growing demand for it. What drives rates up and down is supply of capital in the industry, combined with management weakness. A small example of management weakness: the premium for piracy of ships in the Gulf of Aden can be calculated very roughly by relating the number of journeys through the Gulf to the number of successful kidnaps by pirates. We had built a rating for this and were trading successfully when the competition decided to under-cut our rates by about 50%. At the same time, the pirates doubled their demands. How can any management allow an underwriter to compete at a quarter of the rates of the established market? We have continued to quote the sensible rate which effectively leads to our doing less business. We will be back when our competitors realise their folly and withdraw from the market, as some already have. Chairman’s statement Hiscox Ltd Report and Accounts 2010 Chairman’s statement Hiscox Ltd Report and Accounts 2010 3 3  Chairman’s statement continued The future We are building a business with a brand based on trust. We strive to offer flexible, intelligent underwriting backed by great service which people will want to buy for peace of mind, knowing they will be made good in times of loss, and definitely not because it is the cheapest in the market. But our brand has to be built on the behaviour of our people, and I am very grateful to them for their excellent work which led us to be voted the most trusted insurer in the UK. When I see the calibre of the staff throughout the Group, I am confident that the creativity and growth of the last decade will continue strongly over the next. Robert Hiscox Chairman 28 February 2011 Fortunately the reinsurance market is more disciplined as are many of the areas in which we specialise. We will not compete to hold market share but will underwrite selectively regardless of top line. There is talk that a major market loss is needed to turn the market, and it would appear that some competitors are hanging on to business at the wrong rate hoping that a big bang somewhere will enable them to increase the price. I personally hope that there continues to be a constant attrition of medium losses and no major event so that discipline has to be learnt the hard way. Broker remuneration The vast majority of our business comes from brokers and undoubtedly always will. Their job is a difficult one. They have to assess the risks of their diverse clients and transfer those risks to insurers at a reasonable price. Their definition of reasonable and ours will obviously sometimes conflict, and we must have the discipline to say no – sometimes not easy to do to a robust provider of business. A deficiency in the insurance market has long been how the broker is remunerated. The clients should pay the broker, as they do their other advisers, for the advice given and the work done to transfer the risks. However, in our market, the insurer has traditionally paid the brokers through giving them a slice of the premium as brokerage or commission. This not only leads to obvious conflicts (the higher the premium, the bigger the pay; the placing of business with the highest payer of commission not the best insurer), but also made the clients believe that they got the services of brokers for nothing. As fees have properly grown to be the correct way to pay the broker, the broker fraternity have had to learn how to cost their services, and have been reluctant to charge the proper fee. They have also competed with each other to a ridiculous extent on fees. Not getting enough revenue as a result, they bring pressure on the insurers to make up the deficiency. This is a big issue at the moment, and I just hope that it will be resolved sensibly before a solution is imposed either by the law, or again by a crusading regulator. 4 Chairman’s statement Hiscox Ltd Report and Accounts 2010  Chief Executive’s report Bronek Masojada Chief Executive Hiscox Group rating index Index level (%). 12-month rolling period Reinsurance Insurance In 2010 Hiscox made a pre-tax profit of £211.4 million, a good result considering the low returns on offer in the investment markets and the large number of catastrophes the industry faced. This result reflects the diverse strengths of our businesses: Hiscox London Market and Hiscox Bermuda showed outstanding discipline in their risk selection, while our specialist retail businesses in the UK, Europe and Guernsey strengthened their market positions by focusing on quality products sold at a fair price with a fast and friendly claims service; our US business continues to build critical mass in a difficult market. 2011 will test the industry further as prices remain under pressure and investment returns diminish. Our long-term strategy of balance and diversification has built a business designed for these conditions. Hiscox always plans for profit throughout the cycle, so our London Market and Bermudian businesses will maintain the same excellent underwriting discipline they showed in 2010 and it will be the turn of our specialist retail businesses to drive the Group forward. Hiscox London Market Our London Market business has been the powerhouse of the Group. It delivered a pre-tax profit of £121.4 million (2009: £179.9 million). This result, though lower than 2009, was helped by some canny underwriting decisions, particularly around Deepwater Horizon and the Chilean earthquake. In each case disciplined underwriting, with a focus on margin over volume, led us to incur claims that were substantially below the market average. This discipline also led to a reduced premium income of £572.7 million (2009: £663.0 million), a trend that will continue in 2011. The London Market business is managed through the following six product lines: Reinsurance: This remains our largest line of business, accounting for £234.9 million of premium income. This division took the brunt of Hiscox losses arising from Chile and New Zealand – amongst others – but the fact that it still made a profit shows the excellence of its people and portfolio. It enjoys a great reputation in the market, which has enabled it to attract substantial quota share reinsurance support from other syndicates and major European and global insurers. This allows us to play an influential role in the market while keeping within our risk appetite. The important January 1 renewals were largely within our expectations, with modest reductions in pricing. Margins remain attractive but this line of business 140 120 100 80 60 40 20 0 Fe b 05 – Jan 06 A pr 05 – M ar 06 Jun 05 – M ay 06 A u g 05 – Jul 06 O ct 05 – S e p 06 Fe b 06 – Jan 07 A pr 06 – M ar 07 Jun 06 – M ay 07 A u g 06 – Jul 07 O ct 06 – S e p 07 D ec 06 – N ov 07 Fe b 07 – Jan 08 A pr 07 – M ar 08 Jun 07 – M ay 08 A u g 07 – Jul 08 O ct 07 – S e p 08 D ec 07 – N ov 08 Fe b 08 – Jan 09 A pr 08 – M ar 09 Jun 08 – M ay 09 A u g 08 – Jul 09 O ct 08 – S e p 09 A pr 09 – M ar 10 D ec 08 – N ov 09 Fe b 08 – Jan 10 O ct 09 – S e pt 10 D ec 09 – N ov 10 Jun 09 – M ay 10 A u g 09 – Jul 10 Fe b 10 – Jan 11 D ec 05 – N ov 06 Chief Executive’s report Hiscox Ltd Report and Accounts 2010 5  Chief Executive’s report continued Hiscox London Market 2010 £m 2009 £m Gross premiums written 572.7 663.0 Net premiums earned 396.1 453.3 Underwriting profi t Investment result Foreign exchange 70.6 136.0 39.1 79.7 11.7 (35.8) Profi t before tax 121.4 179.9 Combined ratio 79.7% 78.8% Combined ratio excluding foreign exchange 81.8% 71.0% Hiscox UK 2010 £m 2009 £m Gross premiums written 327.0 304.0 Net premiums earned 302.6 261.0 Underwriting profi t Investment result Foreign exchange Profi t before tax 16.2 7.3 12.4 22.7 0.2 (0.9) 28.8 29.1 Combined ratio 94.6% 97.9% Combined ratio excluding foreign exchange 94.7% 97.6% will shrink gradually as we trim our exposures in response to lower rates. Property: Our primary focus is catastrophe-exposed property risks of global companies, homeowners and small businesses. Property rates have been under pressure for some time and we have substantially reduced premium income to £95.7 million (2009: £137.4 million). Our experience is that good underwriting decisions like these, although painful to execute in the short-term, serve the business well over the long-term. We will return to serve customers with our previous risk appetite when our competitors, who have made this segment uneconomic, retreat nursing their losses, as they inevitably will. As regards our non-catastrophe- exposed activities, during the year we entered the mechanical equipment insurance market through a relationship with a respected underwriting team. Marine and energy: Good disciplined underwriting based on sound appreciation of the technical facts meant we had minimal exposure to those affected by the Deepwater Horizon loss. We have achieved good results in this sector and have the risk appetite to expand if rates rise during the course of 2011. Specialty: Our specialty lines benefit from operating in niche markets including personal accident, event cancellation and abandonment, terrorism, political risks and kidnap and ransom. Specialty continues to perform well and has enjoyed significant releases from reserves as recoveries were made on political risk claims. Casualty: This market, particularly US casualty, remains under pressure and so this line shrank during the year. We had expected to see some losses arising out of the global financial crisis but, so far, these have not materialised. We expect to remain a modest participant in this market for as long as rates remain at their current levels. Aviation and aerospace: Hiscox has had a long-standing participation in the insurance of satellites, both at launch and in orbit. Savvy technical ability meant that we were not involved in some of the major losses that affected this class during the year. We also welcomed to Hiscox a specialist aviation team, who came on board in the second half of the year. Our goal is to build a material business, but only when conditions are right. Looking forward, we expect pricing in the London Market to remain challenging. Generally market prices are under pressure, so it is only through increasingly selective underwriting that we can retain business at attractive prices. We are convinced this is the right approach, even though it may mean that our premium income (and exposure) falls in the year ahead. Hiscox UK and Europe Our businesses in the UK and mainland Europe have a focus on art and private client insurance for wealthy individuals, property and liability insurance of small commercial enterprises, and on errors and omissions insurance for technology and media businesses. We market our products through brokers and direct to our customers. In the year we have seen continued growth while increasing our profitability. Total profit before tax for the year was £39.6 million (2009: £20.5 million) on total premium income of £454.7 million (2009: £421.0 million). Hiscox UK: Hiscox UK’s premium income grew by 7.6% to £327.0 million (2009: £304.0 million) and the combined ratio improved to 94.6% (2009: 97.9%). Profits remained virtually flat at £28.8 million (2009: £29.1 million) despite total catastrophe losses of £28 million arising from the UK freezes in January and November/ December and event cancellation losses arising from the Icelandic volcanic ash cloud. In addition, Hiscox UK experienced some recession-related errors and omission losses. This good performance shows the resilience of our business. The art and private client team deserves to be singled out for praise. In late 2009 they decided that on technical grounds prices were inadequate and implemented price rises of approximately 5% in a falling market. Their discipline was rewarded by a profitable result despite the many challenges of the year. Our commercial area achieved profits, albeit at lower levels than 2009. The direct business continues to expand with the top line growing by almost 20%. This business achieved a good level of profit in aggregate. In addition to the benefits of good underwriting, Hiscox UK has also seen the fruits of a sustained focus on expense ratio. We are positive about the future. We have entered a new underwriting partnership with Dual, an established MGA, where we have taken a 25% share of their existing book of business. We also expect to see our direct business continue to develop. We are cautious about our broker-generated business as we believe that the market will remain soft. The ability of Hiscox UK to withstand market pressures in 2010 shows the strength of our specialist market position and we are confident that it will continue to enhance the value of the Group going forward. Hiscox Europe: Hiscox Europe had a tremendous year and made a profit of €11.9 million (2009: €0.4 million). The top line grew by 11.5% to €146.7 million (2009: €131.6 million), and it achieved a combined ratio of 97.4% (2009: 114.6%). This improvement 6 Chief Executive’s report Hiscox Ltd Report and Accounts 2010 Hiscox Europe 2010 €m 2009 €m Gross premiums written 146.7 131.6 Net premiums earned 134.7 123.2 Underwriting profi t/(loss) Investment result Foreign exchange 6.2 5.7 – (15.8) 16.2 – Profi t before tax 11.9 0.4 Combined ratio 97.4% 114.6% Combined ratio excluding foreign exchange 97.4% 114.6% Hiscox International 2010 £m 2009 £m Gross premiums written 405.2 351.4 Net premiums earned 312.9 277.5 Underwriting profi t Investment result Foreign exchange Profi t before tax 18.1 59.5 27.6 57.7 (2.6) 7.0 43.1 124.2 Combined ratio 97.3% 76.3% Combined ratio excluding foreign exchange 96.4% 78.6% was driven by a number of factors. First, we have made progress in breaking down the silos separating country units, ensuring that lessons learned in one market are rapidly transferred to the others. Second, our creation of a pan-European service centre in Lisbon has allowed us to take advantage of pan-European economies of scale. Third, our decision to invest in the growth of our smaller commercial and technology businesses has paid off; and, fourth, the art and private client teams improved the quality of their book with the application of a more sophisticated pricing approach. We also created a new specialty line that sells kidnap and ransom and related products from our local offices to local brokers and experimented with a direct offering in France. In aggregate, these actions drove growth, improved the loss ratio and reduced the expense ratio. Hiscox Europe is, I believe, now in a position to become a sustainable contributor to the Group. Hiscox International Hiscox International comprises our businesses in Bermuda, Guernsey and the US. Aggregate premium written grew by 15.3% to £405.2 million (2009: £351.4 million), though profits dropped to £43.1 million (2009: £124.2 million). Hiscox Bermuda: Our Bermudian business, supported by a significant third- party quota share reinsurance, was able to grow its income by 15.6% to $303.8 million (2009: $262.9 million). After a relatively loss- free 2009, profits were hit by the Chilean and New Zealand earthquakes. During the year our healthcare team established itself as a sensible player in the market. In 2011 we expect to see pricing in the reinsurance market remain under pressure and as a result our Bermuda business will shrink. Hiscox Guernsey: The team showed great discipline in the piracy market, increasing prices in the face of increasing attacks, higher demands from pirates and the bizarre decision of some of our competitors to slash their prices. This inevitably led to a reduction in piracy revenues but Hiscox Guernsey remained overall flat. Our fine art business had a very good year with modest growth in premiums and increased profits. Our team in Guernsey also provides product leadership for kidnap and ransom across the Group, and their hard work during the year saw us consolidate our position as a worldwide leader in this field, with particular growth in Europe, the US and Latin America. Hiscox USA: Hiscox USA had a tough year. Premiums grew 22.4% to $198.3 million (2009: $162.1 million), but profitability was weak, in part due to some claims from long- standing large technology risks. In early 2009 we made a significant investment in the operation, believing that the financial crisis would allow us to recruit good people and that customers’ concerns about financial stability would lead to a re-rating in the market. We were correct in our first assumption and are very pleased with the strength of talent we attracted, but the effective guarantee given by the government to some of the weaker players meant that rather than a market re-rating, prices actually fell further. Our philosophy of underwriting for profit over volume meant that in this challenging pricing environment we did not reach the scale we expected. In the middle of 2010 we took decisive action and adapted accordingly. We decided to focus our errors and omissions and property business through wholesale brokers only and to concentrate our specialist lines (kidnap and ransom, terrorism, construction, media and not-for-profit directors and officers) on major brokers in those niches. This led to the sale of our animal mortality business and the closure of our Boston office. These swift but necessary actions will allow us to keep focusing on building a quality business in what remains a very difficult market. A milestone was the launch of our US direct commercial business. Our test site opened for business in November 2010, selling errors and omissions, commercial general liability and property owners’ business to firms of zero to ten employees in 15 states. We expect to work on improving our processes and infrastructure during the first quarter of 2011 and once this is stable and working effectively we will support the business with a significant marketing investment. We expect that in time we will see a repeat of the success we enjoy in the UK. Claims It is only when a customer claims that you can live up to your brand promise. Our claims operations across the world were tested during 2010 and the team rose to the challenge. The year began with the challenges of Windstorm Xynthia and a freeze in the UK. It was followed by the earthquake in Chile and losses arising from the Icelandic volcanic ash cloud. The year continued with Deepwater Horizon, the New Zealand earthquake, riots in Thailand, the December freeze in the UK and, finally, the beginning of the Australian floods. Throughout this succession of calamities our claims teams have paid claims with the utmost efficiency and effectiveness. We strongly believe that a claim paid fairly and fast creates a competitive advantage, and judging by customer feedback we largely achieve this goal. In my statement last year I expressed our concerns about the proposed Lloyd’s Claims Scheme. Some of these seem to have been recognised now by others in the market and we hope that as Lloyd’s finalises changes in 2011 it takes these concerns on board. We firmly believe that the need to provide a single point of notification for all claims, to differentiate Chief Executive’s report Hiscox Ltd Report and Accounts 2010 7  Chief Executive’s report continued between large and small claims and to provide a market-wide service for small claims must be recognised. Lloyd’s claims handling, particularly on syndicated risks, is the cornerstone of its enviable reputation, so it is imperative that the market provides an effective unified solution. Investments During the year our investment portfolio, excluding derivatives, delivered a return of £98.8 million, a yield of 3.6% on an average portfolio of £2,717.5 million. The market was testing but on balance rewarded those prepared to take some measured risk. As a result our bond portfolio performed well, as our decision to maintain a healthy allocation to credit paid off. Our risk assets, a selection of equity and hedge funds, produced a good return but in aggregate under-performed their long only equity benchmark. The composition and benchmarking of risk assets will be a focus of attention in 2011. We expect market returns in the near term, particularly from bonds and cash, to remain low. However, we prefer to preserve the balance sheet, accepting the lower income on offer, rather than to stretch further for yield in credit, duration or structured products. Operations and IT As our specialist retail businesses have grown we have needed to increase the robustness of our processes. Last year, across the Group, we issued 370,000 policies and settled 40,000 claims. We rely on the efforts of many dedicated and professional operations and IT staff to deliver the services and infrastructure to do this effectively. Their high standards and those of our front line underwriters and claims handlers have helped us build the best reputation of any UK insurer, according to a 2010 consumer study by the Reputation Institute. The reduction in our expense ratios in the UK and Europe reflects the improving efficiency of our processes. Over a four-year period this has dropped by 6%, making a substantial contribution to profits. We can never be satisfied with how we are doing. During 2010 we conducted a ‘lean’ process review of a number of areas. In each case we identified significant improvements, whether in the timeliness of our underwriting reviews, the quality of our data or the cost of our service. The implementation of these recommendations will, over time, lead to continued improvements in our expense ratio. Solvency II The European insurance industry is in the midst of a tremendous change driven by the introduction of a new regulatory framework called Solvency II. The framework has three essential elements called ‘pillars’: Pillar 1 covers the amount of capital we must hold; Pillar 2 focuses on governance and risk management; Pillar 3 on transparency and disclosure. As a Bermuda domiciled group we are in a slightly anomalous situation. We expect to apply Solvency II principles consistently across our Group, with the Bermuda Monetary Authority 8 Chief Executive’s report Hiscox Ltd Report and Accounts 2010 Actively managed business mix Total Group controlled premium December 2010: £1,671m (Year-on-year change in original currency) (-1.1%) £516m Marine Non-marine Aviation Whole account (+3.2%) £282m Home and contents Fine art Classic car (+24.6%) £262m Professional liabilities Errors and omissions Directors and officers’ liability Commercial office Small technology and media E&O (-9.1%) £250m Kidnap and ransom Contingency Terrorism Bloodstock Specie Personal accident Political risks Aviation Aerospace (-28.6%) £143m (+0.2%) £143m Marine hull Energy liability Upstream- midstream energy Managing general agents Commercial property Onshore energy USA homeowners (-7.6%) £75m Professional indemnity Large technology and media E&O Reinsurance Art and private client Local E&O and commercial Specialty Property Marine and energy Global E&O Chief Executive’s report Hiscox Ltd Report and Accounts 2010 9  Chief Executive’s report continued business has improved the quality of its business thanks to co-ordinated actions over an extended period. Our claims teams make difficult decisions every day – whether resolving a coverage dispute between terrorism and property insurers without the client being adversely affected or dealing with many personal difficulties arising from the UK freeze. It is our ambition to ensure that Hiscox remains a place where the individual makes the difference no matter how much we grow – and with the quality and dedication of the staff who work for us across the globe I feel confident that this ethos will continue to be central to our business. Outlook The markets in which we operate have become progressively more challenging over the past three years, and we expect the trend of increasing competition and falling prices (BMA) acting as our lead regulator, but with collaboration with the Financial Services Authority (FSA) and Lloyd’s in the UK, and other regulators in other jurisdictions. The BMA has applied to the EU for approval as an ‘equivalent regulator’ – effectively that European supervisors can rely on its judgement – and it is making great progress on meeting the various tests which will be applied to it. Success in achieving equivalence will mean that Hiscox is able to apply a single consistent framework across the Group. In many ways Solvency II is simply a formalisation of existing risk management systems used within our business. We have a well developed enterprise risk management approach which has been judged effective by some of the rating agencies. We have also been very transparent to shareholders on the underwriting risks we run. For many years we have published on our website and annual report our ‘boxplot and whisker’ chart which gives shareholders a clear view of the estimated losses we could suffer in the event of major catastrophes. At the moment we are assuming that Bermuda will achieve equivalence and that we will implement the Solvency II approach across the whole Group. We are therefore in constant communication with the BMA, the UK’s FSA and Lloyd’s of London on the path to implementing Solvency II within Hiscox. The challenges of Solvency II arise from the fact that its rules are yet to be fully formulated, from the UK’s well known tendency to ‘gold plate’ European Directives, and that the FSA itself is undergoing wrenching organisational and philosophical changes at the same time as Solvency II is being formulated and implemented. The challenges for all those involved in the process can be summed up by the fact that our application for approval under Solvency II is expected to reach 5,000 pages, and it is thought that the FSA will receive over 100 similar applications. One has to feel sorry for the teams who have to read and approve all the applications. Achieving effective implementation of Solvency II is one of the Group’s top priorities in 2011 and 2012. People Insurance is an industry where the decisions and actions by staff on the front line make a crucial difference to the performance of their businesses. We are lucky at Hiscox in having staff who not only enjoy this responsibility and the challenges which it brings, but who also make the right decisions for our business and its customers. Our exposure to Deepwater Horizon is minimal thanks to a single sound underwriting decision. Our US catastrophe- exposed property portfolio has shrunk thanks to a team exercising discipline. Our UK art and private client business has performed well despite some terrible weather and thanks to brave underwriting decisions going against the market trend. Our European art and private client 10 Chief Executive’s report Hiscox Ltd Report and Accounts 2010 to continue. In this environment our strategy of building our retail businesses to balance the more volatile big-ticket businesses will come into its own. We will allow our big-ticket businesses in Bermuda and London to shrink as they focus on margin over volume, while at the same time we expect our specialist retail businesses to grow their revenue and profits. These specialist retail businesses offer products that are clearly distinct from those of their competitors; they have developed reputations for excellent standards of service and for paying claims fairly. This combination will stand our employees, customers and shareholders in good stead. Bronek Masojada Chief Executive 28 February 2011 The Hiscox Group has over 1,100 staff in 11 countries. Bermuda Hamilton Europe Amsterdam Bordeaux Brussels Cologne Dublin Hamburg Lisbon Lyon Madrid Munich Paris Guernsey St Peter Port Latin American gateway Miami UK Birmingham Colchester Glasgow Leeds London Maidenhead Manchester USA Armonk (New York) Atlanta Chicago Kansas City (Missouri) Los Angeles New York City San Francisco Chief Executive’s report Hiscox Ltd Report and Accounts 2010 11  Hiscox business structure 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 Richard Watson Chief Executive Officer Steve Langan Managing Director Pierre-Olivier Desaulle Managing Director Global reinsurance Group capital support Healthcare insurance Reinsurance Property Marine and energy Specialty Kidnap and ransom Terrorism Political risks Errors and omissions Aviation and aerospace Fine art Kidnap and ransom Terrorism Errors and omissions Directors and officers’ liability Specialty Kidnap and ransom Terrorism Technology/ media Direct to customer commercial business Property Fine art Fine art High-value household Errors and omissions High-value household Errors and omissions Directors and officers’ liability Directors and officers’ liability Specialty commercial Technology/ media Direct to customer household and commercial business Specialty commercial Technology/ media Kidnap and ransom Terrorism Direct to customer commercial business 12 12 Hiscox business structure Hiscox Ltd Report and Accounts 2010 Chairman’s statement Hiscox Ltd Report and Accounts 2010  Hiscox distribution Customers facing complex or unusual risks benefit greatly from the guidance of a broker or advisor which is why most specialist insurance is delivered through an intermediary. Although Hiscox has a multi-channel distribution strategy, the vast majority of our business comes from our broker partners around the world. Hiscox has a strong history of going out to find good business, rather than waiting in London for it to come to us. Hiscox underwriters have always travelled the world to build long-lasting relationships with local brokers that showcase our unique expertise. Previously we brought that business back to London, but over the past 15 years we have benefited from building a local presence in a handful of key regional markets. Why our brand is so important The old way of buying small business insurance is over. Reinventing Small Business InsuranceTM LEARN. QUOTE. BUY. Hiscox has a very strong brand in the London insurance market, but until recently, was completely unknown to UK consumers. To build a successful direct insurance business it is fundamental that your target market is aware of and identifies with your brand, so five years ago we hired Steve Langan to help us. He has used the brand and marketing expertise he gained at Diageo and Coca-Cola to mastermind Hiscox UK’s advertising and direct mail campaign. Many of you will have seen our distinctive adverts, either on TV, in newspapers or on billboards. They have helped transmit Hiscox’s unique culture to a wider audience: bold, intelligent, freethinking, straightforward, responsible and with a passion for good customer service. Our consistent investment has paid off: our direct business grew by 22% last year. In 2010 we had the best reputation of any UK insurer, a consumer study by the Reputation Institute found. This is tangible proof that our marketing investment is helping us to build a brand that customers know and trust. What we have learnt in the UK is guiding our efforts in building our new direct operations in the US and in Europe. Our experience of having offices outside of London since 1995 has shown us that having a local presence brings several advantages. We develop better relationships with regional brokers, who appreciate our specialist knowledge, entrepreneurialism and desire to truly understand their clients’ risks. We have better new business growth, because we see more submissions from these intermediaries than we would sitting in London. And our retention rate is higher, as this business tends not to move solely on price. This strategy has worked: over the past ten years Hiscox UK has grown its broker business by 360%; 69% of this growth has been generated from brokers based outside of London. We aim to grow our market share in Western Europe and the US – regions where we already operate and where we know there is a strong appetite for our products. When the opportunity has arisen to either acquire a good-quality book of regional business at an attractive price or to hire an excellent team of local underwriters we have opened an office, whether in Brussels, Munich, Armonk or Los Angeles. We now have 28 offices across the world, feeding us good new risks that help sustain our business. In continental Europe brokers represent only 30% of our target market so we use a wider variety of distribution channels here. These include banks and composite insurers who are happy for us to cover their clients for their more specialist risks. This diverse choice allows clients to buy our products through their preferred sales channels and it has delivered steady growth over the past five years, including 11.5% in 2010. Since 2005, Hiscox has established a network of offices across the US. Over 40% of the Group’s revenues come from this market, mainly through Hiscox London Market, but our branches throughout the country have enabled us to capture smaller US corporate risks that are not seen in the London Market. Hiscox also has an established direct to consumer business in the UK that it has built up since 2005 and newer direct businesses in the US and France. In all these regions we specialise in professional and general liability as well as buildings and office contents cover. We sell policies directly to professional services businesses with ten or fewer employees. These small firms tend to be uneconomic for brokers as they pay relatively little in premiums. Many have straightforward specialist needs so are better suited to getting their cover online. Hiscox UK has been a great success – it currently insures 38,000 small businesses with an average premium of £400 – and we have high hopes for our US and European direct operations. In the UK we also insure higher value household direct. Hiscox aims to offer our products and expertise to new markets and customers via any route they would prefer. Hiscox distribution Hiscox Ltd Report and Accounts 2010 13  People The quality of our people has been a key ingredient in our success. Hiscox’s reputation for innovation and dynamism has been built in large part on the energy, professionalism, commitment and expertise of our employees. 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. 1,164 Total number of staff at December 2010 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 2010, five new Partners were appointed. Employee engagement survey In September, Hiscox conducted its third 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 as we rank between the 70th and 85th percentiles in all four areas against the global benchmark comprising 145 organisations across 67 countries. 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 straightforward, 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 2010, 77 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. Another source of talent to fill senior roles in the future is our graduate trainee and internship programme. In 2010, we nearly doubled our intake, recruiting 22 graduate trainees into the UK, one in Bermuda and three in France. One of our aims is to educate the brightest students about the vibrant career this industry can offer. The average number of candidates seen for each job filled in 2010 was five. 2. Develop excellence Hiscox has a unique underwriting training programme developed by some of our very 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 instil 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. In 2010 Hiscox Europe instigated a programme of back-to-basics underwriting training with a specific focus on disciplined underwriting in challenging markets. This training helped achieve a 20% increase in new business submissions for our target areas in our commercial lines. Across the Group a total of 353 delegates completed our underwriting training programme in 2010. 14 People Hiscox Ltd Report and Accounts 2010 Hiscox Partners Stephen Ashwell Global Head, Terrorism David Astor Chief Investment Officer Reeva Bakhshi Head of UK Direct Rory Barker Neil Bolton Group Reinsurance Manager Head of Non Marine Casualty, Hiscox London Market 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 Robert Childs Chief Underwriting Officer Paul Cooper Finance Director, Hiscox UK 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, 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 Christopher Sharpe Chief Underwriter, Hiscox Bermuda Damien Smith Head of Non-Marine Treaty Reinsurance, Hiscox London Market Nicholas Thomson Retired Chief Underwriting Officer Andrew Underwood Head of Specialty, Hiscox USA 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 Hiscox Ltd Report and Accounts 2010 15  Group financial performance 89.3% Combined ratio Profit before tax for the year was £211.4 million (2009: £320.6 million), despite the large catastrophe losses and tougher investment markets experienced during the year. The Group recorded a post tax return on equity of 16.5% (2009: 30.1%) and earnings per share 47.2p (2009: 75.2p). Net asset value per share grew by 11.2% to 332.7p (2009: 299.2p) supported in part by the continued strength of the US Dollar. The Group maintains a progressive dividend policy and total dividend per share rose by 10% to 16.5p (2009: 15.0p). Gross premiums written of £1.4 billion were relatively flat compared to the prior year as we cut back in those lines where rates were weak and focused on areas where a greater return was expected. The Group’s overall underwriting performance was relatively strong despite the impact of the large catastrophe losses and we report a combined ratio including the impact of foreign exchange of 89.3% (2009: 86.0%). Notwithstanding the challenge of the investment markets during the year, the Group’s investments produced an annualised return of 3.6% (2009: 7.2%). to £572.7 million (2009: £663.0 million) reflecting the cut back in those lines where rates are weak, in particular, the US property insurance lines and big-ticket professional indemnity. Reinsurance purchased was higher than in the prior year as the segment benefited from a new quota share reinsurance arrangement which enabled an increase in underwriting capacity. Other reinsurance contracts which were renewed with commercial reinsurers during 2010 were on similar terms to the previous year and the quota share arrangement with Syndicate 6104 remained in place. The net claims ratio deteriorated to 48.3%, from 38.8% in 2009, impacted by the losses on the Chile and New Zealand earthquakes together with the Australian floods. As a result, the combined ratio (excluding the impact of foreign currency movements) declined to 81.8% (2009: 71.0%). Profit before tax for the year was £121.4 million (2009: £179.9 million). Hiscox UK and Europe Gross written premiums rose by 8.0% to £454.7 million (2009: £421.0 million) reflecting growth in all core lines especially the professional and specialty commercial businesses. The underwriting performance for each operating segment is detailed below. Hiscox London Market Gross premiums written declined by 13.6% The net claims ratio improved by 3.2% to 50.2% compared to the prior year ratio of 53.4% despite the UK freeze losses experienced in the earlier and latter parts of the year and Windstorm Xynthia in Europe. Group key performance indicators London Market UK and Europe International Corporate Centre 2010 Total London Market UK and Europe International Corporate Centre 2009 Total Gross premiums written (£m) 572.8 454.7 405.2 – 1,432.7 663.0 421.0 351.4 – 1,435.4 Net premiums written (£m) Net premiums earned (£m) Investment result (£m) 389.6 428.0 314.0 – 1,131.6 483.6 391.5 281.9 – 1,157.0 396.1 422.2 312.9 – 1,131.2 453.3 367.3 277.5 – 1,098.1 39.1 17.2 27.6 16.3 100.2 79.7 36.9 57.7 8.9 183.2 Profit/(loss) before tax (£m) 121.4 39.6 43.1 7.3 211.4 179.9 20.5 124.2 (4.0) 320.6 Claims ratio (%) Expense ratio (%) Foreign exchange impact (%) Combined ratio (%) 48.3 33.5 50.2 44.6 53.2 43.2 (2.1) 0.5 0.9 79.7 95.3 97.3 – – – – 50.1 39.7 38.8 32.2 53.4 49.9 33.0 45.6 (0.5) 7.8 1.8 (2.3) 89.3 78.8 105.1 76.3 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. 16 Group fi nancial performance Hiscox Ltd Report and Accounts 2010 2010 2,779.7 1,211.2 3,990.9 1,266.1 332.7 315.8 380.6 – – – – 41.8 40.4 3.8 86.0 2009 2,660.6 1,156.8 3,817.4 1,121.3 299.2 285.7 374.8 £211.4m Profit before tax The combined ratio before the impact of foreign exchange improved by 8.5% to 94.8% from 103.3% in the prior year. This reflects not only the improved loss ratio but also benefits from the efficiencies achieved by the centralising of operations in Europe through the opening of the shared service centre. The Group embarked on several new enhancement projects including the web platform for the US direct business and a management information project aimed at improving the quality and efficiency of financial information provided to management, inherently aiding the implementation of the new Solvency II regime. As a result profit before tax for the year increased by 92.8% to £39.6 million (2009: £20.5 million). Hiscox International Gross premiums written increased 15.3% to £405.2 million (2009: £351.4 million). The rise was driven by Bermuda taking advantage of attractive reinsurance rates and a new quota share arrangement coupled with our continued expansion in the US. Gross premiums written in Guernsey remained stable due to disciplined underwriting on the more volatile piracy lines. The net claims ratio was heavily impacted by the losses on the Chile and New Zealand earthquakes together with the Australian floods during the year and as such declined by 20.2% to 53.2% (2009: 33.0%). The impact on the combined ratio excluding foreign exchange was a deterioration of 17.8% to 96.4%. Consequently profit before tax fell by 65.3% to £43.1 million (2009: £124.2 million). Hiscox Corporate Centre An investment result of £16.3 million (2009: £8.9 million) was recognised on those assets controlled centrally. Total expenses, including certain foreign exchange items, fell by 49.5% to £4.4 million (2009: £8.7 million). Foreign exchange gains of £8.4 million (2009: £10.3 million) include the foreign currency impact on certain intra-group loan balances. Profit before tax of £7.3 million (2009: £4.0 million loss) was recognised. Cash and liquidity The Group’s primary source of liquidity is from premium income and investment income. These funds are used predominantly to pay claims, expenses, reinsurance costs, dividends and taxes, and to invest in more assets. Total net cash inflows for the year were £75.9 million (2009: outflow £150.1 million). The inflow was mainly due to prompt settlement of premiums and reinsurance claims. Net cash outflow from investing activities for the year was £22.2 million (2009: £11.7 million), primarily as a result of the purchase of tangible and intangible assets. The Group purchased the remaining shareholding in its associate company Blyth Valley Ltd, thereby obtaining control of the company. In addition, an investment was made in the US sister company of Blyth Valley Ltd, InsuranceBee Inc, a specialist errors and omissions insurance broker. The Group also disposed of its associate holding in HIM Capital Holdings Ltd during the year. An area of increased investment for the Group during the year was on IT systems development. Net cash outflows from financing activities for the year were £172.9 million (2009: inflow £1.6 million). The outflow is due to the repayment of the borrowing facility and the payment of dividends. The Group maintains relationships with a limited number of banks, whose credit status and ability to meet day-to-day banking requirements are monitored by the Group. There were no impairments recorded against cash or cash equivalents and no issues regarding recoverability have been identified on these assets. During the year, the Group secured a new revolving credit facility for a total of $750 million replacing the £350 million facility in place in the prior year. This may be drawn by way of cash or Letter of Credit or a combination of the two, providing the cash portion does not exceed $450 million. The facility may be drawn in any foreign currency that the Group requests. At 31 December 2010, $165 million had been drawn by way of Letter of Credit and £20 million by way of cash (2009: $225 million and $138 million respectively). Solvency II Solvency II is the new solvency regime for all insurers and reinsurers due to come into effect from 1 January 2013. It aims to create 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 Pillar 3 – Disclosure and transparency requirements. A working group has been established within Hiscox to lead the work on implementing the new rules and a comprehensive implementation plan is well underway. Many of Solvency II’s qualitative requirements are already an integral part of the Group’s risk management framework and an analysis has been done to identify those areas that require small incremental changes. Full details of the requirements are continually developing and as such uncertainty remains over the full impact of the new regime. During the year, the Group made significant progress in achieving its objectives of implementing the three Pillars completing the QIS 5 exercise and enhancing existing corporate governance functions. Group fi nancial performance Hiscox Ltd Report and Accounts 2010 17 looking so attractive, we have taken profits in areas where further upside seems limited. Bond markets have not been without risk and in consultation with our managers we have studiously avoided sovereign bonds from peripheral Europe and have only modest bank debt exposure to a few national champions in Spain and Italy. In contrast to our positive appetite for credit, duration in government bonds has been kept short. With hindsight this approach has been too cautious but the fourth quarter of the year has highlighted the perils of longer dated bonds. Whilst it was a profitable period for the portfolio overall the sudden sell off in government bonds in the last few weeks of the year is a salutary reminder of how quickly the pendulum can swing. Group investments The Group’s invested assets increased over the year to £2.78 billion (2009: £2.66 billion) with the positive effect of good cashflow being partly offset by the decision to repay £138 million of Group borrowing during the period. The investment result, excluding derivatives, amounted to £98.8 million (2009: £182.8 million) equating to a return of 3.6% (2009: 7.2%). In a year when investment markets were characterised by periods of ‘risk on’ or ‘risk off’, the outcome over the 12 months has favoured riskier assets. Volatility, however, remained a feature, with the general sense of optimism being punctuated by periods of doubt particularly in relation to the financial condition of certain Euro zone countries and fears of a slow down in Chinese growth. Faced with growing economic uncertainty in many developed countries, central bankers kept short-term interest rates at abnormally low levels and employed a variety of stimulatory tools, most noticeably quantitative easing, which drove government bond yields to the lowest level seen in recent times. The likelihood of a prolonged period of easier monetary policy encouraged investors to seek better returns away from cash and short-dated government bonds. Consequently the investment return, whilst not matching that of 2009, has comfortably exceeded our initial expectations. With the broadly positive trends from 2009 continuing into 2010 there were very few shifts in the portfolio during the year. Cash was kept at a relatively low but prudent level, supported by significant holdings of government and government-backed bonds. Although mostly short in duration these provided superior income to cash and ensured that the liquidity and integrity of the balance sheet remained high. However, it was the allocations to non government bonds and risk assets that enhanced the portfolio’s performance. Our risk assets exposure was maintained at around 5% throughout the year. It comprises a selection of long only equity funds and equity based hedge funds. The latter account for roughly 30% of this portfolio and are expected to deliver less exciting but more stable returns. When combined with the long only funds, the risk assets produced a satisfactory result in total. The bond portfolios produced substantial profits for the Group and comfortably outperformed the relevant government bond benchmarks. This was due principally to the level of corporate debt exposure which, having been increased in 2009, was retained throughout the majority of 2010. In the core portfolios the bonds of investment grade corporates, where balance sheets have been conservatively managed in stark contrast to those of many over indebted countries, continued to be in high demand. Additionally, our opportunistic allocation to higher yielding and below investment grade securities produced another year of equity like returns. With further gains from these portfolios being made in the fourth quarter and the risk reward ratio no longer 18 Group investments Hiscox Ltd Report and Accounts 2010 Going into 2011 therefore, there is little margin for error given our desire to avoid losing money in any 12-month reporting period. Indeed, with the possibility of interest rates rising from artificially low levels and further volatility likely in equity markets, the chances of an investment loss in 2011 are statistically greater than they have been recently for anything other than a cash-like portfolio. We are therefore more intent than usual on conserving capital rather than chasing yields, particularly in the absence of any compelling and appropriate opportunities. Few commentators expect official rates to rise in our main markets during 2011 but there are signs of inflationary pressures and a policy shift, or at least the expectation thereof, cannot be ruled out. The allocation to cash is therefore likely to drift higher and duration of the bond portfolios kept low relative to their benchmarks. Given that returns from the bond portfolios are forecast to be lower than 2009 and 2010 and will provide a more limited cushion against the possibility of a weak equity market, our allocation to equities is set to remain around current levels. We do, however, believe they represent good value in the medium term and have a reasonable chance of providing a useful boost to the overall performance in 2011. The impact of the financial crisis has not gone away. Economic recovery in the developed world and the outlook for Chinese growth are areas for concern, and doubts remain about solvency Group investment performance Bonds Bonds total Equities Deposits and cash equivalents Actual return Group invested assets* *excludes derivatives and investment in catastrophe bonds. £ US$ Other 31 December 2010 31 December 2009 Asset allocation % Return % Return £000 Asset allocation % Return % Return £000 18.5 56.8 6.9 82.2 5.6 12.2 2.7 4.0 2.8 3.7 82,234 11.1 15,572 0.3 3.6 1,043 98,849 £2,779.7m 19.1 58.6 7.1 84.8 5.0 10.2 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 High quality and well diversified portfolio Investment portfolio: £2,779.7m Asset allocation 12.2% Cash 5.6% Risk assets 82.2% Bonds Group investments Hiscox Ltd Report and Accounts 2010 19  Group investments continued at a sovereign level in Europe and at a municipal level in the US. Having survived 2008 and prospered in the following two years, 2011 will be a year where the investment strategy is more defensively focused and mindful of our primary objective which is the preservation of capital to support the insurance business. This will leave us in a good position to take advantage of an investment world with higher interest rates and where the reward for taking risk is both greater and more apparent. £2,779.7m Invested assets Bond credit quality 5.2% BBB 5.4% BB 13.5% A 8.9% AA 67.0% AAA Bond currency split 1.6% CAD 22.5% GBP 6.8% EUR 69.1% USD 20 Group investments Hiscox Ltd Report and Accounts 2010  Risk management The core business of Hiscox is managing risk; as such the understanding of risk is intrinsic to every level of decision-making in the Group. The risks associated with the core business of insurance and reinsurance represent some of the greater exposures, however the Group is exposed to a number of other risks and, as part of its risk management framework, the Group has systems and procedures to identify and manage them. These procedures are regularly reviewed and improved in the light of the evolving risk environment and best practice. The Group’s risk management framework, which extends to all aspects of risk including insurance, market, credit, operational, liquidity, reputational and strategic risks is headed by the Risk Committee of the Board, which advises the Board in relation to management of the Group’s risk profile. The Group’s risk appetite is set by the Board and cascaded through the Group’s global operations as part of the business planning cycle and through the risk management framework, which encompasses the following committees: Group Underwriting Review Reinsurance Purchase Review Group Reinsurance Security Committee Cash Flow Review Group Broker Credit Committee Investment Committee Reserving Committees Business Continuity Committee. Each committee is chaired by either the Chairman, Chief Executive Officer, Chief Financial Officer or Chief Underwriting Officer, apart from the Business Continuity Committee which is chaired by the Chief Operations Officer. Each committee has a specific remit, such as underwriting risk, reinsurance purchase, investment risk, claims reserving or business continuity. Senior management responsibilities are clearly defined together with reporting lines and the execution of delegated responsibilities is closely monitored by 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 Risk Committee of the Board. These functions are organised centrally to assist in the integration of best practice throughout the Group. A range of risk management tools are used to assess and manage risk both at business unit level and on a Group-wide basis. Major risks The major risks that the Group faces are presented below categorised as either ‘principal’ or ‘secondary’. Principal major risks represent the most pertinent risks to which the Group is currently exposed, and secondary major risks represent other material risks to which the Group is currently exposed, but not deemed critical at this stage. Detailed information relating to the ‘principal risks’ and uncertainties impacting the Group’s financial statements is set out in note 3 to the financial statements. Major risks: principal Insurance risk: catastrophic and systemic insurance losses The Group continues to underwrite significant risks in geographical regions that are prone to natural peril or which provide cover against other catastrophes, such as terrorism. This business remains a compelling proposition for the Group as it is capable of returning good margins over the medium to long-term as the occurrence of catastrophes average 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 primarily manages exposure to these risks through 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 limit losses from risk concentrations. The Group adapts its business plan, target products and reinsurance programme to produce a well-diversified book. This enables us to maximise expected risk/return on the portfolio as a whole and offset potential losses on more volatile accounts. 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 business plans and control the business underwritten to ensure that the risk profiles of contracts match the exposures for which the plans were devised. Aggregation and modelling resources are shared across the Group. Subsidiaries and locations worldwide therefore employ the same sophisticated standard of modelling tools tailored to the characteristics of each specific market. The Group assesses realistic disaster Risk management Hiscox Ltd Report and Accounts 2010 21  Risk management continued 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. The Group also manages underwriting risk by purchasing 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. The purchase of reinsurance in turn exposes the Group to the risk that reinsurance protection against catastrophic and systemic insurance losses is inadequate or inappropriate. This risk is monitored and managed using similar modelling techniques to those described above, under the supervision of a dedicated Reinsurance Purchase Review Group. Insurance risk: 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 suboptimal 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 grouping current prices with exposure and trends over the past 12 months. 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 HM Treasury. Any such requests depend on the final level of claims from deposit holders (net of asset recoveries), the period of repayment demanded by HM Treasury and the ability of the banks to make such repayments. HM Treasury indicated that it will not demand any principal repayments for three years. The Group participates in many industry bodies, associations and task-force initiatives in order to monitor developments and influence their strategic direction. In particular, the continued involvement of the Group’s executives in the reshaping of the Lloyd’s market underscores that commitment. Insurance risk: reserving The Group establishes provisions for unpaid claims, defence costs and related expenses to cover its ultimate liability in respect of both reported claims and incurred but not reported (IBNR) claims. These provisions take into account both the Group’s and the industry’s experience of similar business, historical trends in reserving patterns, loss payments and pending levels of unpaid claims and awards, as well as any potential changes in historic rates arising from market or economic conditions. Details of the actuarial and statistical methods and assumptions used to calculate reserves are set out in note 26 to the financial statements. The provision estimates are subject to rigorous review and challenge by senior management from all areas of the business and the final provision is approved by the reserving committees. The provision is set above the expected or mean reserve requirement to minimise the risk that actual claims exceed the amount provided. Investment (market) risk The Group invests premiums and technical funds, which are held for the payment of future claims, and as such is exposed to investment risk. The Group’s investment policy is designed to maximise returns within an overall risk appetite which stipulates a one in 100 year loss tolerance. Where appropriate the Board may seek to set aside additional capital to support the recommended asset allocation. The overriding philosophy with the Group’s assets is not to lose money or to put at risk the Group’s capacity to underwrite. Technical funds are primarily invested in high quality bonds and cash. The high quality and short duration of these funds allows the Group to meet its aim of paying valid claims quickly. These funds are maintained in the currency of the insurance policy to reduce foreign exchange risk. 22 Risk management Hiscox Ltd Report and Accounts 2010 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. 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. 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 a large portion of claims are funded pending recovery from a reinsurance partner. The Group plans for this risk through the following measures. A proportion of the Group’s assets are allocated to riskier assets (risk 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 risk 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 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 is in US Dollars. Where appropriate a percentage of the capital will be held in the currency matching that of the underlying business 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 19 to the financial statements. Liquidity risk 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. Running stress tests to estimate the size and timing of claims that might be payable in the event of a number of major catastrophes all occurring within a short period of time. We also run scenario analyses which 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. 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. 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. Emerging risks Given the nature of its activities, the Group is exposed to new and emerging risks. 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. Being able to identify and plan for unexpected events has become an increasingly important component of business cycle management. Emerging risk identification and control is therefore a core part of risk management activity in relation to all aspects of the business, including underwriting, operations and strategy. Significant efforts are made, including obtaining external expertise, to try to identify any threats to the Group either actual or potential. The identification of emerging risks is a core agenda item in each Risk Committee. The Group takes all reasonable steps to minimise the likelihood and impact of such events and to be prepared for their occurrence. Major risks: secondary Insurance risk: binding authorities Hiscox generates considerable 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 Risk management Hiscox Ltd Report and Accounts 2010 23 short periods of time. The disaster recovery plan is tested regularly and includes disaster simulation tests. Employees of the Group are widely located 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. Risk management continued and limits and extensive vetting, monitoring, and auditing of compliance thereof. 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 Director of Compliance and Internal Audit. Credit risk: 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 Chief Financial Officer. 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. Strategic risk: Hiscox credit rating The external ratings assigned 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. The Group has identified the key aspects of our business which are critical to maintaining our ratings. These are closely managed 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. Operational risk: 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 24 Risk management Hiscox Ltd Report and Accounts 2010 Boxplot and whisker diagram of Hiscox Ltd net loss (USD) Upper 95%/lower 5% Mean Hiscox Ltd loss ($m) 700 600 500 400 300 200 100 0 s s o l t e k r a m n b 6 $ 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 5 1 s s o l t e k r a m n b 0 5 $ 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 5 2 s s o l t e k r a m n b 0 1 $ 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 4 2 $ 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 0 4 s s o l t e k r a m n b 6 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 0 3 s s o l t e k r a m n b 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 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 Industry loss return period and peril Mean industry loss $bn 5–10 year 10–25 year 25 –50 year 50 –100 year 100–250 year 01 02 05 18 04 07 09 36 14 18 14 66 24 32 19 99 38 40 26 152 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 2010 25  Corporate responsibility At Hiscox several core values guide our business. These are: to challenge convention, to act with integrity at all times, to have respect for all our business partners, to have courage, to do everything to the highest quality and to excel in the service we provide. These values underpin a reputation we have earned for integrity and decent behaviour in everything we do, which we firmly believe is good for the morale of staff and for the results of the business. Hiscox’s commitment to responsible business practices is reflected in: The environment In 2010 Hiscox UK developed an environmental policy statement, laying out its commitment to measure its carbon footprint and to reduce that as far as it can. The policy encourages the business to operate more sustainably by: measuring our use of water, energy and other products in order to reduce their consumption over time; buying sustainably-sourced goods or energy-efficient products where we can; and minimising waste by recycling and reusing products as much as is feasible. It is intended that this policy and environmental best practice will be rolled out across the Group. In 2009 Hiscox UK conducted an environmental audit of its operations and calculated its carbon footprint with the help of independent consultants Corporate Citizenship. In 2010 Hiscox UK undertook to encourage its employees to change their behaviour in an effort to become carbon neutral. The business generated significant cost and energy savings through increased recycling and more careful use of electricity, water and gas. They achieved a 13% decrease in overall waste sent to landfill, a 15% decrease in overall building energy use and a 12% reduction in water use. Overall, Hiscox UK reduced its carbon footprint by 6%; the balance of its (largely unavoidable) carbon emissions were offset through an investment in an African Energy Efficient Stove Project. Our sustainability efforts have also been recognised by the City of London Corporation, which gave Hiscox’s London office a Clean City Scheme gold award in 2010. Hiscox is a founding member of ClimateWise, an insurance industry initiative that aims to reduce the long-term risk on the global economy and society 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 ClimateWise’s principles. The marketplace Dealing with business partners Hiscox regards insurance brokers as important stakeholders in our business, and we endeavour to have good relationships with them to create a competitive advantage in the marketplace. Clear communication is key in this and Hiscox regularly updates its partner brokers of new developments at Hiscox and in the insurance industry. Dealing with investors In keeping with its policy of open and transparent communication, Hiscox reports both its half and full year results to its investors via a series of presentations as well as ensuring all relevant Group financial information is available on its website. In addition, senior management and key employees meet investors and analysts throughout the year to explain and answer questions on the Group financial performance and business strategy. Dealing with customers Hiscox is dedicated to providing its customers with risk management advice to prevent distressing losses such as burglary and fire in the home. The Hiscox philosophy is that insurance is a promise to pay, so should a loss occur, it aims to fully support its customers and to pay their claims as soon as is possible. The workplace Culture The Hiscox culture is underpinned by a set of core values that determine a standard of behaviour that is expected of all our employees. The Group recognises that through this conduct it is more likely to achieve business success and therefore create additional value for its shareholders. Hiscox strives for the highest standards of corporate governance while striving to remain, 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, furthermore, that this 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 serious 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. 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 it gives them 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, 26 Corporate responsibility Hiscox Ltd Report and Accounts 2010 £1.1m Donated to charities Hiscox UK ® Working with co2balance.com Infants School in Tower Hamlets through the Reading Partners’ Scheme. Employees also mentor students at Morpeth School in Tower Hamlets. Supporting the arts and sciences 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 three-year commitment to support the Whitechapel Art Gallery, in the East End of London. We sponsor the collections gallery at the Whitechapel, which is a touchstone for contemporary art internationally. Hiscox is supporting The Royal Institution with a loan and corporate sponsorship. We are proud to support this independent charity which is the oldest independent research body in the world and has been dedicated to connecting people with the world of science for over 200 years. The Hiscox Foundation The Hiscox Foundation is a charity funded by an annual contribution from Hiscox 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 employees to become involved in charitable work. Hiscox staff continued their support of the Richard House Hospice and during 2010 raised over £29,500. The foundation has committed to support HART (Humanitarian Aid Relief Trust) over a three-year period. HART helps 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. regardless of disability, sex, race, religion, sexual inclination or background. Rewards and benefits Hiscox encourages employees to share in the success of the Group through performance- related pay, bonus, savings-related share option schemes and executive share option schemes. Competitive benefits packages contain health and fitness perks and opportunities for flexible working and career breaks. Watson Wyatt benchmarks our salary packages against the financial services industry as a whole and against the Lloyd’s market specifically (where applicable) and our salaries 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. Their training and development needs are reviewed twice a year, as well as their 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 other more 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. The community Hiscox donated £1,109,000 to charities in 2010. 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. It gives employees the opportunity to contribute time to children who require adult role models and some stability. In addition to $50,000 in donations to the not-for-profit organisation Habitat for Humanity, more than 60 employees from five locations in the USA participated in Habitat for Humanity ‘builds’, volunteering their time and labour for homes in various stages of completion. The Habitat for Humanity initiative gave Hiscox USA employees a chance to have a direct positive impact on their respective communities. Hiscox is a member of the Lloyd’s Community programme, which supports local initiatives concerning education, training, enterprise and regeneration. In London, members of our staff help pupils at the Elizabeth Selby Hiscox has made a donation to the Team 2012 Fundraising Appeal, supporting Britain’s athletes on their journey to success. Corporate responsibility Hiscox Ltd Report and Accounts 2010 27  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. 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 2011 Syndicate 33 has a capital requirement ratio of approximately 45% 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 the remainder 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 2011 year of account, Syndicate 33’s capacity has been reduced from £1 billion to £900 million, primarily to reflect the reduced appetite in certain business lines. The chart below right shows the gross premiums written of Syndicate 33 for the last ten years. Syndicate 3624 Syndicate 3624 is a wholly owned syndicate which began underwriting for the 2009 year of account with an underwriting capacity of £150 million. Syndicate 3624 writes 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 73% of syndicate capacity. Total underwriting capacity of Syndicate 3624 has been increased to £250 million for the 2011 year of account reflecting the focus on the expansion in the US. 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 2010 year of account and Cougar Syndicate 6104’s capacity was increased to £45 million. The Syndicate will continue for the 2011 year of account with a reduction in underwriting capacity to £37 million. Syndicate 33 Capacity and Hiscox ownership (£m) Capacity Hiscox Ltd ownership Qualifying quota share 1,200 1,000 800 600 400 200 0 8 4 2 4 8 5 2 6 4 8 2 3 8 4 7 7 7 4 5 0 5 5 0 5 5 7 8 4 7 8 5 3 6 4 0 6 7 5 0 5 7 4 3 0 0 7 4 4 5 8 0 5 7 5 0 0 0 1, 7 3 0 0 9 5 2 7 3 5 6 1 0 2 4 0 5 0 6 3 1 9 1 7 7 2 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 28 Insurance carriers Hiscox Ltd Report and Accounts 2010 Syndicate 33 Gross premiums written currency split (%) 3% CAD 11% EUR 11% GBP 75% USD Syndicate 33 Gross premiums written geographical split (%) 5% Asia 6% Europe 6% UK 29% Rest of world 54% North America Syndicate 33 Gross premiums written (£m) 1,200 1,000 800 600 400 200 0 1,024 994 1,034 885 872 827 844 830 722 567 2001 2002 2003 2004 2005 2006 2008 2007 2009 2010 Insurance carriers Hiscox Ltd Report and Accounts 2010 29  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 (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) and an A (Strong) rating from Fitch. At the end of 2010, net assets exceeded $28 million (2009: $28 million). Hiscox Insurance Company Limited 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 right. 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 Insurance Company Limited has achieved average compound growth in gross premiums written of 13.8% from 1997 to 2010, 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), a Standard & Poor’s rating of A (Strong) and an A (Strong) rating from Fitch. At the end of 2010, net assets exceeded £197 million (2009: £172 million). Hiscox Bermuda has an A.M. Best rating of A (Excellent) and an A (Strong) rating from Fitch. At the end of 2010, net assets exceeded $941 million (2009: $807 million). Hiscox Insurance Company Inc. Hiscox Insurance Company Inc. was acquired by the Group in 2007 through the purchase of the then parent holding company ALTOHA, Inc. Hiscox Insurance Company Inc. is based in Chicago, Illinois and is an admitted insurance company with licences in all 50 US states and the District of Columbia. Its main business was animal mortality insurance for cattle and horses. These business lines were sold during the year and the Company wrote other property and liability coverage. From November 2010, the Company launched direct commercial business. Hiscox Insurance Company Inc. is rated A (Excellent) by A.M. Best. At the end of 2010, net assets exceeded $58 million (2009: $56 million). Hiscox Insurance Company (Bermuda) Limited Gross premiums written ($m) External business 350 300 250 200 150 100 50 0 297 299 263 212 171 2006 2007 2008 2009 2010 30 Insurance carriers Hiscox Ltd Report and Accounts 2010 Hiscox Insurance Company Limited Gross premiums written geographical split by origin (%) 3% 3% 4% 8% Other Europe Belgium Netherlands Germany 12% France 70% UK Hiscox Insurance Company Limited Gross premiums written (£m) 450 400 350 300 250 200 150 100 50 0 404 381 325 284 231 233 242 219 164 176 127 90 98 75 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Insurance carriers Hiscox Ltd Report and Accounts 2010 31  Board of Directors Executive Directors Independent Non Executive Directors Robert Ralph Scrymgeour Hiscox Chairman (Aged 68) Bronislaw Edmund Masojada Chief Executive (Aged 49) Stuart John Bridges Chief Financial Offi cer (Aged 50) Robert Simon Childs Chief Underwriting Offi cer and Chairman of Hiscox USA (Aged 59) Richard Gillingwater Senior Independent Director (Aged 54) 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 Tru st plc, and AGICM Ltd. 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 Bridges joined Hiscox in 1999. He is a Chartered Accountant and has held posts in various fi nancial service companies in the UK and US, including Henderson Global Investors. During the year he was 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 is Chairman of the Lloyd’s Market Association Finance Committee. 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 Offi cer. Robert was Chairman of the Lloyd’s Market Association from January 2003 to May 2005. Robert is a Trustee of Enham (a charity for the disabled), Chairman of the Advisory Board of the School of Management of Royal Holloway University of London, and Chairman of The Bermuda Society. Richard Gillingwater joined Hiscox in December 2010. He is Dean of Cass Business School. He spent a decade at Kleinwort Benson, before moving to and eventually becoming joint Head of Corporate Finance for BZW, a division of Barclays Bank. When that became Credit Suisse First Boston, he became Chairman of European Investment Banking. In 2003 he became Chief Executive and later Chairman of the Shareholder Executive which manages the UK Government’s day-to- day relationships with government-owned businesses. He was awarded a CBE in the Queen’s Birthday Honours List 2008 in recognition of his services to the fi nancial services industry. 32 Board of Directors Hiscox Ltd Report and Accounts 2010 Secretary Charles Dupplin Registered offi ce 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 Confl ict Committee Member of the Remuneration and Nomination Committee Chairman of Committee is highlighted in solid Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 68) Ernst Robert Jansen Non Executive Director (Aged 62) Dr James Austin Charles King Non Executive Director and Chairman of the Confl ict Committee (Aged 72) Robert McMillan Non Executive Director (Aged 58) 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. Dr James King joined Hiscox in 2006. He chairs Keytech Limited, The Bermuda Telephone Company Ltd, Grotto Bay Properties Ltd and the Establishment Investment Trust, a UK listed company. He was Chairman of the Bank of N.T. Butterfi eld & Son Limited until 19 April 2007. He is a Director of Castle Harbour Limited. Dr King is a fellow of the Royal College of Surgeons, Canada and the American College of Surgeons. Daniel Healy joined Hiscox in 2006. He was appointed Executive Vice President and Chief Financial Offi cer 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 offi ces and held other positions in that fi rm during his tenure. He is Chairman of Herald National Bank and he holds Board positions with KBW, Inc. and Harlem RBI, a not-for- profi t organisation. He is also a Senior Adviser to Permira Advisers LLC, an international private equity fi rm. Robert (Bob) McMillan joined the Hiscox Ltd Board in December 2010. He spent 24 years with the Progressive Insurance Corporation where he served in various positions including National Director of Product Development, then claims before becoming National Director of Marketing. He led Progressive’s initiatives in multi-channel distribution, fi nancial responsibility based rating, and immediate response claims. He has received two United States patents related to motor insurance pricing. He has lectured on business innovation at the University of Virginia’s Darden School of Business and at the Harvard Business School. He has been a Non Executive Director of Hiscox Inc. since March 2007. Gunnar Stokholm Non Executive Director (Aged 61) 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. Andrea Sarah Rosen Senior Independent Director (Jan 2010– Feb 2011) and Chairman of the Remuneration and Nomination Committee (Aged 56) Andrea Rosen joined the Hiscox Ltd Board in 2006. She is a Director of Alberta Investment Management Corporation and 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. Board of Directors Hiscox Ltd Report and Accounts 2010 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 2010, 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 new UK Corporate Governance Code, all Directors are required to submit themselves for re-appointment at the Annual General Meeting of the Company. 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. 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 and the new UK Corporate Governance Code as there are no relationships or circumstances which would interfere with the exercise of their independent judgement. The Board’s Terms of Reference include a Schedule of Matters Reserved for Board Decision, a copy of which can be found on the Group’s website: www.hiscox.com. The Board retains ultimate authority for high-level strategic and management decisions including: setting Group strategy, approving significant mergers or acquisitions, approving the financial statements, declaration of the interim dividend and recommendation of the final dividend, approving Group business plans and budgets, approving major new areas of business, approving capital raising, approving any bonus or rights issues of share capital, setting Group investment guidelines, approving the Directors’ remuneration, approving significant expenditure or projects, and approving the issue of share options. The Board has, however, authorised the boards of the trading entities and business divisions to manage their respective operational affairs, to the extent that Company Board level approval is not required. The Board’s committees The Board has appointed and authorised a number of committees to manage aspects of the Group’s affairs. Each committee operates within established written terms of reference and each committee Chairman reports directly to the Board. The Group Executive Committee The Group Executive Committee, 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 and 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 Richard Gillingwater, Ernst Jansen, Dr James King, Bob McMillan, Andrea Rosen and Gunnar Stokholm. The Chairman of the Committee, Daniel Healy, is considered by the Board to have 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 34 Corporate governance Hiscox Ltd Report and Accounts 2010 comprises Richard Gillingwater, Daniel Healy, Ernst Jansen, Dr James King, Bob McMillan, Andrea Rosen, Gunnar Stokholm and 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 twice a year to deal with appointments to the Board and to recommend a framework of executive remuneration. During the year, the Remuneration and Nomination Committee, considered the appointment of a Non Executive Director. A selection process was agreed by the Committee a recruitment consultancy was appointed and a detailed specification was prepared. It was agreed that Andrea Rosen (Acting Senior Independent Director) would represent the Committee in the selection process and she, as well as the Chairman, the Chief Executive Officer and the Group Human Resources Director, interviewed the shortlisted candidates. The Board approved the appointment of Bob McMillan as a Non Executive Director. He has been a Non Executive Director of Hiscox Inc. since March 2007 and the Board consider that the knowledge and experience gained from this role, together with Bob’s background in the insurance industry, are a significant benefit to the Board. Richard Gillingwater took over as Senior Independent Director from Acting Senior Independent Director, Andrea Rosen, on 28 February 2011. The Directors’ remuneration report is presented on pages 37 to 45. The Conflicts Committee The Group has a Conflicts Committee which comprises independent Non Executive Directors from within the Group, and is 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 that 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. Meetings and attendance table Director RRS Hiscox BE Masojada SJ Bridges RS Childs RD Gillingwater DM Healy ER Jansen Dr J King R McMillan AS Rosen G Stokholm Ltd Board Audit Committee Remuneration and Nomination Committee Attended Attended Attended 4/4 4/4 4/4 4/4 0/0 4/4 3/4 4/4 0/0 4/4 4/4 n/a n/a n/a n/a 0/0 3/3 2/3 3/3 0/0 3/3 3/3 n/a n/a n/a n/a 0/0 3/3 3/3 3/3 0/0 3/3 3/3 Corporate governance Hiscox Ltd Report and Accounts 2010 35 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 The Chief Executive held one-to-one meetings with each of the Executive Directors to discuss their performance over the year and to set targets for the year ahead. Shareholder communications The Executive Directors communicate and meet directly with shareholders and analysts throughout each year, and do not limit this to the period following the release of financial results or other significant announcements. Dirk Stuurop resigned as a Director of Hiscox Ltd on 19 August 2010 and did not attend the Annual General Meeting. All other Directors attended the Annual General Meeting in 2010. 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. The Board has reviewed the effectiveness of internal controls during 2010, 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. 36 Corporate governance Hiscox Ltd Report and Accounts 2010  Directors’ remuneration report Total shareholder return (%) Hiscox FTSE Non life insurance FTSE All share 150 100 50 0 -50 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. 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 2010 were Andrea Rosen (Chairman), Daniel Healy, Dr James King, Dirk Stuurop, Ernst Jansen, Gunnar Stokholm and Sir Mervyn Pedelty (until his death in January 2010 when Andrea took over as Chair). The primary purpose of the Committee is to determine: the overall remuneration strategy, policy and cost for the Group; the levels and make-up of remuneration for the four Executive Directors; and the award of sizeable bonuses to individuals other than the Executive Directors. No member 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 Watson, independent remuneration consultants. The Company also uses the Towers Watson compensation benchmarking reports. D ec 05 Fe b 06 A pr 06 Jun 06 A u g 06 O ct 06 D ec 06 Fe b 07 A pr 07 Jun 07 A u g 07 O ct 07 D ec 07 Fe b 08 A pr 08 Jun 08 A u g 08 O ct 08 D ec 08 Fe b 09 A pr 09 Jun 09 A u g 09 O ct 09 D ec 09 Fe b 10 A pr 10 Jun 10 A u g 10 O ct 10 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 37  Directors’ remuneration report continued As a business Hiscox is focused on generating strong 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 Watson, and the competitive position of Hiscox salaries (based on the Towers Watson salary reports), in order to set the overall salary budget. 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 equity with the bonus pool comprising 15% of profits in excess of that. Bonus pools are then calculated for each major business division and line of business based on the performance of that division against the Hurdle Rate of return for the division’s allocated equity. For the large premium business divisions the calculation is the same as for the Group (described above). Effective 2011 the small premium business divisions will have bonus pools calculated by taking 15% of total profits once the Hurdle Rate has been achieved. Individual salaries are set by taking into account all of the above as well as individual performance and skills. The Hurdle Rate for the 2010 bonus was reviewed. On balance the conclusion was that the Hurdle Rate should remain unchanged for 2010. When approving Executive Directors’ salaries, the Remuneration and Nomination Committee takes into account rates of inflation, individual performance, and competitive positioning of salaries as informed by Towers Watson data and other publicly available reports. The base salaries of the Executive Directors were not increased in 2010. 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. All open Hiscox retirement schemes are based on defined contributions. Variable reward Annual cash incentives (bonuses) Hiscox’s remuneration policy is underpinned by the belief that a reasonable portion of total remuneration should be attained through incentive awards, thereby linking rewards directly with performance. The expectation is that successful performance (company From 2011 the Hurdle Rate will be reviewed by using a ‘benchmark rate’ which takes account of the medium-term, forward looking investment returns (specifically 1–3 year Gilt and Treasury yields, cash returns and the general investment environment). The Hurdle Rate will then be set at 5% above this benchmark rate. If the benchmark rate drops below zero or above 7.5% (suggesting a Hurdle Rate of below 5% or above 12.5%) we would review this approach. Based on this, the Hurdle Rate for 2011 has been set at 7.5%. 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. 38 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 Executive Directors’ cash incentives and ROE Pre-tax return on equity % Average bonus as a percentage of salary % 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3 (24) 13 30 28 19 35 36 14 34 19 0 0 90 202 173 54 274 372 53 287 108 The payment of larger bonuses is normally deferred over a three-year period as follows (with receipt dependent on continued service). 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 and below $200,000 £50,000, €75,000, $100,000 taken in year one Balance of bonus split 50% in year two, and 50% in year three Bonus above £100,000 Bonus above €150,000 Bonus above $200,000 50% of bonus taken in year one 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. 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 2010 and the Remuneration and Nomination Committee has also agreed to make awards under this plan in 2011. 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 2010 was 195% 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 the entire ‘shadow dividend’ re-invested in shares within an employee benefit trust. Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 39  Directors’ remuneration report continued Performance conditions Performance conditions for the Performance Share Plan are as follows: 25% of the award vests if the Company achieves an average ROE of 10% post-tax for each of the three years; 100% vests if the average three-year return exceeds 17.5% post-tax; and vesting will occur on a straight-line basis between these points. The Remuneration and Nomination Committee believes that using ROE as the long-term performance condition better aligns the interests of employees with shareholders 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. ROE has been calculated as profit after tax and goodwill amortisation divided by shareholders funds at the beginning of each year, excluding foreign currency items on economic hedges and intragroup borrowings. Save as You Earn The sharesave scheme and international sharesave scheme are offered to all employees and currently have a 55% 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 2010 is outlined in the table below. Details of their contractual notice periods are contained in the table below right. RRS Hiscox 35% 34% 31% BE Masojada 28% 32% RS Childs SJ Bridges 29% 29% 33% 31% 40% 38% 40% 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 profi t 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 2010 Remuneration of Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges 2010 Basic salary £000 2010 Benefits £000 310 438 358 328 2 2 2 2 2010 Bonus £000 300 500 400 350 2010 Total £000 612 940 760 680 2009 Basic salary £000 2009 Benefi ts £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 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 of 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 until resignation on 21 September 2010 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 R Gillingwater DM Healy ER Jansen Dr J King R McMillan AS Rosen G Stokholm Effective date of Hiscox Ltd contract 12 Dec 2006 12 Dec 2006 12 Dec 2006 12 Dec 2006 1 Dec 2010 11 Oct 2006 20 Nov 2008 11 Oct 2006 1 Dec 2010 11 Oct 2006 20 Nov 2008 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 2010 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: R Gillingwater DM Healy ER Jansen Dr J King R McMillan Sir Mervyn Pedelty AS Rosen G Stokholm DA Stuurop Pensions RRS Hiscox BE Masojada RS Childs SJ Bridges Hiscox Ltd Board $000 Committees $000 10 83 83 83 10 6 83 83 53 5 39 29 34 3 2 47 34 17 Total 2010 $000 15 122 112 117 13 8 130 117 70 Total 2009 $000 – 120 110 115 – 130 117 110 110 Increase in accrued pension during the year £000 7 1 12 2 Transfer accrued annual pension at 31 Dec 10 £000 Transfer value of increase in accrued pension £000 Transfer value of accrued pension at 1 Jan 10 £000 Transfer value of accrued pension at 31 Dec 10 £000 Increase/ (decrease) in transfer value of accrued benefi t during the year £000 238 40 252 31 16 2 17 1 4,701 646 5,387 452 5,056 746 6,185 528 355 100 798 76 42 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 Share options SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Total Number of options at 1 January 2010 56,398 180,341 154,578 154,578 154,578 700,473 78,958 206,104 206,104 206,103 206,104 903,373 56,398 56,398 169,195 78,958 206,104 206,104 206,104 206,104 1,072,569 151,679 244,742 360,947 621,433 630,489 1,138,410 1,102,718 4,250,418 6,983,231 Number of options granted Number of options lapsed Number of options exercised – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Number of options at 31 December 2010 – – 154,578 154,578 154,578 (56,398) (180,341) – – – (236,739) 463,734 (78,958) – – – – – 206,104 206,104 206,103 206,104 (78,958) 824,415 (56,398) (56,398) (169,195) (78,958) – – – – – – – – 206,104 206,104 206,104 206,104 (248,153) 824,416 – – – – – – – – – – – – – – – – – – – – – Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date 1.755 1.252 1.465 1.514 1.499 1.755 1.252 1.465 1.514 1.499 3-May-04 2-May-11 3.401 3.401 19-Nov-05 18-Nov-12 1-Apr-13 12-Jul-14 5-Apr-15 2-Apr-06 13-Jul-07 6-Apr-08 – – – 3.364 3-May-04 2-May-11 – 19-Nov-05 18-Nov-12 1-Apr-13 – 12-Jul-14 – 5-Apr-15 – 2-Apr-06 13-Jul-07 6-Apr-08 1.755 3.688 3-May-04 2-May-11 1.020 1.755 1.252 1.465 1.514 1.499 3.410 15-Jun-03 3-May-04 3.410 14-Jun-10 2-May-11 – 19-Nov-05 18-Nov-12 1-Apr-13 – 12-Jul-14 – 5-Apr-15 – 2-Apr-06 13-Jul-07 6-Apr-08 – – – – – (51,525) (46,371) (151,679) (156,749) (267,338) (227,746) (145,181) (427,663) (405,572) – 87,993 93,609 393,687 485,308 659,222 650,775 (97,896) (1,781,928) 2,370,594 (97,896) (2,402,176) 4,483,159 14-Jun-10 1.020 3.380-3.483 15-Jun-03 1.755 3.363-3.600 2-May-11 3-May-04 0.806 3.346-3.615 27-Sep-04 26-Sep-11 1.252 3.363-3.600 19-Nov-05 18-Nov-12 1-Apr-13 1.465 3.363-3.600 12-Jul-14 1.514 3.360-3.585 5-Apr-15 1.499 3.344-3.585 2-Apr-06 13-Jul-07 6-Apr-08 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 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 RS Childs BE Masojada Other employees Number of options at 1 January 2010 4,256 – 4,907 – 4,343 – 204,356 134,699 521,949 347,784 118,893 90,241 – – Number of options granted Number of options lapsed Number of options exercised – 3,210 – 3,210 – 3,107 – – – – – – 204,461 131,239 – – – – – – (6,298) (15,797) (36,626) (29,458) (8,085) (10,019) (14,957) (1,243) (4,256) – – – – – (198,058) (70,960) (4,440) (4,198) (1,294) – – – Number of options at 31 December 2010 – 3,210 4,907 3,210 4,343 3,107 – 47,942 480,883 314,128 109,514 80,222 189,504 129,996 Exercise price £ Market price at date of exercise £ Date from which exercisable Expiry date 31-Oct-10 3.340 01-May-10 2.220 01-Nov-13 – 01-May-13 2.826 01-Dec-11 31-May-12 – 1.956 01-Nov-13 – 01-May-13 2.826 – 01-Dec-10 31-May-11 2.210 – 01-Dec-13 31-May-14 2.896 2.220 3.340-3.600 01-May-10 31-Oct-10 2.210 3.415-3.618 01-Dec-10 31-May-11 31-Oct-11 1.982 3.401-3.510 01-May-11 01-Dec-11 31-May-12 1.956 3.412-3.599 2.418 3.401-3.415 01-May-12 01-Nov-12 – 01-Dec-12 31-May-13 2.752 01-Nov-13 – 01-May-13 2.826 – 01-Dec-13 31-May-14 2.896 Total 1,431,428 345,227 (122,483) (283,206) 1,370,966 International Sharesave Scheme RS Childs Other employees 4,147 89,691 7,363 23,038 161,130 49,751 54,438 73,180 – – – – – – – – – – 89,254 39,845 – (9,371) (7,363) (1,190) (8,242) (2,840) (6,706) (2,825) (4,733) – (4,147) (80,320) – (10,264) – – – – – – – – – 11,584 152,888 46,911 47,732 70,355 84,521 39,845 – 31-Oct-10 2.220 3.340 01-May-10 31-Oct-10 2.220 3.340-3.656 01-May-10 2.220 01-Jul-10 31-Dec-10 2.210 3.543-3.775 01-Dec-10 31-May-11 1.982 31-Oct-11 – 01-May-11 01-Dec-11 31-May-12 1.956 – – 01-May-12 2.418 01-Nov-12 – 01-Dec-12 31-May-13 2.752 01-Nov-13 – 01-May-13 2.826 – 01-Dec-13 31-May-14 2.896 Total 462,738 129,099 (43,270) (94,731) 453,836 44 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 Performance Share Plan SJ Bridges RS Childs RRS Hiscox BE Masojada Other employees Number of awards at 1 January 2010 120,000 110,000 200,000 – 150,000 140,000 225,000 – 80,000 75,000 50,000 – 200,000 175,000 275,000 – 909,580 55,262 2,026,500 52,000 1,553,000 2,906,000 – Number of awards granted 15,882 – – 150,000 19,852 – – 175,000 10,588 – – 76,260 26,470 – – 250,000 – – 266,180 6,882 – – 3,095,096 Number of awards lapsed – – – – – – – – – – – – – – – – – – (10,000) – (22,500) (70,000) (60,000) Number of awards exercised Number of awards at 31 December 2010 Market price at date of exercise £ Date from which released (135,882) – – – (169,852) – – – – – – – (226,470) – – – (66,315) (55,262) (1,822,389) (58,882) – – – 3.416 26-Mar-10 – 07-Apr-11 110,000 02-Apr-12 200,000 07-Apr-13 150,000 3.366 26-Mar-10 – 07-Apr-11 – 140,000 02-Apr-12 – 225,000 – 07-Apr-13 175,000 – 26-Mar-10 90,588 07-Apr-11 – 75,000 02-Apr-12 – 50,000 07-Apr-13 – 76,260 3.381 26-Mar-10 – 07-Apr-11 175,000 02-Apr-12 275,000 250,000 07-Apr-13 843,265 3.371-3.414 12-Jan-09 3.336 05-Oct-09 460,291 3.325-3.660 26-Mar-10 02-Oct-10 07-Apr-11 02-Apr-12 07-Apr-13 – 3.503-3.601 – – – – – – – – 1,530,500 – 2,836,000 – 3,035,096 Total 9,302,342 4,092,210 (162,500) (2,535,052) 10,697,000 Directors’ remuneration report Hiscox Ltd Report and Accounts 2010 45  Directors’ report The Directors have pleasure in submitting their Annual Report and financial statements for the year ended 31 December 2010. capital and changes in the share capital during the year are disclosed in note 24 to the consolidated financial statements. 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 and likely future development 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. 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. Details of the key financial performance indicators are given on page 1. All information described above is incorporated by reference into this report and is deemed to form part of this report. Financial results The Group achieved a pre-tax profit for the year of £211.4 million (2009: £320.6 million). Detailed results for the year are shown in the consolidated income statement on page 49, and also within the Group financial performance section on pages 16 to 17. Going concern A review of the financial performance of the Group is set out on pages 16 to 17. The financial position of the Group, its cash flows and borrowing facilities are included therein. 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 5.0p (net) per share (2009: 4.5p (net)) was paid on 28 September 2010 by Hiscox Ltd in respect of the year ended 31 December 2010. The Directors recommend the payment of a final dividend of 11.5p (net) per share (2009: second interim dividend 10.5p (net)). If approved this will be paid on 21 June 2011 to shareholders on the register at the close of business on 13 May 2011. The Directors propose that shareholders may elect to receive the final dividend in new ordinary shares, a ‘scrip dividend’, rather than cash. A resolution to approve the scrip dividend alternative will be put to shareholders at the Annual General Meeting. It is envisaged that the Company will suspend indefinitely the Company’s Dividend Access Plan if the scrip dividend alternative is approved. Share capital Details of the structure of the Company’s share 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. Details of the Chairman’s professional commitments are included in his biography. In accordance with the new UK Corporate Governance Code all Directors will submit themselves for re-election at the Annual General Meeting of the Company. 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. Andrea Rosen was subsequently appointed Chairman of the Remuneration and Nomination Committee and Acting Senior Independent Director. Dirk Stuurop resigned on 19 August 2010. Richard Gillingwater and Robert (Bob) McMillan were appointed on 1 December 2010. On 28 February 2011, Richard Gillingwater was appointed Senior Independent Director. Political and charitable contributions The Group made no political contributions during the year (2009: £nil). Charitable donations totalled £1,109,000 (2009: £1,171,000) of which £500,000 (2009: £1,000,000) 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 As at 28 February 2011, the Company has been notified of the following significant holdings of voting rights in its ordinary shares: Number of shares % of total Invesco Limited 53,447,456 14.04 Massachusetts Financial Services Company 19,620,700 5.15 Ruane, Cunniff & Goldfarb Inc. 19,410,231 5.10 A copy of the Company’s Bye-Laws is available for inspection at the Company’s registered office. Annual General Meeting The notice of the Annual General Meeting, to be held at the Elbow Beach Hotel, 60 South Shore Road, Paget PG04, Bermuda on 8 June 2011 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 28 February 2011 46 Directors’ report Hiscox Ltd Report and Accounts 2010 Directors’ interests Executive Directors RRS Hiscox BE Masojada RS Childs SJ Bridges Non Executive Directors R Gillingwater D Healy E R Jansen Dr J King R McMillan Sir Mervyn Pedelty A Rosen G Stokholm DA Stuurop Directors’ responsibilities statement 31 December 2010 5p Ordinary Shares number of shares beneficial 31 December 2009 5p Ordinary Shares number of shares benefi cial 6,637,176 6,600,196 3,504,517 3,229,465 1,991,272 1,906,840 1,149,438 1,009,399 – – 100,000 55,000 20,698 – – – 24,116 – – – – – 18,000 – – 50,000 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, present fairly, in all material respects, 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 28 February 2011. Directors’ report/Directors’ responsibilities statement Hiscox Ltd Report and Accounts 2010 47 Opinion In our opinion: the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as at 31 December 2010, 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 8 to the UK Companies Act 2006 The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008 No. 410), as if those requirements were to apply to the Company. KPMG Hamilton, Bermuda 28 February 2011 Independent auditors’ report 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 49 to 99 which comprise the consolidated balance sheet as at 31 December 2010, and the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes. In addition to our audit of the consolidated financial statements, the Directors have engaged us to audit the information in the Directors’ remuneration report that is described as having been audited, which the Directors have decided to prepare (in addition to that required to be prepared) as if the Company were required to comply with the requirements of Schedule 8 to the UK Companies Act 2006 The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008 No. 410). Management’s responsibility for the consolidated 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 and for such internal controls as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement whether due to fraud or error. 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 ethical requirements and plan and perform the audit to obtain reasonable assurance whether the consolidated 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 consolidated 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 audit opinion. We review whether the corporate governance statement reflects the Company’s compliance with the nine provisions of the June 2008 Combined Code specified for our review by those rules, and we report if it does not. We are not required by the terms of our engagement to consider whether the Board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures. We also read the other information contained in the Report and Accounts and consider whether it is consistent with the audited consolidated financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the consolidated financial statements. Our responsibilities do not extend to any other information. 48 Independent auditors’ report to the Board of Directors and the shareholders of Hiscox Ltd Hiscox Ltd Report and Accounts 2010  Consolidated income statement For the year ended 31 December 2010 Income Gross premiums written Outward reinsurance premiums Net premiums written Gross premiums earned Premiums ceded to reinsurers Net premiums earned Investment result Other revenues Revenue Expenses Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Operational expenses Foreign exchange gains/(losses) Total expenses Results of operating activities Finance costs Share of (loss)/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 Consolidated statement of comprehensive income For the year ended 31 December 2010, after tax Profit for the year Other comprehensive income Currency translation gains/(losses) (net of tax of £nil (2009: £nil)) Total other comprehensive income/(loss) Total comprehensive income recognised for the year (all attributable to owners of the Company) The notes on pages 53 to 99 are an integral part of these consolidated financial statements. Note 2010 Total £000 2009 Total £000 4 1,432,674 1,435,401 (278,378) (301,047) 4 1,131,627 1,157,023 1,435,118 1,363,698 (265,596) (303,960) 4 1,131,158 1,098,102 7 9 100,249 22,079 183,165 19,498 1,253,486 1,300,765 26.2 17 9 12 (570,997) (269,891) (206,403) 15,484 (463,218) (256,634) (229,566) (25,554) (1,031,807) (974,972) 221,679 (10,090) (223) 325,793 (5,293) 118 211,366 (32,566) 320,618 (40,121) 178,800 280,497 47.2p 45.4p 75.2p 72.3p 10 16 28 31 31 Note 2010 Total £000 2009 Total £000 178,800 280,497 12 11,729 (69,589) 11,729 (69,589) 190,529 210,908 Consolidated income statement/Consolidated statement of comprehensive income Hiscox Ltd Report and Accounts 2010 49  Consolidated balance sheet At 31 December 2010 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 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 2010 £000 2009 £000 29 16 14 15 64,108 19,742 6,886 14,077 142,736 50,413 22,244 7,318 14,077 141,505 17 19 2,459,107 2,413,300 420,126 488,782 259,647 462,765 485,414 336,017 23 20 18, 26 3,990,852 3,817,412 24 24 24 25 25 20,297 15,800 245,005 49,457 935,555 20,158 11,831 303,465 37,728 748,104 1,266,114 1,121,286 30 – 45,421 – 69,673 29 26 2,279,867 2,122,351 138,539 26,080 339,483 20,457 29,995 348,998 27 19 2,724,738 2,696,126 3,990,852 3,817,412 The notes on pages 53 to 99 are an integral part of these consolidated financial statements. The consolidated Group financial statements were approved by the Board of Directors on 28 February 2011 and signed on its behalf by: RRS Hiscox Chairman SJ Bridges Chief Financial Officer 50 Consolidated balance sheet Hiscox Ltd Report and Accounts 2010  Consolidated statement of changes in equity Balance at 1 January 2009 Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) Employee share options: Equity settled share based payments Proceeds from shares issued Deferred tax Dividends paid to owners of the Company Balance at 31 December 2009 Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) Employee share options: Equity settled share based payments Proceeds from shares issued 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 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) 20,158 11,831 303,465 37,728 748,104 1,121,286 – – 139 – – – – 11,729 178,800 190,529 – 3,969 – – – – – (58,460) – – – – 9,000 – (349) – 9,000 4,108 (349) (58,460) 24 24 32 24 29 32 Balance at 31 December 2010 20,297 15,800 245,005 49,457 935,555 1,266,114 The notes on pages 53 to 99 are an integral part of these consolidated financial statements. Consolidated statement of changes in equity Hiscox Ltd Report and Accounts 2010 51  Consolidated statement of cash flows For the year ended 31 December 2010 Profit before tax Adjustments for: Interest and equity dividend income Interest expense Net fair value gains on financial assets 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 flows from the acquisition of subsidiaries Cash flows from the sale and purchase 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 Dividends paid to owners of the Company Net (repayments)/receipts of borrowings Net cash flows from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at 1 January Net increase/(decrease) in cash and cash equivalents Effect of exchange rate fluctuations on cash and cash equivalents Cash and cash equivalents at 31 December Note 2010 £000 2009 £000 211,366 320,618 (61,606) 10,090 (25,672) 7,065 8,047 1,323 (508) (78,298) 5,293 (87,692) 6,046 5,260 (975) 30,844 14, 15 9, 24 141,646 (2,527) 82 (23,704) 265,602 60,332 1,274 (4,628) (51,580) (58,366) (338,556) (52,533) 36,560 (211,799) 74,584 3,714 (5,066) (1,463) 271,000 (140,030) (3,662) 468 (3,462) (15,591) – – (8,802) (2,911) (22,247) (11,713) 4,108 (58,460) (118,539) 2,504 (48,613) 47,721 (172,891) 1,612 75,862 (150,131) 33 16 24 32 259,647 75,862 508 440,622 (150,131) (30,844) 23 336,017 259,647 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 £63,447,000 (2009: £31,607,000) not available for immediate use by the Group outside of the Lloyd’s syndicate within which they are held. The notes on pages 53 to 99 are an integral part of these consolidated financial statements. 52 Consolidated statement of cash fl ows Hiscox Ltd Report and Accounts 2010  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 1,100 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 2010 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 28 February 2011. 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. In July 2010 the IASB published an exposure draft for Phase II of the Insurance Contracts project. The exposure draft was open for comment until 30 November 2010 and the IASB aim to issue a final standard by mid 2011. The exposure draft proposes a number of significant changes to the measurement of insurance contracts and as such adoption of a final standard in a form similar to the exposure draft will likely have a significant impact on the results of the Group. As yet, there is no effective date agreed for a new standard however transitional provisions propose that it should be applied retrospectively with opening differences accounted for in equity. The Group is generally supportive of the proposed measurement principles for short duration contracts however we have submitted a comment letter to the IASB outlining our concerns and issues with some of the definitions and detail included within the exposure draft. We continue to monitor the progress of the project. In April 2010, the IASB published an exposure draft containing proposals on recognition, presentation and disclosure of defined benefit plans as currently defined by IAS 19. The exposure draft was open to comment until September 2010 and it is expected that a finalised standard will be issued during the first quarter of 2011. The exposure draft proposes that the defined employee benefit cost is recognised immediately and removes the option of the corridor method which the Group currently applies. In addition, the exposure draft proposes that companies present the defined employee benefit cost as follows: service costs within employment expenses; net interest income or expense within finance costs; remeasurement within other comprehensive income. The effective date for the new standard has not been determined however retrospective application will be required. Should IAS 19 be amended to reflect the proposed changes, the Group will no longer be permitted to apply the corridor approach and as such, should the proposals be included within the new standard, we expect there to be an impact to the financial position of the Group. 2.2 Basis of preparation The financial statements are presented in Pounds Sterling and are rounded to the nearest thousand unless otherwise stated. They are compiled on a going concern basis and prepared on the historical cost basis except that pension scheme assets included in the measurement of the employee retirement benefit obligation, and certain financial instruments including derivative instruments are measured at fair value. Employee retirement benefit obligations are determined using actuarial analysis. The balance sheet of the Group is presented in order of increasing liquidity. The accounting policies have been applied consistently by all Group entities, to all periods presented, solely for the purpose of producing the consolidated Group financial statements. The Group elected to apply the transitional arrangements contained in IFRS 4 that permitted the disclosure of only five years of data in claims development tables, in the year ended 31 December 2005 which was the year of adoption. The number of years of data presented was increased from nine in the prior year, to the maximum of ten in the current financial year. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 53  Notes to the consolidated financial statements continued give rise to goodwill nor gain or loss. Adoption of this standard had no impact on previous acquisitions or the financial position of the Group. 2 Significant accounting policies continued 2.2 Basis of preparation continued The Group has financial assets and cash of over £2.78 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 Group is well placed to manage its business risk and continue to trade successfully. A review of the financial performance of the Group is set out on pages 16 to 17. 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 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 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 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 In April 2010, the IASB issued its annual amendments to International Financial Reporting Standards. Such amendments remove inconsistencies and clarify wording and unless otherwise stated are effective for financial years beginning on or after 1 January 2010. The Group adopted the revisions where applicable with no impact to the financial statements. The following standards and interpretations have been issued but are not yet effective. In October 2009 the IASB issued an Amendment to IAS 32 Financial Instruments Disclosure and Presentations, Classification of Rights Issues. The amendment changes the definition of a financial liability in order to classify rights issues as equity instruments in cases where such rights are given pro rata to all of the existing owners of the same class of an entity’s non derivative equity instruments. The amendment is effective for annual periods beginning on or after 1 February 2010. Adoption of this standard will have no impact on the financial position of the Group. The amendment to IFRIC 14, The Limit on a Defined Benefit Asset, Minimum Funding Requirements is effective for annual periods beginning on or after 1 January 2011. The amendment provides guidance on assessing the recoverable amount of a net pension asset in a defined benefit scheme and permits an entity to treat the prepayment of a minimum funding requirement as an asset. Adoption of this standard will have no impact on the financial position of the Group. IAS 24 Related Party Disclosure (Amendment) is effective for annual periods beginning on or after 1 January 2011. The amendment clarifies the definition of a related party in order to simplify the identification of such relationships and to eliminate inconsistencies in application. Adoption of this standard will have no impact on the financial position of the Group. 2.3 Basis of consolidation (a) Subsidiaries Subsidiaries are those entities controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Generally this occurs when the Group obtains a shareholding of more than half of the voting rights of an entity. In assessing control, potential voting rights that are currently exercisable or convertible are taken into account. Management also exercise significant judgement about any actual or perceived control acquired indirectly, through normal commercial dealings with entities of a special purpose nature. The Group does not undertake any such arrangements with such entities where control of that entity would be acquired. The consolidated financial statements include the assets, liabilities and results of the Group up to 31 December each year. The financial statements of subsidiaries are included in the consolidated financial statements only from the date that control commences until the date that control ceases. Hiscox Dedicated Corporate Member Limited underwrites as a corporate member of Lloyd’s on the main Syndicates managed by Hiscox Syndicates Limited (the ‘main managed Syndicates’ numbered 33 and, 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, defined profit commissions as appropriate and interest arising on effective assets included within the experience account, 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. At the date of acquisition, the Group recognises the identifiable assets acquired and liabilities assumed as part of the overall business combination transaction at their acquisition date fair value. Recognition of these items is subject to the definitions of assets and liabilities in the Framework for the Preparation and Presentation of Financial Statements. The Group may also recognise intangible items not previously recognised by the acquired entity such as customer relationships. (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 54 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 2 Significant accounting policies continued 2.3 Basis of consolidation continued (b) Associates continued 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 for each period, and its share of the movement in the associates’ net assets is reflected in the investments’ carrying values in the balance sheet. When the Group’s share of losses equals or exceeds the carrying amount of the associate, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associate. (c) Transactions eliminated on consolidation Intragroup balances, transactions and any unrealised gains arising from intragroup transactions are eliminated in preparing the consolidated financial statements. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. 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. (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 foreseeable future. Non-monetary items carried at historical cost are translated in the balance sheet at the exchange rate prevailing on the original transaction date. Non-monetary items measured at fair value are translated using the exchange rate ruling when the fair value was determined. (c) Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; 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 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. 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. 2.5 Property, plant and equipment Property, plant and equipment are stated at historical cost less depreciation and any impairment loss. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, 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. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 55  Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.6 Intangible assets continued (a) Goodwill continued The impairment review process examines whether or not the carrying value of the goodwill attributable to individual cash generating units exceeds its recoverable amount. Any excess of goodwill over the recoverable amount arising from the review process indicates impairment. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. (b) Syndicate capacity The cost of purchasing the Group’s participation in the Lloyd’s insurance syndicates is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. Having considered the future prospects of the London insurance market, the Board believes 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 contractual 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 when it is probable that the expected future economic benefits that are attributable to the asset will flow to the Group and the cost of the asset can be measured reliably. Amortisation of internally developed computer software begins when the software is available for use and is allocated on a straight-line basis over the expected useful life of the asset. The useful life of the asset is reviewed annually and if different from previous estimates is changed accordingly with the change being accounted for as a change in accounting estimates in accordance with IAS 8. 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 22. (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; 56 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 2 Significant accounting policies continued 2.9 Impairment of assets continued (b) Financial assets continued 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 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. of premium received on in-force contracts that relates to unexpired risks at the balance sheet date is reported as the unearned premium liability. 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. Profit commission is calculated and accrued based on the results of the managed syndicate. 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. 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. (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 (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 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 57  Notes to the consolidated financial statements continued 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 Significant accounting policies continued 2.13 Insurance contracts continued (e) Outwards reinsurance contracts held continued recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers (classified within loans and receivables) as well as longer-term receivables (classified as reinsurance assets) that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Reinsurance liabilities primarily comprise premiums payable for ‘outwards’ reinsurance contracts. These amounts are recognised in profit or loss proportionally over the period of the contract. Receivables and payables are recognised when due. The Group assesses its reinsurance assets on a regular basis and, if there is objective evidence, after initial recognition, of an impairment in value, the Group reduces the carrying amount of the reinsurance asset to its recoverable amount and recognises the impairment loss in the income statement. (f) Receivables and payables related to insurance contracts Receivables and payables are recognised when due. These include amounts due to and from agents, brokers and insurance contract holders. 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 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. Actuarial gains and losses are only recognised when the net cumulative unrecognised actuarial gains and losses for each individual plan at the end of the previous accounting period exceeds 10% of the higher of the defined benefit obligation and the fair value of the plan assets at that date. Such actuarial gains or losses falling outside of this 10% corridor are charged or credited to income over the employees’ expected average remaining working lives. Past service costs are recognised immediately in income, unless the changes to the pension plan are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over the vesting period. (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 58 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 2 Significant accounting policies continued 2.15 Employee benefits continued (c) Share based compensation continued (e.g. profitability or net asset growth targets). Non-market vesting conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period. When the terms and conditions of an equity settled share based employee compensation plan are modified, and the expense to be recognised increases as a result of the modification, then the increase is recognised evenly over the remaining vesting period. When a modification reduces the expense to be recognised, there is no adjustment recognised and the pre- modification expense continues to be applied. The proceeds received net of any directly attributable transaction costs are credited to share capital and share premium when the options are exercised. In accordance with the transitional arrangements of IFRS 2 only share based awards granted or modified after 7 November 2002, but not yet vested at the date of adoption of IFRS, are included in the calculations. (d) Termination benefits Termination benefits are payable when employment is terminated before the normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Group recognises termination benefits when it is demonstrably committed to either: terminating the employment of current employees according to a detailed formal plan without possibility of withdrawal; or providing termination benefits as a result of an offer made to encourage voluntary redundancy. (e) Profit sharing and bonus plans The Group recognises a liability and an expense for bonuses and profit sharing, based on a formula that takes into consideration the profit attributable to the Company’s shareholders after certain adjustments. The Group recognises a provision where a contractual obligation to employees exists or where there is a past practice that has created a constructive obligation. (f) Accumulating compensation benefits The Group recognises a liability and an expense for accumulating compensation benefits (e.g. holiday entitlement), based on the additional amount that the Group expects to pay as a result of the unused entitlement accumulated at the balance sheet date. 2.16 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 19). 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 on-going 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 deferred tax assets and liabilities as being most critical to an understanding of the Group’s result and position. The most critical estimate included within the Group’s balance sheet is the estimate for losses incurred but not reported. The total estimate as at 31 December 2010 is £904 million (2009: £749 million) and is included within total insurance liabilities on the balance sheet. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 59  Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.22 Use of critical estimates, judgements and assumptions continued Estimates of losses incurred but not reported 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 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. The overall reserving risk is discussed in more detail in note 3.1 and the procedures used in estimating the cost of settling insured losses at the balance sheet date including losses incurred but not reported are detailed in note 26. 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 30. Legislation concerning the determination of taxation assets and liabilities is complex and continually evolving. In preparing the Group’s financial statements, the Directors estimate taxation assets and liabilities after taking appropriate professional advice. The determination and finalisation of agreed taxation assets and liabilities may not occur until several years after the balance sheet date and consequently the final amounts payable or receivable may differ from those presently recorded in these financial statements. 2.23 Reporting of additional performance measures The Directors consider that the claims ratio, expense ratio and combined ratio measures reported in respect of operating segments and the Group overall at note 4 provide useful information regarding the underlying performance of the Group’s businesses. These measures are widely recognised by the insurance industry and are consistent with internal performance measures reviewed by senior management including the chief operating decision maker. However, these three measures are not defined within the IFRS framework and body of standards and interpretations and therefore may not be directly comparable with similarly titled additional performance measures reported by other companies. Net asset value per share and return on equity measures, disclosed at notes 5 and 6, are likewise considered to be additional performance measures. 3 Management of risk 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 has set Group wide risk management policies and procedures which include 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 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. The Group’s cash flows are funded mainly through advance premium collections 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. The principal sources of risk relevant to the Group’s operations and its financial statements fall into two broad categories: insurance risk and financial risk both of which are described in notes 3.1 and 3.2 below. The Group also actively manages its capital risks as detailed in note 3.3. Additional unaudited information is also provided in the corporate governance and risk management sections of this Report and Accounts. 3.1 Insurance risk The predominant risk to which the Group is exposed is insurance risk which is assumed through the underwriting process. Insurance risk can be sub-categorised into i) underwriting risk including the risk of catastrophe and systemic insurance losses and the insurance competition and cycle, and ii) reserving risk. i) Underwriting risk The Board sets the Group’s underwriting strategy for accepting and managing underwriting risk, seeking to exploit identified opportunities in the light 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 Group’s underwriters and management consider underwriting 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 underwriting risk 60 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 3 Management of risk continued 3.1 Insurance risk continued i) Underwriting risk continued the Group routinely performs a wide range of activities including the following: regularly updating the Group’s risk models; documenting, monitoring and reporting on the Group’s strategy to manage risk; developing systems that facilitate the identification of emerging issues promptly; utilising sophisticated computer modelling tools to simulate catastrophes and measure the resultant potential losses before and after reinsurance; monitoring legal developments and amending the wording of policies when necessary; regularly aggregating risk exposures across individual underwriting portfolios and known accumulations of risk; examining the aggregated exposures in advance of underwriting further large risks; and developing processes that continually factor market intelligence into the pricing process. The delegation of underwriting authority to specific individuals, both internally and externally, is subject to regular review. All underwriting staff and binding agencies are set strict parameters in relation to the levels and types of business they can underwrite, based on individual levels of experience and competence. These parameters cover areas such as the maximum sums insured per insurance contract, maximum gross written premiums and maximum aggregated exposures per geographical zone and risk class. Monthly meetings are held between the Chief Underwriting Officer and a specialist central analysis and review team in order to monitor claim development patterns and discuss individual underwriting issues as they arise. The Chief Underwriting Officer also holds weekly video conference meetings with this team to discuss interim underwriting matters. The Group’s insurance contracts include provisions to contain losses such as the ability to impose deductibles and demand reinstatement premiums in certain cases. In addition, in order to manage the Group’s exposure to repeated catastrophic events, relevant policies frequently contain payment limits to cap the maximum amount payable from these insured events over the contract period. The Group also manages underwriting risk by purchasing 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. 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 bad underwriting year. The Group compiles estimates of losses arising from realistic disaster events using statistical models alongside input from its underwriters. These require significant management judgement. 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 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 estimated exposure to certain industry events is summarised below. These estimates have been made using modelled assumptions and management judgement and given the nature of risks underwritten may be materially different from actual losses suffered depending on the size and nature of the event. Japan earthquake Gulf of Mexico windstorm Florida windstorm European windstorm San Francisco earthquake Gross loss US$m Net loss US$m Gross loss as a % of total equity Net loss as a % of total equity Net loss as % of insurance industry loss Industry loss size US$bn Return period years 331 790 645 507 638 202 212 173 225 197 16.7 39.7 32.4 25.5 32.1 10.2 10.7 8.7 11.3 9.9 0.4 0.2 0.1 0.8 0.4 50 107 125 30 50 240 80 100 200 110 Overleaf is a summary of the gross and net insurance liabilities for each category split by country of risk. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 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 2010 UK and Ireland Europe United States Other territories Multiple territory coverage Total Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net 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 Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net Types of insurance risk in the Group Reinsurance inwards £000 31,637 24,427 31,983 22,081 181,963 116,634 28,524 23,503 268,350 197,678 Property – Marine and major assets £000 19,881 5,330 2,577 2,044 18,706 16,339 27,577 21,756 177,678 135,679 Property – Other assets £000 Casualty – Professional indemnity £000 136,202 132,554 71,130 67,239 104,422 58,361 34,303 23,207 68,834 50,207 295,631 257,998 63,295 59,135 267,698 248,849 36,326 33,643 44,785 41,549 Casualty – Other risks £000 7,513 2,258 11,779 3,827 39,355 22,837 3,424 2,905 114,857 91,218 * Other £000 Total £000 17,326 10,528 24,360 19,717 20,776 16,720 65,570 52,574 63,405 56,305 508,190 433,095 205,124 174,043 632,920 479,740 195,724 157,588 737,909 572,636 542,457 246,419 414,891 707,735 176,928 191,437 2,279,867 384,323 181,148 331,568 641,174 123,045 155,844 1,817,102 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 Types of insurance risk in the Group 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 *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. The estimated liquidity profile to settle these net claims liabilities is given in note 3.2 (e). The specific insurance risks accepted by the Group fall broadly into the following main categories: reinsurance inwards, marine and major asset property, other property risks, professional indemnity casualty and casualty other insurance risks. These specific categories are defined for risk review purposes only as each contain risks specific to the nature of the cover provided. They 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. The following describes the policies and procedures used to identify and measure the risks associated with each individual category of 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. 62 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 3 Management of risk continued 3.1 Insurance risk continued A significant proportion of the reinsurance inwards business provides cover on an excess of loss basis for individual events. The Group agrees to reimburse the cedant once their losses exceed a minimum level. Consequently the frequency and severity of reinsurance inwards claims is related not only to the number of significant insured events that occur but also to their individual magnitude. If numerous catastrophes occurred in any one year, but the cedant’s individual loss on each was below the minimum stated, then the Group would have no liability under such contracts. Maximum gross line sizes and aggregate exposures are set for each type of programme. The Group writes reinsurance risks for periods of mainly one year so that contracts can be assessed for pricing and terms and adjusted to reflect any changes in market conditions. 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 these types of 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. 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. 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. By nature, some casualty losses may take longer to settle than the other categories of business. 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. Reserving risk The Group’s procedures for estimating the outstanding costs of settling insured losses at the balance sheet date, including claims incurred but not yet reported, are detailed in note 26. The majority of the Group’s insurance risks are short tail and, based on historical claims experience, 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. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 63  Notes to the consolidated financial statements continued 3 Management of risk continued 3.1 Insurance risk continued Reserving risk continued 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. For the inwards 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 the reinsured 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 instruments including financial liabilities. These items collectively represent a significant element of the Group’s net shareholder funds. The Group invests in financial assets in order to fund obligations arising from its insurance contracts and financial liabilities. The key financial risk for the Group is that the proceeds from its financial assets and investment result generated thereon are not sufficient to fund the obligations. The most important entity and economic variables that could result in such an outcome relate to the reliability of fair value measures, equity price risk, interest rate risk, credit risk, liquidity risk and currency risk. The Group’s policies and procedures for managing exposure to these specific categories of risk are detailed below. quotations in the most active financial markets in which the assets trade. The fair value of financial assets is measured 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. In addition, those quoted prices that may be available may represent an 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. At 31 December 2010, the Group holds asset-backed and mortgage-backed fixed income instruments in its investment portfolio however has minimal direct exposure to sub-prime asset classes. Together with the Group’s investment managers, management continues to monitor the potential for any adverse development associated with this investment exposure through the analysis of relevant factors such as credit ratings, collateral, subordination levels and default rates in relation to the securities held. Valuation of these securities will continue to be impacted by external market factors including default rates, rating agency actions, and liquidity. The Group will make adjustments to the investment portfolio as appropriate as part of its overall portfolio strategy, but its ability to mitigate its risk by selling or hedging its exposures may be limited by the market environment. The Group’s future results may be impacted, both positively and negatively, by the valuation adjustments applied to these securities. Note 22 provides an analysis of the measurement attributes of the Group’s financial instruments. (a) 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 (b) 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 2010 was £155 million (2009: £134 million). These may be analysed as follows: Nature of equity and unit trust holdings 2010 % weighting 2009 % 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 69 29 44 56 2 68 30 37 63 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 2010 would have been expected to reduce Group equity and profit after tax for the year by approximately £13.1 million (2009: £11.4 million) assuming that the only area impacted was equity financial assets. A 10% upward movement is estimated to have an equal but opposite effect. (c) 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. The fair value of debt and fixed income assets in the Group’s balance sheet at 31 December 2010 was £2,285 million (2009: £2,256 million). These may be analysed as follows: 64 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 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. 3 Management of risk continued 3.2 Financial risk continued (c) Interest rate risk continued Nature of debt and fixed income holdings 2010 % weighting 2009 % 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 22 31 8 4 6 27 2 28 28 6 4 6 26 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 £28 million (2009: decrease of £32 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 19. At 31 December 2010, £20 million was drawn on the Group’s borrowing facility (2009: £138 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 35. 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 to the policyholder. The creditworthiness of reinsurers is therefore continually reviewed throughout the year. (d) Credit risk The Group has exposure to credit risk, The Group Reinsurance Security Committee assesses the creditworthiness Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 65  Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (d) Credit risk continued 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. 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 2010 Debt and fixed income securities Deposits with credit institutions Catastrophe bonds Reinsurance assets Cash and cash equivalents Total Note AAA £000 AA £000 A £000 Other/ not rated £000 Total £000 19 19 1,530,973 3,819 – 22,931 35,874 18 23 202,410 207 – 169,083 137,223 308,966 – – 253,810 160,382 242,164 2,284,513 4,280 15,452 462,765 336,017 254 15,452 16,941 2,538 1,593,597 508,923 723,158 277,349 3,103,027 Amounts attributable to largest single counterparty 252,213 76,466 43,420 16,583 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 19 19 1,555,636 62 – – 8,120 27,456 18 23 19, 21 198,001 2,860 – – 151,803 136,214 256,120 8,472 – – 230,462 93,999 Other/ not rated £000 Total £000 245,980 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 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 2010 and 31 December 2009 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 2010 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 (2009: £nil). For the current period and prior period, the Group did not experience any material defaults on debt securities. 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. (e) 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 fi nancial statements Hiscox Ltd Report and Accounts 2010 3 Management of risk continued 3.2 Financial risk continued (e) 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 Other non-dated instruments Total Debt and fi xed income securities £000 484,885 807,481 648,551 290,083 Deposits with credit institutions £000 525 3,755 – – Catastrophe bonds £000 3,759 5,606 6,087 – Cash and cash equivalents £000 336,017 – – – 2010 Total £000 2009 Total £000 825,186 816,842 654,638 290,083 733,946 719,700 672,198 359,094 2,231,000 4,280 15,452 336,017 2,586,749 2,484,938 53,513 – – – 53,513 54,168 2,284,513 4,280 15,452 336,017 2,640,262 2,539,106 The Group’s equities and shares in unit trusts and other non-dated instruments have no contractual maturity terms but could also be liquidated in an orderly manner 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 2010 Years 1.89 4.83 3.82 2.24 2009 Years 1.52 4.89 3.21 1.38 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 fi ve years £000 161,531 29,233 112,654 117,058 66,493 39,831 91,515 17,715 37,758 114,352 44,187 11,339 85,066 17,753 28,314 210,116 37,681 14,114 Over fi ve years £000 36,512 1,720 4,049 37,672 9,487 6,061 2010 Total £000 374,624 66,421 182,775 479,198 157,848 71,345 526,800 316,866 393,044 95,501 1,332,211 Within one year £000 Between one and two years £000 Between two and fi ve 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 fi ve 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 *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 19 and 27. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 67  Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (f) 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 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. 2) 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 13). 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 individual entities. 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 21. All foreign currency derivative transactions with external parties are managed centrally. Included in the tables below are net non-monetary liabilities of £142 million (2009: £240 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 12. The currency profile of the Group’s assets and liabilities is as follows: As at 31 December 2010 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 Cash and cash equivalents Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 57,800 11,379 6,302 – 43,762 6,308 7,710 – 14,077 72,080 598,779 1,648,985 360,902 222,202 121,807 57,680 132,916 135,457 – 653 584 – 23,462 174,224 32,927 126,154 54,828 64,108 – 19,742 – 6,886 – 14,077 – 3,432 142,736 37,119 2,459,107 462,765 11,256 485,414 4,142 336,017 23,925 Total assets 1,044,075 2,454,071 412,832 79,874 3,990,852 68 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 3 Management of risk continued 3.2 Financial risk continued (f) Currency risk continued Employee retirement benefit obligations Deferred tax Insurance liabilities Financial liabilities Current tax Trade and other payables Total liabilities As 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 Cash and cash equivalents Sterling £000 US Dollar £000 Euro £000 Other £000 Total £000 – 45,421 – – 545,358 1,417,667 – – 237,488 20,457 29,995 36,698 – – 268,833 – – 67,915 – – – 45,421 48,009 2,279,867 20,457 29,995 348,998 – – 6,897 677,929 1,655,155 336,748 54,906 2,724,738 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 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 – 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 Sensitivity analysis As at 31 December 2010, the Group used closing rates of exchange of £1:€1.17 and £1:$1.57 (2009: £1:€1.13 and £1:$1.61). 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. As at 31 December 2010 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 91.0 (71.9) 7.2 (5.9) 38.5 (28.9) 10.0 (8.2) Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 69  Notes to the consolidated financial statements continued 3 Management of risk continued 3.2 Financial risk continued (g) Limitations of sensitivity analysis The sensitivity information given in notes (a) to (f) 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 30 to these financial statements. Furthermore, estimates of sensitivity may become less reliable in unusual market conditions such as instances when risk-free interest rates fall towards zero. The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation and taking other protective action. 3.3 Capital risk management The Group’s primary objectives when managing its capital position are: to safeguard its ability to continue as a going concern, so that it can continue to provide long-term growth and progressive dividend returns for shareholders; to provide an adequate return to the Group’s shareholders by pricing its insurance products and services commensurately with the level of risk; to maintain 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 was replaced during 2010 for a total of $750 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 $450 million. This facility was secured during 2010 by the Company’s subsidiary Hiscox plc. The Letter of Credit availability period ends on 31 December 2011. This enables the Group to utilise the Letter of Credit as Funds at Lloyd’s to support underwriting on the 2010, 2011 and 2012 years of account. The revolving credit facility has a maximum three-year contractual period for repayment. At 31 December 2010 US$165 million 70 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further £20 million by way of cash (2009: $225 million and £138 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 £45 million for the 2010 year of account (2009 year of account: £43 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 2010 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 Hiscox Insurance Company (Bermuda) Limited Hiscox Insurance Company (Guernsey) Limited Hiscox Insurance Company Inc. A (Excellent) A A (Strong) A (Excellent) A A (Excellent) A A (Excellent) – – – – 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 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. In addition, it includes the European errors and omissions business from Syndicate 3624. 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, Hiscox Inc., Hiscox Insurance Company Inc. and Syndicate 3624 excluding the European errors and omissions, fire and aviation business. 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 13. Corporate Centre forms a reportable segment due to its investment activities which earn significant external coupon revenues. All amounts reported below represent transactions with external parties only. In the normal course of trade, the Group’s entities enter into various reinsurance arrangements with one another. The related results of these transactions are eliminated on consolidation and are not included within the results of the segments. This 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. 3 Management of risk continued 3.3 Capital risk management continued all relate directly to ROE, this concept is embedded in the workings and culture of the Group. The Group maintains its cost of capital levels and its debt to overall equity ratios in line with others in the non-life insurance industry. Capital modelling and regulation The capital requirements of an insurance group are determined by its exposure to risk and the solvency criteria established by management and statutory regulations. In 2005, the UK Financial Services Authority (FSA) and Lloyd’s introduced a new capital regime that requires insurance companies to calculate their own capital requirements through Individual Capital Assessments (ICA). Hiscox Insurance Company Limited and Syndicate 33 maintain ICA models in accordance with this regime. The models are concentrated specifically on the particular product lines, market conditions and risk appetite of each entity. If the FSA considers an ICA to be inadequate, it can require the entity to maintain an increased capital safeguard. The Directors are also required to certify that the Group has complied, in all material aspects, with the provisions of the Interim Prudential Sourcebook: Insurers (IPRU(INS)), the Integrated Prudential Sourcebook for Insurers (INSPRU) and General Prudential Sourcebook (GENPRU) when completing the ICA return. The Group used its own integrated modelling expertise to produce the ICA calculations. The results mirrored those driving the existing internal capital setting process. The 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. 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. It also includes the fire and aviation businesses from Syndicate 3624. 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, Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 71  Notes to the consolidated financial statements continued 4 Operating segments continued (a) Profit before tax by segment 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 Year to 31 December 2010 Year to 31 December 2009 Gross premiums written Net premiums written Net premiums earned 572,748 454,692 405,234 – 1,432,674 663,034 420,982 351,385 – 1,435,401 389,581 428,032 314,014 – 1,131,627 483,611 391,461 281,951 – 1,157,023 396,096 422,180 312,882 – 1,131,158 453,281 367,326 277,495 – 1,098,102 Investment result* Other revenues 39,068 12,054 17,244 3,671 27,624 5,836 16,313 518 100,249 22,079 79,709 12,841 36,902 3,955 57,682 2,700 8,872 2 183,165 19,498 Revenue 447,218 443,095 346,342 16,831 1,253,486 545,831 408,183 337,877 8,874 1,300,765 Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Operational expenses Foreign exchange gains/(losses) (195,570) (213,001) (162,426) – (570,997) (175,823) (195,967) (91,428) – (463,218) (92,832) (99,069) (77,990) – (269,891) (101,518) (87,393) (67,723) – (256,634) (44,733) (89,440) (59,419) (12,811) (206,403) (52,178) (97,193) (61,128) (19,067) (229,566) 11,669 (1,972) (2,610) 8,397 15,484 (35,800) (7,065) 6,989 10,322 (25,554) Total expenses (321,466) (403,482) (302,445) (4,414) (1,031,807) (365,319) (387,618) (213,290) (8,745) (974,972) Results of operating activities Finance costs Share of (loss)/profit of associates after tax 125,752 (4,392) 39,613 (9) 43,897 (433) 12,417 (5,256) 221,679 (10,090) 180,512 (616) 20,565 (20) 124,587 (407) 129 (4,250) 325,793 (5,293) – – (323) 100 (223) – – – 118 118 Profit before tax 121,360 39,604 43,141 7,261 211,366 179,896 20,545 124,180 (4,003) 320,618 *Interest revenues included total £60,332,000 (2009: £74,584,000). The following charges are included within the consolidated income statement: Year to 31 December 2010 Year to 31 December 2009 Depreciation Amortisation of intangible assets London Market £000 455 UK and Europe £000 International £000 Corporate Centre £000 2,155 1,932 1,212 845 403 Total £000 4,605 2,460 London Market £000 650 635 UK and Europe £000 International £000 Corporate Centre £000 3,230 1,187 135 149 60 – Total £000 5,127 919 63 – 72 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 4 Operating segments continued (a) Profit before tax by segment continued 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 2010 Year to 31 December 2009 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 48.3 33.5 81.8 (2.1) 79.7 UK and Europe 50.2 44.6 94.8 0.5 95.3 53.2 43.2 96.4 0.9 97.3 Total 50.1 39.7 89.8 (0.5) 89.3 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 79.7 95.3 97.3 89.3 71.5 103.9 76.3 – – – – – – Total 41.8 40.4 82.2 3.8 86.0 81.7 – – – – – – 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, and operational 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, expenses 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 2010 Year to 31 December 2009 London Market £000 UK and Europe £000 International £000 Corporate Centre £000 London Market £000 UK and Europe £000 International £000 Corporate Centre £000 5,459 4,388 3,223 3,961 4,222 3,129 – – 6,248 3,824 2,875 4,533 3,673 2,775 – – 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 Year to 31 December 2010 Year to 31 December 2009 Gross premiums written Net premiums written Net premiums earned 782,523 472,247 416,103 524,658 443,693 321,236 545,945 438,773 322,341 – 1,670,873 – 1,289,587 666,692 408,037 382,417 – 1,307,059 914,072 440,064 359,297 287,589 287,524 624,755 – 1,713,433 – 1,362,318 – 1,294,696 Investment result Other revenues Claims and claim adjustment expenses, net of reinsurance Expenses for the acquisition of insurance contracts Operational expenses Foreign exchange gains/(losses) 53,870 – 17,848 3,029 28,572 4,393 16,313 518 116,603 109,803 – 7,940 38,395 2,716 59,214 677 8,872 2 216,284 3,395 (263,610) (220,101) (171,347) – (655,058) (242,422) (204,330) (94,873) – (541,625) (127,202) (105,394) (90,489) (55,873) (78,611) (60,755) – (311,207) (12,811) (219,928) (139,923) (61,054) (92,562) (97,948) (69,185) (62,040) – (301,670) (240,109) (19,067) 11,272 (1,983) (2,892) 8,397 14,794 (48,912) (6,951) 6,678 10,322 (38,863) Results of operating activities 164,402 41,683 41,701 12,417 260,203 242,247 21,737 127,995 129 392,108 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. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 73  Notes to the consolidated financial statements continued 4 Operating segments continued (c) Segmental analysis of assets and liabilities The segment assets and liabilities at 31 December and the capital expenditure for the year then ended are as follows: Intangible assets Deferred acquisition costs Financial assets Reinsurance assets Other assets Total assets Insurance liabilities Other liabilities Total liabilities Capital expenditure 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 32,995 51,275 995,824 660,057 514,351 5,524 45,574 413,989 185,625 253,925 International £000 15,441 43,529 797,048 85,778 345,893 Year to 31 December 2010 Corporate Centre £000 Intragroup items and eliminations £000 Total £000 – 2,358 10,148 – 32,480 – 64,108 142,736 226,652 2,465,993 462,765 (468,695) 855,250 954,236 (1,213,155) 2,254,502 904,637 1,287,689 996,864 (1,452,840) 3,990,852 1,315,215 811,866 536,196 208,759 528,390 194,115 – 139,015 (908,884) (99,934) 2,279,867 444,871 2,127,081 744,955 722,505 139,015 (1,008,818) 2,724,738 4,152 2,731 8,742 372 – 15,497 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 Year to 31 December 2009 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 (302,937) 784,750 925,940 (1,040,129) 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 – 168,193 (71,131) 2,122,351 573,775 (610,948) 1,984,675 667,932 557,405 168,193 (682,079) 2,696,126 1,539 2,245 6,962 275 – 11,021 Segment assets and liabilities primarily consist of operating assets and liabilities, which represent the majority of the balance sheet. Intragroup assets and liabilities that cross segments are presented under the separate category heading ‘Intragroup items and eliminations’. Capital expenditure comprises expenditure on intangible assets (note 14) other than goodwill, and additions to property, plant and equipment (note 15), but excluding assets acquired on business combinations. (d) Geographical information The Group’s operational segments underwrite business domestically in Bermuda and from locations in the UK and Ireland, the US, Guernsey, France, Germany, Belgium, the Netherlands, Spain, Portugal 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 International £000 Corporate Centre £000 Total £000 London Market £000 UK and Europe £000 UK and Ireland Europe United States Rest of World 28,534 285,350 127,639 27,459 361,192 176,527 27,360 35,658 8,557 219,210 28,757 108,875 – 341,244 – 190,756 – 588,959 314,159 – 33,028 47,271 324,757 224,878 257,873 111,552 4,440 23,337 Year to 31 December 2010 Year to 31 December 2009 Corporate Centre £000 Total £000 315,199 – – 189,336 – 519,935 – 339,228 International £000 24,298 30,513 190,738 91,013 593,712 450,303 391,103 – 1,435,118 629,934 397,202 336,562 – 1,363,698 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. 74 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 4 Operating segments continued (d) Geographical information continued 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 as such details are not used by the chief operating decision maker to evaluate the performance of the Group. 5 Net asset value per share Net asset value Net tangible asset value Net asset value ) (total equity £000 2010 Net asset value per share pence Net asset value ) (total equity £000 1,266,114 1,202,006 332.7 1,121,286 315.8 1,070,873 2009 Net asset value per share pence 299.2 285.7 The net asset value per share is based on 380,613,336 shares (2009: 374,819,025 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). 2010 £000 2009 £000 178,800 280,497 951,026 (20,429) 1,121,286 (34,820) 1,086,466 930,597 16.5 30.1 Note 2010 £000 2009 £000 61,606 12,971 24,272 75,740 19,733 87,296 8 21 98,849 1,400 182,769 396 100,249 183,165 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 2010 % 3.6 3.8 2.3 2009 % 4.2 8.5 6.5 London Market UK and Europe International Corporate Centre 2010 Total £000 % £000 % £000 % £000 % £000 % Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions/ cash and cash equivalents 39,464 – 138 39,602 4.2 – 0.3 4.0 9,586 6,079 500 16,165 2.6 11.6 22,078 4,468 0.8 3.3 218 26,764 3.6 9.0 0.1 3.2 11,106 5,025 187 16,318 4.7 13.4 82,234 15,572 0.4 5.0 1,043 98,849 3.7 11.1 0.3 3.6 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 75  Notes to the consolidated financial statements continued 8 Analysis of return on financial investments continued (b) Investment return continued Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions/ cash and cash equivalents London Market UK and Europe International Corporate Centre 2009 Total £000 80,616 – 285 80,901 % 8.0 – 0.7 7.7 £000 % £000 % £000 % £000 % 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 5.2 3,455 182,769 7.7 20.7 0.8 7.2 9 Other revenues and operational expenses Agency related income Profit commission Other underwriting income – catastrophe bonds Other income Other revenues Wages and salaries Social security cost Pension cost – defined contribution Pension cost – defined benefit Share based payments Other expenses Marketing expenses Investment expenses Depreciation and amortisation Operational expenses 10 Finance costs Interest and expenses associated with bank borrowings Interest and charges associated with Letters of Credit Interest charges on experience account Interest charges arising on finance leases 2010 £000 2009 £000 6,816 10,616 1,280 3,367 6,651 12,248 410 189 22,079 19,498 80,359 13,689 5,209 1,700 8,047 74,668 11,863 3,803 7,065 86,701 12,391 5,167 13,300 5,260 86,150 11,422 3,129 6,046 206,403 229,566 Note 35 36 2010 £000 3,117 3,216 3,748 9 2009 £000 2,493 2,780 – 20 10,090 5,293 11 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 2010 £000 181 645 96 3 925 10 935 2009 £000 188 638 90 185 1,101 11 1,112 * Other fees relate primarily to corporate advisory and fi nancial 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 fi nancial statements Hiscox Ltd Report and Accounts 2010 11 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. 12 Net foreign exchange gains/(losses) The net foreign exchange gains/(losses) for the year include the following amounts: Exchange gains/(losses) recognised in the consolidated income statement Exchange gains/(losses) classified as a separate component of equity Overall impact of foreign exchange related items on net assets 2010 £000 2009 £000 15,484 11,729 (25,554) (69,589) 27,213 (95,143) 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 Gain/(loss) included within profit representing the non retranslation of non-monetary items Closing balance sheet impact of non retranslation of non-monetary items 2010 £000 2009 £000 (3,207) 1,956 50,525 (53,732) (1,251) (3,207) 13 Foreign currency items on economic hedges and intragroup borrowings The Group has loan arrangements, denominated in US Dollars, in place between certain 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. Impact as at 31 December 2010 Unrealised translation gains/(losses) on intragroup borrowings Total gains/(losses) recognised 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 2010 £000 Consolidated other comprehensive income 2010 £000 1,846 1,846 (1,846) (1,846) Consolidated income statement 2009 £000 Consolidated other comprehensive income 2009 £000 Total impact on equity 2010 £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 (4,362) 4,362 – (4,048) (845) (4,893) The Group did not enter into any economic hedging derivative contracts during the current year. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 77  Notes to the consolidated financial statements continued 14 Intangible assets At 1 January 2009 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 Year ended 31 December 2010 Opening net book amount Other additions Amortisation charges Closing net book amount At 31 December 2010 Cost Accumulated amortisation and impairment Net book amount Goodwill £000 Syndicate capacity £000 State authorisation licences £000 Other £000 Total £000 10,405 (2,430) 24,505 – 7,975 24,505 7,975 – – 7,975 24,505 – – 24,505 10,405 (2,430) 24,505 – 7,975 24,505 6,308 – 6,308 6,308 – – 6,308 6,308 – 6,308 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 7,975 – – 7,975 24,505 – – 6,308 – – 11,625 16,155 (2,460) 50,413 16,155 (2,460) 24,505 6,308 25,320 64,108 10,405 (2,430) 24,505 – 6,308 – 29,521 (4,201) 70,739 (6,631) 7,975 24,505 6,308 25,320 64,108 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 annually for impairment based on the recoverable amount which is considered to be the higher of the fair value or value in use. Accumulated amortisation and impairment of goodwill relates to the amortisation charged prior to the Group’s adoption of IFRS. Value in use is considered to be the best indication of the recoverable amount for goodwill. Value in use calculations are performed using cash flow projections based on financial forecasts covering a five-year period. A discount factor of 2.5% (2009: 1.8%) has been applied to the projections to determine the net present value. The outcome of the value in use calculation is measured against the carrying value of the asset and where the carrying value is in excess of the value in use, the asset is written down to this amount. There were no impairments recognised in the current or prior year for goodwill. 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 asset is tested annually for impairment based on its recoverable amount which is considered to be the higher of the asset’s fair value or its value in use. The fair value of Syndicate capacity can be determined from the Lloyd’s of London Syndicate capacity auctions. Based on the average open market price witnessed in the recent Autumn 2010 auction, the carrying value of Syndicate capacity recognised on the balance sheet is significantly below the market price. As part of a business combination in 2007, the Group acquired insurance authorisation licences for 50 US states. This intangible asset has been allocated for impairment testing purposes to one individual CGU, being the Group’s North American underwriting businesses. The carrying value of this asset is tested for impairment based on its fair value which reflects the total costs to acquire the licences in each state. Other intangible assets relate to the costs of acquiring rights to customer contractual relationships with additions in the current and prior year relating to software licence and development costs. Customer contractual relationships are amortised on a straight line basis over the useful economic life. 78 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 14 Intangible assets continued The carrying value of customer contractual relationships is tested annually for impairment based on the recoverable amount which is considered to be the higher of the fair value or value in use. The asset’s value in use is considered to be the best indication of its recoverable amount. Value in use is calculated for customer contractual relationships in the same manner as described above for goodwill and the same discount rate used. Capitalised software and development costs are amortised when the assets become available for use on a straight line basis over the expected useful life of the asset. The carrying value of software and development costs is reviewed for impairment on an ongoing basis by reference to the stage and expectation of a project. The amortisation charge for the year includes £2,196,000 (2009: £660,000) relating to capitalised internally generated software costs and is included in other expenses in the income statement. The net book value of capitalised internally generated software costs at 31 December 2010 was £16,684,000 (2009: £7,368,000). There are no charges for impairment during the current or prior financial year. At 31 December 2010 there were £4,817,000 of assets under development on which no amortisation has been charged (2009: £nil). 15 Property, plant and equipment At 1 January 2009 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 Year ended 31 December 2010 Opening net book amount Additions Disposals Depreciation charge Foreign exchange movements Closing net book amount At 31 December 2010 Cost Accumulated depreciation Net book amount Land and buildings £000 Leasehold improvements £000 Vehicles £000 Furniture fittings and equipment and art £000 Total £000 40,413 (25,034) 46,066 (26,398) 15,379 19,668 15,379 2,938 (69) (4,644) (151) 19,668 8,246 (296) (5,127) (247) 13,453 22,244 968 (418) 550 550 – (13) (94) (1) 442 940 (498) 42,732 (29,279) 53,486 (31,242) 442 13,453 22,244 442 46 (333) (47) – 13,453 2,568 (395) (3,967) 35 22,244 3,462 (1,536) (4,605) 177 2,985 (200) 2,785 2,785 3,022 – (59) – 5,748 6,007 (259) 5,748 5,748 20 – (81) 77 1,700 (746) 954 954 2,286 (214) (330) (95) 2,601 3,807 (1,206) 2,601 2,601 828 (808) (510) 65 5,764 2,176 108 11,694 19,742 6,104 (340) 5,764 3,162 (986) 2,176 258 (150) 44,678 (32,984) 54,202 (34,460) 108 11,694 19,742 The Group’s land and buildings assets relate to freehold property in the UK and US. Assets with a net book value of £99,000 were held under finance leases (2009: £398,000). The total depreciation charge for the year in respect of assets held under finance leases was £24,000 (2009: £56,000) and is included in other expenses. At 31 December 2010 there were no assets under development upon which no depreciation has yet been charged (2009: £1,906,000). Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 79  Notes to the consolidated financial statements continued 16 Investments in associates Year ended 31 December At beginning of year Additions during the year Disposals 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: 2010 £000 2009 £000 7,318 7,200 318 (527) (223) – – 118 6,886 7,318 100% results 2010 Associates incorporated in the UK Associates incorporated in Europe Associates incorporated in the USA Total at the end of 2010 2009 Associates incorporated in the UK Associates incorporated in Europe Total at the end of 2009 % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profit after tax £000 From 25% to 49% 25% 25% 1,847 455 210 2,512 1,230 284 (1) 1,513 1,098 326 11 1,435 185 20 (1,756) (1,551) 100% results % interest held at 31 December Assets £000 Liabilities £000 Revenues £000 Profi t after tax £000 From 25% to 49% up to 25% 11,100 943 12,043 7,800 436 8,236 8,743 1,379 10,122 234 30 264 During the year, the Group disposed of its 40% holding in HIM Capital Holdings Ltd recognising a gain of £458,000. On 17 December 2010, the Group increased its holding in Blyth Valley Ltd to 100% as referred to in note 33. The company is treated as a subsidiary of the Group from this date. The equity interests held by the Group in respect of associates do not have quoted market prices and are not traded regularly in any active recognised market. The associates concerned have no material impact on the results or assets of the Group. No impairments were identified during the current or prior financial year under review. 17 Deferred acquisition costs Balance deferred at 1 January Acquisition costs incurred in relation to insurance contracts written Acquisition costs expensed to the income statement Gross £000 Reinsurance £000 2010 Net £000 Gross £000 Reinsurance £000 2009 Net £000 141,505 (17,584) 123,921 131,130 (21,068) 110,062 318,876 (317,645) (47,218) 47,754 271,658 (269,891 ) 312,705 (302,330) (42,212) 45,696 270,493 (256,634) Balance deferred at 31 December 142,736 (17,048) 125,688 141,505 (17,584) 123,921 The deferred amount of insurance contract acquisition costs attributable to reinsurers of £17,048,000 (2009: £17,584,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 27). The amounts expected to be recovered before and after one year are estimated as follows: Within one year After one year 80 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 2010 £000 2009 £000 124,822 866 123,921 – 125,688 123,921 18 Reinsurance assets Reinsurers’ share of insurance liabilities Provision for non-recovery and impairment Reinsurance assets Note 2010 £000 2009 £000 463,724 (959) 425,572 (5,446) 26 462,765 420,126 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 236,541 226,224 217,278 202,848 462,765 420,126 Amounts due from reinsurers in respect of outstanding premiums and claims already paid by the Group are included in loans and receivables (note 20). The Group recognised a gain during the year of £4,487,000 (2009: gain of £2,085,000) in respect of impaired balances. 19 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. 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 signifi cantly different from the amortised cost. Note 2010 Fair value £000 2009 Fair value £000 2,284,513 2,255,737 133,841 11,394 154,862 4,280 2,443,655 2,400,972 11,310 1,018 15,452 – 21 2,459,107 2,413,300 Note 21 2010 Fair value £000 2009 Fair value £000 20,000 457 138,000 539 20,457 138,539 An analysis of the credit risk and contractual maturity profiles of the Group’s financial instruments is given in notes 3.2(d) and 3.2(e). The Group’s investment in catastrophe bonds consists of £15.5 million (2009: £11.3 million), comprising of 13 catastrophe bonds (2009: 12) 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 with the maximum loss being equal to the total investment. The Group’s borrowings from credit institutions at 31 December 2010 are denominated in Pound Sterling (2009: Pound Sterling). The entire amount from December 2009 was repaid during the year and the amount outstanding at 31 December 2010 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 £1,460,000 (2009: £49,838,000), realised gains of £1,371,000 (2009: £3,234,000) and unrealised losses of £457,000 (2009: £539,000). Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 81  Notes to the consolidated financial statements continued 19 Financial assets and liabilities continued Investments at 31 December are denominated in the following currencies at their fair value: 2010 £000 2009 £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 20 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 514,726 508,292 1,578,075 1,559,673 187,772 191,712 2,284,513 2,255,737 80,226 61,565 13,071 60,549 51,914 21,378 154,862 133,841 3,755 525 – 11,223 171 – 4,280 11,394 2,443,655 2,400,972 2010 £000 2009 £000 412,524 (1,041) 413,449 (955) 411,483 412,494 298,214 113,269 270,593 141,901 411,483 412,494 7,656 10,020 15,276 11,888 23,230 15,881 17,758 12,227 20,273 16,010 485,414 488,782 474,010 11,404 482,194 6,588 485,414 488,782 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 £86,000 (2009: £395,000) for the impairment of receivables during the year ended 31 December 2010. 82 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 21 Derivative financial instruments The Group entered into both exchange-traded and over the counter derivative contracts for a number of purposes during 2010. 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 2010 all mature within one year of the balance sheet date and are detailed below: 31 December 2010 Derivative financial instrument liabilities included on balance sheet Foreign exchange forward contracts Interest rate futures contracts Credit default swaps 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 Gross contract notional amount £000 Fair value of assets £000 Fair value of liabilities £000 Net balance sheet position £000 20,223 64,407 25,398 10,070 16,557 – 10,500 16,582 2 110,028 26,627 27,084 430 25 2 457 Gross contract notional amount £000 50,105 21,288 71,393 Gross contract notional amount US$000 2,400 Fair value of assets £000 180 906 1,086 Fair value of assets £000 18 Fair value of liabilities £000 Net balance sheet position £000 7 61 68 173 845 1,018 Fair value of liabilities £000 Net balance sheet position £000 557 539 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 £1,522,000 (2009: £769,000) 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 £117,000 (2009: £78,000) 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 ceased trading in these instruments during the year, realising a loss on settlement of £5,000 (2009: £609,000). Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 83  Notes to the consolidated financial statements continued 22 Fair value measurements In accordance with the Amendments to IFRS 7 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 2010 Financial assets Debt and fixed income securities Equities and shares in unit trusts Deposits with credit institutions Catastrophe bonds Total Financial liabilities Derivative financial instruments 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 Level 1 £000 Level 2 £000 Level 3 £000 Total £000 516,528 1,767,985 147,866 – 15,452 70 4,280 – – 2,284,513 154,862 4,280 15,452 6,926 – – 520,878 1,931,303 6,926 2,459,107 – Level 1 £000 457 Level 2 £000 – 457 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 – 539 – 539 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 fi nancial statements Hiscox Ltd Report and Accounts 2010 22 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 to 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, including event linked future contracts. Level 3 contains investments in a limited partnership and unquoted equity securities which have limited observable inputs on which to measure fair value. 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. 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 2010 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 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. 23 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 financial instruments £000 4,260 842 1,824 – – – 6,926 – – – – – – – – – – – – – – Equities and shares in unit trusts £000 Deposits with credit institutions £000 Derivative fi nancial instruments £000 539 245 3,353 123 – – 4,260 5,877 – – – (5,877) – – 40 – – – – (40) – Total £000 4,260 842 1,824 – – – 6,926 Total £000 6,456 245 3,353 123 (5,877) (40) 4,260 2010 £000 2009 £000 260,710 75,307 166,780 92,867 336,017 259,647 The Group holds its cash deposits with a well diversified range of banks and financial institutions. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 85  Notes to the consolidated financial statements continued 24 Share capital Group Issued share capital 31 December 2010 31 December 2009 Share capital £000 Number of shares Share capital £000 Number of shares 20,297 405,943,169 20,158 403,148,858 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 2009 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2009 Employee share option scheme – proceeds from shares issued Dividends to owners of the Company At 31 December 2010 Ordinary share capital £000 20,067 91 – Share premium £000 9,418 2,413 – Contributed surplus £000 352,078 – (48,613) 20,158 11,831 303,465 139 – 3,969 – – (58,460) 20,297 15,800 245,005 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 2010 Number of 5p ordinary shares in issue ) (thousands 2009 403,149 401,331 2,794 1,818 405,943 403,149 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 £8,047,000 (2009: £5,260,000). This comprises charges of £7,619,000 (2009: £4,972,000) in respect of performance share plan awards and £428,000 (2009: £288,000) 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. 86 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 24 Share capital continued Share options and performance share plan awards continued 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) 2010 2009 3.4-3.9 3.9-4.14 3.25 29-30 340.4 1.4 4.24 3.25 31 310.8 The weighted average fair value of each share option granted during the year was 81.5p (2009: 85.5p). The weighted average fair value of each performance share plan award granted during the year was 340.4p (2009: 308.0p). Movements in the number of share options during the year and details of the balances outstanding at 31 December 2010 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. 25 Retained earnings and other reserves Currency translation reserve at 31 December Retained earnings at 31 December 2010 £000 2009 £000 49,457 37,728 935,555 748,104 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. At 31 December 2010 Hiscox Ltd held 25,142,874 shares in treasury (2009: 28,142,874). Additional details are shown in note 37 to these financial statements in respect of additional Hiscox Ltd shares held by subsidiaries. 26 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 2010 £000 2009 £000 802,254 904,150 573,463 800,307 749,016 573,028 2,279,867 2,122,351 131,697 242,496 88,572 173,987 154,903 91,236 18 462,765 420,126 670,557 661,654 484,891 626,320 594,113 481,792 1,817,102 1,702,225 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 1,008,399 808,703 939,565 762,660 1,817,102 1,702,225 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 87 Estimates of ultimate claims are adjusted each reporting period to reflect emerging claims experience. Changes in expected claims may result in a reduction or an increase in the ultimate claim costs and a release or an increase in reserves in the period in which the change occurs (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. The top half of each table, on the following pages, illustrates how estimates of ultimate claim costs for each accident year have changed at successive year ends. The bottom half reconciles cumulative claim costs to the amounts still recognised as liabilities. A reconciliation of the liability at the 100% level to the Group’s share, as included in the Group balance sheet, is also shown. Notes to the consolidated financial statements continued 26 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 2010 and 2009 are not material. 26.1 Insurance contracts assumptions (a) Process used to decide on assumptions The risks associated with insurance contracts are complex and subject to a number of variables that complicate quantitative sensitivity analysis. Uncertainty over the timing and amount of future claim payments necessitate the holding of significant reserves for liabilities that may only emerge a number of accounting periods later. For all risks, the Group uses several statistical methods to incorporate the various assumptions made into the ultimate cost of claims. There is close communication between the actuaries involved in the estimation process and the Group’s underwriters to ensure that all parties are aware of material factors relating to outstanding claims reserves. 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. An allowance is also made for the current rating and inflationary environment. Outstanding claims reserves are actuarially estimated primarily using the Chain Ladder and Bornhuetter-Ferguson methods. The Chain Ladder method 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. Where losses in the earliest underwriting years or years of account have yet to fully develop an adjustment is made to the pattern to allow for further expected development. The selected development factors are then applied to cumulative claims data for each accident year to produce an estimated ultimate claims cost for each accident year. The Chain Ladder method is adopted for mature classes of business where sufficient claims development data is available. This methodology produces optimal estimates when a large claims development history is available and the claims development patterns throughout the earliest years are stable. 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). 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 actuarial team into the quarterly reserving exercise. This process ensures that a consistent approach is taken across the Group. In exceptional cases the required provision is calculated with reference to the actual exposures on individual policies. 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. This often means 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. 88 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 26 Insurance liabilities and reinsurance assets continued 26.1 Insurance contracts assumptions continued (b) Claims development tables continued 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 2010 £000 Total £000 476,153 774,979 1,294,900 447,650 739,639 1,297,603 460,941 699,397 1,279,163 410,797 463,733 698,820 1,170,170 604,706 809,548 1,127,349 860,395 1,033,809 7,880,714 701,387 – 6,644,264 680,601 435,108 – 5,867,378 755,321 443,259 – 4,875,455 779,918 427,233 – 4,214,756 823,545 423,050 456,291 702,505 1,273,288 536,077 – 3,622,764 – 398,472 445,561 684,260 1,274,625 819,846 – 2,340,867 – – 817,655 394,252 440,956 688,004 – 1,641,294 – – – 814,774 395,833 430,687 – 1,205,997 – – – – 382,319 823,678 808,695 808,695 – – – – – – 719,421 1,033,809 7,514,082 808,695 577,680 556,641 689,800 525,823 702,980 – – – – – – 382,319 430,687 688,004 1,274,625 536,077 702,980 726,072 959,350 937,465 – – – – – – – 937,465 719,421 – – – – – – – – (751,596) (347,926) (394,853) (604,658) (1,151,238) (462,855) (542,307) (639,622) (386,599) (182,971) (5,464,625) 57,099 34,393 35,834 83,346 123,387 73,222 160,673 297,843 332,822 850,838 2,049,457 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 2010. 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 2010 £000 Total £000 808,695 382,319 430,687 688,004 1,274,625 536,077 702,980 937,465 719,421 1,033,809 7,514,082 (200,059) (77,565) (96,451) (159,837) (319,643) (112,599) (136,453) (181,382) (119,007) (172,924) (1,575,920) 608,636 304,754 334,236 528,167 954,982 423,478 566,527 756,083 600,414 860,885 5,938,162 (751,596) (347,926) (394,853) (604,658) (1,151,238) (462,855) (542,307) (639,622) (386,599) (182,971) (5,464,625) 184,573 68,737 87,421 141,261 291,641 96,380 101,589 114,995 59,151 20,732 1,166,480 (567,023) (279,189) (307,432) (463,397) (859,597) (366,475) (440,718) (524,627) (327,448) (162,239) (4,298,145) 41,613 25,565 26,804 64,770 95,385 57,003 125,809 231,456 272,966 698,646 1,640,017 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 nine 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 2010 accident years recognised on Group’s balance sheet Liability for accident years before 2001 recognised on Group’s balance sheet 84,784 2,134,241 66,387 1,706,404 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 fi nancial statements Hiscox Ltd Report and Accounts 2010 89  Notes to the consolidated financial statements continued 26 Insurance liabilities and reinsurance assets continued 26.1 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 nine 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 2010 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 2010 £000 Total £000 366,197 537,157 700,937 782,336 695,595 277,174 584,744 689,688 337,866 637,695 698,849 585,504 528,737 302,447 386,549 638,962 792,534 380,010 – 695,742 782,878 453,049 617,910 511,509 312,897 – – 757,545 468,059 585,996 492,745 288,586 – – – 747,108 485,738 481,424 282,392 267,860 348,549 – – – – 747,855 466,500 – – – – – 261,703 344,902 459,225 – – – – – 333,610 267,290 461,672 – – – – – – 461,216 255,949 446,087 – – – – – – – 695,742 585,504 747,855 485,738 585,996 333,610 446,087 255,949 351,754 613,606 575,449 362,671 353,744 576,344 561,005 561,577 – – – 561,577 819,110 5,790,804 – 4,951,287 – 4,339,345 – 3,531,051 – 2,926,750 – 2,391,769 – 1,627,407 – 1,062,572 717,165 – 446,087 – 819,110 5,517,168 (391,358) (229,514) (300,776) (488,664) (639,323) (421,595) (451,859) (484,840) (321,162) (173,650) (3,902,741) 54,729 26,435 32,834 72,913 108,532 64,143 134,137 210,902 264,342 645,460 1,614,427 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 2010. 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 2010 £000 Total £000 446,087 255,949 333,610 561,577 747,855 485,738 585,996 695,742 585,504 819,110 5,517,168 (104,209) (50,055) (73,299) (131,460) (179,351) (103,318) (118,752) (130,649) (91,326) (123,011) (1,105,430) 341,878 205,894 260,311 430,117 568,504 382,420 467,244 565,093 494,178 696,099 4,411,738 (391,358) (229,514) (300,776) (488,664) (639,323) (421,595) (451,859) (484,840) (321,162) (173,650) (3,902,741) 89,314 43,108 64,811 114,344 154,111 88,645 87,112 81,953 48,897 22,793 795,088 (302,044) (186,406) (235,965) (374,320) (485,212) (332,950) (364,747) (402,887) (272,265) (150,857) (3,107,653) 39,834 19,488 24,346 55,797 83,292 49,470 102,497 162,206 221,913 545,242 1,304,085 37,001 1,651,428 28,126 1,332,211 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 fi nancial statements Hiscox Ltd Report and Accounts 2010 26 Insurance liabilities and reinsurance assets continued 26.2 Movements in insurance claims liabilities and reinsurance claims assets Year ended 31 December Total at beginning of year Claims and loss adjustment expenses for year Cash paid for claims settled in the year Exchange differences and other movements Gross £000 Reinsurance £000 2010 Net £000 Gross £000 Reinsurance £000 2009 Net £000 (1,549,323) (733,074) 598,179 (22,186) 328,890 (1,220,433) (570,997) 162,077 478,091 (120,088) (18,872) 3,314 (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) Total at end of year (1,706,404) 374,193 (1,332,211) (1,549,323) 328,890 (1,220,433) Claims reported and loss adjustment expenses Claims incurred but not reported (802,254) (904,150) 131,697 242,496 (670,557) (661,654) (800,307) (749,016) 173,987 154,903 (626,320) (594,113) Total at end of year (1,706,404) 374,193 (1,332,211) (1,549,323) 328,890 (1,220,433) 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 2010 Net £000 Gross £000 Reinsurance £000 2009 Net £000 (864,128) 160,277 (703,851) (725,132) 122,538 (602,594) 131,054 1,800 132,854 216,894 (77,518) 139,376 Total claims and claim adjustment expenses (733,074) 162,077 (570,997) (508,238) 45,020 (463,218) 27 Trade and other payables Creditors arising out of direct insurance operations Creditors arising out of reinsurance operations Obligations under finance leases Share of Syndicate’s other creditors’ balances Social security and other taxes payable Other creditors Reinsurers’ share of deferred acquisition costs Accruals and deferred income Total The amounts expected to be settled before and after one year are estimated as follows: Within one year After one year Note 2010 £000 2009 £000 52,368 181,159 45,476 157,514 233,527 202,990 45 4,887 14,563 13,995 393 316 15,424 20,448 33,490 36,581 17,048 64,933 17,584 82,328 348,998 339,483 36 17 338,541 10,457 336,383 3,100 348,998 339,483 The amounts expected to be settled after one year of the balance sheet date primarily relate to deferred bonuses and the Group’s provision of sabbatical leave employee benefits. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 91  Notes to the consolidated financial statements continued 28 Tax expense The Company and its subsidiaries are subject to enacted tax laws in the jurisdictions in which they are incorporated and domiciled. The principal subsidiaries of the Company and the country in which they are incorporated are listed in note 37. The amounts charged in the consolidated income statement comprise the following: Current tax Expense for the year Adjustments in respect of prior years Total current tax Deferred tax Credit for the year Adjustments in respect of prior years Effect of rate change Total deferred tax Total tax charged to the income statement 2010 £000 2009 £000 58,228 (1,062) 51,030 2,345 57,166 53,375 (22,532) (691) (1,377) (14,146) 892 – (24,600) (13,254) 32,566 40,121 The standard rate of corporation tax in Bermuda is 0% whereas the effective rate of tax for the Group is 15.4% (2009: 12.5%). A reconciliation of the difference is provided below: Profit before tax Tax calculated at the standard corporation tax rate applicable in Bermuda: 0% (2009: 0%) Effects of: Group entities subject to overseas tax at different rates Impact of overseas tax rates on: Effect of rate change Expenses not deductible for tax purposes Tax losses for which no deferred tax asset is recognised Other Sch 23 FA 2003 deduction and share based payments Non-taxable income Overseas tax Prior year tax adjustments Tax charge for the period 29 Deferred tax Deferred tax assets Trading losses in overseas entities 2010 £000 2009 £000 211,366 – 320,618 – 28,866 41,397 (1,377) 273 9,639 396 (1,803) (2,839) 1,164 (1,753) – 1,348 (130) (51) (2,974) – (2,706) 3,237 32,566 40,121 2010 £000 2009 £000 14,077 14,077 The deferred tax asset relates to losses arising in overseas entities and is subject to overseas relief against future profits. Management considers 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 2010 £000 2009 £000 14,968 (60,389) 17,658 (87,331) (45,421) (69,673) Deferred tax assets and deferred tax liabilities relating to the same tax authority are presented net in the Group’s balance sheet. 92 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 29 Deferred tax continued (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 (b) Group deferred tax liabilities analysed by balance sheet headings At 31 December Investment in associated enterprises Financial assets Insurance contracts – equalisation provision* Open years of account Total deferred tax liabilities 2009 £000 14,077 14,077 2009 £000 1,604 – 1,310 4,230 10,514 17,658 Income statement (charge)/credit £000 Transfer from equity £000 – – – – Income statement (charge)/credit £000 Transfer from equity £000 (238) 990 (1,310) (349) (1,434) (2,341) – – – – (349) (349) Income statement (charge)/credit £000 2009 £000 Transfer from equity £000 (17) (453) (16,973) (17,443) (69,888) – (640) (6,106) (6,746) 33,688 (87,331) 26,942 – – – – – – 2010 £000 14,077 14,077 2010 £000 1,366 990 – 3,881 8,731 14,968 2010 £000 (17) (1,093) (23,079) (24,189) (36,200) (60,389) * 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 fi nancial 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. UK deferred income tax assets and liabilities are calculated at 27%. The UK Government has indicated its intention to reduce UK tax rates year-on-year to 24% by the full year commencing April 2014, however at the balance sheet date, no such measures were substantially enacted. 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 £18,216,000 (2009: £8,452,000) including £18,088,000 (2009: £8,488,000) in relation to losses in overseas companies of £51,769,000 (2009: £22,138,000). In accordance with IAS 12, all deferred tax assets and liabilities are classified as non-current. 30 Employee retirement benefit obligations The Company’s subsidiary, Hiscox plc, operates a defined benefit pension scheme based on final pensionable salary. The scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of a defined contribution scheme from 1 January 2007. The funds of the defined benefit scheme are controlled by the trustee and are held separately from those of the Group. The gross amount recognised in the Group balance sheet in respect of the defined benefit scheme is determined as follows: Present value of scheme obligations Fair value of scheme assets Deficit for funded plans Unrecognised net actuarial losses Past service costs recognised in other creditors Unrecognised surplus deemed irrecoverable Net amount recognised as a defined benefit obligation 2010 £000 2009 £000 146,737 (144,056) 140,676 (118,391) 2,681 (12,310) – 9,629 22,285 (17,648) (11,800) 7,163 – – The unrecognised net actuarial losses are the net cumulative gains and losses on both the scheme’s obligations and underlying assets. 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 in the prior year, past service costs of £11.8 million were 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 was recognised immediately. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 93  Notes to the consolidated financial statements continued 30 Employee retirement benefit obligations continued On 8 July 2010, the UK Government announced its decision to replace the Retail Prices Index (‘RPI’) with the Consumer Prices Index (‘CPI’) as an inflation measure used to determine the minimum statutory increases to be applied to the revaluation of deferred pensions and to the increase of pensions in payment. Based on the rules of the Group’s defined benefit scheme, it is expected that CPI will be allowed to be used for revaluation in deferment but RPI should be used for increases in payment. The Group has sought legal confirmation that this impact is limited to contracted out members. The effect of using the CPI to determine the scheme liabilities at 31 December 2010 does not have a significant effect on scheme liabilities. 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 2010 £000 2009 £000 64,249 75,918 3,889 42,488 65,935 9,968 144,056 118,391 The majority of the scheme’s debt and fixed income assets are held through the ownership of 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. 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 Amortisation of net actuarial loss Effect of deemed irrecoverability of surplus Total included in staff costs The actual return on scheme assets was a gain of £14,516,000 (2009: £4,221,000). 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 94 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 Notes 2010 £000 2009 £000 346 7,952 (8,441) – 323 1,520 300 5,720 (7,899) 11,800 – 3,379 9 1,700 13,300 Notes 9 2010 £000 2009 £000 – 1,700 – (1,700) – 13,300 (11,800) (1,500) – – 2010 £000 2009 £000 118,391 8,441 6,075 13,500 – (2,351) 115,166 7,899 (3,678) 1,500 – (2,496) 144,056 118,391 30 Employee retirement benefit obligations continued 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 2010 £000 2009 £000 140,676 346 7,952 114 – (2,351) – 101,615 300 5,720 23,737 11,800 (2,496) – 146,737 140,676 A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme obligations Experience gains/(losses) on scheme assets 2010 £000 – 6,075 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 Additional memorandum information at the end of the current and previous five accounting periods is presented below: Present value of scheme obligations Fair value of scheme assets 2010 £000 2009 £000 2008 £000 2007 £000 2006 £000 2005 £000 146,737 (144,056) 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) 2,681 22,285 (13,551) (20,783) Gross liability recognised on balance sheet – – – – 3,801 3,801 36,124 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 2010 years 24.5 27.6 2010 years 25.6 28.6 2010 % 5.40 6.40 3.60 3.60 2009 years 24.5 27.6 2009 years 25.6 28.6 2009 % 5.70 6.50 3.90 3.90 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 cost of equalisation of scheme obligations of £11.8 million was recognised in 2009 and paid in full in 2010. The Group has agreed to fund the £5.1 million deficit paying instalments over four years. During the year the Group made a second instalment of £1.7 million to the defined benefit scheme (2009: £1.5 million). 61% of any scheme surplus or deficit calculated is recharged or refunded to Syndicate 33. The expected return on scheme assets is based on historical data and management’s expectations of long-term future returns. While management believes that the actuarial assumptions are appropriate, any significant changes to those could affect the balance sheet and income statement. Whilst an additional one year of life expectancy for all scheme members might be expected to reduce the present value of unfunded obligations at 31 December 2010 by approximately £80,000 (2009: £4 million), the Group considers that the most sensitive and judgemental assumptions are the discount rate and inflation. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 95  Notes to the consolidated financial statements continued 30 Employee retirement benefit obligations continued 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 2010 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 5.15% Effect of an increase in inflation Use of inflation assumption of 3.85% 2,681 10,887 2,681 5,946 – – 31 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) 2010 2009 178,800 379,064 47.2p 280,497 372,848 75.2p 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) 2010 2009 178,800 280,497 379,064 14,662 372,848 14,966 393,726 387,814 45.4p 72.3p Diluted earnings per share has been calculated after taking account of 13,996,961 (2009: 14,345,744) options and awards under employee share option and performance plan schemes and 665,060 (2009: 619,870) options under SAYE schemes. 32 Dividends paid to owners of the Company Interim dividend for the year ended: 31 December 2010 of 5.0p (net) per share 31 December 2009 of 4.5p (net) per share Second interim dividend for the year ended: 31 December 2009 of 10.5p (net) per share Final dividend for the year ended: 31 December 2008 of 8.5p (net) per share 2010 £000 2009 £000 19,018 – – 16,834 39,442 – – 31,779 58,460 48,613 Subject to shareholder approval at the forthcoming Annual General Meeting on 8 June 2011, a scrip dividend alternative to a cash dividend is to be offered to the owners of the Company. These financial statements do not reflect this dividend as a distribution or liability in accordance with IAS 10 Events after the reporting period. 96 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 33 Acquisitions On 15 December 2010, the group increased its 25.2% holding in Blyth Valley Ltd to 100%. Full control of the company was obtained and as such the Group have consolidated the results of Blyth Valley Ltd at 31 December 2010. Total cash consideration of £3,662,220 was paid representing net identifiable assets acquired of £243,000 and customer relationships not previously recognised by Blyth Valley Ltd of £3,619,000. In addition, the Group acquired a 25% holding in InsuranceBee Inc for total consideration of $500,000 (£323,000). InsuranceBee Inc was, until the Group acquired 100% of Blyth Valley Ltd, the American sister company of Blyth Valley Ltd and is a specialist errors and omissions insurance broker. 34 Disposals During the year, the Group disposed of its 40% holding in HIM Capital Holdings Limited recognising a gain on disposal of £458,000. 35 Contingencies and guarantees The Group’s subsidiaries are like most other insurers, continuously involved in legal proceedings, claims and litigation in the normal course of business. The Group is subject to insurance solvency regulations in all the territories in which it issues insurance contracts. There are no contingencies associated with the Group’s compliance or lack of compliance with these regulations. The following guarantees have also been issued: (a) Hiscox Ltd and Hiscox Capital Ltd have entered into deeds of covenant in respect of a subsidiary, Hiscox Dedicated Corporate Member Limited, to meet the subsidiaries obligations at Lloyd’s. The total guarantee given under these deeds of covenant (subject to limitations) amounts to £15 million (2009: £15 million) in respect of Hiscox Ltd and $350 million (2009: $350 million) in respect of Hiscox Capital Ltd. 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 circumstance where it considers there to be a risk that the covenant might need to be called and may be met in full. (b) On 5 July 2010 Hiscox plc entered into a new Letter of Credit and revolving credit facility with Lloyds TSB Bank, for a total $750 million which may be drawn in cash (under a revolving credit facility), Letter of Credit or a combination thereof, providing that the cash portion does not exceed $450 million. In addition the terms also provide that upon request the facility may be drawn in a currency other than USD. At 31 December 2010 $165 million (2009: $225 million) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further £20 million (2009: £138 million) by way of cash. (c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2009: £50,000) with NatWest Bank plc to support its consortium activities with Lloyd’s. (d) (e) 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 2010 and 2009. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required. 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 renegotiated 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 US Government Securities of Hiscox Bermuda. Letters of Credit under this facility totalling US$89,110,000 were issued with an effective date of 31 December 2010 (2009: US$109,000,000). Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 97  Notes to the consolidated financial statements continued 36 Capital and lease commitments Capital commitments The Group’s capital expenditure contracted for at the balance sheet date but not yet incurred for property, plant and equipment was £229,000 (2009: £614,000). 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 £7,171,000 (2009: £5,656,000). Operating lease rental income for the year totalled £635,000 (2009: £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 2010 £000 2009 £000 7,505 28 24,737 1 26,437 5,683 177 15,730 457 14,501 58,708 36,548 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 2010 £000 275 344 – 619 2009 £000 468 1,053 – 1,521 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 £8,806 (2009: £20,000). 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 The present value of the minimum lease payments is not materially different to the currently disclosed obligation. 2010 £000 45 – 45 (1) 44 2009 £000 226 177 403 (10) 393 98 Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 37 Principal subsidiary companies of Hiscox Ltd at 31 December 2010 Company Nature of business Country Hiscox plc* Hiscox Insurance Company Limited Hiscox Insurance Company (Guernsey) Limited* Hiscox Holdings Inc. ALTOHA Inc. Hiscox Insurance Company Inc. Hiscox Inc. Hiscox Insurance Company (Bermuda) Limited* Hiscox Dedicated Corporate Member Limited Hiscox Holdings Limited** Hiscox Insurance Holdings Limited Hiscox Syndicates Limited Hiscox Underwriting Group Services Limited Hiscox Capital Ltd* Hiscox Underwriting Ltd Hiscox Europe Underwriting Limited *Held directly. **Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2009: 54,560) at 31 December 2010. Holding company General insurance General insurance Insurance holding company Holding company General insurance Underwriting agent General insurance and reinsurance Lloyd’s corporate Name Insurance holding company Insurance holding company Lloyd’s managing agent Service company General insurance Underwriting agent Insurance intermediary Great Britain Great Britain Guernsey USA (Delaware) USA (Delaware) USA (Illinois) USA (Delaware) Bermuda Great Britain Great Britain Great Britain Great Britain Great Britain Bermuda Great Britain Great Britain All companies are wholly-owned. The proportion of voting rights of subsidiaries held is the same as the proportion of equity shares held. 38 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 37 to 45. 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 2010 £000 2009 £000 44,538 50,845 13,163 964 (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 16. Total 2010 £000 Total 2009 £000 13,228 18,530 3,285 4,632 – – – – (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. 39 Subsequent events Significant flooding in Queensland, Australia, dominated the end of 2010 and beginning of 2011. The Group has provided for £10 million in relation to the net losses which it believes were incurred pre 31 December 2010. The start of 2011 also saw a severe tropical cyclone, Yasi, make landfall in northern Queensland. On 22 February 2011, an earthquake measuring 6.3 on the Richter scale struck approximately ten kilometres south-east of Christchurch, New Zealand’s second most populous city. The earthquake caused extensive damage in the Christchurch area and, although it is too early to assess, the Group expects to report losses of a similar or greater magnitude as those recorded for the September 2010 New Zealand earthquake. Losses relating to these events in 2011 are not included within the results for 2010. Notes to the consolidated fi nancial statements Hiscox Ltd Report and Accounts 2010 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) 2010 £000 2009 £000 † 2008 £000 2007 £000 2006 £000 1,432,674 1,435,401 1,147,364 1,198,949 1,126,164 975,397 898,394 1,131,627 1,157,023 888,828 928,095 1,131,158 1,098,102 201,062 105,180 320,618 163,846 70,808 280,497 974,910 965,190 237,199 191,248 211,366 178,800 50,413 64,108 48,557 33,212 2,459,107 2,413,300 2,081,772 1,747,827 1,241,910 502,871 440,622 (1,817,102) (1,702,225) (1,773,622) (1,433,799) (1,291,329) 195,421 153,697 223,984 336,017 259,647 302,742 167,082 100,151 40,452 1,266,114 1,121,286 951,026 824,304 682,085 332.7 299.2 258.1 209.5 173.2 47.2 45.4 89.3 16.5 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 16.50 15.00 12.75 12.00 10.00 381.40 317.00 362.00 277.00 361.00 194.75 304.50 246.75 280.25 193.75 *Closing mid market prices. † As a result of a change in presentation, 2008 and later years included acquisition costs for the purchase of reinsurance contracts within expenses for the acquisition of insurance contracts. Earlier years include these costs within ‘outward reinsurance premiums’. 100 Five year summary Hiscox Ltd Report and Accounts 2010 To request a copy of the 2010 Hiscox corporate brochure visit www.hiscox.com Design: Browns www.brownsdesign.com Print: Pureprint www.pureprint.com Photography: Portraits © John Ross and Matthew Septimus Cover © Getty Images This report has been printed in the UK by Pureprint Group, a CarbonNeutral® company, using their environmental printing technology. Vegetable-based inks were used throughout. The paper is 100% recycled and the pulp is bleached using a totally chlorine free (TCF) process. Both printer and paper mill are ISO14001 and registered to EMAS. 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 8280 03/10 

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