Review of 1H 2017

Group

⁽¹⁾ The 1H 2016 solvency coverage has not been adjusted.

Motor

Gross written premiums increased 27.4% to £351.3m (1H 2016: £275.7m) through a combination of positive rating actions and in-force policy growth. In-force policies increased by 16.4% to 1.740 million (1H 2016: 1.495 million) as the Group's core and footprint expansion segments all grew in the first half of the year.

Trading profit of £48.1m is 40.2% higher than 1H 2016 (£34.3m) through an improvement in the underwriting and non-underwritten additional services revenues performance. The underwriting result improved as the Group's positive rating actions earn through ahead of claims inflation, and this is reflected in the improvement in the current year net loss ratio of 76.6% (1H 2016: 82.2%). Favourable development of prior accident year reserves of £11.0m equated to 4.0% of net earned premiums (1H 2016: £13.0m; 5.8%).

Non-underwritten additional services revenues increased 26.1% to £30.0m (1H 2016: £23.8m) largely driven by higher instalment income, where higher average written premiums year-on-year and growth in overall policy count in the first half of 2017 increased income.

Home

Gross written premiums reduced 6.0% to £42.0m (1H 2016: £44.7m) as a result of disciplined underwriting in challenging market conditions. In-force policies are 11.0% lower at 517,000 (1H 2016: 581,000) as the Group increased prices ahead of the wider market as it looked to mitigate against rising claims inflation.

Trading profit is 21.4% higher at £3.4m (1H 2016: £2.8m) largely driven by an improvement in the non-underwritten additional services revenues.

The underwriting loss of £2.0m reflects the soft rating environment earning through in combination with claims inflation, in particular relating to escape of water claims as noted by the wider market. The first half performance has benefited from a benign period of weather compared to the first half of 2016 when the Group incurred £5.0m of adverse weather claims. Favourable development of prior accident year reserves of £3.7m equated to 9.0% of net earned premiums (1H 2016: £7.5m; 17.9%).

The expense ratio of 43.3% is 4.6ppts higher than the first half of 2016 primarily due to a full period cost of the Flood Re Levy that was introduced on 1 April 2016. Non-underwritten additional services revenues increased 11.6% to £4.8m due to an improvement in the performance of non-underwritten additional insurance products and higher instalment income. 

Additional services revenues

Total income from additional services increased 14.4% to £58.9m (1H 2016: £51.5m) driven by a strong performance across all income lines. Non-underwritten additional services trading profit increased 23.8% to £34.8m (1H 2016: £28.1m) ahead of the Group's in-force policy growth.

Investments

The Group achieved a gross investment return of 0.9% (1H 2016: 1.0%) and a net investment return of 0.7% (1H 2016: 0.8%). 

The net investment return was slightly lower year-on-year at £5.7m (1H 2016: £6.1m) with performance tailing off towards the end of the period following a marked steepening in the UK yield curve. Net gains on investments include a one-off realised gain of £2.0m as the Group partially disposed of its long dated Gilt to ensure an appropriate matching between assets and liabilities under Solvency II. This is not expected to repeat in the second half of 2017.

Other income was lower at £0.2m (1H 2016: £0.7m).

Trading profit

Trading profit from continuing operations, being earnings before interest, tax, non-trading expenses and amortisation of acquired intangible assets, is management's measure of the overall profitability of the Group's operating activities. The Group's reportable segments are Motor and Home and these delivered a trading profit of £51.5m (1H 2016: £37.1m).

The Group generated a trading profit from discontinued operations (Gocompare.com) of £nil (1H 2016: £13.2m). Gocompare.com was demerged from the Group on 3 November 2016.

Reconciliation of trading profit from continuing operations to profit before tax from continuing operations

The Group incurred £4.3m in finance costs (1H 2016: £4.3m) relating to the £125.0m of 6.75% ten year tier two Subordinated Notes issued on 19 December 2014 ("the Notes").

Profit after tax

Profit after tax from continuing operations

The Group's profit after tax from continuing operations increased 43.1% to £36.5m (1H 2016: £25.5m) largely driven by an improvement in the underwriting and non-underwritten additional service revenues performance.

Profit after tax from discontinued operations

The Group generated a profit after tax from discontinued operations (Gocompare.com) of £nil (1H 2016: £5.2m). Gocompare.com was demerged from the Group on 3 November 2016.

Earnings per share

Earnings per share

Earnings per share increased 17.6% to 8.7 pence (1H 2016: 7.4 pence).

Earnings per share from continuing operations

Earnings per share from continuing operations increased by 42.6% to 8.7 pence (1H 2016: 6.1 pence) in line with the increase in profit after tax from continuing operations.

Dividend per share

An interim dividend of 4.1 pence per share (1H 2016: 3.0 pence per share) has been declared and approved by the Board. The interim dividend is comprised of a base dividend of 2.9 pence per share and a special dividend of 1.2 pence per share. The dividend has been set with reference to the Group's profit after tax and allows for the approximate proportion of one-third (interim dividend) and two-thirds (final dividend), respectively.

The ex-dividend date is 31 August 2017, the record date is 1 September 2017 and the payment date is 13 October 2017. These dates are in respect of both the base and special interim dividend.

Cash flow

The Group's cash and cash equivalents at the end of the period are £35.4m (1H 2016: £28.9m).

Operating activities were a net inflow of £61.3m (1H 2016: £36.8m) largely driven by the Group's strong premium growth in the first half of the year.

Investing activities were a net outflow of £3.4m (1H 2016: £5.2m) and reflects the Group's investment in property, plant, equipment and software.

Financing activities were a net outflow of £48.0m (1H 2016: £34.6m) and includes the Group's 2016 final dividend that was paid in May 2017 of £43.9m (1H 2016: £30.4m).

The Group's cash flow statement can be found on page 14.

Investments

The Group deploys a conservative investment strategy, with the primary objectives of capital preservation and maintaining liquidity. Through better alignment of the investment and liability durations, the Group is able to deliver appropriate returns while minimising earnings and capital volatility. 

Strategic investment allocations

The Group's investment portfolio is in the process of transitioning towards the following strategic asset allocations and target returns. The Group's target allocations and target returns are outlined below:

As at the 30 June 2017 the Group held the following investments:

The Group's total assets under management are 5.8% higher at £912.7m (FY 2016: £862.9m including derivative financial liabilities) reflecting the Group's strong premium growth in the period.

The Cash & Liquidity portfolio is accessible cash for operational activities and is inclusive of a buffer for adverse events. The allocation of 7% is in line with the Board approved liquidity risk appetite.

The Claims backed portfolio is constructed with reference to the expected future cost of the Group's technical liabilities, as defined under Solvency II. The Group continues to designate newly acquired assets as available-for-sale ("AFS") to minimise the impact of interest rate changes on earnings. As at 30 June 2017 the Group has designated £297.2m as AFS and £266.5m as fair value through profit and loss.

The Surplus portfolio seeks to deliver returns while investing in a manner that reflects the Group's risk appetite, in particular with reference to its solvency capital. The strategic asset allocation review continues and the Group expects to allocate surplus liquidity funds on a prudent basis in due course. The remaining assets are invested across a mixture of fixed income and equities.

The Group's total investment duration was 2.4 years (FY 2016: 2.6 years) and the Group continues to take a proactive approach to match its asset and liability durations under Solvency II.

Fixed income

Fixed income credit risk quality

The credit risk quality of the fixed income portfolio remains strong with 65% held in assets rated 'A' or above.

Reserving

The Group holds claims reserves, to cover the future cost of settling claims that have been incurred but not settled at the balance sheet date, whether already known to the Group or not yet reported, net of associated reinsurance recoveries.

For known periodic payment orders ("PPOs") and potential PPO awards, indexed cash flow projections are carried out in order to estimate an ultimate cost on a gross and net of reinsurance basis. The Group currently has 10 PPOs. The cash flow projections were undertaken on a discounted basis.

Due to the inherent uncertainties in reserving, the Group adopts a prudent approach to reserving through reserving in excess of the actuarial best estimate. Over time the inherent uncertainties in the actuarial best estimate reduce and the Group releases the margin above the best estimate. The Group's current reserve margin is comfortably in excess of its actuarial best estimate.

On 27 February 2017, the Lord Chancellor changed the Ogden discount rate from plus 2.5% to minus 0.75%, effective 20 March 2017. The impact of this change on the Group's 2017 performance was not material.

The Group benefited from strong favourable development of prior accident year reserves, with total prior year releases of £14.7m in 1H 2017 (1H 2016: £20.5m). The favourable development represents 4.6% of net earned premium (1H 2016: 7.8%).

Reinsurance

The Group purchases reinsurance as a risk transfer mechanism to mitigate risks that are outside the Group's appetite for individual claim or event exposure and to reduce the volatility caused by large individual and accumulation losses. By doing so, the Group reduces the impact that an event can have on its capital position and its underwriting results in both Motor and Home.

Currently, the Group has in place excess of loss reinsurance programmes for its Motor and Home underwriting activities. The purpose of these programmes is to provide cover for both individual large losses, for Motor and Home, and accumulation losses arising from natural and other catastrophe events for Home. Motor and Home reinsurance treaties are in place covering all years in which the Group has underwritten policies in each line of business.

The Group's Motor reinsurance treaty was renewed on 1 July 2017:

The like-for-like cost increase of the programme was 33%, equating to an increase of £10 per vehicle, as a consequence of the change in the Ogden discount rate in February 2017 from 2.5% to minus 0.75%. The increase in reinsurance costs compares favourably to market estimates and reflects the Group's low risk approach to underwriting, low large loss propensity and strong, long term relationships with its reinsurer panel. The Group has successfully implemented price increases across its Motor portfolio in the first half of the year to help mitigate against the increased cost of reinsurance.

The Home treaty was renewed on 1 July 2017 with no material changes to the programme.

The Group's reinsurance programmes are reviewed on an annual basis and capital modelling is used to identify the most appropriate structure and risk retention profile, taking into account the Group's business objective of minimising volatility and the prevailing cost and the availability of reinsurance in the market.

The Group has no quota share reinsurance or co-insurance arrangements in place.

Capital

The Group seeks to manage its capital in order to maintain a level of capitalisation and solvency to ensure that regulatory requirements are met with an appropriate buffer and that there is sufficient capital available to fund profitable growth opportunities.

The solvency capital requirement ("SCR") is the level of capital the Group is required to hold to meet its obligations if a 1 in 200 year event were to occur in the next 12 months. The Group's normal operating range of coverage of its SCR is 130-150%. The capital surplus above the SCR provides an appropriate level of capital coverage and should enable the Group to continue to meet its regulatory capital requirements. The Group adopts the standard formula to calculate its capital requirements under Solvency II.

The Group's capital position, after allowing for the interim dividend, is outlined below:

The figures quoted for 1H 2017 are estimated and unaudited.

As at 30 June 2017, the coverage ratio of the Group's SCR was 153% (FY 2016: 152%). The Group's coverage ratio includes adjustments, which in aggregate, if an adjustment was not made, would increase the Group's interim coverage ratio compared to the position as at the year end. These primarily relate to timing differences in respect of the Group's interim dividend and the loss absorbing capacity of deferred taxes. Were the Group not to adjust for these factors, the coverage ratio would be 157%.

Own Funds comprise Tier 1 and Tier 2 qualifying capital. The Notes meet the qualifying criteria of a Tier 2 capital instrument and qualify up to a maximum of 50% of the SCR. The quality of the Group's capital remains strong with 69% in Tier 1 and 31% in Tier 2.

Solvency Capital Requirement

The Group's SCR allocation by risk type, based upon the undiversified capital requirement, can be seen below:

The main risk driver is underwriting, consisting of premium, reserve and catastrophe risk, reflecting the capital requirements of the core business activities for the Group.

Sensitivities

The Group's capital structure is positioned to minimise the impact that adverse capital events have on its ability to meet its solvency capital requirements, were they to occur. The adverse capital events below are outlined to demonstrate the Group's capital resilience to such events. 

* Capital coverage movements are stated after earnings, tax and dividend impact.

Dividend Policy

The Group's dividend policy is to target a base dividend of 50% of profit after tax and enhance the base dividend with a further special dividend, if the Group has sufficient capital and distributable reserves, after allowing for an appropriate level of capital coverage of the Group's SCR and future growth opportunities. The Board remains committed to returning excess capital to shareholders where it does not believe it can utilise retained capital for further profitable growth.

The interim dividend will be paid in October of the relevant financial year and the final dividend in May of the following financial year, in the approximate proportions of one-third and two-thirds respectively.

Segmental Reporting

In 2017, the Group changed its reportable segments to Motor and Home to reflect the lines of business it underwrites and the contribution they deliver to the Group's performance. In 2016, the Group's reportable segments were: Motor underwriting; Home underwriting; Non-underwritten additional services; Investments; and prior to the demerger of Gocompare.com, Price Comparison.

Outlook

The Group's 2017 guidance provided in March, assuming stable market conditions and normal weather, was: growth in premiums and in-force policies at 15-20% and 5-10%, respectively; the combined operating ratio to be in the region of 96-98%; and non-underwritten additional services revenues to grow ahead of in-force policies in line with the trend seen in the second half of 2016. The Group now expects to deliver results at the positive end of this guidance.

The Group's ambition is to grow to 3 million in-force policies by 2020.