Final Results
(Thomson Reuters ONE) -
NEWS RELEASE
4 March 2010 For immediate release
Novae Group plc
Preliminary results for the year ended 31 December 2009
Highlights
Novae Group plc ("Novae" or "the Group"), the specialist insurance business,
today announces its 2009 preliminary results. Highlights:
* Underlying profit before tax excluding notional foreign exchange loss on
non-monetary items: £17.7 million (2008: £27.3 million)
* Profit before tax after notional foreign exchange loss on non-monetary
items: £4.2 million (2008: £40.2 million)
* Profit after tax: £26.4 million (2008: £37.1 million)
* Net assets per share: 436.2p, up 4% (2008: 420.0p)
* Net tangible assets per share: 422.7p, up 3% (2008: 410.8p)
* Core dividends per share: 11.0p, up 10% (2008: 10.0p, excluding 4.0p special
dividend)
* Investment income: £31.0 million (2008: £50.0 million), representing a yield
on average invested assets of 3.0% (2008: 5.1%)
* Novae Re: new business formed in 2009, writing new business from January
2010. Estimated gross written premiums of £90-100 million for 2010 across
six underwriting teams
* December 2009: announcement of transfer of NICL renewal rights into Lloyd's
business and other steps to improve return on equity
Matthew Fosh, Chief Executive, today said:
"The Group delivered a robust performance in the second half, returning to
profit after the aviation reinsurance and credit losses reported at the interim
stage. Performance was underpinned by strong investment income. Looking forward,
we expect to see selective rate increases in 2010 and will have the first year
contribution from Novae Re. The restructuring of the Group's capital base,
reduced reinsurance spend and elimination of expense inefficiencies announced in
December 2009 are on track."
There will be a presentation to analysts at 9.00 a.m. today at Novae's offices
on the 8th floor, 71 Fenchurch Street, London EC3M 4HH.
For further information:
Matthew Fosh, Novae Group plc 020 7903 7300
Nick Miles, M:Communications 020 7920 2335
CHAIRMAN'S STATEMENT
Against the backdrop of global economic and market challenges throughout 2009,
Novae continued to stick to its core focus of evaluating and assuming risk for
the benefit of its customers and shareholders.
In the first half of 2009 our results were impaired by losses in aviation and
credit and political risk. The scale of industry-wide claims in both classes of
business was among the worst on record and yet Novae successfully recovered in
the second half and returned a profit for the year as a whole. We were not
diverted from pursuing our strategy of developing a diversified insurance
business, targeting above average return on equity through the disciplined
underwriting of specialist risks balanced between short and long tail business.
Our investment performance has continued to be an important contributor to
profits. Whilst remaining conservative, we extended our risk appetite to take
advantage of yields on investment grade corporate bonds very early in 2009, as
well as permitting a moderately longer duration so as to achieve a better match
with the settlement tail of our liabilities of around three years. It is our
intention to continue to be cautious in our investment policy.
Novae hired additional high quality underwriters in 2009. Our size and culture
offers an attractive environment for talented professionals. In August we
announced the launch of Novae Re which is now writing reinsurance business in
Zurich and London. This is our first move outside the UK and we have worked hard
to ensure that all our management controls are fully embedded in the Zurich
operation. We have a range of skills new to Novae which are enabling us to
participate in business with considerable potential. Also during the second half
of 2009, we expanded our UK property team and are excited by the start our new
colleagues have made.
In December 2009 we announced a restructuring of the Group, bringing business
written in Novae Insurance Company Limited ("NICL") back into Lloyd's. Our aim
is to increase significantly our return on equity by unlocking surplus capital
currently tied up unproductively in NICL. The UK regional insurance market has
remained highly competitive and we have not seen sufficient business that we
want to write to make full use of NICL's capital. It therefore made sense, after
consultation with our major shareholders, to bring the business into Lloyd's and
return to a single unified capital base.
Many of the fundamentals of our market point to an increase in rates. In
particular the sharp fall in investment returns will have a significant impact
on liability business. Broadly, for a medium tail business with an investment
stance such as ours every percentage point reduction in investment returns
should be compensated for by a three to four percentage point increase in
premium rates. That this is not occurring is partly because the claims
environment has not yet been as painful as is necessary to achieve change
despite losses arising from sub-prime, the banking crisis and the activities of
Madoff and others. It may also be partly because insurers do not anticipate
interest rates will remain at current levels for much longer, in spite of a
yield curve suggesting historically low rates in the UK and US for the next
three years. Notwithstanding this environment, we are fortunate to have
underwriters with the skill to make money in these tougher than anticipated
conditions.
During 2009 we reviewed the structure of our boards within the Novae Group.
Non-executive directors are being asked to increase their involvement in the
detail of the business. To provide the right environment without increasing
unduly the burden on our executive colleagues, we have decided to have greater
commonality between the Group board and the two principal subsidiary boards of
Novae Syndicates Limited and NICL. All Group non-executive directors will join
the other two boards during 2010. This will increase the amount of information
given to and participation of our non-executives. At the same time,
non-executives of Novae Syndicates Limited and NICL have agreed to stand down
from those roles. I would like to thank Bill Davis, John Massey, John Thirlwell
and Michael Payton who have served with diligence and insight on the boards of
Novae Syndicates Limited or NICL.
We have also reviewed the size and composition of the Board of Novae Group plc.
Today we announce the appointment of David Pye as an additional independent
non-executive director. David has had a long and successful career in the
insurance industry, underwriting in both the Lloyd's and UK company markets. I
am confident that he will bring a fresh perspective to our Board deliberations.
Allan Nichols, who has been an executive director since February 2000, will be
stepping down from the Group Board at the conclusion of the Annual General
Meeting in April 2010. Allan's move allows Novae to move towards compliance with
the requirements on board composition set out in the Combined Code. Hitherto,
the Group Board had consisted of five executive directors, making compliance in
terms of a majority of independent non-executive directors hard to achieve
without an even larger Board. Allan has made a major contribution on the Group
Board over the past 10 years and will in all other respects continue in his same
executive role as underwriting review director.
I continue to be impressed by the professionalism shown by the underwriters at
Novae and by the highly skilled teams that support our business. They again
deserve our thanks for steering the Group safely through a difficult year.
J P Hastings-Bass
Chairman
4 March 2010
DIVIDEND AND FINANCIAL TIMETABLE
Ex dividend record date: 10 March 2010
Record date: 12 March 2010
Second interim dividend of 8.0p per ordinary share: 31 March 2010
AGM: 29 April 2010
CHIEF EXECUTIVE'S STATEMENT
Novae's financial performance in 2009 reflects a strong underwriting performance
in the second half and a robust investment contribution for the year as a whole.
The first half of 2009 was a challenging period for Novae, with headwinds from
aviation reinsurance losses and from the emerging global recession. The aviation
reinsurance unit incurred losses of $29 million (£19 million), in the first
half; and the trade credit and political risks unit £12 million, of which some
£8 million related to CIFS, the Group's UK trade credit business, and the
balance related to emerging markets credit business. Although disappointing, the
scale of losses that has subsequently emerged from the credit and political risk
area across the broader market demonstrated that amongst our peers, Novae's
early reporting and controlled underwriting have served it well.
The Group succeeded in improving its financial performance materially during the
remainder of 2009. Novae's underwriting and investment performance across the
rest of its business returned the Group to profit for the second half of 2009
and for the year as a whole. Profit before tax was £17.7 million prior to
foreign exchange effects on non-monetary items (2008: £27.3 million).
The second half of the year was also a period in which the Group announced two
major strategic initiatives designed to diversify its underwriting and improve
its return on equity. This followed a period when the Group's capital, for
historical and structural reasons, had not been deployed optimally; these
inefficiencies had been restraining the Group's earnings potential.
The first of the initiatives was the announcement in August 2009 of the
formation of Novae Re, a reinsurance business, through the recruitment of a team
of experienced reinsurance underwriters in London and Zurich. Novae Re is
expected to write gross premium income for 2010 of £90-100 million from a range
of classes including agriculture and engineering risks not typically written
within the London market. This was a significant step for the Group's Lloyd's
business, improving diversification and capital efficiency.
Following the August announcement, Novae Re was launched at the reinsurance
conferences in Monte Carlo in September and Baden Baden in October. The market's
reaction has been encouraging and the Board remains confident that income
expectations for Novae Re in 2010 will be met. The integration of the new team
in London and Zurich has proceeded well, the project has been delivered within
budget and the new Zurich office opened in early 2010.
The second major strategic initiative was the announcement in December 2009 that
Novae would henceforth renew business previously underwritten by NICL, the
Group's UK insurance company subsidiary, into its Lloyd's business. By folding
NICL into the Lloyd's business surplus capital not efficiently deployed within
NICL could be released, and either made available for underwriting or returned
to shareholders. The process for this transfer of business is underway, and is
scheduled to complete before the end of 2010, together with any consequential
return of capital.
Several of the benefits that the Group had targeted as a result of this transfer
of renewal rights into Novae's Lloyd's business have already begun to
materialise. Structural and organisational cost savings have been identified and
the potential for more efficient purchase of reinsurance has been realised. When
combined with the Group's previously announced increase in risk appetite in
general, the scope for improving returns assuming normal loss experience is
increasing as anticipated. The precise amount of capital available to return to
shareholders will depend on our assessment of market conditions and
opportunities during 2010, as well as the speed at which a complex regulatory
and legal process can be completed. However, the objective is clear: capital
efficiency and improved returns on equity.
Taken together, these two strategic steps are designed to move the Group away
from the excess capital and diluted returns which have together acted as a drag
on its performance in recent years. The formation of Novae Re and the other
underwriting teams recruited since the Group's rehabilitation in 2006 have
collectively shortened the tail of the business and allowed increasingly
efficient use of the Group's capital into 2010 and beyond. Growth in premium
income into 2011 will be governed by market conditions, and capital will be
available later in the year, if required, as the NICL capital is released.
The Board remains clear in its willingness to conclude a transaction to divest
the Group's 2002 and prior legacy underwriting on terms satisfactory to
shareholders. Since the £103.6 million exceptional provision was established in
2004, the 2002 and prior underwriting has run off in line with expectations.
Nevertheless, the Board recognises the reputational burden it continues to place
on the Group as a whole and remains focused on securing a transaction to
extinguish this legacy provided the terms are acceptable. A further two major
commutations on the run-off business were completed in 2009 and another
transaction was completed in early 2010. In each case these involved multiple
underlying contracts and served to reduce yet further the size and operational
burden of 2002 and prior underwriting.
In summary, a year which began with a difficult first half has ended on a far
better note. The outcome for the year overall is profitable, NTA per share is
rising, underwriting strength in depth is growing, and there is the prospect
later this year of a return of capital to shareholders. In these circumstances
Novae approaches the future with optimism.
M K Fosh
Chief Executive
4 March 2010
OPERATING REVIEW
Market environment
Rating and the competitive environment
Novae's business mix remains liability-orientated, although its weighting of
property business has increased from 32% of gross written premium in 2006 to
40% in 2009 and an estimated 46% in 2010. Business mix has been an increasingly
relevant consideration since 2005 when extreme losses from Hurricanes Katrina,
Rita and Wilma led to a bifurcation in rating between liability and property
insurance.
For liability business generally, rates peaked in 2003/2004. In late 2008
investment losses, an expected increase in claims activity and operating and
financial concerns surrounding a small number of large insurance and reinsurance
groups led to expectations that liability rates would improve in 2009. However,
rate hardening has been more limited with the principal benefit focused on those
classes such as financial institutions and credit where large losses in the
market have already emerged.
In comparison rates for many property classes, which improved following the
2005 windstorm season, hardened again in 2009 following losses in Gulf of Mexico
energy and US property classes the previous year. The very benign loss
environment for US windstorm-exposed business in 2009 has led to some rate
easing in 2010 but the absence of new entrants and the relatively
capital-constrained position of many catastrophe insurers has helped to maintain
a better balance of supply and demand than for liability classes.
Over the course of 2009, the overall rate increase across the Group's book of
business was around 9%. This breaks down into an increase for the Specialty and
Property segments of around 10%; for Liability of around 3% and for Aviation &
Marine of around 13%. For 2010 the Board is currently anticipating that the
whole account is broadly neutral, reflecting rate increases in areas which have
recently experienced heavy loss activity, and modest movements in areas where
claims activity has been benign.
Novae underwrites business produced by a range of brokers. All brokers are
subject to review prior to the acceptance of business, primarily for financial
resilience, as premium and claims exposure can be significant.
Catastrophe business
During 2009 Novae underwrote two main catastrophe-exposed classes: property
reinsurance and aviation reinsurance. Other units such as energy and US
facilities also have some catastrophe exposure. The Group's overall exposure to
catastrophe business is more limited than most of its listed peers, with the two
event-driven reinsurance units accounting for approximately 20% of 2009 gross
written premium.
In the business planning process catastrophe units are assumed to experience a
normalised or average level of losses in the forthcoming year. Actual
performance tends to deviate significantly from this normalised experience given
the binary nature of catastrophe business: in recent years the Group's
catastrophe units have seen either a series of loss events producing an outcome
worse than business plan, or a benign or relatively loss free period producing
returns better than business plan.
The Group's property reinsurance unit benefited from an extremely benign loss
environment in 2009, as the absence of US windstorm losses generated a
significant level of profit for the unit. It is also exposed to other perils
such as US and Japanese earthquake risk, but in each of these cases loss
experience during 2009 was favourable.
Novae's aviation reinsurance unit was exposed to a number of high profile losses
in the first half. The most prominent was the Air France loss over the Atlantic
Ocean in June, but other events included the Colgan loss at Buffalo, New York
and the Comoros loss in the Indian Ocean. Although these events were
sufficiently severe in aggregate to push the unit into a loss in 2009, this
should be seen in the context of a very profitable period since 2002.
Recession-related exposures
In 2009 some 60% of Novae's gross written premium was derived from liability
classes. Historically, periods of recession and financial stress have tended to
see an increase in claims from these classes. The Board is therefore monitoring
the emergence of recession-related losses carefully.
The first signs of stress in the financial sector emerged in 2007 with the
disruption of the US sub-prime mortgage market. In 2008 this developed into a
more widespread financial dislocation, leading to the failure of Lehman Brothers
in September, the discovery of the Madoff fraud in December and allegations of
fraud in relation to the Stanford financial services business in February 2009.
Novae withdrew from US liability reinsurance business in 2002 and its exposure
to direct business was cut back significantly in 2004/2005. As a result the
Group has consistently said that, while some notifications and claims are
inevitable, by virtue of its very limited appetite for US liability business,
Novae does not expect its ultimate exposure to US sub-prime to be significant.
Madoff and Stanford are US-centric losses. However, because a number of
international banks, high net worth managers and fund of funds invested with
Madoff and Stanford they will have a broader geographic reach than US sub-prime
mortgage losses. The Board, although vigilant, remains satisfied that a
combination of aggregation controls and coverage limitations on inwards
business, existing reserves and the depth of its outwards reinsurance programme
should limit the financial effects of such losses.
More recently a number of recession-related claims have emerged in the UK. To
date these have fallen into three main areas:
* Mortgage fraud
* Professional indemnity and other negligence-type events
* Credit insurance
A number of professional services firms such as lawyers, accountants, architects
and financial advisers are exposed to negligence or fraud claims in a recession.
This business is written in both Syndicate 2007 and NICL. The Group's Lloyd's
business has to date avoided many of the large losses already notified to London
market insurers. Meanwhile NICL was actively repositioning its book to avoid
recession-exposed risks since 2007. For example, NICL reduced exposure to
property-related risks and withdrew from regional solicitors' professional
indemnity business in 2007. The fact that NICL chose not to write for income in
2007 and 2008 means that it is less exposed than many of its competitors.
CIFS, the Group's UK trade credit insurance business, was acquired in 2004. At
the end of 2008 it appeared that CIFS had performed relatively strongly by
avoiding high profile insolvencies such as MFI and Woolworths which emerged in
autumn 2008. However, the depth and speed of the recession in early 2009
resulted in a larger than expected number of individually small and medium-sized
claims. As a result, at June 2009 CIFS loss reserves were strengthened. Although
the financial performance of CIFS is unsatisfactory, it has been trading around
break-even in the second half of 2009 and its record compared to its larger
competitors gives some grounds for optimism. Moreover, the Group's exposure to
continuing UK trade credit losses in 2010 has been reduced by the use of quota
share reinsurance.
Emerging market trade credit losses in 2009 were caused by the worldwide
economic recession and ensuing financial dislocation. There were significant
market losses in 2009 in Ukraine, Bahrain and Kazakhstan. The group is fully
reserved for the Ukraine and Bahrain claims. We chose not to write the
Kazakhstan risks and therefore expect our loss to be more modest than some
participants in this subscription market.
Security rating
Moody's financial strength rating of Syndicate 2007 remains A2. In June 2009
Standard & Poor's rating of Syndicate 2007 improved from 2+ positive to 3-
stable. In addition, Syndicate 2007 benefits from Lloyd's ratings: Standard &
Poor's, A+ stable; AM Best, A stable; and Fitch, A+ stable.
The regulatory environment
The Group's principal subsidiaries are regulated by the FSA. The most recent
ARROW inspection by the FSA was in September 2008. The Group remains committed
to an open dialogue with its regulator through regular and routine briefing.
The current focus of the FSA remains on the introduction of Solvency II, which
is described in detail in the Financial Review.
Lloyd's is a franchisor rather than regulator but it has quasi-regulatory
powers. The most important area of interaction remains Lloyd's own
capital-setting process, which concludes with a formal solvency test in June and
November.
Underwriting performance
Specialty
Specialty continued to be Novae's largest business segment in 2009, accounting
for 42% of gross premiums written. The segment is broadly-based, containing
areas of historical market leadership such as financial institutions as well as
newer units including bloodstock. Two thirds of segment gross written premium is
derived from claims-made liability business with the balance from short-tail
units.
The financial institutions unit recorded a loss reflecting claims activity and a
conservative reserving approach. Other areas of claims-made liability business
made significant profits. London market professional indemnity saw a marked
improvement in profitability while the regional professional indemnity unit was
also profitable. The medical malpractice unit again made a substantial
contribution and there was a much improved performance from management liability
business.
Segmental performance for the year was affected by the heavy losses from credit
business, made up of CIFS, the UK trade credit unit, and emerging market credit
business. Novae identified these problems in the first half of the year and took
action accordingly. The scale and speed of the corrective action taken by CIFS
produced a breakeven result in the second half but the emerging market credit
business continued to strengthen reserves in the second half. The loss on
emerging market credit business outweighed the profits on political risks and
political violence business.
The benefits of the diversity in Specialty lines were evident in 2009. The
segment reported an overall profit in spite of losses on credit business and the
absence of a contribution from its largest constituent, financial institutions.
It is well-placed to exploit a hardening market as individual classes start to
respond to recent claims activity.
Property
The Property segment accounted for 21% of premiums written in 2009, unchanged
from 2008. The significance of direct business increased in 2009, accounting for
52% of segmental income, with the balance being derived from property
catastrophe reinsurance business. In 2010 the scale of the Property segment will
grow reflecting the impact of both the new UK and European direct property unit
as well as an initial contribution from Novae Re. The weighting of reinsurance
business is expected to increase to over 50% of segment income in 2010.
The property catastrophe reinsurance unit writes mostly excess of loss treaties
supplemented by some pro rata treaties, principally for Japanese business. Its
financial performance is primarily affected by the frequency of headline
catastrophe events. In contrast, for the direct units claims activity reflects a
combination of catastrophes, large risk losses and attritional losses.
In 2009 catastrophe losses generally and in the USA in particular were
abnormally low. This was in contrast to the scale of US hurricane losses in
2008 and it resulted in an improved level of profitability for the Property
segment in 2009.
This swing in fortunes was particularly pronounced for the property reinsurance
unit. In 2009 an abnormally low level of catastrophe claims activity produced an
exceptional level of profitability, in contrast with the small profit recorded
in respect of the previous hurricane-ravaged year.
The international direct & facultative property unit was the principal source of
profit from direct property underwriting. It included some benefit from
favourable reserve development in respect of large claims relating to prior
years. The US facilities unit also benefited from the lower level of catastrophe
losses and made a satisfactory profit for the year. In contrast, attritional
losses eroded the profitability of the UK facilities unit in 2009.
The vagaries of catastrophe experience will continue to exert a major effect on
the performance of this segment. However, increased diversification should help
to produce less volatile results.
Liability
This segment accounted for 18% of Group premium income in 2009, down marginally
on the 19% reported in 2008. It remains the Board's intention to limit
occurrence-form liability business to under 20% of the Group's gross written
premium.
Growth within this segment has been restrained by the difficult economic
climate, an uninspiring rating environment and the need to reserve
conservatively. The very material reduction in interest rates since the end of
2008 has had a negative effect on the fundamental profitability of liability
business which some market participants remain determined to ignore.
The need to adopt a cautious approach to reserving such long tail business has
been the subject of frequent comment in the past. As a result, financial
performance tends to reflect reserve releases on more mature business. Last year
saw an extremely favourable experience on business written in 2007. There was
also a better than expected claims experience on 2008 business, although limited
credit has been taken for that at this stage.
In 2009 the outstanding source of profit within the segment was marine
liability. There was also a healthy contribution from non-marine liability
business, particularly the smaller SME business written through NICL. Last year
also saw the first contribution to profits from the international casualty unit
established in 2007.
The fleet motor unit was formed in September 2008. The unit needs to achieve a
degree of scale and this was hampered by a competitive rating environment. As
with other start-up units, the Group is prepared to be patient in allowing the
motor business to apply underwriting discipline rather than chase incorrectly
priced premium income.
Aviation & Marine
This segment has grown in recent years and in 2009 it accounted for 19% of total
premium income, compared with 15% in 2008. Inflated by reinstatement premiums,
aviation reinsurance accounted for 47% of segmental premium income. Energy and
marine business each accounted for half of the remainder.
The aviation reinsurance unit writes primarily an excess of loss account for a
wide range of direct aviation insurers. As such it represents an event-driven
reinsurance unit whose performance will be determined by the frequency of large
aviation losses. Since 2002 the unit has been extremely profitable. However the
first half of 2009 saw a number of high profile aviation losses, which produced
a heavy loss at the interim stage. Although loss experience in the second half
was more satisfactory, the scale of claims from the first half generated a loss
for the year as a whole.
The performance of the aviation reinsurance unit more than offset the profits
achieved elsewhere in this segment. The most significant source of profit was
the marine hull account. This is an area where Novae has been developing a more
significant and better balanced business while remaining highly selective. The
marine war unit also achieved a good level of profitability in 2009.
The energy account recovered to a profit in 2009 after hurricane losses had
produced a marginal outcome the previous year. There were still significant loss
events affecting it in 2009, the most notable being a production well blow-out
off the coast of Australia. Yet, as experience since 2006 demonstrates, Novae
has managed to establish a focused but sufficiently spread energy account
capable of delivering good profits over time.
During 2009 the Group started a marine excess of loss reinsurance account, where
the intention is to focus on foreign business, thereby increasing the
diversification of the segment.
People
Culture and values
The Board regards culture and values as fundamental to the achievement of
Novae's strategic goals. Central to this culture are openness, honesty,
constructive challenge and a collegiate approach to business. No individual is
above challenge and effective peer review is regarded as a key business tool
operating in the wider interests of all stakeholders.
Non-executive directors have extensive interaction with employees other than
executive directors in both formal and informal settings. Regular Board meetings
typically include a presentation on a business area or support function given by
senior managers below executive director level. Non-executive directors are able
to attend committee and subsidiary Board meetings, and all have done so during
2009.
Employee profile
Novae had 245 employees as at 31 December 2009 (2008: 216). The increase in
headcount may be analysed as follows:
Headcount at 31 December 2008 216
Novae Re 13
European property & personal accident team 7
Other joiners 29
Less: leavers (20)
29
Headcount at 31 December 2009 245
The Board has set risk triggers for staff turnover generally as well as turnover
amongst senior staff. During 2009 staff turnover across the Group as a whole was
9.0% (2008: 15.0%). Of the 62 senior staff employed by Novae at the year end,
34 had been with the Group for three years or more. Their average tenure was
five years, and during the year turnover within this smaller group was 6.5%.
In June 2009 a new Director of Human Resources was appointed. This has led to
more refined HR strategy.
Succession planning remains under constant review for business continuity
reasons and also to ensure that the Group can respond robustly and rapidly to
possible staff changes.
Employee engagement
Novae engages with all employees in the day-to-day running of the business. The
Group ensures that it communicates regularly with employees, for example by way
of an employee newsletter and through email where appropriate.
The Group Chief Executive makes regular presentations to employees on corporate
and financial developments including annual and interim results. He meets all
new joiners for a one-on-one meeting and, in conjunction with other executive
directors, hosts regular briefing sessions with employees.
The executive directors and senior management operate an open-door regime under
which any employee can share difficulties or concerns, if necessary outside
their normal reporting line. In addition, the Group provides a confidential
counselling service as well as a formal whistle-blowing policy to resolve
personal or operational issues raised by individual employees.
Learning and development
Novae continues to invest in the learning and development of its employees.
During the year 108 employees attended a total of 282 courses at a cost to the
Group of £0.1 million. In 2010 a new desk-based IT system will be implemented to
capture employees' personal objectives and development plans, monitor progress
against objectives and book agreed training.
The Group encourages staff to train for a wide range of professional
qualifications, including those of the Chartered Institute of Insurance and the
professional actuarial and accountancy bodies. Structured study and exam leave
are provided to candidates sitting external exams, with financial incentives
available on achieving relevant qualifications.
Annual appraisals are completed by mid-February, with goals set for the
forthcoming year. Interim appraisals are conducted in the summer to monitor
progress against targets. Remedial help is offered to employees who are doing
less well than expected.
Compensation
Novae's compensation strategy structure has four components: base salary and
benefits; pension contributions; annual bonus; and long term equity incentives.
Salaries are generally set at peer group medians for equivalent roles. During
2009 a range of benchmarking exercises were undertaken using data from both the
insurance industry and the financial services sector more generally to ensure
salary levels are competitive but not excessive. Executive directors and other
senior managers in non-underwriting roles have had their base salaries frozen
since 1 January 2007. As a result, in many cases they receive base salaries
lower than peer group median rates. Benefits, which are available to all members
of staff on an equivalent basis, include health, permanent disability and life
insurance.
Novae operates a money-purchase pension scheme under which participating
employees contribute 5.0% of gross salary with Novae contributions fixed at
11.0% to 18.5%, depending on age. 190 employees are members of the scheme,
representing 80% of staff eligible to participate.
All permanent employees are eligible for an annual bonus. The amount, which is
set by reference to basic salary, is primarily determined by the Group's
financial and operating performance and by the achievement of objectives
specific to each individual.
UK employees are eligible to join Novae's Share Incentive Plan under which they
may contribute up to £125 a month from their gross salary to acquire shares in
the Group; this is matched by an employer contribution of up to £250. 136
employees, or 57% of those eligible, are members of the Share Incentive Plan. In
addition, the 2007 Long Term Incentive Plan is potentially available to all
permanent employees of the Group. Under this scheme provisional awards may vest
after three years provided explicit performance criteria are satisfied.
The Board encourages a meaningful level of personal investment in Novae shares
by employees, particularly those in senior positions.
Infrastructure
Insurance platforms
During 2009 Novae operated two underwriting platforms: the Lloyd's business and
NICL, its directly regulated FSA risk carrier. Individual underwriting units can
write across both platforms. The Lloyd's business is made up of the managing
agency subsidiary and corporate member which operate alongside Novae
Underwriting Limited ("NUL"), the Group's Lloyd's service company. Novae Re
operates primarily as a Zurich-based branch of NUL.
The Lloyd's business tends to focus on large, international risks which are
typically underwritten on a subscription basis (i.e. individual risks are shared
by a group of underwriters in an agreed percentage). Lloyd's is rated A+
(Strong) by Standard & Poor's and Fitch and A (Excellent) by AM Best, in each
case with a stable outlook. Many international buyers of large, complex
insurance are rating-sensitive and as such the Lloyd's platform offers an
attractive and effective solution at a lower level of capital intensity than
Novae could provide on a stand-alone basis. The principal disadvantages of the
Lloyd's marketplace are its higher frictional costs and mutualisation of losses.
The Lloyd's business operates through Syndicate 2007, which had aggregate
premium capacity excluding acquisition costs for both the 2008 and 2009 years of
account of £360.0 million. During 2008 Novae acquired the remaining £1.6 million
third party capacity from 16 individual names, increasing its capacity for the
2009 year to £340.0 million or 94.4% (2008: £338.4 million or 94.0%). In
November 2009 it acquired the capacity of a European reinsurer which at that
stage provided the remaining £20.0 million or 5.6% of capacity for the 2009 year
of account. As a result, Novae provides 100% of the capacity to Syndicate 2007
for the 2010 year of account. This is a major structural advantage which
increases Novae's operational flexibility and reduces the strategic imperative
of operating a non-Lloyd's insurance platform. For the 2010 year of account
Syndicate 2007 is pre-empting its premium capacity to £525.0 million, reflecting
its increased risk appetite, the opportunities arising from new business
initiatives and the transfer of NICL's renewal business.
In recent years NICL has provided the Group with an alternative platform from
which to write small premium business. NICL is authorised to underwrite business
across the EU but its principal focus is UK regional SME liability business.
NICL generally provides 100% of the indemnity limit for such policies. As NICL
has operated on a stand-alone basis outside Lloyd's its own financial strength
rating has been widely accepted as an important part of its offering. For this
reason NICL has historically been separately rated by AM Best and Fitch.
In August 2009 the Group announced the formation of Novae Re, comprising six new
units underwriting an international reinsurance account. Novae Re's underwriting
teams are located in Zurich and London. They are writing business for the
Lloyd's platform, using the Lloyd's rating and licensing advantages to
underwrite risks that would not normally come to the London market. There is no
current intention to form a separate underwriting platform in Switzerland as the
capital required to obtain an appropriate rating would dilute returns available
to shareholders.
Corporate structure
As at 31 December 2009 the Group was made up of 26 corporate entities and one
ongoing managed syndicate.
In January 2009 Novae acquired Mayheld Limited and its 15 legacy corporate
member subsidiaries for a nominal consideration. Mayheld formed part of a series
of transactions entered into with a European reinsurer in 1998 and 1999 under
which the 15 legacy corporate members, which are in run-off, were reinsured such
that the Group's residual economic exposure was highly remote. In order to
reduce Mayheld's annual running costs it was brought back within Novae's
corporate structure during the year, although the benefit of the original
reinsurance remains unaffected. As a result of this reorganisation Syndicate
Capital Underwriting Limited, an inactive subsidiary, was struck off.
Operational structure
Novae's strategic direction and key policy decisions such as overall risk
appetite are set by the Group Board. Execution of policy within agreed
parameters is delegated to the executive directors.
Below holding company level Novae operates a matrix management structure.
Functional committees, chaired by an executive director, have responsibility for
underwriting, reserving, finance and operations. In addition, the boards of the
Lloyd's managing agency and NICL have regulatory responsibility for the conduct
of the Group's business.
Systems
Novae applies a consistent set of principles to its management reporting and IT
infrastructure which recognise the particular requirements of its Lloyd's
business and of NICL. An IT strategy has been set in the light of the Group's
strategic goals with a detailed roadmap which is subject to periodic formal
review.
Novae has taken a policy decision to avoid development of proprietary software.
The Group's systems work off bought-in solutions provided by third party vendors
such as Xchanging, Capita and Salmon. Novae participates in user groups led by
software vendors and as a result is able to wield considerable influence in
future development whilst avoiding up-front costs and risks associated with
in-house development. There is no current intention of changing this approach.
The single most significant IT project undertaken in 2009 was the phased roll
out of Swordfish, a work-flow management tool. This has been extended to all
underwriting units as well as claims. Swordfish facilitates the development of
best practice in areas such as pricing and risk entry. In addition, it is
delivering significant efficiency and operational gains in peer review and other
assurance areas. Individual risks can now be tracked automatically at every
stage of their life from quoting, binding, peer review, credit control and, if
appropriate, claims management.
The delivery of Novae Re was a second major investment undertaken during 2009.
The extension of the Group's operating systems from the UK to Switzerland, their
development to capture new classes of business and the installation of
management tools in areas such as policy production and credit control was
delivered on time and within budget.
In 2010 the major initiatives will centre on the continuous improvement of
management information across the Group and on ongoing preparations for
reporting under Solvency II.
Risk
Risk management
Novae is a risk-taking business. The provision of indemnity insurance
protections to third parties in exchange for premium receivable requires Novae
to form a view on the likelihood and quantification of loss events that might
result in the assured submitting a claim. In addition, the asset side of the
balance sheet in the form of either investment assets or reinsurance recoverable
exposes the Group to risk by way of loss of value or counterparty failure. The
intermediated and regulated nature of insurance poses additional operational,
credit and reputational risks. Assessing, pricing, managing and mitigating risk
is thus critical to the Group's success.
In order to identify and manage such risks the Group has established a Risk
Committee, which is made up of the Chairman, the Group's executive directors
(one of whom is the Risk Officer, who also chairs the Risk Committee) and an
external risk consultant. The Risk Committee meets quarterly. The key output of
the Risk Committee and its sub-committees is the Group's risk matrix. The matrix
identifies some 125 major risks to which the Group is exposed, which are sorted
into eight thematic groups. These risk groups, either individually or in
combination, map into the six risk pillars identified by the FSA and which form
the basis of the Group's capital assessment under the ICA regime:
FSA risk pillar Internal risk grouping
Group risk Group and strategy
Insurance risk Underwriting; reinsurance purchase; claims; reserving
Market risk Treasury and investments
Liquidity risk Treasury and investments
Operational risk Operations; legal and compliance
Credit risk Credit risk
Novae allocates the majority of its risk budget to insurance risk. The effect of
writing a liability-orientated book, with a mean settlement period of between
three and four years, is that gross assets and liabilities are larger than would
be the case for a pure property insurer. As a result, an element of the risk
budget is required to support market and credit risk as the Group's balance
sheet reflects a longer development tail (and thus a greater aggregation of
assets and liabilities) than an insurance business of comparable size in terms
of premium written but with a shorter development tail.
Risk appetite is set by the Board annually and reviewed more often if commercial
or strategic circumstances require. The absolute level of risk and volatility
set by the Board are then used by the Lloyd's business and NICL to frame their
decision-making. Monitoring of risk positions is carried out using management
information, performance indicators and stress and scenario testing.
There are a number of other forces, several of which are outside the Group's
control, which affect its financial and operational performance.
The economic cycle
In 2009 60% of the Group's gross written premium was accounted for by liability
(as opposed to property) risks. Liability business is exposed to the economic
cycle in that potential loss events such as corporate failure, negligence and
fraud are more likely in a recession than under more benign economic conditions.
For much of 2008 and 2009 many developed economies have been in recession.
Although the Group took action as early as 2007 to limit its exposure to
recessionary losses the effectiveness of this management action will only be
proven over time. In addition, during periods of economic contraction insured
values generally tend to fall, whether linked to property insurance (such as
falling marine insured values as international trade contracts) or liability
classes (for example a fall in billable hours from professional services firms).
Although underlying insurance rates may improve, lower insured values may slow
the benefits of such rate increases.
The insurance cycle
The insurance cycle is the description given to the increase and decrease of
insurance rates over time. The cycle is generally regarded as being
approximately eight years from peak to peak. In practice, the industry is more
complex and dynamic, with cyclical highs and lows for different classes and
geographies occurring at different times.
The cyclical upswing, when insurance rates harden and terms and conditions
tighten, is typically driven by a shortage of capital. Capital constraints have
historically been linked to either catastrophic claims experience and/or
investment losses. In some upswings, for example 2001/2002, catastrophic claims
emerged over the same period as a severe downturn in investment markets. This
led to a rapid improvement in the rating environment. A cyclical peak in the
insurance industry generally comes at the end of a period of strong investment
returns and during a period of benign claims experience. As a result insurers
generate excess returns, attracting new entrants prepared to lower premium rates
and widen terms and conditions.
By late 2008 several of the conditions prevailed that historically would have
led to a cyclical upswing. Many insurers had suffered both investment losses and
claims arising from the 2008 US windstorm season. These were combined with
concerns over the health of a number of large international insurance and
reinsurance groups. In spite of this, to date premium increases have been uneven
and a broadly-based hard market is yet to emerge.
Investment returns
The transaction cycle in liability insurance, being the time from the payment of
the original premium by the assured to the settlement of any claim, is typically
around five years. For liability reinsurance business and certain other classes
in which Novae has been active historically, the transaction cycle can be
significantly longer. As a result investment income makes a more significant
contribution to profitability than for property insurance where typical
transaction cycles are around two years.
For the 10 year period to 30 June 2008 the redemption yield on the short gilt, a
proxy for the sterling risk free interest rate, averaged 5.04%. As a result of
the policy response to the financial crisis in the second half of 2008 interest
rates in most major economies were subsequently cut to historic lows. The effect
of a fall in interest rates of over 400 basis points per annum over a
transaction cycle of three to four years or more has a negative effect on
profitability over which Novae has no control.
Some insurers have sought to offset the reduction in risk free rates by
investing in more risky and volatile assets, such as equities, with potentially
higher returns. The Group has not done this as mature insurance businesses such
as Novae, whose investment assets are generally three to four times
shareholders' funds, are very exposed to investment losses in a period of market
turbulence.
Geographic expansion
In August 2009 Novae announced the formation of a specialist reinsurance
business based in Zurich. Until that time all of the Group's operations were in
the UK and substantially all decision-making and management was carried out from
a single location in the City of London.
The formation of Novae Re presents the Group with a significant opportunity to
grow and diversify its business. However, it also presents additional cultural,
management and operational risks. Although significant resources have been
invested in mitigating these risks the Group's risk profile has been raised as a
result of geographic expansion.
Outsourcing and operational risk
Novae has outsourced a number of processing tasks to third party providers. This
has allowed the Group to seek best-in-class processing without having to scale
up or make additional investments in areas such as IT. In other areas such as
subscription market cash settlement, regulation or market practice effectively
requires the Group to outsource. Its key partners include Xchanging Insurance
Services, external asset managers and IT providers.
To date these arrangements have generally worked well. However, the Group
remains exposed to the failure of an outsourcing relationship.
Regulatory change
Insurance is a regulated activity in the UK and internationally. Novae is
subject to direct regulation by the FSA as well as oversight by Lloyd's through
its Franchise Performance Directorate.
The insurance regulatory regime in the UK is in a state of flux. The long term
future of the FSA has been questioned by the opposition Conservative Party. Any
future reorganisation of the regulatory architecture in the UK could have
unforeseen results. This is further complicated by the introduction of the
Solvency II regime across the EU in October 2012. Solvency II is intended to
introduce a base level of regulation and capital adequacy across the EU. There
remains a significant risk, however, that the detailed interpretation of the
regime may differ across the EU and that UK-based businesses may emerge at a
competitive disadvantage.
Rating agencies
Insurance buyers and brokers are increasingly taking financial strength ratings,
as well as price and policy conditions, into account in buying decisions. In
practice, a minimum rating of A- is a commercial requirement in many markets.
The ability to attract business and grow premium income might be constrained,
potentially severely, if a carrier's rating were to fall below this level.
Four large rating agencies account for the majority of insurance providers'
financial strength ratings. Given events in the banking and investment markets
in 2007-2009 rating agency decisions are coming under increased scrutiny. The
models used by the agencies to establish ratings are proprietary and businesses
such as Novae have little or no control over model construction or the
implementation of rating rules applied to model output. One of the advantages of
the renewal of NICL's business into Syndicate 2007 in 2010 is that all of the
Group's future underwriting will enjoy the Lloyd's A+ security rating and chain
of security.
Outlook
Insurance
Insurance and reinsurance rates responded to areas of high profile claims in
2009. However, there was little general improvement in rating conditions in
response to abnormally low interest rates.
In areas such as US property and Gulf of Mexico energy the upward momentum in
rates in 2009 has been replaced by some weakness in 2010 reflecting the benign
claims experience last year. However, in other areas like aviation reinsurance
and credit business, claims in 2009 will continue rating improvements into
2010. On financial institutions some banks faced radical review of rates and
conditions. After a 9% effective increase in rates across the Group in 2009, a
broadly neutral whole account movement increase is anticipated in 2010.
Some recession-related claims will be seen in 2010 and possibly beyond. However,
there are areas of business where Novae has reduced or eliminated exposure, such
as UK solicitors, where some of the effects of the recession are yet to be seen
in reported claims experience. In other areas like financial institutions high
profile events already reflect the principal consequences of the earlier
business climate, while careful scrutiny of corporate behaviour should reflect
more favourably on future claims experience.
The impact of natural catastrophes is difficult to predict but it would be
unwise to expect a repetition of the benign experience of 2009 on the property
classes. Fortunately, a realistic approach seems to be clear in the pricing of
property insurance and reinsurance business.
Premium arrears have historically been associated with periods of soft insurance
market conditions. Novae has made a sustained investment over a number of years
to identify and resolve overdue payment of premium, if necessary by cancelling
the policy to which it relates. Despite challenging market conditions the value
of premium arrears over sixty days was £0.3 million at 31 December 2009, and has
remained under £0.8 million throughout 2009 as a whole.
Investments
Investment return plays a particularly important role for Novae. The Group's
investment assets are over three times the level of its shareholders' funds, and
given its business mix the profile of its profits are heavily weighted towards
investment return (as opposed to a higher dependency on underwriting profit in a
short tail, property catastrophe business). It is against this backdrop that
events in the Group's two most important investment markets, sterling and US
dollar, should be seen.
Following the banking and financial crisis in the second half of 2008 central
banks cut interest rates in all developed countries to very low, and in some
cases unprecedented, levels. UK base rates fell from 5.00% to 0.50% by March
2009. Over the same period the Fed Funds rate fell from 2.00% to under 0.25%.
Quantitative easing has compounded this.
Since the market lows in March 2009 there has been a very strong recovery in
risk assets with a synchronous rally in commodities, equities and credit.
The Group reviews its asset allocation at least quarterly. This review has
consistently confirmed that Novae's investment assets should continue to be
invested in short duration, investment grade bonds and cash. Although it is
tempting to chase return from other asset classes in a bull market, the risk of
loss and level of equity gearing could have potentially catastrophic effects
from a sustained market fall.
Current consensus is that interest rates are likely to remain low for some time.
There may be some tightening in the US if economic recovery is sustained in
2010, but the turn in sterling interest rates appears further out. Under this
analysis, the very low yields offered by short duration UK and US government
bonds are likely to persist, further dampened by the extent to which
quantitative easing and other policy actions run on into 2010. In effect, part
of the return that might have been earned in 2010 was brought forward into 2009
as a result of monetary and fiscal stimulus. This leaves the outlook in the
asset classes in which Novae invests challenging. The Group's decision to rotate
around 30% of its portfolio out of cash and government bonds into highly rated
corporate bonds, taken early in 2009, will partially mitigate these headwinds.
The Board's central assumption is that the Group will achieve a 2010 return of
1.5%. This compares with a yield of 3.0% in 2009 and 5.
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Datum: 04.03.2010 - 07:12 Uhr
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