Novae Group PLC
16 March 2007
NEWS RELEASE
16 March 2007
For immediate release
Novae Group plc
Preliminary results for the year ended 31 December 2006
Highlights
Novae Group plc ('Novae'), the specialist insurance group, today announces its
2006 preliminary results. Highlights:
- Profit before tax and exceptional items £32.8 million (2005: £17.9 million
loss)
- Operating profit before foreign exchange movements and finance costs £53.3
million (2005: £0.1 million loss)
- Headline return on equity 18.0% (2005: loss). Underlying return on equity
28.1%
- Earnings per share 3.8p (2005: 4.8p loss)
- Combined ratio: 81.4% (2005: 104.6%)
- Net assets per share: 33.0p (2005: 31.2p)
- Net tangible assets per share: 32.0p (2005: 28.9p)
- Exceptional provision usage £14.3 million (2005: £40.0 million), with £12.8
million available to carry forward.
Commenting on the results, Matthew Fosh, Group Chief Executive, said:
'2006 was a defining year for Novae. The formation of our FSA insurance company
and the associated rights issue were major steps forward for the Group. We have
reported operating profits of over £50 million and the legacy effects continue
to ebb. Although evidence of a steadily softening underwriting cycle continues,
high quality underwriting teams are keen to join us, and morale over continued
prospects for growth and profitability in 2007 remains high'
- ENDS -
There will be a presentation to analysts at 10.00 a.m. today at M:
Communications, CityPoint, 1 Ropemaker Street, EC2Y 9HT in the Madrid Room, 9th
Floor.
For further information:
Matthew Fosh - Novae Group plc 020 7903 7300
Nick Miles - M:Communications 020 7153 1521
Novae Group plc
Preliminary results for the year ended 31 December 2006
Chairman's statement
2006 has been a defining 12 months for Novae after four years of recovery and
rehabilitation. The Group has reported its highest ever level of profitability;
it achieved its strategic aim of setting up a second platform to write in
parallel with the Group's traditional Lloyd's business; and the damaging effects
of the Group's legacy underwriting from 1997 - 2000 have continued to fade.
Novae reported pre tax profits of £31.3 million in 2006. At a time when costs
from the past were still being absorbed this was an excellent performance,
albeit assisted by the industry's largely favourable rating environment and
benign claims experience. During 2006 the rating environment has clearly
softened in a number of classes, particularly in UK commercial and liability
lines, but this is from very high levels, so the immediate outlook remains
encouraging. Nevertheless vigilance will be required over the medium term, and
we will reduce our risk exposure as the cycle softens. We have no difficulty in
writing less than we predict if the result is that we protect our shareholders'
capital. Measured growth and diversification remain the order of the day; in our
judgement rapid growth and a land grab strategy are unlikely to be in
shareholders' best interests.
The formation of Novae Insurance Company last July and the associated capital
raising achieved the Group's long held aim of platform diversification. They
also had other major benefits. Novae is significantly less highly geared, and
the quality of earnings is much improved. The Group returned to the banking
market on normal commercial terms as confidence in our rehabilitation grew. The
re-branding and internal reorganisation that accompanied the 'one business, two
platforms' philosophy were further steps towards stabilising and normalising the
business.
Novae's legacy underwriting from the late 1990's has cost shareholders over £250
million. By 2004, when the new management team established the £103.6 million
exceptional loss provision, considerable uncertainty remained about the eventual
outcome. Now, although the legacy still has the potential to cause surprises,
its volatility is ebbing markedly quarter on quarter. Our proposition that the
gross incurred position stabilises by the sixth year after inception has thus
far been borne out by events. We continue to examine transactional solutions to
decouple the assets and liabilities making up the legacy, but will only do so
from a position of negotiating strength.
Looking to the future, the flexibility afforded by our newly formed insurance
company gives us scope to alter underwriting capacity as the rating environment
changes. We remain committed to writing large premium, international business in
the Lloyd's subscription market. This can be very profitable, and we can only
access this business from within the Lloyd's franchise. However, in isolation
the profitability of such business is volatile, and makes for a difficult
investment proposition in the public markets. Small and mid-sized, UK regional
business is an important counter-weight to our Lloyd's operation. This strategy
of diversification reduces overall volatility and renders the business less
exposed to the extremes of the underwriting cycle.
Progress made in 2006 means that we intend to return to the dividend list in the
next twelve months. This achievement reflects the commitment, resilience and
patience of Novae's employees, business partners and capital providers. All have
kept faith during the past four years as Novae has worked hard to free itself of
its past and to demonstrate, beyond doubt, that its core franchise is healthy
and highly profitable. We owe a particular debt to our employees who, whilst
working at a significant financial and reputational disadvantage, have delivered
a market-beating performance in each of the past four years.
There have been some important changes to the Board in the last year. In
September we welcomed David Henderson as a non-executive director. David, who is
currently Chairman of Kleinwort Benson Private Bank, has had a long and
distinguished career in financial services and we have already benefited from
his views and advice. In December, Luigi Santambrogio stood down from the Board
upon his appointment as Chief Executive of Brederode SA. Luigi has been a
non-executive director or alternate for another Brederode representative since
1998 and we thank him and his colleagues for their advice and support over many
years. Clive Chaplin has indicated that he will not be seeking re-election at
this year's Annual General Meeting, having been on the Board of Novae and its
predecessor companies since 1993. On behalf of both the Board and the Group as a
whole we wish Clive well for the future, and it is with sadness that we see him
depart. We have begun the search for a new independent non-executive director to
replace Clive.
Finally, having joined the Board as Chairman in 1998, I will have served for
nine years this autumn. Consequently the Board will be instigating the search
for my successor following our AGM in May this year. Despite the difficult
challenges we have faced since 2000, the business is now demonstrably restored
to health and this is a logical time for me to stand down.
Paul Selway-Swift
Chairman
16 March 2007
Operating and financial review
Our business
Novae is a UK domiciled, risk-taking insurance business. It deploys capital to
assume underwriting risk in its two operating platforms: Lloyd's and Novae
Insurance Company Limited ('NICL'), its FSA-authorised insurance company. It
specialises in providing insurance cover to commercial enterprises. Reinsurance
protection is also provided to other insurance companies around the world.
Novae has a diversified mix of business with underwriters operating across 17
specialist classes of business. These are organised into four reporting
segments:
• Specialty
• Property
• Liability
• Aviation & Marine
Novae's managing agency subsidiary was formed in 1986. In 1998 SVB (as the
business was then known) merged with Syndicate Capital Trust, and in 1999 with
CLM. By the end of 1999 it had net assets of £227.5 million and managed five
syndicates with aggregate premium capacity of £391 million, making it one of the
largest Lloyd's listed groups at that time. In August 2001 it announced
significant losses from US liability underwriting, and in particular reinsurance
business. The Group's financial condition was further weakened by investment
losses and the 11 September terrorist attacks. This was followed by losses from
the Enron and WorldCom collapses and IPO laddering.
By late 2003 a new management team had been appointed to reverse the decline in
SVB's fortunes and to establish a new strategic direction for the Group. At its
core this involved containing the damage from legacy underwriting, mainly by
syndicates 1212 and 1241, while protecting and nurturing the ongoing business.
The rehabilitation involved fundamentally changing the management of the run off
of discontinued business lines; allocating scarce capital to optimise
risk-adjusted underwriting returns; selling SVB's stake in its UK regional
insurance agency; and in its place setting up a wholly-owned UK regional
underwriting business. In June 2006 this process reached an important milestone
with the formation of a new holding company, Novae Group plc, and the completion
by Novae of a rights issue to capitalise NICL.
Operating review
Market structure and competitive position
The non-life insurance industry offers indemnity protection ranging from
personal lines (insuring individuals against damage to or loss arising from
their homes, vehicles and possessions) to retrocession (the reinsurance of
reinsurance). Distinctions are typically made between direct and reinsurance
business; between property and liability (or casualty); and between personal and
commercial lines.
Novae operates principally in the commercial lines market. Its origins lie in
liability insurance and its product mix continues to reflect this. Novae's
business is predominantly direct, with inwards reinsurance business limited to
event-driven property and aviation catastrophe classes. Appetite for
US-domiciled risk is limited, and arises principally from property classes. The
mean development tail is estimated at four years, down from six in 2000/01.
Overall tail length is limited by avoiding liability reinsurance business and
containing the proportion of business written on a losses occurring (as opposed
to claims made) basis to under 20% of the whole.
Novae operates two trading platforms: a Lloyd's business and an FSA-authorised
insurance company. Individual underwriters may use either, making their
selection on the basis of market need and processing efficiency. In 2006 over
90% of gross written premium was transacted by the Lloyd's platform and this is
expected to remain at over 75% into the medium term.
The competitive landscape in which Novae operates may be analysed as follows:
Lloyd's market participants 46 managing agents, with £14.8 billion of
aggregate premium capacity in 2006,
competing in a subscription market to
underwrite large international risks
typically rely on the Lloyd's rating and
licence network to attract business that
cannot be placed in local markets
Major European reinsurers six major European entities such as Munich
Re and Swiss Re offering reinsurance and
retrocessional cover to international
insurers
financial stability, rating and market
reputation are critical in winning and
retaining business
Bermudan and other specialist eight major Bermudan groups including ACE,
insurers XL and the classes of 2001 and 2005
specialist pool underwriters such as GAUM
and La Reunion Aerienne
accepting major international risks on both
a direct and reinsurance basis
US property casualty insurers licensed (or 'admitted') on a state by state
basis
range from monoline insurers focused on
particular regions/lines of business to
large international groups such as AIG and
Chubb
UK commercial lines insurers provide UK regional coverage and offer
property, liability and motor insurance
Axa, Allianz Cornhill, Norwich Union, RSA
and Zurich; virtual insurers such as
Towergate; and subsidiaries of Lloyd's
groups such as Catlin
Strategy and business objectives
Novae's strategy remains to develop a specialist insurance business diversified
by:
Product: liability classes continue to account for around 65% of Novae's gross
written premium, with the balance from short tail, property lines. Liability
classes are written on a direct rather than a reinsurance basis. Around 55% of
business is sterling denominated and 40% US dollar denominated, of which
approximately half is US business
Market: following the formation of NICL, the Group has two operating platforms.
This enables underwriters to write business in the most appropriate market.
Large, international wholesale business which relies on the subscription market
is generally placed in Lloyd's, whereas UK regional, small and mid-sized risks
are written, usually 100%, into NICL. Rating, security and frictional processing
cost are also important for underwriters in deciding where to place individual
risks
Method of distribution: both the Lloyd's business and NICL trade in
intermediated markets. NICL has invested in electronic placement technology and
this is made freely available to brokers. 5% of NICL's business is now delivered
electronically and this is expected to increase as the cost benefits become more
apparent to brokers and as the FSA continues to press for contract certainty at
inception. Lloyd's too is investing in electronic placement but progress is
inevitably slower in a subscription market
Within this overall framework the Group's objectives for the two parts of its
business are:
Ongoing business: the ongoing business is charged with generating a cross cycle
return in excess of the Group's cost of capital. Underwriting unit profitability
is assessed after cost of capital and the residual economic value added is the
prime determinant of unit bonus awards. The implications of increases in the
cost base, and the volume/margin trade off, are well understood at unit level
Discontinued Units: between 1997 and 2000 SVB underwrote a large volume of US
liability business on both a direct and reinsurance basis. This business was
seriously under priced. Indications of future losses led to the August 2001
trading statement. Novae is charged with managing the run off of this business
in the most financially advantageous and effective way for shareholders.
Transactional solutions to accelerate the run off are under constant review,
although the Board will only deal on terms that are economically rational for
shareholders
Wherever possible, these aims are pursued within explicit risk tolerances. For
example, underwriting risk is managed within agreed Willingness To Lose and
investment risk through a Value at Risk framework.
Results for the 2006 financial year
Profit before tax was £31.3 million, or £32.8 million before exceptional
professional costs involved in the scheme of arrangement and formation of NICL
(2005: loss £13.9 million). Although profitability continues to be distorted by
legacy effects, the 2006 results represent the highest level of profitability in
the nine years in which Novae and its predecessor entities have been listed.
Earnings per share were 3.8p, or 4.1p before exceptional professional costs
(2005: loss 4.8p). Net assets per share as at 31 December 2006 were 33.0p, and
net tangible assets per share were 32.0p (2005: 31.2p and 28.9p respectively).
The headline combined ratio at the 100% level was 81.4% (2005: 104.6%).
Combined ratio analysis - 100% level
2006 2005 2004 2003
Claims ratio 47.3% 71.5% 56.3% 66.0%
Acquisition 22.2% 19.4% 24.9% 23.8%
cost ratio
Operating cost 11.9% 13.7% 7.7% 9.8%
ratio
Expense ratio 34.1% 33.1% 32.6% 33.6%
Combined ratio 81.4% 104.6% 88.9% 99.6%
Combined ratio analysis - at Novae ownership level
2006 2005 2004 2003
Claims ratio 48.1% 70.9% 57.0% 60.5%
Acquisition 22.6% 19.4% 24.8% 22.4%
cost ratio
Operating cost 11.8% 13.8% 7.6% 10.1%
ratio
Expense ratio 34.4% 33.2% 32.4% 32.5%
Combined ratio 82.5% 104.1% 89.4% 93.0%
Business structure and reporting framework
Whilst the Group now has two operating platforms, risk selection, exposure
monitoring and reinsurance buying are carried out centrally. The Group reports
its results by operating segment.
The ongoing business is managed day-to-day at unit level. Business plans are
developed at unit level and within explicit underwriting, capital and resource
limits unit heads are given flexibility to pursue those plans. Unit contribution
to the Lloyd's business and NICL are aggregated in setting plans and assessing
performance.
Specialty
Specialty lines is Novae's largest business segment. It includes financial
institutions, professional indemnity and management liability, where Novae
enjoys a strong leadership position. The largest individual risk lines written
throughout the Group are on financial institutions business. These tend to be
for UK and international banks, reflecting a cautious approach to US exposure.
The formation of NICL extends this Specialty lines franchise. Regional
professional indemnity and medical malpractice business bring smaller risks than
those typically seen at Lloyd's and they form key components of NICL's business.
Historically, one of the impediments to writing small and mid-sized business was
cost-effective distribution. NICL's ability to source such business
electronically is an important part of its offering.
Novae has gradually extended its historic Specialty lines franchise. Political
risks and credit business was introduced in 2000 and terrorism was added during
2007. The fine art and specie business has been reorientated since 2003 and in
2005 was supplemented by a cargo account. The Group will continue to seek
opportunities to extend further its Specialty lines franchise while recognising
that the established core business is fundamental to future profitability.
The insurance risk appetite for Specialty business is well-defined and pays
particular attention to various hypothetical loss scenarios. The risk of
multiple exposures resulting from a corporate collapse following a merger is
modelled with the maximum net loss potential for this extreme event capped at
£30 million. In recent years Lloyd's has introduced its own professional lines
disaster scenarios which generate a considerably lower maximum potential loss.
In the political risks sphere the maximum net loss is set at £20 million for the
most severe modelled scenario.
The segment's 2006 combined ratio at the 100% level was 77.7% (2005: 100.0%).
Including investment return segmental profit was £43.4 million (2005: £8.1
million), of which £35.2 million (2005: £6.4 million) was attributable to Novae.
In earlier years, including 2005, overall Specialty results were adversely
affected by reserve development on business transacted several years ago,
particularly US professional indemnity business. Such prior year movements were
materially lower in 2006, enabling the underlying quality and profitability of
the business transacted in recent years to be much more apparent.
2006 2005
£m £m
Gross written premium 158.6 111.5
Net earned premium 129.5 109.1
Net claims incurred 60.2 75.1
Segment operating expenses 39.9 18.7
Profit attributable to Novae 35.2 6.4
Claims ratio (%) 46.5 68.8
Expense ratio (%) 31.2 31.2
Combined ratio (%) 77.7 100.0
Property
Novae underwrites Property business on both a direct and reinsurance basis.
Reinsurance business, which is almost exclusively focussed on catastrophe lines,
accounted for 75% of segmental gross premium income in 2006. Dramatic rate
increases in the reinsurance account outweighed the impact of action taken to
reduce peak exposures.
Catastrophe reinsurance will remain the single largest part of the Property
segment. However, following the recruitment of two highly regarded teams in 2006
the direct units will account for an increased proportion of the segment's
income in 2007. The new teams are focussed on international property business
and UK commercial and residential property facilities respectively. This
complements the US facilities business, where careful selection of coverholders
has been rewarded by a much lower than expected impact following the US
windstorm losses in 2004 and 2005.
Much of the business written in this segment is exposed to natural catastrophes.
A variety of extreme scenarios are modelled to ensure aggregates remain within
defined risk tolerances. For many scenarios the maximum net loss is £30 million
or $54 million. In Japan these limits would apply to a current day cost of a
repeat of the Great Kanto earthquake (1923) or Typhoon Vera (1959). It also
applies to windstorms affecting the UK and Europe, where a repetition of the
severe storms of 1987 and 1990 is reviewed, as well as a specific European storm
scenario set by Lloyd's.
The Group is prepared to tolerate a larger monetary loss than this base amount
for events of exceptional severity. For example, risk tolerance rises to $75
million for a $50 billion insured loss in respect of a Californian earthquake or
a loss in excess of $60 billion from a windstorm in Florida. The only scenario
outside the US where the Group has a property net risk tolerance above £30
million relates to very extensive UK flooding, such as a repeat of the 1953
floods in East Anglia.
By virtue of its catastrophe exposures, the Property segment will inevitably
show marked variability in claims experience, and thus profitability, from year
to year. After the devastating impact of Hurricanes Katrina, Rita and Wilma,
2006 was abnormally benign. Partially offsetting this were the additional
reinsurance costs incurred to cover the run off of Fusion and US open market
business, as well as some underlying deterioration on the Fusion account.
Consequently the combined ratio was 81.4% (2005: 137.8%) and the profit
attributable to Novae was £11.6 million (2005 loss: £29.9 million).
2006 2005
£m £m
Gross written premium 52.1 71.0
Net earned premium 35.7 95.3
Net claims incurred 11.8 98.3
Segment operating expenses 15.4 26.0
Profit attributable to Novae 11.6 (29.9)
Claims ratio (%) 33.1 103.2
Expense ratio (%) 48.3 34.6
Combined ratio (%) 81.4 137.8
Liability
This segment comprises both non-marine general liability business and the
Group's marine liability business. It comprises risks written on an occurrence
form which extends the development tail. This is countered by writing an
accident-orientated account that has only limited exposure to disease claims.
The bulk of the non-marine business in 2006 was derived from the UK. It includes
business under facilities, largely written into the Lloyd's syndicate, and open
market business, now being written mostly into NICL. A wide range of trades and
occupations is written but with the common feature that they all tend to be
small risks. Consistent with a desire to restrict potential exposure to disease
claims, large industrial risks are deliberately avoided.
In 2007 this UK focus will be supplemented by the development of an
international general liability account following recruitment of a highly
regarded team in February. This will bring some exposure to larger risks written
on both a primary and an excess basis. It is likely to be less attritional than
the UK account but the potential volatility implied by exposure to large losses
will be moderated by reinsurance. It will create a more balanced business
profile for the non-marine liability account.
The Group's marine liability business includes a significant element of
land-based marine-related accounts branded as Puffin policies. However, the
larger component of the marine liability account is more conventional marine
business. This includes reinsurance for protection & indemnity clubs and other
business relating to vessel operations or offshore activity.
Risk appetite for the segment is expressed in part by the maximum proportion of
total premium income the Group is prepared to write. In terms of monetary loss,
the Group models event-orientated disasters as well as generic reserving issues
such as a change in Ogden tables. Examples of events modelled include the
collapse of a stadium at a rock festival and an oil rig disaster comparable to
Piper Alpha (1988). The maximum net impact from such a catastrophic event is set
at £20 million based on an extremely pessimistic assessment of the possible
scale of involvement.
The 2006 combined ratio was 92.9% (2005: 85.7%) and the contribution to profit
was £7.3 million (2005: £11.5 million). As in 2005, this included benefit from
prior year reserve releases.
2006 2005
£m £m
Gross written premium 48.7 40.7
Net earned premium 45.2 61.0
Net claims incurred 25.8 30.8
Segment operating expenses 15.7 17.4
Profit attributable to Novae 7.3 11.5
Claims ratio (%) 57.0 50.5
Expense ratio (%) 35.9 35.2
Combined ratio (%) 92.9 85.7
Aviation & Marine
With the principal component of Marine activity included in Liability, it is a
small account of hull and marine war business that is included in the Aviation &
Marine segment. In 2006 this was substantially boosted by the establishment of
an energy book. Notwithstanding this growth and diversification, the aviation
reinsurance account remains the single largest component of the segment.
Aviation reinsurance has continued to enjoy a favourable claims environment in
2006, although there were a number of small loss events in the second half. As a
result, profits in 2006 are lower than the exceptional profits reported in 2005
which benefited from the unwinding of earlier timing differences, although the
overall contribution from Aviation remains significant.
Aviation reinsurance is modelled on the assumption of a normal level of loss
activity. The Group considers a variety of possible disaster scenarios. For a
mid-air collision between two aircraft a maximum net loss potential of £30
million has been set. Reflecting a cautious approach towards terrorism exposure
in the aviation reinsurance market generally, scenarios which assume terrorist
attacks involving several aircraft result in a net loss considerably less than
£30 million.
The energy account has enjoyed a successful first year. A good mix of business
has been secured on attractive terms while claims experience over the period has
been favourable. This was only partially offset by a less favourable claims
experience last year on hull business, where the small size of the account can
bring volatility from year to year in the context of a satisfactory longer term
performance.
The Group's loss appetite for marine business (including energy) is set below
that for aviation reinsurance. For a particularly severe in-house marine
collision scenario the maximum net loss has been set at £20 million. For other
marine scenarios, including those required by Lloyd's, the limit is set at £16
million. Similar constraints also apply to the energy account. In the case of
energy business possible aggregation with property business in the event of Gulf
of Mexico windstorm activity is considered, ensuring action is taken to ensure
that the possible aggregation with property business in the event of Gulf of
Mexico windstorm activity does not produce a loss in excess of the $75 million
ceiling set in relation to severe US property scenarios.
The 2006 combined ratio was 80.0% (2005: 38.8%) and the contribution to profit
was £8.0 million (2005: £14.7 million).
2006 2005
£m £m
Gross written premium 47.5 25.8
Net earned premium 31.4 22.9
Net claims incurred 16.5 1.9
Segment operating expenses 9.7 6.3
Profit attributable to Novae 8.0 14.7
Claims ratio (%) 52.5 8.1
Expense ratio (%) 27.5 30.7
Combined ratio (%) 80.0 38.8
Discontinued Units
The Discontinued Units are made up of the liability reinsurance, healthcare and
third party liability accounts. When SVB operated a multiple syndicate strategy,
these units were represented on more than one syndicate and multiple lines were
frequently put down on individual inwards risks. The financial damage from the
Discontinued Units is largely concentrated in syndicates 1241 and 1212 (the
latter reinsured to close into Syndicate 1241).
Reserving for the Discontinued Units has proved problematic as the quality,
volume and timing of information from cedants and assureds has been poor and the
contractual terms on which the business was written were extremely weak.
Conventional actuarial modelling, aiming to arrive at the best estimate of
reserves required, has repeatedly under-estimated the true position. As a
result, an exceptional provision was established as at 30 June 2004 to absorb
potential reserve movements over and above best estimate. The provision was set
at £103.6 million, being the aggregate of selected top down assessments on a
significantly more pessimistic basis.
The overall pattern of incurred development continues to show stability by the
sixth year following inception. However, some uncertainty remains and individual
calendar quarters can reflect one-off events such as claims audits and
commutations.
In 2004 the Discontinued Business Unit ('DBU') was formed to focus exclusively
on the run off of the Discontinued Units. The DBU has ten dedicated staff and
its 2007 budgeted cost base is £2.2 million (2006: £2.5 million). Including
other resource requirements, the total annual cost of managing the run off from
2002 and prior is over £4.0 million. The estimated total cost of the DBU between
its formation in late 2004 and the end of 2007 is over £13 million.
In addition to reserve movements and run off costs, the Discontinued Units also
require solvency capital support. Our current capital assessment under Lloyd's
rules for Syndicate 1241 is £78.5 million. Further capital is required to
support Syndicate 1007's 2002 run off year. After diversification credit, the
aggregate amount of capital required to support the 2002 underwriting year is of
the order of £40-50 million which at Novae's 2007 cost of capital of just over
10.0% represents an economic burden to shareholders in 2007 of some £5 million.
Thus the total economic damage from the Discontinued Units, including the
unutilised portion of the exceptional provision, is over £250 million, of which
over £200 million has been recognised since the arrival of the new management
team. This compares to the highest level of audited net assets recorded by SVB
of £227.5 million as at December 1999.
Novae has also withdrawn from a number of other classes of business. Some, such
as kidnap & ransom, are relatively modest in relation to the ongoing business
and the Group withdrew because the risk/reward profile and growth outlook were
not attractive. Others such as marine excess of loss, which Novae ceased in
2002, continue to give rise to occasional late reporting of inwards claims, in
some cases dating back to the 1990s.
The most damaging area outside the Discontinued Units has been US dollar
professional indemnity. The Group scaled back its presence in this class in
2001, but because coverage was often offered on a multi-year basis and with
extended reporting periods, a clean break was not possible. Cumulative net
reserve movements from US dollar professional indemnity since 2002 are some $43
million. Although such reserve movements are material in terms of the level of
ongoing profitability, this class has not been added to Discontinued Units to
maintain clarity and consistency of reporting.
Novae continues actively to pursue transactional solutions to the run off of the
2002 year. A financial framework has been used to assess specific proposals.
Discussions continue with a range of potential partners, and Lloyd's and the FSA
are regularly briefed. The Board will not, however, do a deal at an irrational
price.
Trading environment and outlook
Novae monitors rate change on renewal business. Adjustments are made to capture
changes in deductibles and terms and conditions, and also to take claims
inflation into account, particularly in liability classes.
Novae's rating index for the seven years to December 2006 is as follows:
Class 2006 2005 2004 2003 2002 2001 2000
Specialty 243 267 292 281 212 125 100
Property 213 157 158 165 159 118 100
Liability 199 204 207 196 171 117 100
Aviation 278 280 295 304 284 132 100
& Marine
Whole 215 217 230 228 193 123 100
account
In July 2006 the Group pointed out that the rating environment had remained very
strong for an extended period, and that some bifurcation in the market was
becoming evident. There is no doubt that rates in many liability classes are
softening, albeit gradually and from a high level. Rates in the direct aviation
market, in which Novae does not operate, are softening sharply although to date
there has been greater pricing discipline in the reinsurance market. Property
and energy classes that bore the brunt of 2005 US windstorm losses have
strengthened sharply. Other property classes have shown a mixed experience over
the last 12 months.
Novae's central business assumption is that rates will soften across most lines
of business in 2007. Detailed unit plans anticipate real rate reductions of
3-4%. Units are expected to remain profitable after cost of capital
notwithstanding this rate softening assuming normal loss experience, as volume
is expected to be given up to protect the loss ratio.
As well as renewal rates, two other metrics are measured to assess trading
conditions. First, terms and conditions are subject to rigorous review. Second,
resources in premium credit control have been increased and the Group is alert
to slow payment of premium. Notices of cancellation are issued for non-payment
of premium.
Notwithstanding the rating environment, Novae continues to develop and
diversify. In the past year the Group has entered three new classes: marine
cargo, energy and terrorism. The direct property business has been restructured
and expanded. Increasing interest is coming from teams and individuals keen to
come to Novae. Where the Group is confident that new teams will cover their cost
of capital, and where the individuals concerned are high quality and
entrepreneurial, Novae has no hesitation in employing them. A number of exciting
proposals are in the due diligence stage.
Risk management
Day-to-day risk management is delegated by the Board to the Risk Committee,
which is chaired by Jeremy Adams. A formal report from the Risk Committee is
included in the annual report.
Risk is divided into six principal and two subsidiary pillars. The six principal
risk pillars are as follows:
• Insurance risk: made up of underwriting risk (the risk that current
business is under-priced in the light of claims experience) and reserving risk
(the risk that reserves may prove inadequate)
• Market risk: the risk that financial assets may fall in value
• Liquidity risk: the risk that liabilities may exceed available cash
resources
• Credit risk: the risk that intermediaries, assureds or reinsurers may
not be able or willing to meet their liabilities as they fall due
• Operational risk: the risk that the failure of a management control or
process may give rise to operational disruption and/or financial loss
• Group risk: the risk that an intra-group conflict of interest may
arise, or that the financial condition or operational conduct of a subsidiary
may produce systemic effects elsewhere
The second order risk pillars, which are more subjective, are reputational loss
and regulatory change or intervention.
Risk is mitigated by the design and operation of effective controls. The control
environment is subject to continual internal review. In addition, both Lloyd's
and the FSA periodically publish best practice guidance and where relevant
improvements are made reflecting such advice.
Gross risk is mitigated by controls, with capital deployed to absorb net risk.
Where net risk is low (either because gross risk appetite is limited or because
effective controls reduce volatility, or a combination of the two) limited
capital is required. Where net risk is high, significant capital is required.
When planning risk budgets, appetite in areas other than insurance-related risk
is very limited.
Regulation and compliance
Three Novae subsidiaries (NICL, the Lloyd's managing agency and the Lloyd's
service company) are regulated by the FSA. The Group's managing agency and
service company are also subject to the capital regime, franchise guidelines and
other detailed rules of Lloyd's. In addition, the Group as a whole is subject to
the Insurance Groups Directive.
The natures of the FSA and Lloyd's regimes are subtly different. Both the FSA
and Lloyd's impose capital requirements on individual entities. The FSA's
Individual Capital Assessment regime ('ICA') is designed to ensure that a given
business has a 99.5% probability of not failing in the subsequent twelve months.
Lloyd's uses a similar approach to the ICA but loads the base capital
requirement to support a higher rating than the BBB+ to which the FSA's
requirement is calibrated.
The FSA's inspection regime focuses on periodic ARROW visits. The most recent
ARROW visit took place in January 2007. In addition, the FSA undertakes thematic
reviews on individual underwriting areas and business processes. Lloyd's
compliance is more rules-based, with detailed quarterly and annual reporting. In
addition, the Lloyd's Franchise Performance Directorate ensures appropriate
underwriting and claims standards are maintained.
During 2006 a new Compliance Officer joined the Group and the role of Compliance
Assistant was created. The Internal Audit team is made up of three staff.
Together with the Company Secretariat, there are seven employees in the
corporate centre focussing on assurance and compliance.
Customers and intermediaries
Novae operates in intermediated markets serviced by brokers. It is dependent
upon brokers to provide business. The leading international brokers account for
the majority of premium income, although small specialist brokers are important
in individual niche markets.
Brokers are facing operational and financial challenges in part due to the
servicing requirements of run off business. In addition, the direct regulation
of UK insurance brokers by the FSA is increasing focus on areas such as contract
certainty at inception. Some of the servicing roles which brokers historically
performed are now reverting to underwriters, with cost and resource implications
for insurers including Novae.
Following the May scheme of arrangement, all active subsidiaries changed their
name to include 'Novae'.
People
People are a critical factor in corporate success. As at December 2006 Novae had
209 employees functionally deployed across the Group as follows:
2006 2005
Underwriting 94 87
Claims and reinsurance 43 39
Finance and actuarial 33 35
Operations 32 33
Internal audit, 7 5
secretariat and compliance
Total 209 199
Emphasis is placed on training and development, not only for regulatory reasons
but because the rate of product development and legal change makes it
commercially vital. £89,000 was spent on professional development in 2006,
equivalent to £425 per employee.
Staff turnover is a key indicator of the health of the business. Some staff
turnover is important in providing fresh thinking; however, excessive turnover
leads to instability and loss of corporate knowledge. Staff turnover in 2006 was
13.8%, implying average tenure of over seven years.
One of the drivers behind turnover is staff compensation. Novae's general
approach is to pay market comparable salaries, supplemented by annual bonuses
and equity incentives. Bonus schemes set specific targets for each employee with
the potential for bonuses to be a material, and in some cases very material,
component of total compensation. The bonus pool is derived principally from
profits after cost of capital. Participation in equity incentive schemes is
spread widely across the business with over 90 members of the 2005 LTIP.
Capital
As at December 2006 the Group had £326.0 million of gross capital employed as
follows:
2006 2005
£m £m
Equity capital 239.8 112.4
Non-equity capital 86.2 105.1
Gross capital employed 326.0 217.5
Funds at Lloyd's support aligned underwriting capacity of £338.4 million.
Excluding the 2002 and prior solvency deficit of £84.1 million, the 2007 Funds
at Lloyd's requirement is £198.6 million, which represents 59% of aligned
capacity, down on 82% in 2005. NICL remains over capitalised in relation to its
current level of underwriting but this level of support is commercially
imperative to obtain the security rating required by brokers.
Novae is also subject to the capital requirements of the Insurance Groups
Directive. The IGD capital requirement is approximately £100 million. Novae's
admissible capital based on draft calculations is expected to be around £200
million, resulting in a significant surplus. The Group will always report some
surplus given Lloyd's rating ambitions and capital regime. In addition NICL's
capital is not yet fully deployed as it builds scale. Nonetheless, the capital
position is an indication of strength and demonstrates the extent of Novae's
recovery over the past three years.
Managing the mix and duration of capital is key to delivery of shareholder
value. The Group's regulatory capital requirement increased substantially
between 2000 and 2005, and it was compelled to employ available capital
regardless of cost to survive. As Novae has returned to health its regulatory
capital burden has eased and it has replaced distressed forms of capital with
more conventional equity and bank finance.
One of the considerations in managing capital resources is the extent and scale
of short term capital fluctuations. Were a major loss to affect the Group's US
property reinsurance account, for example, Novae would be required to fund this
loss gross for US regulatory purposes, as well as fund the resulting solvency
deficit within its Lloyd's business. The Group's capital resources must be
sufficiently flexible to meet such solvency spikes.
In the absence of unforeseen circumstances Novae intends to recommend that
shareholders approve the payment of a dividend at the Annual General Meeting to
be held in the second quarter of 2008. The amount of that proposed dividend will
be determined in part by profitability for the year ended December 2007.
The Group intends to review other options to maximise shareholder value
including where appropriate buy backs of ordinary shares or convertible bonds.
Security rating
Financial strength and claims paying ability are key factors for insurance
buyers. Competitive position is therefore heavily influenced by rating agency
assessment. Novae is no exception with both of its underwriting platforms the
subject of external rating.
The Lloyd's market is rated by three leading agencies:
Standard & Poors: A (Strong), outlook stable
AM Best: A (Excellent)
Fitch: A (Strong)
Novae's Lloyd's business is separately rated by Standard & Poors, AM Best and
Moody's. Moody's and Standard & Poors have recently improved their ratings,
following growing evidence that the Group's troublesome underwriting legacy is
continuing to fade. The current ratings of Novae's Lloyd's business are as
follows:
Standard & Poors: LSA 2+, outlook stable
AM Best: A (Excellent)
Moody's: IFRS A3 good, outlook positive
NICL is rated as A - (Excellent) by AM Best.
Business infrastructure
Novae operates under a one business, two platforms philosophy. Support services
such as claims and reinsurance are managed on a Group basis.
The Group structure has been further refined. The number of corporate entities
is currently 11, down from 61 three years ago. Of these seven are active and
four are non-trading. No further corporate reorganisations are currently
contemplated.
In July 2006 all employees and key operating assets were transferred to Novae
Management Limited, a central infrastructure company. This allows full
implementation of the one business, two platform philosophy, with users charged
for group services. This arrangement is working well, with operational and
financial benefits accruing as anticipated.
Lloyd's consented to the merger of Syndicates 1007 and 2147 for the 2007 year of
account in September 2006. The merged syndicate is numbered 2007. It has £360.0
million of premium capacity, of which £338.4 million, or 94%, is provided by
Novae. The goal of consolidating all current underwriting into one syndicate,
down from five, has therefore been achieved. It remains Novae's aim to acquire
the capacity provided by a single third party corporate (£20.0 million) and the
remaining 16 names (£1.6 million) as soon as possible but only on terms that are
economically rational.
The May 2006 scheme of arrangement
In March 2006 the Group published proposals to create a new holding company via
a scheme of arrangement; and conditional upon the Scheme becoming effective, to
capitalise NICL with the proceeds of a rights issue. This series of transactions
achieved Novae's strategic aim of diversification by market. It had three other
important effects. First, the new holding company and NICL sit outside the
Lloyd's covenant and charge. Second, the scheme allowed Novae to return to the
banking market on normal commercial terms. Finally, an opportunity was taken to
re-brand the Group.
Business process improvement
Significant improvements have been made to automate and accelerate business
processes and reporting. As well as generating operational efficiencies,
automation initiatives have improved the control environment and reduced the
risk of manual error.
Management information has been restructured across the Group. Performance
indicators and risk triggers have been set for underwriting units and support
functions.
Major investment has been made in underwriting and claims process improvement,
involving electronic data transfer, contract certainty and claims management.
NICL is leading the Group's effort at binding insurance contracts electronically
and 5% by volume of NICL's business is now transacted electronically.
Financial review
Capital management and cost of capital
Novae deploys capital only where the expected risk-adjusted return exceeds its
hurdle rate. Unit business plans assess how much capital is required to support
the agreed level of underwriting; unit performance is then measured on ability
to generate returns greater than the cost of that capital.
The hurdle rate is set at a small premium to the estimated pre tax weighted
average cost of capital ('WACC'). The WACC is calculated by applying the Capital
Asset Pricing Model to the capital stack assembled for each financial year. In
2006 the WACC was 10.4% and the hurdle rate was 12.5%.
2006 out turn and return on capital
Profit before tax was £31.3 million, or £32.8 million before exceptional
professional costs involved in the scheme of arrangement and formation of NICL
(2005: loss £13.9 million). Financing costs were £14.0 million, producing
operating profit before exceptional costs of £46.8 million (2005 operating
profit before gain arising from the sale of the stake in Fusion: £2.9 million).
Average equity capital employed during 2006 was £182.7 million; average gross
capital employed was £278.3 million (2005: £120.2 million and £244.5 million
respectively).
Return on gross capital employed was £46.8 million, equivalent to a pre tax
return of 16.8%. Return on equity capital employed was 18.0%, exceeding Novae's
hurdle rate for 2006 of 12.5%.
2006 2006 2005 2005
Equity capital Gross capital Equity capital Gross capital
employed employed employed employed
£m £m £m £m
Profit / (loss) 32.8 32.8 (17.9) (17.9)
before tax and
exceptional
items
Financing costs - 14.0 - 20.8
Operating 32.8 46.8 (17.9) 2.9
profit
Average equity 182.7 182.7 120.2 120.2
capital
employed
Average debt - 95.6 - 124.3
capital
employed
Average gross 182.7 278.3 120.2 244.5
capital
employed
Return on 18.0% 16.8% - 1.2%
capital
employed
Capital base and 2007 hurdle rate
As at 1 January 2007 Novae had equity capital employed of £239.8 million and
debt capital employed of £86.2 million. The WACC of the 2007 capital base is
currently estimated to be 11.3% and the hurdle rate has been set at 12.5%.
The cost base
Excluding cost of capital, the budgeted cost base in 2007 is £43.3 million
(2006: £45.2 million). Of this £10.6 million are Lloyd's costs including
subscriptions, levies and processing costs, over which the Group has limited
control (2006: £11.3 million). Controllable costs of £32.7 million (2006: £33.9
million) are made up as follows:
2007 2006
£m £m
Staff costs including 20.6 22.4
salaries, national
insurance and incentive
awards
Establishment costs 3.6 3.4
IT costs 2.9 2.7
Professional costs 3.3 3.0
Other 2.3 2.4
Total controllable costs 32.7 33.9
Three fundamental changes have been made to the cost base. First, the sale of
Fusion in November 2005 led to a significant reduction in the controllable cost
base. This was timely as rates in the UK commercial property market started to
soften. Second, the cost base has been rebalanced, cutting out unnecessary
expense and redeploying savings to meet either commercial or regulatory
requirements. It is important that centres of excellence such as the DBU are
broadly contained within the cost base. Third, Novae has moved from a silo
structure, in which support functions could be duplicated between syndicates and
corporate entities, to one where such resources are grouped together and charged
out on a user pays basis.
Balance sheet structure
Novae's gross balance sheet total as at December 2006 was £1,529.9 million
(2005: £1,697.7 million). On the asset side of the balance sheet 82% of gross
assets were accounted for by investments, cash and reinsurance contracts; on the
liability side 77% by insurance contracts. The balance is made up of
infrastructure assets (tangible and intangible fixed assets); working capital
(debtors, creditors and tax); and debt and equity capital.
The major balance sheet items are individually analysed below. The level of
infrastructure assets is expected to remain broadly constant, reflecting the
continued amortisation of syndicate capacity rights offset by capital
expenditure, mainly on IT. The amount of working capital employed at a
particular accounting reference date reflects the underlying monetisation of
insurance flows, and in particular the rate at which underwriting profits and
losses are settled.
Investments
As at 31 December 2006 Novae had financial assets of £827.9 million (2005:
£799.3 million). Including third party capacity, financial assets under Novae's
control were £918.6 million (2005: £861.2 million).
Novae's financial assets are invested in four separate pools:
Lloyd's business - Funds at Lloyd's: £226.3 million of solvency capital or Funds
at Lloyd's (2005: £239.0 million). 75% of this pool, which is managed by Credit
Agricole Asset Management, is in sterling and the balance in US dollars. Half is
held in cash and the balance in high grade corporate bonds, principally
sovereign and quasi-sovereign issuers
Lloyd's business - Premium Trust Funds: £462.3 million of insurance working
capital (2005: £544.7 million). Trust fund balances, which are managed by
Insight, Invesco and Weiss Peck & Greer, are generally held in the currencies in
which premiums emerge except where US and other local regulators require a gross
funding position to be maintained. Assets are held exclusively in short duration
investment grade bonds
NICL: £98.2 million (2005: nil). These assets, which are invested exclusively in
short duration investment grade sterling bonds and cash, are managed by Credit
Agricole Asset Management and Invesco. Outside the Lloyd's framework, solvency
capital and insurance working capital is managed on a combined basis
Corporate cash: £41.1 million (2005: £15.6 million). Corporate cash not required
elsewhere in the Group and outside the regulated businesses is retained in
sterling and managed by Royal London Cash Management, Barclays and Lloyds TSB.
RLCM runs a high quality certificate of deposit mandate, with Barclays and
Lloyds TSB accepting short term deposits
Novae retains a low risk investment policy. A neutral duration benchmark is 2.0
years, and throughout 2006 actual duration was considerably lower. Holdings may
not be taken in instruments rated lower than A+ Standard & Poors equivalent.
Managers invest on the basis of an explicit total return target for each
calendar year and are assessed on their ability to meet this target. Overall
risk is limited by setting a 12 month Value at Risk limit of 1.0% at a 90%
confidence level.
Managers' expectations for investment return in 2007 are currently as follows:
Lloyd's business - Funds at Lloyd's: 5.1%
Lloyd's business - Premium Trust Funds: 4.9%
NICL: 5.3%
Corporate cash: 5.0%
Day-to-day oversight of Novae's financial assets is delegated to the Investment
Committee, which is chaired by Oliver Corbett. The formal report of the
Investment Committee is set out in the annual report.
Reinsurance contracts
Reinsurance is a form of hedging designed to mitigate loss from peak events.
Reinsurance contracts are made up of two components: reinsurers' share of
unearned premium reserve and collections under reinsurance contracts.
Novae has had a large reinsurance collection balance for several years. This is
a result of very heavy use of reinsurance as a trading strategy between 1997 and
2002, combined with the aggregation effect of several years of high claims
activity in a business with an extended settlement tail. In the last 12 months,
collections under reinsurance contracts have fallen by 28%.
In 2003 collection of reinsurance was in some disarray. Although exposure to
insolvent reinsurers was limited, experience demonstrated that willingness to
pay was as important as ability to pay. Moreover, as claims are paid gross and
reinsurance collected separately, cash flow was deteriorating as older
reinsurance collections were failing to settle.
As a result, a major management initiative began in 2004 to analyse overdue
debtors in greater detail and to take specific action to collect cash. As a
result, net of excluded items, reinsurance collections more than 60 days overdue
have fallen from £38.6 million in 2004 to £1.7 million by December 2006. Amounts
overdue by 365 days or more fell from £12.0 million to under £1 million.
Insurance contracts
As at 31 December 2006 insurance contracts amounted to £1,176.3 million (2005:
£1,461.1 million), and were by far the largest item on the liability side of the
balance sheet.
The insurance contracts balance is made up of three components. First, gross
reserves on notified claims and claims incurred but not reported ('IBNR'). These
represent liabilities that Novae is likely to have to settle gross, and where
appropriate subsequently mitigate through outwards reinsurance collections.
Gross claims reserves amounted to £1,027.4 million (2005: £1,278.2 million), or
87% of insurance contracts as a whole. The next largest component is unearned
premium reserve. This reflects premium written and in most cases cash received
but where income is deferred until a later accounting period. Unearned premium
reserve represents business written but earned in future accounting periods. In
a hard market environment, it indicates the quantum of well rated business to be
earned in the future. As at 31 December 2006, the unearned premium reserve was
£136.1 million, compared to £155.8 million in 2005. The smallest element of
insurance contracts is the unutilised portion of the exceptional loss provision.
This was £12.8 million at the year end (2005: £27.1 million).
The rate at which gross claims are running off is an important indicator of risk
in the business. The volatility in gross reserves is concentrated in business
written in 2002 and prior, which years remain open for Syndicates 1007 and 1241.
The gross reserves and population of claims from lead business written by these
syndicates in 2002 and prior have developed as follows:
100% level 2006 2005
Total gross reserves £317.3 million £378.0 million
Year-on-year reduction 16% -
Total claims population 4,604 6,117
Year-on-year reduction 25% -
The value of open claims is heavily skewed towards a small number of large
items. As at 31 December 2006, the profile of lead claims from 2002 and prior
lead business was as follows:
Gross claims 2006 2006 2005 2005
value (100%
level) £m Number £m Number
Under £250,000 77.6 4,388 91.8 5,838
£250,000-£1.0 83.1 173 112.8 224
million
Over £1.0 156.6 43 173.4 55
million
Total 317.3 4,604 378.0 6,117
Inevitably these large claims are complex, and the outcome is heavily dependent
on coverage and litigation issues. Resolution of the litigation surrounding the
collapse of Enron will have the biggest single effect on clearing large lead
claims from 2002 and prior. Important legal action was due before the US courts
in October 2006, but was subsequently deferred until April 2007. Novae's gross
exposure is heavily reinsured, with net retentions reserved several years ago.
However, settling these claims will unwind the Group's reinsurance asset. This
will in turn reduce the overall scale of the balance sheet and the regulatory
capital required to underpin it.
Debt and gearing
Novae has used both on- and off-balance sheet financial gearing to enhance
return on equity. On-balance sheet debt comprises the 2008 convertible bond, US
dollar denominated subordinated notes and conventional bank facilities.
Off-balance sheet debt consists of bank and reinsurer letters of credit which
are treated as admissible assets by Lloyd's.
The convertible bond and subordinated notes are listed. Both on- and off-balance
sheet bank finance is fixed term and the lender's position is protected by
representations and covenants.
Reinsurer letters of credit have been an essential part of Novae's capital
structure during its rehabilitation and have the advantage of being
covenant-free. In addition, once committed they are generally available for
three and a half years as the underlying Lloyd's year of account to which they
relate runs off. The disadvantage from the Group's perspective is that, although
amortised over three years, the cost of such capital is very expensive. As
Novae's Funds at Lloyd's ('FAL') requirement has started to fall, no reinsurer
letters of credit have been renewed into 2007. However, the Income Statement
will continue to reflect the high cost of such finance in 2007 in relation to
earlier Years of Account and, to a lesser extent, in 2008. Assuming the 1
January 2007 capital base is unchanged throughout 2007, financing costs are
expected to be around £12 million.
As Novae used current profits to repair the damage inflicted on its equity base
from legacy underwriting, but at the same time faced a rising capital
requirement, its level of financial gearing increased sharply between 2003 and
2006. Following the scheme of arrangement and equity financing, together with
the gradual reduction in solvency capital as the legacy underwriting has
matured, financial gearing has begun to fall.
2006 2005 2004 2003 2002 2001
£m £m £m £m £m £m
Tangible net 232.4 104.1 119.8 201.3 125.4 118.0
assets
Reinsurer 20.0 60.0 90.0 116.0 76.0 76.0
letters of
credit
Bank letters 20.0 20.0 - - - -
of credit
Subordinated 19.7 19.6 19.5 - - -
notes
Convertible 46.5 45.5 43.9 47.9 - -
bond
Total debt 106.2 145.1 153.4 163.9 76.0 76.0
Financial 45.7% 139.4% 128.1% 81.4% 60.6% 64.4%
gearing
(debt:
tangible net
assets)
Financial gearing is not the only form of leverage in the balance sheet. The
other important sources of leverage include:
Reserve gearing: ratio of gross reserves to tangible net assets
Reinsurance gearing: ratio of reinsurance contracts (excluding UPR) to tangible
net assets
Catastrophe gearing: ratio of modelled loss from extreme catastrophe events to
tangible net assets
On each of these measures the Group was significantly more highly geared than
its peers prior to the scheme of arrangement and equity financing. The
cumulative effect of such high gearing was to generate exceptional returns in a
period of strong underwriting performance but to increase risk dramatically in a
less benign underwriting climate.
Working capital and liquidity
Insurance profits and losses convert into cash flows with relatively little
leakage into areas such as fixed asset investment. The major swing factor is the
period between profit recognition and cash release.
Historically, Lloyd's operated a three year funded basis of accounting under
which profits or losses would normally settle in June three and a half years
after the January in which the relevant year of account incepted. Following
Lloyd's transition to annual accounting, this regime has been partially relaxed
and profits may be released earlier subject to meeting outstanding solvency
deficits from loss making underwriting. There is no such settlement delay in
NICL, although the release of cash and payment of dividends requires the consent
of the FSA under its continuous solvency regime.
Novae was cash flow positive in 2006.
The most significant non recurring cash inflow was the £103.7 million proceeds
from the rights issue in June 2006. £100.0 million of this was subsequently down
streamed to NICL as solvency capital.
Cash flows from the Group's Lloyd's operations were principally driven by
movements in solvency capital. FAL increased in June 2006 by £15.7 million. This
was met from Group resources. There was a subsequent £21.8 million release from
FAL in November 2006. Aside from movements in FAL there was a net cash inflow
from the managed syndicates of £2.5 million. This represented distributions from
the 2003 year of account for 1007 and 2147 of £64.0 million less cash calls on
the run off 2002 year of account for syndicates 1241 and 1007 of £61.5 million.
As expected, NICL was cash flow neutral in 2006.
Working capital is managed centrally and future flows are modelled and
monitored. In order to meet fluctuations in working capital, the Group has a £20
million revolving credit facility. As at 31 December 2006 this was undrawn.
Although Novae has reduced sharply the proportion of business it writes in US
dollars since 2003, it continues to face a number of currency mismatches. These
include translation of non sterling underwriting profits into sterling, a
sterling cost base with a multi currency income stream and the risk that reserve
movements may arise in non sterling currencies but are matched from a regulatory
perspective by sterling solvency capital. Second order effects can arise where
business is written in a minor currency, claims arise in that currency but
reinsurance protection has been bought in a core currency such as sterling or US
dollars.
In order to mitigate potential currency mismatches Novae has adopted the
following strategy:
Underwriting profits and losses are generally left in the currencies in which
they emerge until at least month 24 following that of inception of the relevant
underwriting year, allowing the account in question to mature. At that stage a
proportion of profits may be sold forward for sterling
25% of Novae's funds at Lloyd's are invested in US dollars to offset the effects
of any reserve deterioration in US dollars
Claims management
The claims management function is divided into four units each headed by an
experienced adjuster manager. The three continuing business claims units are
Property, Specialty/Liability and Aviation & Marine; the fourth is the
Discontinued Business Unit. All four adjusting units are supported by the claims
operations team which undertakes processing, monitors non-moving claims and
provides management information. The claims operations team was expanded in 2006
following the introduction of Lloyd's Claims Management Principles and Minimum
Standards.
The focus of claims activity during 2006 in the ongoing units was the property
losses from hurricanes Katrina, Rita and Wilma, together with large Specialty
claims such as losses arising following the collapse of Enron. Within the
Discontinued Business Unit further work was done on reviewing and auditing major
liability reinsurance contracts.
A number of specific objectives have been set for claims management in 2007.
First, Enron-related litigation is due to be heard in the US courts in spring
2007. Assuming this process reaches a conclusion, the claims team will focus on
resolving the related insurance issues. Second, further specific actions have
been identified for the Discontinued Business Unit. Finally, claims management
has been charged with maintaining the progress achieved in improving the speed
of collection of outwards reinsurance.
Tax
The 2006 tax charge was £9.8 million, equivalent to 31% of profit before tax.
This represents the partial utilisation of Novae's deferred tax asset and no
cash tax is expected to be paid.
The deferred tax asset represents credit given for past trading losses. In
effect it recognises the ability of historic trading losses to shield current
and future profits. The benefit from creating the deferred tax asset has passed
though the Income Statement; as that asset is utilised the cost is taken through
the Income Statement.
The deferred tax asset carried forward at December 2006 is £31.6 million (2005:
£41.4 million). Novae Group has limited the amount of deferred tax that can be
recognised in relation to expected future profitability over a relatively short
period. The fact that actual losses exceed the amount that may be recognised as
an asset does not mean that surplus losses are foregone. Surplus losses can be
reinstated as an asset (with the associated gain taken to the Income Statement)
if they can be utilised within a relatively short period. The amount of surplus
losses not currently recognised on the balance sheet is £24.1 million,
equivalent to 3.3p per share.
As well as trading losses, Novae also has £13.7 million of capital losses,
equivalent to 1.9p per share (2005: £12.5 million). These are not recognised as
an asset, but remain available to the Group to offset future capital gains.
The tax charge is expected to remain in the range 30-32%. Expenses disallowed
for corporation tax purposes are relatively modest, being mainly accounted for
by professional costs in relation to capital items, entertaining, depreciation
and amortisation. In common with other insurers, Novae is unable to offset all
of its input VAT and as a result suffers an irrecoverable VAT charge.
Tax computations for all Group companies are agreed up to and including the 2004
year end. Computations for the 2005 year end were filed in the fourth quarter of
2006.
International Financial Reporting Standards and accounting framework
2006 is the second year in which Novae's consolidated accounts have been
prepared under IFRS. No significant changes have been made from the basis on
which consolidated accounts were prepared in 2005.
Further development of the IFRS framework is underway. Some of the areas
currently under review, such as pension accounting, are unlikely to affect Novae
to any material extent. However, in the medium term a combination of IFRS and EU
directives on the non-life insurance sector will lead to changes in the way
insurance liabilities in particular are presented.
Following a review by the Audit Committee, subsidiary companies' financial
statements continue to be prepared in accordance with UK GAAP rather than IFRS.
This decision was taken on cost benefit grounds given the substantial additional
disclosure required under IFRS and the volume and nature of disclosure available
in the Group's annual report.
Annual General Meeting
Following a recent change in company law, a separate document is now required
formally convening Novae's 2006 Annual General Meeting. A circular convening the
meeting is being posted to shareholders today. At the Annual General Meeting two
resolutions will be put before shareholders as special business, in addition to
the usual business considered at such meetings.
The first resolution sets out a proposed amendment to Novae's Articles of
Association. This would increase the annual cap on non-executive directors'
aggregate fees from £150,000 to £300,000. The existing cap was fixed some time
ago and over the recent past Novae's difficulties have deterred potential
non-executive directors from joining the Group. As Novae's rehabilitation
continues, the Board wishes to have the flexibility to refresh its composition
by attracting top quality independent non-executive directors.
The second resolution seeks shareholder consent for the introduction of a new
Long Term Incentive Plan ('LTIP'). When the 2005 LTIP was approved by
shareholders, it was on the basis that that scheme would only make two series of
awards, in January 2006 and January 2007. As a result, a new scheme is now
required, details of which are set out in the attached circular. The design and
operation of the new scheme has been discussed with Novae's major institutional
investors.
Use of the operating and financial review
This operating and financial review contains certain forward-looking statements
which are made by the directors in good faith based on the information available
to them at the time of their approval of this review. Statements contained
within the operating and financial review should be treated with caution due to
the inherent uncertainties, including economic, regulatory and business risk
factors, underlying any such forward looking statements. The operating and
financial review has been prepared by Novae to provide information to its
shareholders and should not be relied upon by any other party or for any other
purpose.
16 March 2007
Consolidated income statement
for the year ended 31 December 2006
Note Year ended Year ended
31 December 31 December
2006 2005
£m £m
Gross premium revenue 6 303.9 366.6
Less premium ceded to reinsurers 6 (83.1) (96.0)
Net premium revenue 220.8 270.6
Fees and commission income 7 9.7 7.3
Investment income 8 32.9 25.8
Total revenue (net of reinsurance 263.4 303.7
payable)
Gross claims incurred 9 (144.3) (350.0)
Reinsurers' share of claims incurred 9 42.1 162.3
Net claims incurred (102.2) (187.7)
Policy acquisition costs 10 (50.6) (53.2)
Other operating expenses 11 (57.3) (62.9)
Currency (loss) / gain on non-monetary (6.5) 3.0
items
Operating profit 46.8 2.9
Profit on disposal of subsidiary 12 - 4.0
Financing costs 13 (14.0) (20.8)
Cost of scheme of arrangement (1.5) -
Profit / (loss) before income taxes 31.3 (13.9)
Income taxes 14 (9.8) (3.2)
Profit / (loss) for the year 21.5 (17.1)
Attributable to: 21.5 (17.2)
Equity holders of the parent
Minority interest - 0.1
21.5 (17.1)
Earnings per share 3 3.8p (4.8)p
Basic earnings per share
Diluted earnings per share 3 3.8p (4.8)p
Consolidated balance sheet
As at 31 December 2006
Note 31 December 31 December
2006 2005
£m £m
Assets
Property, plant and equipment 16 1.3 1.8
Intangible assets 17 7.4 8.3
Deferred acquisition costs 18 24.7 25.3
Deferred tax assets 19 31.6 41.4
Financial assets 21 587.0 579.3
Reinsurance contracts 22 423.3 587.2
Insurance and other receivables 23 213.7 234.4
Cash and cash equivalents 24 240.9 220.0
Total assets 1,529.9 1,697.7
Liabilities
Insurance contracts 25 (1,176.3) (1,461.1)
Financial liabilities, due after one year 26
- Convertible debt (46.5) (45.5)
- Loan notes (19.7) (19.6)
Insurance and other payables 27 (47.6) (59.1)
Total liabilities (1,290.1) (1,585.3)
Net assets 239.8 112.4
Shareholders' equity
Share capital 29 73.2 114.4
Share premium 29 67.1 83.6
Merger reserve 29 69.6 -
Retained earnings 29 (130.8) (154.5)
)
Other reserves 29 155.2 63.4
Equity component of convertible debt 29 5.5 5.5
Total shareholders' equity 239.8 112.4
Net asset value per share 33.0p 31.2p
Net asset value per share excluding syndicate 32.0p 28.9p
capacity
These financial statements were approved by the Board of Directors on 16 March
2007 and were signed on its behalf by:
P E Selway-Swift O R P Corbett
Chairman Group Finance Director
Consolidated statement of changes in equity
for the year ended 31 December 2006
Share Share Merger Other Profit Equity Total
capital premium reserve reserves and loss component of
account account convertible
bond
£m £m £m £m £m £m £m
For the year
ended 31
December 2006:
Profit for the
period
- - - - 21.5 - 21.5
Movement in
treasury shares
- - - - 2.2 - 2.2
Group
re-organisation
(77.8) (83.6) 69.6 91.8 - - -
Rights issue 36.6 67.1 - - - - 103.7
Net increase / -
(decrease) in
equity (41.2) (16.5) 69.6 91.8 23.7 127.4
As at 31
December 2005
114.4 83.6 - 63.4 (154.5) 5.5 112.4
As at 31
December 2006
73.2 67.1 69.6 155.2 (130.8) 5.5 239.8
For the year
ended 31
December 2005:
Loss for the
period
- - - - (17.1) - (17.1)
Movement in
treasury shares
- - - - 1.5 - 1.5
Net decrease in
equity
- - - - (15.6) - (15.6)
As at 31
December 2004
114.4 83.6 - 63.4 (138.9) 5.5 128.0
As at 31
December 2005
114.4 83.6 - 63.4 (154.5) 5.5 112.4
Consolidated cash flow statement Year ended Year ended
for the year ended 31 December 2006 31 December 31 December
2006 2005
Note £m £m
Profit / (loss) before tax 31.3 (13.9)
Cash flow from syndicates (41.0) 32.7
Depreciation and amortisation 2.7 2.6
Unrealised gains on financial assets (0.8) (0.4)
Employee equity incentives 2.9 1.6
Change in receivables less payables 3.1 42.5
Utilisation of exceptional loss provision (14.3) (40.0)
Cash generated from operations (16.1) 25.1
- Interest paid (5.4) (5.2)
- Interest received 14.4 12.4
- Income taxes paid - (1.1)
Net cash from operating activities (7.1) 31.2
Cash flows from investing activities (511.6) (816.1)
- Portfolio investment purchases
- Portfolio investment sales 425.9 792.0
- Acquisition of intangible fixed assets (0.1) -
- Acquisition of property, plant and (1.2) (1.5)
equipment
- proceeds from disposal of subsidiary, net 12 - 0.5
of cash
and cash equivalents disposed of
Net cash used in investing activities (87.0) (25.1)
Cash flows from financing activities 109.8 -
- Receipts from issue of equity
- Expenses relating to issue of equity (6.1) -
Net cash used in financing activities 103.7 -
Movement in cash holdings 9.6 6.1
Movement in syndicate funds 11.3 22.5
Opening cash and cash equivalents 220.0 191.4
Closing cash and cash equivalents 240.9 220.0
Notes to the financial information
1. Significant accounting policies
Novae Group plc is a company incorporated in England and Wales.
In May 2006 pursuant to a Scheme of Arrangement under s425 of the Companies Act
1985, a new parent company was introduced which is now called Novae Group plc.
The previous parent company has been re-named Novae Holdings PLC.
The introduction of a new holding company constitutes a group reconstruction and
has been accounted for using reverse acquisition accounting principles.
Therefore, although the group reconstruction did not become effective until May
2006, the consolidated financial statements of Novae Group plc are presented as
if both companies had always been part of the same group. Accordingly, the
results of the Group for the year ended 31 December 2006 are shown in the
consolidated income statement and the comparative figures are also prepared on
this basis.
The consolidated financial statements include the results of Novae Group plc and
all its subsidiary undertakings (together referred to as the 'Group') made up to
the same accounting date.
The Group financial statements have been prepared and approved by the directors
in accordance with International Financial Reporting Standards as adopted by the
EU ('Adopted IFRSs').
The accounting policies set out below have, unless otherwise stated, been
applied to the Group consistently for all periods presented in this consolidated
financial information.
(a) Adoption of IFRS
In the prior year, IFRS 1 granted certain exemptions from the full requirements
of IFRS in the transition period:
The exemption on pre 7 November 2002 options for share-based payments has been
taken
The Novae Group has applied the business combinations exemption in IFRS 1. It
has not restated business combinations that took place prior to the 1 January
2004 transition date
The exemptions for IFRS 4 - Insurance Contracts, IAS 32 - Financial Instruments:
Disclosure and Presentation and IAS 39 - Financial Instruments: Recognition and
Measurement have not been taken as the Group has applied these standards in
preparing its comparative financial information.
Novae has considered the impact of standards not yet effective and endorsed for
use in the EU; IFRS 7 (Financial Instruments: Disclosures), IFRIC 8 (Scope of
IFRS 2 Share-based payment) and IFRIC 9 (Reassessment of Embedded Derivatives)
are expected to have no significant impact on the balance sheet or income
statement. IFRS 7 will effect the level of disclosure within the notes which
form part of the financial statements.
(b) Basis of preparation
The financial statements are presented in pounds sterling unless otherwise
stated. They have been prepared under the historical cost convention, as
modified by the revaluation of financial assets and financial liabilities at
fair value through profit or loss.
The preparation of financial statements in conformity with IFRS requires
management to make judgements, estimates and assumptions that affect the
application of policies and reported amounts of assets and liabilities, income
and expenses. The estimates and associated assumptions are based on historical
experience and various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis of making judgements
about carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates. The Group
makes use of certain hedging contracts, to which it applies hedge accounting.
The accounting policies set out below have been applied consistently to all
years presented in these consolidated financial statements.
The estimates and assumptions are reviewed on an ongoing basis.
Revisions to accounting estimates are recognised in the year in which the
estimate is revised if the revision only affects that year, or in the year of
the revision and future years if the revision affects both current and future
years.
(c) Basis of consolidation
Subsidiaries are entities controlled by Novae Group. Control exists when Novae
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. In
assessing control, potential voting rights that presently are exercisable or
convertible are taken into account. The financial statements of subsidiaries are
included in the consolidated financial statements from the date that control
commences until the date that control ceases.
All subsidiaries are consolidated within the Group financial statements.
Intragroup balances and any unrealised gains and losses or income and expenses
arising from intragroup transactions are eliminated in preparing the
consolidated financial statements.
(d) Classification and accounting for insurance contracts
Insurance contracts are those contracts that transfer significant insurance risk
at the inception of the contract. Insurance risk is transferred when an insurer
agrees to compensate a policyholder if a specified uncertain future event
adversely affects the policyholder.
(i) Premiums
Written premiums comprise the premiums on contracts entered into during the
year, irrespective of whether they relate in whole or in part to a later
accounting period. Premiums are disclosed gross of commission payable to
intermediaries and exclude taxes and levies based on premiums. Premiums written
include adjustments to premiums written in prior accounting periods and
estimates for future premiums. An estimate is made at the balance sheet date to
recognise retrospective adjustments to premiums or commissions. Outward
reinsurance premiums are accounted for in the same accounting period as the
premiums for the related inwards insurance or reinsurance business.
(ii) Unearned premium provision
The provision for unearned premiums comprises the proportion of gross premiums
written which is estimated to be earned in the following or subsequent years,
computed separately for each insurance contract in line with the risk exposure
profile.
(iii) Claims
Claims incurred consist of claims and claims handling expenses paid during the
financial year together with the movement in the provision for outstanding
claims.
Claims outstanding comprise provisions for the estimated cost of settling all
claims incurred but unpaid at the balance sheet date, whether reported or not,
and related internal and external claims handling expenses.
The ultimate liability as a result of outstanding claims will vary due to
subsequent information and events and may result in significant adjustments to
the amounts provided. Adjustments to the amounts of claims provisions
established in prior years are reflected in the financial statements for the
period in which the adjustments are made, and disclosed separately if material.
The main assumptions used in the calculation of the ultimate cost of outstanding
claims are detailed in note 25.
(iv) Liability adequacy testing
At each balance sheet date, liability adequacy tests are performed to ensure the
adequacy of the insurance liabilities net of deferred acquisition costs. In
performing these tests, current best estimates of future contractual cash flows,
claims handling and administration expenses as well as investment income from
the assets backing such liabilities are used. Any deficiency is immediately
charged to the profit or loss initially by writing off deferred acquisition
costs and by subsequently establishing a provision for losses arising from
liability adequacy tests ('unexpired risk provision').
(v) Reinsurance
The Group cedes reinsurance in the normal course of business for the purpose of
limiting its net loss potential through the diversification of its risks.
Premiums on reinsurance assumed are recognised as revenue on the same basis as
direct business, taking into account the product classification.
Reinsurance assets include amounts recoverable from reinsurers for losses and
loss adjustment expenses. If a reinsurance asset is impaired, the Group reduces
its carrying amount accordingly, and will immediately recognise the impairment
loss in the income statement. A reinsurance asset will be deemed to be impaired
if there is objective evidence, as a result of an event occurring after initial
recognition of the asset, that the Group may not receive all amounts due to it
under the terms of the contract, and that the event has a reliable measurable
impact on the amounts that the Group will receive from the reinsurer.
Reinsurance arrangements do not relieve the Group from its direct obligations to
its policyholders.
(e) Segment reporting
A segment is a distinguishable component of the Group that is either engaged in
providing a type of insurance (business segment), or in providing insurance
within a particular economic environment (geographical segment), which is
subject to risks and rewards that are different from those of other segments.
(f) Revenue
The basis on which premium revenue is recognised is set out in policy (d) above.
Premium revenue comprises written premium less any amounts of unearned premium.
Revenue also includes investment income; accounting policy (n) contains further
details on its recognition.
(g) Fees and commission income
Fees and commission income comprise managing agent's fees receivable from third
party capital providers and commission receivable by the Group's service
companies. Commission income is accounted for at the time when the client is
charged, and a proportion is deferred to meet the future costs for the claims
associated with the premiums that have been written. In addition, commission is
accrued to cover the underwriting costs that have been incurred prior to
inception of the policy.
(h) Expenses
(i) Operating lease payments
Payments made under operating leases are recognised in the income statement on a
straight-line basis over the term of the lease. Lease incentives received are
recognised in the income statement as an integral part of the total lease
expense.
(ii) Financing costs
Financing costs comprise interest payable on borrowings and off balance sheet
letter of credit facilities provided by third parties calculated using the
effective interest rate method.
(j) Income tax
Income tax on the profit or loss for the year comprises current and deferred
tax. Income tax is recognised in the income statement except to the extent that
it relates to items recognised directly in equity, in which case it is
recognised in equity.
Current tax is the expected tax payable on the taxable income for the year and
any adjustment to tax payable in respect of previous years. The Group calculates
income tax using the current income tax rate.
A deferred tax asset is recognised only to the extent that it is probable that
future taxable profits will be available against which the asset can be
utilised.
(k) Foreign currency
Items included in the financial statements of each of the Group's entities are
measured using sterling as this is the functional currency, being the primary
currency of the economic environment in which the Group's entities operate.
Transactions in foreign currencies are translated at the foreign exchange rate
prevailing at that transaction date. Monetary assets and liabilities denominated
in foreign currencies at the balance sheet date are translated at the foreign
exchange rate ruling at that date. Foreign exchange differences arising on
translation are recognised in the income statement. Non-monetary assets and
liabilities, primarily deferred acquisition costs and gross and ceded unearned
premiums, are translated using the historical transaction rate.
(l) Intangible assets
Purchased syndicate capacity has been classed as a finite life asset. It is
included at cost and amortised over the directors' estimate of its useful
economic life, currently fifteen years. Amortisation commences in the financial
year in which the underwriting results from the purchased capacity are first
recognised. Provision is made for any impairment in the carrying amount of
purchased capacity.
(m) Property, plant and equipment
(i) Owned assets
Property, plant and equipment are stated at cost less accumulated depreciation
(see below) and any impairment in value.
Where categories of property, plant and equipment have different useful lives,
they are accounted for as separate items.
(ii) Depreciation
Depreciation is charged in the income statement on a straight-line basis over
the estimated useful lives of each part of an item of property, plant and
equipment. The estimated useful lives are as follows:
Furniture and equipment 3 - 5 years
Computer equipment 3 years
Office refurbishment 3 - 5 years
The residual value, if significant, is reassessed annually.
(n) Financial assets
Financial assets have been designated as fair value through profit and loss on
initial recognition. This has been deemed the most appropriate valuation
methodology for these assets as this reflects the fact that the investment
portfolios are managed, and their performance evaluated, on a fair value basis.
Purchases and sales of financial assets are recognised on a trade date basis.
Any gain or loss as a result of a change in fair value is recognised directly
through the income statement.
The fair value of financial instruments classified as fair value through profit
or loss are held at their quoted bid price at the balance sheet date. Investment
income and charges are recognised on an accruals basis based on the coupon rate.
(o) Derivative financial instruments
The Group uses derivative financial instruments to hedge its exposure to foreign
exchange and interest rate risks arising from operational, financing and
investment activities. In accordance with its treasury policy, the Group does
not hold or issue derivative financial instruments for trading purposes. The
Group monitors the effectiveness of its derivative financial instruments with
regards to the requirements of IAS 39.
(p) Deferred acquisition costs
Acquisition costs comprise all direct costs arising from the conclusion of
insurance contracts. Deferred acquisition costs represent the proportion of
acquisition costs incurred which corresponds to the unearned premiums provision.
Acquisition costs are deferred only to the extent that available future margins
are expected to cover them.
(q) Receivables
Receivables are stated at amortised cost less impairment losses.
(r) Cash and cash equivalents
Cash and cash equivalents comprise cash balances and call deposits. Included
within cash and cash equivalents are balances that are not freely available to
the Group, details of which are set out in note 24. These can be used to settle
policyholder claims.
(s) Impairment
The carrying amounts of the Group's financial assets are reviewed at each
balance sheet date to determine whether there is any indication of impairment.
If any such indication exists, the carrying value is reduced to the estimated
recoverable amount by means of a charge to the consolidated income statement.
The recoverable amount of other assets is the greater of their net
selling price and value in use. In assessing value in use, the estimated future
cash flows are discounted to their present value using a pre-tax discount rate
that reflects current market assessments of the time value of money and the
risks specific to the asset. For an asset that does not generate largely
independent cash inflows, the recoverable amount is determined for the
cash-generating unit to which the asset belongs.
(t) Convertible debt
The fair value of the liability portion of the convertible bond is determined by
discounting contractual cash outflows using the interest rate payable on an
equivalent non-convertible bond. The amount is carried as a liability on an
effective interest basis until extinguished on conversion or redemption. The
remainder of the issue proceeds is allocated to the conversion option and is
recognised and included in shareholders' equity on initial recognition.
Transaction costs are amortised on an effective interest rate basis over the
duration of the bond. These costs have been allocated between the debt and
equity component of the convertible bond in a way deemed most appropriate by the
Group.
(u) Interest-bearing loans and borrowings
Interest-bearing loans and borrowings are recognised initially at fair value
less attributable issue costs, and thereafter at amortised cost. Attributable
issue costs are amortised on an effective interest rate basis over the term of
the borrowings. Borrowing costs are expensed rather than capitalised.
(v) Dividends
Dividends are recognised in the period in which they are paid and received.
(w) Employee benefits
(i) Defined contribution plans
Obligations for contributions to defined contribution pension plans are
recognised as an expense in the income statement as incurred.
(ii) Share-based payment transactions
The Group's equity incentive schemes allow its employees to acquire shares of
Novae Group plc. The fair value of options and long term incentive plan shares
granted are recognised as an expense with a corresponding increase in equity.
The fair value is measured at grant date and spread over the period during which
the employees become unconditionally entitled to the options. The fair value of
the options granted is measured using a binomial lattice model, the
Black-Scholes formula and a Monte Carlo simulation, taking into account the
terms and conditions upon which the options were granted. The amount recognised
as an expense is adjusted to reflect the actual number of share options that
vest except where forfeiture is due only to changes in market conditions or as
the scheme progresses, for example share prices not achieving the threshold for
vesting. IFRS 2 has not been applied to arrangements prior to 7 November 2002,
and those granted subsequently that had vested by 1 January 2005.
(x) Payables
Payables are measured at fair value on initial recognition and subsequently are
stated at amortised cost.
2. Management of financial and insurance risk
Financial risk
Exposure to market (including foreign currency), credit and liquidity risks
arise in the normal course of the Group's business. Further details on these are
provided in the Operating and Financial Review, which also details operational,
group, regulatory and reputational risks.
Market risk
The Group's exposure to market risk for changes in interest rates is
concentrated in Novae's investment portfolio, and to a lesser extent, the
Group's debt obligations.
Insurance reserves and other liabilities deriving from business transacted on
foreign currencies exposes the Group to foreign exchange risk. Premium income
cash flows from the underwriting of business originating outside of the UK are
the primary source of funds for the purchase of investments denominated in
foreign currencies. These investments are purchased primarily to match insurance
reserves and other liabilities denominated in the same currency, acting as an
economic hedge to reduce Novae's exposure to exchange rate fluctuations. An
analysis of investments by currency is provided in note 21.
Credit risk
The Group's portfolios of fixed income securities are subject to credit risk.
The risk is defined as the potential loss in market value resulting from adverse
changes in the borrower's ability to repay the debt. The Group monitors its
exposure to such credit risk by comparing the value and credit rating of its
investments against a benchmark determined by the Investment Committee and this
is reported to the Board monthly. The credit worthiness of the Group's financial
assets are detailed in note 21.
The Group underwrites insurance risk and reinsures a substantial portion of that
risk with third party reinsurers. There is a degree of credit risk associated
with reinsuring to third parties and in order to manage this risk credit reviews
of the underlying financial stability of the reinsurance entity are performed.
This is performed by the Reinsurance Security Vetting Committee. The reinsurers'
share of paid and notified losses is analysed by credit rating in note 22.
The Group also has other receivable amounts subject to credit risk. The most
significant of these are amounts due from brokers. To mitigate risk of these
counterparties' non-payment of amounts due, business and financial standards for
broker approval are established. The Group's exposure to individual brokers is
monitored on a monthly basis by the Broker Vetting Committee.
Liquidity risk
This exists to the extent that the Group must be able to satisfy claims, meet
solvency and funding requirements, and meet working capital needs. This is
further outlined in the Operating and Financial Review.
Insurance risk
Reserving risk and the uncertainty in establishing claims reserves are
measurement risks and are discussed further as part of the disclosure on claims
(see note 25). Underwriting risk is an insurance risk that arises on the Group's
underwriting activities within each of the business segments Specialty,
Property, Liability and Aviation & Marine. These are discussed further in note
5.
Underwriting risk is managed by monitoring risk tolerance levels, referred to
internally as Willingness to Lose ('WTL'). This is set by the Boards of the
Lloyd's managing agency and NICL in consultation with the Board of Novae Group
plc. WTL is defined as being the maximum loss net of reinsurance and
reinstatement premiums the Group is prepared to absorb from any one defined
catastrophic event, being the main concentrations of insurance risks facing the
Group. For example, the defined event for Florida windstorm is assumed to be a
generic scenario with an overall insured loss of $60.0 billion.
Key instances of the Group's WTL as at 31 December 2006 are discussed within the
segmental review section of the Operating and Financial Review.
3. Earnings per share
Basic earnings per share
The calculation of earnings per share of 3.8 pence (2005: loss of 4.8 pence) is
based on a profit attributable to equity shareholders of the parent company of
£21.5 million (2005: loss of £17.2 million) and on 562.9 million shares (2005:
361.2 million shares), being the weighted average number of shares in issue,
excluding shares held by the Employee Benefit Trust and earmarked for the
Group's Long Term Incentive Plan, during the year ended 31 December 2006.
Diluted earnings per share
Diluted earnings per share are calculated adjusting the weighted average number
of shares outstanding to assume conversion of all potentially dilutive shares.
Novae Group has two categories of potentially dilutive ordinary shares:
convertible debt and share options. The convertible debt is assumed to have been
converted into shares and the net profit adjusted to eliminate the interest
effect less the tax effect. For 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) based on the monetary
value of the subscription rights attached to outstanding share options. The
number of shares calculated as above is compared to the number of shares that
would have been issued assuming the exercise of the share options.
For the years ended 31 December 2006 and 2005, the convertible debt and share
options are not considered to have any dilutive effect as the average market
price of ordinary shares during these years did not exceed the exercise price.
Year ended Year ended
31 December 31December
2006 2005
£m £m
Profit/(loss) for the year attributable to equity 21.5 (17.2)
shareholders of parent
Interest expense on convertible debt (net of tax) - -
Profit used to determine diluted earnings per share 21.5 (17.2)
Weighted average number of shares in issue (millions) 562.9 361.2
Adjustments for:
- assumed conversion of convertible debt (millions) - -
- share options (millions) - -
Weighted average number of shares for diluted earnings 562.9 361.2
per share
Diluted earnings per share (pence per share) 3.8 (4.8)
4. Principal exchange rates (to sterling)
Year ended Year ended
31 December 2006 31 December 2005
Year Year Year Year
average End average end
US dollar 1.84 1.95 1.82 1.72
Euro 1.47 1.48 1.46 1.46
Canadian dollar 2.09 2.28 2.21 2.01
5. Segmental information
Segmental information is presented in respect of the Group's business and
geographic segments. The primary format, business segments, is based on the
Group's management and internal reporting structure.
An analysis of the technical profit of the Group is presented below. This
analyses the underwriting return split by business segment, separating out the
activities of the ongoing business from the reserve deterioration on the
discontinued units. It is included to increase clarity over the performance of
the ongoing units, but does not represent a discontinued business analysis for
IFRS 5 purposes.
Segment results, assets and liabilities include items that can be allocated on a
reasonable basis. Unallocated items comprise insurance working capital and
central group items.
The Group comprises the following main business segments in addition to the
Discontinued Units:
(i) Specialty
Business included within the Specialty segment relates to financial
institutions, professional indemnity, management liability, political & credit
risks, specie & cargo and special situations.
(ii) Property
The Property segment consists of both direct and reinsurance business transacted
in the US and internationally (including the UK).
(iii) Liability
The general liability book comprises UK general and employers' liability risks
supplemented by Australian binder business and a marine liability account.
(iv) Aviation & Marine
This segment is dominated by aviation reinsurance but also includes a specialist
hull account, marine war and an energy account, the latter being a new
development in 2006.
5a. Segmental information including 100% level syndicate analysis
This information is presented to include 100% of the syndicate results. This is
to avoid any distortion from the effects of change in ownership of syndicates
between underwriting years. All stated operating ratios are calculated by
reference to the following information:
The segmental results for the year ended 31 December 2006 are as follows:
Specialty Property Liability Aviation Discontinued Total
Marine units
£m £m £m £m £m £m
Gross written 158.6 52.1 48.7 47.5 (4.7) 302.2
premium
Net written premium 129.9 17.2 39.8 36.5 (5.7) 217.7
Net premium revenue 129.5 35.7 45.2 31.4 (5.7) 236.1
Net claims incurred 60.2 11.8 25.8 16.5 10.3 124.6
Operating expenses 39.9 15.4 15.7 9.7 0.1 80.8
(including
brokerage)
The segment results for the year ended 31 December 2005 are as follows:
Specialty Property Liability Aviation & Discontinue Total
Marine units
£m £m £m £m £m £m
Gross written 111.5 71.0 40.7 25.8 (1.3) 247.7
premium
Net written premium 68.4 54.6 29.8 18.8 (4.5) 167.1
Net premium revenue 109.1 95.3 61.0 22.9 (4.5) 283.8
Net claims incurred 75.1 98.3 30.8 1.9 43.5 249.6
Operating expenses 18.7 26.0 17.4 6.3 2.6 71.0
(including
brokerage)
5b. Segmental Novae ownership level analysis
The segmental results for the year ended 31 December 2006 are as follows:
Specialty Property Liability Aviation Dis Group Total
& Marine continued
units
£m
£m £m £m £m £m £m
Net premium 113.2 35.8 45.2 31.4 (4.8) - 220.8
revenue
Net claims (54.1) (12.2) (25.7) (16.5) 5.0 1.3 (102.2)
incurred
Investment 11.6 5.3 4.0 1.7 0.8 9.5 32.9
return
Other income - - - - - 9.7 9.7
Acquisition (21.9) (12.5) (11.5) (5.0) 0.3 - (50.6)
costs
Operating (13.6) (4.8) (4.7) (3.6) (0.4) (36.7) (63.8)
expenses*
Operating profit 35.2 11.6 7.3 8.0 0.9 (16.2) 46.8
/ (loss)
Financing costs (14.0)
Cost of scheme (1.5)
of arrangement
Profit/(loss) 31.3
before tax
* includes the currency loss on non-monetary items of £6.5 million (2005: gain
of £3.0 million).
The segment results for the year ended 31 December 2005 are as follows:
Specialty Property Liability Aviation Dis Group Total
& Marine continued
units
£m
£m £m £m £m £m £m
Net premium 93.6 96.0 61.1 22.9 (4.0) 1.0 270.6
revenue
Net claims (63.9) (97.3) (30.9) (1.9) 6.3 - (187.7)
incurred
Investment 6.1 4.3 2.8 0.8 (0.2) 12.0 25.8
return
Other income - - - - - 7.3 7.3
Acquisition (20.1) (15.4) (14.4) (3.2) (0.1) - (53.2)
costs
Operating (9.3) (17.5) (6.9) (3.9) (2.2) (20.1) (59.9)
expenses
Operating profit 6.4 (29.9) 11.7 14.7 (0.2) 0.2 2.9
/ (loss)
Profit on sale 4.0
of subsidiary
Financing costs (20.8)
Profit/(loss) (13.9)
before tax
5c. Segmental balance sheet analysis
Relevant balance sheet captions are deemed to be attributable to the business
segments as follows:
As at Aviation Total Discontinued
31 December & Marine (ongoing) units
2006 Specialty Property Liability Total
£m £m £m £m £m £m £m
Gross
provision for
claims 519.0 77.2 133.7 74.7 804.6 222.8 1,027.4
outstanding
Liabilities
unallocated
by segment 262.7
Shareholders'
funds
239.8
Total 1,529.9
liabilities
Reinsurers'
share of
claims 276.2 27.9 11.2 33.5 348.8 59.6 408.4
outstanding
Investment 199.1 26.4 49.9 10.7 286.1 74.6 360.7
assets
attributable
475.3 54.3 61.1 44.2 634.9 134.2 769.1
Assets
unallocated
by segment 760.8
Total assets 1,529.9
As at Aviation Total Discontinued
31 December & Marine (ongoing) units
2005 Specialty Property Liability Total
£m £m £m £m £m £m £m
Gross
provision for
claims 580.8 164.9 133.4 73.5 952.6 325.6 1,278.2
outstanding
Liabilities
unallocated
by segment 307.1
Shareholders'
funds
112.4
Total 1,697.7
liabilities
Reinsurers'
share of
claims 338.2 72.0 16.9 41.0 468.1 93.4 561.5
outstanding
Investment 193.3 37.7 6.2 2.0 239.2 100.7 339.9
assets
attributable
531.5 109.7 23.1 43.0 707.3 194.1 901.4
Assets
unallocated
by segment 796.3
Total assets 1,697.7
5d. Gross premium revenue by market
The following table shows the distribution of the Group's consolidated gross
written premium by geographical market (including 100% of the syndicate
results):
Year ended Year ended
31 December 31 December
2006 2005
£m £m
United Kingdom 125.6 111.5
North America 92.1 74.1
Elsewhere 84.5 62.1
302.2 247.7
The assets and liabilities of the Group are not managed on a geographical basis
and subsequently no geographical split has been provided.
6. Net premium revenue
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Gross written premiums 281.2 244.3
Change in the gross provision for unearned premiums 22.7 122.3
Gross premium revenue 303.9 366.6
Outward reinsurance premiums (78.6) (74.5)
Change in reinsurers' share of provision for unearned (4.5) (21.5)
premiums
Premium ceded to reinsurers (83.1) (96.0)
Net premium revenue 220.8 270.6
7. Fees and commission income
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Managing agency fees 0.9 1.1
Other income 8.8 6.2
9.7 7.3
8. Investment income
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Interest income 30.7 29.1
Net fair value gains / (losses) 2.9 (2.6)
Investment management expenses (0.7) (0.7)
32.9 25.8
9. Net claims incurred
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Claims paid (307.2) (321.8)
Decrease / (increase) in gross claims provision 148.6 (68.2)
Utilisation of exceptional loss provision 14.3 40.0
Gross claims incurred (144.3) (350.0)
Reinsurers' share of claims paid 152.3 137.4
(Decrease) / increase in reinsurers' share of claims (110.2) 24.9
provision
Reinsurers' share of claims incurred 42.1 162.3
Net claims incurred (102.2) (187.7)
10. Policy acquisition costs
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Brokerage and other business acquisition costs 49.1 28.2
Increase in deferred brokerage and other business 1.5 25.0
acquisition costs 50.6 53.2
11. Other operating expenses
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Underwriting expenses 27.3 40.8
Distribution company expenses 5.4 9.0
Central group expenses 24.6 13.1
57.3 62.9
Operating expenses include auditors' remuneration as
follows:
Fees payable to the auditor of the Company for the
audit of the Company's annual accounts 0.2 0.2
Fees payable to the Company's auditor for other
services:
- The audit of the Company's subsidiaries pursuant 0.3 0.2
to legislation
- Tax services 0.1 0.1
Further assurance services:
- Actuarial review 0.2 0.2
Other services pursuant to legislation 0.1 0.1
0.9 0.8
Audit fees of £0.2 million (2005: £0.2 million) for syndicates and £0.1 million
(2005: £nil) for Novae Insurance Company Limited are included within the 'audit
of the Company's subsidiaries pursuant to legislation' line in the table above.
In addition, fees of £0.2 million were incurred in relation to the working
capital review and other work undertaken as part of the scheme of arrangement.
All of these amounts are payable to KPMG Audit Plc except £12,000 (2005:
£12,000) which is payable to CLB Littlejohn Frazer.
12. Disposal of subsidiary
On 4 November 2005 the Group disposed of its investment in Fusion Insurance
Services Limited ('Fusion'). Profit on disposal was £4.0 million, arising from
proceeds of £15.0 million net of transaction costs of £1.5 million less the
Group's share of Fusion's net assets of £9.5million.
The carrying value of the assets and liabilities disposed of at 4 November 2005
were as follows:
£m
Cash and cash equivalents 14.2
Accounts receivable 13.5
Property, plant and equipment 0.8
Trade payables (16.6)
Carrying value at disposal 11.9
Less: minority interest (2.4)
Non cash transaction cost 1.2
Profit on disposal 4.0
Proceeds from disposal, net of cash transaction costs 14.7
Less: cash and cash equivalents disposed of (14.2)
Cash flow on disposal, net of cash and cash 0.5
equivalents disposed of
13. Financing costs
Year ended Year ended
31 31 December
December 2005
2006 £m
£m
Cost of convertible bond 4.0 4.6
Loan note interest 2.0 2.0
Reinsurer letter of credit costs 7.5 13.8
Bank letter of credit cost and other fees 0.5 0.4
14.0 20.8
14. Income taxes
Recognised in income statement
Year ended Year ended
31 December 31 December
2006 2005
£m £m
Current tax expense:
Current year - 0.3
Adjustments for prior years - -
- 0.3
Deferred tax (see note 19):
Effect of tax losses (recognised) / de-recognised (9.8) 2.9
Total income tax (benefit) / expense in income (9.8) 3.2
statement
Reconciliation of effective tax rate
Profit / (loss) before tax 31.2 (13.9)
Income tax at the standard UK corporation tax rate 9.4 (4.2)
(30%)
Effect of disallowable expenditure 0.4 -
Tax losses utilised (9.8) -
Effect of tax losses not recognised - 7.4
- 3.2
The future tax charge for the Group is dependent on the ability of the Group to
utilise Group tax losses.
15. Employees
(a) Employee numbers
The average number of persons employed during the period (including directors),
analysed by category, was as follows:
Year ended Year ended
31 December 31 December
2006 2005
Underwriting 91 86
Claims and reinsurance 41 36
Finance and actuarial 33 27
Operations 32 33
Internal audit, secretariat 6 6
and compliance
203 188
Fusion - 114
203 302
As discussed in note 12, Fusion was disposed of on 4 November 2005. With effect
from that date all employees of Fusion ceased to be employed by the Group.
(b) Employee costs Year ended Year ended
31 December 31 December
2006 2005
£m £m
Wages and salaries 13.2 17.8
Performance related pay 10.2 3.8
Contributions to defined contribution pension 1.9 2.4
plans
Social security costs 2.9 2.6
Employee equity incentives 3.2 1.6
Compensation for loss of office 0.2 -
Other related costs 0.3 0.2
31.9 28.4
(c) Share based payments
The terms and conditions of the grants, and number of outstanding options
granted to directors and employees of the Group, are as follows, whereby all
options are settled by physical delivery of shares:
Grant date Outstanding Vesting conditions Contractual
instruments life of
obligations
Share options
24/07/98 262,131 Three years' service 10 years
04/11/99 189,969 Three years' service. At date of 10 years
exercise, increase in net asset value
of Group over preceding three year
period to be 6% higher than increase
in FTSE 350 Index
06/10/00 550,381 Three years' service 10 years
11/11/02 2,137,208 Three years service. 50% vest if 10 years
share price is 150% of price at date
of grant. Performance target rises to
175% and 200% for two subsequent 25%
tranches
18/11/03 750,000 Three years' service. 50% vest if 10 years
share price
10 years exceeds 150% of option
price, a further
25% vest at 175% and the remaining
25% at 200%
18/11/03 1,335,000 Three years' service. 50% vest if 10 years
share price is 125% of option price
with the remaining 50% at 150%
05/05/04 5,524,700 Three years' service. Net tangible 10 years
assets (NTA) must exceed 55.8p + RPI
+ 9% pa at 31/12/06 or NTA must
exceed 55.8p + RPI + 12% pa at 31/12/
07
05/05/04 100,000 Three years' service. 50% vest if 10 years
share price is 125% of option price
with the remaining 50% at 150%
LTIP shares
11/11/02 1,977,180 Three years' service. 1,422,808 vest 3 years,
if share price is 150% x prevailing extended by a
share price. 267,186 vest if share further 2
price is 175 % x prevailing share years from 11
price and 267,186 vest if share price /11/05
is 200% x prevailing share price
05/05/04 150,000 Three years' service. Positive NTA 3 years
17/12/04 1,075,056 Three years' service. Positive NTA 3 years
05/01/05 9,800,000 Three years' service. 25% vest if NTA 3 years
increases by RPI + 5%, a further 25%
at NTA + RPI + 10% and the remaining
25% at NTA + RPI + 15% (these
conditions have yet to be
recalibrated to allow for the effects
of the rights issue)
16/01/06 16,075,810 Three years' service. Award in two 3 years
parts:
Part A (75% of total): adjusted NTA
increases from 28.9p to 34.9p in 25%
increments (ie 50% vests if NTA
increases to 31.9p), where adjusted
NTA equals actual NTA less changes in
NTA attributable to 2002 and prior
Years of Account.
Part B (25% of total): NTA increases
from 28.9p to 34.9p in 25% increments
(ie 50% vests if NTA increases to
31.9p)
The options are exercisable between three and ten years after grant subject to
the satisfaction of the relevant performance targets. The expiry date of all
share options is ten years following the issue date. The expiry date of all LTIP
awards is three years following the issue date.
On 18 November 2006, 1,612,500 LTIP shares vested.
Prior to merger with the Group, CLM Insurance Fund plc (CLM) had granted options
to certain employees under the CLM Insurance Fund plc Senior Executive Share
Option Scheme 1994. These were converted into options in Novae on equivalent
terms.
On 16 January 2006, 3,550,325 deferred shares were granted.
The number and weighted average exercise price of share options is
as follows:
Weighted Number of Weighted Number of
average options average options
exercise 2006 exercise 2005
price thousands price thousands
2006 2005
pence pence
Outstanding at the beginning of 57 11,233 57 11,248
the year
Forfeited during the year 53 (334) 51 (15)
Exercised during the year - - - -
Granted during the year - - - -
Outstanding at the end of the 57 10,899 57 11,233
year
Exercisable at the end of the 57 10,899 57 11,233
year
The options outstanding at 31 December 2006 have an exercise price in the range
of 46.8p to 162.8p and a weighted average contractual life of six years.
The fair value of services received in return for share options granted are
measured by reference to the fair value of share options granted. The estimate
of the fair value of the services received is measured based on a binomial
lattice model. The contractual life of the option (10 years) is used as an input
into this model. Expectations of early exercise are incorporated into the
binomial lattice model.
Share options Fair Issue Exercise Expected Option Expected Riskfree
value price price volatility life dividends interest
rate
Share options
18/11/03(a) 15.0p 49.0p 57.0p 50% pa 10 years nil 5 % pa
18/11/03(b) 18.4p 49.0p 49.0p 50% pa 10 years nil 5 % pa
05/05/04(a) 15.14p 50.83p 50.83p 35% pa 10 years nil 5 % pa
05/05/04(b) 14.4p 50.83p 50.83p 35% pa 10 years nil 5 % pa
LTIP shares
05/05/04 51.0p 51.0p n/a n/a n/a nil n/a
17/12/04 32.5p 32.5p n/a n/a n/a nil n/a
05/01/05 32.5p 32.5p n/a n/a n/a nil n/a
16/01/06 30.0p 30.0p n/a n/a n/a nil n/a
The expected volatility is based on historic volatility. The actual volatility
over the period 2002-2003 was higher than has been the case in more recent
periods, which is reflected in the differential volatility assumptions on
earlier and later incepting options.
Vesting of options is conditional upon a service condition and a market
condition in all cases except tranche (a) of the 05/05/04 grant which has a
service condition and a non-market condition. The fair value of this tranche has
been determined using the Black-Scholes formula, and the other tranches using a
Monte Carlo simulation.
Option life is in all cases 10 years from date of grant, with the option to
exercise from three years subject to vesting conditions being met. In
determining the fair value, it has been assumed that 50% of options will be
exercised after three years, and 10% in each of the subsequent five years.
The historical price of Novae (previously SVB) shares has shown considerable
volatility in recent years, which reflects the position of the Group during the
period in which losses emerged from the US liability business written in the
late 1990s. It appears inappropriate to assume a similar level of volatility in
the future, and a lower value has been assumed for the purposes of valuing the
options.
The 05/05/04 and 17/12/04 LTIP awards have the same vesting condition, i.e.
positive NTA at expiry. The fair value of these at grant has been taken as the
then prevailing share price. The 05/01/05 grant vests in tranches based upon
progressively more onerous NTA targets. In determining the fair value it has
been assumed that the first 50% will vest, which is to say that NTA increases by
RPI plus between 10% and 15% pa over the three years.
The 16/01/06 grant also vests based upon progressive NTA targets, although these
are less onerous than the 05/01/05 grant. Applying consistent assumptions to the
two awards produces a fair value equal to the then prevailing share price of
30.0p.
16. Property, plant and equipment
Group
Computer Fixtures, Office Total
equipment fittings, refurbishment £m
£m tools & £m
equipment
£m
Cost
As at 1 January 2005 9.8 0.3 3.0 13.1
Additions 1.0 0.3 0.1 1.4
Disposals (8.3) (0.2) (2.4) (10.9)
As at 31 December 2005 2.5 0.4 0.7 3.6
Balance as at 1 January 2006 2.5 0.4 0.7 3.6
Additions 1.2 - - 1.2
Disposals - - - -
As at 31 December 2006 3.7 0.4 0.7 4.8
Depreciation 7.0 0.2 2.5 9.7
As at 1 January 2005
Charge for the period 1.9 0.2 0.3 2.4
Disposals (7.7) (0.3) (2.3) (10.3)
As at 31 December 2005 1.2 0.1 0.5 1.8
Balance as at 1 January 2006 1.2 0.1 0.5 1.8
Charge for the period 1.3 0.2 0.2 1.7
Disposals - - - -
As at 31 December 2006 2.5 0.3 0.7 3.5
Net book value
As at 31 December 2005 1.3 0.3 0.2 1.8
As at 31 December 2006 1.2 0.1 - 1.3
17. Intangible assets
Syndicate capacity
31 December 31 December
2006 2005
£m £m
Cost
As at beginning of period 14.6 14.6
Additions 0.1 -
As at end of period 14.7 14.6
Amortisation
As at beginning of period 6.3 5.3
Charge for the period 1.0 1.0
As at end of period 7.3 6.3
Net book value
Opening 8.3 9.3
Closing 7.4 8.3
The amortisation charge is included within operating expenses. The remaining
amortisation period is seven years for the majority of the asset.
18. Deferred acquisition costs
31 December 31 December
2006 2005
£m £m
Balance at start of the year 25.3 46.9
Utilisation of balance brought forward (22.3) (39.5)
Additional amounts deferred in year 21.7 17.9
Balance at end of the year 24.7 25.3
19. Deferred tax
Recognised deferred tax assets
The deferred tax asset is attributable to the following:
31 December 31 December
2006 2005
£m £m
Temporary differences (0.8) (0.8)
Unutilised tax losses 32.4 42.2
31.6 41.4
Unrecognised deferred tax assets
Deferred tax assets have not been recognised in respect of the following items:
31 December 31
2006 December
2005
£m £m
Trading losses (30% of gross unrecognised losses) 24.1 17.9
Deferred tax assets have not been recognised in respect of losses amounting to
£24.1 million due to the uncertainty that future taxable profit will be
available against which the Group can utilise the benefits therefrom. Future
utilisation of the asset has been measured by reference to the Group's projected
profit.
The Group also has accumulated gross capital losses of £45.8 million. No asset
has been recognised in respect of these losses.
20. Principal subsidiary undertakings
Country of Class of Principal Percentage
incorporation share held activity of ordinary
shares held
Novae Holdings PLC England & Ordinary Intermediate 100%
Wales holding company
Novae Syndicates Limited England & Ordinary Lloyd's 100%
Wales managing agency
Novae Corporate Underwriting England & Ordinary Lloyd's 100%
Limited Wales corporate
member
Novae Management Limited England & Ordinary Infrastructure 100%
Wales company
Novae Insurance Company England & Ordinary Insurance 100%
Limited Wales company
Novae Underwriting Limited England & Ordinary Service company 100%
Wales
Novae Capital 1 Limited England & Ordinary Not trading 100%
Wales
Credit Indemnity & Financial England & Ordinary Not trading 100%
Services Limited Wales
Novae Group SIP Trustee England & Ordinary Not trading 100%
Company Limited Wales
Syndicate Capital England & Ordinary Not trading 100%
Underwriting Limited Wales
The results, assets and liabilities of all of the above subsidiaries are
included in the consolidated financial statements.
21. Financial assets
31 31
December December
2006 2005
Fair value through profit or loss: £m £m
Fixed interest securities 586.2 578.5
Equities 0.8 0.8
587.0 579.3
Syndicate 262.5 339.9
Corporate 324.5 239.4
587.0 579.3
Listed 587.0 579.3
Unlisted - -
587.0 579.3
Breakdown of fixed interest securities by credit 31 December 31
rating: 2006 December
2005
% %
Government/AAA 88.7 94.0
AA+/AA/AA- 10.2 3.0
A+/A/A- 1.1 3.0
100.0 100.0
Breakdown of investments by currency: 31 December 31
2006 December
2005
% %
US dollar 45.4 46.4
Sterling 43.5 47.1
Other currencies 11.1 6.5
100.0 100.0
The maturity profile of investments based on the average duration is as follows:
31 Average
December duration
2006
£m Years
Funds at Lloyd's 226.3 0.4
Syndicate Premium Trust Funds 262.5 0.7
Novae Insurance Company Limited 98.2 0.9
The funds at Lloyd' are subject to a charge as detailed in note 30.
22. Reinsurance contracts
31 December 31 December
2006 2005
£m £m
Reinsurance contracts 423.3 587.2
Less:
Reinsurers' share of:
- provisions for unearned premium (21.2) (25.7)
- claims outstanding 402.1 561.5
- provision for losses incurred but not reported (90.7) (108.0)
Balance 311.4 453.5
Being:
Recoveries on claims notified not yet due 316.9 465.2
Provision for bad debt (notified not yet due) (5.5) (11.7)
Net recoveries on claims notified not yet due 311.4 453.5
The reinsurers' share of paid and notified losses can be analysed by credit
rating as follows*:
31 31 December
December 2005
2006
% %
S&P: AAA 19.3 13.1
AMB: A++
S&P: AA 62.1 32.7
AMB: A/A-
S&P: A (inc Lloyd's) 14.8 44.6
AMB: B++/B+
Less than A 3.8 9.6
100.0 100.0
* Due to the way the Group monitors its reinsurance balances, different rating
agencies are used depending upon the domicile of the reinsurer. Standard & Poors
(S&P) and AM Best (AMB) ratings have been grouped together in a way that the
Group has deemed most appropriate.
23. Insurance and other receivables
31 December 31 December
2006 2005
£m £m
Arising from underwriting business 201.9 196.1
Arising from service companies and other subsidiaries 8.6 28.8
Prepayments and accrued income 3.2 9.5
213.7 234.4
Receivables are stated at fair value.
24. Cash and cash equivalents
31 December 31 December
2006 2005
£m £m
Cash 162.8 139.2
Overseas deposits 78.1 80.8
240.9 220.0
Of the total cash and cash equivalents £199.8 million (2005: £188.5 million) is
held by the syndicates in Premium Trust Funds to meet policyholder liabilities.
25. Insurance contracts
(a) Insurance contract liabilities
31 December 31 December
2006 2005
Gross Net Gross Net
Reinsurance Reinsurance
£m £m £m £m £m £m
Unearned premiums 136.1 21.2 114.9 155.8 25.7 130.1
IBNR 308.6 90.7 217.9 357.9 105.0 252.9
Notified claims 718.8 311.4 407.4 920.3 456.5 463.8
Exceptional loss 12.8 - 12.8 27.1 - 27.1
provision
Total insurance 1,176.3 423.3 753.0 1,461.1 587.2 873.9
liabilities
Contracts due 286.7 115.9 170.8 407.3 182.8 224.5
< 1 year
Contracts due 889.6 307.4 582.2 1,053.8 404.4 649.4
> 1 year
1,176.3 423.3 753.0 1,461.1 587.2 873.9
In addition to IBNR reserves established at subsidiary level on the basis of
actuarial best estimate totalling £196.7 million (2005: £232.2 million), an
additional £12.8 million of provision has been recognised as at 31 December 2006
(2005: £27.1 million) in respect of the uncertainty surrounding potential future
claims development from discontinued units. This provision, which is over and
above syndicate reserves set at actuarial best estimate, was established as at
30 June 2004 to meet possible future adverse claims development. During the year
ended 31 December 2006 £14.3 million of this provision was utilised, leaving
£12.8 million remaining at year end.
The provision was established to strengthen reserves associated with the
discontinued business, in particular the liability reinsurance business, which
are subject to a high degree of uncertainty. This reflects market conditions in
the late 1990s and the claims environment in the US in the period covered by the
contracts written being significantly different from that in prior periods,
which makes any projection methodology that relies upon extrapolation of past
trends subject to an increased degree of subjectivity.
For similar reasons Syndicates 1007 and 1241 have not closed their
2002 Years of Account. The 2006 annual reports for both state that the
uncertainty that led to the accounts going into run off at 36 months still
prevails at 60 months. This uncertainty arose due to deterioration in treaty
reserves and late advices from assureds, which have produced some exhaustion of
the excess of loss reinsurance programmes both on an incurred and on an incurred
but not reported basis.
As a result of these matters, there exists significant uncertainty concerning
the amounts provided and subsequent information and events may result in
significant adjustments to the amounts provided.
(b) Movement table for insurance contract liabilities Year ended Year ended
(i) Unearned premium 31 December 31 December
2006 2005
£m £m
Balance as at 1 January 155.8 279.0
Premiums written during the year 250.5 243.4
Less: premiums earned during the year (270.2) (366.6)
Balance at 31 December 136.1 155.8
(ii) Claims reserve Year ended Year ended
31 December 31 December
2006 2005
£m £m
Balance as at 1 January 1,278.2 1,125.5
(Reduction)/increase in claims outstanding (199.6) 198.9
Reduction in IBNR (49.3) (47.4)
(Reduction)/increase in claims handling provision (1.9) 1.2
Balance at 31 December 1,027.4 1,278.2
(iii) Exceptional loss provision Year ended Year ended
31 December 31 December
2006 2005
£m £m
Balance as at 1 January 27.1 67.1
Utilised during year (14.3) (40.0)
Balance at 31 December 12.8 27.1
(c) Claims development
Claims development is shown below on an underwriting year basis.
2001 and
prior 2002 2003 2004 2005 2006 Total
Underwriting year £m £m £m £m £m £m £m
Gross claims:
Estimate of ultimate gross
claims:
2,011.9 241.0 198.6 247.1 260.9 160.4
- at end of underwriting
year
- one year later 2,110.2 230.9 202.3 236.1 238.5
- two years later 2,321.8 226.2 179.0 234.5
- three years later 2,503.9 260.2 164.0
- four years later 2,642.4 267.1
- five years later 2,638.5
Gross claims paid
- at end of underwriting 840.2 4.3 3.9 10.4 22.0 3.1
year
- one year later 1,119.8 27.4 34.8 59.0 86.1
- two years later 1,403.4 67.7 61.5 113.5
- three years later 1,636.8 116.6 79.9
- four years later 1,837.7 142.3
- five years later 1,992.4
Gross ultimate claims 646.1 124.8 84.1 121.0 152.4 157.3 1,285.7
reserve
Gross unearned claims (95.6)
reserve
Third party participation (162.7)
on
syndicates
Gross claims reserve 1,027.4
2001 and
prior 2002 2003 2004 2005 2006 Total
Underwriting year £m £m £m £m £m £m £m
Net claims:
Estimate of ultimate net
claims
1,187.4 158.5 138.6 189.8 178.5 125.6
- at end of underwriting
year
- one year later 1,231.4 156.1 140.7 180.7 157.1
- two years later 1,262.9 140.0 121.6 166.8
- three years later 1,414.9 157.0 116.4
- four years later 1,463.5 159.2
- five years later 1,470.6
Net claims paid
- at end of underwriting 544.9 4.1 3.9 10.3 8.9 3.1
year
- one year later 708.4 21.8 21.1 47.2 40.6
- two years later 848.8 48.6 40.6 77.8
- three years later 983.1 76.3 55.3
- four years later 1,087.0 90.9
- five years later 1,148.4
Net ultimate claimsreserve 322.2 68.3 61.1 89.0 116.5 122.5 779.6
Net unearned claims reserve (78.9)
Third party participation (75.4)
on syndicates
Net claims reserve 625.3
The tables above show the development of claims over time on a gross and net of
reinsurance basis. These claims are shown on an ultimate basis for each
successive underwriting year and include 100% of the syndicate level results.
Balances have been translated at exchange rates prevailing at 31 December 2006
in all cases.
The information shown above is prepared on an underwriting year basis and then
therefore it relates the expected cost of claims to the level of ultimate
premiums. Changes in the projected level of ultimate premiums will therefore
contribute to the movement in claims costs shown above. Across all prior years
net of reinsurance and excluding the business of the discontinued units covered
by a separate provision (see note 25(a)), that component of claims development
that relates to settlement of claims at levels different from reserves carried
or reassessment of reserves required in respect of claims that remain unsettled
amounted in aggregate to a credit of £3.9 million in respect of the Novae
corporate member. It is this amount which constitutes the movement in reserves
net of reinsurance on an accident year basis attributable to Novae.
(d) Assumptions and sensitivities
(i) Assumptions
The ultimate cost of outstanding claims is in most cases estimated by using a
range of standard actuarial projection techniques, such as the Chain Ladder and
Bornhuetter-Ferguson methods. Such methods extrapolate the development of claims
numbers for each underwriting year, based on the claims patterns of earlier
years and expected loss ratios. Exceptions to these standard methodologies are
used in a small number of cases where these are inappropriate.
The main assumption underlying these standard techniques is that past claims
development experience can be used to project ultimate claims costs. Judgement
is used to assess the extent to which past trends may not apply in future and
alternative approaches are applied as appropriate for catastrophe exposed claims
where loss development patterns are less regular.
The approach adopted takes into account, inter alia, the nature and materiality
of business and the type of data available. Specific estimates are set by the
Reserving Committee based on a blend of these techniques, applying their
experience and knowledge to the circumstances of individual claims, and in the
case of certain US liability classes, the advice of US attorneys who specialise
in claims of this nature. Additional qualitative input, such as allowance for
one-off occurrences or changes in legislation, policy conditions or portfolio
mix, is also used in arriving at the best estimate of claims with the input of
internal actuaries.
At the early stage of development of long-tail classes of business significant
weight is given to changes in the rating environment and conditions on renewal
of policies in arriving at ultimate claims costs. Provisions are calculated
allowing for reinsurance recoveries and a separate asset is recorded for the
reinsurers' share, having regard to recoverability.
(ii) Amount, timing and uncertainty of cash flows
Future cash flows are estimated by taking the estimated cost of outstanding
claims, plus liabilities incurred in the future, and spreading these amounts
over future calendar years based upon payment patterns observed from past
experience.
The payment patterns are essentially probabilistic and will allow for situations
where significant reserves are settled in one time period, where that time
period is unknown. For example, claims arising for events surrounding Enron may
well settle over a relatively short period, but at present it is not clear when
that period will start. The payment pattern applied will spread the payments
over the potential settlement period.
The uncertainty in the projected cash flows will be high because it is derived
from both the uncertainty in reserves and the uncertainty in the payment
patterns of the cash flow projected in an individual time period.
(iii) Sensitivity analysis
The insurance contract liabilities are the result of a process that blends
statistical analysis of historical data with subjective interpretation of
qualitative information. These liabilities will therefore be sensitive to
limitations of the available data, and to the subjectivity employed in
interpreting both the qualitative and quantitative information. For example,
certain potential scenarios may not be adequately represented in the data. The
business written by the Group is diverse, and each line of business is analysed
separately so that to a large degree the sensitivity within any one class will
be immaterial at the Group level. Also, the diverse nature of the portfolio
means that the potential downside risk within one class of business may be
offset by upside potential in another.
There are, however, a number of areas in which the sensitivity is potentially
material at the Group level. These are considered below:
(a) Liability reinsurance
Shortcomings in the data provided by the ceding companies mean that reserving
for this class of business is particularly subjective. The account was scaled
down in 2001 and ceased underwriting in 2002 so as time passes the uncertainty,
and therefore the sensitivity of the Group result to the assumptions made for
this class, is reducing. Nevertheless, significant uncertainty remains at the
present time.
It was in recognition of this that the Group established an
additional provision for the Discontinued Businesses (of which liability
reinsurance makes up by far the largest part). This was established after
considering alternative runoff scenarios and so provides some indication of the
sensitivity of the syndicate level insurance contract liabilities to the
assumptions made. The existence of the provision serves to shift the balance of
probabilities relative to the liabilities held in the syndicate, and in
particular reduce the downside potential, although it is possible to construct
scenarios that are worse than that underlying the provision so some downside
risk remains.
(b) Investment banking reserves
The Group has significant exposures to US investment banks which have been
affected by events surrounding Enron and Worldcom, as well as IPO laddering
issues. Estimates of insurance contract liabilities for these potential
exposures have been established in consultation with the Group's legal advisors,
based upon their views as to the likely outcome of the various legal cases and
settlement negotiations. During the course of 2006 settlements were reached on
some of these expenses and therefore the sensitivity has reduced relative to the
end of 2005. Nevertheless, uncertainty remains although this is reduced
significantly by reinsurance.
26. Financial liabilities
(a) Convertible bond
Novae Holdings PLC issued 500,000 7 per cent. convertible bonds at a nominal
value of £50 million on 15 December 2003. On 18 May 2006 the liability due on
these bonds was transferred to Novae Group plc.
The bonds mature five years from the date of issue at their nominal value of £50
million or can be converted into shares at the holder's option at the rate of
one ordinary share per 55.66p (nominal value) (adjusted from 61.22p with effect
from 22 May 2006) of convertible debt. Bondholders can convert their bonds to
shares at any time until 9 December 2008.
The fair value of the liability component and the equity conversion component
were determined at issuance of the bond. The fair value of the liability
component was calculated using a market interest rate for an equivalent
non-convertible bond net of issue costs of £2.1 million. The residual amount,
representing the value of the equity conversion component, is included in
shareholders' equity.
£m
Nominal value of convertible bond issued on 15 50.0
December 2003
Equity component (5.5)
Issue costs deferred (2.1)
Liability component on initial recognition 42.4
Interest expense 13.3
Interest paid (10.5)
Amortisation of issue costs 1.3
Liability component at 31 December 2006 46.5
Liability component at 31 December 2005 45.5
(b) Loan notes
During 2004, the Group issued $36.0 million of 30 year floating rate notes as
follows:
Issue date Maturity Earliest Margin
date redemption rate above
date 3 month US
LIBOR
per annum
$15.0 million floating rate 30 June 2004 30 June 15 August 2009 3.50%
notes 2034
$11.0 million floating rate 30 June 2004 30 June 15 August 2009 4.05%
2034
subordinated notes
$10.0 million floating rate 22 September 30 June 19 November 3.50%
notes
2004 2034 2009
The notes constitute direct, unsecured and unsubordinated obligations of the
issuer ranking pari passu, without any preference amongst themselves, with all
other existing and future unsecured unsubordinated debt of the issuer. Issue
costs of £0.5 million are being amortised on an effective interest rate basis as
at inception. Interest is payable on a quarterly basis in arrears. The notes are
listed on the Irish Stock Exchange. Forward contracts are used to match exposure
to fluctuations in foreign exchange rates and interest rates in respect of the
$15.0 million and $11.0 million loan notes. The loan notes are denominated in US
dollars with the interest payable pegged to the US LIBOR. The forward contracts
which mature on the same date as the interest is due for payment on the loans
have the effect of hedging 100% of the interest rate and foreign exchange rate
risks.
(c) Revolving credit facility
Novae Group has available a revolving credit facility from one of its bank of
£20.0 million, none of which was drawn at 31 December 2006 (2005: £nil).
27. Insurance and other payables
31 31 December
December 2005
2006 £m
£m
Arising from underwriting business 33.2 18.7
Arising from service companies and other subsidiaries 13.1 25.1
Deferred income 1.3 15.3
47.6 59.1
The carrying value of insurance and other payables is a reasonable approximation
of their fair value.
28. Retirement benefit obligations
For certain staff employed by the Group prior to the merger with CLM and for all
employees joining the Group thereafter the Group operates the Novae Group
Retirement Benefit Scheme ('RBS'). The RBS was established with effect from 1
September 1995 by the Group's managing agency subsidiary. It is a defined
contribution scheme and will provide benefits based upon the level of
contributions made. The contributions of employees to the RBS are at the rate of
5% salary. Novae's contributions are dependent upon age and range from 11.0% to
18.5% of salary. No additional contributions were made during the year in
respect of directors.
The funds of the RBS are independent of the Group's assets. The pension charge
of the Novae Group for the year was £1.9 million (2005: £2.4 million). There
were no contributions outstanding or prepaid at 31 December 2006 (2005: £nil).
29. Capital and reserves
Reconciliation of movement in capital and reserves
Share Share Merger Other Profit Equity Total
capital premium reserve reserves and loss component of
account account convertible
bond
£m £m £m £m £m £m £m
Balance at 1 114.4 83.6 - 63.4 (138.9) 5.5 128.0
January 2005
Loss for the - - - - (17.1) - (17.1)
year
Movement in - - - - 1.5 - 1.5
treasury shares
As at 31 114.4 83.6 - 63.4 (154.5) 5.5 112.4
December 2005
Profit for the - - - - 21.5 - 21.5
year
Increase in - - - - 2.9 - 2.9
share based
payment reserve
Acquisition of - - - - (0.7) - (0.7)
treasury shares
Group
re-organisation (77.8) (83.6) 69.6 91.8 - - -
Rights issue 36.6 67.1 - - - - 103.7
As at 31
December 2006
73.2 67.1 69.6 155.2 (130.8) 5.5 239.8
Share capital
Ordinary shares of 10p Preference shares Deferred shares
of £1 of 40p
Number £ Number £ Number £
Authorised
31 December 2005 572,023,200 57,202,320 - - 194,494,200 77,797,680
- Novae Holdings
PLC (formerly SVB
Holdings PLC)
31 December 2006 3,499,500,000 349,950,000 50,000 50,000 - -
-
Novae Group plc
Issued and fully
paid
31 December 2005 366,106,728 36,610,673 - - 194,494,200 77,797,680
Cancellations - - - - (194,494,200)(77,797,680)
18 May 2006- 366,106,728 36,610,673 - - - -
Novae Holdings
PLC
On formation of 2 2 - - - -
Novae Group plc
On redesignation 18 - 50,000 50,000 - -
Group 366,106,708 36,610,673 - - - -
reconstruction -
shares in Novae
Holdings PLC
exchanged for
shares in Novae
Group plc
Rights issue 366,106,728 36,610,673 - - - -
31 December 2006 732,213,456 73,221,348 50,000 50,000 - -
The preference shares are redeemable at any time at the option of Novae Group
Plc. The premium on redemption is £nil. They carry no voting or dividend rights.
The Group has also issued share options (see note 15c).
The authorised and issued deferred shares in Novae Holdings PLC (formerly SVB
Holdings PLC) ('the deferred shares') were created in the context of the capital
reorganisation approved by shareholders on 27 May 2003 and were designed to
enable the re-designation of each of Novae Holdings PLC's ordinary 50 pence
shares, as they then were, into one 10 pence ordinary share and one 40 pence
deferred share. The deferred shares carried no voting, dividend or other rights
and had no commercial value. The authorised and issued ordinary 10 pence shares
were similarly created in the capital reorganisation approved by shareholders on
27 May 2003. The deferred shares were cancelled on the effective date of the
scheme described below.
On 18 May 2006 under a scheme of arrangement between Novae Holdings PLC
(formerly SVB Holdings PLC), the former holding company of the Group, and its
shareholders under Section 425 of the Companies Act 1985, and as sanctioned by
the High Court, all the issued shares in that company were cancelled and the
same number of new shares were issued to Novae Group plc in consideration of the
allotment to shareholders of one ordinary share in Novae Group plc for each
ordinary share in Novae Holdings PLC held on the record date, 17 May 2006. In
the above table the figures up to 18 May 2006 relate to shares in Novae Holdings
PLC. Subsequent movements relate to shares in Novae Group plc.
Novae Group plc was incorporated on 12 January 2006, under the name SVB Newco
PLC, with an authorised share capital of £50,000 and 2 issued ordinary shares of
£1 each. The ordinary shares carry full voting and dividend rights.
On 15 May 2006:
(i) the authorised capital was increased from £50,000 to £350,000,000 by the
creation of an additional 349,950,000 ordinary shares of £1 each;
(ii) £50,000 of unissued ordinary shares of £1 each were redesignated as
non-voting redeemable preference shares of £1 each, which were then issued;
(iii) the remaining ordinary shares of £1 each were sub-divided into 10 ordinary
shares, having in each case the rights set out in the Articles of Association.
Thus, at 18 May 2006, the balance sheet of Novae Group plc was as follows:
£
Assets
Cash and cash equivalents 50,002
Equity and liabilities
Issued capital
Ordinary shares of 10 pence each 2
Non-voting redeemable preference shares 50,000
of £1 each
Total equity 50,002
On 18 May 2006 as part of the scheme of arrangement noted above, a further
366,106,728 ordinary shares of 10 pence were issued, whereby Novae Group plc was
interposed as the new holding company of the Novae Group. As required by Section
131 of the Companies Act 1985 (Merger Relief), no share premium was recognised.
The valuation of these shares totalled £106.2 million; the balance over the
nominal value is £69.6 million which is classed as a merger reserve. Costs of
the scheme of arrangement of £1.5 million are included in the income statement.
Novae Group plc then undertook a one-for-one rights issue, whereby a further
366,106,728 ordinary shares of 10 pence were issued, at a premium of £67.1
million.
Prior to the Group reconstruction, Novae Group plc was an inactive company, and
the acquisition therefore added no additional profit or loss to the Novae Group.
Other reserves
These comprise:
1) A non-distributable merger reserve which represents the premium created on
merger with CLM Insurance Fund plc in 1999 (£61.9 million).
2) A capital redemption reserve of £1.5 million, being a non-distributable
reserve relating to the
acquisition of shares for cancellation. In 1999 0.5 million shares were acquired
and then cancelled at a cost of £0.3 million. In 2000 2.5 million shares were
acquired and then cancelled at a cost of £1.2 million.
3) In the current year deferred shares of £77.8 million were cancelled as
described above.
4) The remaining reserve balance of £14.0 million relates to share premium held
by Novae Holdings PLC.
Equity component of convertible bond
This represents the equity component of the Group's convertible bond issued in
2003. See note 26(a).
30. Contingencies and other commitments
(a) If at 31 December 2006 the Group's corporate member subsidiary, Novae
Corporate Underwriting Limited, or the corporate members disposed of in 2000,
namely Syndicate Capital Nos 1-5 Limited and CLM A-H, J and K, failed to meet
any of its or their Lloyd's obligations, Lloyd's will:
(i) be entitled to require Novae Holdings PLC (formerly SVB Holdings PLC) and
its other subsidiaries (being all of Novae Group save Novae Group plc, Novae
Insurance Company Limited, Novae Group SIP Trustee Company Limited and Novae
Management Limited) to cease or reduce their underwriting; and/or
(ii) having regard to the fact that the Central Fund may be applied to discharge
the obligations of the defaulting subsidiary, be entitled to require each of the
other corporate member subsidiaries to make contributions to the Central Fund up
to the amount of their respective net profits held from time to time in premiums
trust funds, sufficient to reimburse the Central Fund in full for any payment
made on behalf of the defaulting member. At the date of these financial
statements the directors are not aware of any of its corporate member
subsidiaries failing to meet any of its Lloyd's obligations.
(b) Certain of the Group's assets are used as security for covenants used as
Funds at Lloyd's by the corporate member subsidiary members. The assets charged
to Lloyd's at 31 December 2006 comprise financial assets and cash with a value
of approximately £226.3 million. In addition Novae Holdings PLC has granted
Lloyd's a floating charge over its entire assets and undertakings. In certain
circumstances the charged assets may be required to meet obligations to
policyholders should Novae corporate members be unable to do so.
(c) On 19 August 1999, Novae Holdings, as the then ultimate parent company of
the corporate members Syndicate Capital 1-5 Limited, entered into a guarantee in
favour of a European reinsurer in respect of the performance of the obligations
under the reinsurance contract of the same date covering the 1997 and 1998
underwriting years. On 30 November 1999, Novae Holdings PLC, as the then
ultimate parent company of the corporate members CLM A-H, J and K Limited,
entered into a guarantee in favour of a European reinsurer on that date in
respect of the performance of the obligations under the reinsurance contract of
the same date covering the 1997, 1998 and 1999 underwriting years. The Group
disposed of the corporate members, Syndicate Capital 1-5 Limited and CLM A-H, J
and K Limited, on 10 March 2000 to Mayheld Limited. As part of this disposal,
Syndicate Capital Underwriting Limited, a subsidiary of Novae Holdings PLC,
agreed to indemnify Mayheld Limited and the shareholders of Mayheld Limited
against any loss, damage, costs, liabilities, claims, cash calls and expenses to
the extent that the same are not covered by the reinsurance contracts referred
to above, expected to be £nil.
(d) On 21 November 2002, Novae Holdings entered into a guarantee in favour of a
Bermudan reinsurer in respect of the obligations, including the payment of
premiums due, of the Group's corporate member subsidiary, arising under an
excess of loss reinsurance contract provided by that reinsurer. On 25 September
2002, Novae Holdings entered into a contract in favour of the European reinsurer
referred to in (c) above, providing an excess of loss indemnity in respect of a
high level layer of risk covered by a successor reinsurance contract to those
referred to above.
31. Status of the financial information
The financial information set out above does not constitute the Company's
statutory accounts for the years ended 31 December 2006 or 2005 but is derived
from those accounts.
Statutory accounts for 2005 have been delivered to the registrar of companies,
and those for 2006 will be delivered in due course.
The auditors have reported on those accounts; their reports were unqualified,
but both included a reference to the uncertainty of the level of gross loss
reserves for discontinued units to which the auditors drew attention by way of
emphasis of matter without qualifying their reports. This uncertainty is
further explained in note 25 of this financial information.
The auditor's report was unqualified and did not contain statements under
section 237(2) or (3) of the Companies Act 1985.
This information is provided by RNS
The company news service from the London Stock Exchange