SOLVENCY AND FINANCIAL CONDITION REPORT

Transcription

1 SOLVENCY AND FINANCIAL CONDITION REPORT Year ended 31 March 2017 Company No Authorised by the Prudential Regulation Authority and regulated by the Prudential Regulation Authority and the Financial Conduct Authority FRN

2 CONTENTS Summary 4 Approval by the Board 7 Audit Opinion 8 A. Business and Performance 12 A.1 Business 12 A.2 Underwriting Performance 13 A.3 Investment Performance 14 A.4 Performance of other activities 15 A.5 Any other information 15 B. System of Governance 16 B.1 General Information on the System of Governance 16 B.2 Fit and Proper requirements 21 B.3 Risk management system including the own risk and solvency assessment 22 B.4 Internal control system 27 B.5 Internal audit function 29 B.6 Actuarial function 30 B.7 Outsourcing 31 B.8 Any other information 32 C. Risk Profile 33 C.1 Underwriting risk 33 C.2 Market risk 36 C.3 Credit risk 37 C.4 Liquidity risk 38 C.5 Operational risk 38 C.6 Other material risks 39 C.7 Any other information 40 2

3 D. Valuation for Solvency Purposes 41 D.1 Assets 43 D.2 Technical Provisions 44 D.3 Other liabilities 48 D.4 Alternative methods for valuation 48 D.5 Any other information 48 E. Capital Management 49 E.1 Own Funds 49 E.2 Solvency Capital Requirement and Minimum Capital Requirements 52 E.3 Use of the duration-based equity risk sub-module in the calculation of the Solvency Capital Requirement 54 E.4 Differences between the standard formula and any internal model used 54 E.5 Non-compliance with the Minimum Capital Requirement and non-compliance with the Solvency Capital Requirement 54 E.6 Any other information 54 F. Appendices 55 F.1 Appendix 1: Public QRTS 55 3

4 SUMMARY Flood Re Limited ( Flood Re or the Company ) is the Scheme Administrator for the Flood Reinsurance Scheme ( the Scheme ) and is principally engaged in the provision of flood peril reinsurance cover within the UK. The Scheme is a joint initiative between the UK insurance industry and the UK Government. The Scheme was established by the Water Act Flood Re s purpose is to promote the availability and affordability of flood insurance for eligible homes, while minimising the costs of doing so, and manage, over its lifetime, the transition to risk reflective pricing for household flood insurance. Business and performance The Company reported a profit after tax for the year of 104.1m (2016: 6.1m loss after tax). Levy Income of 180m (2016: n/a) was offset by an underwriting loss of 34.2m, operating expenses of 15.7m (2016: 7.6m) and corporation tax expense of 26.0m (2016: 1.5m credit). System of Governance The System of Governance is considered appropriate to the Company given the nature, scale and complexity of the operations. In order to do this, Flood Re provides reinsurance cover at a subsidised fixed rate to cedants, resulting in an expected underwriting loss each financial year. The Company finances this through an 180m levy on UK Household Insurers. The levy also finances the purchase of an outwards reinsurance programme to protect the Company up to a 2.1bn maximum liability limit. Flood Re is a mutual reinsurer and was incorporated in August 2013 as a private UK company limited by guarantee. Regulations designating the Flood Re Scheme came into force on 11 November 2015, providing Flood Re the power necessary to fulfil its purpose. On 1 April 2016, Flood Re was authorised by the Prudential Regulatory Authority ( PRA ) and the Financial Conduct Authority ( FCA ). The governance structure of the Company has operated throughout the year. The Company ensures that individuals meet the Fit and Proper requirements at all times. Flood Re uses the UK financial industry standard three lines of defence approach to managing risks. Flood Re s business strategy relies on a number of operational outsourcing arrangements, some of which are regarded as critical or important to the running of the business, as opposed to developing the functionality in-house. Flood Re launched on 4 April

5 Risk Profile Flood Re classifies risks into six key areas (Insurance Risk, Credit Risk, Market Risk, Liquidity Risk, Operational Risk and Strategic Risk). The Company s most significant Insurance Risk exposure is to losses arising from low frequency, high severity, catastrophe flood events. Reinsurance ceded is placed on both a proportional and non-proportional basis and is the Company s primary mechanism for managing and mitigating Insurance Risk up to a 2.1bn liability limit. In line with Flood Re s design, the premium the Company charges is not reflective of the underlying risk that is assumed. The Company expects that assumed premium will not be sufficient to cover the estimated mean cost of claims. The cost of the subsidy provided through the premium thresholds is met by a levy raised from all insurers writing home insurance in the UK. As net premium income during the past 12 months and the forthcoming 12 months is negative, the standard formula results in a zero premium risk charge. The Company adheres to the Prudent Person Principle through the application of a conservative Market Risk strategy that prioritises capital preservation over investment return. As at 31 March 2017 the Company had liquid assets of 157.2m (2016: 27.4) representing 78% of the total equity and liabilities and 371% of the Solvency Capital Requirements ( SCR ). The Company s maximum exposure to Credit Risk is the gross carrying value of its levy receivables, reinsurance premium receivables, reinsurance recoveries, trade and other receivables and cash and short-term deposits. As at 31 March 2017, all amounts were not yet due. The Company s operating model makes significant use of outsourced service providers to deliver a number of key operational elements. The relationship with, and management of, the outsourced service providers is a key component of the operational risk profile. The Company has a statutory duty to publish a transition plan, updated every five years, that sets out how the market will return to risk-reflective pricing. The first transition plan was published in February During the year, the Company has experienced relatively benign loss activity. Net reserves remain small in absolute terms so the capital charge for non-life reserve risk is not a material contributor to the overall standard formula SCR. 5

6 SUMMARY (cont.) Valuation for Solvency Purposes For Solvency II valuation purposes, assets and liabilities are valued at the amount for which they could be exchanged between knowledgeable willing parties in an arm s length transaction. Amounts due but not yet received or paid are included in the Solvency II balance sheet. Amounts not yet due are included in the cashflows used to calculate Technical Provisions. Solvency II Technical Provisions are calculated applying a probability-weighted average of future cash-flows, taking account of the time value of money using the relevant risk-free interest rate term structure and reflect the benefit of the reinsurance programme in place. Exposure relating to legal obligations is included. An explicit risk margin is added to Technical Provisions. The Solvency II best estimate includes cashflows from expenses incurred servicing existing policies during their lifetime and are allocated between premium and claims provisions. Future cashflows are adjusted to allow for expected default. The Company does not make use of any matching adjustment (Article 77b), volatility adjustment (Article 77d), transitional risk free interest rate term structures (Article 308b) or transitional deductions (Article 308d) referred to in the Solvency II Directive. Capital Management The Company is currently working through a partial internal model application process with the PRA. In the interim period, the Company uses the Standard Formula to calculate its SCR. The Company has identified four areas where the standard formula may not be appropriate, given the risk profile of the Company (Premium and Reserve Risk, Catastrophe risk, Credit Counterparty Risk and Operational Risk). As such, the PRA has set a capital addon in line with Article 37.1.a.ii of the Solvency II Directive (risk profile deviates significantly from the assumptions underlying the standard formula). As at 31 March 2017, the Company had available own funds of 100.3m comprising 75.2m of basic own funds (tier 1 unrestricted), 3.9m of deferred tax (tier 3) and 21.2m of ancillary own funds. The PRA has approved Flood Re to use 50% of the SCR, capped at a monetary amount of 75m, as a method by which uncalled Levy II may be recognised as ancillary ownfund items for the period 1 April 2016 to 31 March 2019 As at 31 March 2017, the Company had an SCR of 42.4m. The largest components of the SCR are Catastrophe Risk 15m, Operational risk 4.7m and a PRA capital add-on of 21.9m. For the year ending 31 March 2017, the Company has complied at all times with the regulatory Minimum Capital Requirements ( MCR ) and SCR. There is no reasonably foreseeable risk of non-compliance with the MCR or SCR and there are no foreseeable dividend distributions. 6

7 APPROVAL BY THE BOARD We acknowledge our responsibility for preparing the SFCR in all material respects in accordance with the PRA Rules and the Solvency II Regulations. We are satisfied that: a) throughout the financial year ended 31 March 2017, Flood Re has complied in all material respects with the requirements of the PRA Rules and the Solvency II Regulations as applicable to Flood Re; and b) it is reasonable to believe that Flood Re has continued so to comply subsequently and will continue so to comply in future. Andy Bord Adam Golding Chief Executive Officer Chief Financial Officer 20 July July

8 AUDIT OPINION Report of the external independent auditor to the Directors of Flood Re Limited ( the Company ) pursuant to Rule 4.1 (2) of the External Audit Chapter of the PRA Rulebook applicable to Solvency II firms Report on the Audit of the relevant elements of the Solvency and Financial Condition Report Opinion Except as stated below, we have audited the following documents prepared by the Company as at 31st March 2017: The Valuation for solvency purposes and Capital Management sections of the Solvency and Financial Condition Report of the Company as at 31st March 2017, ( the Narrative Disclosures subject to audit ); and Company templates S , S , S , S and S ( the Templates subject to audit ). The Narrative Disclosures subject to audit and the Templates subject to audit are collectively referred to as the relevant elements of the Solvency and Financial Condition Report. We are not required to audit, nor have we audited, and as a consequence do not express an opinion on the Other Information which comprises: The Business and performance, System of governance and Risk profile elements of the Solvency and Financial Condition Report; Company templates S , S ,S ; To the extent the information subject to audit in the relevant elements of the Solvency and Financial Condition Report includes amounts that are totals, sub-totals or calculations derived from the Other Information, we have relied without verification on the Other Information. In our opinion, the information subject to audit in the relevant elements of the Solvency and Financial Condition Report of Flood Re Ltd as at 31st March 2017 is prepared, in all material respects, in accordance with the financial reporting provisions of the PRA Rules and Solvency II regulations on which they are based as modified by relevant supervisory modifications, and as supplemented by supervisory approvals and determinations. This report is made solely to the Directors of the Company in accordance with Rule 2.1 of External Audit Chapter of the PRA Rulebook for Solvency II firms. Our work has been undertaken so that we might report to the Directors those matters that we have agreed to state to them in this report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Directors, for our work, for this report, or for the opinions we have formed. the written acknowledgement by management of their responsibilities, including for the preparation of the solvency and financial condition report ( the Responsibility Statement ). 8

9 Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (ISAs (UK & I)), including ISA (UK) 800 and ISA (UK) 805. Our responsibilities under those standards are further described in the Auditor s Responsibilities for the Audit of the relevant elements of the Solvency and Financial Condition Report section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the Solvency and Financial Condition Report in the UK, including the FRC s Ethical Standard as applied to public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Conclusions relating to going concern Emphasis of Matter Basis of Accounting We draw attention to the Valuation for solvency purposes, Capital Management and other relevant disclosures sections of the Solvency and Financial Condition Report, which describe the basis of accounting. The Solvency and Financial Condition Report is prepared in compliance with the financial reporting provisions of the PRA Rules and Solvency II regulations, and therefore in accordance with a special purpose financial reporting framework. The Solvency and Financial Condition Report is required to be published, and intended users include but are not limited to the Prudential Regulation Authority. As a result, the Solvency and Financial Condition Report may not be suitable for another purpose. Our opinion is not modified in respect of these matters. We have nothing to report in respect of the following matters in relation to which the ISAs (UK & I) require us to report to you where: the directors use of the going concern basis of accounting in the preparation of the Solvency and Financial Condition Report is not appropriate; or the directors have not disclosed in the Solvency and Financial Condition Report any identified material uncertainties that may cast significant doubt about the company s ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the Solvency and Financial Condition Report is authorised for issue. 9

10 AUDIT OPINION (cont.) Other Information The Directors are responsible for the Other Information. Our opinion on the relevant elements of the Solvency and Financial Condition Report does not cover the Other Information and, we do not express an audit opinion or any form of assurance conclusion thereon. In connection with our audit of the Solvency and Financial Condition Report, our responsibility is to read the Other Information and, in doing so, consider whether the Other Information is materially inconsistent with the relevant elements of the Solvency and Financial Condition Report, or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the relevant elements of the Solvency and Financial Condition Report or a material misstatement of the Other Information. If, based on the work we have performed, we conclude that there is a material misstatement of this Other Information, we are required to report that fact. We have nothing to report in this regard. Responsibilities of Directors for the Solvency and Financial Condition Report The Directors are responsible for the preparation of the Solvency and Financial Condition Report in accordance with the financial reporting provisions of the PRA rules and Solvency II regulations which have been modified by the modifications and supplemented by the approvals and determinations made by the PRA under section 138A of FSMA the PRA Rules and Solvency II regulations on which they are based. The Directors are also responsible for such internal control as they determine is necessary to enable the preparation of a Solvency and Financial Condition Report that is free from material misstatement, whether due to fraud or error. Auditor s Responsibilities for the Audit of the relevant elements of the Solvency and Financial Condition Report It is our responsibility to form an independent opinion as to whether the relevant elements of the Solvency and Financial Condition Report are prepared, in all material respects, with financial reporting provisions of the PRA Rules and Solvency II regulations on which they are based. Our objectives are to obtain reasonable assurance about whether the relevant elements of the Solvency and Financial Condition Report are free from material misstatement, whether due to fraud or error, and to issue an auditor s report that includes our opinion. Reasonable assurance is a high level of assurance, but it is not a guarantee that an audit conducted in accordance with ISAs (UK & I) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the decision making or the judgement of the users taken on the basis of the Solvency and Financial Condition Report. A further description of our responsibilities for the audit of the financial statements is located on the Financial Reporting Council s website at: Our-Work/Audit-and-Actuarial-Regulation/Audit-andassurance/Standards-and-guidance/Standards-andguidance-for-auditors/Auditors-responsibilities-for-audit/ Description-of-auditors-responsibilities-for-audit.aspx. The same responsibilities apply to the audit of the Solvency and Financial Condition Report 10

11 Report on Other Legal and Regulatory Requirements. In accordance with Rule 4.1 (3) of the External Audit Chapter of the PRA Rulebook for Solvency II firms we are required to consider whether the Other Information is materially inconsistent with our knowledge obtained in the audit of Flood Re s statutory financial statements. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Ernst & Young LLP London 27 July 2017 The maintenance and integrity of the Flood Re Limited web site is the responsibility of the Directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the Solvency and Financial Condition Report since it was initially presented on the web site. Appendix relevant elements of the Solvency and Financial Condition Report that are not subject to audit The relevant elements of the Solvency and Financial Condition Report that are not subject to audit comprise: Elements of the Narrative Disclosures subject to audit identified as unaudited. 11

12 A. BUSINESS AND PERFORMANCE A.1 Business Name and legal form Flood Re Limited ( Flood Re or the Company ) is the Scheme Administrator for the Flood Reinsurance Scheme ( Flood Re Scheme ). The Flood Re Scheme is a joint initiative between the UK Insurance Industry and the UK Government in order to make domestic flood insurance more affordable and available to households in high flood risk areas. The Flood Re Scheme was established by the Water Act 2014 and is expected to be in place for 25 years while the industry transitions to risk-reflective pricing. Flood Re is a mutual reinsurance company and was incorporated in August 2013 as a private UK Company limited by guarantee. In accordance with the Government Resources and Accounts Act 2000 (Estimates and Accruals) (Amendment) Order 2015, Flood Re is consolidated into the Department for Environment, Food and Rural Affairs ( DEFRA ) annual report and accounts. Flood Re is yet to be classified as a non-departmental public body by the Office for National Statistics. The registered office is 75 King William Street, London, EC4N 7BE. Supervisory Authorities Prudential Regulation Authority, 20 Moorgate, London, EC2R 6DA Financial Conduct Authority, 25 the North Colonnade, London, E14 5HS Auditors Ernst and Young LLP, 25 Churchill Place, Canary Wharf, London, E14 5EY Qualifying Holdings For the year ended 31 March 2017, the following four ordinary members have qualifying holdings in Flood Re. Individually they account for 10% or more of the voting rights of ordinary members. - UK Insurance Ltd - Lloyds Bank General Insurance Limited - Aviva Insurance Limited - Royal and Sun Alliance Insurance Plc All of the above ordinary members write UK Household Insurance business and contribute to the Levy I income and gross written premium assumed by Flood Re. 12

13 Parent and Group undertakings None Material lines of business Flood Re is engaged in the provision of reinsurance cover for a single risk (property), a single peril (flood), single currency (pounds sterling) within a single territory (United Kingdom). Under Solvency II, all underwriting transactions are classified and recorded under the Proportional Reinsurance Fire and other damage to property line of business. Significant business or events during the period The Company was authorised by the PRA and the FCA on 1 April 2016 and commenced underwriting on 4 April Brendan McCafferty resigned as Chief Executive Officer effective 11 February Andy Bord assumed the role of interim Chief Executive Officer on 11 February On 13 April 2017, Andy Bord was appointed Chief Executive Officer on a permanent basis. A.2 Underwriting Performance The following underwriting performance analysis is on an International Financial Reporting Standards (IFRS) GAAP basis as reported in the Statutory Financial Statements for the year ended 31 March The Company commenced underwriting activities on 4th April 2016 and has no comparative underwriting results for the prior year s s Gross written premiums 27,672 Gross change in unearned (15,385) premium provision Gross earned premiums 12,287 Premium ceded to reinsurers (75,154) Ceded change in unearned 26,049 premium provision Ceded earned premiums (49,105) Net earned premium (36,818) Fees and commission 8,531 income Net Insurance claims (5,960) Underwriting loss (34,247) 13

14 A. BUSINESS AND PERFORMANCE (cont.) Flood Re provides reinsurance cover at a subsidised fixed rate to cedants, resulting in an expected underwriting loss each financial year. The Company reported an underwriting loss for the year ended 31 March 2017 of 34.2m (2016: none). The underwriting loss is in line with expectations and primarily due to: Negative earned premium of 36.8m - In the first year of underwriting activity, the Company assumed 127,326 policies resulting in gross written premium of 27.7m for the year. - The staggered inception date profile of the underlying insurance policies, in a growing book of business, together with the absence of an existing renewal book of business, results in 12.3m of earned premium in the first year. - Premium ceded to reinsurers for the year is 75.2m. The Company pays a market rate when purchasing outwards reinsurance protection compared to the subsidised premium thresholds it applies to assumed business. In addition, the Company is required to purchase reinsurance protection up to the Liability Limit of 2.1bn and the Loss limit of 100m. - The earning pattern applied to outwards reinsurance contracts results in 49.1m of ceded premium costs being earned during the year. Commission Income of 8.5m - The Company receives sliding scale commission income on its outwards reinsurance arrangements. Commission income varies with, and is directly related to, the underlying reinsurance contracts. During the year, the Company wrote 16.6m of commission income of which 8.5m was earned. Net Insurance claims incurred of 6.0m - Gross claims incurred reflect relatively benign loss experience in the year with no catastrophic flood loss events. The gross loss ratio for the year ended 31 March 2017 is 92%. - Net claims incurred of 6.0m reflect the benefit of the outwards reinsurance programme. - The Company expects that assumed premium will not be sufficient to cover the estimated mean cost of claims. A gross premium deficiency provision of 2.9m has been established to recognise the overall excess of expected claims over unearned premium. This contributes 25 percentage points to the gross loss ratio. A.3 Investment Performance The Company has a conservative market risk strategy that prioritises capital preservation over investment return. The investment mandate agreed between the Company, Government and the Insurance Industry restricts the type, duration and amount of holdings that may be invested in. Flood Re only invests in UK Government backed securities (gilts, treasury notes and UK Government backed liquidity funds). Through its anticipated status as a Public Body, Flood Re has access to the UK Debt Management Office ( DMO ) for investment purposes. Short-term deposits with the DMO vary for periods between one day and three months, depending on the immediate cash requirements of the Company s s Interest income on cash and short-term deposits Investment management fees Total investment income

15 As at 31 March 2017, the Company has 154m of shortterm deposits invested with the DMO and 3.2m of cash at banks. For the year ended 31 March 2017, the Company received interest income on cash and short-term deposits of 0.2m (2016: nil). This represents an annualised investment return on average invested assets of 0.17% (2016: nil). For the year ended 31 March 2017, the Company has not invested in any securitised assets or recognised any realised or unrealised investment gains or losses in equity. A.4 Performance of other activities s 000 s Levy I Income 180,000 Levy II Income Total Levy income 180,000 The Flood Reinsurance (Scheme Funding and Administration) Regulations 2015 and The Flood Reinsurance (Scheme and Scheme Administrator Designation) Regulations 2015 (collectively the Regulations ) enable Flood Re, amongst other matters, to raise an annual insurance industry Levy. The total market Levy of 180m has been set out in the Regulations and is payable in proportion to the relevant insurer s gross written premium compared to the aggregate of all relevant insurers gross written premium in any one calendar year. The first Levy was recognised on 1 April Flood Re also has the ability to issue a compulsory call for additional funding from the industry through a Levy II top up mechanism. Levy II contributions received from the ordinary members of Flood Re are recognised in a mutual member account (MMA) within equity. Levy II contributions received from non-members are treated as income in accordance with Levy I. Levy II income for the year ended 31 March 2017 was nil (2016: nil) s 000 s Total operating and 15,726 7,586 administrative expenses The Company commenced underwriting in April 2016 and incurred a full year of operating and administrative expenses in Operating expenses in the prior year included significant pre-launch project costs of implementation alongside operating costs for a threemonth period from 1 January 2016 to 31 March s 000 s Total UK Corporation tax 26,034 (1,521) charge (credit) The UK Corporation Tax charge for the year ended 31 March 2017 was 26m (2016: 1.5m tax credit) calculated at an effective tax rate of 20% on the profit before tax of 130m (2016: loss of 7.6m). A.5 Any other information Not applicable 15

16 B. SYSTEM OF GOVERNANCE B.1 General Information on the System of Governance The System of Governance comprising the Board and Committee composition and structure, fit and proper requirements, internal control system, risk management framework, key function holders and outsourcing arrangements are considered appropriate to the Company given the nature, scale and complexity of the operations. B.1.1 General Information on the System of Governance The Committee structure as at 31 March 2017 is outlined in the diagram below. Board Remuneration Committee Nominations Committee Executive Committee Risk & Capital Committee Audit & Compliance Committee Reinsurance Sub Committee Operations Sub Committee The table below shows the composition of the Flood Re Board and Committees (excluding the Executive Committee) Name Board Audit and Remuneration Nomination Risk and Capital Compliance Committee Committee Committee Committee Mark Hoban CHAIR INED CHAIR INED INED Andy Bord CEO and ED Judith Eden INED INED INED INED INED Huw Evans INED CHAIR INED Adam Golding CFO and ED David Hindley INED INED INED CHAIR INED Claire Ighodaro INED INED INED INED CHAIR Paul Leinster INED INED INED INED INED INED = Independent Non-Executive Director, CFO = Chief Financial Officer, CEO = Chief Executive Officer, ED = Executive Director 16

17 Board The Flood Re Board maintains overall responsibility for the governance of the Company, setting strategic aims and providing the leadership to put them into effect within the scope of Flood Re s Articles and powers that the Company has been granted under the Water Act and the Regulations. Remuneration Committee Flood Re s Remuneration Committee is responsible for setting the remuneration of the Executive Directors and Chair and overseeing the overall remuneration policy of Flood Re. Fees for the Chair and other Independent Non-Executive Directors are determined annually by the Remuneration Committee and approved by the Board. Audit & Compliance Committee ( ACC ) The ACC is responsible for acting independently from the Executive Team of Flood Re, to ensure that the interests of Members and stakeholders are properly protected in relation to reserving, financial reporting and internal controls. The ACC has responsibility for regulatory and compliance matters, including supporting Parliament s requirement for prudent stewardship of financial resources. The Committee is also responsible for managing and monitoring the capital held by Flood Re in order to manage its risks. During the year, the Committee has selected Mazars as co-source internal audit partner and undertaken a number of deep dive reviews into the treatment of Flood Re specific technical accounting issues alongside establishing the first internal audit programme. Nominations Committee The Nominations Committee reviews the structure, size and composition (including the skills, knowledge, experience and diversity) required of the Board and makes recommendations to the Board with regard to any changes. During the year, the Committee has considered succession planning for Directors and other Senior Executives and has been responsible for the recruitment of Andy Bord as CEO. Risk and Capital Committee ( RCC ) The RCC is responsible for the oversight of the risk management framework and capital adequacy, and to ensure that all risks of the Company are identified, assessed and monitored in line with the risk appetite and policies, and to provide guidance, review and oversight on risk management and capital assessment. During the year, the RCC has focused in particular on Flood Re s internal model application to the PRA and enhancing the risk management framework. Executive Committee ( ExCo ) The ExCo comprises the full Executive Team and is responsible for the day-to-day running of the Company. The Executive Team oversees the running of the Reinsurance Sub-Committee and Operations Sub-Committee. The Reinsurance Sub-Committee is responsible for managing and monitoring the outwards reinsurance strategy and programme within Flood Re s stated risk management framework. The Operations Sub- Committee has oversight and governance of underwriting, claims and operations within Flood Re. 17

18 B. SYSTEM OF GOVERNANCE (cont.) B.1.2 Changes in the System of Governance The Company was authorised by the Prudential Regulatory Authority and the Financial Conduct Authority on 1 April 2016 and commenced underwriting from 4 April The governance structure of the Company has operated throughout the year. Andy Bord was appointed as an Executive Director on 3 February 2017 and assumed the role of interim Chief Executive Officer on 11 February On 13 April 2017, Andy Bord was appointed Chief Executive officer on a permanent basis. Brendan McCafferty resigned as Chief Executive Officer effective 11 February See also section B.2 for a discussion of changes arising from the Senior Insurance Managers Regime. B.1.3 Remuneration policy Flood Re s remuneration policy and practices reflect its objectives of good corporate governance and sustained, long-term value to the industry participants and the need to attract and retain talent with suitable experience. The remuneration policy and practices also aim to promote robust and effective risk management. Flood Re s remuneration policy applies to all employees. The Company aims to provide total remuneration packages that reward superior performance in a way that is consistent with the Company s values and target culture. Flood Re provides total remuneration packages delivered through fixed and variable pay components. Fixed remuneration is determined based on the role and position of the individual employee. Factors affecting this will include professional experience, responsibility, job complexity, and local market conditions. The performance-based bonus motivates and rewards high performers who significantly contribute to the Company s achievements and results, and out-perform according to objectives set for the individual in question and the Company as a whole. The performance-based bonus is in the form of a cash settlement capped at a maximum of between 10% and 30% of base salary (dependent on the role and seniority of the employee within the organisation). There are no shares or share options included in the performance-based bonus. The Remuneration Committee determines the performance based remuneration of the Executive Team alongside the performance based remuneration pool available for allocation, by the CEO, to all other staff. The Remuneration Committee meets twice a year: in February, to set policy decisions and approve the renewal of staff benefits schemes, and April, to accept or amend recommendations for pay and bonuses from the CEO. The Remuneration Committee periodically reviews the general principles of the remuneration policy which will normally be in the February meeting. Flood Re offers all employees access to a Defined Contribution Pension Plan. 18

19 B.1.4 Directors Remuneration disclosures The table below shows the total compensation of Directors and Non-Executive Directors for the years ended 31 March 2017 and s 000 s Short-term employee benefits Post-employment pension and medical benefits Termination benefits 0 0 Total Directors emoluments 1, Executive Directors were eligible to join the pension scheme from 1 January 2016 and their pension contributions represent 12% of base salary. Fees for the Chair and other Independent Non-Executive Directors are determined annually by the Remuneration Committee and approved by the Board. The Chair and Independent Non-Executive Directors are not eligible to participate in annual bonus plans, the employee benefit schemes or the pension scheme. Their pay rates are set by the Board, after taking advice from the CEO, and take into account the time commitment, the responsibilities and complexities of their roles, as well as the rates paid by other comparable organisations within the insurance industry and wider financial services sector. The Directors and Officers of the Company have the benefit of insurance which provides suitable cover in respect of legal actions brought against them. B.1.5 Other related party transactions Through its normal course of business and on an arm s length basis, a number of transactions are by necessity undertaken by Flood Re with its ordinary members and other related parties. Management have identified the following transactions as having been undertaken by related parties in the normal course of its operations: - Levy income: Underwriters of UK Household insurance business are required to contribute to the Flood Re annual Levy in proportion to their relevant underwriting profiles. - Gross written premium and associated claims: if signed up to Flood Re s standard inwards reinsurance treaty, underwriters of UK Household Insurance business may cede the associated flood peril in relation to their inwards policies to Flood Re. - Outwards reinsurance ceded premium (and associated technical balances): through a public procurement process subject to the Official Journal of the European Union requirements, Flood Re places its outwards reinsurance programme on the global reinsurance market. - Commercial insurance: Ordinary members participate on the commercial insurance coverage purchased by the Company. All transactions are entered into on arm s length terms and are considered by management to be market sensitive. As such, Flood Re has decided to exclude the quantification of these related party transactions from the analysis of related parties detailed below. 19

20 B. SYSTEM OF GOVERNANCE (cont.) Transactions with ordinary members For the year ended 31 March 2017, the following four ordinary members have qualifying holdings in Flood Re. Individually they account for 10% or more of the voting rights of ordinary members. Aviva Insurance Limited Lloyds Bank General Insurance limited Royal and Sun Alliance Insurance Plc UK Insurance Limited The above ordinary members write UK Household insurance business and contribute to the Levy I income and gross written premium assumed by Flood Re and may also provide commercial insurance services. Directors and Officers insurance market activities In the normal course of its operations, the company entered into transactions with companies in which Directors and Officers of the Company are also Directors or non-executive Directors. All transactions entered into were completed on market terms. David Hindley, an Independent Non-Executive Director is currently a Non-Executive Director with the Channel Managing Agency Limited (where he is Chair of the Audit Committee). Syndicate 2015, managed by The Channel Managing Agency Limited, writes a portfolio of UK business that includes household exposures. Claire Ighodaro, an Independent Non-Executive Director, is currently a Board member and Audit Committee chair of XL Catlin Unitary Board. XL Catlin write UK Household Insurance business in the United Kingdom and provide flood related reinsurance protection. Until December 2016, Claire Ighodaro was also a Franchise Board member and the Audit Committee Chair of the Society of Lloyd s. Lloyd s syndicates write UK Household Insurance business in the United Kingdom and provide flood related reinsurance protection. Directors and Officers operational activities Andy Bord, Chief Executive Officer of Flood Re, previously held the position of CEO at Capita Insurance Services. During the year, Andy Bord held a number of shares in Capita Plc that have subsequently been sold and currently holds a small number of share options that are exercisable in February Flood Re has contracted with Capita Plc to provide managing agency outsourcing services. For the year ended 31 March 2017, the Company incurred Capita managing agency fees of 5.5m (2016: 3.3m) and has a receivable due from Capita Plc of 0.5m as at 31 March Huw Evans, an Independent Non-Executive Director and Chair of the Remuneration Committee is currently Director General of the Association of British Insurers ( ABI ). For the year ended 31 March 2017, the Company incurred 15k (2016: 20k) of ABI Associate membership fees. Michael Bartholomeusz, the Chief Risk Officer of Flood Re, is also a Director of ORIC International. For the year ended 31 March 2017, the Company incurred 26k of ORIC corporate membership fees. Department of Environment, Food and Rural Affairs In accordance with the Government Resources and Accounts Act 2000 (Estimates and Accruals) (Amendment) Order 2015, Flood Re is consolidated into the DEFRA annual report and accounts. Flood Re is yet to be classified as a non-departmental public body by the Office for National Statistics. 20

21 B.2 Fit and Proper requirements The Company ensures that individuals performing a role requiring PRA approval meet the Fit and Proper requirements at all times to ensure that they have the appropriate competence, expertise, and propriety to carry out their roles. The Company assesses Fit and Proper requirements initially during the recruitment process and subsequently throughout the period of employment. A more granular and role specific analysis is conducted prior to the appointment of an approved person due to the critical nature of the role in terms of the ongoing soundness of the Company and protection of policyholders. During the recruitment phase the Company will: Use Board approved recruitment agencies Assess applicant competence against job descriptions and key functional requirements Involve ExCo members, Directors and Non-Executive Directors in the interview process Perform regulatory reference checking covering five years Verify professional and educational qualifications Conduct criminal record checks Complete identity and address verification checks Search FCA/PRA registers Undertake financial sanctions and anti-money laundering checks During the period of employment the Company will: Complete an induction programme Conduct annual performance appraisals Review job descriptions and delegated authorities Maintain a governance map with clearly defined roles Monitor actual performance against specific targets, objectives and quality outputs Conduct role specific training to ensure technical and non-technical competence Conduct compulsory compliance training for all staff Fully investigate any breaches or incidents Maintain an appropriate Board and Committee structure Perform annual background checks around conduct, propriety, reputation and financial soundness All staff are made aware of and are expected to comply with their specific regulatory obligations. All staff are expected to notify the Company of any change in circumstances impacting on their fitness and propriety. The Senior Insurance Managers Regimes (SIMR) came into force on 7 March 2016, replacing the previous Approved Persons Regime. A requirement of the SIMR is for firms to have governance maps in place for regulatory inspection. Flood Re has prepared a suite of documents which together present the required governance map, comprising an organisational chart, a Committee structure (showing membership and terms of reference) and job descriptions for all SIMF, Key Function holders and individuals with Prescribed Responsibilities. 21

22 B. SYSTEM OF GOVERNANCE (cont.) B.3 Risk management system including the own risk and solvency assessment Overview of Risk Flood Re defines risk as the possibility of incurring misfortune or loss. In principle, a risk is expressed by the combination of the probability (likelihood) of an event and its impact. Uncertainty occurs where it is not possible to assess the probability and/or impact with sufficiently reliable accuracy. Flood Re classifies risks into six key areas (Strategic Risk, Insurance Risk, Credit Risk, Market Risk, Liquidity Risk and Operational Risk). Risk Governance and Culture Ultimate responsibility for risk management and control within Flood Re lies with the Board. Critical to this is the tone it sets with respect to Risk Culture. The Board s responsibility for risk management is discharged through the Flood Re Committee structure (see section B.1.1 above). Flood Re uses the UK financial industry standard three lines of defence approach to managing risks: Flood Re 3 Lines of Defence Risk Governance Framework Board Governance Executive Committee Risk and Capital Committee Audit & Compliance Committee Operations Functions Finance Actuarial Legal Risk Compliance Internal Audit HR 1st Line 2nd Line 3rd Line 22

23 First line of defence is undertaken by the executive team and staff of Flood Re. Their responsibility is to identify and manage risks (mainly through operating mitigating controls), generate and review risk information, and to take appropriate actions to maintain the risk exposure within risk appetite. The first line of defence reports to ExCo and the Risk Function on their management of current and forward-looking risk exposures. Second line of defence is carried out by the Risk Function, led by the CRO and the Compliance Function led by the General Counsel. The Risk function is responsible for providing risk advice, facilitation and co-ordination of first line risk activity, monitoring of risks, provision of independent commentary, oversight and challenge of the management of risks and Internal Model validation. The Risk Function reports to the RCC. The Compliance Function forms an independent part of the second line of defence and is responsible for implementing a governance framework across the Company, compliance monitoring, regulatory disclosure and monitoring of compliance risk arising from activities of outsourced service providers. The Compliance Function reports to the ACC. Third line of defence, carried out by the Internal Audit Function, evaluates and reports to the ACC on the effectiveness of the design and operation of the (risk) control environment. Its responsibility is to evaluate whether the controls and risk information are adequate and effective in mitigating risk to the Board agreed risk appetite levels. It is the responsibility of each of the three lines of defence to ensure the delivery of Flood Re s complete risk management system. Risk Management System The following diagram sets out the major risk management tools and procedures that make up Flood Re s risk management system. Each of the processes and tools utilised in the Risk Management System, in particular the internal model, risk appetite framework and stress and scenario testing, feed into Flood Re s wider business strategy and decision-making processes. 23

24 B. SYSTEM OF GOVERNANCE (cont.) Identify Risk processes & Tools Emerging Risk Reporting Loss Event and Near Miss Capture Business Plan and Strategic Risk Review Report Risk processes & Tools ORSA Report Risk Reports Risk Dashboard Assess Risk processes & Tools Inherent/Residual Risk Analysis Internal Model Risk Quantification Standard Formula Risk Quantification Stress & Scenario Testing Reverse Stress Testing Manage Risk processes & Tools Controls Library Key Control Indicators (KCI s) Monitor Risk processes & Tools Risk Register Deep-dive Reviews Risk Appetite KPI s Identification Flood re operates a live risk register containing all identified and emerging risks at a given date. A number of tools are used to identify new risks or major changes to existing ones. These include Flood Re s emerging risk reporting process, loss event and near miss capture and the annual risk review of Flood Re s strategic business plan. Assessment Each risk on the register is subject to an assessment of both its Likelihood (of occurrence) and Impact (given occurrence). Three separate states are considered for each risk: Assuming no controls (Inherent); With the current controls (Residual); and Acceptable exposure (Appetite). The risk register is prioritised for periodic deep-dive risk reviews. 24

25 Monitor The Company monitors its risk profile against risk appetite metrics on an ongoing basis. The risk appetite framework is made up of Top Down (Board) and Bottom-up (Risk Owner) dimensions. To facilitate risk appetite monitoring, quarterly deep dive risk reviews are completed by the first line owners and reported to the RCC. Key Risk Indicators are monitored on an ongoing basis to highlight potential shifts in the entity s risk profile. Manage Each risk is allocated to a risk owner. Risk owners ensure that risks are managed in accordance with the risk management policy and within the risk appetite agreed for each risk. The management of each risk is aligned to one or more of the following types of actions: Reporting Regular risk management information is reported to each risk owner to ensure that risks are being monitored. The risk owner uses this information and their own judgement in the delivery of the formal deep-dive risk reviews. These risk reviews are submitted to RCC by the risk owner, at a frequency determined by the assessed severity of the risk. In addition to the reporting of these deep-dives, a comprehensive CRO report is delivered to the RCC which draws together the second line teams risk assessments over the past quarter, including over appetite risks, emerging risk analysis, control reviews and details of risk team led exercises such as stress testing. The Chair of the RCC then provides a summary report of the RCC to the Board. Transfer the risk is transferred out of Flood Re to a third party Avoid the risk is avoided through non exposure Reduce the risk exposure is reduced through the exercise of controls to reduce the Likelihood or the Impact Accept the Inherent level of exposure of the risk is acceptable and no additional actions are taken Significant changes in the Company s risk profile trigger an off-cycle deep-dive risk review. A library of risk controls is maintained, with a full mapping through to the risk register. These controls allow the inherent risk levels to be reduced, transferred or avoided to deliver a residual level of risk that is within appetite. Key Control Indicators (KCI s) are used to monitor the effectiveness of these controls. 25