Final Results

RSA Insurance Group plc 22 February 2018

2017 PRELIMINARY RESULTS

Premium income up 4% to £6.7 billion, combined ratio 94%, a new RSA record

Underlying EPS 43.5p, up 10%; statutory profit after tax £322m (2016: £20m)

Return on tangible equity1 15.5% (2016: 14.2%) versus 13-17% target range

Final dividend 13.0p per share (19.6p total for 2017, up 23%)

Stephen Hester, RSA Group Chief Executive, commented:

"In a tough period for insurance markets, we are delighted to produce another year of growing profits, dividends and return on equity for shareholders. Higher premium income also highlights the positive customer response to what we are offering.

"RSA's overseas divisions achieved excellent results in 2017, partly offset by poor underwriting figures in our UK/ London market business as flagged earlier in the year. The Group's performance ambitions remain high and we target further improvement in 2018 and thereafter."

Trading results

· Underlying pre-tax profits up 12% to £620m (2016: £556m)

· Group operating profit £663m up 1% (2016: £655m): Scandinavia £389m; Canada £159m; UK & International £133m2

· Group underwriting profit of £394m up 4% and a new record for RSA (2016: £380m):

- Group combined ratio of 94.0% also a record (2016: 94.2%): Scandinavia 82.9%, Canada 93.9% and UK & International 100.5%2

- Attritional loss ratio improved by 0.1 point versus 20163 with good progress in all businesses except the UK

- Group weather costs in line with last year; large losses elevated at 10.8% of premiums (2016: 8.9%)

- Group prior year underwriting profit of £157m (2016: £109m)

· Total Group premiums of £6.7bn up 4% at reported FX and up 2% at constant FX excluding disposals: Scandinavia up 0.3%, Canada up 5% and UK & International up 2% (all at constant FX)

· Group written total controllable costs down 6%3 to £1,425m. This comprised 8% cost reductions, offset by 2% inflation

· Investment income of £331m (2016: £369m) down 10% versus last year reflecting the impact of disposals and ongoing reinvestment at lower yields

1 Underlying measure, please refer to pages 30 to 36 for further information2 Proforma for share of aggregate reinsurance recoveries and excludes the impact of the Ogden rate change3 Group excluding disposals for 2016 and at constant FX

· Below the operating result, interest expense halved following our debt restructuring. Restructuring costs of £155m (2016: £168m) support the existing and increased cost savings targets

· Statutory profit after tax £322m (2016: £20m)

· Underlying earnings per share (EPS) 43.5p, up 10% (2016: 39.5p). Headline EPS 26.3p (2016: 1.8p)

· Final dividend of 13.0p per ordinary share proposed, bringing total 2017 dividends to 19.6p per ordinary share (up 23%) representing a 45% payout ratio of underlying earnings.

Capital & balance sheet

· Solvency II coverage ratio of 163% after final dividend (31 December 2016: 158%), slightly above 130-160% target range

· Tangible equity £2.8bn (31 December 2016: £2.9bn), 270p per share

· Return on tangible equity of 15.5%1 (2016: 14.2%) in upper half of 13-17% target range.

Strategic and market update

· Balance sheet restructuring is now complete. 2017 actions comprised the £834m disposal of UK Legacy liabilities (announced in February); issuance of c.£300m of restricted tier 1 notes in Scandinavia and the retirement of c.£640m of existing high coupon debt. These actions reduced risk, improved capital resilience, and lowered interest costs

· RSA's entire focus is on the drive for outperformance in our markets. In that context, our many performance improvement initiatives continue to deliver progress; targeted at customer service, underwriting capabilities and costs

· The improved premium trends we report for 2017 reflect the service enhancements we have been implementing. Pleasingly, trends are better in every region versus 2016

· Underwriting capabilities continue to advance across the Group. These include more sophisticated and agile pricing models, underwriter training and portfolio discipline, and technology driven insights. Progress on attritional loss ratios can be volatile but is on track overall, except for UK Household where improvement measures are in train. Underwriting actions to improve large loss performance are being actively implemented - 2017 setbacks showed the need to remediate in places

· Group written controllable costs for 2017 were down 6%2 year-on-year to £1,425m (comprising 8% cost reductions, offset by 2% inflation). Group headcount was down 6% versus 2016 and 23%2 since the beginning of 2014. We are raising our savings ambition for a fourth time and now target over £450m gross savings by 2019 (£395m achieved to date). We do not expect to book further 'below the line' restructuring costs to achieve these savings

· Excellent progress has been made towards our best-in-class combined ratio ambitions across the Group, except in the UK. Scandinavia and Canada have passed the targeted threshold, although in both regions we see scope for further improvements. Ireland has returned to underwriting profit (COR 97%) and we expect good continued progress. In the UK, our performance ambition remains unchanged, although its achievement may take longer than originally hoped. Determined action is underway in order to get back on track

· Insurance market pricing and volumes have started 2018 with comparable trends to 2017, save for classes particularly impacted by poor loss experience

· Bond market yield increases, if sustained, allow upgrades to investment income outlook plus reduced capital drag from bond pull-to-par impacts. Conversely, vigilance will be needed to price for any changes in insurance claims inflation.

1 Underlying measure, please refer to pages 30 to 36 for further information2 Group excluding disposals for 2016 and, where relevant, at constant FX 

MANAGEMENT REPORT - KEY FINANCIAL PERFORMANCE DATA

Management basis

CHIEF EXECUTIVE'S STATEMENT

In 2017, RSA delivered growth in premiums, profits and dividends and an improved 15.5% return on tangible equity1 - all compared to an extremely strong 2016 result.

We are pleased to report record underwriting profits. However, the year also had some disappointment relative to our ambitions. Excellent underwriting results in Scandinavia, Canada, Middle East and Ireland were partly offset by poor UK (and related London market) results. It is our task in 2018 to deliver a bounce-back in the latter whilst sustaining underlying progress across the Group as a whole.

Strategy & focus

RSA is a focused international insurer. We have complementary leadership positions in the major general insurance markets of the UK, Scandinavia and Canada, together with supporting 'London market' and international business. The Group is well balanced between personal and business customers, across our geographies, product lines and distribution channels.

Our business strategy is to sustain a disciplined focus on RSA's existing areas of market leadership, whilst driving intense operating improvement in pursuit of best-in-class performance levels.

External conditions

General insurance markets are relatively mature, consolidated and stable, though with some inevitable underwriting volatility. Attractive performance can be achieved through intense operational focus within a disciplined strategic framework.

For the insurance industry, 2017 was a year with some major external underwriting challenges. At a global level, it seems likely to have been one of the worst loss years in recent times due particularly to three major US/ Caribbean hurricanes and Mexico earthquakes. On a lesser scale, UK market losses around the Ogden discount rate change and Household insurance 'escape of water' inflation also dented domestic insurance results. Notwithstanding these factors, market capacity remains high, and there are limited signs of price inflation more broadly.

Conversely, financial markets during 2017 were more stable, at least as impacting RSA. Bond yields are off their lows and global central bank action to wean markets off QE gives some optimism that coming years might offer return upside for insurers' portfolios. However, tight credit spreads continue to hurt, especially on UK pension accounting. RSA makes a majority of profit outside the UK, so FX rates versus sterling are also important. During 2017 impacts were limited despite swings, although the Brexit process continues to have the potential to deliver volatility.

2017 actions

2017 was another year of intense activity at RSA. The great majority of our efforts were focused on operational improvement in pursuit of our best-in-class ambitions. We also delivered the final pieces of RSA's balance sheet restructuring successfully. We look forward to 2018 as the first clean 'business as usual' year since 2012.

Financial strength: RSA's 'A' grade credit ratings are where we want them. The Solvency II capital ratio at 163% (2016: 158%) is in a good place. The £834m disposal in February of our UK Legacy insurance liabilities removed a source of long-tail risk whilst funding a £640m retirement of high cost subordinated debt capital. This was the final piece of balance sheet work on our agenda. While we aspire to grow 'core tier 1' capital coverage further, the active phase of balance sheet repair is now complete.

1 Underlying measure, please refer to pages 30 to 36 for further information

Business improvement: Our goal is to systematically and determinedly hunt down performance improvement opportunities across the business to move RSA's capabilities and then outcomes towards best-in-class levels. This involves particular focus on improving three areas; service to customers, underlying underwriting results and cost efficiency.

Personal Lines policy count rose at RSA in 2017 for the first time in four years as customers reacted positively to the many improvements we are putting through. The important home partnership with Nationwide commenced business in December. Operational initiatives also contributed, spanning service improvements via digital capabilities in claims and policy servicing, through to capability and proposition uplifts across our business lines. RSA will not chase unprofitable growth. We prize quality of customer relationship over quantity. But nevertheless, serving customers well remains at the heart of all we seek to achieve.

RSA's most important capability lies in our underwriting judgement. Across the Group multiple improvements continued in areas like portfolio discipline, data and model improvement, machine learning and skills enhancement. Attritional loss ratios improved in every business except the UK. Here our attritional results experienced significant setback, largely through Household 'escape of water' claims, which we expect to rectify for 2018/ 2019. The Group attritional loss ratio was slightly better than prior year as a result, not quite as good as hoped for although still substantially better than historically achieved.

Cost efficiency remains a critical performance lever. We have now achieved £395m annual gross savings and are able to raise our savings targets for a fourth time to over £450m by 2019. Digitisation, lean operations, site consolidation, enhanced purchasing, robotics, zero based budgeting - all the tools in modern corporate armouries to boost people productivity - are being deployed effectively across our regions.

Financial results 2017

Underlying earnings per share rose 10% to 43.5p. This produced a return on tangible equity1 of 15.5% (2016: 14.2%), versus our target range of 13-17%.

At a statutory level, net profit before tax rose to £448m (2016: £91m) reflecting a lower level (though still significant) of restructuring charges. It remains our ambition that 2017 be the last year of such charges. 

Premium income was up 4%, in line with our plan, featuring modest policy count increases together with price and FX benefits.

Underwriting profits posted a new record at £394m, up 4% versus our record year in 2016. The combined ratio of 94.0% was also a new record for RSA. Underlying pre-tax profits rose 12%, benefiting from resilient investment income and lower interest expense.

Excellent underwriting results were achieved in absolute and relative terms across many of our businesses. Scandinavia led the way with a combined ratio of 82.9%. Canada also improved, in a challenging market, to a combined ratio of 93.9%. Middle East had record results (COR 87.7%) and the Irish turnaround delivered its first profits since 2012 (COR 97.0%).

The disappointment was our UK business (including its European branches and London market Commercial Lines business). A COR of 102.0%2 reflected three major loss items; £72m of losses from US/ Caribbean hurricanes and Mexican earthquakes (net of GVC recovery), elevated Household 'escape of water' inflation and significant adverse large loss volatility versus long-term averages. Underwriting action is well underway to improve results in 2018.

1 Underlying measure, please refer to pages 30 to 36 for further information;

2 Proforma for share of aggregate reinsurance recoveries and excludes the impact of the Ogden rate change

Reflecting RSA's overall progress in 2017, a final dividend of 13.0p per share is proposed, making 19.6p per share total for 2017, up 23%. This represents a 45% payout of underlying EPS (higher than 2016 but in line with stated policy). RSA's focused business strategy is designed to generate attractive levels of free cash flow, after meeting organic growth needs. With rising earnings targeted, no more restructuring costs and as bond pull-to-par impacts recede in coming years, RSA should have the potential for attractive further growth in shareholder distributions.

Looking forward

Our performance target of 13-17% return on tangible equity represents attractive shareholder return both relative to cost of capital and insurance industry norms. To the extent that RSA's underwriting performance progresses well towards our best-in-class combined ratio ambitions, even better returns are possible. We will try to achieve just that. For 2018, the key tasks are to re-establish respectable performance in our UK business whilst continuing underlying progress in our overseas markets where the majority of the Group trades.

Thanks

RSA made good progress with customers and for shareholders in 2017, despite significant external challenges. In achieving this, we owe thanks to all stakeholders for their support. But most particularly to my colleagues at RSA, who have embraced our best-in-class ambition so effectively, go my sincere thanks and appreciation.

Stephen Hester

Group Chief Executive

21 February 2018

MANAGEMENT REPORT

SEGMENTAL INCOME STATEMENT

Management basis - 12 months ended 31 December 2017

Notes:

UK & International comprises the UK (and European branches), Ireland and the Middle East

Please refer to appendix for 2016 comparatives

1 Proforma for share of aggregate reinsurance recoveries and excludes the impact of the Ogden rate change; 2 Preference dividends of £9m and coupons of £11m paid on 2017 issued restricted tier 1 securities

Premiums

Group net written premiums of £6.7bn were up 6%1 at reported FX and up 2%1 at constant FX.

Foreign exchange provided a 4% benefit to premiums year-on-year, down from 8% for the first half of the year.

We have seen a strengthening of underlying customer activity as capability improvements take effect. Customer retention trends are improving and satisfaction levels remain good. Overall, Group retention improved to 80.2% (2016: 79.5%).

Our goal remains to serve customers well but profitably.

Regional trends for 2017 include:

· Scandinavian premiums were up 7% at reported FX and up 0.3% at constant FX. Growth in Sweden and Norway was partly offset by a small contraction in Denmark. Personal Lines policy counts were up 1%, while Commercial Lines volumes (excluding rate) were down 3%

· Canadian premiums were up 12% at reported FX and 5% at constant FX. The region reported the fourth quarter of consecutive growth in Q4, with Personal Lines policy counts up 3% and Commercial Lines volumes up 1%. There was good growth in our broker channel (policy count up 4% in Personal broker) and our direct channel, Johnson, also returned to organic growth in 2017

· UK & International premiums were up 4% at reported FX and up 2% at constant FX. UK premiums were up 3%, with Personal up 7% (policy counts up 2%) and Commercial flat. Premiums in Ireland were down 7% at constant FX, while Middle East premiums were up 6%.

More detail is provided in the regional reviews on pages 14 to 19.

1 Group excluding disposals for 2016

Underwriting result

Group underwriting profit of £394m was up 4% year-on-year:

Current year profit was £237m (2016: £271m):

· The Group attritional loss ratio of 55.3% was 0.1 point better than 20162 at constant FX. Scandinavia was 1.6 points better, while Canada was 1.0 point better. UK & International was 1.1 points higher than a year ago as improvements in UK Personal Motor, Ireland and the Middle East were offset by a higher attritional loss ratio in UK Household

· Group weather costs were £168m or 2.6% of net earned premiums (2016: 2.6%2 at constant FX; five year average: 3.2%2). Three major US/ Caribbean hurricanes and Mexico earthquakes cost £72m net of reinsurance in 2017 (£115m gross). 2016 was also a year with natural catastrophe losses including the Alberta wildfires, UK & European floods and a US hurricane

· Group large losses were £713m or 10.8% of net earned premiums (2016: 9.1%2 at constant FX; five year average: 9.0%2). This elevated large loss experience was driven by the UK and Canada. While substantial elements of this are volatile, underwriting interventions have also been made to target recovery in 2018 and beyond.

Group prior year profit was £157m, pleasingly higher than our planning assumption and providing a 2.8 point benefit (2016: 2.22 points at constant FX) to the Group combined ratio. This included positive development from each region.

The 2017 underwriting result included a £23m net charge (after release of 2016 margin build) relating to the change in Ogden discount rate in the UK. £20m related to our UK business and £3m to Northern Ireland. This also reflected the benefit of net settlement gains in H2 against H1 revised case reserves.

Our assessment of the margin in reserves for the Group (the difference between our actuarial indication and the booked reserves in the financial statements) returned to its target level of 5% of booked claims reserves.

Underwriting operating expenses

The Group underwriting expense ratio of 14.4% was 0.6 points better than a year ago at constant FX (2016: 15.0%2). Pleasingly, all regions contributed with improvements of 0.3 points in Scandinavia, 1.4 points in Canada and 0.4 points in UK & International.

Commissions

The Group commission ratio in 2017 of 13.7% was flat2 at constant exchange. 

1 Proforma for share of aggregate reinsurance recoveries and excludes the impact of the Ogden rate change, with the corresponding adjustment in Central functions; 2 Group excluding disposals for 2016

Investment result

The investment result was £284m (2016: £298m) with investment income of £331m (2016: £369m), investment expenses of £13m (2016: £12m) and the liability discount unwind of £34m (2016: £59m).

Investment income was down 10% on prior year, primarily reflecting the impact of the disposal of Latin America and the UK Legacy book, together with ongoing reinvestment at lower yields. The average book yield across our major bond portfolios was down slightly to 2.5% (2016: 2.6%).

Based on current forward bond yields and foreign exchange rates, it is estimated that investment income will be c.£285-310m for 2018, c.£275-300m for 2019 and c.£270-295m for 2020. The discount unwind is expected to be in the region of c.£30-35m per annum.

Total controllable costs

Our cost reduction programme has now delivered total gross cost reductions of £395m, compared to a 2018 target of more than £400m. We are raising our target for a fourth time to over £450m gross savings by the end of 2019.

Group written total controllable costs were down 6%1 to £1,425m. This comprised 8% cost reductions, offset by 2% inflation. Canada delivered year-on-year 'real' cost reductions of 9%, Scandinavia delivered 5% and UK & International delivered 5%. The written controllable cost ratio was 21.3% (2016: 23.1%1).

Group FTE2 is down 23% (excluding disposals) since the start of 2014 to 12,636 at 31 December 2017. FTE decreased by 6% during the course of 2017.

The earned controllable expense ratio improved to 21.5% in 2017, with all regions contributing. It is now down 4.4 points since the start of 20141, making good progress towards our ambition of an earned controllable expense ratio of less than 20%.

Non-operating items

Interest costs:

· Interest costs in 2017 were £43m (£54m including the new tier 1 issuance - see below), down from £99m in 2016. The reduction reflects debt restructuring actions over the past 12 months

· In 2017, the Group issued c.£300m of restricted tier 1 notes in Scandinavia and retired £636m of existing high coupon debt. These actions supplemented the £200m debt retirement completed in July 2016

· Coupon costs for the new Scandinavian issuance are reflected at the bottom of the management P&L as 'other equity costs', as per accounting rules. The cost for the year was £11m, with an annualised interest cost for this instrument of £14m.

1 Group excluding disposals for 2016 (and prior years where relevant) and at constant FX

2 Full time equivalent employees

Other non-operating charges:

· Net gains of £47m in 2017 include a £66m gain relating to the UK Legacy disposal (mainly mark-to-market of the assets transferred to the buyer); a £22m charge relating to the commutation of the Group's adverse development reinsurance cover, both as previously noted in 2016; and a £23m software impairment charge relating to the UK, Scandinavia and Ireland

· 2017 included a charge of £59m relating to the premium paid on the debt buybacks completed during the first half of the year

· Restructuring costs were £155m in 2017. These costs are c.£50m higher than originally planned; however, they have enabled a fourth increase in our cost savings target to over £450m by the end of 2019. It remains our ambition that 2017 will be the last year of 'below the line' restructuring charges. Total 'cost to achieve' these savings will have been c.1.3x the annual savings target, improved from the 1.5x originally expected

· The goodwill write-back of £17m in 2017 reflects the re-measurement of the fair value of the Oman business following its IPO process during the year.

Tax

The Group reported a tax charge of £126m for 2017, giving an effective tax rate (ETR) of 28% (2016: 78%). The Group underlying tax rate was 22.1% (2016: 24%).

The tax charge of £126m largely comprises tax payable on Scandinavian and Canadian profits as well as Canadian dividend withholding tax of £28m. The Canadian dividend withholding tax includes £23m attributable to a one-off dividend in connection with an internal debt reorganisation. Excluding this one-off dividend withholding tax the group ETR would be 23%.

The carrying value of the Group's net deferred tax asset at 31 December 2017 was £220m (2016: £216m), of which £217m (2016: £212m) is in the UK. At current tax rates, a further c.£229m (2016: £183m) of deferred tax assets remain available for use but not recognised on balance sheet; these are predominantly in the UK and Ireland.

In 2018, we would expect the Group's ETR and underlying tax rate to continue to trend towards 20% given the scale of the unrecognised UK tax assets.

Dividend

We are pleased to declare a final dividend of 13.0p per ordinary share (2016: 11.0p). Together with the interim dividend of 6.6p, this brings the total dividend for the year to 19.6p (up 23%), representing a 45% payout of underlying EPS. Our medium term policy of ordinary dividend payouts of between 40-50% of earnings remains, with additional distributions where justified.

1 Foreign currency translation reserve

BALANCE SHEET

Movement in Net Assets

Tangible net assets remained broadly constant at £2.8bn at 31 December 2017.

Profit after tax of £385m was offset by negative fair value mark-to-market movements of £194m, mainly reflecting a reduction in the bond unrealised gains reserve. This was driven by the bond pull-to-par effect and the realisation of gains on the transfer of the Legacy assets. Payment of the 2016 final and 2017 interim dividends (totalling £180m) also reduced tangible net assets, together with investment of £131m in intangible assets, primarily IT related (net investment of £37m after amortisation shown as part of profit).

The IAS 19 pension valuation generated a gain of £44m. The annual update to mortality tables more than offset negative movements, including narrower 'AA' corporate bond spreads (see page 24 for further detail). 

1 Ordinary shareholders' funds including preference share capital of £125m

 2 Includes preference dividends of £9m and coupons of £11m paid on 2017 issued restricted tier 1 securities

CAPITAL POSITION

The Solvency II coverage ratio1 increased to 163% during 2017 (31 December 2016: 158%):

Please refer to Appendix (page 23) for further Solvency II details (including sensitivities).

OUTLOOK

RSA's goal for 2018 is to set new record levels of performance for shareholders and to serve customers well, whilst continuing to move business capabilities forward consistent with our best-in-class ambitions.

We expect markets to remain competitive, showing modest growth overall. Our priority is to maintain underwriting discipline and to improve areas of 2017 underwriting disappointment. Nevertheless, we target positive premium growth in aggregate.

We aim to make further gains in attritional loss ratios and in cost efficiency. Weather and large loss ratios are hard to predict, although bounded by reinsurance protection consistent with prior years. However, we do expect to see improved large loss performance compared with 2017.

Investment income (pre discount unwind) is expected to be c.£285-310m for 2018 subject to market movements. Interest costs should be c.£25m with a further c.£14m in coupons paid on restricted tier 1 securities which is recognised directly in equity. We target 2018 to be clear of 'below the line' restructuring costs.

1 The Solvency II capital position at 31 December 2017 is estimated

REGIONAL REVIEW - SCANDINAVIA

Management basis

SCANDINAVIA

Scandinavia delivered operating profit of £389m, up 25%. Driving this was an excellent underwriting profit performance of £315m in 2017, up 24% (at constant FX). The combined ratio (82.9%) was within our < 85% best-in-class ambition for the first time on record. Current and prior year profitability were strong, at £255m and £60m respectively.

Net written premiums of £1,833m were up 7% at reported FX and up 0.3% at constant FX (2016: £1,721m). A number of premium related key performance indicators are showing positive signs. In Sweden, Personal Lines policies-in-force ('PIFs') grew steadily in 2017, with Q4 1.5% higher than Q4 in 2016. Commercial Lines new business in Q4 was 22% higher than the same quarter last year. While Denmark Personal Lines PIFs contracted between 2012 and 2016, this trend flattened in 2017. Commercial Lines returned to growth this year excepting the more volatile Construction, Power & Engineering business.

We continue to make good progress with our customer agenda. Improvement initiatives included the launch of a 'chat bot' service in Sweden and a new customer claims service portal in Denmark. Overall retention was in line with 2016 at 78%, Personal Lines retention improved but was offset by a decrease in Commercial Lines.

The current year attritional loss ratio of 62.6% was 1.6 points better than 2016 reflecting underwriting discipline, ongoing capability improvements and lower claims handling costs. Benign weather experience (0.3 points better than last year) was offset by adverse large loss experience (0.7 points higher than last year but in line with the 5 year average of 5.7%). The prior year effect on the loss ratio was particularly positive, producing a benefit of 3.2% (2016: 1.6%).

The Scandinavian performance improvement programme has continued to deliver well, with particular focus on operational efficiency; for example, process redesign, robotics and automation. We have also pursued further site consolidation and IT cost reduction, and we launched a BPO programme for certain operational and support activities in Q4 of 2017.

Total written controllable expenses were down 3% year-on-year1, with 5% cost reductions absorbing 2% inflation. The earned controllable cost ratio of 23.3% showed a 0.9 point reduction year-on-year. Staff related costs reduced by 8%1 in 2017 with headcount down 9% in the year and down 23% since the end of 2013.

Geographically, Sweden generated an underwriting profit of £259m (2016: £184m1) and a combined ratio of 75.3% (2016: 82.2%1). While the current year combined ratio improved by 2.2 points (3%), favourable prior year development contributed 4.7 points year-on-year, partly reflecting more benign Motor account development. Denmark produced a combined ratio of 90.3%; while this was 0.6 points higher than 2016, the current year combined ratio improved by 1.7 points.

Inclusive of an investment result of £74m (2016: £72m), the region's total operating profit of £389m (2016: £311m) was up by a pleasing 25%.

Scandinavia - Outlook

We continue to expect Scandinavian P&C markets to grow in line with local GDP and we target medium-term growth broadly in line with the market, subject to maintaining underwriting discipline.

Our focus remains on continued sustainable improvement in the underlying performance of the business, particularly relating to customer volumes, attritional loss ratios and costs. While our 2017 result is within the target combined ratio of < 85%, we see scope for further progress in the sustainability and composition of the result.

1 At constant FX

REGIONAL REVIEW - CANADA 

Management basis

CANADA

In 2017, Canada increased operating profit by 14% to £159m (2016: £140m). Underwriting profit also rose 32% (to £98m), despite higher large losses and lower prior year releases than a year ago. The combined ratio improved to within our best-in-class ambition of < 94% and seems likely to compare favourably with local competitors.

Net written premiums of £1,619m were up 12% at reported FX and 5% at constant FX (2016: £1,443m as reported). Growth was particularly strong in the broker channel, with Personal broker up 10% (policy count up 4%) and Commercial broker up 4%, both at constant FX. Johnson, our direct business, also returned to growth in the year (policy count up 2%).

We continue to work hard to enhance our customer offering. In Johnson, we have made strong progress in digital capabilities while customer NPS scores have continued to improve and outperform benchmarks. In our broker distributed businesses, faster response times and new digital tools enable brokers to service their clients anywhere, anytime, reducing the time to quote from hours to minutes. Customer retention has improved to 85.8% from 84.3% a year ago with Personal Lines up 1.7 points and Commercial Lines up 0.9 points.

The business generated an underwriting profit of £98m (2016: £74m), with a current year profit of £56m and a prior year profit of £42m. The current year attritional loss ratio of 56.8% was 1 point lower than a year ago, reflecting both rating action and our investments in pricing sophistication. Weather experience was 2 points favourable to 2016, noting that the prior year included 2.9 points for the Fort McMurray wildfire losses. Large loss experience was elevated at 7.7%, compared to 6.4% in 2016 and a five year average of 5.1%. Prior year reserve releases, while positive at 2.9%, were lower than last year (2016: 4.7%). Overall, the combined ratio was 93.9% (2016: 94.9%).

Our business improvement programme in Canada progressed well, delivering further enhancements to pricing sophistication, process simplification and site consolidation, while the implementation of the Guidewire claims system is proceeding as planned.

Total written controllable expenses were down 7% year-on-year, with 9% cost reductions offset by 2% inflation. The earned controllable cost ratio of 18.7% showed a creditable 2.0 point reduction during 2017. Headcount was down 5% in the year and is now down 21% since the end of 2013.

Canada - Outlook

We target a continuation of the positive premium and underwriting trends that we have seen in 2017. Sustaining a combined ratio of < 94% will remain a priority and we believe that there is scope for further performance improvements from here.

Risks to performance include volatility in weather and large losses. We are working hard to drive large loss ratios back towards long term averages, recognising trends early and taking any underwriting and/ or pricing action required. The Canadian Motor market remains challenging and we continue to lobby through industry associations for product reform.

REGIONAL REVIEW - UK & INTERNATIONAL

Management basis

1 Proforma for net aggregate reinsurance recovery and excludes the impact of the Ogden rate change

UK & INTERNATIONAL

The UK & International business segment delivered operating profit of £133m1, down 44%. Driving this result was a disappointing combined ratio of 100.5%1 (2016: 97.2%).

UK

The UK business result (includes European branches and 'London market' international business lines) suffered from a number of material market events in 2017. This was reflected in a combined ratio of 102.0%1 (2016: 95.4%). Underwriting losses include the impact of adverse weather events (US/ Caribbean hurricanes and Mexico earthquakes) amounting to £72m (net of GVC recovery), adverse large loss volatility and higher Household claims inflation.

Despite this accumulation of adverse market conditions, the underlying UK business continues to make progress. Net written premiums increased by 3% at constant exchange. UK Personal growth of 7% (policy count up 2%) was underpinned by continued growth in our Motor telematics proposition. UK Commercial net written premiums were flat at constant FX in a competitive market. Targeted growth in our Marine and Property portfolios was offset by shrinkage in Commercial Motor resulting from strong underwriting actions.

In December, we successfully launched our new distribution partnership with Nationwide Building Society as well as signing/ renewing a number of other important long term distribution relationships. Our transformation agenda continues to deliver benefits with increased process simplification and enhanced data analytics capabilities. Intense pricing response and underwriting remediation of the issues that hit 2017 is already well advanced.

Total written controllable expenses were down 3% on a like-for-like basis. Real cost reductions of 6% were offset by 3% inflation. The earned controllable cost ratio of 20.3% improved 1.6 points year-on-year. Headcount was down 8% in the 2017 and is now down 24% since the end of 2013.

Ireland

Ireland returned to underwriting profit delivering a profit of £9.5m and combined ratio of 97.0% (or 96.2% excluding Ogden), underpinned by disciplined underwriting actions. The attritional loss ratio of 60.4% was 5.8 points better than prior year. The result also absorbed a £2.5m cost due to the Ogden discount rate change. Net written premiums of £303m were down 7% at constant FX versus 2016 following targeted remediation activity.

Middle East

The Middle East delivered an underwriting result of £25m (2016: £14m) and a record combined ratio of 87.7% (2016: 92.8%) driven by a 5.0 point improvement in the attritional loss ratio. Net written premiums of £208m were up 6% at constant FX despite challenging economic conditions.

UK & International - Outlook

We expect underlying premium trends to continue into 2018 and weather and large losses to return towards long term levels. Attritional loss ratio weakness of 2017 will not fully correct in 2018 as remedial pricing actions take time to earn through. Our plans target further underwriting improvements, cost reductions and capability uplifts.

In Ireland, we aim to improve profit levels through underwriting and cost actions. In the Middle East, the medium term outlook remains positive and work is underway to further develop capabilities, including underwriting and pricing sophistication. For the UK & International business as a whole, we retain the performance ambition of < 94% combined ratio, although we do not expect to reach this level in 2018.

1 Proforma for net aggregate reinsurance recovery and excludes the impact of the Ogden rate change

INVESTMENT PERFORMANCE

Management basis

INVESTMENT PERFORMANCE

Investment income of £331m (2016: £369m) was offset by investment expenses of £13m (2016: £12m) and the liability discount unwind of £34m (2016: £59m). Investment income was down 10% on prior year, primarily reflecting the impact of the UK Legacy business disposal, together with ongoing reinvestment at lower yields.

The average book yield for 2017 on the total portfolio was 2.5% (2016: 2.6%), with an average yield on the bond portfolios of 2.4% (2016: 2.5%). Reinvestment rates in the Group's major bond portfolios were approximately 1.4%.

At 31 December 2017, the average duration of the Group's bond portfolios of 3.8 years was marginally higher than at the prior year end (31 December 2016: 3.6 years).

The investment portfolio decreased by 5% during the year to £13.0bn. The movement was driven primarily by cash outflows for corporate debt restructuring and negative mark-to-market unwind on bond holdings.

At 31 December 2017, high quality widely diversified fixed income securities represented 82% of the portfolio (31 December 2016: 85%). Equities (largely REITs) represented 2% (31 December 2016: 1%) and cash was 8% of the total portfolio (31 December 2016: 7%).

The quality of the bond portfolio remains very high with 98% investment grade and 70% rated AA or above. We remain well diversified by sector and geography.

Unrealised bond gains and pull-to-par

At year-end, balance sheet unrealised gains of £428m (pre-tax) had reduced by £201m or 32% during 2017, driven by realised gains from the UK Legacy disposal, negative mark-to-market on bond holdings due to yield movements and bond pull-to-par.

Based on year-end forward yields, we anticipate that unrealised gains on the AFS bond portfolio should largely unwind over the next 3 years, with c.£150m expected to unwind in 2018. The capital impact of this amount is under £100m, the balance being projected yield change. The capital impact from pull-to-par is expected to fall sharply in 2019 and 2020 based on current market forward yield curves, which have improved further (risen) since year-end.

Outlook

Based on forward bond yields and foreign exchange rates, it is estimated that investment income will be higher than previously guided, namely c.£285-310m for 2018, c.£275-300m for 2019 and c.£270-295m for 2020. These projected income numbers are, however, sensitive to changes in market conditions. We continue to expect a discount unwind on long-tail liabilities of c.£30-35m per annum.

APPENDIX 1

Further information

DISPOSALS

2016 net written premiums of £6,408m included £127m in respect of businesses now disposed (Latin America and Russia). The underwriting profit of £380m for the same period included a loss of £12m in respect of these disposed businesses. See page 26 for further detail.

CAPITAL

Solvency II sensitivities

The above sensitivities have been considered in isolation. The impact of a combination of sensitivities may be different to the individual outcomes stated above.

Reconciliation of IFRS total capital to Eligible Own Funds

1 The interest rate sensitivity assumes a non-parallel shift in the yield curve to reflect that the long end of the yield curve is typically more stable than the short end; 2 The IAS 19 surplus cap will dampen upside credit spread sensitivities, so these should not be extrapolated

PENSIONS

The table below provides a reconciliation of the movement in the Group's pension fund position under IAS 19 (net of tax) from 1 January 2017 to 31 December 2017:

At an aggregate level, the pension fund position under IAS 19 improved during the year from a £197m deficit at 1 January 2017 to a deficit of £88m at 31 December 2017 (net of tax).

The UK position improved by £90m during the year, driven by deficit funding contributions (£65m pre-tax) and actuarial gains (primarily due to updated views of life expectancy). Gains were partially offset by actual pension increases being higher than expected.

The UK defined benefit schemes closed to future accrual on 31 March 2017 and, where applicable, the stated accounting position of those schemes has been reduced for the tax cost of an authorised return of surplus.

The non-UK schemes' deficit improved by £19m during the year, due largely to a combination of favourable membership experience and positive asset performance.

IAS 19 sensitivities on UK schemes

1 Actuarial gains/ (losses) include pension investment expenses, variance against expected returns, change in actuarial assumptions and experience losses

2 Other movements include regular contributions, service/ administration costs, expected returns, interest costs and settlement gains/ (losses)

3 Sensitivities are rounded to the nearest £0.1bn; for example, the net interest rate stress as modelled is circa £60m adverse

4 Actual net sensitivity to changes in interest rates and breakeven inflation will vary depending on size and direction of stress and is also highly dependent on the level of credit spreads at any point in time

5 Includes 15% reduction in equities and 10% reduction in all other 'growth' assets

REINSURANCE

Updates to our reinsurance programme for 2018 are outlined below.

The 3 year Group aggregate reinsurance cover that commenced in 2015 has been renewed until the end of 2020. The key terms of the new 3 year deal are as follows:

· Cover protects all of our short tail business including Property, Marine and Construction/ Engineering

· Events or individual net losses of £10m or greater are added together across our financial year. When a loss exceeds £10m it is included in full

· Cover attaches when the total of these retained losses is greater than £170m

· Limit of cover is £150m per year, with £300m maximum over the 3 year period

· Counterparties are high credit quality reinsurers (45% AA- or better, 46% A- or better, 9% collateralised).

Retentions for our UK and Ireland Motor programme have been reduced to £1m and €1m respectively (£3m and €3m respectively in 2017).

Outside of these, our key retentions remain unchanged at £75m for UK Cat; £50m for non-UK Cat (Canada/ US/ Caribbean C$75m); maximum of £50m for Property Risk.

SEGMENTAL ANALYSIS

Management basis - 12 months ended 31 December 2016