RSA HY 2018 Results

RSA Insurance Group plc 2 August 2018

Earnings per share up 18%; interim dividend up 11%; return on tangible equity 16%

Underwriting result down due to adverse weather, especially in Canada (but up excluding weather impacts)

Stephen Hester, RSA Group Chief Executive, commented:

"RSA is reporting a strong first half. Activity is high across the Group, aimed at building capability to outperform in our markets.

First half underwriting results were below our ambitions due to adverse weather costs. On an underlying basis we showed areas of excellent performance however, and with much we can continue to improve."

Trading results

· Statutory profit after tax up 19% to £245m (H1 2017: £206m)

· Pre-tax profits up 12% to £296m (H1 2017: £263m)

· Group operating profit of £304m down 15% (H1 2017: £360m) due to adverse weather, which was £53m in excess of the five year average2. Regional results were: Scandinavia £147m; Canada £25m; UK & International £144m

· Underwriting profit of £171m down 23% (H1 2017: £222m):

- Group combined ratio of 94.7% (H1 2017: 93.2%): Scandinavia 87.6%, Canada 100.5% and UK & International 95.3%

- Attritional loss ratio up 0.4 points but flat net of changes in reinsurance

- Group weather costs elevated at 4.9% versus a benign prior year (H1 2017: 1.2%)

- Large losses improved to 9.7% of premiums (H1 2017: 11.4%)

- Group prior year underwriting profit of £92m (H1 2017: £79m)

· Net written premiums ('NWP') of £3,219m down 5%1 but flat net of changes in reinsurance2:

− Headline premiums were dampened by c.£180m of budgeted reinsurance costs, primarily for the triennial Group Volatility Cover ('GVC') renewal

− NWP up 1%1 in Scandinavia, with Sweden up 6%1

− NWP up 5%1 in Canada. Scotiabank, one of Canada's leading retail financial services providers, has agreed to switch its exclusive general insurance partnership to RSA from 2019, giving us an exciting new distribution channel

− NWP down 5%1 in UK & International or 2% net of changes in reinsurance, as underwriting and rating actions (including scheme exits) take effect

1 At constant FX2 Please refer to pages 27 to 34 for further information

· Total Group written controllable costs down 2%1 to £697m. This comprised 4% cost reductions, offset by 2% inflation

· Investment income of £160m (H1 2017: £171m) ahead of guidance but down 6%1 versus last year due to reinvestment at lower yields

· Below the operating result, interest expense more than halved following debt restructuring actions in prior years. As planned, restructuring charges fell away (H1 2017: £100m)

· Headline earnings per share (EPS) up 18% to 21.8p (H1 2017: 18.4p). Underlying EPS2 down 10% to 21.0p due to adverse weather (H1 2017: 23.3p)

· Interim dividend of 7.3p per ordinary share declared, up 11% (H1 2017: 6.6p).

Capital & balance sheet

· Solvency II coverage ratio of 169% after dividend accrual (31 December 2017: 163%), above 130-160% target range

· Tangible equity £2.9bn up 6% (31 December 2017: £2.8bn), 285p per share

· Return on tangible equity of 16.2% (H1 2017: 13.1%) in upper half of 13-17% target range.

Strategic and market update

· RSA's focus is on building capability 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

· Financial market conditions have been relatively stable as they impact RSA, albeit with negative foreign exchange impacts of circa 2% in the first half. Political uncertainties in the UK and internationally continue to give the potential for volatility however

· Insurance markets remain competitive overall, with significant variations by region and by product line. Scandinavian markets were relatively stable. In Canada prices are responding to weather and auto loss cost challenges. The UK and 'London market' are experiencing soft conditions requiring volume trade-offs for underwriting discipline.

1 At constant FX2 Underlying measure, please refer to pages 27 to 34 for further information

MANAGEMENT REPORT - KEY FINANCIAL PERFORMANCE DATA

Management basis

CHIEF EXECUTIVE'S STATEMENT

RSA's first half performance was strong with EPS up 18%, dividends up 11% and a return on tangible equity of 16%. This reflects an inherently stronger business, better able to absorb underwriting volatility; together with an absence of restructuring costs reflecting the Group's progress.

The Group combined ratio of 94.7% was good by historical standards, but short of our plan and H1 2017 due to adverse weather costs. Our view of RSA's underlying earnings capacity is unchanged however.

RSA continues to focus intensely on building performance capability in pursuit of our best-in-class ambitions for both customers and shareholders. We are making good progress, but with much more we can do. We expect to have setbacks - from external events and in our own execution - but to progress nevertheless.

Market conditions in the first half remained competitive, with areas where the correct underwriting and price actions required a 'top line' trade-off. Conversely, large parts of our business saw good progress in both top line and 'bottom line' drivers.

We are investing across RSA to serve customers better, to be better underwriters and to drive further efficiencies. Top line was positive1 in two of our three regions, with UK weaker as our underwriting measures to improve on 2017 results took hold.

H1 attritional loss ratios (except in the UK) and expenses tracked closely to plan. The balance of naturally volatile underwriting items was £59m1 negative in H1 versus prior year with weather costs £118m1 adverse, partially offset by lower large losses (£55m1) and better prior year development (£4m1). Pleasingly, large losses were significantly better in the UK and Canada where 2017 corrections were needed, but Scandinavia had poor results in this respect - just volatility as far as we can tell.

In terms of our regional businesses; the UK & International segment saw 142%1 higher underwriting profits - though there remains work to do, not least to navigate soft market conditions. Our important Scandinavian business saw lower underwriting profits due to large loss and PYD volatility but on an underlying basis is on track versus our plans. Similarly Canada had poor headline results due to very challenging weather, but was on track in all other respects. Weather volatility is a continuing feature of that market which we have previously highlighted.

We enter the second half of 2018 with confidence, while mindful of market challenges. Good progress is being made in modernising technology platforms in every region. Underwriting actions and technical capability remain in focus. And we are pleased to have concluded an important new bancassurance alliance in Canada with Scotiabank, one of Canada's leading retail financial services providers.

Stephen Hester

Group Chief Executive

1 August 2018

1 At constant exchange 

MANAGEMENT REPORT

SEGMENTAL INCOME STATEMENT

Management basis - 6 months ended 30 June 2018

Notes:

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

Please refer to appendix for H1 2017 comparatives

1 Preference dividends of £5m and coupons of £7m paid on Restricted Tier 1 securities

Premiums

Net written premiums of £3,219m were down 5% at constant FX but were flat excluding the impact of changes in reinsurance1. Premiums were dampened by c.£180m due to costs for the triennial GVC renewal and a reduction in retention levels for certain reinsurance programmes. These were budgeted in our plans. Foreign exchange provided a 2% headwind to premiums year-on-year.

We continue to see a strengthening of underlying customer activity where capability improvements take effect. Both customer satisfaction measures, such as net promoter score ('NPS'), and sales and service metrics are improving. Group retention was slightly lower at 79% (FY 2017: 80%). Scandinavia and Canada Personal Lines were up, while UK & International was down as a result of underwriting and rating action.

Regional trends for H1 2018 include:

· Scandinavian premiums were down 1% at reported FX but up 1% at constant FX. Attractive growth in Sweden was partly offset by contraction in Denmark and Norway. Personal Lines policies-in-force ('PIFs') were up 1%, while Commercial Lines volumes (excluding rate) were down

· Canadian premiums were flat at reported FX and up 5% at constant FX. The region continued the positive growth trends seen in 2017, with Personal Lines PIFs up 2% and Commercial Lines volumes up 5%. Retention is performing particularly well with both Johnson, our direct and affinity channel, and Personal broker improving over the last year to 90% and 88% respectively. Johnson continued to grow organically, achieving growth of 3% in H1 2018

· Net written premiums were down 5% in UK & International or down 2% excluding reinsurance changes, both at constant FX. Our partnership with Nationwide in the UK is doing well; retention was 87% in H1 and NPS scores remained strong. However, overall premiums were down as we maintained a disciplined approach in terms of pricing and re-underwriting certain portfolios (including scheme exits where necessary). Net written premiums in Ireland were down 3% at constant FX, while premiums in the Middle East were flat.

More detail is provided in the regional reviews on pages 12 to 17.

1 Please refer to pages 27 to 34 for further information 

Underwriting result

Group underwriting profit of £171m was down 23% year-on-year due to adverse weather, particularly in Canada:

Current year profit was £79m (H1 2017: £143m):

· The Group attritional loss ratio of 55.3% was 0.4 points higher than H1 2017 (54.9%) but 0.3 points better than H2 (55.6%). The ratio was broadly flat year-on-year when adjusted for the impact of changes in reinsurance. Scandinavia was 0.1 points better than last year. Canada was in line with our plans and flat versus H1 20171; Auto price increases also earn through more strongly in H2. The UK & International attritional loss ratio was 0.4 points better than H1 last year1. Pleasingly, the first half of 2018 was 1.6 points1 better than the 2017 full year ratio as pricing and underwriting actions start to earn through

· Weather was the dominant feature of the first half and the comparison is further distorted by a benign H1 2017. Group weather costs were £155m or 4.9% of net earned premiums (H1 2017: 1.2%; five year average: 3.2%). Canada was the most affected region with a weather ratio of 10%, twice the annual five year average. In particular, at a cost to the industry of more than $500m, the windstorm of early May is likely to be the most costly insured event in Ontario and Quebec since the 2013 Toronto floods2. The UK & Ireland saw Storms Eleanor and Emma, with Emma known locally as the 'Beast from the East' and costing an estimated £47m pre-tax 

· Large losses were £310m or 9.7% of net earned premiums (H1 2017: 11.4%; five year average: 9.0%). Pleasingly, both Canada and the UK & International reported improved ratios in line with our plans after seeing elevated large losses in 2017. Losses increased in Scandinavia, albeit one Commercial Property fire loss accounted for about half of the increase and added 0.6 points to the Group loss ratio. All large losses are independently reviewed and the 2018 Scandinavian results to date point to volatility rather than the emergence of an underwriting issue.

Group prior year profit was £92m, higher than our planning assumption and providing a 3.0 point benefit (H1 2017: 2.8 points) to the combined ratio. It included positive development from each region.

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

Underwriting operating expenses

The Group underwriting expense ratio of 14.6% was 0.3 points better than last year (H1 2017: 14.9%). All regions contributed with improvements of 0.7 points in Scandinavia, 0.1 points in Canada and 0.2 points in UK & International.

1 When adjusted for changes in reinsurance 2 Source: Catastrophe Indices and Quantification Inc.

Commissions

The commission ratio of 13.2% improved by 0.4% (H1 2017: 13.6%) mainly due to a lower proportion of Commercial Lines in the business mix.

Investment result

The investment result was £136m (H1 2017: £148m) with investment income of £160m (H1 2017: £171m), investment expenses of £7m (H1 2017: £6m) and the liability discount unwind of £17m (H1 2017: £17m).

Investment income was down 6% on last year, primarily due to ongoing reinvestment at lower yields. The average book yield across our major bond portfolios was down slightly to 2.3% (H1 2017: 2.4%).

Based on current forward bond yields and foreign exchange rates, it is estimated that investment income will be c.£300-310m for 2018.

Total controllable costs

Group written total controllable costs were down 2%1 to £697m. This comprised 4% cost reductions, offset by 2% inflation. Scandinavia delivered year-on-year cost reductions of 8%, while UK & International delivered 3%. In Canada, costs increased by 1%; while staff costs reduced, higher software amortisation and IT costs reflected capability investments and supported growth initiatives.

Group FTE2 decreased by 4% since H1 2017.

The earned controllable expense ratio improved by 0.7 points1 to 21.5% in H1 2018. It is now down 4.3 points since the start of 20143, making good progress towards our ambition of an earned controllable expense ratio of less than 20%.

Non-operating items

Interest costs:

· Interest costs were £13m (£20m including the Tier 1 issuance - see below), down from £30m in H1 2017. The reduction reflects the debt restructuring actions taken in 2016 and 2017

· Coupon costs for the 2017 Tier 1 issuance are reflected at the bottom of the management P&L as 'other equity costs', as per accounting rules. The cost for H1 was £7m (H1 2017: £3m).

1 At constant FX

2 Full time equivalent employees

3 Group excluding disposals

Other non-operating charges:

· Net gains of £44m in H1 2017 included a £66m gain relating to the UK Legacy disposal (mainly mark-to-market of the assets transferred to the buyer) and a £22m charge relating to the commutation of the Group's adverse development reinsurance cover

· H1 2017 also included a charge of £59m relating to the premium paid on the retirement of c.£600m in high coupon debt

· As expected, no non-operating reorganisation costs were incurred in H1 (H1 2017: £41m).

Tax

The Group reported a tax charge of £51m for H1 2018, giving an effective tax rate ('ETR') of 17% (H1 2017: 22%). The tax charge largely comprises tax payable on overseas profits. The Group underlying tax rate for H1 2018 was 19% (H1 2017: 22%).

The carrying value of the Group's net deferred tax asset at 30 June 2018 was £194m (31 December 2017: £220m), of which £197m (31 December 2017: £217m) is in the UK. The change in the carrying values of the Group and UK deferred tax assets is mainly due to a decrease in the IAS 19 deficit on a UK pension fund. At current tax rates, a further £235m (31 December 2017: £229m) of deferred tax assets remain available for use but not recognised on balance sheet; these are predominantly in the UK and Ireland.

The Group ETR and underlying tax rates for 2018 are likely to be below 20% (2017: 22%).

Dividend

We are pleased to declare an interim dividend of 7.3p per ordinary share, up 11% (H1 2017: 6.6p). Our medium term policy for full year ordinary dividend payouts is unchanged - targeting between 40-50% of earnings, with additional distributions where justified.

BALANCE SHEET

Movement in Net Assets

Tangible net assets increased by 6% to £2.9bn at 30 June 2018.

The increase was driven by profit after tax of £283m offset by foreign exchange movements of £27m and fair value mark-to-market movements of £49m. The latter mainly reflected a reduction in the bond unrealised gains reserve driven by the bond pull-to-par effect. Payment of the 2017 final dividend (£133m) also reduced tangible net assets, together with investment of £74m in intangible assets, primarily IT related (net investment of £34m after amortisation shown as part of profit).

The IAS 19 pension valuation generated a gain of £164m and this was primarily as a result of an increase 'AA' corporate bond spreads (see page 22 for further detail).

TNAV per share increased by 6% to 285p.

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

 2 Includes preference dividends of £5m and coupons of £7m paid on Restricted Tier 1 securities

CAPITAL POSITION

The Solvency II coverage ratio1 increased to 169% during H1 2018 (31 December 2017: 163%):

Please refer to Appendix (page 21) for further Solvency II details (including sensitivities).

OUTLOOK

In the second half of 2018, we will continue the drive to improve business capabilities for customers and shareholders.

We are anticipating market conditions comparable to H1. We target improved underwriting profits based on more normal weather costs and further progress against other aspects of the underwriting result.

Investment income of c.£140-150m is anticipated for H2.

Overall, we aim to deliver attractive full year 2018 performance.

2 Equates to the mid-point of the 40-50% normal policy range

REGIONAL REVIEW - SCANDINAVIA

Management basis

SCANDINAVIA

Scandinavia delivered operating profit of £147m for H1 2018, down 25%1. The combined ratio (87.6%) was 5.7 points higher than last year, mainly due to lower prior year development (down 3 points) after an unusually positive result in H1 2017. Elevated large losses also contributed (up 2.2 points).

Net written premiums of £1,057m were up 1% at constant FX, with Personal Lines premiums up 7%1. Swedish Personal Lines grew by 10%1 and policies-in-force ('PIFs') were 2% higher year-on-year. Motor PIFs were up 3%, mainly due to strong online new business, while Personal Accident grew by 2%. Danish Personal Lines premiums were up 3%1 within which Motor PIFs grew by 1%. Commercial Lines premiums were down 6%1 with volumes down 10%. We exited two schemes in Norway in 2017 which accounted for 4%1 of the reduction in premiums.

Customer metrics are developing well. We rolled out an 'effortless' measure across the region to determine and then track how seamless customer interactions are against defined targets. Customer satisfaction scores are improving, with Danish Personal Lines showing the highest quarterly score for three years in Q1 (80%). We continue to invest in online sales capabilities which is being well received by customers; in Sweden, online sales were 74% higher in the first half than H1 last year. Overall, retention was slightly lower than last year at 78%. Sweden and Denmark both improved; however, Norway reduced as a result of scheme exits.

The current year attritional loss ratio of 63.0% improved versus H1 2017. Good progress in Denmark was offset by challenges in Norway, where the attritional ratio was impacted by higher weather-related frequency and by underperforming schemes currently in remediation. Large losses were elevated at 8.0% compared to the five year average of 5.7% (H1 2017: 5.8%). While frequency was higher than last year, one Commercial Property fire loss in Denmark contributed 1.3 points to the loss ratio. All large losses are independently reviewed and the results to date point to volatility rather than the emergence of an underwriting trend. The prior year effect on the loss ratio was particularly positive in H1 2017, producing a benefit of 4.7%; the H1 2018 ratio of 1.7% is closer to the levels at which we typically plan.

The performance improvement programme continued to deliver well. We are building a centre of excellence to drive end-to-end Lean processes, working to optimise data management across the region and investing in a data analytics team. We have also established a new change management framework, launched zero-based budgeting and more than 90% of leaders have now participated in a new leadership development programme. Key regional appointments included a Chief Operating Officer and a Chief Data Officer.

Total written controllable expenses were down 6% year-on-year1, with 8% cost reductions absorbing 2% inflation. The earned controllable cost ratio of 22.5% improved by 1.7 points. Staff related costs reduced by 8%1 in H1 2018 with headcount down 6% against H1 2017 and down 23% since the end of 2013. Denmark delivered the most progress, reducing the controllable cost ratio by 4.2 points.

Geographically, Sweden generated an underwriting profit of £113m (H1 2017: £118m1) and a combined ratio of 77.9% (H1 2017: 76.1%1). The weather loss ratio was 0.7 points higher than last year, while the prior year contributed 0.7 points less. Denmark produced an underwriting profit of £14m (H1 2017: £46m1) and a combined ratio of 95.7% (H1 2017: 84.9%1). Pleasingly, the Personal Lines combined ratio improved by 1.5 points helped by a reduction in the attritional loss ratio. However, the Commercial Lines ratio deteriorated by 19.1 points due to elevated large losses and a lower prior year result. The underwriting loss in Norway of £15m (H1 2017: £5m1 loss) was impacted by adverse winter weather and a deterioration in attritional claims. In particular, Household saw higher weather-related claims frequency and Motor continued to experience inflation in repair costs. The Norwegian Motor market is highly competitive, while rate has struggled to keep pace with claims inflation, there are signs that the market is beginning to harden.

1 At constant FX 

REGIONAL REVIEW - CANADA 

Management basis

Canada delivered operating profit of £25m for H1 2018, down from £68m1 in the prior year. Adverse weather was the dominant feature and the comparison is further distorted by a benign H1 2017.

Net written premiums of £729m were up 5% at constant FX (H1 2017: £695m1). In Personal Lines, policy counts were up 2% and Johnson, our direct and affinity business, continued to grow organically (3%). Retention performed particularly well, with both Johnson and Personal broker improving over last year to 90% and 88% respectively. This was despite holding our discipline on rate in Auto and Household. We are pleased to have announced that Scotiabank, one of Canada's leading retail financial services providers, has agreed to switch its exclusive general insurance partnership to RSA from 2019, giving us an exciting new distribution channel. In Commercial Lines, volumes increased by 5% over H1 2017. While retention was down, new business was up and rate was ahead of both last year and our plans.

We continue to work hard on our customer offering. In Johnson, NPS reached a new high of +52 in Q1 (up 5 points). We are enhancing the customer journey and telephony statistics (such as call answering time) have improved, driven by staff proficiency and lower call volumes as a result of digital initiatives. Our automatic call back for qualified leads had a quote rate of 82% in H1. In the broker channel, the 2018 'voice of the broker' survey scored NPS at +48 and scored the ease of doing business with RSA at 79%.

The business generated an underwriting loss of £4m as a consequence of the adverse weather (H1 2017: £38m1 profit). This was composed of a current year loss of £29m and a prior year profit of £25m. The attritional loss ratio of 58.2% was up 0.3 points in H1 due to higher reinsurance costs. Within this, increased frequency and severity in mid-sized losses (particularly fire) impacted Household and Commercial Auto saw some deterioration in haulage and taxis. Personal Auto improved in both Johnson and the broker channel, reflecting rate supported by a series of claims initiatives. Ontario and Alberta make up the majority of our Auto premiums and, by the end of 2018, we will have put almost 10% of rate through these provinces over the last 18 months. The weather loss ratio stepped out by 7.3 points to 10%, twice the annual five year average of 5%. Canada endured a series of significant weather events in H1. At an estimated cost to the industry of more than $500m, the early May windstorm is likely to be the most costly insured event in Ontario and Quebec since the 2013 Toronto floods2. Relative to peers, our book is slightly weighted towards Household and Commercial Property risks which are more exposed to events of this nature. The large loss ratio was 6.9% and closer to the five year average; while volatile by nature, this was also helped by our improved propensity modelling capability. Prior year reserve releases of 3.4% were marginally higher than last year (H1 2017: 3.0%). Overall, the combined ratio was 100.5% (H1 2017: 94.8%).

Our business improvement programme is progressing well. Enhancements to pricing sophistication include more segmented peril rating in Household, where we have increased the number of price points from thousands to millions and introduced more than 20 new target segments. Radar is helping us to improve the speed and efficacy of our regulatory rate filings. The implementation of the Guidewire claims system is proceeding as planned, bringing paperless technology and a customer-facing portal. Finally, we continue to roll-out Lean, including sustainability checks for early adopters.

Total written controllable expenses of £146m were up 3%1 in H1 2018 or 1%1 excluding inflation. While staff costs were 1%1 lower, higher software amortisation and IT costs reflected capability investments and supported growth initiatives. Importantly, the earned controllable expense ratio of 19.1% improved again. Productivity also improved, with a 12% increase in premiums per FTE in June 2018 compared to June 2017. Finally, headcount was down 7% in H1 2018 and is now down 21% since the end of 2013.

1 At constant FX2 Source: Catastrophe Indices and Quantification Inc.

REGIONAL REVIEW - UK & INTERNATIONAL

Management basis

UK & INTERNATIONAL

UK & International delivered an operating profit of £144m in H1 2018, up 33%. The combined ratio (95.3%) was 2.7 points better than last year, despite a 3.7 point increase in weather costs.

UK

The UK business, including European branches and 'London market' international business, generated an underwriting profit of £39m in H1, up 129%. The combined ratio of 97.0% was 1.7 points better.

Net written premiums were down 6% in H1 2018 or 3% excluding reinsurance changes. Headline premiums were dampened by £44m due to higher reinsurance costs resulting from a reduction in retention levels for certain programmes.

Personal Lines premiums were in line with H1 2017 as reported, but up 4% excluding reinsurance changes. Household premiums were up 20%. Our partnership with Nationwide is doing well and generated premiums of £86m in its first full 6 months of trading; retention was 87% and NPS scores are strong (claims +68%; sales % service +64%). On the wider book, we are holding our discipline on rate to mitigate the 'escape of water' issues which presented in H2 2017. However, rate of between 4% and 17%, depending on the channel, drove a decrease in retention and new business. In Motor, H1 premiums were 24% lower than last year, although this was 12% excluding reinsurance changes. We applied rate of 9% and this impacted retention and new business in a softening market. Pet volumes were down 10% and were impacted by rate of 17%.

On Commercial Lines, premiums were down 11% as reported, but down 7% excluding reinsurance changes. Rate has been positive in all major classes in H1; for example, Motor achieved rate of 9% and Marine achieved 7%. However, holding our underwriting discipline has meant a trade-off with top line (volumes down 10%) in ongoing 'soft' market conditions. The decrease in premiums also reflected underwriting decisions on some large individual risks (in Property and Marine in particular) and our exit from certain large schemes as we restructure our delegated authority book.

The improvement in the combined ratio of 1.7 points was achieved despite weather of 5.1% (H1 2017: 1.3%), with Storm Emma costing an estimated £42m pre-tax (£47m including Ireland). Pleasingly, large losses reduced by 3.9 points and are now trending closer to the five year average, although this comes with the usual volatility caveat. Excluding the impact of reinsurance changes, the attritional loss ratio in H1 2018 was 0.3 points higher than H1 last year. However, it was 1.4 points better than the 2017 full year ratio as pricing and underwriting actions start to earn through.

Written controllable expenses of £280m were down 1% in H1, with 3% cost reductions offset by 2% inflation. The earned controllable cost ratio of 21.2% was broadly unchanged, despite the contraction in premiums. Headcount was down 1% in H1 2018 and is now down 22% since the end of 2013.

Ireland

Ireland's performance improved strongly in the first half, generating an underwriting profit of £19m (H1 2017: £2m) on a combined ratio of 87.3% (H1 2017: 98.8%). The attritional loss ratio of 57.6% was 3.3 points better, while the large loss ratio improved by 6.3 points following elevated losses last year. The result was helped by favourable prior year development of 3.2%, compared to adverse development of 2.2% in H1 2017. Net written premiums of £151m were down 3% at constant FX.

Middle East

The Middle East delivered an underwriting profit of £14m (H1 2017: £13m) and another record combined ratio of 84.9% (H1 2017: 87.3%). This was driven by a 3.0 point improvement in the attritional loss ratio. Net written premiums of £102m were flat at constant FX.

INVESTMENT PERFORMANCE

Management basis

INVESTMENT PERFORMANCE

Investment income of £160m (H1 2017: £171m) was offset by investment expenses of £7m (H1 2017: £6m) and the liability discount unwind of £17m (H1 2017: £17m). Investment income was down 6% on prior year reflecting a number of factors including the reinvestment of bonds at lower yields and some strengthening of Sterling.

The average book yield over the period on the total portfolio was 2.5% (H1 2017: 2.5%), with average yield on the bond portfolio of 2.3% (H1 2017: 2.4%). Reinvestment yields on the Group's major bond portfolios over the year was approximately 1.5%.

At 30 June 2018, the average duration of the Group's bond portfolios is marginally lower at 3.7 years (31 December 2017: 3.8 years).

The investment portfolio decreased by 3% during the first 6 months to £12.6bn. The movement was driven primarily by FX translation of regional portfolios and negative mark to market on bond holdings.

At 30 June 2018, high quality widely diversified fixed income securities represented 83% of the portfolio (31 December 2017: 82%). Equities (largely REITs) represented 2% (31 December 2017: 2%) and cash was 6% of the total portfolio (31 December 2017: 8%).

The quality of the bond portfolio remains very high with 98% investment grade and 71% rated AA or above. We remain well diversified by sector and geography.

Unrealised bond gains and pull-to-par

Balance sheet unrealised gains of £361m (pre-tax) reduced by £67m or 18% during the first half, driven by negative mark-to-market on bond holdings due to yield movements and bond pull-to-par (c.£50m).

Outlook

Based on forward bond yields and foreign exchange rates, it is estimated that investment income will be c.£140-150m for H2 2018.

Based on forward yields, c.£70m of unrealised gains on the AFS portfolio are expected to unwind in H2 2018. The capital impact of this amount is under £50m, the balance being projected yield change.

These projections are, however, sensitive to changes in market conditions.

APPENDIX 1

Further information

CAPITAL

Solvency II sensitivities

Underlying sensitivities are broadly in line with those published for the year ending 31 December 2017.

The above sensitivities have been considered in isolation. The impact of a combination of sensitivities may be different to the individual outcomes stated above. Where an IFRS valuation of a pension scheme surplus is restricted under Solvency II, downside pension sensitivities may be dampened relative to those shown.

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 asymmetry in credit spread sensitivities reflects the fact that upside pension sensitivities are restricted to the surplus cap. The upside sensitivity should not therefore be extrapolated

3 Includes preference shares and Restricted Tier 1 notes

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 2018 to 30 June 2018:

At an aggregate level, the pension fund position under IAS 19 improved during H1 2018 from a £88m deficit at 1 January 2018 to a surplus of £145m at 30 June 2018 (net of tax).

This was driven primarily by widening credit spreads over the period, in addition to the deficit funding contributions paid.

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.

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)

SEGMENTAL ANALYSIS

Management basis - 6 months ended 30 June 2017

1 Preference dividends of £5m and coupons of £3m paid on 2017 issued Restricted Tier 1 securities

COMBINED RATIO DETAIL 

Group