Directors' Report, Corporate Governance & Remuneration Report
Remuneration Report
The following report by the Remuneration Committee (the Committee) has been approved by the Board for submission to shareholders at the 2006 AGM.
Overview
The emphasis of the Committee’s work during 2005 has been on further strengthening the link between performance and reward as part of our strategic drive to reinforce a performance culture across the Group.
A major focus in 2005 has been the review of long term incentive provision, resulting in the development of the 2006 Long Term Incentive Plan (the 2006 Plan). A key element of the 2006 Plan – which shareholders are being asked to approve at the 2006 AGM – will be a stretching performance condition based on a sliding scale which ensures that the highest levels of reward will only be delivered for exceptional performance, measured in terms of both financial results and the returns delivered for shareholders. Overall, the 2006 Plan has been designed to deliver broadly unchanged on target total remuneration for executive directors. Higher levels of remuneration will only be delivered if Company performance is superior or outstanding.
During 2005, the Committee also completed a review of pension provision in the light of changing UK pensions legislation, in particular the Finance Act 2004. In summary, our responses to the changes are:
- We will not compensate executives who are affected by the new taxation limits effective as from 6 April 2006 (A Day),
- We have implemented a communications programme designed to ensure that executives are equipped to plan their own retirement in the context of the new regime,
- We have decided that, if any UK based executive can demonstrate that he or she has accumulated approved pension benefits worth 80% or more of the new Lifetime Allowance, we will consider permitting that executive to take Company pension contributions in the form of a taxable cash allowance, adjusted so that the cash alternative is cost neutral to the Company. No executive director is currently expected to qualify for this cash alternative.
Our policy in respect of pension benefits for executive directors has not changed and is set out below.
The Committee is accountable to shareholders through its annual remuneration report which is voted on at the AGM, and remains committed to reflecting the interests of shareholders and the pursuit of best practice in remuneration policy. The Committee welcomes and values its ongoing dialogue with shareholders on remuneration policy.
TopThe Remuneration Committee
The Committee’s responsibilities are set out in its terms of reference which are available to shareholders on request and on the Royal & SunAlliance website. These include:
- Determining the terms and conditions and remuneration of the Chairman, and the terms and conditions and remuneration of the executive directors,
- Overseeing the operation of the Company’s share based long term incentive schemes, including approving the value and timing of awards and overseeing the operation of performance conditions.
The Committee also considers and advises the Board on the Group’s broader remuneration policy in relation to senior executives reporting to the Group CEO (the Executive Team).
Members of the Committee have no personal financial interest, other than as shareholders, in the Committee’s decisions and they have no conflicts of interest arising from cross directorships.
In constitution and operation the Committee complies fully with the Combined Code as appended to the Listing Rules of the UK Listing Authority.
Membership
During the year the directors who served on the Committee were: John Maxwell (Chairman), Edward Lea and Malcolm Le May. All of the non-executive directors on the Committee were determined by the Board to be independent. The attendance record of members in 2005 is shown in the table in the Corporate Governance section.
Advisors
In developing remuneration strategy during the year, the Committee obtained its principal advice from New Bridge Street Consultants LLP, who provided no other services to the Company during 2005.
The terms of engagement for the remuneration consultants for 2006 are available to shareholders on request and on the Royal & SunAlliance website.
The Group CEO is invited to attend all meetings of the Committee, except when his own remuneration is being discussed, to inform the Committee on company strategy and performance and senior executive pay strategy. The Group Human Resources Director normally attends meetings to provide information on wider remuneration strategy and practice within the Group. The Group Chairman is invited to attend meetings as appropriate.
Remuneration policy principles
The key principles which underpin the Committee’s remuneration policy are:
- Total remuneration is set at a level which enables the recruitment, retention and motivation of high quality executive talent,
- There is a strong and visible link between remuneration and performance,
- Executive remuneration and shareholder interests are strongly aligned,
- Incentive arrangements are leveraged so that only exceptional performance attracts the highest level of reward,
- A balance of short and long term performance measures is used, incorporating measures of financial performance, delivery of shareholder value and a robust assessment of personal contribution,
- Remuneration policy and practice is transparent to shareholders.
Elements of remuneration
Remuneration for executive directors in 2006 will consist of five principal elements, of which only base salary is pensionable.
- Base salary,
- Annual performance bonus (delivered as cash and Deferred Shares*),
- Conditional awards of Matching Shares*,
- Conditional awards of Performance Shares*,
- Pension provision and other benefits.
* Subject to shareholder approval at the 2006 AGM.
This structure will be replicated for other members of the Executive Team.
The proposed balance between fixed and variable elements of annual direct compensation for executive directors for on target and maximum performance is as follows:
For the purposes of the charts, the LTI element shows the present value of the projected gain arising from one year’s awards under the 2006 Plan after three years. The valuation incorporates assumptions about share price movements and the Company’s performance against conditions, and reflects policy on the scale of initial awards.
Base salary
Base salaries for executive directors and members of the Executive Team are set on appointment with reference to market data. The Committee’s policy is to relate base salary to the median level for equivalent roles in similar companies facing similar levels of complexity and challenge in the UK and internationally. In the UK, the comparator group most frequently used is a sample of financial services companies within the FTSE 100. Base salaries are reviewed annually on the basis of market movements and an assessment of the performance of the executive. The 2005 salary review process resulted in the following increases for executive directors:
- Andy Haste, Group CEO, received an increase of 10% taking his base salary to £770,000 as at 31 December 2005,
- George Culmer, Chief Financial Officer, received an increase of 10.5% taking his base salary to £420,000 as at 31 December 2005,
- David Paige, Group Risk Director, joined the Group in February 2005 and received an interim increase of 3% effective 1 August 2005, taking his base salary to £340,000 as at 31 December 2005,
- Bridget McIntyre, UK Chief Executive, joined the Group in November 2005 on a base salary of £350,000; no review of her salary was required during 2005.
Above inflation increases for executive directors in 2005, where given, reflect a strong business year and the strength of individual contributions. The next review date for base salaries is April 2006. Recognising that base salaries are now generally competitive, 2006 increases are expected to be broadly in line with market movements in Boardroom pay.
The following table sets out the base salaries of UK based executives below Board level on a banded basis as at 31 December 2005. No such executive received a base salary in excess of £375,000.
| Base salary range | Number of employees |
|---|---|
| £250,001 and over | 2 |
| £200,001 – £250,000 | 9 |
| £150,001 – £200,000 | 10 |
Annual performance bonus
The executive directors and members of the Executive Team participate in an annual performance bonus plan. As in 2005, if stretching business and personal targets are met, participants receive a cash bonus of up to 50% of base salary, and Deferred Shares worth up to 16.5% of base salary. For outstanding performance, a cash bonus of up to 100% of base salary and Deferred Shares worth up to 33% of base salary are achievable. The Deferred Shares will normally vest after three years provided the executive remains in employment with the Company. Total annual bonus potential will therefore be capped at 133% of base salary, as in 2005. Under the 2006 Plan, an award of Matching Shares will be made on a pro rata basis to the Deferred Shares. From 2006, executives will also be offered the opportunity to voluntarily invest up to a further 33% of their cash bonus into Deferred Shares, although the Committee reserves the right to reduce permissible investment below this level.
The majority of the annual bonus is determined by business performance, measured against Combined Operating Ratio (COR) targets for each of the Group’s core businesses. Due to the particular nature of the business portfolio in the US, a special suite of metrics has been developed for this business incorporating the underwriting result, the effectiveness of claims management, expense control, and asset and liability management. COR is the preferred measure for our core businesses as it is the single indicator which most fully captures the underlying strength and performance of an insurance business.
The balance of the annual bonus is determined following a structured assessment of each executive’s performance against detailed and specific personal objectives. Objectives typically include financial, customer, risk management, compliance, people management and business improvement targets. The Committee reviews and signs off executive directors’ objectives early in the financial year. The Group CEO’s performance is assessed annually by the Group Chairman and members of the Committee. The Group CEO carries out a similar assessment for each of his direct reports, subject to review and sign off by the Committee in the case of executive directors. Assessments also take account of appropriate leadership style.
Bonuses paid to executive directors in respect of performance year 2005 are included in the table of directors’ emoluments. These reflect the strength of business results in 2005.
UK based executives who are members of the global 'Top 100' group (the Top 100) participate in a bonus plan which is structured in the same way and measured using the same metrics as the plan described above. For outstanding performance a cash bonus of up to 65% of base salary and Deferred Shares worth up to 33% of the cash bonus are achievable.
Long term incentive plans
In 2005, awards of executive share options were made under the Executive Share Option Scheme (ESOS) to executive directors and other senior managers outside the US. Following the 2005 review of long term incentive provision, it is intended that regular awards under the ESOS will be discontinued from 2006 and will be replaced with awards under the 2006 Plan. The ESOS will, however, remain available for use in exceptional circumstances, such as executive recruitment.
In 2005, awards were also made under the Share Matching Plan (the 2004 Plan), which was approved by shareholders at the 2004 AGM. The 2004 Plan was designed to operate for two financial years only; awards granted in 2005 were therefore the final awards under the 2004 Plan.
2006 Long Term Incentive Plan (the 2006 Plan)
The 2006 Plan will be submitted for shareholder approval at the 2006 AGM and will be the primary long term incentive plan, replacing the expired 2004 Plan and executive share options (as outlined above). Full details of the 2006 Plan have been circulated to shareholders in the AGM Notice. The key features of the 2006 Plan and the policies associated with its operation are summarised below.
Performance Shares
Participants may receive a conditional award of shares with the grant level and performance condition determined by the Committee prior to each grant. Executive directors, members of the Executive Team and the Top 100 will be eligible for awards of Performance Shares.
It is intended that, in 2006, awards of Performance Shares to executive directors will be limited to a maximum face value of 100% of base salary, other than in exceptional circumstances. Awards of Performance Shares to members of the Executive Team in 2006 will be limited to a maximum face value of 80% of base salary, other than in exceptional circumstances. Account will be taken of personal performance in determining the scale of the award to each executive. For executives below this level, distribution policy will normally be based on a formula which relates the size of award to performance and potential, as measured through the annual performance appraisal process.
In any year, the face value of Performance Shares granted to any individual will be limited to 150% of base salary in normal circumstances subject to an overriding cap of 250% of base salary in exceptional circumstances such as an executive recruitment.
Performance Shares will vest after three years subject to performance against the performance condition (see below) and provided the individual remains in employment with the Group (other than in exceptional circumstances such as death or retirement at normal retirement age).
Deferred Shares
As described in the annual performance bonus section above, executive directors, members of the Executive Team and the Top 100 may be granted Deferred Shares as part of annual bonus. These Deferred Shares may not be withdrawn and will normally vest three years from the date of grant subject to continued employment with the Group. In addition, from 2006 executives may invest an additional portion of bonus in Deferred Shares on a voluntary basis. Voluntarily Deferred Shares are not at risk of forfeiture and may be withdrawn at any time (but the right to Matching Shares would lapse on those Deferred Shares withdrawn).
Matching Shares
Executives may receive a conditional award of Matching Shares pro rata to the number of Deferred Shares held. The maximum matching ratio for Matching Shares:Deferred Shares will be 2.5:1, calculated on the gross value of the bonus invested in Deferred Shares. At threshold performance the matching ratio will be 0.625:1. Details of the performance condition proposed for the first grant are provided below.
Executive directors, members of the Executive Team and the Top 100 will be eligible for awards of Matching Shares.
Matching Shares will vest after three years subject to performance against the performance condition (see below) and provided the individual remains in employment with the Group (other than in exceptional circumstances such as death or retirement at normal retirement age).
Awards under the Plan will be funded through a combination of new issue and shares purchased in the market.
Performance conditions
The Committee will determine the performance condition for each grant of Performance Shares and Matching Shares, with performance measured over a single period of three years with no provision to retest. In 2006, grants of Performance Shares and Matching Shares related to non voluntarily Deferred Shares will be subject to a performance condition consisting of a combination of Return on Equity (ROE) and Total Shareholder Return (TSR) targets. These are set out below:
- 50% of the shares comprising the award will vest according to nominal ROE performance. If underlying average annual ROE over three years commencing with the financial year of grant is below 10%, no part of the award subject to the ROE performance condition will vest. If underlying average annual ROE over three years is 10%, 25% of the award will vest. If underlying average annual ROE over three years is 16%, 100% of the award will vest. Vesting will be on a straight line basis in between. Underlying ROE will exclude items of an exceptional nature which in the view of the Committee do not reflect the underlying performance of the business. Underlying ROE will be measured in respect of the Core Group, excluding US operations,
- 50% of the shares comprising the award will vest according to TSR performance against a comparator group of UK and International Financial Services companies. Below median performance, no part of the award subject to the TSR performance condition will vest. At median performance, 25% of the award will vest. At upper quintile (top 20%), 100% of the award will vest. Vesting will be on a straight line basis in between,
- Additionally, before any share subject to the TSR condition vests, the Committee must be satisfied that the Company's TSR performance is reflective of underlying financial performance,
- The comparator group will consist of the following companies: Aegon, AGF, Alleanza, Allianz, Aviva, AXA, Baloise, Fortis, Generali, Legal & General, Munich Re, QBE, Swiss Re and Zurich Financial Services. The Group's TSR will be independently calculated and verified by the Committee for the purposes of the 2006 Plan.
The vesting of Matching Shares related to voluntarily Deferred Shares will be determined solely by the ROE performance condition.
ROE has been selected as the measure of financial performance as it is a key measure of overall business performance which is used internally by the Company and is also visible externally to shareholders.
The TSR performance condition has been designed to provide alignment between executive remuneration and shareholder interests and to ensure that an element of the package is linked directly to share price performance. The comparator group has been selected to ensure that performance is compared fairly against a group of similar companies operating in a similar competitive environment.
The use of ROE and TSR in combination provides a balanced approach to the measurement of Company performance over the longer term.
Equity Incentive Scheme for US Employees
In 2000 shareholders approved an alternative share option scheme for US managers based on US market practice. Grants of options over American Depositary Receipts (ADRs) are made no more than twice a year.
Dilution
Dilution levels for all schemes are held strictly within ABI limits (10% over 10 years for all schemes and 5% for discretionary schemes).
Share ownership guidelines
Strengthened share ownership guidelines were introduced in 2004 for executive directors and members of the Executive Team.
The Group CEO is required to build and maintain a minimum shareholding in the Company equivalent to 150% of base salary. The other executive directors have a target of 100% of base salary and other members of the Executive Team have a target of 50% of base salary. In order to ensure that progress is made towards this target, executives are required to retain shares to a value of 50% of the net of tax gain under all executive schemes until the relevant guideline is attained. This requirement will apply to awards under the 2006 Plan, and will continue to apply to awards under all existing long term incentive plans.
Pension and other benefits
Andy Haste is a member of the SAL Pension Scheme (SAL), a contributory defined benefit occupational pension scheme. In common with all other members of the Royal & SunAlliance defined benefit occupational pension schemes, from 1 January 2006 Andy Haste's future benefits within SAL will accrue on a Career Average Revalued Earnings (CARE) basis rather than on a final salary basis. Royal & SunAlliance has decided to retain a cap within its defined benefits schemes after A Day and, accordingly, Andy Haste's benefit accrual will continue to be calculated by reference to a 'capped' salary (which will be measured each year in line with past practice). In addition to his benefits within SAL, Andy Haste receives an age related taxable cash allowance to enable him to make his own provision for retirement above the cap. In 2006 he will be paid an allowance of 27% of base salary for this purpose.
Until 31 December 2005, George Culmer participated in a contributory defined contribution occupational pension scheme (the Royal & SunAlliance UK Pension Scheme 2002). From 1 January 2006 this scheme was replaced by the Royal & SunAlliance Stakeholder Pension Plan (the Stakeholder Plan), a contributory defined contribution stakeholder pension scheme. George Culmer became a member of the Stakeholder Plan from 1 January 2006. In 2006 he will receive employer contributions worth 15% of base salary, subject to an employee contribution of 5% of base salary up to Inland Revenue contribution limits as applicable. Additionally, following a review of the market competitiveness of his pension benefits, the Committee decided to provide George Culmer with a taxable cash allowance of 15% of base salary, in order to bring his overall pension provision closer to the market median.
David Paige elected not to join a Royal & SunAlliance pension plan on appointment and instead receives a taxable cash allowance of 17.5% of base salary, in order to enable him to make his own provision for retirement.
Bridget McIntyre joined the Group on 1 November 2005 and was enrolled in the Stakeholder Plan as from 1 January 2006. In 2006 she will receive employer contributions worth 15% of base salary, subject to an employee contribution of 5% of base salary up to Inland Revenue contribution limits as applicable. Additionally, Bridget McIntyre receives a taxable cash allowance of 15% of base salary, in order to bring her overall pension provision closer to the market median.
In addition, the executive directors participate in a number of benefits available to other senior managers including life assurance at the rate of four times base salary, sickness and ill health early retirement benefits and private medical insurance. They also have a choice between a company car and a monthly cash car allowance. In common with other employees, the executive directors are eligible to participate in the Royal & Sun Alliance International Sharesave (SAYE) Plan.
Service contracts
The Committee's policy on service contracts is that they should be subject to a maximum notice period of one year. Generally in the event of termination and in all cases of termination on performance grounds the Committee's policy would be to seek and apply mitigation.
Andy Haste's service contract commenced on 2 April 2003 and he was appointed as a director of the Group on the same date. His contract expires under normal circumstances in January 2024 unless terminated earlier by the Company or by Andy Haste on 12 months' notice. Exceptionally, when he was appointed, the Committee agreed that, in the event of termination other than on grounds of gross misconduct, he would be entitled, within the first three years following his appointment or within two years of a change of control occurring before the third anniversary of his appointment, to liquidated damages equal to one year's base salary, plus the average of any annual bonuses paid during the previous two years and one year's pension contributions and other taxable benefits. This arrangement lapses on 2 April 2006.
George Culmer's service contract commenced on 1 May 2004 and he was appointed as a director of the Group on the same date. David Paige's service contract commenced on 1 February 2005 and he was appointed as a director of the Group on 16 February 2005. Bridget McIntyre's service contract commenced on 1 November 2005 and she was appointed as a director of the Group on 2 November 2005. The service contracts for George Culmer, David Paige and Bridget McIntyre terminate under normal circumstances in October 2024, July 2013 and July 2023 respectively unless terminated earlier by the Company or by the individual on 12 months' notice.
External directorships
Where appropriate, the Group encourages directors and other senior managers to accept, subject to the approval of the Group Chairman and the Group CEO, an invitation to join the Board of another company in a non-executive capacity, recognising the value of such wider experience. In these circumstances, managers are permitted to retain the remuneration from the non-executive appointment. For executive directors and other members of the Executive Team, external appointments are limited to one.
Non-executive directors
All non-executive directors of the Company have letters of appointment which set out the terms and conditions of their appointment. Non-executive directors are not entitled to bonus payments or pension arrangements, nor do they participate in the Group's long term incentive plans.
Under the Group's Articles of Association, the remuneration paid to non-executive directors is determined by the Board, within limits set by shareholders. Prior to 2005, non-executive directors' fees had remained unchanged for five years. In 2005, following a review of market practice for similar roles in FTSE 100 companies, the fee structure for non-executive directors was revised to reflect market movements and also to reflect the increased responsibility and time commitment involved in carrying out non-executive duties, including chairing and participating in Board Committees. The basic fee for a non-executive director was increased from £35,000 to £45,000pa. The additional fee for chairing the Group Audit Committee was increased from £10,000 to £20,000pa and the additional fee for chairing the Remuneration Committee was increased from £10,000 to £12,500pa.
The fee for chairing the Investment Committee was set at £12,500pa. Additionally, a fee of £5,000pa was introduced for any non-executive director sitting on more than one committee but not acting as Chair of any committee. These fee rates will be unchanged for 2006.
The Committee determines the Group Chairman's remuneration. The fee payable to John Napier in respect of his appointment as Chairman of the Company (effective 17 March 2003) was increased effective 1 January 2006 from £250,000 to £325,000pa in order to reflect market movements and also to reflect the complexity and challenge of the role. John Napier's letter of appointment was effective 9 January 2003 and the term of his appointment was initially three years; it has now been extended until 31 December 2008. No further review of John Napier's fees is anticipated during the current term of his appointment. The appointment may be terminated by the Chairman on three months' notice to the Company.
Edward Lea and John Maxwell have letters of appointment effective from 10 July 2003; Noel Harwerth and Malcolm Le May have letters of appointment effective from 30 March 2004. These letters of appointment all request one month's notice should the non-executive director wish to resign.
Historical TSR performance
The main graph above is included in the report of the Committee as a requirement of Schedule 7A to the Companies Act 1985.
The graph shows the TSR of the Group with reference to the FTSE World Europe Insurance Index. The FTSE World Europe Insurance Index comprises the range of European insurance businesses which most closely match our competitor group, and the TSR comparator group selected for 2006 awards under the 2006 Plan. TSR performance relative to the index is shown over the five years from 31 December 2000 to 31 December 2005.
The inset graph shows the TSR of the Group with reference to the same index over the 12 month period ending 31 December 2005.
TSR reflects the change in value of ordinary shares in a company over time, as represented by the evolution of a notional initial investment of £100 in the shares and including any distribution of dividends.
