Setting our direction

The Board is encouraged by the good progress made by the Group during 2012

Portrait of Chairman, Mike Biggs

“I believe the Company has a high quality Board that has the expertise and experience to provide excellent support and challenge to the business.”

Mike Biggs, Chairman

This was a very important year for Direct Line Group. We made significant progress in delivering the objectives set out in our transformation plan, whilst also substantially separating operations from RBS Group. In October, we successfully listed on the London Stock Exchange in the UK’s largest Initial Public Offering (“IPO”) in 2012.

It was also an important year for the Board, which I joined as Chairman in April. We recruited three additional independent Non-Executive Directors, and I am pleased to report that the Board was at full strength prior to the IPO.

Strategy overview and results

The strategic plan to transform Direct Line Group into ‘Britain’s best retail general insurer’ was launched in 2010 by our Chief Executive Officer, Paul Geddes and is now well established. We have made progress in many areas of our business including transforming our pricing and claims functions and improving our capital efficiency.

To supplement this plan, the Group announced a new set of targets in September 2012. These are for the Group to generate an overall return on tangible equity ("RoTE") of 15%; improve the combined operating ratio ("COR") to 98% in 2013; reduce the COR in Commercial to less than 100% in 2014; and achieve gross annual cost savings of £100 million in 2014.

The Board is encouraged with the progress made in 2012 as demonstrated by a pro forma RoTE of 13.4% and a COR for ongoing operations of 99.2%. Both outcomes show substantial improvement over 2011. Operating profit from our ongoing operations was up 9.3% at £461.2 million.

IPO

On 16 October 2012, Direct Line Group listed on the London Stock Exchange following the IPO by RBS Group of 35% of the Group’s shares. The IPO was met with significant investor demand and the shares have subsequently performed well, rising by 24% from the IPO price of 175 pence per share to close the year at 216.4 pence per share.

As a result of receiving state aid, RBS Group is required by the European Commission to cede control of Direct Line Group by the end of 2013 and to divest itself of any remaining shares in the Group by the end of 2014.

Governance and Board changes

The year saw a number of changes to our Board’s composition, which meant we were compliant with the UK Corporate Governance Code at the time of Admission to the Official List of the London Stock Exchange.

I joined the Board as Chairman in April and began by recruiting further Directors to build a Board suitable for the Group’s ambitions and to join the existing independent Non-Executive Directors, Andrew Palmer and Jane Hanson. I am delighted that during the course of the year a further three independent Non-Executive Directors joined the Board – Glyn Jones, Clare Thompson and Priscilla Vacassin. Glyn also holds the position of Senior Independent Director. Glyn, Clare and Priscilla bring a variety of strengths and skills from their previous experience and these are discussed in the corporate governance section.

Furthermore, RBS Group currently has two nominated directors on the Company’s Board, Bruce Van Saun and Mark Catton. RBS Group has the right to nominate up to two members of the Board as long as it remains a controlling shareholder of Direct Line Group and up to one member provided it owns between 20% and 50% of the shares.

Dividend

The Directors have proposed a final dividend of 8 pence per share. This proposal is in line with the policy set out at the time of the IPO. On the basis that the final dividend represents two-thirds of the total annual distribution, the full-year pro forma dividend of 12 pence per share would represent a payout ratio of 55% of earnings from ongoing operations.

The Group has adopted a progressive dividend policy which from 2013 will aim to raise the dividend annually in real terms to reflect the cash flow generation and the long-term earnings potential of the Group.

Relationship with RBS Group

Our ongoing relationship with RBS Group is set out in a number of agreements of which the Relationship Agreement and the Transitional Services Agreement ("TSA") are the most important.

The Relationship Agreement sets out that, notwithstanding the significant shareholding held by RBS Group, Direct Line Group is to carry on its business independently of RBS Group. The agreement ceases once RBS Group holds less than 20% of the shares of Direct Line Insurance Group plc (the "Company").

Under the TSA, RBS Group continues to provide IT and certain other services for a transitional period of up to 36 months.

Summary

2012 has been a year of very significant progress for Direct Line Group and the Board would like to acknowledge the effort and commitment of every member of staff in what has been an extremely busy and demanding year.

Signature of Michael N Biggs

Michael N Biggs, Chairman