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Adopting The New Strategic Report

Adopting The New Strategic Report

This note has been approved by the AFM Board. It has been produced by the AFM Regulation and Governance Committee to explain how members should adopt the new style of strategic report at the earliest possible opportunity, as part of our continued intent to adopt high standards of corporate governance in the mutual insurance sector.

Background

The Government, as part of its collation agreement in May 2010, announced its intention to 'reinstate an Operating and Financial Review to ensure that directors' social and environmental duties have to be covered in company reporting, and investigate further ways of improving corporate accountability and transparency'. Company law has been updated, to take effect from 1 October 2013, to require certain companies to produce a strategic report as part of their annual report and accounts, for years ending 30 September 2013 onwards. FRC has duly prepared draft guidance on the content of the report, which is aligned to the UK Corporate Governance Code (see the Annex for an overview of relevant passages from the Code), and which is designed to encourage the production of shorter and more informative reports. This was issued as an exposure draft on 15 August for comment by 15 November.

Content of the strategic report

The strategic report has three main content-related objectives:

  • to provide context for the related financial statements;
  • to provide shareholders with an analysis of the entity's past performance; and
  • to provide insight into the entity's main objectives and strategies, and the principal risks it faces and how they might affect future prospects.

The FRC guidance provides extensive proposals on what the strategic report should include, of which the following bullets are a brief summary:

  • It should be concise, forward-looking, signpost the location of supporting detail, and reflect the collective views of the company's directors. Consistent with the changes to the Code in 2012, it should be fair, balanced and understandable.
  • It should include a description of the company's principal objectives and its strategy for achieving them, along with an overview of the business model.
  • The key performance indicators used to assess progress should be included, along with a description of trends or factors likely to impact future performance, and the risks and uncertainties the company faces and how it plans to mitigate them.
  • The strategic report should provide an analysis of the development and performance of the business in the financial year and of its position at the end of that year. This will supplement the financial information, and cover questions commonly put to the AGM.
  • Key strengths and resources of the organisation should be described (whether tangible or intangible). Social, community or environmental issues relevant to an understanding of the business should be included.
  • An overview of the company's employees should include a breakdown of directors/ senior managers and employees by gender.

The guidance is intended to be principle-based and best practice, rather than a mandatory set of content.

According to the legislation, the purpose of the strategic report 'is to inform members of the company and help them assess how the directors have performed their duty under s172' of the Act.

The legislation removes the option for a firm to issue a summary financial statement, introducing the option to provide the strategic report (with some supplementary material) in its place.

Extending the strategic report to the mutual insurance sector

The specific requirements for the strategic report are incorporated into changes to company law- these will affect some AFM members, but not friendly societies. However FRC has approached the guidance on the basis that it 'may be useful for other entities'.

The report builds on the current 'business review', but seeks to inform owners more effectively, with a clearer overview of how the company is being run in their best interests. Whilst the proposed content is intended for shareholders of listed companies, it seems almost entirely relevant to members of mutuals. Indeed it supports many of the elements for reporting covered in the Annotated Corporate Governance Code.

The presentation of information in a concise, narrative way is likely to be more relevant to, and to engage, members of a mutual than a financial overview, and presents a clear opportunity to demonstrate the value of the business model.

Issuing the strategic report in place of either the full report and accounts or the summary financial statement may well increase the likelihood of a member understanding the benefits of the organisation and/or to vote at the AGM. It would also be a positive signal to regulators on transparency, and in demonstrating value. Coupled with the revised Auditor's report (see the separate guidance note) this helps ensure the report and accounts provide a robust account of the performance of the business.

On the whole, the content of the strategic report does not represent a significant change from the current approach. We recognise that for some very small AFM members, where narrative reporting might currently be limited, the new requirements impose a greater burden. For this reason, AFM recommends that members adopt the requirements as soon as practical, though not necessarily for 2013 annual reports.

The duty of a director, as set out in s172 of the Act, is to 'act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole'.

S78 of the Friendly Societies Act requires friendly societies to lay their report and accounts before the AGM and to send copies to every member who asks for them. Where a member asks for friendly society accounts under s78, they must be sent the full accounts as there is no equivalent to the exception provided by companies' law (which now states a mutual company can replace the full report and accounts with the strategic report and certain prescribed supplementary material). If a friendly society currently sends out the summary financial statement, as a matter of good practice, there is nothing in their legislation to prevent them from replacing this with the strategic report.

Association of Financial Mutuals, October 2013

Annex

Schedule B of the Annotated Corporate Governance Code (version October 2012) covers disclosure requirements, and includes the following components for the annual report:

The annual report should include:

  • a statement of how the board operates, including a high level statement of which types of decisions are to be taken by the board and which are to be delegated to management (A.1.1);
  • the names of the chairman, the deputy chairman (where there is one), the chief executive, the senior independent director and the chairmen and members of the board committees (A.1.2);
  • the number of meetings of the board and those committees and individual attendance by directors (A.1.2);
  • where a chief executive is appointed chairman, the reasons for their appointment (this only needs to be done in the annual report following the appointment) (A.3.1);
  • the names of the non-executive directors whom the board determines to be independent, with reasons where necessary (B.1.1);
  • a separate section describing the work of the nomination committee, including the process it has used in relation to board appointments; a description of the board's policy on diversity, including gender; any measurable objectives that it has set for implementing the policy, and progress on achieving the objectives. An explanation should be given if neither external search consultancy nor open advertising has been used in the appointment of a chairman or a non-executive director. Where an external search consultancy has been used it should be identified and a statement made as to whether it has any other connection with the company (B.2.4);
  • any changes to the other significant commitments of the chairman during the year (B.3.1);
  • a statement of how performance evaluation of the board, its committees and its directors has been conducted (B.6.1). Where an external facilitator has been used, they should be identified and a statement made as to whether they have any other connection to the company (B.6.2);
  • an explanation from the directors of their responsibility for preparing the accounts and a statement that they consider that the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess and provide the company's performance, business model and strategy. There should also be a statement by the auditor about their reporting responsibilities (C.1.1);
  • an explanation from the directors of the basis on which the company generates or preserves value over the longer term (the business model) and the strategy for delivering the objectives of the company (C.1.2);
  • a statement from the directors that the business is a going concern, with supporting assumptions or qualifications as necessary (C.1.3);
  • a report that the board has conducted a review of the effectiveness of the company's risk management and internal controls systems (C.2.1);
  • where there is no internal audit function, the reasons for the absence of such a function (C.3.6);
  • where the board does not accept the audit committee's recommendation on the appointment, reappointment or removal of an external auditor, a statement from the audit committee explaining the recommendation and the reasons why the board has taken a different position (C.3.7);
  • a separate section describing the work of the audit committee in discharging its responsibilities, including: the significant issues that it considered in relation to the financial statements, and how these issues were addressed; an explanation of how it has assessed the effectiveness of the external audit process and the approach taken to the appointment or reappointment of the external auditor, including the length of tenure of the current audit firm and when a tender was last conducted; and, if the external auditor provides non-audit services, an explanation of how auditor objectivity and independence is safeguarded (C.3.8);
  • a description of the work of the remuneration committee as required under the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008, including, where an executive director serves as a non-executive director elsewhere, whether or not the director will retain such earnings and, if so, what the remuneration is (D.1.2);
  • where remuneration consultants are appointed they should be identified and a statement made as to whether they have any other connection with the company (D.2.1); and
  • the steps the board has taken to ensure that members of the board, and in particular the non-executive directors, develop an understanding of the views of major shareholders about their company (E.1.2).

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Headingx

 

Corporate Governance Questionnaire Keyx

A

AFM PREDECESSOR

AFM Predecessors are Association of Mutual Insurers and Association of Friendly Societies

Annual election

Annual election of all board directors has become commonplace in PLCs, since it was incorporated into the Code in 2010. This was a reaction to governance failures and their contribution to the financial crisis. Annual elections give members an opportunity to react to the performance of the company and are also required for directors that have served for more than nine years.

B

BOARD

Board includes committee of management.

C

CODE

The UK Corporate Governance Code (previously called The Combined Code), subject to the annotations made by AFM in the Annotated Corporate Governance Code (current version dated 2012).

COMPANY

Company means a mutual insurer and includes a friendly society.

CP

Code Provision of the Code.

D

Diversity

Diversity includes but is not limited to gender. Directors may differ in many important characteristics, such as educational and functional background, industry experience, social connectedness, insider status, gender, and race. The Davies report in 2011 put forward a voluntary target for gender diversity for the boards of listed companies of 25% by 2015.

E

Entrepreneurial leadership

The organising of a group of people to achieve a common goal using proactive entrepreneurial behavior by optimising risk, innovating to take advantage of opportunities, taking personal responsibility and managing change within a dynamic environment for the benefit of the organisation

Externally facilitated performance evaluation

An external facilitator brings rigour and struture to the performance evaluation of a board, as well as an independent and impartial perspective. Evaluation of the board of larger companies should be externally facilitated at least every three years. The external facilitator should be identified in the annual report and a statement made as to whether they have any other connection with the company.

F

Fair, balanced and understandable

This broad definition of the basis on which the annual accounts was prepared is intended to address the concern that the narrative report should reflect the board's considered view of the information that members and other users of the annual report and accounts needed, rather than being viewed as promotional in nature, and to ensure that the narrative and financial sections of the report were consistent.

I

Independent non-executive director

Member of the Board of Directors of an entity who is an outsider, meaning he or she is not an employee of or otherwise closely connected with that entity. An example is a broker sitting on the Board of a client company. Such directors are important because they bring unbiased opinions regarding the company's decisions and diverse experience to the company's decision-making process. In order not to have a conflict of interest, independent directors should not participate on the boards of directly competing businesses. Directors are typically compensated based on a standard fee for each board meeting, or on an annualised basis.

L

LARGE COMPANY

A Large Company is any mutual that does not meet the definition of a small mutual i.e. because it has gross premium income on average over the preceding three years of £20 million per annum or more and/or it has assets on average at the end of the last three financial years of £100 million or more.

M

Major shareholders

Although mutual insurers do not have shareholders, the principles underpinning the provisions of the Code are relevant and should be considered in relation to appropriate methods for facilitating direct member dialogue and involvement that may be in place (such as member forums or panels and/or delegate systems) and/or any members with significant membership rights. Also referred to as principal shareholders and significant shareholders in the Code.

MP

Main Principle of the Code.

MR

A recommendation from: "The Myners review of the governance of life mutuals published in December 2004"

P

Performance evaluation

Performance evaluation is a key means by which boards can recognise and correct corporate governance problems and add real value to their organisations. Boards who commit to a regular evaluation process find benefits in terms of improved leadership, greater clarity of roles and responsibilities, improved teamwork, greater accountability, better decision making, improved communication and more efficient board operations.

S

Senior independent director

The role of the Senior Independent Director includes the following:

  • Providing support for the Chair in the delivery of his or her objectives;
  • Ensuring the views of the other Directors are conveyed to the Chair;
  • Attending sufficient meetings with a range of members, perhaps in company with the Chair, to develop a balanced understanding of their issues and concerns;
  • Ensuring that the Chair is passing on the views of the members and especially that any concerns are conveyed to all Directors;
  • Ensuring that appropriate succession planning procedures are in place in relation to Board succession;
  • Carrying out the annual evaluation of the Chair in conjunction with other Non-Executive Directors while also taking account of the views of the Executive Directors; and
  • Taking responsibility for an orderly succession process for the Chair.

SMALL COMPANY

Small Company means a mutual with gross premium income of under £20 million per annum on average over the preceding three financial years and assets of less than £100 million on average at the end of the last three financial years.

SP

Supporting Principle of the Code.

Statutory duties

The Companies Act 2006 codified certain common law and equitable duties of directors for the first time. The Act sets out seven general duties of directors which are:-

  • to act within powers in accordance with the company's constitution and to use those powers only for the purposes for which they were conferred
  • to promote the success of the company for the benefit of its members
  • to exercise independent judgement
  • to exercise reasonable care, skill and diligence
  • to avoid conflicts of interest
  • not to accept benefits from third parties
  • to declare any interest in a proposed transaction or arrangement.

The statutory duties do not apply to the directors of friendly societies, although they must comply with very similar duties under the common law.

U

Unfettered powers of decision

No one person should be able to make major decisions about the organisation on his or her own.

Unitary board

Unitary boards include both executive and non-executive directors and make decisions as a unified group. By comparison a two-tier board has a separate management and supervision board

Y

YEAR

"Year" means the financial year of the company in respect of which the questionnaire is being completed