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.
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 FRC has duly prepared draft guidance on the content of the report, which is aligned to the UK Corporate Governance Code (see the Annex for an overview of relevant passages from the Code), and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.
The strategic report has three main content-related objectives:
The FRC guidance provides extensive proposals on what the strategic report should include, of which the following bullets are a brief summary:
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.
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
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:
AFM Predecessors are Association of Mutual Insurers and Association of Friendly Societies
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.
Board includes committee of management.
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 means a mutual insurer and includes a friendly society.
Code Provision of the Code.
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.
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.
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.
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.
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.
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.
Main Principle of the Code.
A recommendation from: "The Myners review of the governance of life mutuals published in December 2004"
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.
Senior independent director
The role of the Senior Independent Director includes the following:
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.
Supporting Principle of the Code.
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:-
The statutory duties do not apply to the directors of friendly societies, although they must comply with very similar duties under the common law.
Unfettered powers of decision
No one person should be able to make major decisions about the organisation on his or her own.
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
"Year" means the financial year of the company in respect of which the questionnaire is being completed