Code principle – Remuneration
Introduction by Dr John McAdam
Our remuneration policy has been designed to promote the long-term success of the company, with a significant proportion of senior executives' pay being performance-related.
After what has been a particularly busy year for the remuneration committee, I am pleased to introduce the directors' remuneration report for the year ended 31 March 2019. This includes my statement, an 'at a glance' summary, a revised directors' remuneration policy which is intended to take effect from the date of our 2019 AGM (subject to shareholder approval) and the annual report on remuneration for the year ended 31 March 2019.
Remuneration policy review
Although the current directors' remuneration policy was approved by shareholders in 2017 and was intended to run until the 2020 AGM, during the summer of 2018 the committee decided to accelerate its review of the executives' remuneration arrangements (and the incentive elements in particular) to make sure that they would be well aligned with the proposed business plan for the new regulatory period from 2020–25 and the expectations of investors and Ofwat. It was also important for the committee to consider how various aspects of good governance which stem from the latest UK Corporate Governance Code and investors' guidance on pay might be embraced.
Between December 2018 and April 2019 we consulted directly with major shareholders and other key stakeholders about our proposals. That process was valuable, and allowed the committee to thoroughly consider views on a range of areas.
Following the company's business plan being accorded fast-track status by Ofwat in January 2019 in its initial assessment, our draft determination was published in April. Together with positive feedback from stakeholders this led the committee to finalise its policy review earlier than required. This enables us to propose a new directors' remuneration policy at the 2019 AGM, ready for the start of the new regulatory period in April 2020, which fully supports the business plan goals, aligns the interests of the executive directors with those of shareholders, and responds to the regulator's desire for even greater engagement to link remuneration with delivery of outcomes that are important to customers, whilst recognising ever-evolving standards of corporate governance.
Further information about the policy review, along with full details of the proposed policy, are shown in the Review of the directors' remuneration policy and the Directors' remuneration policy.
Implementation of the current directors' remuneration policy during 2018/19
The committee believes that executive directors' salaries remain appropriately positioned relative to the market. While our policy is that executive directors will normally receive a salary increase broadly in line with the increase awarded to the general workforce, Steve Mogford, Russ Houlden and Steve Fraser each received a base salary increase of two per cent with effect from 1 September 2018, whereas the headline increase applied across the wider workforce was higher, at three per cent. Salaries will next be reviewed in September 2019.
Employees throughout the company participate in the annual bonus scheme, alongside the executive directors, to ensure shared focus on the business plan at all levels. The current bonus measures reflect the importance of the targets set by our regulators for the period 2015–20.
Despite the challenges presented by the extreme dry weather conditions during the year we have seen another very good year of customer service, operational and financial performance in 2018/19.
New approaches introduced in recent years that improve the speed and quality of our delivery, alongside a focus on helping customers communicate easily with us in ways that best suit their lifestyles, have seen us continue to set ever higher standards of customer service. The Priority Services programme and our efforts to ensure that customers in difficult financial circumstances are supported are recognised by many, including Ofwat, as being market-leading. Achieving our best ever score against Ofwat's qualitative service incentive mechanism demonstrates the continued success of our approach to customer service and it is satisfying that having started the regulatory period with performance levels in the lower quartile and potentially facing financial penalties, we are now in a position where we anticipate being eligible for a regulatory reward.
We also achieved our best ever annual performance against the outcome delivery incentives (ODIs), reflecting good all-round operational performance. Overall, performance was good against our wastewater measures and significantly improved against our water measures with a net reward achieved in both areas. ODI performance across the whole regulatory period remains ahead of the business plan.
Underlying operating profit was better than in 2018/19 and the efficient and effective delivery of the capital programme is reflected in our Time, Cost and Quality index (TCQi) score which remains high at 95.4 per cent.
When considering the personal contributions of the executive directors, amongst other achievements during the year, Ofwat's fast-track rating of our business plan and commendation of our high quality and industry leading approach in many areas is testament to their performance, and to their leadership of the wider team.
Overall company results, together with the strong personal performance of the executive directors, has resulted in annual bonus out-turn of around 79 per cent of maximum (compared to the 2017/18 outcome of around 75 per cent of maximum) and a company-wide bonus pool totalling £17 million (compared to £16 million in the prior year). Half of the annual bonuses earned by the executive directors will be deferred into shares for a period of three years.
The final outcome of the Long Term Plan awards, which were granted in 2016 and whose performance is measured over the three years to 31 March 2019, is expected to be confirmed as 60 per cent later in the summer of 2019. Again, this reflects the continued delivery of high standards of customer service set in recent years, and the achievement of the stretch level of sustainable dividend performance. Ongoing uncertainty about the water sector continues to affect the share price, and the threshold target set for relative total shareholder return over the period was not achieved so there will be zero pay-out in relation to that measure. The awards for the executive directors will actually vest only after the completion of a further two-year holding period, during which the shares will remain subject to withholding provisions. This approach aligns the interests of the executive directors with those of shareholders and customers.
Agenda for 2019/20
While it is clearly important for the executives and wider workforce to remain focused on the delivery of the current plan in the final year of the regulatory period, it is also important to look towards the new regulatory period and make transitionary steps where appropriate.
The annual bonus plan will therefore operate in a similar way to 2018/19, except the measures based on Ofwat's service incentive mechanism will be replaced by measures based on Ofwat's new C-MeX approach. Details are shown in the Annual report on remuneration.
The 2019 LTP awards will also be based on a similar structure to that used in recent years, although the committee is considering whether it might begin to reflect the performance measures included in the proposed directors' remuneration policy in the construct of the 2019 LTP awards, and major shareholders will be consulted on the proposed approach before the awards are made. The committee will continue to focus on setting stretching targets that drive excellent customer service, operational and financial performance and enhance long-term shareholder value.
Later in the year the annual bonus measures and targets for the new regulatory period will be agreed, to ensure that, alongside the proposed LTP structure, all incentives continue to support the business strategy and provide appropriately stretching goals.
The committee will also continue to review how the developing corporate governance and remuneration environment, in particular the changes to the UK Corporate Governance Code, might be reflected in the way the committee operates.
I hope we will receive your support for the resolutions relating to remuneration at the forthcoming AGM.
Chair of the remuneration committee