Annual Report & Accounts 2008

Directors’ remuneration report

As a company incorporated in Bermuda, the UK Directors’ Remuneration Report Regulations 2002 do not apply to Lancashire. However, the Board is committed to providing information to shareholders and complying with corporate governance standards and best practices to the appropriate extent, taking into account the Company’s size and the nature of its business.

All information shown is unaudited.

Remuneration committee

The Remuneration Committee comprised the following members during the year and to the date of this report (all of whom are independent non-executive Directors excluding Martin Thomas, the Chairman of the Board, who was independent on appointment):

• William Spiegel (Chair)
• Jens Juul
• Ralf Oelssner
• Martin Thomas

The Remuneration Committee’s responsibilities are contained in their terms of reference, a copy of which is available on the Company’s website. These responsibilities include determining remuneration for the Company’s executive Directors and senior management of the Group within a framework agreed with the Board.

Advice to the remuneration committee

During 2008, Hewitt New Bridge Street (“HNBS”) were appointed by the Remuneration Committee to give advice on market trends, practices and appropriate levels of remuneration for executive Directors and members of senior management. HNBS also advised the Remuneration Committee on the structure and implementation of the Company’s Restricted Share Scheme which was approved by the Company’s shareholders on 4 January 2008. HNBS did not provide any other services to the Company during 2008. Greg Lunn, the Company Secretary, and Dewey & LeBoeuf LLP, the Company’s legal counsel, provided the Remuneration Committee with advice in relation to remuneration matters including the operation of the Company’s share schemes. Dewey & LeBoeuf LLP provided other legal services to the Group during 2008.

Meetings of the Remuneration Committee may also be attended by other Directors including the Chief Executive Officer and Chief Financial Officer, but such attendance is by invitation only and not by right. The Chairman and the executive Directors are not involved in determining their own remuneration.

Remuneration policy

The Company’s remuneration policy is geared towards providing a level of remuneration which attracts, retains and motivates executive Directors and senior management of the highest calibre to further the Company’s interests and to optimise long-term shareholder value creation. The remuneration policy also seeks to ensure that executive Directors and senior management are provided with appropriate incentives to drive individual performance and to fairly reward them for their contribution to the successful performance of the Company.

The Remuneration Committee has adopted the principle that base salary should be set broadly in line with the median for executives in a role of comparable standing and that executive Directors should be able to achieve total remuneration at the upper quartile level (compared to peer companies generating similar returns) when justified by superior performance. The Remuneration Committee also takes into account levels of pay elsewhere in the Group, when determining the pay levels for executive Directors and senior executives.

The details of the component parts of the remuneration package for executive Directors are set out below.

Remuneration of executive directors

The executive Directors’ remuneration is made up of the following elements:

• Base salary
• Bonus
• Long-term share-based incentives (‘restricted shares’)
• Pension
• Other benefits, including medical, dental, vision coverage, air travel and housing and other allowance for expatriates.

An appropriate balance is maintained between fixed remuneration and variable (performance–related) remuneration. Variable remuneration is made up of an appropriate mix of short-term and long-term incentives. At a level of ‘target’ performance or better, the level of variable pay comprises a significant majority of the overall package.

Base salary

Salaries for executive Directors are determined by the Remuneration Committee before the start of each year and where an individual changes responsibility or position. The Company needs to offer salaries at around median market levels so that it is able to attract and retain executive Directors and senior executives of a suitable calibre to execute the Company’s strategic plans and provide long-term shareholder value creation. The Remuneration Committee also takes into account pay levels elsewhere in the Group when setting the salary levels for executive Directors and senior executives.

From 1 January 2009, the salaries for executive Directors have been increased as follows: Richard Brindle, Chief Executive Officer – no increase; Simon Burton, Deputy Chief Executive Officer – a 3 per cent inflationary increase; and Neil McConachie, Chief Financial Officer – by 4.5 per cent increase to reflect the market value of the individual and his role.

Annual bonus

The Company operates a cash bonus plan based on annual performance of the Company and the individual executive.

The Company performance element is based on growth in book value and Return on Equity (“ROE”) against the business plan approved by the Board and a relative ROE versus peer companies. Individual performance metrics will be set at the start of the financial year and assessed by way of a performance rating.

The level of bonus in 2008 was capped at 400 per cent, 350 per cent and 325 per cent (400 per cent, 350 per cent and 350 per cent for 2009) of salary for the Chief Executive, Deputy Chief Executive and Chief Financial Officer, respectively. The target level of bonus is half of the maximum.

Long-term incentives

Restricted share scheme (the “RSS”)

In 2008, the Company introduced a new restricted share scheme. Under the RSS, executives may be granted a conditional award of shares which are released to the executive after three years, subject to the achievement of stretching performance conditions and continued employment. The purpose of awards under the RSS is to motivate and retain certain individuals who are responsible for the attainment of the primary long-term performance goals of the Company and its subsidiaries. The executive Directors are eligible to receive share awards under the RSS at the discretion of the Remuneration Committee. Awards are made each year following the announcement of preliminary results.

The Remuneration Committee has considered carefully the grant levels and performance conditions for awards in 2009. Award levels will be 318,750 restricted shares for the Chief Executive and 93,125 shares for the Deputy Chief Executive and 99,375 for the Chief Financial Officer with the actual number of shares received subject to satisfaction of time and performance conditions as set out below.

For half of each award the performance condition will be based on the Company’s total shareholder return (“TSR”) performance against a comparator group of international insurance companies over a three year period measured from the date of grant. 25 per cent of this part of the award will vest if the Company’s TSR is equal to the company whose TSR is ranked at the median. All of this part of the award will vest if the Company’s TSR is equal to the company whose TSR is ranked at the upper quartile or above. Vesting will take place on a straight line between 25 per cent and 100 per cent for TSR performance between median and upper quartile.

For the remaining half of each award the performance condition is based on ROE over three financial years in the performance period. 25 per cent of this award will only vest if average annual ROE over the performance period exceeds 3-month U.S.$ LIBOR calculated on a daily basis plus 8 per cent. All of this part of the award will vest if the Company’s average ROE is equal to 3-month U.S.$ LIBOR calculated on a daily basis plus 18 per cent. Vesting will take place on a straight line basis between 25 per cent and 100 per cent for ROE performance.

TSR and ROE were chosen as performance criteria on the basis that TSR provides an objective reward for stock market out-performance of the Company’s peers and ROE provides a focus on underlying financial performance.

Pension

Executive directors receive pension contributions from the Company under a defined contribution pension plan the Company operates for its employees. Under this plan, and in line with market practice in Bermuda, the Company contributes 10 per cent. of base salary up to a maximum of $20,000. In addition Richard Brindle receives contributions to a UK defined contribution pension plan in respect of his salary and employment with the Company’s UK operations. Details of the pension contributions made to executive Directors are set out in the Directors' emoluments section.

Other benefits

Other benefits for executive Directors comprise medical, dental and vision coverage, air travel and housing and other allowances for expatriates.

Service contracts

The executive Directors of the Company are Richard Brindle, Simon Burton and Neil McConachie. Richard Brindle was appointed as Chief Executive Officer of the Company under an original service contract dated 9 December 2005. Neil McConachie was appointed as Chief Financial Officer under an original service contract dated 1 February 2006. Simon Burton was appointed Deputy Chief Executive Officer under an original service contract dated 1 January 2007.

Richard Brindle’s, Simon Burton’s and Neil McConachie’s original service contracts with the Company have been replaced with new service contracts entered into with effect from 1 January 2009. All service contracts contain six month notice provisions by either party. Details of the salaries payable under these contracts are set out in the emoluments table below.

In the event of early termination, the executive Directors’ contracts provide for compensation up to a maximum of base annual salary plus the fair value of benefits to which the executive Directors are contractually entitled for the unexpired portion of the notice period. The Company seeks to apply the principle of mitigation in the payment of compensation on the termination of the service contract of any executive Director. There are no special provisions in the service contracts for payments to executive Directors on a change of control of the Company.

The Board may allow executive Directors to accept external appointments. In accordance with the Combined Code, the Board will not agree to a full-time executive taking on more than one non-executive directorship, or the chairmanship of any company.

Non-executive directors

Remuneration policy

The Company’s policy for the non-executive Directors’ and Chairman’s remuneration is to set fees at an appropriate level so as to attract individuals with the range of skills and experience suitable for an international insurance group of the Company’s size and complexity. The Chairman and the non-executive Directors receive no benefits in addition to their fees and do not participate in any incentive or performance plans or pension arrangements. The Company encourages share ownership by the Chairman and non-executive Directors, and non-executive Directors who do not own shares are encouraged to use a proportion of their fees to buy shares in the Company and retain such shareholdings for their remaining periods of office.

Terms of appointment

The non-executive Directors serve subject to the Company’s Bye-laws and under letters of appointment and are appointed for varying terms which are terminable by either party on six months’ notice with absence of earlier termination in accordance with the Bye-laws. The non-executive Directors are typically expected to serve twice for three year terms, although the Board may invite a non-executive Director to serve for an additional period. Their letters of appointment are available for inspection at Annual General Meetings.

Name	Position	Date of letter of appointment	Date of next re-appointment
John Bishop	Non-executive director	19 March 2008	2010 AGM
Jens Juul	Non-executive director	16 November 2007	2011 AGM
Ralf Oelssner	Non-executive director, senior independent director	31 July 2007	2009 AGM
Robert Spass	Non-executive director, chairman of audit committee	9 December 2005	2009 AGM
William Spiegel	Non-executive director, chairman of remuneration committee	9 December 2005	2009 AGM
Martin Thomas	Non-executive chairman	16 April 2007	2010 AGM
Barry Volpert	Non-executive director	12 December 2005	2011 AGM

Relative performance

The following graph shows the Company’s performance, measured by TSR, compared with the performance of the FTSE AIM Index. This index has been chosen because it best reflects the Company’s nature and size.

Directors’ emoluments

Directors’ emoluments for the year ended 31 December 2008.

Director	Base salary/fees	Other(i)(ii)	Benefits(i)(iv)	Pension(i)	Annual bonus(v)	Total 2008 emoluments	Total 2007 emoluments
Non-executive directors
Martin Thomas	275,000	100,000	–	–	–	375,000	332,005
John Bishop	109,603	42,464	–	–	–	152,067	–
Jens Juul	140,000	–	–	–	–	140,000	17,500
Ralf Oelssner	175,000	48,000	–	–	–	223,000	206,736
Robert Spass	175,000	–	–	–	–	175,000	166,784
William Spiegel	175,000	–	–	–	–	175,000	164,086
Barry Volpert	140,000	–	–	–	–	140,000	133,483
Executive directors
Richard Brindle	675,000	447,292	329,267	64,729(iii)	1,561,753	3,078,041	6,713,424
Simon Burton	386,250	–	182,406	20,000	512,023	1,100,679	2,385,406
Neil McConachie	381,037	–	178,904	20,000	530,642	1,110,584	1,775,676

• (i)Some amounts were paid in pounds sterling and converted at prevailing exchange rates.
• (ii)Martin Thomas receives a fee of $100,000 per annum for his appointment as non-executive Chairman of LUK. John Bishop and Ralf Oelssner are also non-executive Directors of LUK and each receives fees of $30,000 per annum and $2,000 for each LUK Board or committee meeting that they attend in respect of their appointments. In addition, John Bishop receives a fee of $5,000 per annum in respect of his chairmanship of the LUK Audit Committee. Richard Brindle receives an annual salary of £235,465 from LUK in respect his employment.
• (iii)Including a contribution of £23,547 in 2008 (2007 – £23,547) to a UK defined contribution pension plan in respect of Richard Brindle’s salary and employment with LUK.
• (iv)Benefits include UK national insurance contributions, payroll taxes, medical, dental, vision coverage, air travel and housing and other allowances paid by the Company for expatriates.
• (v)Provisional number as final audited results of peer companies are awaited in order to calculate the final bonus payable.

Directors’ warrants, options and RSS awards

(i) Time vesting ordinary warrants

Name	Warrants held at 1 January 2008	Warrants granted during the year	Warrants exercised during the year	Warrants lapsed during the year	Warrants held at 31 December 2008	Exercise price(ii)	Date from which exercisable(i)	Expiry date
Richard Brindle
16/12/05	7,625,217	–	–	–	5,718,913	$5.00	16/12/05	16/12/15
16/12/05	–	–	–	–	1,906,304	$3.90	16/12/08	16/12/15
Simon Burton
09/03/06	444,804	–	–	–	333,603	$5.00	09/03/06	16/12/15
09/03/06	–	–	–	–	111,201	$3.90	16/12/08	16/12/15
21/09/06	114,378	–	–	–	86,083	$5.00	21/09/06	16/12/15
21/09/06	–	–	–	–	28,295	$3.90	16/12/08	16/12/15
Neil McConachie
16/12/05	453,152	–	–	–	294,293	$5.00	16/12/05	16/12/15
16/12/05	–	–	–	–	158,859	$3.90	16/12/08	16/12/15
09/03/06	317,717	–	–	–	158,859	$5.00	09/03/06	16/12/15
09/03/06	–	–		–	158,858	$3.90	16/12/08	16/12/15

• (i)The time-vesting ordinary warrants vested 25 per cent on issuance on the admission of the Company’s shares to trading on AIM on 16 December 2005. 25 per cent of each warrant then vested on each of the first, second and third anniversaries of the admission of the Company’s shares to trading on AIM.
• (ii)On 10 December 2007, the Company declared a strategic dividend of $1.10 per common share payable to shareholders of record, 11 January 2008. The declaration of the dividend triggered a contractual obligation, pursuant to the terms of all warrants, for the Company to pay an amount per warrant equivalent to the dividend for each vested warrant; and to adjust automatically the exercise price for each unvested warrant by an amount equivalent to the dividend. Consequently on 25 January 2008, the Company paid a dividend of £0.5622 per warrant on all of the vested ordinary warrants, reflecting the dividend paid to shareholders. The exercise price for the unvested ordinary and performance warrants has been adjusted downwards by $1.10 to $3.90 per warrant. The contractual obligation to pay a dividend equivalent on each vested warrant, and to adjust the exercise price for all unvested warrants, applies to all past, present and future dividends declared by the Company.

The market value of the common shares on each date of grant was 16/12/2005: £3.21; 09/03/2006: £3.27 and 21/09/2006: £3.44.

(ii) Performance vesting ordinary warrants

Name	Warrants held at 1 January 2008	Warrants granted during the year	Warrants exercised during the year	Warrants lapsed during the year	Warrants held at 31 December 2008	Expiry price(ii)	Date from which firste ercisable(i)	Exercise date
Richard Brindle
16/12/05	2,745,078	–	–	1,189,046	288,843	$5.00	31/12/07	16/12/15
16/12/05	–	–	–	–	1,267,189	$3.90	31/12/08	16/12/15
Simon Burton
09/03/06	240,196	–	–	104,042	25,274	$5.00	31/12/07	16/12/15
09/03/06	–	–	–	–	110,880	$3.90	31/12/08	16/12/15
21/9/06	194,443		–	84,224	20,460	$5.00	31/12/07	16/12/15
21/9/06	–	–	–	–	89,759	$3.90	31/12/08	16/12/15
Neil McConachie
16/12/05	343,135	–	–	148,631	36,105	$5.00	31/12/07	16/12/15
16/12/05	–	–	–	–	158,859	$3.90	31/12/08	16/12/15
09/03/06	343,135	–	–	148,631	36,105	$5.00	31/12/07	16/12/15
09/03/06	–	–	–	–	158,858	$3.90	31/12/08	16/12/15

• (i)The performance warrants were scheduled to vest in three tranches: 20 per cent on 31 December 2007, 40 per cent on 31 December 2008 and the remaining 40 per cent on 31 December 2009. As a result of the compound IRR target for 2007 and 2008 not being met a number of performance warrants lapsed. The 40 per cent of the originally issued number of performance warrants that remain outstanding will vest on 31 December 2009 subject to the Company achieving certain performance conditions. The performance conditions are based on a combination of compound return and fully converted book value targets. 50 per cent of the 40 per cent will vest if the compound IRR target is met and the other 50 per cent of the 40 per cent will vest if the fully converted book value target is met. There are minimums established for both targets below which zero warrants will vest.
• (ii)On 10 December 2007, the Company declared a strategic dividend of $1.10 per common share payable to shareholders of record, 11 January 2008. The declaration of the dividend triggered a contractual obligation, pursuant to the terms of all warrants, for the Company to pay an amount per warrant equivalent to the dividend for each vested warrant; and to adjust automatically the exercise price for each unvested warrant by an amount equivalent to the dividend. Consequently on 2 April 2008 (and once the performance conditions had been verified), the Company paid a dividend of £0.5622 per warrant on all of the vested performance warrants, reflecting the dividend paid to shareholders. This resulted in a payment of $162,388 to Richard Brindle, $25,711 to Simon Burton and $40,597 to Neil McConachie. These payments were made once the exact number of vested performance warrants was confirmed following completion of a review of the application of the performance conditions by Ernst & Young as required by the terms of the performance warrants. The exercise price for the unvested ordinary and performance warrants has been adjusted downwards by $1.10 to $3.90 per warrant. The contractual obligation to pay a dividend equivalent on each vested warrant, and to adjust the exercise price for all unvested warrants, applies to all past, present and future dividends declared by the Company.

The market value of the common shares on each date of grant was 16/12/2005: £3.21; 09/03/2006: £3.27 and 21/09/2006: £3.44.

(iii) Share options under the 2005 LTIP

Name	Options held at 1 January 2008	Options granted during the year	Options exercised during the year	Options lapsed during the year	Options held at 31 December 2008	Exercise price(ii)	Date from which first exercisable(i)	Expiry date
Richard Brindle
09/03/06	762,522	–	–	–	762,522	£2.69	09/03/07	08/03/16
29/06/07	150,000	–	–	–	150,000	$5.77	29/06/08	28/06/17
Simon Burton
09/05/07	300,000	–	–	–	300,000	$6.01	09/05/08	08/05/17
29/06/07	500,000	–	–	–	500,000	$5.77	29/06/08	28/06/17
Neil McConachie
09/03/06	508,348	–	–	–	508,348	£2.69	09/03/07	08/03/16
29/06/07	200,000	–	–	–	200,000	$5.77	29/06/08	28/06/17

• (i)The share options under the 2005 LTIP were not subject to any performance conditions.
• (ii)The options vest as to 25 per cent on each of the first, second, third and fourth anniversaries of the date of grant provided that the option holder remains in the employment of the Group at the relevant anniversary.
• (iii)Following an amendment to the 2005 LTIP, approved by the Company’s shareholders at the special general meeting of shareholders held on 4 January 2008, the Remuneration Committee exercised its discretion to reduce the exercise price for all outstanding vested and unvested options by $1.10 or £0.5622 effective 9 January 2008. The adjustment was made to reflect the strategic dividend paid by the Company in January 2008, and the consequent reduction in shareholders’ equity.
• (iv)No LTIP options were exercised by Directors during 2008.

The market value of the Common Shares on each date of grant was 09/03/2006: £3.27; 09/05/2007: £3.57 and 29/06/2007: £3.42.

(iv) Awards under the restricted share scheme

Name	Awards held at 1 January 2008	Awards granted during the year	Awards exercised during the year	Awards lapsed during the year	Awards held at 31 December 2008	Vesting date(ii)
Richard Brindle
Performance award	–	360,001	–	–	360,001	28/03/11
Exceptional award(iii)	–	33,381	–	–	33,381	28/03/11
Simon Burton
Performance award	–	109,378	–	–	109,378	28/03/11
Exceptional award(iii)	–	22,254	–	–	22,254	28/03/11
Neil McConachie
Performance award	–	101,032	–	–	101,032	28/03/11
Exceptional award(iii)	–	22,254	–	–	22,254	28/03/11

• (i)The market value of the common shares on the date of grant (28 March 2008) was £2.86.
• (ii)The vesting of 2008 RSS awards is subject to two performance conditions. Half of each award is subject to a performance condition measuring the Total Shareholder Return (“TSR”) performance of the Company against the TSR performance of a select group of comparator companies, over a three-year performance period. 25 per cent of this half of an award vests for median performance by the Company, rising to 100 per cent vesting of this half of the award for upper quartile performance by the Company or better (with straight-line vesting between these two points). The comparator group of companies comprises Amlin, Arch Capital, Axis Capital, Endurance, Flagstone, Hiscox, IPC, Montpelier, Partner Re, Platinum, Ren Re and Validus. The other half of each award is subject to a performance condition based on average annual return on equity (“ROE”) over a three-year performance period. If average annual ROE is between the 3-month U.S. Dollar LIBOR calculated on a daily basis plus 8 per cent. and the 3-month U.S. Dollar LIBOR calculated on a daily basis plus 13 per cent., between 0 per cent and 50 per cent of this half of the award will vest, on a straight-line basis. If average annual ROE is between the 3-month U.S. Dollar LIBOR calculated on a daily basis plus 13 per cent. and the three-month U.S. Dollar LIBOR calculated on a daily basis plus 18 per cent. or more, between 50 per cent and 100 per cent of this half of the award will vest, on a straight-line basis.
• (iii)The exceptional RSS awards were made in 2008 to assist in the continuing incentivisation of executives between the closure in January 2008 of the LTIP to further awards and the future vesting of the RSS awards made subject to performance conditions.

The market value of the common shares at 31 December 2008 was £4.25 and the range during the year was £2.58 to £4.25.

Approved by the Board of Directors and signed on behalf of the Board.