Directors’ remuneration report

In this report, which will be submitted for approval at the AGM on 29 July 2010, we describe how the executive directors are remunerated. Those parts of the remuneration report which are subject to audit by Ernst & Young are marked 'audited'.

The Remuneration Committee

The role of the Remuneration Committee

The Remuneration Committee of the Board (the Committee) determines the remuneration and terms of employment of the Chairman of the Company, executive directors of NWG and NWL and a further seven senior managers, in accordance with a remuneration policy approved by the Board. The terms of reference for the Committee are published on our website at www.nwg.co.uk (in the ‘about us: corporate governance’ section) or a copy can be requested from the Company Secretary.

The Committee is always available to engage with major shareholders and their representatives to discuss remuneration matters. During 2009, the Remuneration Committee did consult with its larger shareholders, the Association of British Insurers and RiskMetrics on the change that has been made to the LTIP performance measures. This is described below.

Remuneration Committee members

The Committee members are Martin Nègre (chairman until 31 March 2010), Sir Patrick Brown, Anita Frew, Alex Scott-Barrett (chairman from 1 April 2010), who are all considered by the Company to be independent, and Sir Derek Wanless. The membership of the Committee was, therefore, compliant with the Combined Code throughout the year. Martin Parker, the Company Secretary, is secretary to the Committee.

External advice

The Committee continued to receive advice during the year from its appointed advisers, Hewitt New Bridge Street (HNBS), and also from the Managing Director (although never about his own remuneration). HNBS was paid £41,616 for these services in 2009/10 and continues to assist the Committee in maintaining best practice in relation to remuneration. HNBS did not provide any other services to the Company during the year.

The Committee’s work in 2009/10

The Committee met three times during the year with 100% attendance by all members, to:

• set the remuneration package for the new Chief Executive Officer;
• discuss and approve the new policy on LTIP performance measures;
• agree bonus payments for 2008/09;
• set performance targets for executive directors and senior managers;
• agree salaries for 2010/11;
• determine the vesting percentage to be applied to the LTIP awards made on 21 December 2006 which vested on 21 December 2009; and
• grant LTIP awards on 4 January 2010 (to vest on 4 January 2013).

As the Committee works closely with NWL’s remuneration committee, Committee papers and minutes are circulated to all NWL and NWG non-executive directors, who can give their views direct to the Committee chairman and can attend meetings if they wish.

Remuneration policy

The Committee considers the principles and provisions of the Combined Code when setting its policy and believes it is fully compliant. The policy of the Company is to provide remuneration that is sufficient to attract, retain and motivate directors of the quality required to run the Company successfully, while paying fairly. Although HNBS provides the Committee with detailed comparative data on other companies in the sector, the Committee is aware of, and avoids the risk of, remuneration being ratcheted up as a result of benchmarking exercises.

Consistent with its fair pay policy, when considering the remuneration packages of senior executives and directors, the Committee takes into account pay awards to other employees in the Group. The Committee also considers environmental, social, risk management and governance issues when setting remuneration terms.

The remuneration policy of the Committee is:

• that the setting of base salaries is largely influenced by individual contributions and internal relativities rather than external comparators (although for 2009/10 the Committee was influenced by general economic conditions);
• that the annual bonus plan recognises the interests of all of the Company’s stakeholders (shareholders, customers and employees) rather than being focused solely on profit; and
• that management shares in the longer term value created for the Company’s investors and the serviceability of the Company’s regulated assets.

Elements of remuneration

The remuneration of the executive directors comprises:

— basic salary;

— benefits (including pension and participation in the Company’s SIP);

— a performance related annual bonus; and

— annual LTIP awards.

In addition to reviewing each constituent element, the Committee reviews the remuneration packages as a whole to ensure that they remain appropriate in terms of structure and quantum. The chart below shows the composition of the new Chief Executive Officer’s remuneration (as a percentage of basic salary) both at ‘target’ and ‘maximum’ levels of performance. Maximum performance assumes the achievement of maximum bonus and full vesting of LTIP awards.

Basic salary and benefits

Basic salary is reviewed annually based on individual contributions and internal relativities. The Committee also has regard to market practice in other quoted water companies and similar sized companies more generally.

Current basic salaries, together with the previous year’s salaries, are set out below:

The basic salaries of the executive directors were not increased for 2009/10. For 2010/11 salaries for senior executives have been increased by 1.3% (except for John Cuthbert who retired on 31 March 2010 and for Heidi Mottram who was appointed on 1 March 2010). This is the same as for all other employees.

Benefits provided to the executive directors comprise membership of pension schemes (as detailed below), car allowance and healthcare.

Pensions

The main features of the Northumbrian Water Pension Scheme are set out in note 24 to the financial statements. Basic salary is the only pensionable element of the executive directors’ remuneration packages.

The executive directors’ pensions were modified with effect from 1 January 2008, in line with the changes proposed for the pension scheme as a whole, and the executive pension arrangements were closed to new entrants on that date. This means that Heidi Mottram receives an employer’s contribution of 8% of salary to the money purchase section of the Northumbrian Water Pension Scheme. She makes an employee contribution of 5%. The employer’s contribution of 8% is the same as is available to any other employee making a 5% contribution.

Annual bonus

The annual bonus plan has been designed to reflect the interests of all of the Company’s stakeholders. Consistent with prior years, maximum annual bonus potential for the executive directors for 2010/11 is 70% of salary, which is apportioned as follows:

Annual bonus %

Actual performance against the 2009/10 targets was as follows:

In accordance with the terms agreed on her appointment, Heidi Mottram was awarded a bonus in respect of March 2010 equal to 38.5% of her salary for that month. This was the average percentage of the bonuses awarded to John Cuthbert and Chris Green for the year.

For 2010/11, the same bonus metrics will continue to be used with the same weightings as described above.

LTIP

Under the LTIP, executive directors and senior managers may receive, at the discretion of the Remuneration Committee, annual conditional awards of shares in the Company worth up to 100% of annual salary at grant, although only the executive directors participate at the 100% level. All awards have three year pre-vesting performance conditions.

For the three annual awards granted from December 2006 to December 2008 the vesting of up to half of an award is subject to relative total shareholder return (TSR) performance against the FTSE 250 (excluding investment trusts) and the other half is subject to a relative return on capital employed (ROCE) target as monitored by Ofwat.

In the latter half of 2009 the Committee reviewed its policy on the pre-vesting performance conditions that should apply to LTIP awards. The Committee, with advice from HNBS, came to two conclusions that led to changes being made to its policy on performance conditions, namely:

the volatility in the share prices of companies in the Financials and Oil & Gas FTSE sectors had increased dramatically and this was no longer correlated with NWG’s share price movements. This means that these companies are not the best comparators in a relative TSR performance condition; statistically they are more likely to be grouped at the top or the bottom of the list. Accordingly, for LTIP awards made in 2009/10 and future years, the TSR comparator group will exclude companies from these defined FTSE sectors; and

the work undertaken on drawing up the business plan for 2010-15 showed that there were other long term performance measures, in addition to ROCE, that should be measured and potentially rewarded. These are performance against Ofwat’s serviceability targets and customer satisfaction levels. As such, they have been incorporated as LTIP performance metrics.

These changes were discussed with the Company’s top shareholders and received their support. The Committee thanks them for their constructive engagement in this exercise. This consultation did result in the LTIP award date slipping from early December to 4 January 2010. However, this was still within the six week grant window as permitted by the LTIP rules.

The details of this award to Chris Green are:

† Based on a closing share price on 31 December 2009 of 270.3 pence.

Details of the pre-vesting performance condition for these awards are:

The advantages of using these targets include:

• the continued use of TSR provides consistency with past awards, alignment with investors and, as a result of the less correlated and volatile sectors now being excluded, provides an improved line of sight for executives;
• the use of an absolute ROCE target ensures that reward is directly linked to the management’s delivery of the business plan;
• they recognise that the maintenance of NWL’s regulated assets (through the serviceability targets) is critical to the longer term returns for shareholders; and
• customer satisfaction is a key objective for NWL and customers are important stakeholders.

In the event of a change of control, the Committee would determine the extent to which the performance conditions had been met and the proportion of the performance period that had elapsed in deciding whether or not any vesting of awards would take place.

The LTIP award, granted on 21 December 2006, became available to vest on 21 December 2009. The Committee instructed PricewaterhouseCoopers (PwC) to assess the level of vesting of this award. PwC reported that 33.2% of the award was available to vest (being 66.5% of the award relating to the Company’s TSR performance against the FTSE 250 Index and 0% of the award relating to the Company’s ROCE performance against the other water companies). Prior to vesting, the Committee satisfied itself that the recorded TSR performance was a genuine reflection of the Company’s underlying performance. Details of the number of awards which lapsed and those which were exercised by the directors of the Company are shown in Table 3.

Full details of award levels and performance conditions are shown in Table 2.

Responsible investment

The Committee is aware of Guideline 3.2 of the ABI Guidelines on Responsible Investment Disclosure and is satisfied that neither the executive directors’ annual bonus targets nor the LTIP performance conditions are likely, inadvertently, to motivate irresponsible behaviour.

Non-executive directors’ fees

The Company’s remuneration policy is that the Chairman and the non-executive directors should receive a fixed fee for their normal duties. Reflecting the added responsibilities and time commitment, chairing the Remuneration and Audit Committees attracts an additional fee over the non-executive directors’ standard base fee.

Fees payable during 2009/10 and the Company’s policy from 1 April 2010 (in line with the approach taken in respect of the salaries of NWG executives) are:

The Chairman and the non-executive directors do not receive benefits in kind and do not participate in bonus, pension or share schemes operated by the Company. Further details of non-executive directors’ remuneration are set out in Table 1.

Directors’ interests in LTIP awards

The directors’ conditional interests in the ordinary 10 pence shares of the Company, awarded in accordance with the terms of the LTIP as at 31 March 2010, are set out in Table 3.

Ordinary 10 pence shares required to fulfil LTIP awards which have vested may be provided by the Northumbrian Water Group plc Employee Trust, through Northumbrian Water Share Scheme Trustees Limited. The Trustees are Sir Patrick Brown, Martin Nègre, John Cuthbert (until 31 March 2010), Anita Frew, Alastair Balls and Kate Alsop. At 31 March 2010, the Trust held a total of 914,518 ordinary 10 pence shares. This represents 0.2% of the Company’s total issued share capital, so is materially less than the 5% limit on shares that can be held in trust. In line with the ABI Guidelines, dividends are waived on these shares and the voting rights attached to these shares will not be exercised at the AGM.

Share dilution

The Company’s share plans contain dilution limits that comply with the ABI Guidelines. Shares for both the LTIP and SIP schemes are provided by purchase on the market. There has, therefore, been no dilution to date and there is no commitment to issue new shares in relation to either scheme.

Performance graph

The graph below shows a comparison between the TSR for the Company’s shares for the five year period to 31 March 2010, and the TSR for the companies comprising the FTSE 250 Index (excluding investment trusts) over the same period. This index has been selected as the Company is a constituent of the FTSE 250.

Service contracts

All non-executive directors are appointed for a term of 12 months with a six month notice period for the Company and the director. The executive directors have service contracts with 12 months notice periods and which expire when the directors reach normal retirement age. The contracts do not contain any liquidated damages clauses. Details of the contracts of the executive and non-executive directors who served during the year are shown in Table 4.

Terms and conditions of appointment of non-executive directors are available for inspection at the Company’s registered office during normal business hours and at the AGM. The terms of appointment set out the expected time commitment for each non-executive director.

Retirement of John Cuthbert and recruitment of Heidi Mottram

John Cuthbert retired on 31 March 2010 and Heidi Mottram was appointed as an executive director on 1 March 2010, giving the Company the benefit of John Cuthbert’s expertise and experience in a one month handover process to Heidi Mottram. Heidi Mottram took up her position as Chief Executive Officer on 1 April 2010.

As explained above, Heidi Mottram has been employed on a salary of £320,000. She will not participate in the Company’s final salary pension scheme (now closed) and instead, the Company will make an employer’s contribution of 8% of salary into the Company’s money purchase scheme for her benefit. She will participate in the annual bonus plan and LTIP as described above. No other compensation was paid to her in connection with her recruitment.

External appointments of executive directors

The Board’s position on external appointments is described in full in the corporate governance report but, in summary, the Board has agreed that executive directors of the Company who are appointed to non-executive directorships which pay a fee may retain the fees, subject to obtaining the Chairman’s consent before an appointment is accepted. Only one such external appointment per director will generally be permitted. On 1 November 2009, John Cuthbert was appointed as a non-executive director of Bellway plc. This appointment was made following John’s decision to retire from the Group earlier in the year. John Cuthbert retained the director’s fee received from Bellway plc, which is an annual amount of £46,380. Heidi Mottram is a Board member of Yorkshire Forward for which she is paid and retains an annual fee of £8,666.

Directors’ interests in shares

The directors’ beneficial interests in the ordinary 10 pence shares of the Company, as at 31 March 2010, are set out in Table 6. The NWG Board has agreed to introduce a guideline requesting NWG directors to build up (over a maximum of five years) shares in the Company with a value equal to one year’s basic salary (in the case of the executive directors) or one year’s fees (in the case of non-executive directors).

Directors’ interests in shares under the SIP

The Company SIP is open to UK employees with more than three months’ service. Further details of the SIP are set out in the directors’ report and business review. During the year, the executive directors had the opportunity to participate in the SIP and their interests in the ordinary 10 pence shares of the Company, purchased and held in accordance with the terms of the SIP, are set out in Table 7.

This directors’ remuneration report has been produced in accordance with the Companies Act 2006 and Schedule 8 of the Large and Medium sized Companies and Groups (Accounts and Reports) Regulations 2008. It was approved by the Board and signed on its behalf by the chairman of the Remuneration Committee. It will be put to the shareholders for approval at the Company’s AGM.

Alex Scott-Barrett

Chairman of Remuneration Committee

1 June 2010

These tables form the part of the directors’ remuneration report which are audited (except for Tables 2 and 4 which do not require auditing).

Table 1

Directors’ emoluments (audited)

The emoluments of the directors of the Company for their services as directors of the Company and (where relevant) its subsidiaries, are set out below, rounded to the nearest thousand pounds:

Table 2

Summary of LTIP performance conditions (unaudited)

Table 3

Directors' interests in LTIP awards (audited)

As at 31 March 2010, the directors had the following conditional interests in the ordinary 10 pence shares of the Company, awarded in accordance with the terms of the LTIP:

Table 4

Directors’ service contracts (unaudited)

Details of the contracts of the directors who served during the year are shown below:

Table 5

Directors’ pensions and pension benefits (audited)

The accrued defined benefit pensions and corresponding transfer values for the executive directors are set out below:

Table 6

Directors’ interests in shares (audited)

The directors had the following beneficial or family interests in the ordinary 10 pence shares of the Company as at 31 March 2010:

Table 7

Directors’ interests in shares under the SIP (audited)

The directors who held office as at 31 March 2010 had the following interests in the ordinary 10 pence shares of the Company, purchased and held in accordance with the terms of the SIP: