Challenger Limited (CGF) Earnings Call Transcript & Summary

Good morning. I'm Stuart Kingham, Challenger's Head of Investor Relations, and welcome to our first half 2020 financial results briefing. In a moment, I'll ask Richard Howes, CEO; and Andrew Tobin, CFO, to present our financial results. This will be followed by a question-and-answer session. So could I just please remind those present to flick your phone on to silent. I'll now hand over to Richard.

Thank you, Stu. Good morning, everyone, and thank you for joining us today, whether you're in the room, or on the phone. It's a pleasure to have the opportunity once again to deliver Challenger's first half results. We've made strong progress this year in delivering on our vision and strategy. And our performance over the half rather clearly demonstrates the resilience of our business in what continues to be a challenging operating environment. Now reflecting on my first 12 months as CEO, I'm really pleased with the progress we've made. We've leveraged our successful business model, leading brand and diverse distribution to deliver solid results in a challenging environment. At the same time, we've made investments in initiatives to capture growth as our marketplace evolves. The significant disruption in the Australian wealth management industry following the Hayne Royal Commission has brought both challenges and opportunities for our business. While the disruption is expected to continue for some time, our immediate and targeted response together with the ongoing execution of our long-term strategy for growth has put Challenger in a good position to deliver solid returns and optimize performance through this period. Challenger Life continues to be the leading retirement income brand. 93% of financial advisers rate us as a leader in retirement incomes, and this remains more than 30 percentage points ahead of our closest peer. And our broad distribution networks and platform access allow us to reach a large majority of financial advisers despite the ongoing disruption in the financial advice industry. In our Life business, we've leveraged our established relationship with the MS&AD group to expand our annuity business in Japan. Our access to the foreign currency annuity market in Japan through MS Primary is delivering strong results and building on our geographic diversification. As our superannuation system continues to grow, our products remain highly relevant for retirees who want financial security in retirement. This has become increasingly important for retirees as they seek reliable income in the low-rate environment. As more retirees find they need to consume part of their capital to maintain their lifestyle in retirement, lifetime annuities provide peace of mind, allowing retirees to confidently spend part of their savings, knowing they have income guaranteed to last for their lifetimes. Underpinning our financial performance is the high-quality investment teams that support our Life business. We have specialist capability in asset origination, portfolio construction and asset and liability management. This underpins an investment portfolio that's delivered consistently strong returns for shareholders. Over many years, we've delivered compelling normalized return on equity, consistent with the -- consistently above the RBA cash rate plus a margin of 14%. And we've achieved this while operating within a robust risk management framework. An outworking of this has been the maintenance of our strong capital position, reflected in us consistently operating within the range of 1.3 to 1.6x our prudential capital amount for many years. Our Funds Management business has a strong track record of performance. Our distribution network has global reach, and we have a diversified suite of contemporary products that bring exceptional investment solutions to our clients. Our multi-boutique business, Fidante Partners, continues to be one of the leading active managers in Australia, evolving its successful business model and expanding partnerships and products this half. As a business, Challenger remains scalable and efficient. We have one of the industry's leading cost-to-income ratios, which has reduced about 10 percentage points over the last 11 years, demonstrating our continued commitment to cost discipline. Now we cannot achieve any of this without our diverse and highly engaged team or our strong risk and compliance culture. We maintain one of the highest sustainable engagement scores in the industry at 84%, and we were recognized as a global top 100 employer for gender equality in 2019. Finally, our vision to provide customers with financial security for retirement is supported by active consideration of environmental, social and governance matters across our business. This has seen us continue to expand our responsible investment capabilities, partner with our community and advocate for sound public policy for retirees. This commitment to sustainability supports the positive outcomes for our customers, our shareholders and the community now and into the future. Now today's result is really an outworking of this strategy and represents a solid performance for the half. Group assets under management grew strongly, up 10% to $86 billion, and this includes a 6% increase from Life investment assets as well as a 10% increase in Funds Management FUM. Normalized net profit before tax was up 3% on the prior corresponding period to $279 million, which again reflects increases in both our Life and Funds Management businesses. As we flagged, our profit outcome reflects our investments in a range of distribution, product and marketing initiatives. This investment of $6 million for the first half -- or was $6 million for the first half and is expected to reach $15 million over the full year. These initiatives are designed to respond directly to the disruption we've seen in the advice industry and to ensure we're well positioned to capture growth opportunities as the wealth industry continues to evolve. Now I'll talk about that a little later on in the presentation. Normalized net profit after tax was down 4% to $191 million, reflecting a higher effective tax rate for the first half. Statutory net profit after tax was up $214 million to $220 million, with a positive net investment experience of -- a positive investment experience of $38 million. The statutory profit also includes a $9 million charge arising from the impairment and associated windup costs of 2 small boutiques. Importantly, normalized return on equity for the half was 15.2%. This is 30 basis points above our target, being the RBA cash rate plus a margin of 14%. In addition to the solid results for the half, we've continued to make good progress on our strategic priorities. In our Life business, we've progressed our distribution, product and marketing growth initiatives designed to build long-term capability in light of the evolving wealth management market. Our program of work includes 3 streams. Firstly, we're investing more in direct conversations with our end customers to educate and to build bottom-up demand for our products. Secondly, we're making it easier for advisers to do business with us through a tighter integration with the advice process in order to increase the allocation to annuities. Thirdly, we're expanding our capability in partnering with institutional clients. This includes partnering with profit-for-member funds in order to help them provide retirement income solutions for their growing member base. Working with our strategic partner, the MS&AD group, we've also expanded our annuity business in Japan. The reinsurance relationship with MS Primary is delivering strong results. Pleasing progress has also been made in growing Life's wholesale longevity reinsurance business. We've completed 3 transactions in the U.K. pensions market in the half which together have delivered a 67% increase in present value of future expected profits from the Life Risk business to $830 million. This will support earnings growth for our Life business going forward. This activity leverages our capability that we've built as Australia's leading provider of lifetime annuities, and we participated in the U.K. longevity swap market since 2008 as a natural extension of Challenger Life's business as a life insurance company. In Funds Management, Fidante Partners has continued to evolve its successful multi-boutique model with expanded partnerships and products. In October, we announced a joint venture with one of the world's leading global alternative asset managers, Ares, forming Ares Australian Management. Ares will bring high-quality credit and other alternative investments to the Australian market, and this is a testament of Fidante's ability to attract leading investment managers from around the world. Fidante Partners also expanded its successful ActiveX platform of ETFs with the launch of our new fixed income ETF from Kapstream. This builds on the success of Ardea's ETF which opened in 2018 and has attracted solid flows through this new channel. In December, the Australian Office of Financial Management, AOFM, appointed Challenger Investment Partners to provide portfolio management services for the Australian Business Securitisation Fund. Now this $2 billion fund was established by the government to improve access to credit for small businesses. CIP's work includes drawing on our deep credit expertise to assist with the evaluation of investment proposals. CIP's appointment is an acknowledgment of the strength of the team's fixed income capability more broadly. And the credential will be particularly valuable in taking CIP to a global audience, which is a key strategic priority for our Funds Management business going forward. We've also made good progress against the priority areas of our sustainability strategy. We've launched a new strategic partnership with COTA New South Wales, which is the peak body for people over 50 in the state. And our partnership will deliver a community program that aims to address underemployment of older Australians. This work is still in the early stages, and I look forward to seeing the progress and impact of this important collaboration with employers, employees and other stakeholders. During the half, we also delivered a significant project to redefine the Challenger values for our employees. Our values are integral for the way we do business at Challenger. And the project involves significant engagement with the entire Challenger team, building on the strong culture that we have in order to ensure that it remains fit-for-purpose and evolves with our strategic priorities. Our new values act with integrity, aim high, collaborate and think customer set out the behaviors we need to make community expectations and to deliver on our vision and strategy. These were launched in September, and I'm pleased to say they are really well received by our employees, and we're making great progress in embedding them in the business. So with that, I'll now hand over to Andrew, who will take us through more detail on the financial results. Thanks, Andrew.

Thanks very much, Richard, and good morning, everyone. As you've already heard today, our results for the half demonstrated our strong business resilience in the current operating environment, and this is displayed through a number of our key financial metrics reported today. Looking at the group results, the main headlines are as follows. Net income for the period was $423 million, up $18 million or 4% compared to the prior corresponding period, with the Life cash operating earnings up $15 million or 5%, and funds management income up $3 million or 3%. We remain disciplined on expense management with underlying expense growth of $3 million or 3%. And on top of this, we have spent $6 million on distribution, product and marketing initiatives to drive long-term annuity sales growth. And as Richard has noted this morning, we plan to spend up to $15 million on these initiatives across the full financial year. Overall, the EBIT margin decreased slightly to 66.5%, and group net profit before tax increased by $9 million or 3% to $279 million, as shown on the right-hand chart. Now looking at the group results in some detail. The increase in normalized profit before tax was supported by growth in average assets under management, which increased by 6% in Life and 5% in Funds Management compared to the prior period. Normalized net profit after tax was $191 million, down $9 million or 4%, reflecting an effective tax rate of 31% compared to 26% in the prior period. The higher tax rate reflects lower contribution from offshore earnings, which are generally taxed at rates lower than 30%, lower utilization of available group losses and the nondeductible interest expense on the Challenger capital notes. Given the first half tax outcome, I expect that the tax rate for the full year will be toward the top end of our 28% to 30% range that was guided at the start of the financial year. In terms of statutory profit, which includes valuation movements on Life's assets and liabilities, we saw a positive investment experience of $38 million after tax, offsetting a $9 million loss after tax in relation to the impairment and wind up costs for 2 Funds Management boutiques. Overall, we posted a statutory profit after tax of $220 million, up significantly compared to the prior period. Now moving on to Life's financial performance. Total sales for the period were $3.1 billion, up 15% on the prior corresponding period. The sales outcome reflects 3 main themes: firstly, strong growth in Other Life sales; increased sales volume from Japan; and lower domestic annuity sales, which were impacted by the challenged advice market and also the transition to the new means test rules. The increase in Other Life sales translated into solid overall Life book growth of $924 million or 6.2% growth in total liabilities. Annuity book growth was just under $100 million for the half or 0.7% growth. Life cash operating earnings were up $15 million or 5% on the prior period after absorbing a $12 million reduction in the normalized capital growth assumption change on the equities portfolio. EBIT increased by $8 million to $286 million, and also included the $6 million increased spend on the distribution product and marketing initiatives. Life's normalized return on equity was 16.8% for the period, down 70 basis points compared to 1H '19, reflecting higher shareholder capital levels held over the last year. Now let me talk through the key business metrics for Life in detail. Firstly, looking at Life sales. Total Life sales increased by 15% or approximately $400 million to $3.1 billion. Annuity sales were $2 billion or 9% lower than 1H '19. However, this was offset by a significant increase in Other Life sales, which nearly doubled to $1.2 billion. We're working hard to navigate through the current challenges in the domestic advice market, and this is evident by the expanded distribution footprint we are building, including gaining access to new institutional channels. Domestic term annuity sales were $1.3 billion, down 16% on 1H '19, and this reflects lower retail flows offset by flows from a new institutional client for $300 million. Lifetime sales were $211 million for the period, and down by $230 million compared to last year. Volumes were impacted by the introduction of the new means test rules, which were introduced on 1 July last year. Addressing this, we have continued to support advisers in transitioning to the new rules, and we've also revised our CarePlus product offering. The customer value proposition of these products remains very strong, and we expect to see the ongoing increase take up these products in future periods. While the Lifetime volumes were lower than last year, this was more than now offset by the increase in Japanese annuity sales. MS Primary sales increased by $296 million to $471 million for the period, following the commencement of our new U.S. dollar reinsurance agreement with MS Primary from 1 July last year. The overall volume is tracking ahead of our annual minimum contracted volume with MSP, which is JPY 50 billion or $660 million. Other Life sales, representing Challenger's institutional Guaranteed Index Return products and Challenger Index Plus Fund, were very strong at $1.2 billion for the half. This sales outcome was supported by new client demand for guaranteed returns in the current low-interest rate environment. Now looking at our overall book growth. Total Life book growth was $924 million or 6.2% and was largely driven by the Other Life inflows of $830 million. The Other Life flows were also significant when compared to the last 5 years, and this is shown in the blue section on the bar chart. This generated a 25% increase in the total GIR and Index Plus Fund balance over the last 6 months. The modest annuity net book growth of $94 million or 0.7% of opening liabilities reflects the domestic sales disruption that I've previously discussed. The maturity rate was also higher than expected at 14.5%. This was due to an early redemption of $150 million across a single portfolio of clients. The original portfolio was invested for a 5-year term annuity and the withdrawal occurred midway through year 4. As a result of this early redemption in the first half, I expect that the full year maturity rate will increase slightly to around 26%. Overall, though, the total book growth for the period of $924 million was very solid given the current operating environment. We continue to be focused on growing our long-term annuity portfolio as it embeds significant value. The chart on the left here highlights that 35% of the current period sales were either Lifetime annuities or Japanese annuities, up from 29% in 1H '19. Another metric we focus on is new business tenor and I'm pleased to report that this was 9.1 years in the period, up from 8.6 years in 1H '19. Looking at the chart on the right, our Total Life book now stands at a record level of $15.6 billion. The continued shift to longer-term annuities has resulted in the combined Lifetime in Japanese policy liabilities, now representing 41% of the Total Life book, and it is now the same size as our term annuity portfolio. We remain confident of being able to continue to grow the long-term annuities with the broadened MS Primary reinsurance agreement and the new means test rules, which support Lifetime income streams now in place. Now turning to Life's margin in more detail. Life 1H '20 COE margin was 3.53% and decreased by 14 basis points on 2H '19, which was broadly anticipated. The walk from 2H '19 to 1H '20 is set out on the right section of the chart, and key observations are as follows: the product cash margin expanded by 5 basis points over the half. Asset yields fell by 21 basis points, but this was more than offset by lower interest and distribution expenses of 26 basis points. Lower asset yields were primarily driven by declines across the fixed income and property portfolios. However, the fixed income yield included $8 million or 8 basis points in relation to a perpetual fixed income bond that was fully repaid in the period. This is considered to be one-off in nature and so will not be repeated in the second half. Income on shareholder capital declined by 8 basis points due to the impact of lower interest rates, given that shareholder capital is not hedged for interest rate movements. For example, the 3-month bank bill rate was 73 basis points lower in the first half '20 compared to the second half '19. And finally, normalized capital growth was 11 basis points lower. This fell as a result of reduction in the equity normalized capital growth assumption from 4.5% to 3.5% from 1 July. This change was flagged last June and is in accordance with our expectations for the period. Now looking at Life's investment portfolio. Life maintains a high-quality investment portfolio in order to generate cash flows to meet future annuity obligations. We review the investment allocation based on the relative value of different asset classes, expected ROE outcomes and matching requirements. There have been no major changes to the asset classes over the period. Property declined marginally below 1% to 17% of the portfolio, following the completion of our sales process. And offsetting this, equities and other increased by 1% to 13%. The fixed income and the infrastructure allocations remained unchanged in the period. The fixed income portfolio now stands at $13 billion, and currently has an investment-grade allocation of 75%, up from 74% at 30 June. The portfolio continues to be well diversified across different industries, ratings bands, sub-asset classes and also geographies. The property portfolio of $3.3 billion is mainly focused on domestic properties that provide longer-term rental income streams. Australian properties accounted for 89% of the portfolio, mainly represented by office properties in major capital cities, and 11% or $360 million of the portfolio is allocated to Japanese property. This mainly consists of suburban shopping centers focused on nondiscretionary retail activities. The equity and other portfolio of $2.5 billion is allocated mainly to low beta exposures and absolute return funds, with each valued at around $1 billion and represents over 80% of the equity portfolio. The low beta portfolio is predominantly a collar strategy that provides downside protection and also limits the participation in upside share price appreciation. The absolute return funds include systematic global macro funds and market neutral, long-short funds. Investment returns from both portfolios are expected to have a lower correlation to listed equity markets. And finally, the infrastructure portfolio of $800 million has remained stable over the half. The portfolio is mainly in listed format and is diversified across industries and geographies. Additional disclosures on our investment portfolio and detailed metrics on each of the asset classes are also included in our analyst pack for your reference. Now looking at Life investment experience. This slide outlines the breakdown of the pretax investment experience profit of $56 million for the period. The $55 million gain in the fixed income portfolio represents actual capital growth of $32 million and normalized capital growth of $23 million. The actual capital growth includes a valuation gain of $58 million driven by credit spreads contracting in the period and a credit default loss of $26 million or 20 basis points. The credit loss is specific to a small number of select exposures, and it's not indicative of a broader trend in the portfolio. Overall, we remain comfortable with the current settings of the fixed income portfolio. The $10 million investment experience loss on property reflects positive office valuations, offset by weaker retail valuations. The property valuation gain of $24 million averaged 1.5% on an annualized basis across the portfolio, and this compares to our normalized growth assumption of 2%. The equity and other portfolio loss of $22 million reflects higher domestic and international equity markets and lower absolute return fund gains relative to the normalized growth assumption of 3.5% per annum. The total return being capital and income across the portfolio was broadly in line with expected benchmark returns when considering the defensive nature of the portfolio. Strong listed and unlisted infrastructure gains of $36 million, well in excess of Challenger's normalized capital growth assumption of 4% resulted in an investment experience gain of $18 million on the infrastructure portfolio. And looking at policy liabilities. The total valuation gain here was $15 million, supported by a small positive contribution from new business strain and $14 million from assumption and valuation movements. The new business strain outcome reflects the lower volume of sales in the current period relative to the reversal of new business strain from prior periods. And the assumption valuation change reflects broad-based changes in economic and actuarial assumptions, including surrender assumptions, expected inflation rates, expense assumptions and changes to the illiquidity premium. Now turning to capital. Challenger's position remains very strong with $1.55 billion of excess regulatory capital including group cash. This increased by about $80 million over the past 6 months. Challenger Life company's regulatory capital of $4 billion was consistent with the position at 30 June. The prescribed capital amount decreased marginally, mainly reflecting growth in Life's investment assets and an increase in the net insurance risk charge, offset by a reduction in capital intensity. The capital intensity fell from 13.8% to 13.3% as a result of an improvement in the fixed income credit quality and the reduced allocation to property. Overall, the PCA ratio remained relatively stable at 1.54x, APRA's minimum requirement and is towards the upper end of our target, 1.3 to 1.6 range. The common equity ratio also increased in the period to 1.07x at 31 December. Challenger currently has 2 separate charges of capital notes, which qualifies additional Tier 1 regulatory capital of CLC. The optional exchange date for the first tranche of the capital notes, totaling $345 million is 25 May 2020. Subject to market conditions, Challenger plans to exercise its option to redeem the capital notes and concurrently launch a replacement capital notes offer. Our strong capital position and targeted asset allocation provides significant flexibility and ensures that we are well placed to support future growth of the business. Now looking at Funds Management. Net inflows for the period were $1.9 billion, and average FUM increased by 5% over the past 12 months to $81.1 billion. Net income growth was $3 million or 3%, supported by increased property leasing and development fees generated by Challenger Investment Partners. Fidante Partners' income was stable at $46 million in the half, with increase in FUM-based fees and performance fees, offset by lower Fidante Partners' Europe transaction fees. Performance fees were $3.5 million in the half, up from $2.5 million in the prior period. Expenses increased by $6 million or 6%, predominantly due to the build-out of the Japanese office and increased marketing and technology costs associated with FM's new product and growth initiatives. Overall, Funds Management's EBIT was $28 million, up $2 million or 7% for the half. Now looking at Funds Management's net flows in a bit more detail. The chart on the top left highlights the continued strength of retail net inflows. The retail inflows were $1.4 billion this half, reflecting Fidante's extensive distribution networks and channels, including the ActiveX series of exchange-traded funds. This series features fixed income active ETFs from Ardea and Kapstream, and there are plans to launch more funds into the future. Institutional inflows in the half were $600 million compared to a net outflow of $2 billion in the prior period. The prior period outflow was driven by a profit-for-member fund internalizing its investment management capability. The charts on the lower left and upper right highlight the asset class composition of net flows for the period and funds under management. There were strong flows in both fixed income and equities, and alternatives experienced a slight outflow in the period. Fixed income and equities continue to make up the majority of Fidante's funds under management, which now exceeds $62 billion. Long-term performance of the Fidante Partners Australian boutiques remains very strong with 91% of FUM outperforming benchmarks over the past 5 years, and 89% of funds have achieved either first or second quartile performance since inception. This also gives us a high degree of confidence in being able to continue to attract inflows for Fidante Partners, and the current pipeline of institutional flows is in a very healthy position. And finally, in relation to dividends. The Board has declared an interim dividend of $0.175 per share fully franked consistent with 1H '19. The dividend payout ratio was 55.5% of normalized EPS and above our target range, reflecting the Board's confidence in future growth opportunities and the strength of our capital position. With the Dividend Reinvestment Plan in place, the net cash dividend payout ratio is expected to reduce by approximately 2%. And looking ahead, we also plan to maintain the full year 2020 dividend at the same level as 2019, being $0.355 per share. So in conclusion, this is a solid set of financial results and demonstrates the resilience of our business in a challenging operating environment. Life has been able to diversify its distribution channels, and CLC's regulatory capital position remains very strong, sitting towards the top end of our target range. Our Funds Management business has also continued to grow as demonstrated by nearly $2 billion of net flows and the establishment of new distribution partnerships and also product launches. So with those comments, I'll now hand back to Richard for his comments on outlook and strategy before taking questions. Thanks, Richard.

Thanks, Andrew. Okay. Thanks, Andrew. Looking to the future, we're confident we have the right plan in place to optimize our performance in the current challenging operating environment while positioning the business for growth future. Ongoing disruption in the financial advice market has seen the industry change significantly over the last 12 months. 15% of advisers have left the industry, and there are a number of sale processes underway as banks prepare to exit the sector altogether. This has continued to impact our domestic annuity sales. And while we're firm believers in the role of financial advice, we expect this disruption to be ongoing for some time. Public policy changes have also had an impact on Lifetime annuity sales, including CarePlus as advisers adjust to the new age pension means test rules, which were introduced on 1 July 2019. While in the short term, these changes themselves are a source of disruption, they are a positive for our industry and for our business over the medium and longer terms. They encourage the take-up of innovative retirement income streams such as our flexible income and enhanced income Lifetime annuities. And under the new rules, many customers who would take up these options receive higher age pension payments early in their retirements. Challenger needs to support advisers as they move to these new rules, which has been made more difficult due to disruption across the industry. The good news, though, is that a new cohort of advisers writing these new options is emerging. Lifetime annuity sales in the second quarter were up 22% on the first quarter. Ongoing low interest rates have created a unique investment environment. And while low interest rates reduce returns for investors more broadly, we're confident we can continue to deliver strong returns for our shareholders, as reflected in our ROE target. This investment environment has also driven equity markets to all-time highs, and it's driving solid demand for defensive assets including fixed income and guaranteed income products. Recent data from Plan For Life shows that fixed income attracted higher net flows than any other asset class in the September quarter. Specifically, fixed income enjoyed $2.8 billion of net inflows while the domestic equity market was in net outflow. This data also showed that Fidante Partners was #1 in the domestic retail fixed income with inflows, net inflows more than twice that or twice that our nearest competitor. The breadth of our product offering means we're well positioned in both our Life and Funds Management businesses to perform well in this environment. Ongoing pressures on active managers from the flow to passive management as well as performance issues have seen many super funds become more selective in their choice of active managers. However, our contemporary funds management model and our track record of performance is making us an attractive partner in this environment. This ensures we're able to leverage our brand and our broad distribution networks and long-established relationships. The financial services industry has seen a significant decline in consumer trust following the Hayne Royal Commission. While this has created a more challenging distribution environment for our business, Challenger's strong reputation and brand among both advisers and consumers is a key strength. This has created a significant opportunity for Challenger to better educate and engage with customers and provide direct support for advisers in the -- as the industry evolves. Finally, in terms of our operating environment. The long-term structural tailwinds that drive our business forward, remains strong as our superannuation system continues to mature and as more Australians transition to the retirement phase. These tailwinds underpin our long-term growth, and Challenger remains ideally positioned to capture these opportunities as the system matures. Now we continue to remain focused on the priorities we set out in August and focused on executing our strategy for long-term sustainable growth. We're responding directly to the evolving wealth management market with a clear program of work designed to produce more direct engagement with customers and to improve the experience for advisers through a tighter integration with advice processes. The profit-for-member funds sector continues to grow, winning market share from the retail segment and benefiting from system growth. Moreover, an increasing number of their members will transition to retirement. This proves -- this will provide a significant opportunity of growth for Challenger as the funds focused on providing more comprehensive retirement income solutions for their members. The strong relationships we maintain in this sector and our thought leadership put us in a good position to capture these opportunities as the system matures. We'll continue to leverage our relationship with the MS&AD group and to broaden our access to the Japanese annuities market. Our agreement with MS Primary to reinsure U.S. dollar annuities extends our annuity arrangement in Japan beyond Australian dollar products and in line with our arrangement is on track to deliver strong results this financial year. Our model and long-term track record of performance across our Funds Management business will support us in expanding our product and distribution offering. CIP's appointment to the AOFM's Business Securitisation Fund supports our plans to take CIP to a global audience and is the perfect example of how our team are providing excellent funds management solutions for our clients. Importantly, we'll maintain our focus on financial discipline and on retaining our strong capital position. This focus is what enables us to deliver on our promises to policyholders while also delivering strong returns for our shareholders. Finally, we will maintain our leading operating and people practices. Our team are committed to our vision and strategy, which is fundamental to our ability to deliver positive outcomes for our customers, our shareholders and the community now and into the future. So looking now at our outlook for the full year. We're on track to deliver normalized net profit before tax around the top end of our guidance range of $500 million to $550 million. Our normalized cost-to-income ratio is 33.5%, and that's tracking better than we expected, thanks to our continued focus on cost discipline. We're on track to achieve our ROE target, which is the RBA cash rate plus a margin of 14%, and our first half ROE was 15.2% or 30 points above this target for the period. The full year dividend is expected to remain unchanged to $0.355 a share, and this is expected to be above our target payout ratio of 45% to 50% of normalized net profit after tax, reflecting our confidence in future growth of the business. We also expect to remain highly strongly capitalized, noting that our PCA ratio at the half was 1.54x, which is towards the top end of our target range. So I think today's result demonstrates the resilience of our business and the success of our strategy to diversify and strengthen our business over many years. As our domestic annuities business to be -- continues to be impacted by disruption in the retail financial advice market, our diversified distribution has supported us in capturing institutional demand for guaranteed returns in a low interest rate environment. We've also benefited from our access to the Japanese market through our MS Primary partnership, which has offset reduction in domestic sales for the half. Our differentiated boutique model has seen us attract exceptional flows, with a particularly strong contribution from the retail market. It's a model we continue to build on with new boutiques and products to capture growing demand. Importantly, we're also making significant progress against our strategic priorities, with our investment in distribution, product and marketing growth initiatives, positioning Challenger to capture growth as the wealth management industry evolves. Now while we expect disruption to continue through FY '20, I remain confident that we're well positioned for the future and can continue to deliver positive outcomes for our customers, shareholders and other stakeholders. So thank you for your interest today and ongoing support of Challenger. Andrew and I would now be delighted to take your questions.

Just as a matter of protocol, we'll take questions in the room first before going to the phones. Could I just remind you just to, if you're asking a question, just to state the name of the company you represent?

Kieren Chidgey from UBS. Just a couple of questions, maybe starting on the sales. The Japanese run rate is obviously tracking very well, annualizing over $900 million compared to the $660 million minimum target you've set. So any commentary around sort of whether or not that annualized run rate sort of a better guidance to what you would expect on a full year? And then I'd also be interested in sort of commentary around the revised CarePlus product and sort of when that was launched and how you expect that to pick up.

Okay. Thanks, Kieren. Obviously we're really happy with how our partnership with the MSP, with MS Primary, is progressing. And the run rate and so forth is very strong for the half. There's really, I suppose, 2 things which drive [ off the ] volume that gets written. It's the amount of foreign currency annuity sales, particularly in U.S. and Aussie, that MSP writes themselves in Japan, and then it's the quota share amount that they provide to us. Now MSP are able to vary that quota share amount. And so while I'm really happy with the way things are going there, I'd fall short of assuming that, that run rate is going to continue. But nonetheless, I'm really pleased with how it's tracking at the moment. And your -- the other question was on CarePlus. So as I mentioned, our Q2 sales in lifetime annuities, which includes CarePlus, showed a 22% increase over the period, and that reflects good increases in both Liquid Lifetime products and CarePlus. We varied our CarePlus product in response to customer feedback more broadly, but also in and around the changes to the age pension mean -- well, the means testing rules more broadly, which govern things like aged care fees and so forth. And the way -- just to maybe put a little detail on that, the way CarePlus works is there's 2 products, there's a lifetime annuity and then a life insurance contract. And the changes to the means testing rules meant that the particular configuration of that combination didn't work particularly well. In particular, the life insurance contract was treated quite harshly. So we've made some variations to how those 2 work together, and that's providing better outcomes for customers across the board, including the means testing. And so that's driving solid, solid upticks in inflows, and I'm really encouraged by that and encouraged more broadly about what we expect to see in the future on it.

I've just got a second question on Life Risk and then a final one on guidance. The step-up in the NPV of future profits around that Life Risk book, I think it's about $335 million in the half, which seems probably like the biggest value driver the company has actually had over that 6-month period, so fantastic result. But maybe you can just discuss what level of risk is being assumed to generate such a significant value uplift over a short period?

Yes. So the context for that is that [ this is ] a market that we've been operating in since 2008. The longevity swap market in the U.K., it's driven by defined benefit pension schemes there seeking to de-risk their longevity risk. And I suppose we're really building on our expertise as the leading provider of lifetime annuities in this country. And it's a natural extension of our business being a regulated life insurance company. It's the kind of market where you can go for periods of time without doing a single transaction, and we stick very closely to our discipline around pricing these transactions and adhering to our return on equity targets. And so we've been fortunate. It was a period of high volume in that market, and we were able to acquire more than what we'd been doing in prior years, and hence, the 67% increase in PV of future expected profits to $830 million. We are required to hold capital for those risks. Importantly, they are a source of diversification. So as you would imagine, the gains or losses from variations in the longevity improvement experience tend to be unrelated to market movements. And so there's diversification both in an economic sense and also from a regulatory capital point of view. But it's very much business that we write within our risk management framework.

And just a final question. To look at the revised [ PBT ] guidance with the top end around $550 million for the full year. You did $279 million first half, so it implies $271 million around about that second half, so $8 million lower, which appears to reflect just that life one-off that Andrew called out. So if we adjust for that, it's pretty flat half-on-half. I would have thought with the net book growth the business is enjoying, you might be talking about something a bit stronger. So what else is sort of offsetting some of that? Or is there just embedded conservatism even within that revised guidance?

Kieren, we're halfway through the year as well. So I think it's an appropriate guidance metric to provide to the market at this point in time. But to the heart of your question, the $8 million I called out in the fixed income portfolio is considered to be one-off, that's not repeatable. But I would also remind you of the DPM expense base. We've spent $6 million in the first half. We expect to spend up to $15 million for the full year. So a marginal step-up, an additional $3 million or thereabouts in that expense base as well. So they are the 2 key things that we think about. Noting that there's all sorts of things in the portfolio that can go up or down, we think it's an appropriate guidance setting for the market at this point in time.

Simon Fitzgerald here from Evans & Partners. Just 2 questions here. On Page 12 of the presentation, you did call out that $150 million withdrawal. It was related to one adviser. Just wanting for you to elaborate a little bit more in terms of what that adviser's thinking was and whether the penalty is similar across the -- ultimately the investing clients. And then whether you think there may be other advisers at risk for doing something similar.

Yes. Thanks for the question, Simon. We've called it out because it's very unusual. It was -- to give you a little bit more context, this was a 4-year fixed term annuity, which was redeemed, if you like, a year early. It was in relation to a group of clients who were advised by one adviser, and it was to redeploy money into -- to change the asset allocation of that particular group. It is unusual that the early withdrawal commutation adjustments were applied equally across the portfolio of customers, and it's not the sort of thing we expect to see going forward in the portfolio.

Okay. And the second question then, just on the Australian fixed term annuity sales, there was a decent step-up in the second quarter versus the first quarter in terms of those sales. I'm just wondering, is that all sort of related, do you think, to the change in the DSS rules? And are they just starting to take effect there? Or do you envisage that some of these disruption issues are starting to stabilize a bit?

Yes. Maybe as a starting point, it's been a reasonably difficult period for retail fixed -- fixed term annuity sales, and for the same reason that it's actually been quite a tough period for term deposit sales more broadly in the industry. The yield curve through most of the first half of this financial year has been flat to a little bit inverted. So as retail investors look at where they're going to put their money, they tend more to put it in very short-term term deposits or [ at-call ] cash accounts. So that's been a source of disruption, if you like, in terms of fixed-term sales. We have been fortunate in getting some payoff, if you like, from the investments we're making in diversifying our investment channels. So one of the things I talk about in the DPM initiatives is the investments we're making in terms of capabilities of partnering with institutions. And we are seeing greater institutional demand in a low interest rate environment for guaranteed income. So part of our fixed term sales was a successful institutional sale for the half there, Simon.

Brendan Carrig from Macquarie. Richard, maybe just following on from some of your comments there. The fixed term pricing that you're offering at the moment, there's quite a reasonable differential between that of the major banks, which is obviously a reasonable proxy for competition in that area. Do you see any scope for potentially that pricing to come down as the adviser disruption begins to ease or, as it appears, it has started to ease? Or would we expect that to stay there and not get the margin pressure -- margin offset on the distribution expenses going forward?

Yes. Thanks for the question, Brendan. So in thinking about pricing all of our annuities, the main frame of reference is our return on equity target. So obviously, we're having regard to what returns we can get on the asset portfolio and thinking about the fixed term annuity pricing as a source of funding within that equation. We're also mindful of where competition is at. And it's true to say, term deposit pricing is less competitive relative to prevailing interest rates than it has been in the past. Although in an environment where, as I mentioned earlier, because of the inverted yield curve, it's been challenging to have retail investors look beyond very short-term dates in what would otherwise be 2-, 3- or 4-year, 5-year investments. We're maintaining pricing where it is, I think, provided we're maintaining that discipline around ROE. But that's the main priority.

And the second question, just on the sales volume mix. Obviously, we've talked a little bit about those institutional sales. To what extent do you think that this might be a structural shift in the low rate environment? And can you make any comments about the pipeline that might support any views around this being a structural shift?

Yes. That's a good question. So you would -- one observation you can make is that, historically, a good source of fixed term sales has been the major bank hubs, who have been able to look at a book of term deposit holders and decide in certain circumstances that an annuity might be delivering a better outcome for advisers. Now as the major bank -- major banks have been retreating from advice, there is some structural change there that the industry is looking different to what it had done previously. I think there is still underlying demand for that type of product, and referral networks are yet to emerge. But the bancassurance, if you like, as we used to think about it, is not sort of existing in its historical form. I do think that there will be ongoing opportunities for institutions to step in and give us more sales volume down the fixed term channel. And so that's part of what we're trying to do by diversifying our channel. But of course, that business tends to be lumpier and less consistent from period to period.

And sorry, just one quick last one. Just on the de-risking that we saw in the book during the period. Was that a decision at all linked to the uptick you saw in the losses? Or was it more of a risk premier-based decision?

Yes, I think it's not reflective of some overall concern in any particular part of the portfolio. As you know, we're a relative value-based investor, so we'll move capital around the portfolio as relative value opportunities present themselves. We've had some really compelling opportunities in the short pay AAA RMBS space over the period, which has seen us deploy money into that part of the portfolio. A result of that is a lessening of the capital intensity within the fixed income portfolio and across the book more broadly. But best to think about that as a relative value decision rather than an indicator of some broader level of concern.

Brett Le Mesurier from Shaw and Partners. That's what I was going to ask you about actually. The -- there was a $900 million reduction in your corporate credit investment and about $1 billion increase in your asset-backed securities. What was the increase in margin as a consequence of that change?

I think, actually, in terms of raw margin, that would have delivered a slight decline in margin. And I'd need to go back and look at the precise maths on that. Obviously, to the extent that we're moving from investment-grade corporates, and there was a portfolio of investment-grade corporates that we're maintaining in U.S. dollars in the U.S., but after a very strong rally during the half, for relative value reasons, we decided to reduce our exposure there. And at the same time, as I described, there was very compelling relative value in short pay RMBS. That move is something that enhances return on equity as all our relative value decisions do. And because it was net reducing risk, it probably reduced -- if you just looked at those 2 things in isolation, it would have reduced net -- it would have reduced the margin on the -- or the margin above swap of the fixed income portfolio. So it's more a -- it's best to think about these things in terms of return on equity.

And when during the period did that happen?

I couldn't give you a precise date for that, Brett.

No, I'm more interested in -- was it towards the beginning or the end? So does it have an impact in this half as well?

It will have a -- well, it had a -- yes. So it was over the period. It wouldn't have had a significant impact in terms of the earnings in the first half.

And the capital you're saying reduced as a consequence of that? Do you have a feeling as to what the reduction in capital was?

I wouldn't be able to put a precise number on it. As you know, we think about our capital in a broad portfolio context, and I'm very comfortable with where we're at in terms of -- towards the top end of our 1.3 to 1.6 PCI range.

And maybe, Richard, I can add to this. The overall capital intensity we called out in the briefing, it fell from 13.8% to 13.3% as a broad measure of capital intensity across the portfolio. That does reflect the changes in the fixed income portfolio, but it also reflects the reduction in the property allocation that we had in the period.

And the asset risk charge was the same at the beginning and the end of the period. Was it stable throughout the period?

Brett, we report on a 6 monthly basis as a -- at a snapshot of the point in time. We've called out the fact that the portfolio really didn't change from opening to closing dramatically. I would say it would be broadly stable on a month-by-month basis, but I'd have to go back and check those months. But the key takeaway is that broadly no change across the portfolio allocation from an asset perspective, and overall capital intensity falling by that 0.5% over the period.

Matt Dunger from Bank of America. If I could just confirm the outlook guidance for normalized cost-to-income ratio. You're saying it's tracking better. Is that better than the above 30% to 34%? So we're expecting it below 34% now.