Helia Group Limited (HLI) Earnings Call Transcript & Summary

Thank you for standing by. And welcome to the Genworth Mortgage Insurance Australia First Quarter 2020 Earnings Results. [Operator Instructions] I would now like to hand the conference over to Ms. Pauline Blight-Johnston, CEO and Managing Director. Please go ahead.

Thank you, Tenada. Good morning, everyone. And thank you for joining us this morning to discuss the first quarter financial results of Genworth Mortgage Insurance Australia. I'm Pauline Blight-Johnston, Genworth's Chief Executive Officer and Managing Director. I'm here with Chief Financial Officer, Michael Bencsik. This is my first earnings call with investors since joining Genworth, and I'm delighted to be here with you today. I'm looking forward to meeting many of you in person when we all get back to working in the office. I'll start with Slide 5 of the presentation. At the outset, I want to make some remarks about the environment we find ourselves in due to COVID-19. When I joined Genworth in early March, the coronavirus was beginning to impact global investment markets and the health impacts are becoming clear as new cases rapidly spread around the world. A week later, the World Health Organization declared a global pandemic. In the interest of protecting the health and well-being of our people, all the customers and stakeholders we interact with as well as the broader community, Genworth employees started working from home on the 11th of March. I've been very impressed with the way our people have transitioned to this new way of working remotely. We've maintained service levels for our customers, and we're regularly engaging with customers to assist them and their borrowers. I'll talk more about that shortly. Genworth entered these uncertain times well placed, with a healthy capital base, leading market position and robust operational procedures. These strengths have been a great benefit to us in navigating the uncertain and changing environment that we find ourselves in and will continue to serve us well as this situation plays out over the coming months. The fundamentals of our business is strong, as demonstrated by the solid first quarter performance and momentum that was evident before the impact of COVID-19. Turning now to Slide 6 and our financial results. The business performed well at the quarter with solid insurance business growth and improved client experience, particularly in Western Australia and Queensland. A strong contributing factor to the results was the 18.5% increase in new insurance written from $5.4 billion in the first quarter of 2019 to $6.4 billion in the first quarter of 2020. Gross written premium also increased 32.2% from $86.3 million in the first quarter of 2019 to $114.1 million in the first quarter of 2020. These increases reflected higher growth across Genworth's lender customers. This was due to the increase in property prices in major capital cities, such as Sydney and Melbourne and the low interest rates. Net earned premium in the first quarter was up 3.4% to $75.4 million. Our loss ratio was 47.1%, benefiting from favorable aging of delinquencies due to rising house prices. In late February, COVID-19-related volatility in investment markets began to impact Genworth's investment portfolio. This continued into March and resulted in mark-to-market unrealized losses for the quarter, as noted on Slide 11, which Michael will talk. On the 26th of March, Genworth withdrew our outlook for the full year financial results due to the uncertainty arising from COVID-19. Over recent months, we have been undertaking scenario analyses of possible future LMI claims outcomes arriving from COVID-19 based on a range of economic scenarios. As a result of this work, we have determined that the outlook for future LMI claims has materially changed with claims expected to increase towards the end of 2020. Genworth have made allowance for additional COVID-19-related claims with a write-down of $181.8 million of the deferred acquisition costs or DAC asset on our balance sheet. This write-down has impacted the first quarter, resulting in a statutory net loss after tax of $125.6 million. Excluding the write-down, underlying net profit after tax increased 8.1% to $24.1 million compared to $22.3 million in the first quarter of 2019. This is a write-down of a noncash asset arising from acquisition expenses relating to policies written in the past that would ordinarily be amortized over the life of those policies. The ultimate impact of COVID-19 on the Australian economy is still at this stage unknown. So whilst we have made allowance for central scenario estimate of future claims, ultimate claim costs may prove over time to be materially greater or less than this estimate. Importantly, the company remains in a strong capital position, even after allowance for the debt write-down and aim to withstand volatility in claims outcomes. The impact of COVID-19 reduced Genworth's regulatory solvency ratio on a Level 2 basis from 1.9x to 1.78x. This still sits comfortably above the top end of the Board's target range of 1.32 to 1.44x and represents surplus capital of $267 million, above the top end of the target range. In addition, Genworth's capital position is within or above the Board's target range in all the scenarios that we tested in our analyses, including those significantly worse than the central estimate scenario. Michael will go into more detail regarding the debt write-down when he goes through the first quarter financials. On to Slide 7 now. From a strategic perspective, we continue to enhance our capabilities across the mortgage value chain, helping our lender customers to better meet the needs and expectations of their borrowers. The success of our approach to-date is reflected in the strength of our relationships with over 100 lenders. In 2019, we announced that our major customer, Commonwealth Bank, renewed its supply and service contract for a further 3 years, effective 1 January 2020. We have a long-standing relationship with the bank and are delighted to have the opportunity to continue servicing their borrowers. You would also have seen in our ASX release earlier this morning that we've announced 2 further customer renewals. These include an exclusive LMI relationship with a nonmajor bank and an extension of our relationship with a mutual vendor for the first time on an exclusive basis. Both of these contracts over a 3-year period effective from April 2020. The renewals reflect the success of our strategic program of work to strengthen our customer partnerships and grow our business. Fostering long-term relationships with exclusive contracts enables us to build industry-leading connectivity with our lender partners. We work very closely with lenders to understand and respond to what they and their borrowers need. We know that our lenders are happy when the borrowers are happy. This is why our product innovation and enhancement continue to be a strategic priority for our business as the home loan market responds to regulatory market and customer expectation changes. From our new market premium products that will allow borrowers more flexibility to our advanced decisioning and borrower support system, we are committed to helping Australians achieve their dream of home ownership. And the benefits flow through at our end, too. For example, we've expanded our Lapsed Policy Initiative program, which is a tool that captures new data sources enabling us to more properly identify loans that have been discharged or refinanced. This allows a release of unearned premium and associated capital, improving the financial efficiency of our business. As our business adapts to a COVID-19 world, we will continue to engage with our customers to provide digitally focused solutions and the value-add product expertise that they have come to expect from Genworth. Our aim is to provide insightful loss management, risk and capital solutions that strengthen our customer partnerships and grow our revenues. Turning now to Slide 8 and the economic and market conditions we encountered in the first quarter of the year. While clearly things are different today, it is worthwhile looking at the environment in which our business operated through the quarter. So I'll cover this slide briefly now. Australia entered the COVID-19 pandemic from a position of relative strength. The positive momentum we observed in the economy over the fourth quarter in 2019 continued into early 2020 before the impact of the COVID-19 pandemic. We continue to see recovering metropolitan housing markets over the first quarter of 2020 and a generally brighter outlook for exports and commodities and a strong services sector. The national unemployment rate over the first quarter was stable year-on-year, with a noticeable improvement in major markets in Western Australia and Queensland. The bad bushfires in New South Wales, Victoria and Queensland over the latter part of 2019 and into January 2020, together with the ongoing drought, are expected to have an adverse impact on first quarter GDP growth. The recovery of metropolitan housing markets, which we observed in the second half of 2019, continued into first quarter with strong growth in both Sydney and Melbourne. Historically lower cash rate, tax cuts and ongoing infrastructure investments at both the federal and state levels provided strong support for the economy to the early part of 2020. Our in-force portfolio delinquency rate was stable compared to the first quarter of 2019. We also started to see improvements in our Western Australian portfolio, particularly in non-mining regions, which showed improved delinquency rates over the same period. Clearly, the COVID-19 economic impacts will dominate the economic landscape over 2020 and into 2021 and it is now likely that notwithstanding the strong growth over the early part of 2020, we are likely to see declines in both GDP and house prices over the remainder of the year. Moving to Slide 9. Since February 2020, there's been a significant change in Genworth's operating environment due to the economic disruption caused by COVID-19. The federal and state governments and Reserve Bank of Australia have announced stimulus packages to support jobs and businesses through this period of economic uncertainty. Many lender customers have announced supportive initiatives and advised that home loans that have been granted repayment deferrals will not be treated as delinquent loans and not reported as in arrears. We welcome and fully support initiatives by governments and vendors to assist borrowers during this time. We are working closely with our lender customers to understand how they are responding to the current circumstances and to ensure we are appropriately supporting borrowers while prudently managing underwriting risk. We've expanded our hardship policy to enable lenders to provide further support to borrowers impacted by COVID-19. It's a testament to the quality of our people and our system that we've continued to meet all our customer service levels, particularly given our people are operating remotely from home and dealing with higher volumes. Our business has transitioned remarkably well to this new way of operation. Genworth came into this difficult period very well positioned, operationally and financially. And we continued to manage our business prudently and efficiently to ensure we can continue to play our part to help Australians realize the dream of home ownership now and into the future. I'll now hand over to Michael Bencsik to expand on our financial position and the first quarter results.

Thank you, Pauline, and welcome to everyone on the call. Turning to our financial performance, starting on Slide 11 with our first quarter 2020 income statement. The COVID-19 pandemic, which emerged during this quarter is expected to materially impact the economy throughout 2020 and 2021, as Pauline mentioned. Notable for Genworth and other financial institutions are the implications on Australia's unemployment rate and the level of house prices, which has changed the outlook for future LMI claims on our business. Our first quarter 2020 underlying net loss after tax of $103.2 million included an allowance for an additional COVID-19-related claims, requiring a write-down of $181.8 million of the deferred acquisition costs or DAC asset on our balance sheet. This allowance was a result of undertaking a range of economic scenarios by Genworth during the quarter, to analyze future LMI claims from COVID-19 based on a range of possible economic outcomes. I will cover this in more detail later in our presentation. However, excluding the COVID-19 debt write-down, pleasingly the underlying net profit after tax increased during the quarter by 8.1% to $24.1 million compared to $22.3 million in the first quarter of 2019. This reflected the higher LMI premium growth that started to emerge in fourth quarter '19, led by rise of home buyer confidence and housing affordability, particularly in the Sydney and Melbourne markets, supported by the lower interest rate environment. The gross written premium result of $114.1 million was up 32.2% from $86.3 million in the first quarter of 2019. The result reflects stronger LMI flow business across Genworth's lender customers as property prices continue to recover during the quarter, and partly, bulk transactional business, which Genworth provides mid-market and non-ADI lenders, both covered through the warehouse or RMBS transactions. Net earned premium of $75.4 million was up 3.4% over first quarter 2019, reflecting seasoning of prior book years, higher group written premium volumes and ongoing lapsed policy cancellation initiatives. Net incurred claims of $35.5 million was down 11.9% in the first quarter 2019, with our loss experience benefiting from favorable aging of delinquencies. Our investment income earned on technical and shareholder funds resulted in a loss of $8.9 million during the quarter compared to income earned of $63.1 million in the first quarter 2019. Equity and credit market volatility increased markedly during the March month due to low investor confidence arising from the rapid global spread of COVID-19, which started to impact Genworth's investment portfolio. Specifically, investment income on technical funds was $33.3 million or up 1% over the first quarter 2019, with returns on government and semi-government bonds benefiting from a declining interest rate environment. Technical funds investment income includes realized gains of $8 million from rebalancing within the fixed income portfolio. Net investment income on shareholders' funds was a $42.2 million loss compared to an income of $30.1 million in first quarter 2019. Risk-free rates and equities dropped sharply during March as credit spreads widened, particularly in the U.S. dollar corporate bond portfolio. This result includes the $10.8 million unrealized loss in equities. [ Overall ], we have seen during April was that the fixed income and equities portfolios have continued to recover as credit spreads have improved in Australia across A-rated and U.S. BBB rated corporates, particularly in the U.S. due to improved federal reserve support, but partially reversing these earlier losses. Net interest income and dividend income of $14.9 million was lower compared to $21.8 million in first quarter 2019, with returns pressured by the lower interest rate environment. As a result, our annualized investment return for this quarter was 1.9% compared with 2.7% for first quarter of 2019. Moving now to Slide 12 on the liability adequacy test. As at March 31, 2020, the effects of COVID-19 have yet to impact or incurred premium liabilities reported. This is expected to commence towards the end of 2020 as claims are incurred. Any future effects from reduced economic activity, increasing unemployment or reduced house prices is yet to flow through to delinquent loans. These impacts are considered in the context of estimating our future premium liabilities required under the Liability Adequacy Test or LAT. Genworth is required to determine premium liabilities in compliance with both the APRA financial standard 340 for our quarterly accurate reporting requirements and also AASB 1023 general insurance contracts. The net insurance liabilities recognized on balance sheet must exceed all future claims expected to arise on in-force policies, including an appropriate risk margin as future premiums to be earned. This is known as the Liability Adequacy Test. Estimating the future impacts of the economic environment on Genworth's LAT is not too dissimilar to estimating future credit losses for loans in the banking industry, both can be viewed as forward-looking measures. If the LAT test is [ failed ], the deferred acquisition cost or DAC balance sheet asset is written down to the extent of LAT efficiency. An unexpired risk liability is also required where the LAT efficiency exceeds the DAC asset available to be written down. Genworth uses a stochastic modeling process that supports the estimation of the premium liability and henceforth future claims. As the premium liability measurement relies on future cash flows, the measurement is sensitive to the uncertain future economic impacts of COVID-19. As shown on Slide 12, Genworth modeled various scenarios of potential outcomes, including quick recovery, central estimate and delay recovery scenarios. Unemployment, gross domestic products, house price index, mortgage rate and wages growth were key economic assumptions used in each scenario. Of these, unemployment and house price depreciation have the largest impact on our portfolio. As unemployment is largely concentrated in demographics, such as casual employees, who will have a lower representation in home ownership, we have adjusted unemployment down by about 1% to 8.2% under our central estimate, reflecting the lower unemployment rate we have expected to be attributable to our portfolio. The government stimulus packages, including JobKeeper and lender customer hardship packages offered to borrowers were assumed to be effective mitigation actions in restarting the economy. These assumptions were then stressed based on the duration of the assumed recovery and the scenarios model post mitigation. The central estimate adopted for the LAT assessment by the appointed actuary incorporated a median view of all economic, external forecasts. As of March 31, 2020, the resulting expected future claims, including an appropriate risk margin exceeded the net insurance liabilities, creating a LAT efficiency of $181.8 million under the accounting standard AASB 1023. This LAT efficiency was largely related to the older book years of 2013 to 2014, where we had mining with new book years for 2017 onwards benefiting from higher pricing and stronger underwriting standards. As a result of the scenario modeling and the LAT efficiency, we have written down that DAC asset by $181 million at March 31. The DAC asset relates principally to acquisition costs associated with obtaining mortgage insurance policies returning either to new business or renewals, capitalized and amortized over the life of these policies. This write-down is a noncash accounting item. Importantly, our PCA coverage ratio across all scenarios tested remained above the board target range of 1.32 to 1.44x capital. Moving now to Slide 13. New insurance written, which illustrates the quarterly view by products in first quarter 2018 and the loan-to-value ratio or LVR of our LMI business. During first quarter 2020, our new insurance written increased 18% this quarter to $6.4 billion compared to 1 quarter 2019, reflecting housing market recovery and lower interest rates. You can see from these charts that there's been a change in the mix of business, with the proportion of under 80% LVR business written, decreasing from 15% in first quarter 2019 to 6% in first quarter 2020, with the 80% to 90% LVR business increasing from 65% from first quarter 2019 to 72% in first quarter 2020. The level of new business we write in each LVR band has 2 implications for our business, namely the average price of flow business and our gross written premium earned; and secondly, the level of regulatory capital required to support this new business. The next slide, 14 provides some further detail on our gross written premium performance during first quarter 2020. The left-hand chart shows gross written premium and the average flow price of business since first quarter 2018, indicating the continued shift to more LMI flow business be written in the 80% to 90% LVR band, than in the above 90% LVR bands, reflecting in far tighter credit policies and risk appetites introduced by lenders in 2019. The average premium, however, increased to 1.83% from 1.75% in first quarter 2019. The right-hand chart on this slide illustrates the drivers in the increase of the level of GWP with a 32% increase quarter-on-quarter, largely from stronger LMI flow business across Genworth lender customers with property prices continuing to recover in the major capital cities of Sydney and Melbourne. The key features of our loss performance are shown on Slide 15. Net claims incurred for the quarter were 12% lower at $35.5 million compared to $40.3 million in first quarter 2019, reflecting favorable aging of delinquencies. The number of paid claims in first quarter 2020 of 333 was up 4.4% on first quarter 2019 or 319, where the average amount paid per claim declined to $92,700, reflecting the lower number of paid claims from mining regions. In first quarter 2020, we increased net reserves by $4.7 million for an extra 6 to 12 months in COVID-related aging of older mortgage in arrears, where these are unlikely to cure naturally as the litigation evictions and open house options are placed on hold for 6 months. Our first quarter 2020 loss ratio was 47.1% compared to first quarter 2019 at 55.3%, reflecting this favorable aging of delinquencies from both mining and nonmining regions. Turning to Slide 16, shows the delinquency roll and incurred loss drivers. Delinquency rates across the portfolio were unchanged at 0.57% when compared to first quarter 2019, but increased by 1 basis point when compared to fourth quarter 2019. Whilst Western Australia at 1% and Queensland at 0.75%, continues to experience the highest delinquency rates, Western Australia pleasingly improved by 5 basis points. The New South Wales delinquency rate of 0.44% increased 3 basis points, largely due to partly aging and the decrease in policies in force as a result of policy cancellation initiatives. New delinquencies were down 12.6% to 2,326 compared to 2,662 at first quarter 2019 as mining regions improved during this quarter. Since first quarter 2019, the trend in softening cure rates continued, with the number of cures decreasing to 1,940 at first quarter 2020, with slightly lower cure rates, particularly in New South Wales, Victoria and Western Australia. Cure rates are typically lowest in the first quarter of each year before rising in the later -- in the year. On the bottom of this table, you can see how we evaluate our loss development and manage our reserving. The new delinquency reserves at first quarter 2020 of $38 million were up $3 million compared to first quarter 2019, reflecting the reported new delinquencies and a higher average reserve per delinquency. The cures line represents the release from reserves of those delinquencies that naturally cure in each period. The aging line shows the additions to reserves that we make for delinquencies that transition from 1 arrears bucket to the next on the basis that the longer a loan is delinquent, the greater profitability it will go to claim. Our goal is to ensure that by the time a delinquency occurs and transitions to the final stage of mortgage in possession, we are holding 100% of the projected claim as a reserve. Slide 17 highlights the continued strength of our balance sheet. The asset side of the balance sheet comprises a $3.1 billion investment portfolio, with more than 83% held in cash and fixed interest securities with a rating of A- or better. As at March 31, 2020, $72 million was invested in equities and $633 million of the investment portfolio were invested in non-AUD income securities. Our investment portfolio plus our potential reinsurance recoveries are essentially what is available to our policy models to meet our claims obligations, providing us with over $4 billion of claims paying resources. On this slide, the right-hand pie chart there shows the composition of our unearned premium reserve by book year. We have retained about $1.3 billion of unearned premium on our balance sheet, which we will continue to earn over time. Slide 18 shows that our regulatory capital position remains strong with our PCA coverage ratio at 1.78x capital. The chart on the right shows the trend of a declining probable maximum loss to $1.64 billion, driven by lower LVR business being written in this 80% to 90% LVR band and phasing of larger bank books, meaning that the amount of capital we are required to hold is reducing over time. Slide 19 provides a further view of our capital position. The notable changes to our solvency ratio during first quarter 2020 on a pre- and post-COVID-19 basis, with the impact of the payment of our full year '19 dividend in March 2020 of $31 million and the $181.8 million debt write-down, which reduced our solvency ratio on a Level 2 basis from 1.9x to 1.78x capital. This PCA coverage ratio remains comfortably above the top end of the Board's target range of 1.32 to 1.44x, representing a surplus capital of $267 million as of Q1 2020. As I mentioned earlier, Genworth has modeled various scenarios of plausible outcomes referred in this slide to let the quick recovery, central estimate and delayed recovery. The chart at the bottom illustrates that Genworth's capital position was above the Board's target range in all scenarios that were tested. Finally, Slide 20 highlights our reinsurance program that was renewed on the January 1, 2020. The program provides a 1-year cover with an option to extend to a full year term, varying between 6 to 10 years, depending on the layer. As of March 31, 2020, the company had $800 million of excess of loss reinsurance cover with a well-diversified panel of over 20 different reinsurers participating across the program with the minimum rating of A-. The program is structured to provide aggregate cover on a paid claims basis and continues to drive efficient economic capital credit. With that, I'll hand then back to Pauline for the wrap-up.

Thanks, Michael. As pleased as we are with the company's first quarter performance, we have turned our full attention to the rapidly changing operating and economic environment. There's little doubt, that COVID-19 pandemic is an unprecedented challenge for the global economy. The stimulus packages and lender initiatives will help to push on the impact of COVID-19 on Genworth's claims experience in the short term. The level of increased claims we experienced will largely be determined by the pace of the ensuing economic recovery following the home loan repayment deferrals. We are closely watching economic indicators and ensuring we maintain the necessary financial and capital flexibility to manage through this period. Our underlying business and customer value proposition remains fundamentally solid as we look ahead. We're more focused than ever on supporting our customers. We will keep responding with appropriate loss mitigation activities to work in tandem with the various stimulus packages, income support and member initiatives, to ensure that the company is able to support lenders and borrowers at this time of need and over the long term. Genworth entered this period with a strong capital base, leading market position, robust operational processes and an experienced team. The company remains well capitalized with a solid balance sheet, a solvency capital ratio of 1.78x and a net tangible assets $3.28 per share as at March 31, 2020. We have sufficient capital, financial and human resources to manage and grow the business in a wide range of economic outcomes. We'll continue to work together with our lender customers through this period and beyond to support Australian borrowers, helping as many people as possible to realize the dream of home ownership. With that, I'll open up to any questions you may have.

[Operator Instructions] Your first question comes from Simon Fitzgerald from Evans & Partners.

Congratulations Pauline on the role. My first question relates to the write-down. I'm just trying to think about the amortization, that's $11 million per quarter. Should I be thinking about that as a tailwind of $44 million in terms of cost improvement for the full year, next year and starting, obviously, next quarter?

Yes. Thanks, Simon, for your question. In relation to the DAC write-down, assuming that there are no changes to our business outcomes or any deteriorating environment. The write-down of the DAC will give us some amortization benefit into this year. We, of course, still will accrue deferred acquisition costs as we continue to write, sort of, new business or undertake mortgage policy renewals, but that will accrue over time. So it will provide an amortization benefit for the remainder of this year.

Sure. And then also in terms of the LAT test, I'm interested to know a little bit more about the time frames. You talked about a delayed recovery. What does a delayed recovery look like and delayed from what point? So maybe you can sort of just go into a little bit more detail on the time frames there, please?

Yes. Sure. Look, when we conducted our sort of economic scenarios, we conducted them over a 3-year sort of financial year period from 2020 to 2022. So what we -- the delayed recovery refers to more of a sort of an L-shape recovery where we expect to see a deterioration of economy approaching the upper sort of bound range of the forecast that we've got there, particularly whilst the government package might be effective, this is the JobKeeper package, we would expect to see unemployment creeping up to around that sort of 10% range. All it means is that we would expect to see a slower mitigation impact of both the lender, borrower actions for the 6 monthly repayment holidays and also the JobKeeper package having an impact. So when we looked at our sort of different scenarios, the central estimate, when we looked at those economic assumptions I called out in the call, we took a median average of all the economic forecasts. As you'd appreciate, there's a wide range of forecasts and the emerging consensus is not yet there and still a degree of uncertainty. So -- but when you look at sort of particularly the main drivers of our business, which is unemployment and to a lesser extent, house price depreciation, we looked at around about a 9% average unemployment rate over that sort of period, peaking at around 8.2%, but we took a 1% haircut of unemployment to reflect the casuals, which were in the headline rates, which are reflective of our portfolio. So in terms of the LAT efficiency test, we have to undertake this every quarter. So by the time we get to the half year, we'll have some further convergence on the economic assumptions that we'll be able to sort of update the market at that point.

Sure. That makes sense. And look, just 1 more question from me. I think I heard you say that the write-down related mostly to the 2013 and '14 book years. When -- I'd be surprised if any of those book years would actually result in a claim under the assumptions that you had just given the LVRs going into this crisis was 68% and 74%. That's the effective LVR. And they're obviously a long way from the original LVR. So could you just sort of help me with that a little bit?

Yes. Sure. Look, when we looked at the -- when we started accruing the deferred acquisition costs, it included those earlier book years, and we're able to sort of model the alignment of the DAC balance sheet asset according to the book years. So when we look at 2017 onwards, which we've got tighter underwriting standards and more favorable pricing, the DAC deficiency was in a positive sense. So mainly the larger book years of 2015 and 2016, which were the highlight of our mining years were the main impacts on our sort of DAC write-down. So there's not a lot of income from those books and we continue to see those aging.

Your next question comes from Andrew Buncombe from Macquarie.

Just 2 from me, please. The first one is on the earnings curve for premium revenues. With what's changed in the economy recently, should we be assuming that that's going to change again? And any thoughts on that would be great?

Yes. Sure, Andrew. I think what we are seeing is that with the repayment holi -- 6 months' repayment holidays, which aren't treated as delinquent loans and repricing. We are seeing a movement out of our earnings curve. As you'd be aware, we undertake a review our earnings curve annually. So we will be looking that over in a bit more detail towards the half year at this point. But we are experiencing some further extension of earnings curve, not in a material sense at this juncture.

Perfect. And then the other question that I had, I noticed that your probability of adequacy was still 70%. Maybe if you can just remind us on why that differs to APRA's guided 75%, please?

Yes, sure. The 70% profitability equity is an accounting policy treatment. We're able to come up with a -- probably radically different to APRA. APRA stipulates to 75%. The 70% is basically built including a risk-free margin of around 17%, which reflects the uncertainty of the estimation of premium liabilities. So when we look at our sort of noncash write-down, we have to take the right plan in terms of Australian Accounting Standards, which allows us to use a 70% probability of equity. There's some further disclosure in a bit more detail for you in our full year '19 annual report, if you wish to refer to it.

Your next question comes from Andrew Lyons from Goldman Sachs.

And Pauline, congratulations on the role. I just wanted to ask a quick question about the go forward. To the extent that we do see further economic deterioration, can you just help us to understand how this will come through the P&L from the perspective of the potential for further DAC write-downs versus you start to actually see reserve build. Can you just sort of explain how this scenario would play out that one's increasing and the other isn't? Or the other way around, please?

Yes. I'll take that call. Thank you. What we'll say when we look at liability adequacy test, we'll continue to perform that every quarter. Basically, because we were writing off $181.8 million of the deferred asset, any sort of change in economic conditions in relation to estimating our future claims under premium liabilities will have an increase in that LAT efficiency. So whether LAT efficiency is in excess of any deferred acquisition costs we have on our balance sheet. And I referred to on the call that, that will increase over time every month as we write new business, then we're required to raise unexpired risk return. Based on our central estimate, though, we do believe that we will have some minor deficiency, but that will really depend upon how we're sort of seeing our sort of underlying performance of the business. When we look forward, I think in terms of the central estimate, we're quite comfortable with our economic assumptions at this point. And -- particularly around the unemployment rate, which is an indicator of mortgage stress on our business and incurred losses going forward.

And so as far as the extent to which we see loss ratio going up, would that not happen until you're actually seeing delinquencies come through, which given the repayment holidays is unlikely to be the back end of the year. Is that the right way to sort of think about it?

Yes. That's correct. I mean what we are seeing in terms of the 6 monthly repayment holidays that the banks are now offering is that these are going to be treated as delinquencies or reported in arrears for the first 6 months. So what we are seeing is that, that would start to probably emerge as delinquencies probably towards the right end of the 2020 financial year and into 2021. What we have seen, though, in terms of hardship repayment holiday that we're starting to work to with lender customers, is it around sort of nearly 99% of these hardships that we're seeing are performing borrowers that have equity in their loans. And these have been put straight into these repayment holidays by the banks. And most of the -- 92% of these sort of hardships that we're processing on behalf of our lender customers have never been in delinquency. So we're not expecting to see any sort of emergence in the short term.

That's really helpful. So just one final one. How does the DAC write-down today impact the extent to which you'll be reserving and taking potential losses sort of through the back end of the year? Does this provide a bit of a cushion, I guess, that will reduce the need to reserve going forward? Just trying to sort of understand...

So the reserving, we do 2 types of reserving on our case-based reserving and the other factor-based reserving. The reserving process is slightly separate from the DAC write-down. What we -- we are currently well over reserved at over 100% in terms of our reserving, and that's really reflecting more in terms of where we are seeing sort of mortgage in arrears moving forward. So as you've seen in the quarter, we took around $4.7 million of reserving, just reflecting the delay in delinquencies occurred because of delays and litigation and that sort of action. So the reserving process is in reflection somewhat different to DAC write-down.

Your next question comes from Weimin Xie from MX Capital.

Can you tell us what's the house price depreciation assumption for the delayed recovery case?

Sure. On Slide 12 of the pack there in terms of the delayed recovery. What we are looking at in terms of about a 6.4% house price depreciation, peaking at around sort of second quarter 2021. So by the end of the year of December '20, we do expect that, that to be around that 6.4% moving into 2021 and declining as the market returns to around sort of 2.7%. But what we have seen is that whilst we had house price appreciation up until the first quarter of 2020, we do expect to see an emergence of house price depreciation over the ensuing year.

6.4% decline doesn't sound enough -- stressed enough. What's the sensitivity, say, if you have 10% house price depreciation, how much additional deficiency would that be? Just get some sensitivity.

Around about sort of -- look, probably another way of looking at it is about a 1.1% increase in unemployment impacts our losses by around sort of 5%. So that has a sort of a positive correlation. House price depreciation is probably a lesser order impact on -- in terms of our sort of book as we see going forward. So that's probably the one I'd call out for.

And then the second question is, given the lower interest rate and the bond yield, how does that impact your reserving maybe of the pricing going forward?

It doesn't impact our reserving. But in terms of our return on investment portfolio, that has reduced to about 1.7% at the first quarter. Because our mix of our strategic asset allocation is in sort of government bonds, we do expect to see a continuation of low investment returns in this low interest rate environment. But in effect, what we have seen in terms of our strategic asset allocation with credit spreads improving over the April sort of month end, we do expect to see a reversal in equity growth going forward over the next couple of months. So we do expect to see an investment return being at that sort of 1.7% to 1.6% range over the second 6 months.

If your pricing -- because you're looking at pricing, for pricing is about 1.8% for a while now, but the interest rate stepped down. So structurally, shouldn't you change your pricing to reflect the future reality?

Look, we do review our pricing on a regular basis according to the level of risk that we have. So we continually review our strategic asset allocation every month. So -- and do adjust our portfolio in accordance with that level of risk. So by definition pricing is also included within that.

Your next question comes from Siddharth Parameswaran from JPMorgan.

A couple of questions, if I can. Just one -- firstly, just actually following on from Andrew Lyons' question just around how we should think about this flowing through the P&L from here. I'm not sure I fully understood the answer. So I mean, obviously, with the debt write-down, we will see presumably lower expenses going forward over the next couple of years. Just the way that we should think about what this write-down represents, should that basically -- should that lower expense basically offset what you're expecting to come through as losses? So I mean, so basically, is it just a bring forward of losses, and we should basically see a similar level of, I suppose, underwriting margins going forward. Could you just help me understand whether that is the correct interpretation of what we should think going forward?

Yes. So I'll take that question. Thank you. Look, when we look at our sort of underlying cost base, we did call out at the full year that we would have some rise in insurance costs and also acquisition costs in relation to new business that we are writing. Under the sort of COVID environment, what we are looking at as a business is rephasing and also looking at sort of expense savings across the business. And on an underlying basis, we would expect to see our cost income ratio declining over that future period. This is because what we are looking at is realigning some of our strategic program of work to allocate resourcing more to our different parts of our business to support our lender customers and our customer outcomes as a result of hardships. So we do expect to see as a result of that, some extent savings moving forward.

Yes. But -- sorry, but just -- I mean just a question I asked was just about the principle of thinking about what's happening with the LAT write -- sorry, with the DAC write-down. Is that basically meant to represent the losses that are expected to come? So just those 2 factors alone should offset each other. Am I interpreting that correctly or incorrectly?

Yes. That's correct. I mean I think what you're seeing is that we don't have that deferred acquisition expense amortized through our P&L. So that will provide an expense benefit moving forward, which will offset anything around our incurred losses going forward.

Yes. Okay. Okay, fine. Maybe just a question just around -- thoughts around dividends from here. APRA have made some statements around requiring insurers and banks to be cautious about payout ratios going forward. Just -- I mean, how should we think about what this might mean to your business for the next foreseeable couple of years? Because I mean, are we likely to be in a position where we will have an uncertain environment for a couple of times, it would impact your ability to pay dividends over that time?

Sid, thanks for the question. Our Board has not turned their mind to a first half dividend yet. That's something that we'll do following the first half results when we bring those to account in August. You are right. APRA has been making some statements regarding their expectations around financial services companies. And so any dividend that we do declare will be -- require us to be satisfied that we have sufficient capital buffers to see us through a range of economic possible outcomes coming from COVID-19 and will also require APRA approval for a reduction in our capital base, given that our statutory net profit will most likely be negative, of course. So we just need to wait and make those calls at the time based on what we see at the time.

Okay, fair enough. And then if I could ask one more, just on the reinsurance. I think I heard you say that your reinsurance is on a paid-claim basis. Is that right? So just to understand what that means. If these losses -- I mean, so obviously, we're going to enter a potentially protective period where claims will come through. Does that mean that the reinsurers actually have an ability to price forward in terms of -- when you come for renewal, they're expecting more claims, so they can basically charge you corresponding for what they'll be expecting or I actually don't know how long you -- how many years you've bought ahead for it. So maybe if you could just give us some clarity on that.

Yes. Look, the years are around sort of 2 to 3 years. The attachment point where our reinsurers would need to take funds is at $1.375 billion on the first layer. So we've never had a claim under our reinsurance program at this point in time. So we're also, in particular, when we look at our sort of capital basically looking at 1 in 200 APAR event in terms of capital to meet our sort of any future claims, we've never had to rely on our reinsurance program at this point in time.

Okay. And just a final question. So the economic scenario you're putting in on a go-forward basis versus about 1 in 200. I mean, what is this? Is this sort of a 1-in-20-year scenario that you're putting on? Or what...

Sure, sure. Look, I think 1 in 200 event would be unemployment going to the mid-teens and house price depreciation being in around the mid-30%. So this would be regarded as 1=in=100 event, given the recent pandemic was once-in-a-century anyway. It's how you look at it.

There are no further questions at this time. I'll now hand back to Ms. Blight-Johnston for closing remarks.

Thank you, everyone, for joining us this morning. We're very pleased that the business is in a very strong capital position, and we look forward to meeting you all to discuss this over the coming months. Hopefully, we can get back and meet you in person soon. Thanks very much for your time this morning.

Thank you.