Helia Group Limited (HLI) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Helia Group Limited AASB 17 Investor Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Paul O'Sullivan, Head of Investor Relations. Please go ahead.

Hello, and welcome to the AASB 17 Investor Briefing for Helia Group Limited. I am Paul O'Sullivan, Head of Investor Relations. This morning, we will start with the presentation from our CEO, Pauline Blight-Johnston who'll provide a short overview of AASB 17 and a recap of Helia's recent 3Q '22 market update. Our CFO, Michael Cant, will provide a detailed overview of AASB 17 and Pauline will then wrap up with closing comments. After the presentations, we will open up for questions from analysts and investors. Please note that we will not discuss any additional financial information in relation to FY '22 trading as this will be covered as part of Helia's full year 2022 financial results, which is scheduled to be released to the ASX on 24 February 2023. I will now hand over to Pauline.

Thank you, Paul, and good morning, everyone. Before I commence, I'd like to acknowledge the Cammeraygal people of the Eora Nation on this land we're holding our meeting today. I pay my respects to their elders past, present and emerging into all Aboriginal and Torres Straits Islander people here today. By now, you would have all noticed our new company name of branding, which we're very excited to get a separate identity for our business, better reflects our activities and strategy going forward, including our purchase of accelerating financial well-being to home ownership. Helia, inspired by the sun, reflects who we are and how we use our expertise, experience and understanding to show people possibilities to shine alive on solutions and to create brighter outcomes. We believe it represents our strategic intent to the company to build on our uniquely strong foundations to continue to find better ways to help Australians achieve the dream of home ownership. Although our name is new and inspirational, our core strengths and ambitions aren't changing and aren't going to. Our commitment to being a forward-thinking leader that correct value for our customers, people and communities and our shareholders remains unwavering. Now I'm going to turn to Slide 5. And just to give a little bit of overview about the new accounting standards. I think the most important point that we want to get across today, of course, is that whilst the accountants [ don't always like ] saying this, accounting is typically a story that is trying to represent what is going on in the business and trying best to do so, it's not actually the business. So we are looking at a new accounting standard that does do some things differently, but we are not changing our business and nothing about the accounting standard changes the underlying economic cash flow, the fundamentals of our business. Nevertheless, it's very important. And so our aim today is that you understand better how things will look under the new accounting standard and know what to expect. So from 1 January 2023, so the beginning of next year, we are transitioning to AASB 17 insurance contracts, which will replace the existing standard that we use for our accounting, AASB 1023 general insurance contracts. There's going to be changes in financial reporting for Helia. But as I said before, there's no change to the lifetime value of the policy, which is ultimately determined by how much premium we collect and how many claims we pay and that doesn't change. There's no change to lifetime policy cash flows, to the business economics, or to our approach to capital management. We will still make [indiscernible] under the new standard we have under the old. The timing of recognition of that will change. AASB, we will see changes to revenue expense recognition, which does flow through the timing of profit and the magnitude of earnings. Overall, we expect revenue recognition to be a little bit later than one has been under AASB 1023. That means that -- in addition, there are some positives coming through the new accounting standards. And in particular, we expect that the reported financial results will be somewhat less volatile, and our return on equity [ may be ] is likely to be higher under the new standard than has been under AASB 1023. Now that's all a very high-level view of that. Michael is going to take you through all the detail as to how that comes through and why. But before he does, I'm just going to pause for a minute and see a bit of a recap on our 3Q '22 market update. As you know, we have to prepare quarterly information for APRA, which we do publish, and we did publish a couple of weeks ago. We don't have a call on it, but -- so it's worth just having a quick update while we're here. And you can see that over the quarter, we've continued to deliver the strong underlying financial performance that we have been delivering throughout 2022 year-to-date. Very similar trends to what we've seen in the first half of the year. GWP was down again in the third quarter, reflecting lower industry volumes of high loan-to-value ratio lending, but the earned premium continued to benefit from filings of cancellations. And as we stated back then, we do expect NEP to be at the top of our disclosed range of expected outcomes. So on top of that range of between $375 million to $435 million. Over the quarter, claims incurred continued to be very low. And we haven't yet seen a material uptick in delinquencies or claims coming through from the increasing interest rates. And we do expect that full year 2022 net claims incurred will be in a range between negative [ $25 million ] and positive [ $25 million ]. So we're not quite sure whether we're going to have a positive or a negative number yet in our claims line, but it's going to be very close to 0. It may take some time, and we expect it will take a little bit of time for change in the economy to flow through to delinquencies. Of course, we are still expecting claims to increase over time and to normalize at some point in time. Very hard to exactly keep the timing on that, but probably sometime in the latter half of 2023. Once again, investment income has been impacted by rising bond rates. Although in the third quarter, that was not as significant as it was in the first half. And we are starting to also see the benefit coming through of the increased bond rates in our higher running yields in our investment portfolio. And lastly, we were very pleased to reiterate that we continue to deliver on our [indiscernible]extend strategic agenda. And we have recently announced that we've entered a strategic partnership with Household Capital, one of Australia's leading reverse mortgage providers. We're really delighted with this strategic investment. And we entered a strategic partner alongside label in general, who are one of the world's leaders in reverse mortgages. So it's a great 3-way partnership and a good way for us to diversify our offerings into an adjacency when we think there's some real opportunity in the market, and we have some capability to bring alongside of others with some excellent capabilities. We're also pleased to have announced in the last quarter that we have signed the CBA contract renewal. And of course, we've also taken our rebranding to market. So a lot going on in our business, some really good momentum. But today, we need to talk about accounting standards. So I'll pass back to Michael to cover that.

Thank you, Pauline, and welcome to everybody on the call. Thank you very much for joining us today. Helia is well progressed on our preparations for the implementation of the new insurance accounting standard, AASB 17. As a specialist insurer, providing long-term LMI contracts, we expect that the new accounting standard will impact us more than most. Our focus today is to explain the key changes in the insurance accounting standards and in particular, how they will impact Helia. I've structured my presentation into 3 parts. I'll firstly take a look at the balance sheet, then onto the income statement; and finally, the impact on regulatory capital. Slide 8 has an overview of the key changes of AASB 17 in each of these 3 areas. On the balance sheet, the key change is the replacement of the old unearned premium liability with a liability for remaining coverage. The liability for remaining coverage under AASB 17 is a forward-looking view of liabilities based on expected future cash flows and includes an allowance for future profits on existing policies known as the Contractual Service Margin or CSM. On transition to AASB 17, we expect that there will be an increase in opening liabilities. This is largely due to the magnitude of CSM or future profits in the liability. We estimate that this will result in a reduction to net assets on transition of approximately $180 million to $300 million. On the income statement, net earned premium is replaced by what is termed insurance revenue. Insurance revenue under AASB 17 is the portion of premium that is recognized in each period and includes component for the release of CSM. The resulting pattern of revenue recognition under AASB 17 is similar to today. But as Pauline said, it's a little later to what occurs under the current accounting standard. The income statement under AASB 17 also reacts differently to certain key elements of experience. In particular, the impact of cancellations and interest rates will emerge differently resulting in a less volatile P&L. In relation to regulatory capital, APRA is updating their standards to align with the new accounting standards. The new accounting standards do not change the regulatory capital requirements. There are no changes to the PCA requirement or capital base and the PCA coverage ratio is unchanged. However, APRA has proposed a new draft rule relating to net assets and the PCA. This new rule will not impact Helia on transition, but there are certain future scenarios where the draft new rule could be an additional constraint. In aggregate, we do not foresee any changes to our capital requirements on transition to AASB 17 nor any change to our approach to capital management. I'd now like to spend a little bit of time on one of the key concepts in AASB 17 in the contractual service margin. And understanding the mechanics of the CSM is fundamental to interpreting the AASB 17 financial statements. At the outset of a group of contracts, typically, a cohort 1 year of new business, the amount of CSM is determined. The starting CSM for a cohort represents the expected present value of profit over the life of that cohort. Profit is not recognized at the time of writing new business, but rather a portion of the CSM balance is recognized in each period based on the insurance service provider. In any given period, there is a stock of opening CSM on the balance sheet. A portion of this is released to the income statement each year, and at the same time, the stock of CSM on the balance sheet is replenished by new business written. The concept of CSM under AASB 17 is very similar to the life insurance margin on services approach, which recognizes planned profit in line with the services provided. And I suspect some of you on the call today are quite familiar with that standard and its application in life insurance. I'd now like to turn to Slide 10 and take a closer look at the composition of the balance sheet. The chart on Slide 10 shows the key items on the balance sheet under both the current and new accounting standard. The asset side is largely unchanged and specifically investment assets will be the same. Deferred acquisition costs, which are an explicit item under the current accounting standards do still exist under AASB 17, but they are presented as an implicit offset to the liability for remaining coverage rather than a separate asset on the balance sheet. On the liability side, the outstanding claims liability will be very similar to the new liability for incurred claims under AASB 17 with the only material difference being that the liabilities under AASB 17 are now discounted. The biggest change in the balance sheet is the switch from unearned premium liability to a liability for remaining coverage. Slide 11 shows the key changes in the balance sheet diagrammatically. As I've said, the biggest change is the treatment of the liabilities for future periods. And in particular, the shift from unearned premium liability, which is a historic accrual-based concept to a liability based on the present value of future cash flows and future profit margins. The resulting liabilities under AASB 17 are expected to be higher than under the current accounting standard. This is entirely due to the quantum of future profit margins included in the liability. The increase in accounting liabilities under AASB 17 will be partly offset by a higher deferred tax asset, which in essence reflects timing differences in the tax payable. I'll now turn to Slide 12, which looks at the components of the liability for remaining coverage, which includes the expected future cash flows particularly claims and expenses; a risk margin to allow for uncertainty and allowance for future profits. On transition, the quantum of future CSM under AASB 17 will be higher than the embedded future profit that is within the unearned premium liability in the current accounting standard. As I've explained before, this will mean that the liability of the AASB 17 is greater. And accordingly, net assets on transition are expected to be lower. Effectively, a component of past retained profits is being added back into liabilities less the deferred tax asset and will emerge as profit in future periods. This is entirely a timing issue. All that has changed is the timing of revenue and profit recognition. The expected future claims and expenses have not changed. On the next slide, on Chart 13, looks at the breakdown of CSM by cohort of business. This information will now be reported explicitly in our accounts and provide insightful information about the profitability of different cohorts. There are a couple of key takeouts from this slide, which I'd like to draw your attention to. Firstly, as expected, recent years have the largest stock of CSM. Secondly, as we've previously communicated, the book years from 2015 onwards are much more profitable than old cohorts. Cohorts from 2015 to '19 have more future CSM than the level of embedded future profits under AASB 1023. And as I'll explain later, this is due to a slightly later pattern of profit recognition on AASB 17. Finally, the liability for cohorts pre-2014 under AASB 17 is higher than the equivalent unearned premium liability. And this is due to the requirement under AASB 17 for each cohort to have a minimum liability sufficient to cover its expected future claims and expenses. In aggregate, as you can see from the chart, there is a very significant CSM in the liability for remaining coverage, and this will be released into the income statements in future years. I'd now like to turn to lead that focus on the income statement. And on Slide 14, we have a summary of what the income statement will look like under AASB 17 and in comparison versus the current presentation on the AASB 1023. As explained earlier, earned premium is being replaced by a new term insurance revenue. Insurance revenue comprised of an allowance for expected claims incurred, expected expenses, amortization of acquisition costs and with amortization and recognition of CSM. The income statement presents a combined insurance services expense, which comprises the incurred claims and expenses. Claims incurred are expected to be very similar to the current accounting standard. Accordingly, the main difference between the underwriting results and the AASB 17 Insurance Services result will relate to revenue recognition. And I'll elaborate later on some of the specific differences in recognition. Investment income is the same under both accounting standards. AASB 17, however, does have an additional item on the income statement being what is termed the insurance finance expense, which has 2 key elements. The first is an unwinding of the discount rate on the value of insurance liabilities, reflecting the fact that all insurance liabilities are now discounted. And secondly, and importantly, the component of the insurance financing expense reflects the impact of changes in interest rates on the value of insurance liabilities. And this second item is important in ensuring consistency in the valuation of assets and liabilities and accordingly, a degree of matching and less volatility in the profit and loss statement. Now turning to Slide 15, where I'd like to take a closer look at the components of the insurance services result. The release of CSM is expected to be a material component of profit over time. Similarly, in each year, there's expected to be a corresponding release of risk adjustment over time. These 2 items should be relatively stable. The key variability in revenue and profit will come from experience variations, most notably on the claims line. I should also highlight that if future assumptions change and a cohort is expected to be loss-making, then that group will be referred to as onerous and the present value of any shortfall will be immediately recognized in the income statement. Onerous contracts and loss recognition would only be expected to be an infrequent occurrence. Slide 16 depicts the profile of revenue recognition for a cohort of new business, allowing for the expected pattern of cancellations over time. The pattern of revenue recognition under the current accounting standard, AASB 1023 is driven by the earnings curve and is shown in the diagram in purple. The pattern of revenue recognition under AASB 17 is shown in aqua. Overall, the 2 profiles are quite similar. But as you can see, if you look at the chart closely, the profile under AASB 17 is slightly later and in particular, does not have the same peaks in recognition in years 2 to 5. The AASB 17 profile also extends for 15 years compared to 12 years on the current earnings curve. These differences in these revenue profiles largely explain the higher opening liability under AASB 17. In essence, the later recognition of revenue on individual cohorts means that there are more unrecognized profits in the liability for remaining coverage. One aspect of AASB 17 that I've referred to already is the reduced volatility to interest rates. To protect against changes in interest rates, our investment portfolio is closely matched to our liabilities. Under the current accounting standard, assets are marked-to-market, but the liabilities are not dependent on interest rates. And in effect, this causes a degree of artificial volatility in our income statement. This anomaly is addressed under AASB 17 as the value of liabilities is determined using prevailing interest rates and, therefore, valued on a consistent basis to the assets. Accordingly, we expect to see reduced volatility in the income statement arising from interest rate movements. I'd now like to turn to the third key element of the presentation that is on regulatory capital. And Slide 18 contains a representation of the regulatory capital position. Now prescribed capital amount, well PCA is not changing. Similarly, the aggregate capital base, as mentioned by APRA, is not changing. However, this presentational split of the capital base between net assets and what is terms technical surplus will change to reflect the different treatment of accounting net assets. One possible change that APRA are contemplating is the introduction of a new net assets test linked to the PCA. APRA is currently consulting with the industry on this possible change; if introduced, the new rule would not impact Helia on transition. In summary, our regulatory capital requirement is not expected to change as a result of the transition to AASB 17. I appreciate I've covered a lot of ground today, and there's a lot to absorb. To recap, AASB 117 is quite a change from the current insurance accounting standard and the key changes for Helia are as follows: On the balance sheet, we'll have a Liability for Remaining Coverage that includes an allowance for future profits. This Liability for Remaining Coverage is expected to be higher than the unearned premium liability and accordingly, on transition, we expect to see a reduction in net assets in the range of $180 million to $300 million. On the income statement, the timing of revenue recognition is different, slightly later. Incurred claims expense should be very similar to the current accounting standard, the cancellations will impact profits over time rather than in the immediate year. Interest rate changes will also cause less volatility in profit. And on the capital side, while APRA has not yet finalized their capital requirements, we expect to see no change in capital requirements on transition and our PCA ratio will be unchanged. To finish, I'd like to briefly touch on timing. The new accounting standard comes into effect from the first of January 2023. Our financial year 2022 results will be prepared on the existing accounting basis. We do intend to provide a further AASB 17 update to market in the second quarter of 2023, and this will include a pro forma income statement and balance sheet. Our first results -- reported set of results on a new accounting basis will be for the first half of 2023. I trust I've been able to give you a good understanding of the new accounting standard and how it impacts Helia, but I'm sure there will be plenty of questions. With that, I'd now like to hand back to Pauline for some closing comments.

Thank you, Michael, and I have to thank Michael and all of our actuarial and accounting teams for the work they've done try to simplify this. As you can see from all that information that Michael shared, it is quite a change to our accounting and particularly in terms of terminology. And so I think the team is tend to try to make that clear and simplify a whole of complexity, but we are available to answer questions as you work your way through it. As I said at the start of the presentation, AASB 17 changes our financial reporting, it changes the way we tell the story of the business in our accounts, but it doesn't change the business. There is no change to the aggregate profit we will make over the last time of our policies. There's no change to policy cash flows. There's no change to the economics or our approach to capital management. Turning to Slide 21, which summarizes all of this. As we said today, we do expect that the NPAT will be of a similar magnitude going forward, but less volatile than what it was under AASB 17 -- sorry, less volatile under AASB 17 than what it was under AASB 1023. Our operating net assets are expected to be lower than in our AASB 1023 basis as we bring the present value of future profits on to the balance sheet exclusively. As a result, the return on equity is expected to be higher, whilst our weighted average cost of capital remains unchanged. Today, we also want to clearly reaffirm our capital management plans and that these don't change under the new accounting standards, including our sustainable full year ordinary dividend of $0.24 per share with some scope for growth over time. An unchanged Board's targeted PCA ratio of 1.4 to 1.6x and an intention to return surplus capital to within the target range. With that, we will open up to any questions that you may have.

[Operator Instructions] Your first question comes from Andrew Buncombe with Macquarie.

Just 3 from me, please. The first one is on the proposed APRA capital standard changes. Can you give us an update on the expected time line for implementation of those?

Andrew, it's Michael. The APRA has put out exposure draft in essence of the proposed changes. Most of the issues are terminology and linking it. So a bit of a nonevent. As I said, there's 1 more significant change, which is that new reference to the net assets test. I'm not -- I don't think it's 100% clear yet on when APRA would expect that to come in. They have indicated that for regulatory reporting, they will expect all entities to be reporting under the current basis until 30 June next year. So the natural point of making that change, you would expect is from first of July next year, but that hasn't been confirmed by APRA.

Sure. That's fine. And then the second question...

And just a brief. Andrew, I did say it, but in some respects, the date that it comes in -- from our perspective, it's because it's not going to have a difference whether they introduced the first of January, first of July or end of the year, it wouldn't be changing our capital requirements. So to some extent, we are -- well, we will need to report against that potential new case. It won't change our capital requirements.

That makes sense. The second question is just in relation to your definition of onerous contracts. I'm just interested in getting an understanding of what level of detail that's cut out. Is that defined at a bank customer level? Or is it more specific cohort than that?

We're still working through the absolute finalization of that, Andrew, that -- at the very least, it will be done at a policy year basis. So we're certainly not expecting to do it at a customer-by-customer level. But the minimum in the standard is that we need to do for each year.

Got it. And then the final one, obviously, the ROE is going to step up. I'm just interested whether the components of management LTI is going to be restructured so it accounts for these accounting changes for ROE? Is that going to change?

I might jump in to take that one, Andrew. The Board needs to remind you it yet has not done so yet, but the intent would not be to make management hurdles any easier or harder to achieve than the level at which they've been previously set. So we are aware that we will most likely need to make adjustments to make it a consistently -- sort of a consistent degree difficulty threshold.

[Operator Instructions] Your next question comes from Simon Fitzgerald with Jefferies.

Just on Page 16 or Slide 16 to start off with. Just looking at the AASB 1023, just looking at the profile of that, I had in mind previously that, that was a reflection of the claims cycle in terms of when they're most likely to pop up. How should we take that then in terms of the AASB 17, which is a different sort of profile and even stretches out over a longer period of time?

Yes. Thanks, Simon. Again, let me -- the first thing I'd say is, while the profiles are not dissimilar, the concepts underneath that are very different. So the earnings curve required us to set that up with a view to the expected pattern of claim incidents. The revenue profile under AASB 17 has multiple components, and in each component there's guidance in the standard on how you have to recognize. So the expected claims component of revenue is expected to be -- you need to recognize that in line with your expected claim incident. So that part of it is very similar to the earnings curve. But the CSM part of it is required to be recognized in relation to what term the insurance services provide. So it's independent of when you [ have claim ] and it's more related to the provision of service. So conceptually, there are important differences. But what we have tried to do in this chart is to illustrate that while conceptually they are different, the resulting pattern is not miles apart, albeit a little bit later. And perhaps the main reason why the curve goes out beyond year 12 related to that need to [Technical Difficulty] CSM in relation to the insurance service providers. And while we expect to see very few claims back far out, The reality is we are still providing an insurance [Technical Difficulty] that has been there for some profit and recognition needs to be held back for that period.

Sure. I guess the revenue profile then becomes a little less sensitive to a delay in claims or pushing out of claims in that sense, given you're saying that there's more components than just that sort of claims profile to think about with the revenue.

That's an interpretation.

Yes. The second question, just on the liabilities in terms of how they will be revalued with changes in interest rates. What benchmark will you be looking at, sorry, if you mentioned that before I missed it. In terms of what interest rate?

The standard, without going into too much detail into standard, effectively talks about [Technical Difficulty] and duration of that will be a function of the duration of the liabilities. So that's affected as a risk concept that as that moves, that's what will drive the revaluation of liabilities.

Yes. And then just with the cancellations in terms of how now they're going to be spread out across a number of years. Will it be spread out like how long a period will that be taken through?

Yes. So maybe I just might get back a little bit and explain how it exactly works. So cancellations are fundamentally economically good in our -- for our business. So we come off risk. We've taken a single premium. So the economic benefit of a cancellation isn't changing. But what's changing is the way we recognize it. So today, if the cancellation happens, we release any unearned premium overnight. And effective will be bringing forward all the future revenue to the year that the cancellation happens. The way the dynamic happens under AASB 17 is effectively the benefit of the cancellation gets pushed into the CSM and effectively respread over the life in line with the pattern of CSM.

Yes. The other thing probably just worth noting on cancellations is the -- they also have a beneficial impact on the capital requirement. Again, it's one of the things that's driven our strong capital outcomes this year is the high cancellations and that won't be any different under the new accounting standard because the regulatory capital is not changing. We'll get the same capital credit from cancellations.

There are no further questions at this time. I'll now hand back to Pauline for closing remarks.

Thank you very much. Thank you, everyone, for dialing in today at relatively short notice, and thank you in advance for [Technical Difficulty] you're going to spend wrapping our minds around the changes to our accounts. As we hope that we've shared the message today that AASB 17 does make changes to the recognition, measurement, presentation and disclosure of our financial results, the fundamentals of the business remain unchanged. We do expect less volatile financial results and higher returns under AASB 17, and we'll continue to provide further updates as we transit into the new standard over the course of 2023. Very importantly, the standard does not -- change in the accounting standards do not change our strong capital position and the fact that we are very well placed to navigate the changing economic landscape. And again, we look forward to providing an update on how 2022 panned out for us in our financial and strategic progress when we report our results in February. Until then, thank you all for your support. And we'll speak to you soon. Thank you. I'll hand back to the moderator now to end the call.