Insurance Australia Group Limited (IAG) Earnings Call Transcript & Summary

Well, good morning, everybody, and welcome to IAG's results presentation for the 6 months ended the 31st of December 2019. I can tell by the number of people in the room that it's a pretty busy day today. So again, I appreciate those that have joined by webcast and by telephone, but a special thank you to those of you who were able to attend in person. It's always a little easier to talk to people live. It is customary when we have meetings or events at IAG to acknowledge the traditional owners of the land. And today, we're meeting on the land traditionally owned by the Gadigal people of the Eora Nation. More specifically, we're meeting at a place that we now know as Darling Park, but traditionally, it was called Tumbalong, and it was a place where we know that indigenous people have gathered for thousands of years to collect shellfish and share in a sense of community. So in the spirit of reconciliation, I'd like to acknowledge their elders past and present. So this morning, I'll give you a high-level overview of our results as well as a summary of some of the key activities in the last 6 months and those planned for the balance of the financial year. Then Nick will talk, as usual, to the detailed numbers before I return and summarize. And then Nick and I will be happy to take any questions that you may have. So as we released our headline numbers towards the end of January, some of today's news should come as no surprise. However, the new news is, of course, the weather event of the last weekend. And whilst clearly, the bushfires have significantly impacted our first half headline result, the important message that I'd like to emphasize is that our underlying performance has been strong, and it is in line with our expectations that we held at the beginning of the year. The foundations that we've built over the last few years leave us in a strong position to increase our focus on customer engagement and growth without compromising our underwriting and pricing disciplines. And I'll speak shortly to some of the operational changes that we've made recently to further drive this. GWP growth in the half was consistent with our full year guidance of low single-digit growth, taking into account the exit of certain businesses and product lines and lower CTP pricing effects, all of which we highlighted last August. And our underlying margin was well ahead of this time last year and similar to the preceding 6 months. At a country level, we've seen a solid underlying performance here in Australia and another very strong result in New Zealand, although claim costs were impacted by a large hailstorm event. Perils were, again, a big feature of the half and have, as we all know, been very prominent since balance date, particularly here in Australia. Today, we've announced a further downgrade to our reported margin guidance for the full year, lowering it by a further 200 basis points to reflect the heavy rain event, which we expect will be kept at a cost to us of $135 million, and Nick will talk in more detail to this shortly. The large events that we've been dealing with do, however, bring out the best in our organization as, time and again, we respond to the needs of our customers in a compassionate and timely manner. As ever, I want to call out the fantastic passion and commitment of our people who look after our customers through these events, often across key holiday periods, which serves, of course, to reinforce the strength and the quality of our brands. One item that I was less happy to announce at the end of January was the provision we set aside for customer refunds, which, at the post-tax level, amounts to $82 million. This relates to a specific multiyear pricing issue, which we identified, where eligible customers did not always receive the full discounts that they are entitled to. We have now addressed the underlying cause of this particular issue, and we are now focused on identifying affected customers, providing refunds to them as quickly as possible. The issue was picked up as part of a broader review of our pricing systems and processes, which we initiated and which is ongoing. On a more pleasing note, in October, we announced an agreed sale of our interest in SBI General in India. The associated transactions remain on track to complete in the present half, once regulatory and other approvals are in place. And we expect to recognize a significant profit on sale and a large positive regulatory capital effect once concluded. In the last half, we also completed the sale of our Indonesian business, but the agreed sale of Vietnam failed to proceed, and we're now examining alternative exit options. We're in a strong capital position, and have declared an interim dividend of $0.10 per share, which represents nearly 61% of cash earnings for the half. The dividend is franked to 70%, which is identical to the franking on the preceding dividend paid last September. Now looking at some of the key operational activities of the past half, and some of those planned for the balance of the financial year. The devastating bushfires were all too often in the headlines, and aside from meeting the needs of our customers, we were very pleased to be able to help the rural fire service through the use of the NRMA Insurance helicopter. The helicopter is equipped with a fire retardant gel but also participated in more standard water-bombing activities, racking up over 200 hours of service before it even got to Christmas. It goes without saying that one of our top priorities in the second half is supporting our customers to recover from these dreadful fires, not to mention the more recent large events. We've also been busy progressing initiatives in the Smash Repair and new business areas. We have repair hubs up and running in both Australia and New Zealand now, and these are comprehensive motor vehicle repair ventures to improve the consistency and the quality of repairs but also to improve the customer experience through reduced repair time lines at a more efficient process. And of course, they will also reduce the cost of our own claims expenses. There will be further expansion of these in the second half. An associated venture is the recent MotorServe acquisition from NRMA motoring and servicing, offering a one-stop mobility shop for our customers, including a car servicing option. Integration of MotorServe into our offerings will be a priority in the second half. And in the new business space, we've just completed the first 6 months of ownership of a controlling stake in Carbar, the digital car trading platform, which will undergo further expansion in the second half as we cater for growing customer appetite for alternative forms of vehicle ownership and mobility more broadly. With the simplification of our claims systems largely done, the emphasis continues to switch to consolidation of our policy and pricing systems, and the first major release of this program of work is expected in the opening half of FY '21. In our risk management, a new risk target operating model has been introduced across the organization as we progressively raise our risk capability and capacity. You may have also seen some recent refinements to our operating model with the appointment of Julie Batch to head our newly created Strategy & Innovation division, which combines IAG's existing strategy function with some of Customer Labs and an expansion of Neil Morgan's role to lead the Technology & Digital division, which adds all the digital teams to his previous Group Technology responsibilities. These changes were months in the planning, and we see them as a logical step as we transition to the next phase of our strategy with a greater emphasis on future growth from our core insurance business as well as adjacent business opportunities. We plan to outline our longer-term plans and strategy in more detail at an Investor Day here in Sydney on the 14th of May, and we hope that you'll be able to join us then. In the meantime, let me hand over to Nick who's going to run through the numbers in more detail.

Thanks, Pete, and good morning to everyone. I'll start with our scorecard, which, as Pete said, is sort of delivering a strong underlying performance for the group in the 6-month period. So the quick highlights here that we have on this slide are that we've had some modest premium growth but kind of in line with expectations, and the key drivers there have been some of the things that have occurred around CTP pricing as well as some of the business exits. And there's an underlying story that's slightly different, and I'll come back to that. At the margin level, the underlying margin that we've delivered first half '20 is consistent with what we delivered second half '19. But if you go back 12 months, you can see sort of over that period an uplift in that underlying margin, and that's really despite the sort of 70 basis point headwind we have in our results driven by lower interest rates. So we've absorbed that, and sort of from 12 months ago, underlying margins are up. Reported has obviously been impacted by the perils, particularly the bushfires up to 31 December as well as those lower reserve releases that we've already flagged. Shareholders' funds income has turned around from 12 months ago really driven by what's happened in equity markets. And sort of the bottom line of the group compared to 12 months is down, but that's really driven by the fact that in first half '19, we had a $200 million profit from the sale of the Thai business that doesn't occur in this result. In fact, we have an $82 million after-tax provision for customer refunds that Pete mentioned as a negative. So compared to 12 months ago, that's some of the big drivers. What I'm going to do now is sort of unpack some of the numbers that are on this chart and give you a bit more detail on some of them. So starting with top line, as I sort of -- as we said, our premium growth has been modest for the half, and that's sort of in line with our expectations. So what we've delivered on premium is what we thought. If I look at like-for-like is, though, it's around about underlying growth of about 2.5%. That's really the run rate of IAG at the moment, a growth profile of about 2.5%. So within our numbers is a $50 million drag from some of the commercial agency businesses that we have sold that were in our results 12 months ago that are absent in these numbers as well as lower CTP pricing that's affected both -- or sort of New South Wales, ACT and South Australia, so the 3 markets that we operate in has driven lower CTP pricing throughout our portfolio. As a positive, in this story, we do have some currency gains between New Zealand and Aussie that are lifting that -- lifting our number a little bit. So the real story for us is that within our short-tail personal lines businesses, and you see all the detail in the pack, so our motor and home books, we're seeing rate flow through our portfolios in line with claims inflation. Pleasingly, we are seeing a little bit of volume growth within the RACV and the AMI businesses in New Zealand in the motor portfolio, so we see a little bit of volume growth there. Then we've got higher commercial rates flowing through our portfolios in Australia and New Zealand, that's sort of flowing through both. Although in Australia, you'll see that our volumes are down a little bit within our commercial book, wherein New Zealand, we've had both rate and volume growth. So it's a slightly different story there between Australia and New Zealand. CTP, I flagged. In total, our CTP premiums compared to 12 months ago are down 9%. And that's really driven by the changes of the schemes that I mentioned before. We would expect underlying growth in sort of our top line to be similar second half to what we've just delivered first half, so sort of the guidance that we've got in the market we're reconfirming of that low single-digit growth for IAG for FY '20. On the margin side, the story is, if compared to 12 months ago, underlying margins are up. And really, that story is all about the delivery of some of those optimization and simplification benefits are flowing through to our P&L. There is an offset, though, as you're aware of, around increased regulatory and compliance costs that we've -- that's all within these numbers. But then net of those is still a positive that are flowing through to our results. The Australian commercial lines and New Zealand commercial lines businesses have improved in profitability, so that's a positive. Against that, though, is this sort of 70 basis point drag from interest rates. The net of all that is driving that underlying performance up even after absorbing the interest rates. At reported, I think we know the story. Reported margins are driven by 2 big things: around perils for the 6 months, and lower reserve releases are driving the reported outcome for the half. Just in a bit more detail on those 2 topics. On releases -- we probably should have shown some of this in slides in previous halves to sort of understand what's really been happening but -- so the first comment on releases is we definitely had an expectation at August that's different than what we've delivered for the half. We have delivered a reserve release for the half of 0.1% of earned premium. That's lower than we thought we were going to be delivering for this 6-month period. So behind that, it's kind of a few different stories. So within our CTP, ACT, South Australia, in our workers' comp business and in our professional risk business, we've just had a little bit more claims development, some of them individual cases than we expected that are driving a bit of a negative there, some development across some of those portfolios. We're not seeing though -- I just want to say this slowly, we're not seeing signs of sort of superimposed inflation. So this is not a systemic problem we're seeing across our long-tail portfolios. We think -- we see this as some isolated examples in those portfolios where we're seeing a bit of development. Against that, as a positive, we are seeing reserve releases continue to flow out of our New South Wales CTP scheme. The net of all of that story is this small number of 0.1%. And -- but if you look at the quantum -- and of course, that reserve release out of CTP and New South Wales has come down as that scheme has changed. I mean what we really want to show you was what's really happening with our outstanding claims reserves over a 5-year period. If you sort of go back 5 years, we had roughly $9 billion of outstanding claims reserves sitting on our balance sheet. If you look at that number today, that number is closer to $5 billion. If you look within that, our long-tail classes have come down by 55%. CTP outstanding claims reserves on our balance sheet are down 60% compared to 5 years ago. So I think we know the story there, but sort of unpacking it is impact of quota shares are really -- have really had a material impact on the amount of liabilities that we have on the balance sheet. The fact that we have had large reserve releases in the past has just put that quantum down, so they're just not sitting there anymore. And of course, the changes of these schemes, where average premium is coming down, the risk profile is coming down, that ends up flowing down to the reserves flowing -- getting smaller, and the duration has come back as well. So the duration is less than it used to be 5 years ago. The combination of all of that has driven our balance sheet numbers to come down significantly. And of course, then the quantum of our reserve releases are also coming back. That's kind of the real story that's happening in IAG. What we're guiding you to for the second half is reserve releases of sort of 1%. So the maths of that is pretty modest for first half; 1%, second. So for the full year guidance, we're guiding you to 0.5% reserve releases for FY '20. But also, what we're also saying is that over the medium term, we're -- you should still assume around about 1% of earned premium being in the form of reserve release as part of our ongoing results. On perils -- and I thought I'd divide this into 2, sort of what's in the numbers at 31 December, just so we're all clear, and then what we're saying about guidance to June '20 because they're kind of -- there's been a lot happening in the last 5 weeks. So just on the numbers that are booked for 31 December, and we're about $100 million over our perils assumptions for the half. You see that number in the pack, it's $419 million, it's about $100 million over our expectations for the half. Within that, there's about $180 million net cost that we've had through to 31 December from the bushfires. That's the major contributor to our perils cost for the half. And what that peril has done is trigger -- or did trigger our calendar 2019 aggregate protection. So that's kind of the 31 December. With the events that we then had post-December, we've then revised our perils assumption for the full year up to $850 million. So we significantly increased that from our original assumption in August, which was $641 million. So we're going $641 million. We're in interim step, as you're aware, end of January. Now we're saying today, we're assuming $850 million. I'll just go through the elements of that so we can sort of see where we're at. So we're at $419 million at December. In the month of January, we had perils, we had significant bushfires, although much of that was protected from our calendar 2019 aggregate protection program. So not even in the '20 program, in the '19 program, we covered much of the bushfires in January. And then we had a significant hail event that went into our main catastrophe program. So our net cost of that was $169 million. So our position at 31 January was that our net perils cost to our company is $645 million at the end of January. We then had a significant event over the weekend, which then goes into our second event coverage under our main cat. So it's sort of 5 weeks into the calendar year, we're into our second event on our calendar cat program. And that drop-down, of which we flagged, goes from $169 million from first event to $135 million. So our main program comes in then. So our net cost of the weekends and, in fact, it's still ongoing, weather event will be $135 million. And we believe, with the claims that are coming in, we'll be above that. And so that's our net cost. So we then had to estimate based upon all that information, considering we're 2 catastrophes in, in the first 5 weeks, what does that mean for our guidance to June '20? We've come up with a number of $850 million. Essentially, what we've done there is, say, let's look at the run rate, normally in February through to June, let's grow it -- adjust that for changes of exposure and the normal things we do. We have some additional protection as well from $101 million peril stop-loss, and we've assumed that we'll get some recoveries under that, which gets us to a net number of $850 million, it's in our assumptions for guidance for June '20. We're also saying, as you'll see in the packs, that the way our program works, we dropped down. So $169 million, first event hail; $135 million, second event weekend weather whether sort of New South Wales. The position as of today is a cost about -- the maximum cost of an event from today is net $50 million. It's the maximum P&L charge that can go through our accounts. You can see the way we've structured our program. It drops down -- the more events we have, the more -- the lower that number gets. Of course, this is not an exact science. But what we have done is come up with what we believe is a reasonable assumption for full year's perils position for IAG. On reinsurance, just generally, I mean we've announced this in early January, we have renewed the program conceptually in a similar structure to what we've had in calendar '19. You'll be aware that we have lifted the top of that from $9 billion to $10 billion, really driven by change -- a growth of our exposures as well as taking some additional coverage for sort of modeling risk. And what we can say is we're well served by this program, and we continue to be in a strong place in relation to reinsurance going forward. Just on expenses, and this is a good story for IAG, and it's been a real focus of our company over the last couple of years. You're aware we set a targeted reduction of $250 million of the cost base of running our company. And you can see in this slide, which we've shown you before, that that $250 million is being delivered through the P&L now. So it's in our P&L run rate for the 6 months ending December 31. Against that, and we've flagged this before, that we couldn't absorb all the additional regulatory and compliance costs. So that's a negative against that $250 million. But you can see the way we set up the slide that the $250 million, the original objective we have delivered through the P&L. And we're very pleased with that, right? This has been a main focus of attention at IAG. What we've been trying to do is simplify our business, optimize our processes, make it a simpler place to work in, importantly, make it a simpler place for our customers to interact with. One of the outcomes has been the cost reduction that we can see flowing through to the P&L. So we're sort of bringing to an end that optimization program, and we kind of can see that flowing through. Of course, it goes without saying we'll continue to look for efficiencies in how we run our company. At the same time, though, we'll be looking for opportunities to invest where we see opportunities to build out further products and services. And that's sort of what we do as the leadership team of the company. Just looking at the divisions, and I just sort of gave comment on some of this already. Firstly, starting with Australia, if you look at the headline number, it's flat premium for the period. Behind that is sort of a couple of different stories around that: exit of some commercial agencies, which was a drag on the commercial business; we've also got that CTP pricing flowing through all the Australia businesses. Underlying or like-for-like growth is more like 2%. It's pretty good. Within personal lines and within the short-tail personal lines, the Australian motor and home portfolios, it's more like 3% to 4%, predominantly price that's flowing through those businesses matching any sort of claims inflation, so there's a good outcome there. Within commercial, we're seeing right flow-through sort of 5% to 6%, but we're seeing something offset against that in volume. So the net number is very modest, so we definitely are seeing some volume losses as those prices have been flowing through. Underlying margin compared to 12 months ago is up. And really, the benefits of those optimization program -- the net benefits of optimization, regulatory and compliance, interest rates, is a net positive that's flowing through to that business as well as we're just seeing an uplift in underlying commercial profitability within the Australian business. We expect a similar story at an underlying level for Australia in the second half. With New Zealand, our New Zealand business continues to deliver strong results. At a growth level, we grew our business in New Zealand by around 4%. There's some currency, so you'll see when we convert it to Australia, it's closer to 6%, but in New Zealand currency, it's roughly 4%. The commercial New Zealand business grew by about 8%, a combination of volume and price flowing through our New Zealand commercial book. Within the consumer, it was more modest. As I mentioned before, we had a bit of volume growth within the AMI business, but also within New Zealand, there's been some changes to the way the EQC scheme works, a bit of risk transfer back to the scheme, so there's some de-risking of our premiums, and therefore, they've come down a little bit. That flowed through to our business and the entire market so that there's a bit of drag within the consumer premium line. Underlying profitability that we've delivered in the first half '20, similar to the run rate of New Zealand last half. And really, there's a couple of different stories there. It's also delivering the cost -- the benefits of the simplification program are flowing through the P&L. We also flagged this last year, New Zealand had a good run, had low perils but just generally had a benign claims environment. We see the run rate of claims, underlying claims, in first half '20 more sort of normal. And so sort of that underlying claims performance is there. The headline claims number in New Zealand has been impacted by a fairly large hail event that occurred in Canterbury in first half '20. So you'll see that at the reported line. With New Zealand, similar to Australia, we expect the New Zealand underlying performance to be sort of -- second half '20 to be similar to what we've just delivered first half '20. So that -- we're going well there, underlying performance is strong. Something similar -- we would expect something similar to second half '20. Fee income has got a bit of a change, so it is flagged to, say, with what's in this line. There's a small -- in the net number there, you can see there's a small loss of $2 million that's flowed through to the P&L. There's kind of 2 stories. That's the Victorian workers' comp fee-based business that had a result of around $8 million profit. Against that, we had losses of around about $10 million from some of these newer businesses that we're building out that we flagged in August. There's a range of those. For example, we have Ambiata, our data analytics business; Carbar, is what Pete mentioned, we're building out a car subscription service and a car trading platform business, some losses that were occurring there; we're building another business called Safer Journeys. And what we're going to do is step through this in a bit more detail with you at our sort of Analyst Day in early May. We're also flagging, though, that we do expect this number to be up -- a loss of up to $50 million for the full year. So we're going to continue to invest in this business and accelerate those that we think makes sense. And we'll provide you a lot more color on exactly what that is and how we're building out products and services for our customers at the May Investor Day. Just on capital, I mean the group's capital position continues to remain strong. What we've done on this slide is just a reconciliation of where we were at 30th of June and where we're at, at 31 December. I mean the big drivers here are how much money we made, earnings, less the dividends we paid. As always, there's a few other ups and downs within here. Just pointing out a few. We had excess -- sort of the excess tech provisions, there's been a bit of drag on that because we have had to include the impact of the perils events of January and February, which we haven't booked in our accounting P&L but were booked in our capital accounts. We kind of have to bring forth that bad news into our capital to a degree. We've got a new accounting standard around leases, where everything is grossed up on the balance sheet. There's sort of a negative bit of drag on the capital from that, and there's a couple of other smaller things that have flowed through. There's a tiny positive in there from the sort of the last of the quota shares flowing through to the capital account. You can see -- we point you to common equity Tier 1 as the key capital ratio that we want you to look at in relation to IAG. You can see, even after the $0.10 dividend, that was sort of towards the top end of our targeted common equity Tier 1 capital ratio. And then Pete flagged India. We do expect to settle on India in the second half of this financial year, so between now and 30th of June. The capital impact of that will be -- there will be another 400 -- approximately $400 million of additional common equity Tier 1 capital generated once those proceeds are received. That is a 16 basis point positive impact on our ratio. And it -- I would highlight again, it remains our intent at IAG to operate our businesses within those targeted capital ratios. And if we are surplus to those ratios over the medium term, our intention is to return that to shareholders. So in conclusion, sort of wrapping up, we really see this as a strong underlying performance of our business. We're super pleased with the simplification program, the focus that has occurred at IAG and the way we have delivered against what we set up to deliver, so we're very proud of that at IAG. We should expect -- or you should expect a similar underlying performance of IAG second half to what we've just delivered for the first half. Of course, our reported has been impacted by both the perils we had up to 31 December but also, over the last 5 weeks, the significant perils that we've had across Australia that are impacting our reported margins for this current financial year. So on that note, I'll hand you back to Pete.

So thanks, Nick. Before closing up, I'd just like to comment on broader climate and customer equity matters. On climate, we're very pleased to see that the national dialogue has changed. It's, in fact, elevated in recent months, even if it has taken the awful bushfire events to prompt this. IAG has had a long commitment to addressing climate-related issues through the activities of the Australian Business Roundtable for Disaster Resilience & Safer Communities, which we founded in 2012, and even well before that as we started to look closely what was then seen as an emerging risk in the early 2000s. Today, we released the latest 6-monthly update against our 3-year climate action plan, and there has been some important progress in the last half. We launched the Severe Weather in a Changing Climate report coauthored by our natural perils team, which, using the latest data on the state of the climate, makes predictions on future extreme weather events. A key aim of the report is to establish a central source of scientific information which can be built on. It does show that our climate is changing more rapidly than some predicted, and it highlights our firm view that we need a national coordinated approach from government, from businesses, from industry to build more resilient communities and reduce the impact of disasters. We've also seen good progress against our emission targets. We're on track to deliver a 20% reduction by the end of FY '20. And there has been a continued shift in our equity investment portfolio to companies that have a lower exposure to climate-related risks or that have a forward-looking strategy to manage those risks. As at the 31st of December 2019, high-risk companies now represent only 0.08% of our total investment portfolio or less than $10 million. We also continue to roll out our customer equity framework, improving awareness and understanding of customer needs across our organization. This includes being able to respond to the needs of customers experiencing vulnerability as well as understanding how to better design products and services so we can be even more sure they deliver what is intended and what is needed. Our commitment to act fairly with care and compassion must apply to all our customers, regardless of their age, gender identity, mental and physical abilities, culture, language, financial or social situation. And we test this commitment through our work with our Ethics Committee and our Consumer Advisory Board. We see our focus on these areas, climate change and customer equity, as hallmarks of an organization that thinks deeply about its relevance and its sustainability. So in summary, we've had a strong underlying performance in the opening half of FY '20, which matches the expectations that we had at the beginning of the year. Our FY '20 guidance has been revised solely for perils and prior period reserve release factors. This leaves us in a strong position to implement the next era of our strategy, and we look forward to sharing that with you on the 14th of May here in Sydney. So with that, Nick and I will be very happy to take any questions that you might have. And I think we'll start here in the room. Andrew?

Andrew Buncombe, Macquarie Securities. Three questions, if I can, please. And the first one is on the dividends. The dividend in the first half was at the bottom end of the payout ratio range. Can you just give us a bit of color as to why that is and maybe, more importantly, how we should be thinking about the second half dividend against that range?

Yes. I mean it's -- we think about this as an annual number, not -- when we look at the interim. So really, I mean sort of that -- we've got a policy of paying out between 60% to 80%. We'll deliver on that again. I don't think you should overthink the half payout ratio as such. We also -- we've tried to generally sort of look at full year earnings, we had to revise down full year earnings, and then for the interim to sort of be somewhere between 40% to 50% as sort of a rule of thumb about how we've approached it, not so much just on the actual half payout ratio for the first half. We definitely will rebalance for the full year. There'll be 60% to 80% of the cash earnings on a 12-month basis. That's kind of how we've looked at it.

Okay. Excellent. The second question is around the topic of reinsurance reinstatements. Can you just give us a bit of an idea of what sort of scenario you would need to see before you'd be essentially forced to buy a reinstatement? And how far away are you from it?

Yes. I mean it depends on -- I mean -- so at the moment, let's divide this into 2, where with these events that we've had so far this calendar year, the hail event and the weekend weather here in New South Wales and then Sydney in particular, they're not causing us to go and reinstate because they're kind of -- they're big, but then they're at the bottom end of the program. I mean we would need another significant event for us to then have to go back and look at whether or not we need to reinstate anything. So at the moment, let me just say that clearly, there's no drag in the June '20 -- I think that's the point, there's no drag in the June '20 financials from some sort of reinstatement. That's the point at the moment. And let's hope it stays that way.

Yes. No, excellent. And then the last question was on the cost-out. I appreciate that the slides show that you're getting to $250 million. As I reconcile that back to the expense page, I think it's on Page 14 of the investor report, when you net off the gross commissions against the gross underwriting expenses, there's no improvement there against PCP. So is it fair to assume it's going through a -- or claims? Or how do I reconcile those 2 sheets?

Yes, it's a process here, obviously. So we have the cost. When we sort of simplify them, we see our cost base of running IAG at 2.5, there's 2 things that are happening. Some of those are allocated to, as you said, between claims handling, and some of those allocated to underwriting. Of course, within those numbers also, we have an allocation of the regulatory and compliance costs that are also being -- because we're putting everything above the line here into the margins. We're not differentiating that concept. So everything is in the underlying margin. And so it's really the way we've attributed that, there's probably a greater bias in the claims handling to some of those benefits that are flowing through. But we've tried to, both on the slide that we presented today and also within the pack, sort of unpack that and sort of help everyone through, so you can see where those benefits are.

Brett?

Just staying on the -- Brett Le Mesurier, Shaw and Partners. Just staying on the capital issue. I noticed the way you've described the DRP. You've said that the shares are likely to be bought back rather than will be bought back. Why is there the uncertainty about that?

I think we -- I think that's more common wording, Brett. Don't overanalyze that point. I think our intention is to neutralize. That's been the form of IAG for the last -- since I've been the CFO, that we've always neutralize any dividends are not issued any new script, and that's our intention.

Just maybe on the claims inflation. What are you seeing in home insurance for the rate of claims inflation?

I mean to date, relatively modest, low single digit. I mean there's going to be a little bit of pressure in the system. When we were talking today, if you sort of add up across Australia and New Zealand, we've had 80,000 new claims in a hurry come our way by the time we look at sort of hail events in New Zealand, hail in Australia, other property damage, bushfire from Australia. That's probably going to put a bit of pressure in the system in both the motor and the home repair networks. We're not seeing that come through yet, but that's got to be a -- that's something that we need to be thinking about as we manage this over the next 6 months. But sort of answering directly, low single-digit types -- 2%-, 3%-, 4%-type inflation.

So have you allowed for an increase in that in the second half when you're talking about similar underlying performance?

Yes, I don't think it will -- I don't -- yes, it's probably more. The way that would really flow through, I think that would -- if there was a risk, it's probably more like first half '21 of that sort of the cumulative impact of all those. We're not seeing that. I'm just highlighting that it's a potential risk that us and the industry has in Australia and wanted to be thinking about that also in terms of pricing.

Just maybe on the commercial insurance. You consistently have substantial rate increases, but your premiums don't grow. Now I recognize that you sold a business that is why premiums went backwards. But nevertheless, you consistently don't have growth in premiums while you're increasing premium rates. Are you concerned about anti-selection which could be occurring?

I mean we worry about that point, and we also sort of can't shrink to greatness as we continue to lose volume. And so -- and we've said this a few times that we are shrinking, if I may say it this way, less. We feel like we have a more stable portfolio today than we did 12 months ago or 24 months ago, sort of answering the question. We don't believe that we are being selected against in this process. And what we do believe is we're creating a platform for growth from the sort of rebalance book, and we feel like we're almost there is kind of the...

Can I add maybe, Brett, to that? I think we saw a little bit of increased competitor activity around packaged SME in the half. And again, we're not going to give up our sort of underwriting or pricing disciplines just to hold shares. So in the volume loss here in Australia, there was a reasonable proportion that related to packaged SME. But there's also been, as we all know, just an enormous amount of pressure in the agri sector, rural communities that are doing it very tough. And that's been the other portfolio where we've seen some not insignificant shrinkage.

The rate increases aren't resulting in higher profits, are they?

They're probably -- they're higher margins. But of course, we're losing business. So in dollar terms, maybe it's roughly neutral. In margin terms, it's up. But because we're shrinking volume at the same time, we would like to think that over time, we'll start growing the dollar earnings from our commercial portfolio as we've rebalanced it. That's our intent.

If we don't have another question in the room, I can see that we have 3 questions on the phone. So we might go to our first caller. Thanks. Kate?

[Operator Instructions] Your first phone question comes from Shreyas Patel with UBS Investment Bank.

It's actually Kieren Chidgey here. Just a couple of questions. The commercial portfolio continues to see remediation from a volume point of view, putting aside the agency exit, how long do you envisage that sort of will continue from here? I thought sort of that had largely been completed by the end of '19?

I mean -- Kieren, it's Nick. I mean we believe -- and this is not an exact science. We believe that, that portfolio is pretty stable now, and we're going to be disciplined here around price. We believe that we now have a platform that is a lot more stable than it was 12 or 24 months ago, and we believe now there's opportunities to potentially even grow it a little bit where those opportunities exist. But we're cautious on this, we don't want to end up sort of growing into businesses and sort of coming back in margin again. So we've been very disciplined with how we've gone about this, and we sort of feel like we've reshaped our book to where we want it to, and I'd say that's kind of now.

All right. And just a second question on underlying margins, just going back to an earlier question, just in your comments, Nick, that sort of the outlook into second half, fairly flat in both Australia and New Zealand. Obviously, you've got expense efficiencies feeding through and some rate increases still coming through. So what are the offsets to that? Earlier, you said sort of you're kind of cautious of inflationary trends post recent events that you don't see that really potentially hitting until first half '21. What else is sort of in there that's offsetting some of the tailwinds that should be assisting?

Yes. I mean, I don't think there's any sort of any big thing that we're sitting around that's different, worrying about second half versus first half. We're cautious about that comment around any sort of inflation, post of an inflation impacting our businesses in Australia or New Zealand. We're managing a cost profile, and in particular, sort of regulatory and compliance cost profile, that feels like it's going one way. So we're managing that. And there's certainly some strain that we're looking at on that topic. Against that, there's some positives flowing through, continuing development, continuing to deliver the simplification benefits. Pricing has been flowing through the book, and we would expect that to continue. Remember, so most of our pricing, I will say, that's flowed through, and particularly across all of our short-tail book, is really in line with inflation. I don't sort of see margin expansion from pricing that's occurred in the first half in the second half from personal lines. I really see pricing that's flowing through our book in Australia and New Zealand probably matching inflation and sort of that being relatively similar second half to first half. Does that -- Kieren, am I answering that question?

Yes, yes. No, that's fine. And then a final question, just as we look forward into '21, and obviously, it's early days, but you had a small sort of miss on your cat budget in '19, obviously, a bigger miss this year. Is it shaping up in all likelihood that we'll see a bigger increase to the cat budget as we head into '21? Or will you sort of look through this year as a more unusual year?

I mean I think we'll do both. We won't overreact to what seems like an unusually high period of perils. At the same time, I think that we will need to look again at the way our perils assumptions are flowing through to our pricing of our business. So I think it will be both. Do I feel like -- if I think on what's been happening the last couple of years, we've been up -- lifting up our perils assumptions by about at sort of gross $50 million per year. Do I feel like the number -- that assumption is likely to be more than $50 million in '21? Yes. Are we going to try to reflect all of this bad run we're having in the community for our customers and financially for our company? Unlikely. So it'll be somewhere in between, it'd be -- will be my thinking at this point.

Your next question comes from Matt Dunger with Bank of America.

If I could go to the catastrophes, the $135 million impact from recent activity, that's about 180 basis points. You talked to the increased frequency back on the 24th of January. Did you not factor some deterioration in back then?

I mean -- it's Nick, again. I mean what we've really done, we had a revised allowance of $715 million end of January. We had -- I mean we said at the time, if we have events over $100 million, we'll have to go back and look at that. We literally had an event over $100 million within 2 weeks or less. And so we've adjusted for that by the full amount, $135 million. So really, we've gone $715 million plus $135 million, which is the net cost of the weekend, calling it $850 million. Just on the other point of the fact -- the maths of that, 180 basis points, not 200, we're simply rounding. So don't -- there's nothing more to that story other than we've just rounded to 200 basis points versus 180 when we changed guidance. There's no -- there's nothing else to that story other than that.

Okay. And how are you managing the higher cost of claims handling around both from a regulatory impact and also from a catastrophes impact?

Well, from a regulatory perspective, that's just built into the guidance that we've already given. We have some of that covered off through the provisions that we've made for, what we call, RT, which is our risk transformation program. Some of the increased claims handling costs as a consequence of these catastrophe events is actually covered under our reinsurance program.

Great. And one last question, if I could just ask. On the customer refunds, which you raised in January, you noted you reported them to ASIC in September 2019. Why did it come so -- why did it take so long for this to come to light? And also, does this provision draw a line in the sand on remediation?

So Matt, it's Peter. It's quite a complex process for us to go back and unpick all of our sort of rating algorithms. We discovered this, reported it to ASIC and have been working diligently ever since to try and sort of identify affected customers and to quantify the refunds that we're going to make to them. The review is still ongoing. And so at this stage, we have nothing further to add beyond the matter that we've already drawn your attention.

Your next question comes from Nigel Pittaway with Citigroup.