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

Good morning and thanks for joining us at IAG's results presentation for the year ending 30th of June 2021. We're joining you today from Cammeraygal and Worimi Land. And I want to pay my respects to their elders past, present and emerging. I'm joined today by our Chief Financial Officer, Michelle McPherson. Michelle and I are delivering this presentation from our homes, supported by our IAG team also at their homes, recognizing the COVID-19 restrictions that are currently in place across Australia. I'm going to start with some high-level comments on the numbers that we shared with you at the end of July. I'll then hand over to Michelle, who's going to talk through the financials in a bit more detail, including our capital position and dividends. And I'll come back at the end and just cover guidance for FY '22 and a bit more detail on our strategy being delivered over the next couple of years. I'll just start by making some high-level comments. As I outlined with the preliminary results released in July, we have been encouraged by the sound underlying financial performance that IAG has delivered during the year. I'm pleased to share we're paying a final dividend of $0.13 per share, given the level of cash earnings that we have generated over the 12-month period. And despite this performance, though, the company has delivered a loss driven by a number of disappointing unusual items. As these relate to historical issues that we've identified, we have provisioned for and we're rectifying. In this regard, we've made significant investment to lift our risk and operational capabilities to help reduce the risk of these types of issues occurring again. I'm confident that the organizational changes that we have made will drive improved performance from IAG, setting ourselves up for success over the next 3 to 5 years. So just a snapshot of the numbers that we have delivered. We grew our premiums by just under 4% over the last 12 months. This was a pleasing result, maintaining the momentum that we shared with you at the half. We've also delivered a resilient underlying margin performance, which was a bit lower than the first half when we did benefit from lower motor vehicle claims frequency relating to the lockdowns. We've made no changes to business interruption provision that we established last November, and Michelle will give you a bit more color on that. And our capital position is strong and which will be further assisted with the sale of our Malaysian business. And finally, we have reintroduced guidance given our confidence in how our business is performing. We've made significant progress on our new operating model, and we're pleased to be reporting 2 different segments for our Australian business. I'll just focus on some of these divisional highlights. Our direct business in Australia continues to operate strongly. We grew rate and volume in our direct business. We delivered healthy underlying margins that were stable at just under 20% in both the first and the second halves, excluding COVID-19 adjustments. We've previously indicated that our intermediated business has been reporting unacceptable returns. While margins still remain low here, we are moving this business in the right direction with an underlying margin of around 4% recorded across both halves, helped by high rate increases that are starting to flow through that business. And finally, we also held our normalized margins at healthy levels in our New Zealand business. The lower second half underlying margins of around 14%, really have been driven by some slightly higher costs and some elevated large loss experience that we saw. I'll now hand you over to Michelle, who's going to provide a bit more detail on the financials.

Thanks, Nick. Good morning, everyone. I'll start with a few key callouts from the headline numbers you can see on this slide, most of which were shared with you when we released our preliminary results in July. As Nick has outlined, we're encouraged by the resilient underlying insurance profitability and premium growth that we delivered in FY '21. We also reported an almost $500 million positive swing in the investment income line, driven by the equity market recovery we saw during the year. The $427 million net loss after tax included the impact of our business interruption provision that we recognized in the first half. It also reflected additional provisions in the second half and the impairment loss we recorded on the upcoming sale of our Malaysian business. In line with our usual practice, we have excluded these unusual items from cash earnings, which was $747 million for the year. Gross written premium momentum remained relatively strong with growth of 3.8% across the year. Most of the growth was rate driven, with some pockets of volume growth. A few highlights I'd like to call out. In Direct Insurance Australia, we lifted premium rates at mid-single-digit levels and experienced some volume growth in motor and CTP, partially offset by volume losses in home. Our intermediated business continued to achieve solid rate increases, averaging 8% across the year as a consequence of deliberate actions we've been taking across certain portfolios, and this did constrain our premium growth. Our New Zealand business delivered low single-digit rate increases and 2.8% overall GWP growth in local currency terms. So our underlying margin performance. For the full year, this was reported at 14.7%, lower than 16% in FY '20. The first half included a net COVID-19 benefit of $60 million to $70 million, mainly due to lower motor claims frequency, as Nick touched on earlier, whereas there is no net benefit in FY '20. Also, as we shared this time last year, IAG no longer assumes a 1% release from reserves in calculating the underlying margin. The COVID-19 difference, the change in our normalized reserve release assumption and lower interest rates explains most of the full year change in margin. Looking at the half-on-half change, the underlying margin reduced from 15.9% to 13.5%. If I exclude the first half COVID-19 benefit I referred to, the first half adjusted underlying margin was around 14.2%. There was negligible net impact from COVID-19 in the second half. The reduction to 13.5% reflects some additional expenses in Australia and New Zealand, which are not expected to recur. We did see elevated large losses in New Zealand in the second half and changes in reinsurance costs also had an impact. I'll unpack each of these areas of our underlying result on the coming slides to make sure I'm providing a clear picture and remove any uncertainty in respect of the adjustments I've called out. Moving to underlying claims. We recorded an underlying claims ratio of 53.7% in the current year, similar to 54.1% in the previous year. This ratio excludes all peril costs and prior year reserving changes and focuses on our working claims. As reflected in the graph on this slide, we thought it would be helpful to back out the COVID-19 influences half by half to highlight the trends in more detail. As you can see, these underlying loss ratios have been stable with small improvements in recent halves. This reflects both positive and negative influences which we provide more detail on in our investor report that we've released today. The earn through impact of higher rates has been a key driver on the positive side, particularly short-tail commercial products, with some of the largest rate increases have occurred in recent periods. We expect this to continue into FY '22. I understand many of you will be interested in our expense trends. This slide highlights the change in our gross expenses excluding the impact of levies, commissions and quota share effects. FY '21 gross underwriting expenses were 5.6% higher than FY '20. As I highlighted in our first half '21 presentation in February, this increase includes higher compliance and governance costs and corporate insurance costs. In addition to these impacts, we incurred some one-off additional expenses of approximately $30 million on a prequota share basis in the second half associated with implementing our new operating model across the group and property consolidation costs in New Zealand. I've expressed the $30 million on a prequota share basis to align with the gross expenses in the table on this slide. If I exclude the one-off costs, second half gross underwriting expenses were relatively flat compared to the first half. Nick will talk further on about our strategy, which will enable improved outcomes over -- in this area over time as we drive efficiencies through our cost base. We saw further reserve strengthening of $66 million in the second half, taking our full year reserve strengthening to $81 million, which is up from reserve strengthening of $48 million in FY '20. This outcome reflects more adverse claims development across a number of long-tail classes that we've observed in recent years. The main impact has been felt in our commercial liability classes in our intermediated business in Australia, which as you know, is a key area of focus for us. We have been experiencing higher average claim sizes in recent accident years, driven by superimposed inflation for medium-sized bodily injury claims, as claims frequency has improved. We've also called out professional risks and workers' compensation, where we have also had to address reserve adequacy in both halves. We believe these trends reflect mixed economic conditions, enhancing customer and their legal advisers' focus on personal injury compensation. We are watching the developments closely to keep ahead of this challenge. I'll touch briefly on peril costs and reinsurance. We've finished the year with natural peril costs of $742 million, a touch below the attachment point at which our FY '21 perils stop-loss cover would have kicked in. This was in line with the update we provided on 16 June, how disappointing to be above our perils allowance again. As we look into FY '22, our aggregate cover has now transitioned to a financial year basis and is broadly similar to previous years. We have added over $100 million to our natural perils allowance for FY '22 to arrive at $765 million for FY '22. This has increased significantly from $658 million in FY '21, which benefited from additional reinsurance cover provided by the 2020 aggregate cover program. Our pricing has been anticipating this and has continued to reflect this step change in FY '22. In materially stepping up our perils allowance, we have made the decision not to purchase a peril stop-loss cover for FY '22 on the basis that it was uneconomic and we have improved confidence in our allowance. I thought it'd be helpful for me to take some time to walk through detail on the $200 million in pretax charges that are included in our net corporate expense line in the second half. As we shared in July, there were no changes to the overall business interruption provision in the second half. To give you some more color on this. We undertook extensive scenario testing of the provision in second half '21, taking into account the stronger economic rebound and consideration of a number of short-duration lockdowns. We also ran scenarios for the current Greater Sydney and surrounds lockdown, assuming it's -- runs for 8 weeks from the 26th of June, and we also included Victoria in that scenario. We concluded that we are comfortable with the adequacy of our BI provision under most scenarios, especially given the substantial risk margin established when we set the provision in November 2020. As the outcome of the second test case becomes clearer in coming months, we'll, of course, revisit this view. On the other provisions that impacted in the second half, the customer refunds provision has been updated to reflect the latest position of our view of the refund programs and administration costs over the life of the program. This has resulted in an additional charge of around $160 million in the second half and includes a significant allowance for uncertainty, now at $100 million of the overall provision. To arrive at this provision, there has been a comprehensive review across our products and policies to ensure we identify any issues and make it right for our customers. We've now finalized the identification phase of the review and are well advanced with our refund program, which we expect to complete over the next 12 to 24 months. We've also previously flagged a payroll compliance review similar to many large Australian corporates and have recognized a pretax charge of $51 million for prior period remediation payments and related program costs. Another area I know you want to understand is the potential claims that could arise from our previous ownership of BCC Trade Credit. As communicated in early March, we have no net insurance exposure to trade credit policies. This position has not changed. When you have the chance to review our financial statements in detail, you will see a $437 million gross provision for claims in our accounts, offset by an identical amount of reinsurance recoveries. Our financial statements and investor report provide more detail on this topic, and we can discuss further in Q&A today, if that would be helpful. To capital. Our capital position remains strong. The CET1 ratio reduced to 1.06x before dividends compared to 1.19x at the end of December, mainly due to the payment of the interim dividend. We're also calling out on this slide the increase in risk charges driven by a range of factors, including higher investment assets, increased claims reserves and a slightly higher insurance concentration risk charge. When we finalize the proposed sale of our Malaysian business that we announced in July, our capital position will improve by around $150 million, and our CET1 ratio will increase by around 6 points. For my final slide, I'll take you through the approach followed in determining our $0.13 per share final dividend that the Board declared today. IAG's normal approach is to identify unusual, nonrecurring items, record these in net corporate expense and exclude the items when calculating cash earnings. A consistent approach has been followed this year. The dividends in FY '21 represent a payout ratio of 66% of cash earnings, close to the midpoint of the 60% to 80% payout range that we target. I'll now hand you back to Nick. Thank you.

Thanks, Michelle. I want to share how we're strengthening the fundamentals of our core insurance business to build a stronger and a more resilient IAG. Six months ago, we said that we would hold ourselves to our account on the 4 strategic pillars that you'll see on the slide, and we'll share progress with you every 6 months on what we've done. Our redesign operating model to create 3 core insurance businesses is in place. Each division is aligned to the insurance needs of specific customers and the way those customers want to engage with us. Intermediated in Australia has clear accountabilities and I've ensured appropriate executive focus on this business. I want the fundamental insurance capabilities here to be stronger so that it can continue to support our important partners and our brokers. This business has underperformed in recent years. and we have prioritized this as a significant opportunity under our new structure. I'm also excited about the new team that we have in place at IAG. We have 3 high-quality external appointments that have joined us. Michelle as our Chief Financial Officer; Jarrod Hill, who starts in a couple of weeks as our Group Executive in charge of our Australian intermediated business; and then more recently, we announced Tim Plant, who's joining us as Chief Insurance and Strategy Officer. Tim's role is a new one at IAG, and he will use his deep insurance experience gained in senior roles that he's had in a number of other large insurers to improve our overall underwriting discipline across the entire company. Michelle, Jarrod and Tim, of course, complement the existing executive team and will play a major role in delivering a stronger and a more resilient IAG. Our 4 strategy pillars have provided a clear road map for us and I'd like to share some of the progress that we have made. It's been a pleasing year for customer growth, with some tangible milestones achieved. We've had 75,000 new customers across our Australia and New Zealand business in our direct businesses. This represents just over 1% growth in our customer base for our direct businesses. The highlight here has been the online rollout of NRMA Insurance across Western Australia, South Australia and Northern Territory alongside our new customer loyalty program, which has been piloted as part of that rollout. I've already highlighted the significance of changes to our intermediated business as part of our efforts to build out better businesses. Pricing capability initiatives will continue to support our portfolio management efforts in the intermediated business going through into FY '22. Our progress on digital initiatives and efforts into the future are underpinned by the creation of a single core insurance platform, which we're rolling out across IAG. After completing Stage 1, we now have a single claims platform that can be used across the entire organization. Stage 2, which is underway now, will consolidate and simplify multiple policy and administration systems that we have in place. When we complete this work, we'll be able to provide consistent products and services to customers wherever they are, whatever -- on whatever digital platform they choose to engage with us. Uplifts in our risk infrastructure also give me confidence. We've implemented a $100 million program of work to fundamentally improve the risk practices across IAG. After 18 months, this program, which internally we call Project rQ, is near complete, and as it is, can considerably strengthen the control environment of our company. Embedding rQ will continue to be a big focus in the year ahead. And as you can see, we've established good early momentum on the implementation of our strategy. Given our confidence in the underlying performance that we've outlined today, we've reintroduced guidance for FY '22. This will include the following key metrics: low single-digit premium growth expected in FY '22 and our reported insurance margin in the range of 13.5% to 15.5%. We have provided on this slide a road map on the underlying assumptions on -- around that margin improvement. We expect an improved underlying performance in FY '22, underpinned by the changes that we've already taken. We are targeting rate increases that will continue to flow through both in our personal and commercial lines portfolios. And we'll also be leveraging the efficiencies and greater focus that will flow through from our redesigned operating model that we've announced and already have in place. So in closing, just a few comments. This slide summarizes our value proposition to our shareholders. It outlines the financial outcomes of the strategy I've discussed today and how we'll be delivering against those 4 pillars. Creating a stronger, more resilient IAG will deliver our targeted cash ROE of 12% to 13% and an insurance margin of 15% to 17% and growth over the next 3 to 5 years. This goal encompasses organic customer growth that at least matches the market across our direct businesses. It also includes an insurance profit of at least $250 million to be delivered by our Australian intermediated business. And it includes delivering further simplification and efficiencies in the cost structure of our company as well as strong risk infrastructure. This is the type of return profile that you should expect from us. We look forward to sharing more about this in an Investor Day that we've planned for 11th of November. Michelle and I are now happy to take any questions that you may have.

[Operator Instructions] Your first question comes from Andrei Stadnik from Morgan Stanley.

I wanted to ask a question, firstly, on GWP growth. In this FY '21 result, looks like IAG [ lacks some call ] by about 2.5 percentage points in terms of cleaner underlying GWP growth. And this feels like historically a record gap. So is there anything behind that? Was IAG distracted about having to handle a business interruption issue? Because that just feels like a very high gap by history.

Andrei, it's -- mate, it's Nick. I mean just -- I mean without sort of lining up the 2 results, I mean, our overall sense would be within our direct personal lines businesses across Australia and New Zealand, we've grown there by over 1% in customer as well as rate has flowed through. What we have seen, though, and you'll see this in the detail within our Australian intermediated business, we have seen customer numbers and volume come back a bit. We've had rate flow through as a positive, but we've seen customer numbers come back. There still have been a little bit of portfolio remuneration that's occurring there. That might explain some of that. But overall, we are -- we feel like we've got the business set up the way we want. And we -- and as you can sort of tell by the -- sort of the outlook comments that we are pretty confident on directionally where our company is going and the growth opportunities that are in front of us.

I wanted to ask another question around cost out. And I think, Nick, when you started as a CEO, in one of your first kind of media statements, you said you want to run a more efficient IAG, and you mentioned a number of different systems. And it looks like your cost out ratio -- sorry, cost ratio is quite a bit higher than some peers. So when can you move on this? Is this something we're going to expect to hear more about on the Investor Day?

Yes. I mean we are -- I mean there's sort of multiple parts to this story, Andrei. So that we are looking at technology simplification across the whole company. And I mentioned that we now have one claim system across IAG, and we have built and launched and using a policy and admin system, we're going down a Guidewire path. And now -- that's now in place. Now we need to migrate multiple systems onto that. That will take the next couple of years. . In addition to that organizational design and one of the objectives of the way we've structured the company going forward is that we're a simpler, more efficient organization and greater clarity of accountabilities, and there will be some efficiency gains that come out of that as well and some of that's even within the guidance, as I indicated for next year. What we'll also do is -- what we want to do is we're building out those plans in more detail, and we're seeing the benefits flow through. We'll provide the market more color on that as things progress. And one of those opportunities, as you've said, will be at the Investor Day in November.

And if I can sneak in one final question, please. The New Zealand Earthquake Commission proposal reformed a quite substantial, at first glance, in -- proposing to increase their cap from $150,000 to $400,000. And that would imply very substantial relocation of premiums away from private sector insurers, such as yourselves. What is the latest on that? And how can you mitigate any potential impacts on the New Zealand business?

Andrei, just to check, there hasn't been any announcement today, has there? Because I haven't seen that. So that's -- so you're just saying what's being discussed as the potential changes to the scheme, is that right?

Correct. Yes. There was a proposal that came out 1.5 years ago, just when COVID hit. So it was a little bit hard to keep a track on it, but it's just a proposal for now. A potential proposal, yes.

Okay. So just making sure that I haven't missed something today. No, the New Zealand government has been reviewing effectively the retention that they have around earthquake. That is still being discussed by understanding within government. So there hasn't been anything announced around that. And we are working with industry, IAG New Zealand, industry in New Zealand are working with the government on that, around the way that scheme is going to work going forward. I suspect it will increase above the current level. I doubt it will go to the level that you described, the $400,000. So I'm thinking somewhere in between is likely. And we'll just work with that as that's announced. It's likely to have some sort of time line as well in relation to the implementation, I would have thought, over the next sort of 12 to 18 months.

Your next question comes from Andrew Buncombe from Macquarie. Please go ahead.

I just had 2, please. The first one is in relation to the new gross provision that you've incurred for BCC and Greensill. Are you able to give us a bit of color as to how much of that provision is IBNR? But also, have you put a claim to the reinsurers yet?

Andrew, it's Michelle. Thanks for that question. So it's all IBNR at this point in time. Sorry, I think there's a small amount that's been played -- paid, but the $437 million is largely IBNR. And we have picked up the equivalent reinsurance recovery associated with that, and you'll see that in the financials. And we've been working with our reinsurers as we work through that process and meet the requirements of all the information. So very comfortable with the recognition on both sides of that equation at this point in time.

Yes, that makes sense. And then just in terms of my second question, it's in relation to the margin targets of 15% to 17%. My understanding previously was that they were targets for FY '23, yet the documents today seems to suggest that they're medium term. Have they been pushed out? Am I interpreting that correctly?

I haven't [ made them ], Andrew. Sorry, Nick. You go.

No. You go, Michelle. You go.

No, no, Andrew, there's been no change. It was over a 3-year time horizon. So the same as what we talked about in February.

I mean, Andrew, I'll just make a comment there. I mean that's the setting -- I mean, we're trying to get there as quickly as possible. And that -- in sort of framing the financial setting of the company, in my view, is sort of an ROE or it's sort of targeting that sort of range that we've indicated, which is -- which it means an insurance margin of about 15% to 17%. That's the sort of setting that I believe we can also be delivering a growth profile as well. And so that -- we're trying to get there as quickly as possible.

Sure. And then maybe just a quick final one, please. Just interested in how the Star versus Chubb court ruling from last week may impact your BI provisions.

I mean it's quite -- I mean -- I think it's quite a technical finding. And so the read through to us is quite modest. And so in our view, we've obviously had the first test case, which has sort of clarified the quarantine Biosecurity topic. Second test case is really what -- was what we need clarity from around how our policies are going to respond. And so the answer in particular to the Chubb, I mean, it's a small positive, but the read through for the type of policies we have and implications for IAG are quite modest.

Your next question comes from Kieren Chidgey from Jarden.

A couple of questions. Just starting around growth. You've been making very strong margins in direct Australia and New Zealand and don't seem to be pushing rate as strong as sort of your largest peer in that market, but still seeing some soft login growth. Just wondering, in your mind, what are the key catalysts to achieve sort of that medium-term target in both those businesses of growing at least in line with market and the margins are sort of already sort of around target [ then also ]?

Yes. Kieren, I mean we're quite close. So that -- our Australian -- our direct businesses were growing in customer numbers by just over 1%. So we're starting to see some genuine organic growth of IAG, which we know in the past, a lot of that growth profile has just been priced. We're trying to get that balance right between just increasing the number of customers that we engage with as well as price. So we're seeing some of that already, things like having a -- being up, having an intermediated offering now across Australia or ex Victoria. It's going to make a little bit of a difference. We're having -- a simplified technology platform will make a difference because it will be easier to put digital platforms on top of that consistently across the way we run our company. And we're just being a bit more active in how we go to market and our brand propositions, our advertising. And sort of the sum of those -- and there's already momentum in our place around this topic around growing -- genuinely growing the company and having more customers next year than the -- than last year. And we're seeing that already, and I want to try and build on that over the next couple of years. So I think the sort of the settings have kind of already starting to be put in place, it's now driving that agenda forward. And we've got evidence of that working already.

All right. And just secondly, on the commercial business, you've flagged margins, underlying margins around -- still around the 4% level. In the second half '21, you're achieving rate rises of around 8% on average. Can you just indicate where you think inflation is in that part of your business? And how long you believe you need to sort of maintain those positive jaws between rates and inflation to get the margin up to that 10% plus level you're required to get the group back into the 15% plus range?

Sure. I mean it's almost -- there's 3 parts to that business. There is the intermediated personal lines business, the Coles, the Steadfast Direct and some other partner personal lines businesses we have. There is the short-tail commercial business, and there is the long-tail commercial business. And there's kind of -- they kind of got some different themes in them. In the personnel lines business, we have had some challenges there around profitability. So there is just rate increases flowing through because of our starting position. We are seeing some -- a little bit of claims inflation in some of the property classes in home, but relatively modest and a little bit in motor. In short-tail commercial, that business is increasingly looking better, I'd say. And low single-digit type inflationary pressure within that business. And then the callout for us is some of those long-tail classes, particularly the liability, where we are seeing inflation, and that's sort of a different issue around -- settlements around damages, injury, where we're seeing a 10% type plus inflationary pressure within that part of the portfolio. So I think in relation to expectations, you'll still -- we'll still see, certainly, significant rate increases across those long-tail classes. Less so on the sort of the commercial and the personal lines portfolio as we're increasingly having those portfolios deliver a reasonable return.

That's great. And one last question, just a quick clarification. The $30 million of nonrecurring sort of corporate and New Zealand costs you've called out, were they -- can you just give us a feeling for the split between the halves. Was that predominantly second half?

It was all in the second half. And it's a combination of costs associated with the implementation of the new operating model that Nick announced on becoming CEO in November last year, together with some property consolidation costs in New Zealand as we're looking at our ways of working as we move forward.

Okay. And the $30 million is prequota share, is that correct?