Medibank Private Limited (MPL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Medibank Private Limited HY '22 Results Investor and Analyst Teleconference. [Operator Instructions] I would now like to hand the conference over to David Koczkar, Chief Executive Officer. Please go ahead.

Good morning, and welcome to the Medibank 2022 Half Year Financial Results Presentation. I'll begin by acknowledging the traditional owners and custodians of country throughout Australia and their connections to land, sea and community. I join you today from Melbourne, the home of the Wurundjeri people of the Kulin Nation. I pay my respects to elders past, present and emerging, and I extend my respect to all Elders on the lands on which we work and live. Today, I'm joined by our executive leadership team, including our Group Executive CFO, Group strategy, Mark Rogers. I am pleased to share with you the performance of Medibank over the first half. Today, we have delivered a strong result showing that our focus on our customers and our strategy to grow as a health company is working. Attitudes to private health insurance continued to positively shift resulting in continued policyholder growth across both the Medibank and ahm brands. And we've also seen double-digit growth in Medibank Health. Today, I will take you through the key highlights of the results, including progress on our strategy and our vision. I'll also share our plans to expand in health and while we are reshaping our health services business under the new name of Amplar Health. After this, I will hand over to Mark for the financials, provide an update on our outlook, and we will then take your questions. Starting on Slide 4. Our customers remain at the heart of everything we do, and this ongoing focus is resonating with them. They trust us more than ever as their partner in health. We continue to achieve high levels of customer efficacy with service NPS up for both Medibank and ahm. Customer advocacy for the Medibank brand has never been stronger, and we are now clearly leading the sector. More customers are choosing to use our digital channels, and we have continued to engage with them proactively to ensure they are on the best cover to meet their needs. We're focused on value including delivering our lowest average premium increase in 21 years, the largest customer's financial support in our history through COVID and increased out-of-pocket savings for our customers through our market-leading Members' Choice Advantage Network. And the health offerings are resonating too. More customers are engaging with our Live Better and preventative health programs. Our health concierge is supporting more people through their hospital journey and we've expanded our work with governments to support critical community health responses to COVID and more. Moving to Slide 5. Our business has again demonstrated its resilience to the impacts of COVID with solid growth in both our health insurance and Medibank Health businesses. I'll speak to this briefly, and Mark will provide greater detail shortly. Our focus on our customers has helped us grow policyholders by 3.3% over the last 12 months or 28,100 policies over the 6-month period and a further 4,500 policies in January, in what has been a very competitive market. Much of our growth continues to be driven by attracting younger people and those who are new to private health insurance. Pleasingly, we are also now seeing sustained momentum in the Medibank brand with 6 consecutive quarters of growth, the first time in almost 9 years. Our dual brand strategy has set us up well to respond to these changing market dynamics. And while industry growth has somewhat slowed compared to FY '21 as we expected, the market remains buoyant. This momentum alongside ongoing discipline in where we invest for growth and how we run our business helped drive a 10.3% increase in health insurance operating profit. COVID had a modest cost impact on our health insurance business of $2.9 million in the half, with our customer support package largely offset by permanent claims savings. Strong demand for our telehealth and health and well-being offering largely offset the impact of closed borders on our travel insurance business, supporting an increase in Medibank Health segment profit, which was up 36.7% to $25.7 million. And at the group level, net profit after tax was down 2.7% to $220.2 million, reflecting a decrease in net investment income compared to the first half last year. And finally, the Board has determined we will pay a fully franked interim dividend of $0.061 per share. On to Slide 6. From the beginning of the pandemic, we've been there for our customers, our people and our community. As COVID restrictions continue to impact our customers' ability to access some of their hospital or extra services, in December, we announced the next stage of our giveback program, returning around $135 million to customers by deferring their premium increases for 5 months from April 2022. And today, we've announced we will extend the deferral by an additional month now to October 1, 2022, bringing this giveback amount to around $163 million. We've always committed to return all permanent net claim savings due to COVID. Our total support now stands at around $463 million, and we will continue to assess these savings and return them to our customers. While we are pleased to be able to support our customers throughout the pandemic now is the right time for governments to minimize future use of restrictions to elective surgery. These restrictions for surgeries have impacted the quality of life for our customers and increase the pressure in the health system. And while some surgeries may be call elective for our customers, they are anything but. The recent easing restrictions on some surgeries is welcome, but we believe the plan is needed to avoid these restrictions to patients in the future. This work needs to include the reintroduction of international health care workers to address Australian hospitals caused by the workforce shortage and burnout hospital and health care workers. Through the ups and downs of the last 6 months, we continue to prioritize our people's health and well-being. Our new way of working is helping people stay connected and be there for each other. We've also supported our team with a range of targeted mental health and well-being programs as well as their health concierge for COVID support. Our people remain strongly engaged and through supported in their health and well-being. We're also playing a bigger role in caring for people in the community impacted by COVID. Through our joint venture with Calvary, we provided COVID support to more than 130,000 people in the community. We also continue to provide free community health and well-being activities. And in August, met our goal of getting 1.5 million people active, 10 months ahead of schedule. Now to emerging customer trends on Slide 7. As COVID continues to influence our lives, the way that people in Australia think about health continues to change. Health care is now the single biggest issue of concern ahead of the economy or cost of living. The longer-term health consequences of the pandemic are now emerging including the impact of missed health screenings and diagnostic scans, the catch-up that will be needed after restrictions and the increasing demand for mental health support, which is why we are supporting our customers in both prevention and new care models. As telehealth, virtual care and home care are embraced, more people are wanting to access health care differently and in a way that best suits them. They want the same convenience they are experiencing in other parts of their lives. And at the same time, people are also prioritizing their health and well-being, more than 80% believe that mental health is just as important as physical health. Businesses are also investing in health and well-being programs and the Australian government is focusing more on prevention, too. As attitude towards the value of private health insurance shift significantly, we've seen the strongest industry-wide growth in people under 30 with hospital cover in almost 7 years. Most people view private health insurance as a critical part of the health system, helping reduce pressure on public hospitals. Not surprising perhaps as the elective surgery waiting list in the public system continue to be twice as long as in the private system. COVID has redefined the health sector at the same time as people's expectations are changing. People want a better, more integrated, more personalized health experience. And that's why now is the time to reimagine health. And it's this opportunity that's shaping our strategy, which I'll now talk to in detail on the following slide, Slide 8. Our strategy to grow as a health company is working. Ultimately, this is about prioritizing our efforts to more broadly support the health of our customers while growing our business and driving broader health system change. We continue to prioritize our efforts to support the needs of our customers and people and deliver leading personalized and connected experiences, supporting by our digital platforms and analytics. To make a more positive impact on the communities we are part of, we've also embedded our sustainability approach into our purpose and strategy. To strengthen and grow our core insurance business, we will further differentiate our offerings by delivering more value, more choice and more control to our customers. This will see us continuing to develop innovative products and services to meet all customer needs and by utilizing our unique dual brands and market-leading provider networks. And finally, to expand in health, we will pursue opportunities in targeted high-growth markets. This will build on our strong foundations to grow in areas such as preventative health and our integrated care solutions across virtual health, primary in community care and short-stay settings. We are clear on what these markets are and how we will invest within them. We are also clear on who we will partner with and we will continue to remain disciplined in our expansion in health. Our focus over the medium term will be to expand and connect our investments in health for our customers, continue to bring benefit back to our core PHI business and help transform the system. I'll now talk in more detail about each focus area, beginning with Slide 9. We are committed to delivering leading experiences for both our customers and our people, ones that are built on deeper relationships, a greater understanding of people's needs and a focus on their health and well-being, and this focus is resonating with our customers and our people. Our customers are increasingly choosing to engage with our products and services through digital channels and we're enhancing their experience to be more intuitive, seamless and personalized to meet their needs. Our My Medibank app is playing a greater role in supporting our customers' health and our recent platform investments are paying off with our leading analytics capability driving a 50% increase in the number of AI-enabled customer interactions in the last 6 months. As a result, our customer advocacy milestone is in great shape and is well above our benchmark for the half. For the full year, this milestone remains the same. Our purpose-driven and inclusive culture, progressive way of working and our focus on health and well-being is part of our DNA. Ensuring our people feel empowered has seen a greater collaboration between teams, resulting in better delivery for customers, with greater speed and agility, with employees being more engaged. While there is a lot of competition in the health care and technology sectors right now, our own experience is that our culture and our health and well-being proposition resonates strongly. We are pleased to report that we are on track with our FY '22 employee efficacy milestone measured by employee NPS. At the half, we are above our target. We are collaborating with our communities to make a difference, and it is our purpose and vision that tie into our approach to sustainability. This focus on ESG is simply fundamental to our strategy and what we do. Moving to Slide 10. At our core, our role is to provide our PHI customers with access to the best products and service in the market. To do this, we have to continue to offer customers real choice and greater value. This focus is driving the growth we are seeing in our core business. Our 2 brands are continuing to attract more customers, especially younger people and those new to PHI, with around 70% of our new customers being people under 40. We're retaining more customers with more adding hospital covered to their extras and less downgrading or dropping cover. And we're leading the way with products and services that offer more of what they want like our new range of flexible extras products for both brands. We've seen strong growth in the corporate market, which we expect to continue. And in the last half, we also retained all existing university accounts and won all competitive university tenders that we participated in. This positions us strongly for growth in our overseas business as more international students return to Australia. Giving customers more value, our leading Members' Choice Advantage network has delivered around $17 million in out-of-pocket savings for almost 600,000 customers in the first half. And with more hospitals and specialists coming onboard over the last 6 months, around half our customers now live within 25 kilometers of a short-stay site, enabling us to almost double to take up by our customers of our new no-gap surgical offering for total joint replacements. We're also rewarding our customers for looking after their health and well-being to a Live Better program and meeting a wider range of their needs through our travel, pet, life, car and home insurance products. This helps us to also deepen our relationship with customers, and we continue to see a significant improvement in retention rates for these customers. And to better support customers to navigate the health system, over the past 6 months, our Health Concierge team supported around 24% of Medibank customers who were admitted to hospital. We have also continued to give our customers the choice to receive their care at home, to the range of programs that make up Medibank at home. Our market share and health insurance productivity milestones remain the same, while our policyholder growth milestone has been updated. Now aiming to achieve between 3.1% and 3.3% policyholder in FY '22, including continued growth in the Medibank brand, which assumes no material change in market growth. Meanwhile, we are on track to deliver $15 million of productivity savings in FY '22. Now on Slide 11. We're expanding our health capabilities as we increasingly play a bigger role in the health and well-being of Australia. We see significant opportunity for our company to grow by helping our customers be both be better and get better. And it's our ability to do both that sets us apart from others in health. This is why we have continued to invest where we can drive innovation in health, and we can -- where we can give customers greater access, choice and control around their health. We call this Personal Choice Healthcare, which we will deliver by continuing to work closely with businesses and health professionals to help join the dots in the health system for people. And I'm pleased to say that our customers are embracing these new offerings. Our Live Better rewards program is on track to reach around 0.5 million customers by full year and 64,000 customer actions have been rewarded in the last 6 months for COVID vaccination, blood pressure and skin checks. We're now looking to expand Live Better into other high-growth health and well-being markets. We've doubled enrollments in our preventative health programs, a trend we expect to continue as we expand further, digitize our programs and integrate them into our primary care services, including the Myhealth GP network. Our Better Minds hub, an app, also launched in August and has seen more than 60,000 downloads and visits so far. This support for mental health, which offers well-being checks and one-to-one coaching is resonating with customers, particularly given the impacts of COVID. In addition, we will soon pilot a new virtual psychology clinic working with Myhealth as well as Medinet a leading digital platform. The virtual psychology clinic aims to give people a convenient way to access mental health support. And this digital clinic could also have future applications more broadly in allied health. Our investments in short-stay hospitals also took another step forward with our joint venture with a group of doctors for a new surgical hospital in Melbourne gaining development approval. East Sydney Private Hospital is performing well, and we are finalizing investment discussions for the launch of another short-stay hospital. In addition to no-gap procedures, our short-stay investments now cover some no-gap general surgery procedures with more procedures to come. Our aspiration is to invest in a network of short-stay hospitals through partnerships and in collaboration with doctors in major markets across the country. And in support of the public system, through our joint venture with Calvary Health, we expanded the services and footprint for My Home Hospital, which is delivered on behalf of well-being SA. This virtual care call center platform is also what helps us deliver COVID care at home and our remote monitoring technology that is supporting COVID positive patients via our telehealth capabilities in others states. As mentioned, to realize our ambition, our Health Services business is changing. Under the new name Amplar Health, it will increasingly focus on supporting the needs of our core Medibank and ahm customers in health. From there, it will continue to draw on our capabilities to provide services to other providers and payers to support their public and private patients in other markets. We'll share more on Amplar Health later this year. For FY '22, our health and well-being milestone, we are targeting around 480,000 customers engaging with Live Better rewards and activities, our preventive health programs and any new care offerings developed. We are also broadly on track to achieve the Medibank Health milestone by the end of this financial year. I'll now hand over to Mark.

Thanks, David, and good morning. This result demonstrates how increasing policyholder numbers and cost control delivers growth in the health insurance business and the impact strong double-digit growth in Medibank Health has on the group operating profit trajectory. Pleasingly, our businesses have been resilient during the pandemic and with premium increases remaining low, customers continuing to focus on the health and well-being, we expect this to continue. Importantly, the business enters the second half with good momentum, a strong balance sheet and is well positioned for further growth. Before I go into more detail on the operating performance, I'll make a few comments on the Group's profit and loss segment. Group operating profit was up 12.3% to $286.5 million. However, lower investment income resulted in profit before tax falling 2.7% to $313.2 million. On some of the other line items, the reduction in other income and expenses reflects lower property sublease income. However, this was offset by a significant reduction in specified intangible amortization as these balances are now largely fully amortized. The effective tax rate of 29.7% reflects nontaxable income in the investment portfolio, and we expect a similar rate for the full year. And reported EPS was down 2.7% to $0.08 per share. However, underlying EPS, which adjusts for the normalization of investment returns, was up 4.4% to $0.077 per share. On Slide 14, we provide a granular view of private hospital claims paid for the 12 months to November. The trend of surgical claims are recovering more quickly than nonsurgical claims has continued. However, the recovery varies between states and is highly dependent on the extent of lockdowns. Total claims growth outside of Victoria and New South Wales was 4%, with surgical claims growth of 6% partially offset by a 2% contraction in nonsurgical claims. In Victoria and New South Wales, total claims were flat, with surgical claims growing by 3%, offset by 5% lower non-surgical claims. Across all geographies, particular softness in respiratory and rehab specialities continues and as anticipated, psychiatry claims are growing at a higher rate than most other nonsurgical specialties. We've maintained the deferral assumption for surgical and nonsurgical claims at 85% and 50%, respectively and following the most recent lockdowns to deferred claims liability has increased $105 million to $329 million. And COVID had a modest $2.9 million negative impact on financial performance period with the $136.6 million cost of customer support, largely offset by permanent claim savings of $133.7 million. Turning to Slide 15, which covers the health insurance results, which reflects strong resident policyholder growth, a continuing benign claims environment and the benefit of increasing scale and increasingly, it was achieved despite the decline in profitability in the overseas portfolio, which continues to be impacted by the closed borders. Reported Health Insurance gross profit was up $24.6 million or 4.9% to $530 million. Revenue and claims up 3.8% and 3.7%, respectively. Adjusting for COVID impact, which gives a better view of repeatable performance, underlying gross profit was up 6.5% to $532.9 million and underlying operating profit up 13.7% to $283.8 million. A better-than-expected risk equalization outcome this period resulted in reported and underlying gross margin, both increasing 20 basis points. And coupled with the improvement in the management expense ratio reported and underlying operating margin increased 40 and 60 basis points, respectively. Turning to Slide 16. The resident health insurance market remains buoyant and we estimate that over the last 6 months, the industry policyholder numbers grew by approximately 1.3%, with continued strong growth in new to industry and younger cohorts. In the last 4 months, our policyholder numbers increased by almost 62,000 or 3.3%, including 28,000 in the last 6 months. The acquisition rate of 5.6% was in line with the prior period, and although the lapse rate was up 70 basis points to 4.1%. This in part reflects the retention benefit from the premium increase deferral in the prior period. Over the last 12 months, Medibank policyholder growth was approximately 24,000 or 1.7% despite the closure of the recon network at times during the period. The improvement in the Medibank acquisition rate was driven by strong growth in the corporate and digital segments and increasing product value and differentiation continue to support customer retention. ahm continued its strong growth trajectory with policyholders up 8.3% in the last 12 months and more than 60% over the last 5 years. Whilst both the acquisition and retention rates were lower than the prior period, in part, this reflects the capping of aggregator volumes as we buy and sell to direct channels and the retention benefit of the limit rollover in extras in 1H '21. We expect ahm to continue growing strongly in the second half with increasing direct sales of the recently launched choosable extras products and the benefit from additional customer retention activities. Turning to Slide 17. This slide is focused on underlying resident claims, and we provided a reconciliation to reported claims in appendices. Underlying resident claims, which excludes COVID impacts are up 4.1%, and underlying net claims, which includes risk equalization were up 4.2%. Whilst the risk equalization payment was up $3 million, this was impacted by the recent lockdowns in Victoria and New South Wales, and we expect a higher amount will be payable in 2H '22. Underlying resident claims growth for per policy unit was down 70 basis points to 1.9% with underlying hospital and ancillary claims growth down 30 basis points and 130 basis points, respectively. The lower hospital claims growth is a continuation of the trend we saw in 2H '21 and reflects the risk equalization impact I just mentioned and softer growth in medical claims. Following additional investment in product benefits in the prior period, extras claims growth returned to a more normal level. And you can see the impact COVID restrictions had on public hospital claims during the period and physiotherapy claims growth was softer than other modalities and reflected these services were less impacted by COVID during previous periods. Slide 18 details underlying performance split between the resident and overseas portfolios, which shows its strong growth in the resident portfolio was partially offset by a decline in the overseas portfolio. In the resident portfolio, underlying gross margin was up 50 basis points to 14.7%, with improving revenue and lower claims growth per policy unit. Importantly, the downgrading trend continues to improve with stronger Medibank policyholder trajectory, portfolio management initiatives and sales mix are contributing, and this had a positive impact on the revenue per policy unit. For the period, downgrading was 60 basis points, and we expect this to be around 70 basis points for the full year. In the second half, we expect the risk equalization benefit we saw in the first half to unwind, resulting in underlying claims growth for the full year of 2.3%, which is modestly below 2H '21. In the overseas portfolio, the closure of international borders continues to impact performance. And although policy units were down 11.9% in the last 12 months, the rate of decline was markedly slower in the last 6 months. In line with the trend we saw in 2H '21, claims per policy unit was impacted by tenure mix and increased service usage. As a consequence, underlying gross profit was down $9.9 million. However, the Board is starting to reopen and promising early signs of increasing student enrollments, we expect performance to stabilize during the second half before progressively improving over the next 12 to 24 months. Moving to Slide 19. Management expenses were down 0.7% to $249.1 million reflecting ongoing disciplined cost management, the benefit of our productivity agenda and lower noncash costs. The $2.3 million reduction in noncash costs includes lower D&A and with the progressive shifting of ahm sales to direct channels, lower deferred acquisition cost amortization. Operating expenses were essentially flat with cost inflation of approximately 2% and modest volume impacts offset by $7 million of productivity savings from process improvement, an increasing level of customer interactions through digital channels and flexible working. A combination of lower management expenses and increasing revenue resulted in the management expense ratio adjusted for the impact of customer support measures falling 40 basis points to 6.9%. Whilst we will continue to leverage the benefits of scale and target further improvement in the management expense ratio, we remain very focused on balancing these objectives with our growth aspirations. And we are on track to deliver $15 million in productivity savings this year and expect management expenses of approximately $530 million. Turning to Slide 20. During the last 6 months, we continued to see COVID impact on Medibank Health business with closed borders impacting travel insurance sales. However, this was partially offset by strong demand for community-based health care and COVID related services. Segment profit increased by 36.7% to $25.7 million, with operating profit up 21.2% to $23.4 million and a $2.3 million contribution from our health care investments, and that's compared to a loss in the prior period. Pleasingly, this included strong growth in both patient and clinic numbers in the My Health general practice business and improvement in both the East Sydney Private Hospital and My Home Hospital investments. Operating performance reflects 6.9% revenue growth and a 170 basis point improvement in operating margin. The fall in gross margin was partly driven by increased home care labor costs due to constrained availability and mix impacts. But this is more than offset by an improving management expense ratio. During the period, strong growth in telehealth and health and well-being revenue and early signs of recovery in travel insurance but partially offset by a modest reduction in home care revenue as elective surgery restrictions in Victoria and New South Wales impacted demand. A combination of the 2.1% decrease in management expenses to $41.8 million and strong revenue growth resulted in a management expense ratio improving 250 basis points to 26.8%. Although the external environment remains uncertain due to COVID, the business is tracking broadly in line with achieving the FY '22 profit milestone of $47.3 million. And whilst we will stop delivering the 1800RESPECT contract from FY '23, with our immediate growth opportunity for this business around the needs of the Medibank customer, this is not expected to have a significant impact on Medibank Health's growth trajectory. Looking now at our investment portfolio on Slide 21. Whilst equity markets generally remained buoyant over the last 6 months. Investment income of $30.9 million was $40.9 million lower than in the prior period, with the growth and defensive portfolio down $14.8 million and $24.6 million, respectively. In the growth portfolio, the reduction in income reflects that the prior period benefited from the strong recovery in equity markets following the initial favored form and manager outperformance. In the defensive portfolio, the significant reduction in income includes the benefit of tightening credit spreads in the prior period. In this period, lower yields due to significant market liquidity and the steeping of the yield curve impacting our international holdings. Underlying investment income, which adjusts for returns on growth assets relative to our long-term market return expectation of 8% and for credit spread movements, was down $19.1 million to $19.8 million. The underlying investment grows 88 basis points above the RBA cash rate. And whilst this was materially down on the prior period, on an annualized basis, it is in the middle of a targeted range of 150 to 200 basis points above the benchmark. Turning to Slide 22. Our capital business remains strong with the PHI capital ratio of 13% at the top end of our target range and unallocated capital of $195 million. During the period, Health Insurance required capital increased to support revenue growth and the increase in other required capital largely reflects a $63 million investment in My Health. APRA released a draft PHI capital standard in December that will apply from July 1, 2023. Whilst the standard is still in draft form, it is not expected to negatively impact our capital position and importantly, allows for the issuance of Tier 2 debt. The final standard is due to be released in the third quarter of this calendar year. And subject to this, we will provide an update on our capital settings at the 1H '23 result. We continue to expect that this new standard will result in an increasing quality of capital in the industry and be the catalyst for industry consolidation. Importantly, our strong capital position and increasing certainty on the ability to issue Tier 2 debt means we are well placed to fund further inorganic growth as well as consider capital management in the future. Finally, the Board has declared a fully franked interim dividend of $0.061 per share, which is an increase of 5.2%. This is a 79.1% payout of underlying NPAT impact. However, for the full year, we expect the payout to be towards the top end of the 75% to 85% target range. Finally, on to Slide 23 and our key areas of focus further through the remainder of this year. We will continue to leverage the investment made in technology, digitization and analytics to grow our businesses and we'll increasingly look to connect them to deliver synergies and support change in the health care system. In the resident health insurance business, we remain very focused on maintaining top line growth. and we'll look for further opportunities to invest where this makes commercial sense. Key areas of opportunity include increasing our share of the growing corporate market, improving ahm retention and an increasing focus on customer life cycle management. In addition to leveraging and investing in our market-leading hospital contracting and payment integrity capabilities, increasing customer uptake of our preventative health programs and integrated care models are key focus areas. We must also ensure that the next phase of prostheses reform is delivered and savings are not eroded away. In the overseas health insurance business, we are well placed for the reopening of borders having recently established a number of new university partnerships, invested in both our digital and product propositions and uplifted our claims management capabilities. Our productivity agenda, disciplined management of noncash costs and increasing scale will support further improvement in the management expense ratio and provide capacity to invest in growth. And finally, continuing to grow Medibank Health remains a key area of focus, including through inorganic growth opportunities that have arisen during recovering and growing the travel insurance business, and increasingly leveraging our strong balance sheet into further inorganic growth opportunities. I'll now pass back to David, who will make some concluding remarks.

Thanks, Mark. I will now speak to our 2030 vision on Slide 25. The tasks of health system will keep growing as the health needs of our population continue to increase. Our country's health challenges are well known, but the reality is we are moving too slowly. Australia remains one of the slowest adopters of the OECD of the U.K. models and is trailing behind when it comes to new approaches for joint replacements, general surgery, ENT, and other modalities. Access to quality health care is the right of every person in Australia. Our customers not only trust us to help them navigate the health system, they expect us to be there for them beyond simply paying for their care. It's why we are working to give customers more choice, more value and more control of the health. These are the changes our customers want. It is this mandate that will help shape our future. And in doing so, help ensure the sustainability of our health system. As a country, we need to continue to work together to remove unnecessary cost in the system and improve health care value. Alongside other important government reforms needed, prostheses reform remains a key industry priority, given the potential for around $500 million in savings over 4 years that the government has committed to. Savings, which will translate directly to the hip pocket of families through lower premium increases. Reform is important, but it is not the only factor that determines our success. As a company, we will continue to drive the change needed. We are adopting a preventative health mindset with a focus on programs that can help people be better before they require treatment to get better. Personal Choice Healthcare will also play a greater role in the future where customers have greater access, choice and control. This is why we are committed to continuing to invest in and build out integrated care options that are more sustainable and better super needs of our population. This will enable us to grow our business and catalyze the change we all need. To realize this ambition, it's imperative. We continue to work with our partners, with government and health professionals, so we can impact real change across the system. And while no one organization can do this alone before us is the opportunity for Medibank to be a leader of this change. At the heart of our strategy and the vision for the future is a commitment to sustain the quality health outcomes we currently enjoy in this country by helping more people in Australia in their whole journey in health. And this commitment is shared by the incredible team here at Medibank. When we think about our future as a company and the future we want for Australia, we know we have -- we will have been successful when we've delivered the best health and well-being for Australia. Turning to Slide 26 now. Our strategy continues to evolve, but our customers and people remain at the center of everything we do. Right now, health remains the #1 issue that concerns people in Australia, and we will maintain the focus of our response by supporting our customers' changing needs. We will continue to grow our core business through differentiated offerings across our unique 2 brands, and we will further expand in health by our investments in health markets to offer more value, choice and control for people, to support both the private and public systems. Underpinning all of this is our belief that by putting customers at the center of health, we will achieve our vision of the best health and well-being for Australia. On to Slide 27. Turning to our FY '22 outlook. We continue to assess claims activity and any permanent net claim savings due to COVID will be given back to customers through additional support in the future. We are aiming to achieve between 3.1% and 3.3% policyholder growth in FY '22, including continued growth in the Medibank brand, which assumes no material change in market growth. Our underlying average net claims expense per policy unit is forecast to be around 2.3% among resident policyholders. We remain focused on controlling our costs with an FY '22 productivity target of $15 million in health insurance management expenses. And based on this, we expect our FY '22 health insurance management expenses to be around $530 million. And finally, targeted inorganic growth for both Medibank Health and Health Insurance also remain areas of focus. I'd like to thank the opportunity to thank the executives online today and all our colleagues at Medibank for their crucial role in helping deliver these results. Despite all the uncertainties of the past 6 months, they have continued to support each other and deliver even more for our customers and the community. We have great momentum in the business, and that is due to how our people turn up each and every day. I'll now hand over for any questions on the call.

[Operator Instructions] The first question today comes from Matt Dunger from BofA.

I could just pick up, David, on the point you were making around productivity savings. Previously, you talked to $40 million of productivity savings across FY '22 to '24. How is COVID impacting the savings and the ability to continue delivering productivity savings?

Thanks, Matt. Look, we remain very committed to our productivity agenda. I think how we run our business, focusing our customers and remain disciplined is a key part of our strategy. Mark, I may hand you to give a bit more details to that answer.

So I mean part of our productivity agenda is to increase the level of customer interactions through digital channels. As a consequence of COVID and branch networks being closed. I think that adoption and acceptance of digital interactions has actually increased. So that will actually help us achieve that productivity target. What I would say though is compared to 12 months ago, the level of inflationary pressure is slightly higher than what we saw going into COVID. So that's something we're going to need to watch very closely.

And if I could just ask a second question on the Medibank Health operating profit target. You've organically looking to replace the Garrison contract. I think that implied about $47 million of operating profit. Should we assume that, that excludes the investments you've specifically called out here around My Health and East Sydney, which you said, contributed $2.3 million, are they incremental to that target?

Yes, Matt, we spoke at the full year about the impact closed borders we're having on travel insurance. So at the full year, we reaffirmed that we expected to achieve the milestone, but softness in the travel insurance outcome would be offset by the return for health care investments. And that's the way we expect to achieve that milestone still.

The next question comes from Andrew Buncombe from Macquarie.

Maybe just to follow up on one of Matt's ones. What do you think are sustainable long-term MER is for the health insurance business?

I mean, I think that will really depend on what our market share and revenue growth is, Andrew. So I think if you look at us, we're currently running at a MER, it's about 200 or 250 basis points below the rest of the industry. So we've got a message leverage and scale advantage. And to put it in context, if we had a flat cost base, and we grew our revenue at 4.5% to 5% revenue growth, that would give us a 30 to 40 basis point MER improvement in the next 12 months. So it really comes down to where the revenue growth goes from here.

Excellent. My second one is just in relation to Slide 17. So it says in the middle of the table on the left-hand side, average claims expense per policy unit growth of 1.9% but that's lower than the hospital 2.2% and the extras 2.5%. Are there different definitions on those?

No, there's not, Andrew. You've had a slightly higher growth in extras policy units compared to hospital policy unit. So it's a consequence of that shift in mix.

And then just a final one. Now with DCL balances going up across the industry again. How long do you think it will take for the DCL to online?

This is the subject to no further significant hospital restrictions or Code Brown or no labor availability challenges. We're expecting 12 to 24 months at this point, Andrew.

The next question comes from Sean Laaman from Morgan Stanley.

A couple of questions. You've delayed the premium increase by further month, a number of other insurers have put through delays as well, of course. Wondering if there's any update you can share with respect to our potential for prostheses reform?

Yes. So there's a strong commitment by the government see with prostheses reform. We know that doesn't make sense that we're paying between 40% and 100% more than other countries. In fact 45%, in some instances, more on the public system. So the reform program is focusing on realigning that price difference between the private and the public system. The expectation given to us is value being realized of around $140 million over the next year. And we're in the final throes of consultation about how to make that actually happen.

Next question. You've given the underlying claims expense growth guidance of 2.3%. Is there anything you can share in terms of trends in actual claims expense that you've observed so far in the 2H?

It still vary doors for 2H. Sure, and on other than to say that with the co-brands or reinforce across January, we had very soft hospital claims. So we've had sufficient further permanent claim savings to fund the additional one month of premium increase deferral. And in really round numbers, we probably put another $60 million to $70 million on to the balance sheet in January.

Great. Next question. You mentioned the approval that you've now received on queue. Is that on track for still a potential 2023 opening? And then are you able to disclose where I think you mentioned in your prepared remarks that there's another similar queue in development or close to being finalized some agreement that you're able to disclose where that is? And last part to this question, you also mentioned in the prepared remarks that you're looking more at JVs for one of a better term to go this route. So it's going to be more sort of greenfields or brownfields, this opportunity to develop these short-stay models?

Well, I'm going to start with a few comments, and then Andrew Wilson, who runs this area for us might add something station remarks to [ Edney ] Hospital in Melbourne. Here, we've gained approval, and we expect that to be on track. We are close to being able to announce another investment but we don't have any more details to share today. And as we expand our investments in short-stay settings where we see a very large market opportunity, and we'll continue to work with partners, with doctors to make sure that when we do invest, the value is given for our customers through no out-of-pockets and to make sure that there is preserved autonomy between patients and doctors as they offer this new choice. But Andrew, I might hand over you for how you're seeing the market.

I think you're getting too good at asking the question, David. I'm not sure I got to have to be able to add except to say it's -- yes, it's on track or well and good and will be demolishing the existing facility in the not too far distant future. And look, our strategy is partnerships with doctors, and that's been right from the get-go. That's what we've said, and that's what we intend to keep doing. It's critical to in our view, the development of new models of care that doctors are in the driving seat and have complete clinical autonomy as to how they function and how these hospitals develop.

Sure. Andrew, I might add one comment. I think you made a point about brownfields. That's a really important point. And so I think if you look at the U.S. history, there's been a lot of brownfields retooling of what were previously acute hospitals into ambulatory surgical centers. And I suspect that will increasingly be part of the narrative in Australia, and that's something we're actively looking at, not just greenfields, also brownfields.

Awesome. And one last question, if I may. I also mentioned in the slide pack, we are slow adopters here in Australia compared to OECD averages of some of these short-stay models. Should we just be thinking that's due to lack of availability of facilities to have those such short-stay surgeries conducted? Or is there other things we should be thinking about that you're also proactively addressing?

I think if you look at -- depending on the procedure type, you can get a percentage of procedures safely done in short-stay or day procedures, where there be 40%, 50%, even sometimes at 90% of procedures. Now I'll take George, for example, in some countries, it took 25 years to make that transition to maturity. But where they are doing about 40% of joints in a short-stay environment today in Australia, about 1% is done. I think, as Mark alluded to before, that transition both took some time and involve new facilities and also conversion of existing facilities. And I think that's what's playing out in the market, Australia, but it will take some time. And we're working on both direct investments with partners to catalyze that change but also working with existing hospitals to work with them to deliver that short-stay no-gap proposition to our customers, which we've seen almost doubling of uptake over the last year.

The next question comes from Andrew Goodsall from MST Marquee.

Just looking at the composition of the policy growth, could you give us a sense of sort of what's driving that? I guess, in particular, I'm just thinking we've previously seen Australian residents offshore returning home and whether that's a trend that you're still seeing in those numbers?

Well, I might make some opening comments and I'll pass over to Rob Deeming, who looks after our customer brands area. But when we look at the customer sentiment in the market, as I said, before health is the #1 priority right now, more than the economy and cost of living. There's a genuine increase in interest in taking more control over health and well-being and also there's an appreciation of the challenges of the public system. In addition, with our lowest premium increase in 21 years in the industry, all of those factors are making health insurance more affordable. And what we're very pleased about is the quality of the growth that we are achieving. Our brands, very strong advocacy levels. We're seeing strong growth in younger customers. And pleasingly, around 70% of our new growth that customers are under 40. So all those factors give us confidence that the market growth, albeit slightly lower in growth -- absolute growth amounts in last year continues to be buoyant. Rob, I might hand over to you to share a bit of what you're seeing in the market as well. I think Rob may not be on the line. So I think we'll leave it there.

Just to build on a couple of the comments that you made there, David, I think it's very positive to see such strong sentiment in the market, and that's reinforcing interest in private health insurance. We've been particularly pleased with the strength of both the consumer portfolios, but also the corporate portfolio in the first half. And as you say, I think it's particularly encouraging to see the interest of younger consumers and that's reinforced, I think, by our investment in channels that make it easier for younger consumers to work with health insurance, both on the joint side with investments in our digital channels but also in the way that we are reinforcing our service model with an emphasis on self-service messaging and more digital options. And so I think it reinforces the investments we're making for younger consumers but it's particularly pleasing to see the continued interest in health insurance, and that's being reflected in market growth and growth for us.

Terrific. Just perhaps one for Mark. Just with your deferral assumptions, I think, of 50% and 85%, just wondering whether there's been enough normal activity or a period of normal activity where you've been able to validate whether they're the right assumptions? Or is there a chance that ultimately is going to take 12 to 24 months to play out, that some of that might end up being written back?

Look, Andrew, it always remains an option. I would say now we've had non-Victorian, New South Wales out of lockdown for the vast majority of the previous 12 months, we're getting a lot better data to help reinforce those assumptions but nearly 85% driven by fairly detailed and unequivocal clinical advice. But I'd say the one area I am watching closely is not the nonsurgical assumption because we are still running below, while surgical claims have recovered and they're 6% above outside of Victoria and New South Wales, the prior period, nonsurgical claims are still soft. That's probably the nonsurgical assumption that we are looking at more closely than the surgical assumption.

Okay. Great. So far, the experience is sort of about right in terms of sort of, I guess, 15% dropout rate in effect?

Well, there's nothing to disprove that, but it's still very early in the recovery cycle where we've got another 1 to 2 years to go. So we'll continue to monitor. We're getting progressively more and more data, Andrew, and that will help refine and inform any changes to both assumptions. But like I said, it's probably the nonsurgical one we're looking at more closely at the moment.

And final one for me. Just any thoughts with change of government. We've not really had any clarity from the opposition on sort of some of their policies. But I think our working assumption is that they're not going to revert back to the sort of 2% cap type policy for 2 years. I think that's done and dusted, but just interested in your views there.

Yes. Having spoken to both sides of politics, I think both definitely understand the strength that we have in Australia of a strong private and public system. I think the premium increase environment we've had over the last 3 years where we've had 3 years of a rate increase with the 2 in front of it. That's a strong commitment by the industry to remove unnecessary costs and invest in innovation. So I think both sides of the government are expecting to see that and understand the importance of reform to deliver that. that's what we're planning. And that's why we're continuing dollar both sides and helping support them in sustaining health care for the future.

The next question comes from Nigel Pittaway from Citi.

Just first of all, I was hoping to explore a little bit more the guidance of risk equalization payments in second half, just sort of what trends you're seeing to provide that guidance, particularly in light of what you said about soft hospital claims in January?

Yes. So Nigel, it was a tale of 2 quarters in the first half. We saw a very soft contribution in the first half and a lot of the factors that were driving that started to unwind in the second half. So from the Medibank brand perspective, we had a very high recovery rate on Medibank customers. So the age demographic drive higher and nonsustainable recovery rate on the gross deficit. And then in ahm, its contribution was softer just because of the more subdued claims. So on the basis of what we saw in the second quarter, and that the co-brand now will start to unwind, we'd expect to revert to a more normal pattern of risk equalization for the second half. And that's the major factor in our uplift from the 1.9% first half underlying claims growth of 2.3%. But maybe to put it in context, we had a 10 basis point drag on risk equalization and underlying claims this period. We typically see 30 to 40 basis points and that wouldn't be expected to change over a 3- to 6-month period. That would take a lot longer if that change was going to be a sustained feature of our performance.

Okay. So does that -- that basically means you've got to see the older cohorts going back to hospital they're right for that to come through? Is that right or?

No, you actually need to see everyone going back to hospital because it's really about how much ahm makes us a contribution to the pool. So the vast majority of ahm customers don't draw -- don't recover, we don't recover from the risk actualization pool given the age demographic. So as the claims go up across the industry, ahm used to pick up a higher risk equalization charge. And then on Medibank, what we expect will happen is that rather than just the older people going to hospital will get a younger cohort going as well, and that will bring down the gross deficit recovery rate for Medibank.

Okay. Secondly, I just wanted to pick up on what you said on Slide 18 that you're continuing to monitor rehab referral trends for signs of permanent change. I mean and recollection, you were sort of splitting those savings at the moment between COVID and underlying. Is that still going on?

So no, we're not splitting those savings. 100% of any rehab savings are being treated as either going on to the balance sheet or they're part of our permanent claim savings this period. When we factor in the 2.3% underlying claims growth for the full year, we know we're effectively assuming that those rehab referral rates revert back to historic trends. So there's upside on that 2.3% over time if those referral rates don't revert back to historical levels.

Okay. And then maybe just finally, I mean, looking at the other income and expenses, in the second half last year, they went up because you were saying you are sort of involved in a fair number of M&A. Obviously, you flagged the potential for an M&A, and you said you're close to another announcement, but we don't seem to have seen the same pickup in costs in that line. So just wondering whether there's sort of any commentary on that? Is there less activity? Or are they going somewhere else or?

Yes. It's a good question, Nigel. So we had a significant M&A transaction in the prior period, which is the My Health transaction, we had investment bankers and another -- a number of other advisers involved in what was a contested process. So you know as well as that typically doesn't come cheap, whereas most of the hospital transactions we're doing, we're managing through our in-house M&A team at a much lower cost. And we have a precedent model that we've used in both East Sydney and [indiscernible], which we are now rolling out at a lower cost than the quick execution time into new hospitals.

The next question comes from Kieren Chidgey from Jarden.

A couple of questions, if I can. Maybe just starting on downgrading. I think you previously been suggesting somewhere around 100 basis points this year and now so you're flagging 70. With the 6-month premium rate deferral ahead, is it your expectation that you can continue to run below that 100 basis points through the FY '23?

Yes. So Kieren, subject to there being no major financial stock in the community or premium increase is not going up for the FY '23 around. We continue to expect we'd run below that 100 basis points and at or around 70 or 80 basis points in FY '23.

Okay. And then, Mark, maybe just going back to some of your commentary around claims inflation. The 2.3% for full year obviously implies something closer to 2.7% in second half. So what's sort of the better guide as to where you see the run rate of underlying inflation? Are there just some anomalies between the 2 halves around risk equalization that you've talked to, and we should be looking at the 2.3% sort of the best guide to underlying annual inflation? Or is it more a pickup to 2.7% as we enter FY '23?

Yes, you're right, Kieren, the risk equalization is lumpy between the first and second half. So I look across the 12 months is a good guide going into FY '23 rather than looking at the second half exit level.

Okay. All right. And then finally, just a question on the rate deferral. I think you flagged $163 million as a revised number. So the delta between that and what you booked this period, $136 million. I presume you'll just provision that in second half for '22?

Yes, that's correct.

Just on the math around it, Mark, I presume it only applies to high, so the premium base is sort of $7.2 billion, $7.3 billion. So half year saving on a 3.1% increase seems to suggest the saving on the customer side closer to $110 million rather than the $160 million you flagged. What am I missing here?

Kieren, there's a few second level details, which I'll get collect to take you through. But in part, there's some mix shifts and other portfolio management initiatives that impact the realized savings and have been impacted by prepayments and a number of other factors. So -- but we'll take you through that in more detail offline.

The next question comes from Siddharth Parameswaran from JPMorgan.

Okay. Great. Just a few questions, if I can. Firstly, just in terms of how you're judging the levels of profits that you're making in COVID environment. I mean you're committed to giving all the benefits back. And so far, that's how you've been tracking. We're obviously a few years in income I think the original way that was being assessed, which I think was your budget and was it '19 or '20? And what your views on the underlying profitability going to be for the next few years. I was just wondering if you could comment on whether there's any change to that, whether we're nearing the end of those budgets and how you'll be tracking this going forward, given that you still have quite a large provision there of PCLs $327 million that's growing at the moment?

I'll just quickly kick off with some of the points you've raised and hand over to Mark. I mean I think we will absolutely maintain a commitment to profit from COVID returning any net permanent claim savings to customers. I think our recent announcement brings that total to $463 million approximately, and we'll continue to reassess. That's the right thing to do by customers. Our result as a company is driven by looking after our customers and growing and managing our costs. So I think those 2 things are slightly different, and we will absolutely maintain the focus on doing things for the long run.

Yes. So Sid, we have 2 methodologies a top down and bottom up. So effectively, it was our prior to COVID expectation, and then we're adjusting that for identifiable macro impacts. And then we now have the benefit of the non-Victorian, New South Wales operating behavior. It's effectively not being impacted by COVID or largely not affected by COVID, and we're using that bottom-up analysis to adviser as well. So we're probably a better place now than we were 2 years ago because we have 2 years more data, and we actually have good preceding information coming out of the non-lockdown states.

So just to clearly, inflation on the non-lockdown states, was that better than expected? Or was that worse than expected?

It's risk equalization side, it's broadly in line what's expected.

Okay. The second question, if I could ask around capital. So Mark, I mean you said that you're not expecting any impact to your capital position from the new APRA standards. There's also some unallocated capital at a group level. I was just hoping just for clarity around what you're saying here. So is your comment that taking both those buckets into account what's already in the Health division and the unallocated capital and the ability to draw on Tier 2, that there won't be any change or any need for additional capital? Or is it purely in relation to what you're holding within the regulated Health division now, which I think is around 13.5% of premium?

So the comments Sid relates solely to the capital in the Insurance division. So it's completely aside, not contemplating what's happening in unallocated capital. So to clarify, we don't expect the total amount of capital we require in the health insurance business to be negatively impacted. There could be a slight positive impact, i.e., slightly less total capital required. The most important factor though will be the mix of that capital. So we will be able to take around $175 million of Tier 2 debt and replace that we'll release the amount of ordinary equity and replace that with Tier 2 debt going forward. So that's the single biggest impact in the mix of capital, but the amount of total capital and the health fundings is if anything, will be slightly lower rather than slightly more.

Okay. Okay. Okay. That's interesting. And then just the $195 million unallocated, does that -- I mean, presuming you need to hold something at the group level just on an ongoing basis, is that reflective of what you need? Or is any of that surplus requirements?

So the entire $195 million is in addition to what's required in Medibank Health and at the group level. So we have an operational risk buffer that sits at the group level. That's included in the other acquired capital. So that could be the $195 million is subject to Board approval is the amount that we could spend on M&A at this point or capital management, and that will be augmented by the $175 million of Tier 2 should be raised in the future.

Okay. Okay. That's very clear. And just a final question, if I can. Just in terms of Medibank Health. I mean, there's a couple of impacts that you've called out here just I think the impact of COVID restricting travel and also just affecting some of the other services you provide. I was just wondering, as we come out of COVID, if you could provide us some idea of which of these impacted greater and what we should be expecting to happen to the profits in that division as we move to a more normal environment?

So Sid, at a high level, in aggregate, I suspect COVID will have somewhere between $2 million and $4 million impact on the operating profit of the business by cost for FY '22. And so that provides us with a tailwind going into FY '23. I mentioned in the presentation that we've lost the -- no longer going to be providing the 1800RESPECT contract that's a relatively low-margin business, probably does $25 million plus of revenue a year, but it's relatively low-margin contracts. So that will have a very limited impact on the operating profit trajectory. I guess the way we're thinking about Medibank Health going forward, and you saw at this period, you get strong double-digit growth in operating profit from your existing businesses, and you augment with some M&A. And our aspiration is through both of those opportunities to actually add meaningfully to the group operating profit trajectory. And you would have seen that the group operating profit trajectory this period was 200 basis points above the profit growth for the PHI business.

The next question comes from Doron Kur from Credit Suisse.

Maybe just to follow-up on Sid's last one there. You mentioned some positive effects from more universities -- more university deals that you've recently won. Would that not take a bit of time to come through because actually, all the universities start so you have -- has already started to need to wait a year for more students to come through? Or is that not the right way to think about that?

[indiscernible] submission year. So that will take some time to get to full run rate because typically, the student year -- the student term is 3 years, so it will take us 3 years to come the full run rate, but that will make a positive contribution in the second half.

Yes. Okay. Great. And you're seeing more students just excluding the contract won students in general, the intake this year and if you have for that versus previous years?

Well, admissions are up Doron, but it's subject to them getting in country and actually starting their course. So probably 3 or 4 weeks away, but the early signs, positive.

Just to add to that, we're very optimistic about that recovery. I think as we've seen in other markets, our investments in proposition of products and health services is something that appeals not just residents but also students. And I think that's what's enabled us to win these contracts. And I think that gives us a lot of confidence about when that market rebounds to grow.

Great. That's very helpful. And then just one on the policyholder growth. It's clearly a good result this half and upgraded guidance suggesting stronger growth next half. Is that suggesting more market share gains? Or is it just a combination across the Board, including the student -- the international that we just discussed now?

The market we've talked about there is the resident market and whilst we did anticipate and it's come to fruition, the growth rate is going to be slightly less than FY '21, where we saw a 3.1% growth in the market, it's still going to be buoyant. We expect the growth in the second half of the market to be similar to what we saw in the first half. So when you add all that up together, 3.1% to 3.3% growth target is growing above system.

Just add to that, David. I guess, Doron, we probably think we've done -- and we haven't got the APRA data, obviously. So we're kind of bootstrapping what we're seeing through the risk equalization survey. We suspect in the first half, we get around 8 or 9 basis points of market share growth. And based on David's comment that we expect the second half growth to be in line with the first half, we'd expect to grab slightly more market share in the second half.

At this time, we're showing no further questions. That does conclude our conference for today. Thank you for participating. You may now disconnect.