Medibank Private Limited (MPL) Earnings Call Transcript & Summary

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

Good morning, everyone, and welcome to the Medibank 2022 Full 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 Narrm country, the home of the Wurundjeri Woi Wurrung Peoples. I pay my respects to the elders past, present and emerging, and I extend my respects to all elders in the lands on which we work and live. I'm joined by our executive leadership team here, including our Group Executive CFO and Group Strategy, Mark Rogers. And I'm pleased to share with you the performance of Medibank over the full year. But first, I want to thank our people for their unwavering focus on our customers. I'm proud that, together, we have achieved the milestones we set out to deliver against our strategy and today are committing to new milestones to reflect where we aim to go over the next few years. Despite another challenging year, we have delivered another strong result driven by continued policyholder growth, double-digit growth in Medibank Health and remaining disciplined in how we grow and run our business. We are delivering this result at a time when Australians are doing it tough, with the rising cost of living a challenge in many households. And yet, a record number of Australians continue to take out private health insurance, putting their health and wellbeing first. The pandemic has triggered a new focus on health and wellbeing, which we expect to continue. The latest APRA data shows 7 consecutive quarters of growth in PHI membership and now, nearly 14.2 million Australians have private health cover. Growth is being driven by younger customers and those new to the private health industry, which is a positive sign for industry sustainability. And by keeping a strong focus on productivity and costs, I think we can call time on the infamous death spiral. Today, I'll take you through the key highlights of the results. I will share our view on participation in the medium term and our continued focus on strengthening the health system. After this, I'll hand over to Mark for the financials, provide an update on our company priorities, our outlook, and we'll then take your questions. So starting on Slide 5. So to begin, let me briefly touch on our FY '22 highlights. Despite the challenging backdrop, we continue to deliver for our customers. High levels of advocacy reflect the way we have supported our customers and the continued deepening of our relationships, with service NPS for both Medibank and ahm brands remaining very strong. On brand efficacy, we achieved our highest-ever results, with Medibank Group's brand NPS leading the top health insurers. Our ongoing investments in supporting customers to engage with us through our digital channels is also making a difference, with 1.4 million customers registered for the My Medibank app. We've also seen a 23% increase in claims made through the app, which makes it easier for our customers and better for our business. We've continued to meet our commitment to not profit from COVID, with our customer support now standing at around $682 million, which includes the recent 7-month deferral of premium increases. We also know that customers want to see more value in their cover. Our Members' Choice Advantage network is one initiative that delivers immediate savings to a household budget. This year, our customers saved $31.2 million in out-of-pocket costs through our dental and optical network, which forms one of the largest health providers that works in the country. We've celebrated our 0.5 million Live Better members since launching in 2019, which we believe is now the fastest-growing health and wellbeing program in Australia, and our preventative health programs continue to grow along with our Health Concierge program. Now to our financial results on Slide 6. We're pleased with the company's performance, and the momentum is strong. Customer growth has been a standout, with the number of resident policyholders up 3.2% or almost 61,000 over the last 12 months. We expect next week's APRA's numbers to show a continued gain in our market share. The quality of our growth was also strong, with 7 out of our -- of 10 of our new customers being younger adults and those taking our cover for the first time. Our momentum was strong in the last quarter of the year, and this continued last month, with growth of around 5,800 policies and with no notable change in suspensions. Doing our bit on cost remains a key priority. And this year, we maintained our industry-leading management expense ratio, dropping by 30 basis points to 7.4% on an underlying basis and remaining well below the industry average of 9.6%. This is the fifth year in a row we have recorded a decrease. The combination of cost discipline, differentiated offerings across our dual brands and accelerated growth in corporate and digital channels helped drive a 10% increase in Health Insurance operating profit to $592.6 million. In our Medibank Health segment, a strong contribution from our health care investments, the provision of COVID-related services and recovery in the travel insurance business in the second half resulted in a 44.9% increase in segment profit to $45.5 million. A $24.8 million loss in net investment income, down from a $120 million gain last year reflects volatile markets. This flowed through the group NPAT, which was down 10.7% to $393.9 million. And lastly, the Board has determined we will pay a final fully franked ordinary dividend of $0.073 per share, bringing the full year dividend to $0.134 per share. Now to Slide 7. As a company, we responded to every challenge that has been laid at us. 5 years ago, the focus was on participation and value of the product. In the last election, the focus was on how we would manage in a cost-constrained environment. And during the pandemic, the focus was on how customers could use their cover. We have responded to each challenge. The current environment also has its challenges, which we are monitoring closely. However, we expect growth to continue in the industry, supported by strong fundamentals in our growing economy, including historically low unemployment as well as solid consumer resilience. Consumers are also no longer seeing health spending as discretionary. And they're actually spending more on their health than before the pandemic. The majority of PHI customers are also now viewing their cover as essential. And paying to PHI ranks only behind mortgage and rent and utilities in terms of priorities, with customers more likely to hold on to their health insurance and reduce spend in other areas. More people are valuing what private health insurance has to offer, including greater choice and access, especially given the increased awareness of the sustained pressures in the public health system, which we know will take some time to address. And those that already have cover are holding on to it, with retention across the industry the highest in 10 years and the proportion of customers intending to drop their cover the lowest it's been in 5 years. We have also seen the lowest levels of downgrading in our resident portfolio in the last decade. As shown in the middle chart on this slide, the gap between premium increases and wage growth has been and will be a strong determinant of industry growth. As we have done more recently, keeping premium growth low relative to wage growth is key to maintaining participation and remains our ongoing focus. Overall, we have seen industry rate growth reduce slightly from last year, albeit more slowly than we had anticipated. And while we do expect the rate of growth will continue to moderate, participation will remain strong, with growth rates likely to remain above pre-pandemic levels for some time. The economic conditions mean we will need to continue to manage our business well. And also, as Mark will shortly describe in more detail, we are seeing a relatively benign claims environment, with a number of cost headwinds and tailwinds leading into an inflationary period. As a result of the changes we had made over the past few years, our business is stronger and more sustainable. And as a result, we are better able to support our customers through what's ahead. Now turning to Slide 8. People in Australia enjoy world-leading health outcomes. But as we know, there are many issues we need to overcome to sustain this. More patients are needing treatment, our aging population is increasingly presenting to hospital with more complex comorbidities. And around 1 in 2 Australian adults would have at least 1 chronic health condition. Our public health care system is under stress, with issues exacerbated by COVID. Ambulance ramping, growing emergency department wait times, lengthening elective surgery waiting lists and difficulty accessing mental health care, coupled with the critical workforce challenges, means the public system's ability to meet this growing demand is diminishing. And as a nation, we are grappling with how we sustain the quality of life we expect in a challenging economic environment. We need a health system that's fit for this future. The health is lagging other industries in productivity, with the health sector below the national average. Medibank's own financial discipline has seen us take out around $100 million of our own costs from our business over the last 5 years while investing to bring new health programs to our customers. These changes are needed across the entire health system, but the ask of the industry is more than any one business can deliver. As a nation, we only invest around 1% of our budget on prevention. Australia also remains one of the slowest adopters in the OECD of new care settings, that offer more patient choice, minimize unnecessary time in hospital and reduce out-of-pocket costs. And as you've heard us say before, there continue to be opportunities for further reform. Prostheses is the prime example of how difficult it is to deliver real change in our health system. Despite all the vested interests, all parties now agree that Australia should no longer pay some of the highest prices in the world for medical devices. There is now a way forward to achieve this once-in-a-lifetime opportunity, to deliver more than $900 million of savings to private health consumers over the next 4 years. And even more importantly, there is recognition that reform of this scale will provide greater equity in health, meaning that the private system will be more accessible to more people, which is so important in taking the pressure off the public system. But look, the devil remains in the detail. And while our government remains committed to this reform, vested interests remain. So to ensure we can keep premium increases low, we need to maintain the commitment to the process and the commitment to move with pace. The known issues in health can no longer be ignored. Our health system is fatigued, and the pace of change is not keeping up with our growing health needs. However, there are promising signs, with many partners demonstrating their preparedness to be early adopters of the changes needed. But until recently, they have been in the minority, with large parts of the sector wanting to remain with the status quo. We are at a critical juncture as we emerge from the pandemic, and it's widely recognized that we all need to move with greater urgency. Now to Slide 9. In responding to these challenges, we must embrace the 4 megatrends that are evident around the world. First, the consumerization of health. Health is one of the last sectors to pivot to the consumer, and COVID, in many ways, has been the catalyst for this change. This acceleration is set to continue. And like other industries, we will see consumers driving the innovation we need, including to our almost 4 million customers. We need to shift to prevention. In Australia, more than $38 billion is spent each year on care for people with chronic health conditions. Almost half of all Australian adults have health conditions that could be better supported, with close to 90% having potentially avoidable risk factors, including being overweight, smoking and being physically inactive. Being proactive about chronic disease management and prevention is needed to better deliver better health outcomes, while also delivering long-term sustainable benefits for the health system, with almost 40% of the disease burden being avoidable through prevention. The rise of new care settings is another megatrend. And whilst there has been some recent shift towards these new ways to deliver care, more needs to be done to move suitable procedures away from more costly acute overnight hospitals. And as an example, we know from our own research with KPMG that if 30% of all patients were provided a short stay in hospital accompanied by home care across both the public and private systems, by 2030, 217,000 bed days could be saved. And patients could save $102 million in out-of-pocket costs. We all know that when you save unnecessary bed days, you take pressure off the resources connected to them, providing a relief valve for our nation's overstretched health workforce. And finally, outcome-based care, to provide better coordination across the system, and we're funding it aligned to quality health outcomes. Reform is needed to deliver on this agenda, but we will not wait, and we will continue to act, shaping our strategy to embrace these 4 megatrends, enabling us to grow as a company and to play our role to drive the change so needed in the Australian health system. Now to Slide 10. Our strategy to grow as a health company is working. In delivering leading experiences as a consumer health business, we continue to focus on meeting the needs of our customers, our people and the community. To differentiate our core insurance business, we continue to focus on delivering more value, choice and control for our customers, with our 2 brands and one of the most extensive provider networks as distinct points of difference. Lastly, our growth in prevention and integrated care will help us further expand in health. This pillar is also focused on scaling and connecting our health investments and partnerships, bringing benefits to our core insurance business, also being a catalyst of change in other parts of the health system. Our investments are delivering value, and we remain clear on our target markets for growth and who and where we will partner. On the next few slides, I'll talk to how these pillars contributed to our strategy over the year and where our focus lies for FY '23. So let's begin with Slide 11. As I mentioned earlier, our customer efficacy remains strong, and we exceeded our FY '22 customer efficacy milestone, which we have now reset for FY '23. Driving this is our ongoing work to make things easier for our customers and harnessing our digital and analytics capabilities to have more personal and informed conversations with them. These investments will continue as we build out a holistic and personal digital gateway, better connecting our customers to our health services. This focus also reflects the growing number of customers seeking to use technology to engage with us, with 42% of service interactions taking place by self-service channels, up from 38% last year. We are pleased to report that we are well above our FY '22 employee efficacy milestone benchmark, helping to achieve this with the launch of our new vision, to deliver the best health and wellbeing for Australia and the way we have engaged our teams, to get them behind where we want to go by 2030. Supporting our community is also central to Medibank's strategy. You can see some of our ESG highlights on Slide 33, including our commitment to reconciliation, access and inclusion and our pathway to Net Zero, which we'll announce in more detail next month. Now to Slide 12. We again delivered growth across both brands in FY '22. With some challenges and opportunities ahead, having 2 differentiated and growing brands enables us to offer products and services across the full spectrum of customer needs. Our retention over the past 2 years is higher than at any point in the last decade. Downgrading in the resident book is at its lowest in 10 years, and new-to-industry and younger customers make up around 70% of new joins. We also continue to see significant loyalty among customers engaging with Live Better and those holding multiple products such as travel and pet insurance. We're seeing growth returning to the overseas portfolio, and our corporate offering is continuing to get results. Pleasingly, we retained all our existing university accounts and won 80% of all competitive university tenders that we participated in during the year. In the corporate market, our growth has been buoyed by employees increasingly investing in their employee value propositions, where we've seen a significant rise in the number of employees subsidizing PHI for their people. Given our breadth of offering across health, we were successful in winning 100% of the tender opportunities presented to us in this space. We will continue to target growth in these markets in FY '23, in addition to our growing regional presence. We're also investing in our core offering and work with our customers to develop new excess products in Medibank and ahm that offer a new level of flexibility and value and doubled our Members' Choice Advantage network, adding new services such as physio and chiro, designed to have lower or no out-of-pocket costs. Overall, we have made strong progress on our market share and Health Insurance productivity milestones. We're up 4 basis points in shares since FY '21, and we expect further improvement when the APRA data is released next week. Our new FY '25 aspiration is to grow market share by between 25 and 75 basis points on FY '22. And meanwhile, we will maintain our discipline around costs, and we are still targeting $40 million in productivity savings by FY '24, including the $15 million we delivered in FY '22. Now turning to Slide 13. Expanding health is central to our strategy, and we have made good progress in FY '22. There can be no doubt of the benefits of prevention and integrated care newer settings bring to the health system and the whole community. A 40% increase in uptake of our preventative programs shows the unmet need in the community as well as our growing capability, working alongside our primary care partners to fill this gap. We will continue to ramp up our own preventative programs, including Live Better. This is a key differentiator for us as our customers are looking for us to be their partner in health. Mental health is another area of pressing need. And with some people having to wait up to 6 months to see a psychologist, we need a different approach. That's why we are piloting a telepsych clinic, in collaboration with doctors in Myhealth GP network and using the Medinet tech platform, building on our existing partnerships with both companies. This year, Myhealth expanded its network to 106 clinics while we invested $10 million in Medinet to support its scale to provide more services to more GPs across our community and their patients. And as I mentioned at the half year results, our rebranded health services business, Amplar Health, is growing by supporting the needs of our Medibank and ahm customers. There's enormous opportunity for Amplar to do more in this space. This focus helped us increase the number of customers supported by our Health Concierge team when they go to hospital, helping us to offer them more choice around their health care and reinforce their relationship with Medibank. 1 in 4 of our Medibank customers are now opting to have rehab in the home after joint replacement, which we expect to continue to increase. And in FY '22, we more than doubled our no-gap network, including short-stay across 7 states and territories, which means 64% of our customers will live within 25 kilometers of a no-gap site by October. We will continue to grow this program. In addition to supporting our own customers, we continue to apply our capabilities to service government and community partners. This includes programs to alleviate pressure on GPs and emergency departments in 2 primary health networks in New South Wales and our continued delivery of the My Home Hospital in South Australia through our partnership with Calvary. For our FY '22 health and wellbeing milestone, we exceeded our targets, with 568,000 customers engaging with our Live Better and preventative programs. Our new milestone for FY '25 is to grow our health and wellbeing programs, including 800,000 Live Better Reward participants and more than 50,000 preventative program participants. Medibank Health has reported a segment profit of $45.5 million, just short of our $47.3 million target, which is a very strong achievement given we didn't contemplate a pandemic when this milestone was set back in February 2019. Consistent with our growth aspirations, we have a new Medibank Health milestone, to target an average of at least 15% per annum organic segment profit growth over the next 3 years. We're also aiming to invest between $150 million and $250 million in our target health markets, including additional short-stay hospitals, while we continue to review Health Insurance opportunities where targets become distressed in the current operating environment. I will now hand over to Mark.

Thanks, David, and good morning. This is a pleasing result, with momentum in the Health Insurance business continuing and very strong double-digit growth in Medibank Health, including a meaningful uplift in the contribution from our health care partnerships. Importantly, Health Insurance performance was driven by continued policyholder growth, subdued downgrading and ongoing cost control, and was achieved despite the impact of border closures on the nonresident business. Group operating profit was up 12.5% to $594.1 million, with strong growth in Medibank Health adding meaningfully to Health Insurance operating profit growth of 10%. However, volatility in financial markets drove a $24.8 million loss in the investment portfolio compared to a $120 million gain in the prior period. And as a consequence, profit before tax was down 11.4%. And whilst reported EPS was down 10.7% to $0.143 per share, underlying EPS, which adjusts for the normalization of investment returns, was up 9.1% to $0.158 per share. Moving to Slide 16. The granular view of COVID hospital claims paid for the 12 months to May shows how the recent Omicron outbreak and the associated restrictions on surgery numbers and staff availability has impacted the claims recovery. Whereas at the 1H '22 result, we reported flat claims paid in Victoria and New South Wales and a 4% increase across other states, this period, they were down 7% and 2%, respectively. With the continuing trend of nonsurgical claims being more impacted and recovering more slowly than surgical claims, we have reduced the deferral assumption for these claims from 50% to 40%. And given the ongoing softness in rehab claims, there is an increasing likelihood this trend could become permanent and favorably impact underlying claims. With claims remaining below our underlying expectation, we continue to build the deferred claims liability, which has increased by $225 million to $448 million. Given the current challenges in the health system, we expect it will take approximately 2 years for these deferred procedures to be completed. Slide 17 covers the health insurance result, which shows reported revenue and gross profit grew by 2.7% and 5.5%, respectively. During the period, the risk equalization payment increased in line with growth in the number of ahm policies, which is skewed to younger and lower-claiming customers, and our claims growth continuing to be lower than industry growth. And COVID had a very modest cost this period, with the customer give-back funded by further permanent claim savings. Underlying gross profit increased 5.3% to $1,129 million, with underlying revenue growth of 4.7% and a 10 basis point improvement in underlying gross margin to 15.6%. Pleasingly, this reflects improved downgrading and was achieved despite closed borders impacting profitability in the nonresident business. Underlying operating profit was up 9.5%, with continued cost discipline and the benefit of increasing scale, the major contributors to the 30 -- 40 basis point improvement in underlying operating margin to 8.2%. Turning to Slide 18. The resident health insurance market remains buoyant, and we estimate that over the last 12 months, industry policyholder numbers grew by approximately 2.7%, including a strong June quarter. Importantly, the trend of industry growth being of high-quality, including in new-to-industry and younger age cohorts, has continued. In the last 12 months, our policyholder numbers increased by over 60,000 or 3.2%, with a modest deterioration in the acquisition and lapse rates, largely reflecting favorable COVID impacts in the prior period. Medibank policyholders grew by 1.9%, with a stable lapse rate and a 30 basis point improvement in the acquisition rate, supported by strong growth in the corporate segment and through digital channels. ahm continued its strong growth trajectory, with policyholders up 7.3% to more than 500,000. And whilst the acquisition rate was down, this reflects lower sales through aggregators and growth in policyholder numbers. We continue to [ buy ] sales to more profitable direct channels, which accounted for greater than 50% of total sales this period. Whilst a 70 basis point increase in lapse, in part, reflects the retention benefit of the extras limit rollover last year, further improvement in customer retention remains is a key area of opportunity for ahm. And despite the deterioration in economic conditions, the lapse rate in the second half for both brands was lower than in the prior corresponding period, and we have not seen any notable change in the level of customer suspensions. We will continue to monitor this very closely, and options will always be available to customers who experience hardship. Now turning to Slide 19. Underlying resident claims, which excludes COVID impacts, were up 4.3%, and underlying net claims, which includes risk equalization, were up 4.5%. As expected, risk equalization had a more significant 20 basis point impact on claims growth for the full year compared to 10 basis points in the first half, in line with the return to more normal claiming patterns. Underlying resident claims growth per policy unit was down 20 basis points to 2.3%, with increase in hospital claims growth more than offset by the reduction in extras. Extras claims growth returned to a more normal level, following investment in additional product benefits last year. And the modest increase in hospital claims growth reflects sales mix and the benefit of claims initiatives in the prior period. Given the volatility in risk equalization over the last 2 halves, we expect underlying claims growth across the last 12 months of 2.3% to be the best indicator of growth in FY '23, subject to the emergence of any prostheses savings and assuming rehab trends return to pre-COVID levels. Slide 20 details underlying Health Insurance performance, which shows that strong growth in the resident business was partially offset by a decline in nonresident. In the resident business, underlying gross margin was up 20 basis points to 15.4%, with improving revenue and lower claims growth per policy unit, and the business has good momentum going into FY '23, with growth in spot policy units 60 basis points above the average. Increase in revenue per policy unit includes a 30 basis point improvement in downgrading to 60 basis points, with the Medibank policyholder trajectory, portfolio management initiatives and sales mix all contributing. Despite the expected increase in downgrading in the second half [ by eventuating ], based on economic conditions, we expect this to increase to around 80 basis points next year. In the nonresident business, with the gradual reopening of borders, policy units increased by 8.8%. However, as much of this growth was at the back end of the year, the average balance was still down 8.6%. Gross -- underlying gross profit was down $11 million to $37.5 million. Both underlying gross profit and gross margin improved materially in the second half as the intake of new students saw tenure and mix impact starting to unwind. Based on this, we expect gross profit in FY '23 to be higher than FY '21, with further upside if the worker and visiter market segments continue to recover. Moving to Slide 21. Management expenses were up 1% to $536.1 million, with our productivity program and lower noncash costs largely offsetting cost inflation and growth in nonresident sales commissions. The $4.8 million reduction in noncash costs includes lower D&A. And importantly, with the progressive shift in ahm sales to direct channels, lower deferred acquisition cost amortization. The increase in sales commissions reflect strong growth in nonresident policy units, particularly in May and June. And based on the current momentum, we expect a similar increase in commissions in FY '23. Operating expenses were up 0.9%, with cost inflation of approximately 2.5%, additional statutory costs and modest volume impacts largely offset by around $15 million of productivity savings. And whilst cost inflation is likely to increase to between 3.5% and 4% next year, this is expected to be, in large part, offset by further productivity savings. Despite the increase in management expenses, the underlying management expense ratio fell 30 basis points to 7.4%. Going forward, we will continue to leverage the benefits of growth and scale to target further modest improvement in the management expense ratio. And whilst we will remain disciplined, we are very focused on balancing this objective with our growth aspirations. Turning to Slide 22. Importantly, the Health Insurance business is well placed to manage in a more inflationary environment. Continuing to grow our market share will be important, given industry policyholder growth is expected to soften, albeit still remaining well above pre-pandemic levels given the community focus on health and the challenges in the public system. The continuation of low premium increases, implementing the adult dependent reform policy to encourage more young customers to have cover and increasing the number of no-gap services for our customers will also help. The current 7-month premium increase deferral, continuation of low premium increases thereafter and portfolio management initiatives will help manage downgrading pressure. And whilst we're expecting some deterioration, this is off a very low level of 60 basis points. On claims, it is critical that prostheses reform delivers real benefits as these are an offset to other inflationary pressures. By providing more services to Medibank customers, Amplar will also help address rising health care costs through an increasing focus on prevention, supporting the adoption of in-home care and delivering integrated models of care at scale. And we will closely track spend in more discretionary ancillary modalities, which could be impacted by economic conditions and continue to monitor rehab referral trends. Continued disciplined cost management in our productivity program will be even more important given the environment. Managing noncash costs by increasing sales through our largely fixed cost direct channels and closely managing D&A will remain areas of focus. And increasingly, we believe our disciplined productivity capabilities and scale will set us apart from the majority of our competitors. Now turning to Slide 23 and Medibank Health. Across the year, there were a number of offsetting COVID impacts to the business, with closed borders impacting travel insurance sales and lockdowns impacting home care patient numbers. However, this was largely offset by the provision of COVID-related services. Despite this, segment profit increased by almost 45% to $45.5 million, with operating profit up 26.7% and a $4.7 million contribution from our health care partnerships. Revenue increased 13.4% to $322 million, with strong growth in telehealth, health and wellbeing and recovery in travel insurance sales in the second half, partially offset by a modest reduction in home care revenue. Gross margin was down 110 basis points to 40.1%, with higher labor costs in home care, the impact of transitioning out of the 1800RESPECT and Beyond Blue telehealth contracts and business mix impacts. Management expenses were up $3.6 million, including a $2 million contract exit and other one-off costs. But given the strong growth in revenue, the management expense ratio improved 240 basis points to 27.5%, which reinforces the benefit of creating scale in this business. Given the strong momentum in the business and with the potential around the needs of the Medibank customer, over the next 3 years, we expect, on average, at least 15% per annum organic growth, with the potential for further growth from M&A activity. Turning to Slide 24. Volatile investment markets had a significant impact on investment income this period, with a loss of $24.8 million compared to a $120 million gain in the prior period, with the growth and defensive portfolios down $83 million and $61.9 million, respectively. In the growth portfolio, the reduction in income was due to the significant correction in equity markets. And in the defensive portfolio, this includes a $26.5 million cost due to widening credit spreads this period compared to a $16.1 million benefit in the prior period. Underlying investment income was down $25.2 million, including $19 million in the defensive portfolio. We have significant market liquidity, and the steepening of the interest rate curve impacted yield. As a consequence, the underlying investment return of 141 basis points above the RBA cash rate was below the target range of 150 to 200 basis points. In FY '23, underlying investment income in the defensive portfolio will benefit from the increasing RBA cash rate, with its 25 basis points increase adding $5 million of income and the expectation that the liquidity and interest rate curve impacts will not be significant as in FY '22. Turning to Slide 25. Our capital position remains strong, with the Health Insurance capital ratio of 13% at the top end of our target range and unallocated capital of $148 million. During the period, Health Insurance capital increased in line with revenue growth, and the $40 million increase in other required capital largely reflects investment in new hospital joint ventures and Medinet. The reduction in unallocated capital includes the cost of these investments, partially offset by the benefit of lower intangible and illiquid assets. The Board has declared a fully franked final dividend of $0.073 per share, bringing full year dividends to $0.134 per share, which is an increase of 5.5% and an 84.8% payout of underlying net profit after-tax. We continue to expect the final APRA capital standard, which will apply from 1 July 2023, will not negatively impact our capital position. And subject to the standard being released in September, we will provide an update on our capital settings at the 1H '23 result. And given our strong capital position and ability to issue Tier 2 debt under the new standard, we are well placed to fund further inorganic growth and if suitable opportunities are available, to consider further capital management. Turning to Slide 26. In conclusion, the business enters FY '23 with good momentum and has a number of avenues for growth. In the resident Health Insurance business, this will require maintaining policyholder growth, managing the operating jaws and further leveraging the benefits of scale. We will augment this for strong organic growth in Medibank Health and in the nonresident Health Insurance business, which will benefit from the reopening of borders and the investments we've made over the last 2 years. In the next 3 years, we also aim to invest between $150 million and $250 million inorganically, primarily in health and wellbeing, primary care and new care models, but we'll also consider Health Insurance opportunities where targets are distressed. And increasingly, we will look to deliver synergies between our businesses, which differentiate our customer experience and deliver value to our shareholders. I'll pass back to David to make some closing remarks.

Thanks, Mark. So let's look at Slide 28. What sets Medibank apart from others in the market is our ability to support our customers across their whole life and health, from prevention to treatment. This unique ability enables us to deliver more of what customers need and to grow our relationships with them. It drives our growth and creates synergies across our businesses, from improving customer retention, to reducing unnecessary claims and costs. I want to show you how this works for our customers using the example of preventing, managing and treating mental health. From supporting our customers with their everyday mental wellbeing through our Live Better program and our Better Minds Hub, which last year saw almost 80,000 visits, we are able to help people manage their emerging needs. But where more support is needed, our 24/7 mental health support line, which saw a 66% increase in usage last year, helps people understand their treatment options. In addition to making it easier to access our partners through our insurance covers, we are also piloting the telepsych clinic and extending our Health Concierge program to help customers needing treatment with pre- and post-hospital support. We will continue to invest in these services and other programs aimed at reducing the very high hospital readmittance rates in mental health, which currently sits at around 50% within the 12-month period, to improve patient outcomes and reduce unnecessary costs. And as I've said before, it's our ability to deliver customers with this breadth of offering that sets us apart from others in health and will support our growth ambitions. So turning to Slide 29. Our focus for FY '23 is clear. By continuing to put customers at the center of health, we will achieve our vision for the best health and well-being for Australia. We delivered a strong result in FY '22, and there is positive momentum across our business leading into '23. There will be challenges ahead. But like we have done in the past, we remain well positioned to manage uncertainty. Affordability and value for money in health are increasingly important to consumers. And while we expect industry growth to slow slightly, it will remain positive at above pre-COVID levels. We will continue to focus on growth opportunities in our target PHI markets, including the recovery in our non-resident business, but we'll remain disciplined in how we grow and how we run our business. And we will continue to stick with our commitment to not profit from COVID by returning any permanent net claim savings to our customers. We are different to others, and our growth strategy diversifies our earnings, differentiates our core insurance brands and supports improved experiences and outcomes for our customers. And as Mark outlined before, we have multiple avenues for growth. In addition to our core business, we will further expand in health by scaling our existing businesses and with our partners deliver more health services to our customers. We will also continue to use our strong balance sheet to invest in further opportunities with partners in our target health markets that will strengthen our core business to help transform and sustain the health system. I will now speak to Slide 30. So turning to our FY '23 outlook. We will continue to ascend activities 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 around 2.7% policyholder growth, assuming a modest decline in industry participation growth in FY '23 relative to FY '22. We expect underlying net claims expense per policy unit growth in FY '22 of 2.3% to be the best indicator of growth in FY '23 among resident policyholders given the restabilization volatility. We remain focused on controlling our costs with a productivity FY '22 to FY '24 target of $40 million. Inflation is expected to largely offset by productivity. Finally, targeted organic and inorganic growth for Medibank Health and health Insurance remain areas of focus, supported by our strong capital position. I'll now hand over the call for any questions you want to have.

[Operator Instructions] your first question comes from Sean Laaman with Morgan Stanley. Pardon, Sean, if could just please reregister. Your next question comes from Vanessa Thomson with Jefferies. Sorry, Vanessa, if you could also please reregister. Your next question comes from Scott Russell with UBS.

David Mark, can you hear me okay?

Hear you fine, Scott. Thanks.

All right. Third time lucky. I've got a couple of questions about claims, if I can. Perhaps you can put into context the guidance you're giving for claims inflation to remain flat at 2.3%. How do you reconcile this with CPI accelerating towards 6% plus?

I'll start by a few comments and then hand over to Mark. Look, I think what's important to remember, there are some challenges in the system, but there are headwinds and tailwinds there. And we've provided a guide for what we expect next year. I think we're also thinking about inflation as an impact to our customer base, which we've gone through. Before, we still expect a buoyant market and think about our own business. But I'll get Mark to talk about the impact on claims going forward.

Scott, so our second half underlying claims growth gives us a lot of confidence going into FY '23. There are some potential headwinds from inflation, but there are equally potential tailwinds as well. And I'd call that the [ CCs ] reform and rehab referral trends as being 2 potential tailwinds that could eventuate. So I think on balance, 2.3% is a number I'm really comfortable with. In fact, if anything, I'd say it's probably at least for '23, slightly optimistic given we are achieving rehab referral trends returning back to pre-pandemic levels. And they're currently -- rehab spend probably now tracking at around 15% per annum growth below surgical claims growth.

Can I ask you about prosthesis reform? So it was quite a sizable estimate from the federal government back in March for the 4-year benefit, $800 million to $900 million from prostheses reform over 4 years. You're a 1/4 of the market, and I think they're planning to put through roughly half of the reduction in gap private versus public hospitals in this current financial year. So it's not hard to do the mathematics of what it might mean for your claims costs in FY '23. Can you talk through whether that's the right way to make an estimate of prostheses reform benefits in FY '23? And to what extent that that's shaped -- or how much of that benefit is flowing into the 2.3% guidance you've given?

Let's start just on prostheses, just generally, we have made good progress, as I said before. There is a road map outlined and we are seeing the first tranche of that both in terms of the implantables and general miscellaneous conditions that we will see roll out. I think, as I said before, there's a general now appreciation that this is a reform that we've got a chance to deliver. I think the government and the department remain absolutely focused on it, but there's time to go through. We need to remain committed and we need to move at pace. So I think that hopefully helps everyone's position on where we're going. Mark, about the insurance.

Sure. We're expecting for the industry, $90 million of price cuts to start progressively coming through from 1 July. So that's $90 million for the industry. So on the basis that there is no inflationary impact because of higher utilization or any other I'd call it skunk works, for lack of a better term, we should start to see those savings to progressively during the course of 2023. And to the extent they do, and we're not baking them until they're actually delivered and hit the bottom line, that would be a tailwind to the 2.3% guidance we've given. Equally, if inflationary pressures are higher, then we expect that could potentially be a headwind.

And just to clarify, when you refer to it as a tailwind to say that, that benefit is in excess of your guidance or it's captured within the inflation guidance?

So to the extent prostheses savings, if that was the only impact on claims next year that we weren't expecting, if those prostheses savings are delivered, that would bring the 2.3% down.

Your next question comes from Sean Laaman with Morgan Stanley.

Can you hear me okay this time?

Yes, Sean.

Excellent. Bit sort of mid- to longer term on claims, and I know I always ask about this, but looking at the potential opportunity from more short-stay models, there's an issue that's currently brewing in the market where we could end up in a situation where half the private beds in Australia are owned by private equity that we could be having maybe sort of when you throw Healthscope into the mix, sort of $10 billion worth of assets stripped out of the industry and parked offshore. And therefore, half the industry has materially lower margins and then less able through organic means to generate cash flow to fund any requisite sort of brownfields or expansion programs for capacity. So I'm wondering if that's necessarily a bad thing. I mean it's officially it's bad. Or does it actually spur activity or investment in the short stay and day hospital industry is somewhat of a pressure release valve, I guess. So I'm wondering if you give us some thoughts on the cadence of potential move to more procedures done in that short stay in day surgery setting, and maybe flavor it with some comments on East Sydney and Q.

Thanks, Sean. Look, I think as I said before, we're one of the slowest adopters in OECD countries of new care settings that can deliver safe quality care at lower costs. And I think we've often talked about joints where some of the industry best practice at a country level might be 30%, 40% of joints done in these settings. Australia is around 1%. I think we've outlined in the pack today, a couple of other examples for you. I think these transitions take time, and that's why we're investing both directly with our partners in short-stay hospitals to catalyze that change but also in partnerships. We've doubled our network over the last year. And as I said before, 2/3 of our customers thereabouts will be living near a short-stay site. I think this is -- if you look at the longer term, yes, sustainability of the system, we need to keep the consumers' interest absolutely at the forefront. And that's all about delivering the quadruple aim of health. And there's opportunities here to transform the system by delivering high-quality care, better experiences with short stay and recovery in the home with more value. And I think any company in the organization is looking at the long term will think that's an opportunity for transformation. I think given the environment we're in right now, there is a pretty real critical juncture for change. And I think that's why we're seeing in our hospital discussions with our partners, some really innovative agreements which are balancing short-term needs with longer term transformation. I think that we'll start to see more of that rolling out in the medium term.

And a question on management expense ratio. How sustainable is the downward provision I know you've talked about productivity gains coming through? But is there much more to go in keeping that line suppressed?

Sean, obviously, it gets progressively harder and harder to deliver the same level of productivity savings because the addressable cost base is reducing. Having said that, I'd still expect the MER to improve next year. but not at the same 30 basis point improvement level that we saw in '22.

Your next question comes from Vanessa Thomson with Jefferies.

I just wondered if you could give us some insight on the investment portfolio in July of this year, and with credit restraints having come in a bit. Has there been any benefit as yet?

Vanessa, thanks for your question. So July was a strong month for us. So we've had the double benefit of spreads coming in, as you said, but also the yield curve in the U.S. along into the curve started to come off a bit. So in the second half of last year, we had both spreads blowing out and the yield curve going to a normal yield curve fairly quickly and steeply. We've seen both of those factors unwind a little bit in July. So it was a very positive month in July.

Right. Okay. And then also I wanted to ask this $25 million left in productivity savings target for FY '23 and '24. I wondered if you could guide us for savings in FY '23.

Yes. Really round numbers, I'd say that we delivered equally across the 2 years. So it's not going to be exactly 50%, but it will be in that range.

Okay. Okay. And then just one last question and perhaps it's a little early. But I wondered if you've seen any consequence from later diagnosis of conditions, depending on restrictions? Or is it, I know you spoke about 2 years for those deferred claims to run off. And then I guess on top of that, is there an impact on later diagnosis?

Look, we do know that there's been a drop off in some periods in the pandemic around 30% from testing. We haven't seen significantly big impact for that. But with -- we're using our Live Better program to encourage our customers to get things like the flu jab. I think we were awarded about 70,000 customers getting the COVID vaccine last year. So we do what we can to help increase those sort of preventative health measures. But maybe I'll just turn to Andrew, whether you've seen anything in the [indiscernible] business in that regard, Andrew?

Yes. Look, I think we haven't really -- I don't think we've seen that come through so much. But certainly, anecdotally, that's the case, talking to people in the health system, particularly around later presentations of cancer. The one area where I think there is a definite trend is in mental health we are definitely seeing an uptick in presentations across the board, both within the health system but also in terms of calls to our mental health line and also I think there's going to be some emerging pressure on claims potentially there as well.

Your next question comes from Kieren Chidgey with Jarden.

A couple of questions, if I could. Maybe just going back to the claims inflation questions earlier. Clearly, there are a lot of pressures across the economy, including escalating wage inflation. We've seen some pretty tense negotiations between Bupa and Ramsey. I'm just wondering sort of as you think forward over sort of the next 12 months and you start going through some contract renewals, whether or not sort of that claims inflation number could change quite materially. What is, how should we think about the renewal profile in terms of key contracts and what impact that might have over the next 8, 10 or 24 months?

Thanks, Kieren. I'll start off here. Look, it is a challenging environment that we've actually maintained very strong constructive discussions with our hospital partners. We have -- it's BAU really for us. We've got 450 agreements. In the last couple of years, we've reached agreements with about 250 hospitals. And going forward to FY '23, about 85% of our spend is already contracted. And just to be clear, hospital spends about half of our total claims spend. So look, absolutely challenges. But in the same way, as I said before, the conversations we're having are balancing the needs to support hospitals to deliver care, but also keeping what is absolutely top of mind for us in the community is what customers need, which is to reduce pressure on premiums and to make sure that we can innovate. And so we're seeing lots of conversations around investing in new models of care. Hospital agreements aren't just price. It's also about quality measures, about volume to meet demand, and it's about avoiding hospital acquired complications. So we see really positive constructive conversations, and that's helped us navigate this through the last year, and I think that's how we'll see it going forward.

And Kieren, I'll just add to that. I think you're right, David, it's right. You have the progressive impact of whatever happens on hospital contracting coming over a number of years. But I actually see the ability for us as an industry to actually deliver and sustain the benefits from prostheses reform. And then in an ideal world, maintaining the low level of rehab referral trends that we're currently seeing is having a bigger potential impact on claims inflation going forward than what the conversations with the hospital groups could have any other direction. But in my mind, there are the 2 key thematics of claims inflation going forward.

And sort of related to that, as you think about sort of as we move the next premium renewal round where you lodge in October, is it the expectation, given this time last year, I think from memory, you were talking about 2.4% claims inflation expected through '22? It's done a little bit better than that. You're talking to sort of similarly low level over the financial year ahead. Sort of is there a need in your mind to seek higher premium rates at the upcoming renewal particularly given things like prostheses reforms starting to kick in?

Kieren, I think we never make a future prediction of premium increases. But as I said before, we audit everything we can to support a strong viable private health insurance sector, which will take the pressure off the public system. I think the new government like the last government isn't interested in seeing high levels of premium increase. I think we showed in the chart before strong participation is linked to the difference between premium increases and wage growth. And 6 or 7 years ago, we were seeing increases with 5 handle and wage growth with a 2 handle, and we saw participation reduce. I mean now going forward, I think with the expectation of lower premium increase environment, higher wage growth. That's what we're focused on to maintain strong participation. So I think that's really the conversation we're having at the moment. Saying that, as Mark said before, and as we said, I said before, the prostheses seeing prostheses benefits flowing through is pretty cool, and that's probably the biggest unknown at this stage between now and October.

Just a quick final question. The $150 to $200 million investment in Medibank Health. Can you just give us an idea of sort of the return hurdles and expectations around that additional investment?

Yes. So I think we, if you look at our cost of capital, depending on what the risk-free rate is, Kieren, it's somewhere around 8% to 9%, you'd expect us to cover our cost of capital on those investments on a stand-alone basis. But I think if you just think about the cost of capital in the segment, you're missing the bigger opportunity to deliver benefits back into our core business and drive system change. But in the stand-alone Medibank Health segment, assume we're going to make a 9% to 10% cost of capital at minimum.

Your next question comes from Andrew Goodsall with MST Marquee.

I'm just going to start with the 2.3%, I guess, just trying to see that in the context of hospital capacity. If you're looking at utilization of some of your deferred care -- deferred surgical use. Is that -- does that make sense if I sort of stack your 2.3% up plus the deferred COVID care? You probably ultimately got to high profile use of the hospitals. But what your underlying just isn't going to necessarily get much above the 2.3% in that mix. Is that a factor in your thinking?

So the 2.3% of the underlying claims growth expectation. So the spend on claims could be higher than that because this recovery in the deferred procedures, but the 2.3% looks through those COVID impacts.

Right. So if a hospital has got capacity to do more and just taking care of the deferred claims, your 2.3% looks very real against that, in that context?

In fact, at the moment, Andrew, we're not even getting anywhere near the 2.3%.

I was going to say that you would have had a holiday first 1.5 months from what I see in the hospital data.

Well, last year, we are slightly just slightly below the $600 million of lower claims compared to that 2.3% expectation. So..

Yes. And next one, just looking at the high growth that you've seen in ahm. Just if you could talk to the direction of your -- the contribution to the risk equalization pool going forward into '23.