Medibank Private Limited (MPL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Medibank Private Limited Half Year '23 Results Investor and Analyst Teleconference. [Operator Instructions] I would now like to hand the conference over to Mr. David Koczkar. Please go ahead.

Good morning, everyone, and welcome to the Medibank 2023 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 Narrm, 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, including our Group Executive CFO and Group Strategy, Mark Rogers. I'm pleased to share with you the performance of Medibank over the half year. Today, we've delivered a solid result, driven by our commitment to support our customers. It is this focus that continues to drive our business and inform the decisions that we make. It is this focus on our customers that also drove our response to the cybercrime event. We recognize the significant impact that cybercrime had on our customers, and we will continue to support them through our cyber response support program. While we did see some impacts to policyholder growth in the second quarter, we are seeing positive signs of recovery and steady performance in Medibank Health despite the external environment. What I'm most proud of over the last 6 months is our ability to respond to the challenges put in front of us, whether it be COVID, inflation or cost of living pressures and of course the cybercrime event. Our values and our focus on our customers and our people enables us to respond. And while there is always more work to do, we will emerge stronger from these challenges. Today I'll take you through the key highlights of the results. I'll also share our short-term focus on regaining momentum in our core resident business and on how our growth strategy remains the same to play our role in sustaining health care in Australia by continuing to expand in health. And after this, I'll hand over to Mark, who will discuss our financial performance as well as share how we are positioned for growth as we manage inflation. And then I will provide an update on our outlook, and then we'll take your questions. So starting on Slide 5. To begin, I'll touch briefly on our half year '23 focus and highlights. The cybercrime was an unprecedented event, and I will go into some details shortly. But what I'm most proud of is how our people came together and how our focus on our customers never wavered. We've put in place a comprehensive cyber response support program for our customers and it further enhanced our security environment. We've responded to more than 60,000 customer calls and provided almost 13,000 health and wellbeing, identity protection and monitoring support interactions for our customers. We continue to meet our commitment to not profit from COVID, with our customer support now topping a record $1 billion, which is the largest financial giveback from any Australian health insurer so far. With inflation and interest rates continuing to rise, we know many Australian household budgets are under pressure, which is why we worked hard to deliver our lowest premium increase in 22 years earlier this month. We also deferred the increase for 2 months, which is in addition to the $207 million cash back our customers will receive in May as part of the give-back program. Our no gap network now extends to 27 hospitals across the country, and we've seen a 300% growth in no gap procedures compared to the prior period. Our Members' Choice Advantage network continues to deliver immediate savings to household budgets. This half, our customers have saved around $12 million in out-of-pocket costs through this network, which forms one of the largest health provider networks in the country, and it remains a key differentiator for our customer offering. We also continue to focus on preventative health with our Live Better Reward enrollments up 52% compared to the prior period. Almost 25% of Medibank customers admitted to hospital received personalized health support by our Health Concierge program, and we delivered around 1.3 million virtual health interactions to our customers and the community. Now to our financial results on Slide 6. Over the past 12 months, our resident policyholder growth numbers increased by almost 35,000. However, with a loss of almost 13,000 policyholders since the cybercrime event, growth over the 6-month period has been more subdued with policyholders up 1,700. This result is in part due to the majority of marketing and other acquisition activity stopping as a result of the cybercrime. The impact of the cybercrime was mostly contained within our resident health insurance business in the second quarter with other parts of our business continuing to perform well. A standout over the 6-month period has been the significant growth in our nonresident business, which grew by 33,400 policy units or 17%. With the resumption of travel helping accelerate recovery and grow this market, we continue to focus on growing share in this segment. Pleasingly, our health insurance operating profit increased by 8.7% to $305.2 million. As we continue to reposition Medibank Health in the post COVID environment, segment profit dropped 4.3% to $24.6 million, largely due to slower-than-expected volume recovery in the home care business and the end of our 1800 Respect and Beyond Blue contracts. On a continuing basis, the segment growth rate was 7.4%. We've reported a $55.9 million net investment income, up $25 million, which reflects the benefits of high interest rates and narrowing credit spreads. This was offset by $26.2 million in nonrecurring cybercrime costs, which at the full year we expect to be $40 million to $45 million. Group NPAT was up 5.9% to $233.3 million. And lastly, the Board has determined we will pay an interim fully franked ordinary dividend of $0.063 per share. Now to Slide 7. Today, we're able to share with you the outcomes of our ongoing investigations into how the cybercrime event occurred. This includes that the Medibank user name and password used by a third party IT service provider was stolen and used across our network. The criminal was able to access our network through a misconfigured firewall and the criminal obtained further user names and passwords to gain access to a number of our systems, and their access was not contained. As you would expect, our immediate focus was to support our customers and to secure our environment, to close down the attack path, and that is what we've done. Since the time of this event, we have been focused on how we can best support our customers. As you know, we launched our cyber response support program for our customers, which includes mental health and well-being support, identity protection and financial hardship measures. We extended call center hours, and we increased our customer support team by more than 300 people and redeployed our resources via phone and messaging channels to support our customers. And in November, we added 2-factor authentication for inbound calls to our contact centers to increase the level of security for our customers when they call for support. From a technology perspective, we have bolstered existing monitoring, added further detection and forensics capability across the Medibank system and network and has scaled up analytical support by specialist third parties. Additionally, we have ensured firewall authentication is fully configured across our whole network. And in December, we completed Operation Safeguard, which saw us take our systems off-line to further strengthen and enhance security protections and implement a program for further tactical activities, including those recommended by specialist third parties. The external review by Deloitte is ongoing. There is no doubt in my mind that we are in an arms race on cybercrime and the rules are changing every day. That's the new world we are operating in. We now defend more than 18 million perimeter attacks a day. Given this ever-changing cyber landscape, our focus going forward will be on continuing to support our customers and ensuring they have confidence in the protection of their data. We will continue to strengthen our security environment and enhance the security literacy of all our users and reinforce that security is everyone's business. And we will continue to evolve our approach to data management, particularly in light of impending reform to the Privacy Act and changing community expectations. Turning to Slide 8. The cybercrime was a significant event, and as you'd expect, it impacted our policyholder growth in the second quarter of the year. With the resumption of more normal business operations at the start of January, there are promising early signs of regaining momentum in the second half of FY '23. Last month, net resident policyholder loss slowed to around 1,100, while this month, up to 18 February, we have seen net growth of 200. Acquisition is improving for both brands, with cybercrime is no longer the top reason for people choosing to leave us. And in January, switching intent and returned to pre-cyber levels. Notwithstanding the impact of the cybercrime event, customers continue to choose our health and wellbeing solutions and take out additional life, pet or travel insurance policies with us, a good sign of their underlying trust in us. Efficacy levels have recently rebounded, although we have still some work to do to return to the high levels we achieved in FY '22. These early signs give us confidence of regaining our growth momentum in the core resident business, which will be further supported as we reinstate our marketing and retention activities this month. We're also continuing to focus on looking after our people who have shown incredible fortitude over the last 6 months. They tell us that they're well-supported and informed and remains strongly committed to our customers and to our vision. On to Slide 9. Australians continue to put their health and wellbeing first. The industry has now experienced 9 consecutive quarters of growth to September 2022, a record 14.37 million Australians now have private health cover. Retention rates remained relatively stable and above pre-COVID levels with growing numbers of younger adults and those taking our cover for the first time joining the industry. Importantly, this is taking pressure off public hospitals still recovering from the impacts of COVID, supported by low unemployment, increasing waiting lists in the public health system and reforms targeting younger people, we anticipate the resident market will continue to grow, albeit at a slightly slower rate. Despite the economic conditions and increasing interest rates, the impact is yet to be felt in the private health insurance industry. But it is important as an industry that we continue a longer-term focus on affordability, which is why we continue to work with the Australian government on key reforms, including prosthesis reform. And while we've seen some early signs of savings being realized, there remains a lot more work to be done on reforms that improve affordability and reduce waste in the system. In the nonresident market, there are strong signs of recovery. International student arrivals are rebounding strongly, and we expect further acceleration given China's recent announcement that students must study abroad to achieve their accreditation, suggesting this market will return to pre-COVID levels within 12 months. With working visas back to pre-COVID levels supported by government policies to address skill shortages and with visitor numbers also increasing, we forecast a return to prepandemic levels within 12 to 24 months for these segments. On to Slide 10. When you look around the world, there are 4 clear megatrends in health, and we continue to shape our strategy to respond to them. The consumerization of health is shifting the focus to personalized and connected experiences, with technology playing a critical role. We're building deeper relationships with our almost 4 million customers that go beyond the traditional health insurance, improving choice and health literacy and connecting people with communities as we work to empower our customers to manage their health and well-being. The growing prevalence of people with chronic health conditions and the potentially avoidable impact that this has on health systems requires a shift to prevention. As preventative health spending is expected to more than double by 2030 in Australia, we are supporting GP-led proactive care through our investment in MyHealth and working to make Live Better an integral part of our customers' lives with relevant prevention programs accessible to all. The ability to provide quality care that gives patients and providers greater choice and value is leading to the rise of new care settings. While Australia still lags behind many other countries, we are making good progress on our virtual care, short stay and home care offerings, increasing the accessibility of these new care options. And finally, the move to outcome-based care stems from the need for care to be more coordinated and funding better aligned to health outcomes as highlighted by the strengthening Medicare Taskforce report. We're building on our partner and provider networks to develop more integrated care options and develop connected experiences across triage, primary acute care that have a greater focus on patient outcomes, experiences and value. We have strong foundations in response to these megatrends and our aspirations for each are aligned to our vision, to create the best health and wellbeing for Australia. Now on to Slide 11. We know that our strategy has been the driving force behind our performance over many years, and that is the right one for our customers and our business. But given the recent cybercrime event and the changes in the external environment, we've reprioritized some activities in the short term to regain growth momentum in our core resident business and to accelerate our repositioning of Medibank Health. Ultimately, our strategy to grow as a health company and the pillars that contribute to this have not changed. I'll now talk in more detail about the contribution of each pillar to our strategy, looking back over the past 6 months and ahead for the remainder of FY '23. Now to Slide 12. We continue to reflect deeply upon the cybercrime's impact on our customers and apply the lessons we have learned. Our determination to deliver for our customers has only been strengthened by the events of last year. Our investments to improve our customer experience enabled us to quickly adapt our processes and divert resources to support our customers through the cybercrime. As mentioned earlier, we will also continue to evolve our approach to data management for all our customers, implementing lessons from the cybercrime event. Engagement with our digital channels continue to grow. As we further simplified processes, online claims increased 29% and self-service interactions were up 24%, while more than 40% of ahm's new customers joined online. Our ongoing integration of Live Better into the My Medibank app saw almost 2/3 of new Live Better members joining by the app, which we continue to enhance with the development of Home for Health, connecting our health care offerings seamlessly for our customers. As you would expect, customer efficacy as measured by service NPS was impacted by the cybercrime event. However, our scores remain above the benchmarks we set for the full year. For the full year, this milestone remains the same. Our people remain strongly committed to our vision and to our customers. And we remain above benchmark with higher levels of employee efficacy. And when it comes to our community, we are making good progress on our sustainability commitments, including our ongoing transition to 100% renewable energy, community programs, including parkrun and addressing loneliness and our procurement spend with Aboriginal and Torres Strait Islander businesses. Turning to Slide 13. Our unique dual brand strategy aims to provide customers with products and services that deliver more choice, more health and wellbeing to support and especially more value as financial pressures continue to mount the many households. Most of our new joins were younger customers and those new to industry, continuing the trend of the last few years. This half we have won or renewed 130 corporate accounts. We delivered health and well-being programs to more than 143 corporates and grew our online GP service for international students by almost 200%. We've also seen significant growth in the proportion of customers taking out additional life, travel and pet and car and home insurance, up 63% and saw stronger retention amongst those who had multiple policies or who were engaged with Live Better, highlighting the value of our strategy to deepen our relationship with our customers through diversified products and services. Live Better remains the strong differentiator for the Medibank brand, attracting new customers and engaging them in their health and wellbeing journey. It's also delivering more value for our customers. In the last half, we expanded the range and doubled the number of providers where members can earn Live Better award points. To date, customers have redeemed around $16 million in rewards. The strength and breadth of our provider and partner networks continues to be a key enabler of our differentiation strategy. We successfully negotiated 44 hospital funding agreements this half, collaborating with a number of hospital partners on initiatives that create mutual value for our customers and hospitals. This represents 26% of our current hospital agreements. While we haven't got the December data in yet, we expect to have lost market share over the last quarter as a result of the cybercrime. And given the cybercrime has impacted policyholder growth, we are updating our milestone. By the end of the year, we expect to be in a strong position with the momentum we saw in the first quarter. We will then look to achieve a 3-year market share growth of between 25 and 75 basis points, consistent with our existing milestone. And when it comes to our health insurance productivity milestone, we are now aiming to deliver $30 million in savings between FY '23 to FY '25, including $10 million in this financial year. Now to Slide 14. Australia has a great health care system, but it needs to keep evolving. Driving innovation in health to give customers greater access, choice and control over their health is where we can and are playing a meaningful role. Our expansion in health also provides us with the ability to bring benefits back to our customers and deliver them more value. Almost 1/3 of Medibank patients undergoing joint replacements are now choosing to have rehab at home, although no gap network has doubled in size. We are also supporting more customers to manage their health and wellbeing, increasing enrollments in our preventative programs by 6% and growing both the membership of and engagement with Live Better, which is on track to achieve 670,000 members by July. We are also on track to achieve our health and wellbeing milestones, which remain unchanged. Through Amplar Health, we're also working to reduce pressures on hospitals and strengthening both the public and private health systems. Our investment in MyHealth, supports the crucial role GP-led care plays, particularly in preventative health. With 107 primary care clinics, MyHealth is well-positioned to play a larger role in coordinated, proactive prevention in line with the recommendations of the Medicare taskforce. Further enhancing this is the growth of Medinet's virtual practice platform for GPs, which is supporting our ambition to scale our virtual health offering, while meeting the needs of our customers and the broader community. Recent investments are also supporting our expansion into health and to progress our development of the new care settings which are critical in providing our customers with greater access choice and control of their health. This month, a new orthopedic theater was completed at East Sydney Private Hospital to deliver short-stay surgery and support the public system with 20% of surgeries now helping reduce public waiting lists. And we expect the world-class orthopedic surgical center at Macquarie University Hospital in Sydney and Adeney Private Hospital in Melbourne to open mid next year. The challenges in the public system are real, with ambulance ramping at emergency departments, increasing elective surgery waiting lists and a stretched primary care system. In support, our joint venture with Calvary in South Australia, the South Australian health My Home Hospital service had a significant increase in referrals this half. More than 2,600 patients were admitted, and we saw a 76% increase in virtual bed capacity compared to the first half in FY '22. This service is one of the first in Australia receiving referrals from ambulances. Also our work to enable North Coast Health Connect in Northern New South Wales is boosting health equity and access to primary care through 24/7 triage and direct connection to local health services in the region. Since coming online in December, the service has responded to more than 600 calls and web chats. These types of innovation are what is desperately needed in our health system, both private and public. And this is the role Medibank is uniquely suited to play, providing access to care for people who need it at the time that they needed, without putting further pressure on a system that is strained. Over the next 3 years, we aim to invest between $150 million and $250 million in our target health markets, including additional short-stay hospitals. While some of these investments will take time to deliver meaningful financial returns by helping increase the value of our services supporting the health of people throughout Australia, our customers included. I'll now hand over to Mark.

Thanks, David, and good morning. The key themes of the result are continued momentum in the health insurance business, solid performance in Medibank Health despite the external environment and recent contract transitions and a strong capital position. Health insurance performance reflects continued policyholder growth and positive jaws in the resident business. And very strong policyholder growth and margin recovery in nonresidents. Group operating profit was up 7.4% to $307.8 million. And whilst investment income increased by $25 million, this was offset by nonrecurring costs associated with the cybercrime. For the full year, we expect these costs to be between $40 million and $45 million, including nonrecurring additional investment in IT security. And reported EPS was up 5.9% to $0.085 per share and underlying EPS, which adjusts for the normalization of investment returns, was up 6.7% to $0.082 per share. Now moving to Slide 17. The granular view of total claims for the 6 months to November shows that despite very limited COVID restrictions this period payments were below the prior period, reflecting changing customer preferences, workforce shortages and hospital operational impacts. We continue to see the same trends as observed in previous periods with nonsurgical claims being more impacted than surgical, particular softness in rehab and respiratory claims and no evidence of increasing mental health claims. An emerging trend this period was prosthesis claims growth being 7% below the growth in private hospital surgical claims due to the positive impact of the 1 July price reforms. This period of resident claims were more than $267 million or 9% below our expectation of underlying claims growth per policy unit of 2.3%. And given this and the absence of government restrictions on hospital admissions, we have not added to the deferred claims provision this period. At 31 December, the provision sits at $411.6 million, which is down $37 million from 30 June due to customer lapse and the expiration of Medibank extras limits. Slide 18 covers the health insurance result, which shows reported revenue and gross profit grew 2% and 9.3%, respectively. During the period, the risk equalization payment increased in line with growth in the number of ahm customers, which is skewed to younger and lower-claiming policies. And our claims growth continuing to be low than industry. Permanent claims savings were returned to customers through $267.7 million of giveback initiatives, resulting in COVID having a modest $500,000 negative impact on operating profit. Pleasingly underlying gross profit increased 8.8% to $579.6 million with underlying revenue growth of 5.6% and a 50 basis point improvement in underlying gross margin to 15.3%. And whilst the management expense ratio was 30 basis points higher, underlying operating margin was up 20 basis points to 8.1% and underlying operating profit up 7.7% to $305.7 million. Turning to Slide 19. The resident health insurance market remains buoyant with estimated growth in the last 12 months of 2.5%. And although this is slightly lower than FY '22, it has been impacted by Medibank's growth in the last 3 months. Importantly, the trend of growth in new-to-industry and younger age customers has continued, which given they are typically lower claiming positively impacts the quality of the insurance pool. In the same period, our policyholder numbers increased by almost 35,000 or 1.8%. However, with a loss of 13,000 policies since the end of September, growth in the last 6 months of 0.1% was well below the 1.5% achieved in the prior period. In the last 6 months, customer lapse and acquisition deteriorated by 80 and 60 basis points respectively. Following the cybercrime, customer retention was impacted by the diversion of resources to support higher call volumes and the majority of above-the-line marketing and other proactive sales activity also paused. Pleasingly, the Medibank acquisition rate was only down 30 basis points, which is indicative of the positioning and resilience of the brand. And although the ahm acquisition rate was down 160 basis points, this was largely due to lower aggregate sales. As David mentioned, with the resumption of more normal business operations, since 31 December we've seen policyholder trajectory improve with acquisition rates recovering and retention rates stabilizing. In the second half, as we return to growth, we will focus on the growing corporate market, allocating additional resources to improve retention and increasing ahm aggregator sales. Turning to Slide 20. Underlying resident claims, which exclude COVID impacts were up 4.8% and underlying net claims which includes risk equalization were up 5%. Risk equalization had a 20 basis point impact on claims growth this period, which is an increase on the prior period and consistent with the return to more normal-age claiming patterns. Underlying resident claims growth per policy unit was up 40 basis points to 2.3%, with stable hospital claims growth and an increase in extras. Hospital claims growth reflects that the higher risk equalization charge was offset by prosthesis savings with the increase in extras due to investment in additional benefits and sales mix. And health care cost inflation had minimal impact on claims growth this period, with the majority of private hospitals already contracted for FY '23. Assuming the prosthesis savings we saw this period are maintained and based on rehab referral trends at pre-COVID levels, we expect underlying resident claims growth for the full year of 2.3%. However, given the economic environment, we are closely monitoring spend and more discretionary extras modalities for signs of further softness. Slide 21 details underlying health insurance performance, which shows strong growth in both the resident and nonresident businesses. In the resident business, underlying gross margin was up 10 basis points to 14.8%, with revenue and claims growth per policy unit of 2.4% and 2.3% respectively. The decrease in revenue growth per policy reflects the lower premium increase this period and a 10 basis point increase in downgrading to 70 basis points. Despite the economic conditions, we expect downgrading of 70 basis points for the full year, aided by our focus on increasing product value, portfolio management and sales mix activities. And based on the improved premium increase of 2.96% and the expectations for underlying claims growth, this should result in modestly positive jaws for the full year. Pleasingly, the momentum in the nonresident business has continued with a 34.4% increase in policy units and underlying gross profit up 107% to $31 million. The favorable student tenure and mix impacts we saw in 2H '22 have continued, and underlying gross margin of 34.1% compared to 21.5% and 29.2% in 1H and 2H '22 respectively. Our customer growth has continued in January, and with further growth in the work and visitor market segments likely, gross profit in the second half is expected to be higher than in the first half. In the medium term, further growth opportunities exist through utilizing our unit integrated health offering, improving product value, including in virtual health and investing further in this attractive market segment. Now moving to Slide 22. Management expenses were up 10% to $273.9 million, with the major driver of the increase in nonresident sales commissions, which grew with policyholder acquisition. Whilst commissions of $11.4 million were in line with 2H '22. Based on the current policyholder trajectory, we expect that will increase further in the second half. The modest growth in D&A reflects higher spend on digital assets. And whilst deferred acquisition cost amortization also increased, this remains above the level of new acquisition costs. And in line with the new insurance accounting standard, we will commence expensing all acquisition costs from 1 July. Operating expenses were up 7% with cost inflation of 4% and modest volume impacts, partially offset by approximately $4 million of productivity savings. This period we also had a higher proportion of annual investment and some other spend than normal. But this is expected to unwind in the second half. Whilst achieving productivity savings, this period has been impacted by the cybercrime. We are targeting $30 million of savings over the next 3 years, including $10 million this year. And despite the underlying management expense ratio increasing 30 basis points to 7.2%, we expect management expenses of $560 million from the full year and that the management expense ratio will not be above last year's. Going forward, we will continue to leverage our productivity program and the benefits of scale to target further modest improvement in the management expense ratio whilst balancing the need to invest for growth. Turning to Slide 23 and Medibank Health. Whilst the majority of COVID impacts on Medibank Health have unwound, this period performance in the home care business was impacted by subdued private hospital admissions and higher labor costs. And in telehealth, the transition out of the 1800 Respect and Beyond Blue contracts in 2H '22. Excluding these contracts, segment operating profit was up 7.4% to $24.6 million with a 14.6% increase in operating profit, partially offset by a lower contribution from our health care JVs where the prior period included nonrecurring COVID income. Revenue increased 5.9% to $139.5 million, with strong growth in health and wellbeing and recovery in travel insurance sales, partially offset by a reduction in telehealth and home care. Gross margin was down 40 basis points to 44.7%, with higher home care labor costs and inflationary impacts, partially offset by business mix. However, flat management expenses and a 170 basis point improvement in the management expense ratio meant operating margin increased 130 basis points to 16.9%. And this reinforces the importance of increasing scale in this business. The areas of focus for the second half include volume and performance uplift in home care, continuing to reposition the business to meet the emerging needs of Medibank customers and delivering synergies between our businesses. And whilst profit growth this period was impacted by these lost telehealth earnings, business has good momentum and growth potential for meeting the needs of Medibank customers. And we continue to target on average organic growth of at least 15% per annum over the next 3 years. Moving to Slide 24. Investment income was up $25 million or 80.9% to $55.9 million [indiscernible] higher interest rates and tighter credit spreads this period. The $8.6 million reduction in income in the growth portfolio was due to manager underperformance and property investments and mixed performance in equities. With strong returns in the domestic market more than offset by weaker returns in international. In the defensive portfolio, the $20.9 million increase in income includes $22.5 million from the higher RBA cash rate and $3.9 million from tighter credit spreads. This is partially offset by the steeping yield curve, resulting in $8.6 million lower-than-expected income on international fixed interest holdings. During the period, the average RBA cash rate was 235 basis points. And based on the current spot rate of 335 basis points. In the second half, we expect an additional $10 million of interest income in the defensive portfolio. Underlying investment income was up $26.6 million and the underlying investment return up 52 basis points to 1.45%. The 27 basis points spread above the RBA cash rate is on an annualized basis below our target of 150 to 200 basis points. However, based on the current shape of the yield care, we expect the spread to improve in the second half. Slide 25 covers capital. Our capital position remains strong with a Health Insurance capital ratio of 13% at the top end of our target range and unallocated capital of $198.1 million, modestly above the prior period. During the period, Health Insurance required capital increased in line with revenue growth and the increase in other required capital largely reflects the hospital joint ventures that David mentioned and the investment in Medinet in 2022. A strong capital generation and level of unallocated capital means we are well-placed to fund inorganic growth and consider capital management opportunities don't eventuate. And following industry consultation, the final APRA capital standards have been issued and included a number of favorable outcomes relative to our standards. From 1 July, we expect our target health insurance capital ratio will reduce to 10% to 12% of forecast premium revenue from the current 11% to 13%. At the top end of this range, health insurance capital at 31 December would have been 2x the minimum regulatory requirement for PCA, noting that our PCA as a proportion of premium revenue is significantly lower than the industry average due to our scale and operating margin. And the Board has declared a fully franked interim dividend of $0.063 per share, which is an increase of 3.3% and a 76.5% payout of underlying net profit after tax. And to finish, a few comments on our areas of focus for delivering growth and managing inflation in the second half. In the Health Insurance business, maintaining revenue momentum is key, and our immediate imperatives are reestablishing resident policyholder growth, continuing to manage downgrading, and maintaining the strong growth trajectory in nonresidents. The markets Medibank Health operate in remain attractive. And we continue to focus on growing participation in our leading health propositions, increasing scale to create operational efficiencies and delivering synergies between our businesses. Over the next 3 years we also aim to invest between $150 million and $250 million through further M&A where this adds scale, geographic coverage or new capability. We continue to target ways to offset inflationary pressure in claims. And with initial promising signs, it's critical that prosthesis reform continues to deliver benefits, including through changes to the way that general and miscellaneous items are funded. Potential offsets to inflation include the increasing likelihood, but the current low rehab referral levels will at least in part be permanent, the trend of more procedures occurring on a same day rather than an overnight basis. And the benefit of continuing to grow participation amongst younger customers. And by providing more services to Medibank customers, Amplar will also play an important role through an increasing focus on prevention, supporting the shift in new care settings and delivering integrated models of care at scale. And maintaining our cost discipline, productivity program and closely managing noncash costs will be critical to expense management. And increasingly we believe our economies of scale will provide a competitive advantage to most peers on. I'll now pass back to David to make some closing remarks.

Thanks, Mark. Let's look at Slide 28. Whilst our strategy is the right one, as I said before on the short term, our immediate priorities post the cybercrime event are to continue to support our customers and our people. Focused on reestablishing our momentum in the resident policyholder growth and continuing to reposition Amplar Health to support our core customers and pursuing our growth agenda in health. We are a resilient business with great people. Our customers and their needs will always be at the heart of our business. The lessons we have learned from the cybercrime will continue to shape our response and we will emerge a stronger business. And we are well-positioned to grow on multiple fronts. Based on the early signs of momentum, we are confident that we can regain growth momentum in our resident policy holder numbers and we'll continue to focus on gaining share in the growing nonresident market. We will continue to scale and connect our existing health and wellbeing businesses with strong foundations in our target high-growth markets. We'll continue to prioritize growth in Medibank Health by directly supporting Medibank customers, as well as looking for opportunities to take pressure off the public system through our scalable health offerings. We remain uniquely positioned in the market and are very well capitalized to fund growth so we can continue to use our strong balance sheet to invest in further opportunities with partners to support our growth ambitions. We have an incredible team of people at Medibank. And I want to thank them for the support they have shown to our customers and each other. I'll now speak to slide 29. Return to our outlook for FY '23, we continue to assess claims activity and remain committed to not profit from the pandemic, returning any permanent net claim savings due to COVID to our customers through additional support in the future. Following the withdrawal of our policyholder growth outlook in October, our new outlook for resident policyholder growth in FY '23 is to grow by 0.5% to 0.75%, which assumes the continuation of trends we have seen in January and February and a modest decline in industry growth rate in FY '23 relative to the full financial year '22. We'll provide a further update on our performance and outlook at the Macquarie conference in May. We expect underlying claims per policy unit of 2.3% for FY '23 among resident policyholders. We remain focused on controlling our costs. And as Mark mentioned, our productivity program was impacted by the cybercrime during the half. We are now targeting $30 million of savings over FY '23 to '25, including $10 million in FY '23. Nonrecurring cybercrime costs are expected to be $40 million to $45 million in FY '23, which includes a one-off investment in IT security and excludes potential of further customer and other remediation, regulatory- or litigation-related costs. And finally, targeted organic and inorganic growth for Medibank Health and Health Insurance continue to be areas of focus, supported by strong capital position. I'll now hand over the call for any questions.

[Operator Instructions] Your first question comes from Matt Dunger from Bank of America.

Appreciate the additional detail around policyholder growth and the FY '26 aspiration. Given you've reinstated marketing activity, you're talking about options on aggregator for our Chairman and the corporate market. Why is the target 3 years away? And when can you get back to system growth?

Thanks, Matt. Look, I think first, we are resuming all business operations since January. You know, we're very pleased with the early signs of recovery. So things we look at particularly switching intents now back to pre cyber levels, our net promoter score, customer advocacy scores are getting pretty close back to pre cyber levels and our sales conversion is also back to where it was. So I think as we ramp up our marketing activities and further strengthen our attention activities, yes, we think that that will lead to our growth for the full year this year being 0.5% to 0.75%. And when you look at that as a Q4 growth rate, we're then pretty similar to where we were in Q1 and that that then gives us confidence that then we move for the next 3 years, we're back to where we were before the cyber event.

Great. And if I could just ask a follow up on claims inflation. Private hospitals are seeing some higher surgery volumes. Appreciate you've given us some additional detail on some of the offsets, but how long is the 2.3% underlying able to be maintained? Do you think you can maintain that medium-term?

So Matt, that's going to be a balance between a whole series of factors, but bearing in mind our payments to private hospitals are less than 50% of our total claims payments. And whilst we're seeing some inflationary impact through hospital indexation, equally probably the biggest opportunity for our claims line is on rehab. So we're currently seeing somewhere in the vicinity of 20% lower rehab referral rates than what we saw pre-COVID, and that's, we're assuming they revert within a 2.3%. If they don't, that's a potentially $50 million to $60 million of claims saving going forward. And then when you look at the other claims component of our claims, of the majority, you've got prosthesis, which is deflationary, you've got the medical benefits, which are capped at a pretty low level given the government's a co-payer. And then there's a potential that we get a deflationary impacts in ancillary given some of those discretionary modalities will be impacted by inflation. So if I sit here today, Matt, and say what's the bias? Is it up or down from the 2.3%, at least in the short term I'd say the bias is more to the downside than the upside. And the reason I say that is our current claims are 9% below that 2.3% underlying expectation.

Your next question comes from Vanessa Thomson from Jefferies.

I just wanted to follow, circle back on that rehab referral trend. I think at the last result you said the rehab spend was 15%, around and below the surgical claims growth. Is that still true?

It's 20% below the surgical claims growth. The surgical claims are down 2% and rehab was down 22%. So in fact the trend is actually -- there's a bigger gap opening up between surgical and rehab claims growth. We're also now seeing about a third of our customers that have a total joint replacement having treatment in the home and not in the hospital. And both of those factors are giving me increasing the level of confidence that at least some of the rehab savings we're seeing will be permanent.

Right. And I then also wanted to ask about the prosthesis reform again. I think initially the expected benefit in FY '23 was $90 million for the industry. Is that kind of what you're seeing? Is the benefit you're seeing aligned with that target?

So Vanessa, we're definitely seeing the price savings come through. It will take a little bit more time for the emergence patterns of lower to ensure there's no utilization offset. But I think there are some really good promising signs that the reform will actually deliver real benefits this time. And then when we look forward into the next round of cuts, we'll have another small set of cuts on 1 March, which is related to a few items in the general miscellaneous list, but there will be a wholesale second stage of price cuts coming through on 1 July. And in that group we're expecting a modestly higher benefit level next year compared to this year in terms of total price cut benefit.

Your next question comes from Kieren Chidgey from Jarden.

I've got a few questions. I might just start on sort of the health insurance claims trend. So just wondering if you can unpack sort of the difference between the 2.3% underlying you're talking about and then some of the trends on slide, Slide 17, I think, where you're showing first half '23 has actually seen more of a benefit relative to PCP with total hospital claims down 7% pre-COVID relative to 4% last period. What's sort of the difference between those 2 sort of outlooks?

So Kieren, do you want to direct me to the -- you're looking at Slide 16, which is the…

17. Sorry, Mark. 17. So where you're showing hospital claims per policy unit first half '23, tracking 7% below pre-COVID. First half '22 was 4% below. So just wondering sort of given you're showing there that things have improved on PCP, how we sort of tie that in with the 2.3% underlying inflation number you talked to?

Yes. So don't forget, Kieren, we had some impacts in the second half of last year, which we had high growth in the second half of last year. So I think you're seeing the second half impacts flowing through into this period. What I'd say at a high level though, across most of the trends and particularly surgical, we are seeing softness now relative to what we were seeing in the second half of last year. So I'd say you need to look across not just the PCP but also versus the sequential halves as well.

All right. And the 2.3 mark, I think last result you were saying similar to some of the previous questions this morning that you were allowing for rehab to kind of get back to where it was, still tracking obviously 20% below. And you also had been pretty conservative on prosthesis benefits coming through. Both of those areas seem to be tracking better than expected. So just wondering why so you haven't revised down the 2.3% outlook? Are there other areas that have been slightly higher, including ancillary?

Yes, a good question, Kieran. So let me start with prosthesis. So we are building in some benefit within the 2.3, but not all of the benefit. We'll wait to see the emergence pattern to ensure that utilization doesn't offset. So I think it's prudent we take a conservative approach given the history on prosthesis savings over the last couple of periods. And when I look at rehab, Kieren, we are assuming this $25 million to $30 million of savings in rehab relative to our 2.3% assumption. So we're assuming rehab reverts. In the current period, there was real savings on rehab of between $25 million and $30 million that we gave back to customers through permanent claim savings. You're right, it's conservative, but we see those as being natural offsets to any inflationary pressure coming through hospital indexation. And on rehab, we really needed to see 12 months of performance and behavior in hospitals without any restrictions. And if you recall, most of the most recent restrictions unwound in February and March of last year. So I think we're now getting with the inflection of time, more confidence that rehab wont revert, and we'll reassess that assumption in terms of reversion or staying at current low levels at the full year result.

All right. And just a second question more around sort of industry policy trends and outlook. I mean you've given a fairly stable downgrading outlook of 70 basis points despite the tougher economic climate ahead. Just wondering at an industry level what you're expecting in terms of penetration rates. Particularly interested in sort of views around, say, the 30- to 50-year age cohorts, just given they're obviously going to be more impacted by higher mortgage rates coming through.

Well, I'll start [indiscernible] and Mark, you can jump in. I think what we're definitely seeing is still a continuation of the post-pandemic factors in industry, certainly increased interest in health and wellbeing. Customers are seeing more value in PHI, I think, more than 2/3. It's a growing number, seeing private health insurance essential and the knowledge of the challenges in the public system, particularly with waving was very well-known. I think also the focus of the industry and also us on keeping premium increases as low as they can be, we sustained lower premium increases. That's also helping with affordability. I think you got to look at the customer base of PHI. They're twice as likely to be higher income earner than nonholders. I think whilst there will be some impacts in some parts of the community, I think there's a resilience in the PHI customer base there. And we continue to see strong retention rates above the pre-pandemic levels. I think the other point on the younger customers, we did, as you saw last quarter, we and others put in the dependent reforms to allow customers up to 31 to be on their parent's cover. We have seen -- it's early days, we've seen that come through. And so I think that's a key focus continuing for reforms, how do we keep premium increases low as we can, how do we retain attraction to younger customers. But we've seen our acquisition in the last half for the customers under 40 is still being above or around 70%, which is a continued trend for us.

And maybe, Kieren, on your downgrading point. There was a slight improvement in the level of downgrading this half, 70 basis points versus 60 basis points in the prior corresponding period. But we did invest fairly significantly in the loyalty proposition. And also, it's fair to say during the second quarter when we were trying to retain customers post the cyber event, we had to use offers and other incentives more than we normally would. So we had 2 one-off factors that we don't expect to occur in this period. So when we look forward into the second half, we think we've got some capacity within that 70 basis points to absorb any further economic pressure. And you're right, back to your last question. In the first half of '22 we saw a more significant sales mix towards extras where in this period we've got a much higher sales mix towards hospital. And provided either the sales mix to hospital or extras doesn't change or the Medibank and AHM policyholder growth doesn't become too a skew, we're not seeing a lot of pressure -- a lot of further downside or upside to that 70 basis points for the full year.

Your next question comes from Andrew Buncombe from Macquarie.

The first one is just in relation to the DCL. You obviously haven't put any new claims into that bucket this period for company-specific reasons. But going forward, do you expect to put any more in? Or have you officially closed the window on that?

You never officially close the window, Andrew. But I would clarify, it's not company-specific reasons. The driver of having a DCL is that there is federal government or state health authority restrictions on private hospital admissions, which we had none of. So our reading at least to the accounting standards, there was no constructive obligation, and therefore we were not able to accrue further DCL. Having said that, if there are further restrictions going forward, then obviously the same methodology we've used in the past would be possible again.

Yes. That helps. And then just my second question is in relation to Slide 14 where you have again flagged the $150 million to $250 million of investment in Medibank Health over 3 years. Can you just give us an update given what's happened with the cyber event? Should we be expecting that to be more back-ended now or evenly over the period? Just some comments on the shape would be great.

Thanks, Andrew. I'd like to kick off and maybe, Andrew Wilson, if you want to make any comments on what we're seeing in the market. But look, the cyber event was significant for our business, but it hasn't impacted really our opportunities to expand in health. Our partnership programs continue to drive very positive impact to our customers and where we've maintained a lot of discussions in market about potential targets and opportunities for growth. We will remain very disciplined in how and where we grow, as you would expect. But based on our pipeline and our focus areas, we remain very confident about that objective.

Yes. Thanks, David. Look, I would echo that. I mean, we've got a strong pipeline in the areas that we've been very clear about. We're looking at, particularly in ambulatory care, short stay. And that really hasn't changed at all as a result of the cyber impact. We think there are tremendous opportunities for us inorganically as well as organically. And we'll continue to look at areas of companies where they're going to add business, to add value to our business in the segments that we're in.

Your next question comes from Siddharth Parameswaran from JPMorgan.

A couple of questions, if I can. Firstly, just if I could just bring you back to Slide 17. I think it was where you were showing a significant reduction in the cash payments for several different segments there. I was just wondering if you could help us quantify if the rehab and respiratory claims were to persist at these lower levels. I think you mentioned on the rehab side it was about $50 million to $60 million permanent savings that would continue. I was just wondering if you could also help quantify what respiratory might be.

Yes. So respiratory is about 6% of our total claims and rehab is around 23%. I don't think we said they would, we said there's an increasing likelihood they may.

Yes, yes, sure. Yes. So I understand. Okay. Well, maybe on that point, just -- well, maybe 2 related questions around that. Just could you help us understand the logic of the rehab being down? And that when will you get comfort around this? Is there something that's fundamentally changing in the hospital system that's leading to that rehab being down? And when will you get comfort around that point?

So kind of go back to when we were at the start of COVID, bed availability was really low, many beds were put aside for potential COVID admissions. So the low acuity beds in -- particularly in rehab were held available for the public health system. So I think you've got discharge planners and surgeons more comfortable of discharging patients to home for rehab or not having a rehab at all. That's just continued. It's now 2 years since that started, and we haven't reverted. There's also a change in customer preference starting during COVID where customers didn't want to go to a rehab facility for 14 days and risk being infected if another patient had COVID. So it's a combination all through the referral chain from patients all the way through to surgeons having changing preferences, a greater understanding and appreciation of the capacity and ability to rehab in the home. And I think I may have mentioned in an earlier answer, 1/3 of our customers that go through a total joint replacement now have rehab at home.

Yes. Okay. So it sounds like it should be pretty imminent in terms of your assessment of that. Just around ancillary then, if I could just ask for a similar observation on -- versus -- I mean, similar to what you show on Slide 17, are cash claims down on ancillary at all? Or how are they tracking versus pre-COVID levels?

Yes, of the $267 million of savings we had this year, permanent claim savings, $54 million of those were lower ancillary savings -- were ancillary -- related to the ancillary product. So slightly less than 25% of our total claims savings, which is ancillary accounts for about 25% of our policies. And we're seeing a bit of a mix there. We're seeing dental claims still being pretty strong. And I think like most in the community, I didn't go to the dentist for 12 months. But the areas we're watching most closely, specialties like in modalities like optical where customers are choosing to have a new pair of glasses every 2 years, not every 12 or 18 months. And then natural therapies and physiotherapy are pretty soft as well. So I think you're going to get a stratification in ancillary and extras between dental and the majority of the other modalities.

Sure. I mean the difficulty is with those permanent savings of $54 million that you flagged, I think there's DCLs and other factors that clinch that number. Is this running on a cash basis? How is it tracking?

That would be around $30 million, $30 million to $35 million. There's about a $20 million Medibank ancillary provision that was released at 31 December.

Yes. Okay. Just a final question for me is just around DAC. And I think with the new APRA standards, there will be -- you won't be able to capitalize the DAC anymore. And a lot of your growth certainly has been coming through the ahm channel, I think, through aggregators, et cetera. I was just wondering if you could comment on whether we might see a change in your marketing strategy going forward or whether that influences anything, whether we might see a change in the expenses that come out of the change in the accounting standards on once you switch over?

Yes. So, if anything, expensing rather than capitalizing will be a slight tailwind for expenses because we're currently running off the DAC balance. Our strategy for some time has been to continue growth in the [ ag ] channel, but moving more of our sales to the direct channel. So I suspect it's going to be a second order impact for us, but slightly positive going forward. What it does mean though is it opens up the marketing spend bucket more broadly and greater fungibility between above-the-line marketing or paying commissions because they now all get treated exactly the same way from an accounting perspective.

So just to add to that. From a strategic perspective, as Mark said, we will continue to bias acquisition to direct channels. In the last half, 80% of our joins were direct, which is up from about 70% the previous year. Some of that will be due to changes in marketing spend. But we -- that's a target that we have that's quite differentiated in market. So that continues to be a focus.

Your next question comes from Nigel Pittaway from Citi.

Just first of all wanted to return to the turnaround in policyholder growth in this year. In past I think you said acquisition in both brands had improved. Can you make any comment about what's happened to the lapse rates over the period?

Well, I think when you look at the first half, the acquisition rates, particularly for Medibank, were pretty -- I mean, they were down slightly year-on-year, but held pretty strong. And we've seen that continue. As I said before, our sales conversion rates have held pretty strong. A third of the ahm business has rebounded pretty quickly. I think given the impact of the cyber event and the associated impact on the Medibank name, that did impact the Medibank brand slightly more. But as we resume retention activities, that's where our major focus are. I think the lead indicator I look at is switching intent by our members, and that's now back down to pre-cyber level. So the thought about leaving is about the same. There are reasons for leaving, and they are not due to cyber as much as they were. And we expect to see improvement as we focus on those activities.

Yes. And so Nigel, the Medibank lapse was impacted by 90 basis points across the -- versus [ pac ]. And ahm was only down 60 basis points. So Medibank brand out in the media, bigger lapse impact. Medibank retention program more developed and more embedded than what it is in ahm. So turning it off also had a bigger impact. So we'd expect that returning those retention programs back on. Similarly, it will be easier to have an impact on Medibank retention as a consequence.

Okay. So more particularly in the 6 weeks of this year, has there been improvement in lapse rate? Or have you seen an improvement in acquisition rate with lapse rate still remaining pretty similar?

Well, in both, but largely there's been a bigger impact on acquisition.

Yes. Okay. And then just sort of turning to -- sorry, yes.

No, go ahead, ask your question.

Okay. I was going to go on and sort of ask about sort of in terms of -- I think you're saying that your fourth quarter growth rate you think should be similar to 1Q, which does seem to indicate confidence that the worst of the cyberattack impact is behind you. So I was just wanting to hopefully explore that confidence a little bit and also sort of maybe just a question that your -- how confident you are that you're not going to get sort of a second wave where individuals start sort of really trying to up the scamming activity versus customers? Can you maybe comment on that? I realize it's probably sensitive, but.

Well, Nigel, I think there's -- first and foremost, the cybercrime event was a significant event and impacted our customers. And that's the first thing we should say. And our priority and my priority for the business at that point was to understand what happened, was the shutdown of the attack path, which we've now done and safeguard and support our customers. We rediverted resources to do that. We greatly reduced our marketing spend. And that contributed to policyholder loss. The main reason for leaving during that second quarter was due to the cyber event which we expected. I think as we go now, since we are resuming more normal business operations, we're rediverting our people back to more normal activities because the calls into our call center around cyber are greatly reducing. We continue to support customers if they need us with our cyber recovery program. But what we're seeing is customers now want us to support them with their health and wellbeing. We're having people now looking to join us. We're having retention rate conversations more and more. And so based on those early signs, we're confident that when we get to Q4, we will be resuming the similar growth momentum that we had in Q1. Look, the question of the go-forward, I think this is an arms race out there in the world of cybercrime and the rules of the game keep changing. Before the cyber event, we were successfully repelling around 200 million, 225 million cyberattacks on our perimeter each month. Now it's almost 3x that. And so we will continue to learn the lessons we have learned. We will continue to make sure we do everything we can to strengthen our environment, but we're going to remain vigilant as every company needs to.

Okay. Okay. And then so maybe just finally, I mean obviously you said you've done sort of 44 hospital negotiations. I appreciate you've got some defensiveness in there because you've negotiated forward. But can you give us any sort of broad flavor as to sort of the level of inflationary pressures that are starting to come in to those negotiations?

Well, I think what we say is we recognize that the COVID environment has been challenging, and it has required all of us to rethink how we run our business. We've taken $100 million out of our own cost base over the last 5 years. We've had an ongoing dialogue with all our 450 hospital partners. We just don't turn up the day before the contract is ready and provide our expectations of rate. So we have seen a move towards a more forward-looking partnership agreements where we're creating mutual value for customers. We need to keep premium increase as low as they can be, but also recognizing in supporting hospitals who are keen to create an environment of innovation and sustainability, and that's what we've been focused on.

And Nigel, on behalf of our customers, there's a certain affordability we can pay for all claims inflation. And if you've got deflation in prosthesis and you've got rehab rates to the lower than pre-pandemic, then of course the affordability to pay for higher hospitalization has improved. So it actually comes down to the, is there certain affordability. And if we don't have unnecessary prosthesis cost increases and utilization increases and rehab referral trends are helpful, and of course that opens up the opportunity to reassess what's affordable from an indexation perspective. And I guess that's the way we think about it.

Your next question comes from Dan Hurren from MST Marquee.

I just wanted to ask about IT costs versus the one-off cybercrime costs in FY '23. So I know we're not talking about FY '24 guidance at this stage, but is there a risk of a high reported IT spend in the cybercrime arms race as you call it, beyond the $40 million to $45 million one-off costs this year. I guess I'm asking you is do we need to think about some of that nonrecurring actually becoming recurring? And I guess finally, is this considering the productivity savings.

Well, I think the first answer, that productivity for us isn't always on activity. And that's about -- cybersecurity and IT security has actually been an area of investment over the last few years. In fact, we've probably doubled our spend in this space over the last 3 years before this year. So I think that's certainly the priority for us and certainly a priority going forward.

And I don't want to look too far ahead, but I'm not expecting at the half year or full year result next year that we're talking about cyber being, additional ongoing cyber costs being a major factor of any increase or decrease in management expenses. I think you -- we're more spending time thinking about our long-life IT assets that are almost fully depreciated and the impact that has on our costs. I think there was a question before about deferred acquisition costs and the impact of the new standard and also the overseas commission of this period being very, very high given the policy order growth has been 34%. I'm thinking those 3 factors will be part of our narrative at the next conversation on costs rather than ongoing run costs for IT security.

Your next question comes from Doron Kur from Crédit Suisse.

Sorry, nothing more from me.

There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.