nib holdings limited (NHF) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the nib investor briefing conference call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Mark Fitzgibbon, Managing Director of nib. Thank you. Please go ahead.

Thanks, Christian, and good morning, all. Thanks for your time. While we're obviously disappointed by our latest forecast for fiscal '20 and update today, it's fair to say our original guidance has been under a little pressure for a couple of months and naturally we have been extremely diligent about our continuous disclosure obligations. But the latest industry risk equalization numbers surprised us and made this update today necessary. We're seeing that at the very beginning of fiscal '20 that it was a reset of sorts given our high arhi margins of fiscal '19 and lofty margins in our international workers businesses in the face of growing competition. However, we sure didn't quite expect this level of decline in underlying profit as a new base. As our announcement today stated, behind the downgrade is a higher-than-originally-anticipated claims inflation across all insurance businesses, although it is worth emphasizing much of the deterioration in arhis is associated with an under provision of our outstanding claims in fiscal '19 and, as I've touched upon already, a higher-than-expected risk equalization obligation. This year, we forecast a total risk equalization transfer of almost $250 million compared to just $228 million in fiscal '19, an increase of about 9%. We are currently examining every area of our claims exposure and business operations to improve our full year performance. There are a number of areas within claims where we have identified shortcomings and already, our arhi management expenses have at least, as a ratio, half-on-half drop. Naturally, there'll be a focus upon this when we present our half year results next month. While not to dismiss the current weak performance and outlook and the challenges we face ahead, I want to stress all businesses are in very good shape. They still enjoy organic growth, strong margins and high returns on invested capital. Group consolidated revenue is expected to grow by more than 5% for the full year and arhi near 4%. These are businesses in decline. And it's not as though we don't have a number of initiatives in the pipeline to keep building the company, our revenues and earnings. We have on foot, for example, project Jane and our new JV with Cigna, leading digital and technological investments in place, our China JV ramping up, opportunities to expand our iwi book in New Zealand and significant cost-saving potential by the recent consolidation and rationalization of our back-office functions. So with those opening comments, I'll hand it over to questions, Christian. And joining me, of course, is Michelle and Matt Neat.

[Operator Instructions] Your first question today comes from the line of Ashley Dalziell from Goldman Sachs.

My first question, just on international and New Zealand. Within the release, you talk about a return of margins to more sustainable levels. Just would be interested in any color you can provide on your view of sustainable net margins in those businesses.

Do you want to go first, Michelle?

Sure. So obviously, Ashley, we are not in a position, given it's not been included in our announcement, to talk about the margins that we're seeing in the first half. But if I refer you to the sort of margins we saw for our international inbound business last year of a bit above 30%, 31.1%, I think, was the number. We're seeing that come off, and that's not surprising. It's been something that we've been alluding to for a little while, that in a tougher competitive environment, together with some of the claims experience, that we would see those coming away from that sort of number. We'll obviously have more color on that in our half year results presentation, but they have been at numbers. I think I've been quoted for a number of years now saying that I don't think they're at sustainable levels, and we kept proving ourselves wrong year-after-year. This change has kicked through probably a little faster than we anticipated, which is part of what's driving this upgrade -- this announcement downgrade today.

Yes. I was just going to say it's something we'll be reflecting upon when we have a little bit more detail from here. I think it's fair to say since these businesses have been set up, we've been banking whatever we can, adjusting pricing to competitive pressures, recognizing at some point the margins in the vicinity of 30% wouldn't be sustainable. And so those pressures are starting to work their way through, but it will still be highly profitable businesses and remain businesses, which deliver strong returns on the capital we have to place in those businesses.

Okay. Just a second one on arhi. Just wondering if you can give us what you were originally forecasting for the risk equalization contribution versus the $250 million you're calling out today. And then just secondly, I guess around the composition of claims that you've seen in the Dec quarter or the December quarter. Any kind of noticeable changes from what you were talking to at the result back in August?

Mark, do you want me take that one?

Yes, yes, yes.

Okay. So Ashley, again, and I'm really not trying to hedge, but obviously, we haven't included the specifics of the movements in the elements in our results presentation, but we weren't expecting the net risk equalization to be up 9%. A key driver of that is the calculated deficit. That is our contribution to the industry claims, and we've called that out. And it's fair to say we've seen some new information about experience of other funds following the end of the quarter that we use as the basis of estimating, both our actuals to the end of the year and our forecast going forward, and there was a sizable variance in that from what we had previously anticipated.

Ashley, I think you can take it as a general rule of thumb, if we're pricing it -- what was it in last year? 3.2% or thereabout. Generally, we expect claims inflation on that order, including risk equalization. So the swing is around about -- is around that. But certainly, year-on-year growth of 9% is really demonstrating just what -- how problematic it's becoming as a system where you have an insured population which is aging and more and more younger people leaving the system. So it's actually penalizing those companies like nib who remain good at attracting younger, healthier risks and investing in risk management in its current configuration.

Okay. Just one final one for me, just on arhi. You noted a slightly improved policyholder growth trend through the half. Can you make any comments on, I guess, policy downgrading through the half? Have you noted any improvement over FY '19 coming off that lower 2019 rate increase?

I think we'll talk more about that at our half year results, Ashley. Where the business is -- the book is growing. We're seeing some downgrading as we have in the past, but the top line revenue growth is -- we're quite satisfied with, given what we see across the industry in general.

Your next question comes from the line of Andrew Buncombe from Macquarie.

Just the first question. I noticed that the arhi net margin guidance is unchanged from 6%., but given all the momentum behind claims trends, how should investors be thinking about net margins into FY '21? I suppose all I'm trying to say is, do you think things are going to get better or worse from here?

Well, we've obviously just gone through a pricing process with government and priced at a level, which we believe is sufficient -- more than sufficient to sustain our arhi net margin in that target, around 6%. But as we have discovered this year, things can change. We'll certainly be -- we stand by that assumption that our pricing this year will cover the level of inflation. We'll be doing our level best to better manage underlying risk and our claims exposure and experience to deliver those results.

If I can add, Andrew. I think the other observation that I would make is one of the -- well, the key driver for us talking today is industry claims experience. And obviously, there are elements of that that given we were surprised by what we saw at the end of this quarter, that may have an impact into the future, and we're working through our thinking on that as well.

Perfect. And then my only other question and that's is probably a good segue. Given a large part of this announcement is coming from industry experience and not necessarily your own, how is the business thinking? Or how is the Board thinking about the dividend payout ratio this year if it's more about the industry rather than yourself? Is there a reason to pay out above the current guidance range?

Yes. We've previously signaled that our current dividend payout ratio of 60% to 70% is premised on a growth rate within arhi, which we're no longer achieving. So with that lower growth rate we face today of between 2% to 3%, we could theoretically increase that payout ratio while still retaining sufficient capital in the business to support that book now. It's something we're thinking about, something the Board is considering. So there is scope to increase the payout ratio to maybe somewhere between 70% and 80% rather than the current 60% to 70%. But that's a decision that we made in due process as we -- as the Board considers the half year results and our requirements for capital retention next year and beyond.

Your next question comes from the line of Kieren Chidgey from UBS.

Just wondering -- and I missed, I think, the first question, so apologies if it was covered. The $30 million delta relative to the original guidance, can you just give us a broad breakdown as to what relates to arhi relative to the international businesses collectively?

Michelle?

Again, I can only talk generally, Kieren. We will obviously have a lot more color in that as we look at the first half results next month. But it is fair to say it is -- the arhi results is relative to the overall size of the arhi results, a smaller percentage than what we're seeing across the international businesses. Some of those are a reasonable contribution to the delta. We also have some investments in some of the new initiatives that we've called out. So we announced just before Christmas the joint venture with Cigna, which we see as the key part of delivering on our personalization strategy moving forward and there are operating costs associated with that in the second 6 months of the year that have come into play as well.

Okay. And as we look out to second...

Yes. I might just add to that that $30 million delta -- because I don't want to put it all on arhi, I think I'm fairly comfortable with arhi given the factors I've explained. Somewhat frustrated that our earnings have dropped against our expectations in those international business and in New Zealand and with Travel Compared to our original expectations. And as Michelle has mentioned, though part of the variations around some quite significant investments, new investments we're making in things like the Cigna JV, and perhaps at half year results, we can call that out with a little bit more detail. But it's certainly not all on arhi. It really is across the board in terms of our operations.

Okay. And relative to first half, I know there's seasonality in the margin, particularly in arhi. But the revised guidance, how would you suggest second half has been reset relative to first half? Is it a similar sort of trend on an underlying basis? Or are you assuming some further pickup that might have been stronger in the December quarter continuing through second half?

Assuming improvement, but Michelle, I'll flip to you.

Yes. We are assuming -- so the first half is difficult. And there's a footnote in the ASX announcement because of the impact associated from 30th June '18 and 30th of June '19, what was an overprovision and then an underprovision. So it does put a fair bit of noise into those half-on-half comparisons. Second half of the year, we have made allowance in this outlook for what we're now seeing as industry claims experience for arhi, together with the other factors that we've touched on. But we are expecting the second half of the year to perform better than the second half of last year.

Okay. And finally, obviously this industry claims experience has come through after you've filed through your April 20 premium rate increase. And it sounds like, clearly, the broader inflation backdrop in the industry is a bit than worse you had envisaged. What else can you do across the business, particularly interested in the expense side of the equation to manage the net margin into sort of both second half and '21?

Mark, did you want to take that?

Well, it's just -- it's a fairly routine challenge, I suppose. It's around tighter utilization management, and we are heavily investing in a number of programs designed to better manage utilization. By that, I mean the risk of hospital readmissions, identifying people with chronic illnesses and keeping them healthy and very much the guts of our new JV with Cigna is around utilization management. It's about tighter contracting with our various providers. One of the frustrations in this for me is not so much -- is the constraints -- our claims experience means we're more constrained to invest more in claims. That sounds like a little bit of oxymoronic. But for example, in order to achieve tighter networks with specialists and avoid the kind of out-of-pocket experience that you may have read about in the paper today, we're looking to work more closely with specialists and perhaps even pay them more and increase their Medicare payments in order to get better utilization management, better outcomes for our members. And I think more nearer term, there's the whole question of claims leakage, fraud, mitigating upcoding and bad behavior by providers. And one of the more significant investments we've been making operationally in the business is around new benefits management platform designed to mitigate that risk of claims leakage. So there's a broad suite of measures being taken across the business to better manage what is effectively $0.85 of every dollar we collect in premiums.

Okay. And the expense side of the equation is -- we've seen the MER drift up the last few years. Is there more that can be done to bring that back down?

You'll see it come off in our half year results, half-on-half. I won't get into any more detail on that today, largely reflecting progress we're making in improving productivity and efficiency across the business. . Probably the most -- and most of it depends on ongoing automation of previously manual functions. And I think the most significant thing to look out for in the next 12 months is the emerging of all our back-office operations into a single business and platform. Call center, claims payments, policy administration. We have engaged a new executive specifically to bring those all together and introduce a much more significant level of automation and, to the extent it makes sense, outsourcing.

The next question comes from the line of Matthew Dunger from Bank of America.

Can I just delve further into what you're seeing around claims trends perfectly? More specifically, I mean. Are you saying you're not seeing any further deterioration in mental health processes? This as all industry-related?

Matthew, it's Michelle. No, we're not saying that. I -- for the purposes of the announcement we made today, we've not gone into a whole lot of detail around that, recognizing we'll talk to you at our half year results announcement in February. What we are calling out is the thing that shifted has led to us making this announcement today is what we've seen happening at the industry experience level as well. But I think in terms of Mark's opening comments, the discussion we had in the announcement, we have been seeing a tick up in claims, and there are a range of factors that go into that, including things like mental health that you've alluded to.

Okay. And if I can just touch on the Travel business. Have you seen much of an impact from the recent bushfires around travel claims also on the revenue side from that Travel business on take-up of travel? And what sort of outlook are you seeing for the rest of FY '20?

Mark, comfortable for me to take that?

Yes, sure. Sure, yes.

So Matthew, I'm not in a position to speak in detail about the impact of the bushfires and those sorts of things. We're obviously monitoring that and very sensitive to making sure we appropriately support our policyholders. We have called out in the announcement that the domestic sales environment has remained tough, and that we have been experiencing some challenges integrating the May '19 acquisition of QBE Travel. So what we have called out is that the FY '20 results will be positive, but it will be down on last year's $6.6 million UOP. Now the offset to that, which is really pleasing, is the international sales that we see up almost 13% on prior year. And while it's a bit of a longer time horizon, we remain confident in the outlook for that business.

Your next question comes from the line of Siddharth Parameswaran from JPMorgan.

Just a couple of questions, if I can. Firstly, just Mark and Michelle, from what I gather, I think you're saying the emphasis in terms of what led to this downgrade is very much the arhi division and also just the -- I mean -- and mainly driven by the industry trends. But I mean can I just -- question is because I mean what you're flagging there is that you've had about a $20 million absolute growth in the risk equalization contribution. Presumably, you would have been expecting some increase anyway. So -- I mean just because of exposure growth. So it seems to me like most of the downgrade seems to have come from everything other than arhi. Would that be a fair assumption?

So Sid, as Mark touched on in his earlier comments and as I alluded to, the element associated with arhi is small on relative basis to the underlying arhi performance, and there've been contribution from the other adjacent businesses as well as the investment in the new areas. Yes, we were of course expecting some increase in the net risk equalization. As Mark alluded to in his opening comments, we've been seeing some claims trend signs for a little while now across all of our PHI businesses. So there are a range of elements into it. The point that moves that is what has triggered a change from where we were this time last month or months prior. And so yes, it's fair to say the adjacent businesses have been under some pressure from a competitive point of view and a claim's experience point of view. We're not in a position today. You'll get more color again with the half year results announcement to give you element-by-element of what's the difference between the previous guidance and this guidance and recognizing the $170 million is the -- at least $170 million. So it has some elements in it. But I think there's contribution across the board.

Yes. Look -- and again, we'll get to this at the half year. But if you -- that $30 million -- at 30,000 feet, the way I look at it really back of the envelope about 1/3 arhi, and we've spoken about that, about 1/3 the adjacent businesses, and we've spoken about that, about 1/3 some of these one-off costs associated with the Cigna JV and other investments we're making. But you'll get much more definition around that next month. It's certainly not all on arhi. It's certainly not all on the adjacent businesses. That is -- it is surprisingly very evenly spread. And the common denominator, at least in the -- with arhi and the adjacent businesses, is claims inflation exceeding our original expectations and eroding margins.

Yes. Okay. Fair enough. Okay. Just one last question for me. Are we now seeing claims inflation trends track above premium rate inflation if we take off these one-off factors?

Again, Sid, I think all I can say is that we've not put in front of you today detailed claims inflation analysis. It's fair to say that these sorts of numbers are seeing claims growth on prior year at a higher percentage than income growth that we need to look underneath that, which we obviously do and can share in more detail to the investor press as to the drivers of that.

Yes, yes. Look, I think the risk with claims inflation is on the upside, like we're currently running, again, back of envelope, somewhere around 3%. We can all remember days of 5% and 6%, but it's been at 3% for a few years now. And that upside risk on claims inflation just means we have to work even harder in a way I've already described around better managing utilization and underlying risk, better managing provider costs and networks and better managing claims efficiency and leakage.

Yes. Okay. And just one final question for me. Just on the international businesses. I mean you mentioned that there was some competition coming on pricing. Is that right? Have you -- I mean can you just expand a little bit on that? And could you also just mention if you've actually lost any contracts or if any contracts actually came up for renewal in the last year?

The story of the workers and the students is not so much us losing businesses. In the workers business, the clients will come and go, but both students and workers are doing well in terms of growing their customer base. The issue is more around the pricing required to retain your customer base and the growth, which impacts our margins, and that pricing pressure comes with increased competition. And there's been a few nuanced factors in both workers and students. So for example, I think -- Michelle, correct me if it's wrong, I think it's students. We had an underprovision last year, which would impact the half year result. Not as significant as arhi but nevertheless, not immaterial. In workers, we've had some, what we suspect, experience around adverse selection. We tried a new visa class sort of as an opportunity, and it hasn't turned out to be as attractive as we thought, and we've dealt with that. But if you don't experiment with these things, you never learn and grow. So this business is still very good. Business is growing, but the margins that we've enjoyed in the past appear to be something of the past.

Your next question comes from the line of Nigel Pittaway from Citigroup.

Just on the growth, first of all. I mean would it be fair to say that youth-based discounts have had a big sort of influence on your level of premium growth in there?

So I missed the start of that, Nigel. What had an influence on -- an influence on...

The youth-based discounts. So the...

Yes. Yes. That has -- that will have an impact. Giving a discount to a bunch of younger people under 30 is going to impact your premium [indiscernible] for sure.

So has that been one of the factors that's driven the risk equalization up a bit more than you expected as well? Would that be a right connection to draw?

No, I don't. So the risk equalization's the calculation of the gross deficit, the amount of claims you have that are eligible for risk utilization. And our claims, like most others, have been growing as the book ages and the per-capita contribution that every fund has to make. And of course, as it's been the story for a long time now, because we have been growing higher than the rest of industry, our per-capita contribution to that gross deficit has been growing. So going back to my earlier point, we are being penalized for the fact -- well, the fact that we are growing relative to the industry. And then our growth is still not as much as it was maybe 10 years ago but are still skewed towards the youth market where you get no compensation for their claims through risk equalizations but you pay a per-capita -- same per capita contribution for a 29-year old as you do for a 65-year-old.

So if I can build on that, Nigel. It's fair to say that we worked really hard to introduce the PHR reforms, including the youth discount at the earliest possible date for all of our policyholders. And we had factored into our thinking that we would get an element of growth as a consequence of that. So it's not the reason for deterioration to what we originally were anticipating. We understand where you're going. Obviously, it is those younger better risk that contribute in part to funding the pool, but we had factored an element we don't -- from that into our forecast. So what we're calling out here is the higher actual industry claims experience, not number of policyholders that we have.

Yes. And it's probably worth mentioning, the Minister and government allowed us dispensation in our pricing round this year. So for example, and this is just speaking hypothetically, if our application was for 3%, but because of the discount we had provided, we're only collecting 2.7% in additional income, he -- the government recognized 2.7% as the number rather than 3%.

Okay. And then I'm just trying to get sort of a feel for the right interpretation about what's happening to industry claims inflation here. I mean obviously, given you're making assumptions into second half, you're only saying arhi is about 1/3 as the reason for the downgrade. I mean it sounds like -- I mean just how material is that increase in industry claims inflation that you're sort of flagging today, I guess?

Well, as I've already mentioned, Nigel, I think that the risk -- if we say inflation is running at 3%, I think the risk where we stand today is on the upside rather than the downside. I still think there are factors that are going to keep that inflation number low, mainly macroeconomic factors. But again sad is the fact that the risk pool is aging, and we are seeing the average age is growing with the loss of younger people and the natural aging of the retained insurance population. But look, I'm -- the point I want to emphasize, I'm still -- I'm confident that we can manage the arhi business for that 6% target margin. What we've seen this year and a little bit the year before, we've been flying well above that number for reasons which have turned out to be not as reliable as we thought, given the various OEC adjustments we've had to make. But whatever happens with inflation, our goal is going to be to maintain that 6% margin, and I'm very confident we will.

So without going to too much detail, one of the things that is -- challenges we forecast going forward is risk equalization is based upon paying claims. And to the extent that participants in the industry now may have timing issues associated with claims, payments, et cetera, that can have an impact. . There's certainly an element of that that we understand has come through in the most recent numbers that we've been seeing. And so we're trying to allow for that in our reporting -- of thinking about our forecast going forward. But there's certainly less certainty knowing what that looks like based upon those sorts of variables.

[Operator Instructions] There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

Yes. Thanks, Chris. We'll have nothing more to add unless you have, Michelle.

No.

Thanks for your time today. Sorry the news wasn't better. It's certainly rebasing the business lower than we anticipated. But make no mistake, we're -- after a long period of earnings growth, we're determined as ever to build upon where we're at today and we look forward to catching up with you all next month, I hope.

Thank you, everyone. Appreciate your time.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, you may now disconnect.