nib holdings limited (NHF) Earnings Call Transcript & Summary

Okay. Well, good morning all. Thanks for your time today. I suppose I should be standing up. Usual routine practice. I'll give a brief overview of the result, emphasis on brief. But the importance is in the interpretation of the result. Because certainly, looking at the half-on-half result, it needs interpretation. Michelle will then dive into the detail of the result on a P&L basis. And then I'll come back and hopefully have enough time to talk a little bit about the outlook because let's face it, it's the outlook we're mostly interested in, particularly given the transition we're attempting as a company. So that's the process today. The half year result numbers you have in front of you -- is this clicking over, Matt? Oh, I'm clicking it over. Yes. Look, I don't want to spend a lot of time on these numbers. As I say, you have them before you. I'll come back in a moment with just some general observations and interpretation. Sufficient to say, people are spending more on their healthcare and claiming more in the business. The group results don't look too -- well, the underlying operating result doesn't look too pretty on the surface, but I'll come back and comment upon that in a moment. We remain like -- both sides maintained last year's interim dividend of $0.10 per share. We're confident we can maintain that when we go through the process of reviewing our capital standards as APRA is requiring. Okay. Some observations. It's obvious that the first half result on the surface is disappointing, particularly when you line it up against the first half '19 results. And it's indicative of a general environment of growing claims pressure we are starting to kick up ever so slightly. I suppose the -- and there are many factors underneath that. I'm just throwing some statistics in here like the risk equalization is a real issue for us. It's effectively us subsidizing the growing utilization and cost of other health insurers. And for this full financial year, it's going to be in the order of $250 million. Nevertheless, we just regarded that as tax on our business. And even if you back that in, we're confident in the investment we're continuing to making in organic growth, and I'll come back to that in a moment. As Craig pointed out last week, something needs to be done about prosthetic pricing, up 10.7% year-on-year and now costing us about $80 million. Look, we need prosthetic devices, of course. As an industry, we're part of the same supply value chain as our medical devices colleagues, but that's not satisfactory, that growth in volume and that growth in pricing, I've mentioned the risk equalization. And you saw from the APRA data the other week that the industry is facing real cost pressures with premium growth up 4% overall and revenue up only 2.5%. But there is some important call outs to that, particularly in respect to the half-on-half result, and I'll talk more about the underlying state of the business towards the end. But looking at the half-on-half results, we've made -- well, I think we need to make allowance for the fact that the first half '19 was seriously advantaged by reserves release from '18. In other words, we understated the '18 -- sorry, we overstated the '18 results -- we understated the '18 result and releases are benefited in '19. And conversely, the 21st half result was disadvantaged. You make allowance for those -- you make allowance for the actual claims that we paid, and the result at a group level is more like a 2% UOP reduction and with arhi actually improved by a couple of percent. It's not to make excuses, we own this first half result. But if you do make an allowance for that provisioning, it does look -- the comparison looks very different. And the underlying margin within arhi is 6.4%, it's still above our targets. So that's one call out without wanting to sound like it's an excuse. It's not an excuse, it's an explanation as to the significant variation between the 2 halves. I think the other important call out is we're still growing as a business. Our revenue grew 6.4% at a group level. And even within our core health insurance, arhi business, performance has been strong. If you look at last calendar year, the business has grown -- that business has grown 2.5% against an industry growth of 70 bps. So we continue to well and truly outperform the industry. And margins, as I touched upon, remains strong. The arhi margin reported is 5.9%. But if you normalize for that OSC adjustment, it's 6.4%, as I mentioned, ahead of our target range. New Zealand is around 9%, strong. And international workers and students, even though it's come off a bit, we're still doing about 90% net margin and growing as a business. So the underlying performance of the business in terms of ongoing organic growth, return on the invested capital, we've just updated our lifetime profitability and very confident of what we're investing in growing the business is more on getting a return on that investment. We've made good progress in reducing operating expenses. It's not to say that we don't have to do more. But as you can see from the numbers there, operating expenses down 4% half-on-half, and we're making some tough decisions and we're reorganizing the company to try and bake -- fry out some of those expenses, and there's more to come. Probably the most important point I'd like to make this morning is even though things are a little bit challenging at the moment compared to where we've been in the past, it's not as though we're short of new ideas to grow the business. I'm full of initiatives to reset the business and continue to grow profitability. And I'll talk a little bit about that -- a little bit more about that further on. And of course, most fundamental thing that I look at -- okay, it can be exaggerated depending upon your organic growth versus asset accumulation and the inclusion of goodwill on your balance sheet. But ROIC in the business, return on invested capital, which we think a lot about as a company, remains very strong at 16.7%. And just a slide here to show that the fundamentals still look very positive. And I won't spend any time in this slide except to say that culturally, there's a real sense in the business. I'll talk a bit about this further on, that we're not just here to provide a financial services product. We're here to make a broader contribution, particularly to the overall health and well-being of community. And we have broader social and ethical obligations to the communities we serve, and we take that very seriously and we're very active on a number of fronts, as this slide indicates. So I'll throw it over to Michelle. And as I mentioned, I'll come back, and I'll talk a little bit about the outlook and how we're thinking and where we expect to be.

Good morning, everyone. A highlight of our first half result when compared to PCP is that all segments of our business grew both membership and premium revenue with group underlying revenue up 6.4%, as highlighted on this slide, to almost $1.3 billion. However, as Mark has already called out in his key observations, claims inflation across our PHI businesses as well as timing in the receipt and payment of claims impacting our unpaid claims reserves resulted in a group underlying operating profit of $83.2 million, down just over 27%. As we'll cover in more detail further on, our New Zealand business was a standout exception to this trend, delivering an underlying operating profit of $11.1 million, up almost 17%. So jumping straight in to our Australian Residents Health Insurance business. At just over 75% of the group UOP, arhi definitely remains the core economic engine of our business. Sales are up more than 12% compared to first half last year with nib accounting for almost 38% of the overall industry growth. Overall, we grew our membership by 1.4% compared to just 0.3% for the industry. Premium revenue up 3.8%, includes the impact of both membership growth and premium adjustments. And it was modest, in line with our initiatives designed to improve affordability for our members. This also includes targeting a net margin of 6% which is below some of the highs we've seen in more recent times given the historically low levels of inflation in 2018. So with a UOP of $62.6 million, down 29% on the first half '19, the comparison is materially impacted by the claims movements that Mark has already touched on and has detailed on this slide. We're highlighting these movements, and not to make excuses, as Mark said, rather have explanations. And it's really driven by the material size of the variation in the first half '19. The variation that we've seen in the first half '20 of $4.8 million under provision at 30th of June 2019 is within normal margins that we would expect and evidences the changes that we've made to our estimation and the increasing reliability of our outstanding claims provisioning. So if we normalize for claims development, we see the actual reported net margin of 5.9% being more in the order of 6.4%, which compares to the first half '19 number -- equivalent number of 6.6%. As we highlighted in our January guidance update, claims data for the end of the December quarter for the industry as a whole has highlighted growing industry claims and has seen a 10.3% increase in our net risk equalization expense half-on-half. Total management expenses at $101 million, for the half are down 6.4% with a total MER of 9.7%. Our marketing management expense ratio is flat as we continue to invest in growing the business as evidenced by the policyholder growth and our other MER, which is where we've been talking to you we've been focusing on to drive efficiencies, is down 100 basis points half-on-half. Employee costs for the arhi segment are down $1.4 million. By way of example, recognizing organization realignment and rationalizing our retail network as our members move to more online and self-service options. So to do a bit of a deeper dive into the movements in gross profits, this is a summarized version of our waterfall graphs. For those of you who like the detailed version, they are in the appendix to the presentation, but I don't propose to talk through that today. As highlighted earlier, as you can see on this graph, the claims development has been the most significant driver of the movement. Profit downgrading led by affordability concerns that are familiar to all of you, for the industry, resulted in a $3.7 million unfavorable net gross profit impact. Offering $750 excess to all of our members on our entire product range for the PHI Reforms implemented last year improved affordability but did impact on our reported favorable growth variance, at the same time, it's slightly diluting gross profit per member. At 1 April 2019, price increase, average price increase of 3.38% did assume a reduction in net margin would occur and allowed for the introduction of the youth discount last year. Claims expense in arhi reflecting both utilization and service cost growth continues across a number of hospital procedures with some examples included on this slide, while ancillary growth remains consistent with recent trends. Mental health benefits, being in-hospital psychiatric services, were a key driver of the increase between -- on this -- shown on this graph, between April 2018 and March 2019 off the back of the mental health waiver introduced in April 2018. For reference, over 500 of our members made use of the mental health waiver in the 12 months to 31 December 2019, at an estimated cost of $7.1 million, recognizing this is as a critical part of our value proposition for our members. Prostheses pricing reforms in February 2017, February 2018 and August 2018 did result in lower benefits per person growth during that period. However, we have been seeing prostheses inflation increasing significantly since April 2019. The absence of prostheses reforms during this period is part of the reason for that. But in addition, we are seeing higher-than-expected increases in some items, including insulin pumps, closure devices and skeletal reconstruction. Recent hospital experience is indicating a return to longer-term historical trends. To move on to our International (Inbound) Health Insurance business. Our students and workers businesses continued to deliver impressive top line premium revenue growth, up 15.4% half-on-half, driven by net policyholder growth of 7% for the period. We have anticipated for some time, I recall many of you questioning me when I raised this previously, that we would see some pressure on our margins from competition in this business. And we've certainly seen that in the first half '20 result, perhaps a little faster than we'd previously expected. Competition combined with increasing claims experienced, driven by increased utilization of medical services and an overstatement of our June 2018 result impacted first half in the prior period. So our reported gross margin for the half fall to 50.7%. Now if we normalize that, that's more in the order of 51.5%. Management expenses at almost $20 million were up nearly 23% half-on-half, with marketing costs being the major driver of that, up 16.7%. Other expenses are a function of growth with increases in our claims handling costs and our contact center support costs. As you would no doubt expect, we have an ongoing focus on claims adjudication, processing and digital options to create operational efficiencies. We've pulled back on our nib international student services business after lower-than-anticipated penetration into the U.S. market with a refocus to our higher-margin Australian inbound sales. At this stage, we are not anticipating a material impact of COVID-19 based upon current travel restrictions that are in place with our diversified country of origin sales mix, reducing geographic concentration risk in this business. As already mentioned, our New Zealand business delivered a standout result for the period, growing both revenue and underlying operating profit. Premium revenue was up almost 14%, reflecting very strong policyholder growth of 5.7% and premium adjustments made to account for increases in claims. Policyholder growth was driven by the acquisition of new corporate clients, successful changes to nib's adviser distribution model and our partnership with Uni-Care to provide health insurance to international students. Underlying operating profit at $11.1 million was up almost 17%, notwithstanding that claims for the period were up 16.1% as a function of utilization, which half-on-half increased 13.4% and was driven by small value claims and policyholder growth. Unlike our other PHI businesses, first half '20 benefited from a $1.1 million release of our 30 June 2019 outstanding claims provision, noting that the first half '19 comparable result had a benefit of $0.9 million from a release of the 30 June 2018 outstanding claims liability. Our First Choice Network, which guarantees 0 out of pockets for our members remains a key tool in managing service cost inflation, with approximately 95% of our claims now going through a First Choice Network provider. Our population health initiative with Maori tribe, Ngati Whatua Orakei, has continued to grow with an ongoing focus on improving the health outcomes for those members. At this stage in our New Zealand business, we're also not expecting a material impact of the COVID-19 on Uni-Care student policy sales and claims. Management expenses at just over $34 million were up 8.3%. However, our management expense ratio was down 140 basis points, reflecting a strong focus on cost control while maintaining our investment in growth. And our reported margins for the period are stable and within our target range. To our nib Travel business. Our travel business continues to grow sales and operating income. However, with an underlying operating profit of $1.7 million, it's very fair to say the first half '20 result was weak, with the acquisition and integration of the QBE Travel business having been a drag on our performance in the first half. nib Travel is now Australia's third largest travel insurer, and we're determined to improve the commercial performance of this business through deliberate and meaningful changes that are in progress. For the half, sales were up 4.8%, if we exclude the benefit from the QBE Travel acquisition, which completed in May 2019. If we include the QBE travel impact, sales were up 86.5%. Domestic sales exceeded $400,000 with our first half sales benefiting from the acquisition, noting that the Australian travel insurance market conditions remain challenging. Our international sales continued to perform strongly, up 17% or just over 14% if we exclude the impact of QBE Travel. We have experienced encouraging performance for our worldnomads.com brand in key markets of the U.S.A., Europe, U.K. and Canada. The U.S.A. market grew 26% for the period and now represents 40% of our international policy sales. Sales NPS of just over 64 is strong and reflects the ongoing traveler-first focus within the business. COVID-19 is not expected to have a material impact on claims for travel cancellations. We do note the potential sales impact if it impacts people's decision to travel as we move forward. Acquisition costs, up 55.2%. Large numbers we're talking about here are growing faster than operating income due to the change in distribution mix following the recent acquisition. During the half, we were kept busy with implementing our new multiyear underwriting partnership with AXA XL, a division of AXA, enhancing our leading industry expertise and underwriting reach, including directly managing product and claims with the introduction of a new performance-based payment structure. Gross profit after commissions at 34.4% highlights the importance of our second half focus and ongoing focus on rightsizing our operating cost base for this business because operating expenses at just over $24 million were up nearly 43% with additional locations coming into the business. There were also some one-off costs that are included in our statutory operating profit of $4 million associated with the travel acquisition. To provide a summary of some nonunderwriting operating profit metrics, I'll just make some call-outs on this slide. The increase in our net investment income reflects a return to more normal levels given the soft equity performance we encountered in our investment growth portfolio in first half '19. The increase in finance cost is a function of the introduction of the leasing standard during the period as flagged when we provided our guidance for the year. Claims rising faster than premiums during the period, timing of supplier payments, increases in group-wide employee costs following the QBE Travel acquisition, lower cash flows from investments and tax payments during the half resulted in a $5.9 million operating cash outflow. And during the period as of 31 December, we completed the nib/GU Health fund merge following the October 2017 acquisition of GU. To finish my section of today's presentation, I thought it's useful to draw out a summary of our capital position on this slide. We will shortly, as you would expect, be submitting a response to APRA's discussion paper on new private health insurance industry capital standards for the Australian market. It's fair to say there were no surprises for us in the discussion paper, but there's still a number of specifics that need to be worked through. And APRA has identified 2 rounds of consultation together with some modeling work that will be done as well and allowed a lot of time for input into the development of these standards with the new standard expected to come into play from 1 July 2023. As part of our review of the capital associated with the nib/GU Health fund merge that occurred 31 December and as called out, I think, at the time we acquired the businesses in October 2017, the Board made the decision to adjust our Australian internal capital targets such that our risk appetite supporting those capital targets now sees an increase in allowance for inadmissibility of deferred acquisition cost intangibles and nonacquisition related intangibles from 50% to 75%, which has seen an increase of almost $30 million in our internal capital that we're holding. In addition to this, we adjusted the risk appetite to allow for 100% inadmissibility of acquisition-related intangibles. So even after this, taking into consideration our interim dividend, we're still showing available capital above our Board-approved internal targets of just over $69 million, supporting the position we've previously communicated to you about organic accumulation of capital as we move to a world of new Australian capital standards expected in 2023. I'll now hand back to Mark to discuss outlook.

Thanks, Michelle. Okay. But before I just talk a little bit about our outlook and our latest thinking, I'll just sort of take the opportunity today to introduce Ed Close. So Ed's replaced Rhod McKensey, running arhi business. Ed was one of Rhod's lieutenants. He's been in the business for a few years, he went through an internal selection process, and he's a great guy. We've got every confidence that Ed would take that and continue to progress our business as well as Rhod has over the years. Matt Paterson has arrived. Matt has a BPO background. So what we've done in the organization has pulled together all about -- hit the 2 separate back-office operations like paying claims and contact center to create a single centralized unit. And with that, we expect to see significant productivity and efficiency improvements. So we'll have one central back office gradually because Rome's not built in a day. And so these businesses will, over the period -- over the next 18 months, be brought together. We have a common technological platform and a common -- a more consistent approach to the member/traveler experience. So we welcome both Edward and Matt to the business. Look, we didn't anticipate it hitting so hard this year as our recent downgrade suggests. For some years now, we've been looking at the gross profit in arhi, plus 17% and then workers and students, plus 60%, and recognize, at some point, there'd be a convergence between the underlying claims inflation and the revenue growth we've been achieving. As I said, we didn't expect it to hit so hard this year, but it has. But we certainly haven't been sitting around devoid of ideas as to how we deal with that and how we reset the business to maintain our past performance of underlying EPS growth. That same thinking is behind our -- the transition we're going through as a business. So 12 months ago, we changed our mission statement, our purpose, a way from being here to provide financial products to protect you once you're already sick or injured and hook you up with the right providers, doctors and hospitals to your better health. Now that may sound like a bit of a platitude, but it's not. It's informing so much that's happening in the business. It's capturing a global trend which we want to be part of, which is about -- look, private health insurance is no longer just here to protect you once you're already sick or injured. But private health insurance is here to help you and your doctors understand your individual risk profile. And with that and with the help of data science, prevent that risk or better, manage that risk or more precisely, treat that risk. This is where the world is going with private health insurers. They're becoming more health care companies rather than financial services company. And we're on board with that thinking, and it's permeating every part of the business about how we think about our value proposition and the member experience. So business strategy is particularly important for us at the moment in terms of guiding this transformation. It's highlighted by the shift to personalized health care. Naturally, there's still an emphasis on affordability and sustainability, although something we think about a lot in the business is that affordability is a relative construct. It's relative to what value we get from the product or service we buy and very much undetermined, in my thinking with -- for millennials at home that they're not that interested financial protection anymore. But what they are interested in is us helping them improve their health literacy. So it relates to their individual health pro, connect them with the providers who are not just there to assist when they're already sick or injured, but those that are there to assist them, better manage their health, better prevent the risk of disease. And with that, hooked them up through the marvelous advances we're seeing today in terms of content delivery and IoT devices. So the emphasis is still on affordability and sustainability. We're still very focused on growing the arhi business, as I mentioned earlier and Michelle touched upon. Sales are up 12% year-on-year in what is a very tough environment out there. But in terms of hospital cover, the industry was flat in the 12 months to December. Our hospital cover grew 2%. So it's not just the lighter ancillary products we're managing to continue to sell and grow out there. Economies of scope is still very important to us. Obviously, workers and students have come off a bit. But as I touched upon earlier, growth is still there. The net profit margin is still there around 19%. New Zealand is going particularly well. And we're having some challenges with nib Travel, but learning quickly, and it's evident. It should be evident to you that this is not a business that doesn't have a growth trajectory. It does. It's a business we need to knock into shape, rightsize the cost base to deliver the types of -- kind of returns that we need to deliver to make the investment justifiable. And Racing Red Queen. Most of you are familiar with, it's just part of that narrative and our commitment to continue to experiment and innovate. We'll get some experiments wrong every now and then, such is the nature of experimentation. That platform we built to sell health insurance to students going to the U.S.A. from China or India, whatever the case may be, didn't work. We gave it our best shot. And we've closed down that particular business, not the platform because there's a lot of technology that were constructed in the platform, but it's no longer an area of focus in the business. That is our discipline. Look, I'm not going to go through this slide, obviously. Just to reemphasize, the point that we do see a fundamental transition required in the business, moving away from a business today which is as I've already touched upon, there to protect you once you're already sick and very limited by legislative constraints, and a little bit ad hoc in our intervention when it comes to helping our members maintain their health or avoid the risk of hospitalization or readmission, to one which is much more customized and focused on the individual. And with that insight, able to deliver a much broader universe of preventative and corrective products and services, which helps increase the health literacy of our member based on their own personal profile and which helps them connect with the system, us for being able to connect with providers and other -- both preventative and corrective and was much more advanced in terms of the interventions we make. One of the issues that we've observed in the last 30 years in terms of health insurers getting actively involved in health management, it's a bit scattergun. You can only generate the return on investment necessary if you're very precise about where you're spending your money. So for example, if we are precise about Mark's risk of developing skin cancer based upon the analysis we've done, we can afford to provide Mark with a free trip to the dermatologist, with free sunblock, with the best app in the world to detect skin cancers, with maybe even a drug which increases Mark's skin melanin. We can afford to do that to Mark and maybe 5,000 of our members who we've identified as extreme risk. You can't afford to do that over 500,000 people. So in this world of precision and data science, we're much more focused and targeted upon our interventions. And of course, it's not just a rhetoric. I'd like to think the joint venture with Cigna is absolute proof of just how serious we are about this transformation and just how real other third-parties, in this case, Cigna, see the opportunity. Like Cigna, an USD 80 billion company, they're not part of this joint venture for fun. They see a real opportunity in the Australian market to bring their IT and their IP to Australia. And this is a vehicle, which together, we'll do that. And I think it's fair to say that the likes of Cigna and others don't see the Australian market or the New Zealand market as $30 billion and $5 billion private health insurance markets per se. They see Australia as a $200 billion health care market. And they see opportunities for private-public partnerships, just like the kind of partnership we're already demonstrating through Ngati Whatua Orakei in New Zealand. So the Cigna joint venture is a very significant development in this business transformation we're attempting, and they're engaged. They have 3 people here already under secondment, where our dialogue with Cigna is constant and deep, and we're very excited about how this particular engine will help us deliver upon our promises. We have already demonstrated how we're better connecting our members with providers through -- you're on your -- I've got my phone. On your phone now, you can search for an orthopedic surgeon by location, you can read patient reviews. And increasingly, we're developing that relationship groups of specialists and clinicians starting off on an orthopedic surgery in Newcastle, but soon to be cardiologists as well. And the goal there is together, we work with the surgeon to not only ensure a no out-of-pocket experience for our members, but practice which is more in keeping with the science. Maybe Jack or Mary doesn't need that knee replaced, maybe losing 5 kilograms will avoid that knee replacement. So we're working more closely with our clinical partners to ensure a more holistic, less expensive experience for our members. The challenge there is going to be around scalability, how do you take this IP and actually scale it over the nation. I've mentioned Ngati Whatua Orakei. This is a very significant experiment, which transcends our business in New Zealand. If we can demonstrate our ability to take wraparounds around a discrete population, and through data science and insight, better manage the health and outcomes of their population, that's the foundation for a much broader approach to public and private partnerships with government or even more population-based projects with other Iwi tribes, Maori tribes or other discrete population in Australia or whoever else. And we're on the verge of delivering our new wellness app. So we see our app as the future front door and gateway to our membership. We know from the experiences of companies like Oscar in the U.S.A. that the higher the app engagement with your members, the lower the price elasticity of demand, and the greater persistence, the lower retention. So we see our app as a key tool to not only expand the value proposition but reducing that within the business. So there's a lot going -- there's still a lot to do and we've mapped out all of our -- everything I touched upon there, we've mapped out in terms of what needs to be done to fulfill this kind of vision. And we're well and truly out of the blocks, particularly with the Cigna joint venture. Near term outlook. Arhi continues to grow nicely. We expect that to grow around 2% to 3% this year and next year. It's something we're thinking deeply about in the business that, look, if we are going to make this investment, particularly in personalization and improve the value proposition in the way that we intend -- what implications does this have for organic growth, 2, 3 and 4 years out. So we'll be looking to bake in some new assumptions in our planning on the back of our personalization efforts. We see our net margin in our business as we have for years at around that 6% level, hopefully, a little bit better. We're worried in the past when it has been post 7%. We don't see that as being keeping with our long-term sustainability. We think at 6%, we often -- I talked to Greg Hunt about this, we think that's a reasonable number in terms of the return on the invested capital our shareholders have in the business. As I mentioned earlier, lifetime profitability remains very attractive. These fish are still good for eating. It's just a question of how you catch them. There's still a large gap between -- the NPV on a new poli holder is very solid in our business and certainly gives us a cause to be confident about continuing to invest. The watch point there is how do you press in that investment in this world of regulatory price control. M&A possibilities. Look, we'll wait and see. How successful APRA will be in promoting consolidation? I suspect at the end of the day, APRA's moral suasion could have an influence. But we know from the past that pulling off these mergers is -- can be quite difficult, if not impossible in some cases. We expect the adjacent businesses to grow at the current run rate. Net insurance margins be more like what you've seen in the first half. As I touched upon earlier, I think the days of us making gross margins of somewhere between 60% and 70% of these businesses are behind us. Michelle touched upon the fact that price competitions are compressing those margins. That's true, but equally, there is some claims experience there that we have to get a handle upon. And again, our personalization agenda and the efforts we're making in terms of health management apply equally to international workers and students in our New Zealand business and our travel business as they do the arhi business. The QBE transaction has been tough, and the integration has been tough. But I think most of it -- well, I'm confident most of it's behind us now. And out the other end will pop a bigger nib Travel business, as Michelle touched upon, the third in the market. And we can start to more actively cut the cloth, to use that metaphor, to ensure the type of profitability and returns we seek. Looking -- notwithstanding COVID-19 and other broader threats in the longer run, travel insurance is still thematically, a very attractive business. Our challenge is to get it right. And it goes without saying, if we don't, eventually, we'll make the tough decisions that need to be made. But I'm not anticipating, I've seen a lot of belief in this business, probably as $130 million in terms of capital investment. So we need to be making -- back of envelope, maybe UOP of 20 or 25. We're a long way off that admittedly, but we're incurring a lot of costs at the moment, which won't be around, certainly, not next fiscal. And as we gradually integrate the business and to centralize some of the activities in a way that I touched upon earlier, I'm confident we'll get there. Michelle has touched upon COVID-19. It's having an immediate impact in terms of -- particularly in terms of international students. We don't rely on China with international students like we used to. It's about 12%, 14% or thereabout of our sales. India is our primary market. Hopefully, the COVID-19 issue doesn't become a constraint there. So we'll navigate that short-term impact. And hopefully, once it's behind us, the students continue. Not as large an impact on workers so far, whether there's a general impact or pandemic impact on our business, our arhi business, our New Zealand business, we think not because most of you're familiar with the history. Whenever -- because private health insurers tend to fund the more discretionary part of health care spending, whenever there's a pandemic threatening hospitals, people shy away of having elective surgery. Now we're not seeing any of that yet, but it's more -- it's not a particular risk to our arhi business. It's more a risk to our international workers and students business and of course travel insurance because people aren't traveling as much, but we see that as a short-term risk as well. China is an interesting creature. We still await and wait and wait our license from the Chinese regulator. It was delayed -- well, there'd been a number of delays, but the main delay has been the merging of the Chinese insurance regulatory body with the Chinese banking regulatory authority. In the meantime, we've been exploring other options, such as buying a broker's license, which at least allow us to sell health insurance, recognizing that it's not our intention nor will -- I don't think it will ever be our intention to actually underwrite the business to become a fully blown insurer. And already, our team there generated revenues, though. So the team there are providing health management services to corporate clients and have -- already have an impressive stable of corporate clients. And I think we generate about $2 million this fiscal year in revenue. It's still losing money because of the cost base, but it's certainly out of the blocks and running hard. Just some general observations. I've already -- I won't labor the personalization in Honeysuckle Health JV of Cigna anymore, except to say it's real, and we see it as a key engine in our business and our future. There's a very heavy focus upon claims and operational efficiency. So I'll speak a bit about operational efficiencies this morning and we're getting some good results already, as Michelle alluded to. Claims efficiencies is -- let's face it, in our business, it's claims that move the dial. And when we think about claims efficiency, we think about avoiding hospitalization where that's warranted and possible, such as weight loss or other therapeutic measures rather than the knee or major joint replacement. We think about avoiding the risk of hospital readmissions, an area ripe to achieve benefits. Only -- just a simple example, only this week, I was reading an article, I think it was in Lancet, where in this one trial, they reduced the risk of readmission in hospital by improving the nutrition of people once they left the hospital. So when we're in a hospital, we're well fed and well nourished by the hospital. Often now, particularly if we're frail or elderly or vulnerable, we go home and we don't get a -- the patients don't eat, they don't hydrate properly, they forget their pills and they end up back in hospital. So just one example of where we see ourselves play a more active role in ensuring that people, when they go home, they look after themselves, they take their meds, they're properly fed and hydrated. And with that, hopefully, avoid the risk of readmission. In fact, one of Honeysuckle Health's initial programs will be around post hospital discharge planning to ensure our members are well looked after. And we see some additional capital accumulation as anticipated by the APRA review, noting that the APRA new capital standards won't be in place now, it appears until fiscal '23. That's not stopping us from preparing for that development and gently accumulating additional capital, which we anticipate will be required under the new capital standards. And our guidance remains as we communicated to the market back in early January. Look, it would be remiss of me not to finish off by thanking and congratulating Michelle on her 25th results announcement. Is that right, 25?

Yes, we've done them all together. So...

So Michelle and I have been together now for about 17 years doing this. It's been my honor and my privilege to work with Michelle. She's as capable a person as I've ever worked with, and she's been a bedrock in our success today as a company. And she's going to be very much missed, both as a professional and a person. And just so you know, King is -- Queen is dead, long live the Queen or King. And we're busy trying to find someone to replace Michelle. That's big boots to fill. And -- but we will. And I would anticipate being in a position to announce a replacement, hopefully by the end of next month. And depending upon their own work circumstances, having somebody in place May, June, July, something like that. In the meantime, Glenn Treadwell has been Michelle's trusted, loyal and highly competent lieutenant. Over the years, we'll fill in for Michelle -- we'll replace Michelle until we find a permanent appointment. So well done, Michelle. It's been a wonderful ride, and we'll miss you. And -- but we wish you every success in your career with -- have you said? Yes, with IAG. Okay. Q&A.

Michelle, Sid Parameswaran from JPMorgan. A couple of questions, if I can. Firstly, just on the guidance. Effectively, your guidance -- you've retained the $170 million underlying operating profit, the guidance to beat that. That implies an improvement in the second half. And usually, we've seen seasonality go the other way. I think usually, it's about a difference of 1.5% to 2%. So usually, there's a gap of about $15 million as a headwind. Could you just give us some idea of why you actually are expecting underlying operating profit to be higher in the second half rather than lower?

So one of the things -- and I said I wouldn't take you here, but in the appendix slide, we've shown you a normalized gross margin for the arhi business particularly. But for all of the segments, which does show when you look through to the results in the provision movements -- and I'm on slide, for those following along, on Slide 36, that for the last couple of years, on a normalized basis, we are seeing improved second half gross margin versus first half. That doesn't take away from the fact that we do see higher levels of ancillary claims. But other seasonality factors come into play as well, particularly in the 2/3 of our claims space, which is hospital, medical and prostheses. So that's one thing that I'd point you to, Sid, and part of the reason why I've included that information in the presentation. The second thing is, obviously, we do have a focus on policyholder growth acquisition costs in the second half, particularly around rate change for our arhi business, which we are continuing to invest in growth. But we've been very clear on the initiatives we have underway to drive cost out of our other operating cost base. And so you'll also see some elements of that influencing where our guidance is pitched at this point in time, together with the results of the other segments. So whilst arhi is just over 75% of UOP for the first half, movements in the other segments half-on-half also have an impact.

Okay. And just a question then just about how we should think about next year. I know there's no guidance for '21. But if we look at your recent filing, 2.9%, that's lower than the 3-point, I guess, 3.38% the year before. You've -- I mean, even on your numbers, you're flagging that there was gross margin pressure over the last year. There's a substantial reduction in prices now versus what was there last year, and your graphs are showing an increase in claims costs. You're saying normalization. It looks like hospital inflation is running around 4% per policy. So quite a big -- quite a -- a much higher number than the 2.9% and that's without even downgrading. So it seems to be a big gap. Should we be thinking that there'll be further pressure into '21? Are there things that you can do to offset those?

He's sitting next to me wanting to answer this question, so I'll let you jump in about it...

Yes. No, that's a good question. Thanks, Sid. It does look like a challenging environment. Although, as I touched upon earlier, we're quite confident that we can deliver 6% plus margin. That's our target, and we work very hard towards that. When you look at the underlying numbers that we're seeing. There is some evidence of product anti-selection. We're correcting for that quickly. The government reforms added benefits to some of our policies in a way which I suspect created a level of anti-selection. So we're addressing that. We're looking forward to the next round of prosthetic reductions, which clearly will help. We're looking to more assertively introduce the programs that I spoke about earlier, which Honeysuckle Health will be a key part of, such as post hospital discharge planning and avoiding readmissions. So there's a number of -- these things aren't corrected with just -- well, the only one fell swoop which will correct them is a price increase, but we haven't got that luxury as you've touched upon. That will be corrected through several initiatives. And then on the operating cost, we see some opportunity as well. So we're going to have to work hard to address that dilemma that you point to. Will 2.9% be sufficient? Well, time will tell. But so far, our forecasting and plan suggests that it will be. So I suppose, look, ultimately, to turbocharge, I'd characterize this result as a bit of a reality check, a bit of a reset. It's a turbocharge. It's going to cut the top line. It's going to become from us providing a value proposition, which is superior to that in the market. And it's going to come on the basis of us using that same capability and technology to better control the utilization and claims experience.

Just want to ask a question on that, just the anti-selection that you mentioned. Are you considering any forced closures of policy groups or detrimental changes?

Yes. No, we just stopped selling products, which typically -- we typically don't -- I can't remember the last time we forced a transfer.

Several years ago because it's not a good member experience, as you would expect. But it is something that we monitor closely. I think the last time was -- I'm going back to -- I think it was 85.

Yes. And you can do -- the other lever that we often pull is to remove the [ near ] excess option, right? People who are going to adversely select against you will typically want to buy [ near ] excess because they have something in mind.

And that makes sense. Part of the challenge we've got with some of the examples, insulin pumps are one example, is when we made the reforms, we didn't want to disadvantage members who had access to a level of coverage that there was a gold level element of coverage, but they may have been on the silver product. And so by closing it to new sales that stops us seeing the anti-selection from new people coming in to take advantage of that.

Okay. I don't want to worry you about it.

Try and shortcut too much, but I think it's times like this which creates a sense of urgency and the environment for us to make some of these -- take some of these steps to more aggressively get with doctors and establish alliances like the ones I suggested, or to go harder on a more active intervention with post hospital discharge planning or whatever the case may be. So it's a [ new win attempt on ] the good, and I'm looking at the challenges we face at the moment as an opportunity to bring about some necessary change in the way our businesses operate, certainly, but also in the way the private health insurance business operates. Of course, it's not in government's interest at all to see participation decline the way it has been. Like you take that important 25 to 34 segment of the market, participation as a percentage of that population has dropped from 40% down to where it's 30%. It is a semi crisis. We lost 15,000 people last year under 40, we have to reverse that. And we're not going to reverse it just by doing the same things we've been doing for the last 5, 10, 20 years. We really have to get on the front foot. And we really have to get government behind us to bring to that younger market our value proposition which is beyond just being there to fix you once you're already sick because they think Medicare can do that, and they've got other options to spend their hard earned.

It's Matt Dunger from Bank of America. If I could ask a question on the dividend, the payout ratio lifting above the 60% to 70% target you said you're confident to maintain, is that maintaining against the second half of '19 or the $0.10 per share you're paying out at the moment?

It's maintaining against the first half of the interim dividend from fiscal '19. The final dividend will depend upon the circumstances at the time. The further development of our thinking around APRA's likely expectation and of course, the performance of the business.

Yes. So just if I can follow up on that. How are you looking at capital accumulation given you're saying you need to accumulate capital, but you're maintaining a higher dividend payout ratio? How do you get to APRA's higher requirements?

Well, Michelle and her team are doing modeling at the moment about what that might look like, emphasis on what that might look like. In the meantime, as you'd expect, we have a view about our CPR, our capital prudential requirement. We have a view about our target. We have a view about what capital we need to retain in the business to support new initiatives, such as China and such as Honeysuckle Health. We've got no plans to accumulate capital to pay down debt. And what pops out the end is what we can afford to pay our shareholders. Less on allowance for what capital we might -- we feel we need to accumulate, as I say, APRA's anticipated -- the expectations of APRA that we anticipate. But we're still working on what we think that legit number will be. Is that fair to say?

It is. And the current consultation paper also doesn't make any reference to grouping, and that was one of the key considerations around what the level of capital we might want to accumulate relates to, to look at Tier 1 capital that we would need to have. So we've got a good pathway at this point in time. We're confident around that journey but there's still a number of unknowns particularly around things like the insurance risk charge that would be in the new standard. It's still quite open under the commentary. So at this point in time, we continue to update the Board through the Audit Committee regularly around what we're seeing, what the modeling is showing us and making balanced judgments around that, recognizing we now have a much longer time horizon than we previously anticipated. I think last time we had really detailed discussions on this was in the first half of 2018, and we were looking at, I think, coming into place, I'm looking at Glenn from sort of FY '20, '21. So we're now actually 1 July 2023, which is actually FY '24. So...

Yes. So the Board had probably 2 hours on this on Friday. The Board eventually reached the position that as a signal of confidence in the business, we could maintain the interim dividend from last year. And based on that $0.10 a share as an interim dividend, we'll still have, as Michelle has touched upon, surplus capital accumulation retained in the business. And that I'm very comfortable with the plans that Michelle has outlined in terms of how we get to eventually deciding what our appropriate target should be and runway to that.

And if I may, I'd just add, as I highlighted in my commentary, the Board have also been thinking about our risk appetite. So we actually increased our internal target at 31 December, recognizing that we're very confident, deferred acquisition cost intangibles, et cetera, will be inadmissible. And so we're on a journey from 50% to 75%. So we're making those decisions along the way around our internal targets.

And just one last question, if I could. On the M&A, how are you running the ruler over potential acquisitions within Australian private health insurance space?

Well, we're obviously having a look, particularly encouraged by Geoff Summerhayes' observations and APRA's very advert view about the need for consolidation. We measure opportunities in terms of the kind of criteria of scale, like if it's too small sometimes it's not worth the effort, I wouldn't rule it out but that's a factor. Their location in the marketplace, their level of capitalization, how stressed we believe they may be under -- we're not on the APRA's capital standards, but more likely APRA's standards around governance and risk management. So there's a range of criteria that we're applying. And once we've landed that, we'll give it some more thought as to our next moves, if there are any moves at all. Of course, as I touched upon earlier, there's a lot of inertia. You can spend a lot of time and money and effort on engaging without a result.

Sean Laaman from Morgan Stanley. I'll just pass over a few comments if you could, Mark, on the following. So if you look at the last APRA statistics, it kind of seems that there's a bit of a troughing in terms of people leaving the system and we're still negative but slightly negative. And maybe this latest round of price increases, we might see a little bit of a pickup at, I guess, in terms of participation rates. So in looking at top line today and your outlook, it kind of seems fine. So it really comes down to the other end of the stick and what you can do on sort of further claims management. So for example -- and Medibank's observed the same thing, you've seen quite a big spike on prosthetics. Is there anything beyond government reform that you can proactively do to manage that expense line down? And is there anything further on regulatory reform that you might envisage over the near term to help you manage that?

Yes, that's -- thanks, Sean. As I touched upon earlier, there's a wide range of things we could do on the claims line. We can keep people out of hospital in the first place through more active intervention with our membership, particularly where it's informed by data science and the doctors have bought into it. We can avoid readmissions on the same basis. We've just spent a lot of money -- invest a lot of money in building the new claims engine in the business, a new benefit management platform, which will capture deviation, fraud, overpayments at the front end of the claims before we've been paid. So we expect -- that is a high return on invested capital, and it hasn't been a big liquid capital to build the new platform, it's taken a while. But we're confident that, that's going to have an impact. We can more -- we can collaborate more closely with doctors in a way I've already described that we're doing through our clinical partners program in Newcastle. I think as I touched upon the challenges of how do you actually scale that across Australia and New Zealand, we can drive harder our preferred provider networks, substitute offering volume for price with providers, and we're doing that already through our preferred ancillary provider networks, and particularly in New Zealand through our First Choice Network. So there's a broad range of measures that we're taking and acknowledging, as you are and as I did earlier, that ultimately our success, not only so much in terms of -- not so much in terms of margin because we're happy to sit at that 6% level. So any efficiency we gain will push back to our membership in form of our low prices and, hopefully, meet regulatory requirements and acknowledging that given most of the market, it's still fairly price elastic, taking advantage of that price competitiveness. So that's the theory, and that's the plan.

Andrew Buncombe, Macquarie Securities. Two questions, if I can, please. Just the first one, you started to speak to another MER in arhi of 6.0%. You mentioned the conversations with Greg Hunt. It seems like you've changed the definitions there and moved some of the costs out of marketing into other. Is that right? Or maybe some color behind that would be useful, please.

So what's included in the investor press is the same format that we've always included in the investor press, but it's different from what sits on the face of the statutory accounts in terms of acquisition costs. The acquisition costs per the statutory account's income statement has a level of labor cost allocated to it for our teams. That is not some -- the process to actually do that doesn't have the level of rigor we're comfortable with on managing our teams month-to-month, day-to-day. So basically, what we report as our marketing MER on the investor press and have done consistently over time is just the commission costs we pay, direct-to-marketing acquisition costs, et cetera, all of the labor costs for running our business. So our marketing and products team sit in other MER.

And then the other question that I had was just some context. Are there any other major hospital contracts coming up for renegotiation in the next 6 to 12 months that we should be thinking about?

So we, I think, have alluded, we had a couple of main ones this year. Some have completed, some are still underway.

[Operator Instructions] Your next question comes from Nigel Pittaway with Citigroup.

Just -- first of all, just a quick question on the reserve top-ups. Am I right in thinking that $4.2 million that have gone through the P&L during the half, is that the right number?

Nigel, are you talking at a group level or just for the arhi business?

Well, that was my next question, was then how much relates to arhi. But yes, it's $4.2 million at the group level.

So arhi is $4.8 million, increase International (Inbound) Health Insurance is $0.5 million. And New Zealand had a release of $1.1 million.

Okay, great. Okay. And secondly, just last one, very quick housekeeping. You mentioned that the leasing standard was in line with prior expectations. So does that mean $2 million benefit to UOP during the half?