nib holdings limited (NHF) Earnings Call Transcript & Summary

Well, good morning, everybody. Thank you for your time this morning. We've got a bit to get through this morning, but before I do, I'd like to begin by acknowledging the Awabakal people, who are the traditional owners of the lands on which I'm dialing in from today. I would like to pay respect to elders past, present and emerging. I would also like to acknowledge the traditional lands from where each of you may be tuning in for our [ full year ] results presentation today and also pay my respect to their elders past, present from country in these locations. Additionally, [Foreign Language] to our members, employees and friends in New Zealand. We're glad that you're able to join us today. Well this is a very busy slide, but as always, we're kicking off with establishing why we're here, that is your better health, a lot of information here. I suppose a key observation in this slide is just how hard we've been working and concentrating at least in the last 6 months on the -- in preserving and supporting our members, our employees and the community at large; and that will continue while ever this COVID-19 threat remains present. And there's just an additional slide and some of the many community initiatives we have been taking as a company. We'll break this down as we go through our presentation today, so I won't speak in any detail to each of these points, the key KPIs commercially that we've been working towards and [ set out ] all the results. Just some summary observations from me. Nick will go -- Nick, who I'll introduce in a moment, will go through some of the commercials in more detail. And towards the end, I'll come back and talk about observations and so relate to our outlook, but at this point, look, there was a somewhat mixed result, yes. We believe the business fundamentals are strong. Our core flagship business arhi grew by 1.9% for the year, accounting for almost, what, 42% of total industry growth, with premium revenue up 3%. It's worth pointing out, of our growth too, most of that was hospital covered growth. So I think, of about 12,000 net policyholders we added, 9,000 were actual hospital policyholders, whereas if you look at the industry results as a whole, the growth of about 28,000, hospital coverage actually retreated by about 3,000. So our growth is actually high quality. New Zealand growth was very powerful, and you can see it from the numbers there. And notwithstanding the impact of COVID-19, we still saw impressive membership growth in our international marketplace. And of course, COVID-19 [ damaged that ] towards the end, but those businesses are still in very good shape and even throughout COVID are still managing their way quite successfully. Of course, profitability was materially impacted by COVID-19. There's a very large provision we have made in the accounts, acknowledging that much of the activity which didn't occur across April and into May is likely to return. How much of that activity remains to be seen. Well I'll probably turn to that point a bit further on. There was a similar provisioning in New Zealand. And as I've mentioned, our international health and workers insurance business were dramatically impacted by the restrictions on foreign entry in the last quarter. And of course, travel took a complete torpedo in the fourth quarter as people simply abandoned travel. Look, there are some silver linings in the results. We remain very well capitalized as a business. Nick will talk more about that further on. And our debt-to-cap is still low and very manageable at under 30%. There's some evidence, as a consequence of COVID-19, that consumer awareness about the risk of disease and the need for protection has increased quite dramatically. We're seeing that in our sales and retention numbers. So again, I'll return to that point towards the end. And it's created even more momentum for some of the opportunities we see in the business around better care management, when you use that expression. I've just used one example there of how our Clinical Partners program is providing a far superior experience for our members vis-a-vis avoiding out-of-pocket costs. Our group operating expenses were down. And of course, a thing I'm most proud about in the last 12 months is the joint venture we've forged with the large U.S.-based global health care company Cigna. That is very much a fundamental step in our overarching business strategy, and again I'll talk to that a little bit further on. Many of you may have met Nick Freeman. Nick joined us in late June as our Chief Financial Officer, replacing, of course, Michelle McPherson, who did an absolutely outstanding job for 16 -- or 17 years. And Nick has very quickly adapted himself to the business, and he is making giant strides. So over to you, Nick.

Thanks, Mark. And hello to everyone on the call. It's a pleasure to be here. As some of you can see, I'm actually in my house. I'm down in Victoria, still in lockdown, but a pleasure to see you virtually and look forward to meeting everyone on the call at some stage. And so while Mark has covered off some of the outline of fiscal 2020, I thought I'd spend a little bit more time going on the detailed financials. So we might look at Slide 10, if we could, please, the group income statement. And you can see from this slide that, overall, nib achieved what I'd call a sound operating result in 2020, but of course, the ever-present impacts of COVID-19 were there. So the underlying profit of $150 million was unfavorable to the $201.8 million in '19. So COVID-19 -- and also there are some outstanding claims liability impacts from prior periods that I'll go through that are impacting. We did make a $98.8 million COVID-19 claims provision for deferred and suspended claims, and that represents around 80% of our estimate of the treatment deferred from FY '20. This 80% represents hospital at 85%, ancillary at 70% and New Zealand at 90%. And you can see the table at the bottom right hand of Slide 10 can set out the details. In terms of some other key drivers of the result. Revenue growth of 4.2% was a highlight, with nib again producing stronger-than-market policyholder growth. Revenue was impacted in FY '20 by $16 million due to the deferral of the April price increase, and the full impact of that is around $38.5 million for the period 1st of April to the 1st of October. There was also slower top line growth in sales for our international inbound health insurance business. That includes the international students and workers. However, these businesses did grow year-on-year, and we were actually quite pleased with how resilient they were in the second half. Unfortunately, revenue growth was not sufficient to offset the claims increases, and this was largely impacted by general claims inflation, the growth in the international businesses which didn't end up being offset by the revenue in the second half of '20 because of the revenue impacts of COVID-19; and also some prior year effects, which I'll come to in the next slide. Another significant impact was the impact of COVID-19 on our nib Travel business, which had an underlying operating loss of $19.7 million, and this loss manifests itself in the other income and other expenses lines. Other income declined mainly due to the extreme slowdown in travel from COVID-19. And then the other expenses increased mainly due to the full year impact of the acquired QBE travel business, which occurred in late May 2019. So the full year impact comes through in that year, but unfortunately the revenue was impacted by COVID-19. We've made a swift cost response in nib Travel. We will talk a little bit more about that in the segment results, but there is a lag impact, and this will be more prevalent in FY '21. There was an $8 million impact in -- relating to some specific intangibles in nib Travel, and we've made additional disclosure on this in Note 14 of the annual report. Turning to other one-off costs, you can see that they've grown as a result of the completion of the QBE travel business and also the GU Health integration, which was a total of $9.3 million, and then restructuring and organizational realignment costs made up the bulk of the balance. And then net investment income was down 54% due to negative returns on growth assets, which isn't really a surprise given the environment, but we have seen a good bounce back during July and August. So now turning to some of the gross profit drivers in more detail, and we'll go to Slide 11, if we could, please. So you'd see from here a key driver in the decline in UOP is the reduction in gross margin from $529.4 million to $506.2 million in FY '20. You can see that, from this table, the strong growth continues to be a positive and was sufficient to offset the mix and product downgrading impacts, such as the arhi members electing the $750 excess introduced as part of the PHI reforms in April 2019, but the major impact relates to F '19 and hindsight restatements to the outstanding claims liability, 2 aspects here. Firstly, it was mostly in respect of the favorable restatement to the June 2018 balance taken up in 2019, but then there was also a negative restatement on the June 2019 balance taken up in 2020. So the combination of those 2 impacts significantly changed the year-on-year comparable. You can see we've outlined there in some detail the net COVID-19 impacts. They're largely offsetting, with claim savings largely offset by the provisioning and the price increase deferral. In addition to the [ net ] COVID-19, it's just worth highlighting, and Mark spoke to it earlier, that we did offer support packages, including other clinical and community initiatives, totaling $1.5 million. If we go to the segments, to our core business, the arhi. Almost 90% of the group, so it remains the core earnings engine for our business. And it had strong policyholder growth in quite challenging operating conditions, and we're very pleased about that. Premium revenue was up 2.9% to almost $2.1 billion. And the 6-month postponement from April '20 impacted that business by $15 million, with the other $1 million being in New Zealand. Otherwise, if that hadn't occurred, premium revenue growth would have been 3.7%. The net policyholder growth, which we've mentioned 1.9%, was well and truly ahead of the industry rate of 0.4%. And with just over 9% market share, nib accounted for more than 40% of total industry growth during the year. Pleasingly, 38.4% of sales were new to private health insurance, up from 35% last year. And our multichannel distribution strategy is driving this growth, which includes our own direct-to-consumer channels, along with our white labeling capability that attracts some leading brands such as Qantas and Suncorp. The UOP result was $133.6 million, down 10.6%, and includes that $90.4 million COVID-19 claims position. Again -- provision, sorry. Again, New Zealand was the balance. And then a key driver of that UOP was that claims expense, including the risk equalization, was up 5.3%. While our net margin of 6.4% is within our target range, you can see it's down from 7.3% in F '19, but it's similar to the F '19 normalized number, which as I said before those impacts on the outstanding claims liabilities brings it down to the 6.2%. Gross margin is down, with claims expense outstripping revenue growth. The key drivers on that include the mental health waiver and increased utilization of prostheses and joint replacements. A number of measures are underway in regard to this, including product changes, the Clinical Partners program that Mark will have touched on and our recent joint venture with the U.S. health care company Cigna to establish Honeysuckle Health. Had a good focus on operational efficiencies in this business and pleased that not only did we achieve the operational efficiencies. We also enhanced the member experience, delivering some good results during the year. So management expenses are down 5.5%. And the expense ratio is down 90 basis points, but pleasingly the Net Promoter Score improved to 35.3, up from 32.5 last year. I might jump to Slide 14 now, if I could, please, the arhi business. The international students and workers business again delivered quite a good operating performance. The second half was obviously impacted by COVID-19 due to the restrictions on inbound international students and workers. And -- but premium revenue of $123 million was up almost 12%, aided by net policyholder growth of 6.3%. The high margins we've historically achieved in this business have come under some competitive pressure. I think that it's consistent with the first half '20 experience and has been anticipated, but having put all of those 2 together, the second half performance actually is quite strong. It did deliver the strong profit in the second half of '19 and showed some good resilience in the face of COVID-19, and we look forward to that business bouncing back strongly in the future when the international students and the workers come back. Looking to Slide 15, the New Zealand business. This is a good business. It's well positioned in the New Zealand market and it performed well. Underlying operating profit increased 18% to $23 million, and that included an $8.4 million COVID-19 provision. Premium revenue were up 11.4%, reflecting strong policyholder growth and price adjustments to account for the increasing claims. The net policyholder growth at 7.4% was strong; and showed success in growing our corporate group and white label channels, which includes the leading brand New Zealand Automobile Association. And then claims of $146.1 million were up 12% due to policyholder growth and the increased hospital and ancillary utilization, but importantly, our First Choice network, which guarantees 0 out-of-pockets, was a key tool in managing service cost inflation. And 90% of all providers in the network and approximately 95% of claims now go through the network. This further enhances the value proposition for our New Zealand members. And turning to travel. So travel has been one of the hardest-hit sectors as a result of COVID-19, and unfortunately nib Travel hasn't been immune to these effects. And you can see what we've done is just put the 2 halves in there, because you can see that nib Travel is a tale of 2 halves. The first half had revenue growing strongly, and there was a focus on leveraging this down to the bottom line. However, COVID-19 impacted that and had a material impact on our second half income, driving an underlying operating loss of $19.7 million. You can see that travel expenses increased, reflecting the full year impact of the QBE travel integration. The operating increases also reflect significant increases in customer refunds, credits and claims, as you can imagine, brought on by travel arrangements being disrupted or canceled. And at the peak of that COVID-19, our travel business had a backlog of 39,000 claims. So it's a credit to our teams, that they've got through those claims, but that has obviously impacted the second half expenses. A cost response was executed during the fourth quarter. You can see that acquisition costs are down significantly, and marketing costs are also down. nib Travel was also eligible for the federal government's JobKeeper scheme, with the business receiving $2 million in wage subsidies during financial year '20. And that's actually included in the other income line. Our focus remains on reducing the expenses into next year with a heavy emphasis on rightsizing the business cost base and improving the efficiency in preparation for the return to travel whenever that may be. Moving on to Slide 17, investments, gearing, cash flow and capital. You can see here net investment income impacted by the return on the growth assets. However, these represent only about 17% of our portfolio. And there was a solid performance by the defensive assets, which had the bulk of the allocation of 83%. So that ameliorated the overall impact. Finance costs have increased 26% mainly due to the reclassification of leases from the new standard IFRS 16. There was no change to our debt. Any movement is due to the impact of foreign exchange on our New Zealand debt portfolio, which is NZD 70 million. Gearing, as Mark has mentioned, remains in line with our capital management policy below 30%. And it's designed to optimize the weighted average cost of capital for the group. And you can see the full year dividend payout ratio was 71%. Operating cash flow has increased by $27 million, and that's due to the net impact on the claims from those timings around the OSC adjustments that I've mentioned before and also COVID impacts as well as the reclassification of lease payments due to the revisions from IFRS 16. If we look to Slide 18, on capital, you can see that we have remained available capital of $57 million after allowance of the final dividend. The reduction in capital year-on-year reflects the adoption of AASB 16, the leases; and also allowance for COVID risk and stress tests and in nib Travel; as well as the investments in our joint ventures, which is mainly Honeysuckle Health. You can also see that, during the year, we combined GU Health into our overall health funds. So that finishes my outline. So thank you very much, and I'll now hand back to Mark.

Thanks, Nick. Okay, Well that's the recent past, with all of the learnings that come with it, so let's talk about the future now. So Slide 20 is our business strategy. This slide may understate the role we see personalization is having across our broad strategy and across all of our businesses. This is basically a transformational strategy we're attempting, whereas in addition to providing the level of financial protection we have to our members for such a long period now, we also want to be up front with them, using data science and technology, being well placed to predict the risk of disease and, with that prediction, putting in place products and services for our members which prevent the disease or better manage the disease or more precisely treat that disease. It's an enormous ambition but one we're prepared for and one we've already sunk significant time and money and effort into. And I suppose the deliverable for future consumers is that not only do they get the level of financial protection they've always enjoyed, but they get an electronic health record. They get personalized risk profile, one which based upon the data science is -- predicts the risks for that individual. With that, they get a good health plan. With that, they get a connection to the broad range of services and products that we've organized to keep them healthy in the first place. So that particular investment is really at the heart of our ambitions across the various business components, arhi, international workers, international students, New Zealand and even travel. We think it will increase the value proposition for consumers, particularly younger people; and we think, will help better manage costs, both claims cost and operating costs. So that's a key to our business strategy. The emphasis on personalization; improvement in affordability and, hopefully, our sustainability. And I'll come back to the question of sustainability in a moment, but it also supports growing our core arhi business and the various adjacent businesses. Clear areas of focus for us at the moment, as you'd expect, is the ongoing COVID-19 crisis; and how we adapt to that both in terms of the -- right across the broad spectrum of the business from the way we design products to the way we price products, to the way we operate the business. The very nature of work in nib has quite dramatically changed. And we're quite determined as a business not to simply return to the past but to take this opportunity to rethink not only where we work but how we work, the hours we work and the whole mindset and philosophy of -- to the work. So as you'd imagine, an ongoing heavy part of concentration in business. The personalization and business transformation strategy, I've already mentioned; the engine beneath this, although not exclusively, about the new joint venture, what we call Honeysuckle Health, but it's the main technological platform providing the science and, with that, the insight and support to allow us to pursue our ambitions. We're still very confident about market growth across all of our businesses. We've already established arhi is performing well. And I'll come back to some more contemporary data in a moment, but we're equally confident that the international workers and students markets will return to normal, if you like, once COVID-19 is behind us. And in fact, the students business may well benefit from the [ real ] crises we're seeing in places like U.S.A., the U.K. and Europe. So we're still very happy to continue to invest in those businesses once conditions improve, and in the meantime, we still see enormous opportunity in arhi in New Zealand. A lot of attention being paid to claims and operating cost efficiencies. So again, the personalization strategy and the work that we're doing behind Honeysuckle Health, we believe, will help us make more informed decisions about how we manage the underlying risk of our [indiscernible] and the claims that flow with that. And there are numerous steps being taken throughout the organization, quite significant steps, to reduce operating costs. For example, we are consolidating all of our back-office operations, be it policy administration, contact centers, digital engagement, claims paying, into a single operating unit now led by a new executive person. Very interested in regulatory reform and opportunities. I think the government is aware that the sustainability of private health insurance relies upon the constant influx of younger people. And so how do we increase the value proposition for younger people? By deregulation. For example, how do we deregulate so that anyone can receive nib cover wherever they meet health care system rather than this antiquated and ridiculous situation where we're limiting the cover and care within the hospital. And risk equalization is a particular tax on younger people, and I'll come back to that point in a moment. And very focused on minimizing the impact of COVID-19 on our travel business and where we're not just sitting around waiting for things to approve -- improve for the moment. There are some sales starting to reappear internationally, although our key concentration at the moment is to reduce operating costs. So the loss of share, obviously we're not happy about. We think we can improve quite dramatically on that this financial year. Look, this is just a chart I threw in for this presentation just to show what a pernicious impact risk equalization is having on the marketplace. So we often hear about the decline in participation as a percentage of the population [ and ] industry. And so it's even -- it's actually worse than those headline figures. You will see from this graph the real drop-off amongst members under 40, who are so critical to, as I say, [ refresh the risk pool ] and keep average cost down for everybody. And the second graph there shows that -- if there's no reform to the system. So the way it works now: Every SEU, as I call, or every person who's insured basically pays about a $900 flagfall into risk equalization. So before they make a claim, $900 of the premium goes into the risk equalization pool. And you can see, based upon prediction, in the second graph that, that almost doubles inside the next 10 years. So this idea that risk equalization can remain as it is, is really one we have to question because the tax it's imposing, the flagfall it's imposing on younger people is just so onerous. And look, the good news is the industry, I think, are united in this view now. And there's an active project unfolding designed to think about, look, how can we protect our community writing through a more efficient and equitable risk equalization system. Okay. Let's talk about the outlook. Look, we're a bit under 2% this year, so 2% to 3% in arhi may seem ambitious, but that's what we're striving for. And we're backing it up with the necessary product design and, in particular, marketing investment that's required to do that kind of growth in such a sleepy market. I guess the most significant element of our outlook is simply the unpredictability of claims given COVID-19, so we've made somewhat of a -- call it, a guessing, if you like, about what level of deferred claims from fiscal '20 will reappear in fiscal -- this current fiscal period, [ fiscal '21 ], recognizing there are so many moving parts to that. So does this catch-up actually push activity which would have normally occurred out into fiscal '22 and beyond? Perhaps. Is there an underlying reduction in what would normally be a claims experience given the natural aversion consumers and even doctors have to hospitalization? At the moment, these are all extremely uncertain factors and one which even in our own budgeting is causing us to create a range of expectations or scenarios around what the gross margin and therefore our profitability might be for next year. So I can't emphasize enough just how uncertain that claims trajectory is and even how uncertain provisioning in the industry [ is made ] as a whole for that deferred claims experience from April and May. And at the time, as many of you recall, where people were predicting elective surgery would be shut down until Christmas this year, it turned out to be a very narrow window of reduced activity. We'll still shoot for our circa 6% net margin. And there's ever-present premium pricing risk, as you all understand. We have our deferred 1st of April increase coming up now at the 1st of October. We announced today that we will defer that increase for people on JobSeeker or JobKeeper. Otherwise, we expect the 1st of April increases, which in our case was 2.9%, will go ahead on the 1st of October. And then there's a question of what level of pricing we'll require on the 1st of April next year, and that would be very much influenced by whatever the claims trajectory turns out to be. Prudent capital management remains in focus, particularly given the uncertainty associated with COVID-19, but as I mentioned and as Nick reaffirmed, we believe we're capital strong and very conscious of managing whatever scenario may come along, hence our caution around dividends for this year. Very concentrated, and I've touched upon already, on how we actually use data science and personalization and investments we're making in better managing the underlying health risks of our insured population and in digital health. We think COVID-19 is going to have real consequences for digital health. We think it will be very strange to our grand kids or great grandkids that, once upon a time, when you're sick, you saw a doctor face to face, with the risk of cross infection and exposure sitting around in waiting rooms with a bunch of sick people. And we still see some opportunity around M&A, but again, our approach is opportunistic. We're not spending too much effort and time on pursuing M&A. If opportunities come along, as I suspect they may, we'll certainly be there ready to have a look at any possibility. I'll just quickly go through this. I've touched already upon the international inbound health insurance. And market conditions, we expect, will recover this year. We are still making sales in workers and students, but attrition within those businesses is high. So we are losing the -- our stock of policyholders, although it still remains at about 170,000 international -- or workers and students. New Zealand is very similar to Australia. I think that is a marketplace that has a heightened sense of the value of private health insurance. And there are some particular growth corridors we see in New Zealand around our role in helping Maori tribes or iwi manage the overall risk of their populations. [ And nib Travel ] will eventually recover. And as I've touched upon earlier, our focus is very much upon driving down those operating costs and minimizing the losses, and we'll do that. And the result this year will be a dramatic improvement, on this year. We still expect to lose money in that business this year but on a much lower level. Look, China, I expect we will actually acquire a license this year with partners. We found after almost 3 years that waiting on regulatory approval for our own license is problematic. So lots of activity there in terms of how we secure that license. In the meantime, we're generating strong revenues by providing health management services to corporations in China. And of course, Honeysuckle Health, which I've touched upon, which is already going great guns, led by a former executive of nib, Rhod McKensey. And I know Cigna is very happy with the progress being made. Look, I just thought I'd share this today to give you a sense of what's going on at the moment. I suppose a key takeaway here is that arhi is doing well in a COVID world. So this is sales and lapse up until the week before last. The figures speak for themselves and also speak to that notion I've mentioned a couple of times now about this heightened consumer awareness of risk of a disease and the need for protection. The international workers and students business are feeling the effects of COVID but are still making sales. And as I mentioned, just the attrition within those books are causing a drop in net growth, but we still have a very strong stock of students and workers. New Zealand is similar to Australia. The comparison with last year is a little bit distorted inasmuch as that last year result included a very large membership that we gained with a certain corporate business, which we haven't replicated so far this year, but the growth is still there. And of course, you can see there the travel numbers, how dire they are, although in international markets there's signs of life, so yes, with almost 7,000 sales made to date. This is maybe even more interesting. So what we're finding is that -- well let's go through them individually. So ignoring Victoria, the hospital benefits paid, we're looking at a 2.7% increase. Now that's a little bit difficult, taking that 2.7%, because as we know, claims experience can take 2 to 3 months to fully develop. Nevertheless, it's directional and it's suggesting that we will be seeing more significant growth than we are, if not for Victoria's. And that's probably best called out in this next metric, which shows eligibility checks, which is a more real-time measure of what's going on at the moment. So you can see eligibility checks excluding Victoria are up about 8%. It sounds about right given the assumptions we made in the claims deferral and our expectations about how that may play out, but when you take -- when you include Victoria, they're flat. So we're seeing growth, but Victoria is bringing it down to next to 0. And it's a similar story with ancillary benefits, where we're seeing strong growth, if not for Victoria, but once Victoria is included, yes, we're -- it's negative growth. So look, these numbers are just a snapshot. They're illustrative. They're not meant to be definitive, but hopefully, they'll give you some sense of what is actually happening on the ground; and how this catch-up in claims, which were fully expected and provided for in our FY '20 accounts, is being offset by the what is a terrible experience in Victoria. Okay. Well I'll pause there. And as always, happy to take any questions.

[Operator Instructions] Your first question comes from the line of Andrew Buncombe from Macquarie.

Just 2 from me, please. The first one, just in the context of your annual net organic policyholder growth target of 2% to 3% for next year, how are you thinking about the system growth for this metric for FY '21?

Well it's a tough question, Andrew. Pretty much the same. More what we're doing in the business in terms of our view of the world is to think about, under our personalization strategy, what could we reasonably expect in terms of stimulating the market. Say for example if we do fulfill this vision that I've outlined in the way I've outlined, would participation in the system grow from 50% today to 60%? And if it did, what might we be able to grab of that market growth? So in terms of our own planning, I think it'd be fair to say that we expect the market will continue to stay flat, that we will continue to grab more than our share of that. And as I've mentioned, we accounted for 42% of total system growth last year, but our real ambition is, rather than just grab more of what is a very soft market, how do we actually bring something to the marketplace which really stimulates greater interest in private health insurance? Because it's not only providing financial protection. It's providing a value proposition around the ability to predict and prevent or better manage disease.

And then the other question that I had was just in relation to your assumptions around hospital and ancillary claims catch-up. They seem to be different to the APRA guidelines and to some peers as well. Maybe if you can just walk us through why you've used different assumptions for the catch-up, please.

Well as I touched upon, Andrew, this is frankly a guesstimate. Nobody, APRA or any of our other competitors, will accurately predict what this number is likely to be, particularly given the fact that they're so confounded by what's happening in Victoria. So we've had a -- we've tried to form a view based upon looking at the case mix. We've gone that granular. So if Jack and Mary didn't have their hip replaced, what's the likelihood of any attrition or when it may be rescheduled? And we've done similar analyses across our ancillary case specs and we've landed on those numbers. I understand APRA are happy with us forming that kind of view. They've been more conservative, of course, with their requirements or provisioning, so you shouldn't be surprised that there is some difference. Nick, do you want to add to that?

Yes, sure. I mean the APRA requirement are from a prudential basis and a capital basis, which is an extreme event, so you'd expect them to be a little more stringent. And so we've taken those. We are using those in our prudential calculations, and our capital is still well above prudential. And then in regard to against peers, well, we've only really had the opportunity to be able to see against one peer. And while the composition might be a little bit different, I think it's relatively similar.

I think, to expect that the claims -- that the treatment deferred in April and May this year will fully return during the course of our financial '21, given underlying attrition, given what's at Victoria, given the broader issue that I touched upon earlier, people having -- patients and doctors having a more natural aversion to hospital and may be looking for more conservative treatment -- I think to suggest that 100% will come back would be archly conservative, [ but the more we ] understand and expect [ how best to position ].

Your next question today comes from the line of Sean Laaman from Morgan Stanley.

2 questions, just 1 on the rate increases and 1 on Honeysuckle Health. So on the rate increases, just to, I guess, take your temperature on your confidence with respect to both being approved in October this year and April next year is the first question.

Well I'm confident, as I've touched upon, but the caveat on that, Sean, is way back before -- way back in March when everyone was as confident on the Friday that the 1st of April increases would go forward, and by the Sunday, that had changed. So these things can turn on a penny given the politics associated with that. And the main reason I was not keen initially to defer the 1st of April increases was all very preemptive. And as time has shown, the suggestions way back then, the predictions way back then had -- elective surgery would be compromised until Christmas, we thought, were exaggerated, but nevertheless we thought, given the pressure at the time, it was the right thing to do. But if you look at the numbers, the level of compensation we have given just with premium deferrals of about $45 million was -- probably will turn out to be much more than what we saved. And that's not even including additional financial we -- support we gain by way of suspensions and waivers and product extensions. So look, these things can change quickly. My here-and-now view is the 1st of April postponed increases will go forward in the 1st of October. We, and I know there some other insurers, have taken action to ensure that, that doesn't impact those most vulnerable such as those on JobKeeper and JobSeeker. I think the bigger test will probably be the 1st of April next year, being the election year. I'm not quite sure when the election will be, but obviously we can expect some regulatory pressure from insurers to keep those premium levels to the minimum.

Great. And then on Honeysuckle Health, is that a material investment at the moment? And do envisage -- maybe this is better off-line in more detail, but do you envisage that it's something that will underpin the portfolio of products that nib sells? Or is it a few products? Just to kind of help us understand what the end game is here.

The end game is that people become members of nib not just because of health insurance. They may or may not buy health insurance in the first instance, but because that -- by joining the nib membership, they get, as I've mentioned, electronic health record. They get a very personalized individual risk profile, one which understands their individual risks based upon the data we've been able to collect and interpret. This is the essence of the science we're developing. And that they get a good health plan with that and that they are connected with a broad range of products and services [ that I've often ] used an example that, if Mark is identified as having an acute risk of skin cancer, we preemptively help him manage that through free trips to dermatologists, free sunblock for the rest of his life, a drug that increases his skin melanin, et cetera, et cetera, et cetera. So that's our vision. That will be -- so the value proposition becomes when I become a member of nib because, [ despite being a member of nib ], I'm likely to live a healthier, longer life. And as I say, I may or may not buy health insurance, [ drop that in the shopping cart to stop it ].

Your next question today comes from the line of Matt Dunger from Bank of America.

Looking at your internal capital target. That's increased by over 50% year-on-year. Mark, I wondered if I could ask you. To what extent does the 5% to 6% target on net margins that you've previously looked at for arhi remain appropriate given the higher capital levels that you're expecting to hold and you're expecting internally?

Well, the 5% -- for those of you who have been around long enough, you will know we always cited the range of 5% to 6%; and that, that 5% to 6% operating margin in arhi, we believe, will generate a return on invested capital of about 15%. There's nothing in my view that's changed. A few years ago, we shifted that target away from 5 -- from a range of 5% to 6% to 6% mainly because we were doing better than 6%. And so we didn't want to set the bar lower than what we thought was sustainable. So I don't see that position changing. We've had plenty of headroom in terms of that kind of internal rate of return given where our WACC is at the moment. Nick, did you want to comment?

Sure, yes. I mean it's a good question. I think the -- a couple of thing, if you look year-on-year, is that the internal capital target, it has increased for a couple of reasons due to the COVID stress tests and also the inclusion of some of the other impacts in regard to the nonregulated entities and the joint ventures and so forth in terms of available capital. And then when we combine the GU Health fund into the overall health funds, that's been a big increase as well because that's shifted also some intangibles which had to be taken into account. So on -- overall the way -- I've been looking at this in terms of the overall available capital which takes those things into account, and that has reduced year-on-year. And as I said, it's reduced mainly because of the change in the lease standard. It's reduced because of the impact of the investment in Honeysuckle Health and the China joint venture. It's reduced because of the -- sorry. I'm just trying to find the other one other than -- so the lease standard and also the future -- any expected losses for travel into the future. So those are the main reasons for the reduction. Overall, we're still coming into an overall surplus position, but again it's that capital is very much on our radar across the course of the next year or 2.

And of course, the returns are -- I think the return on equity which we've cited, what, 14.5% -- I think the return on invested capital was about 12%. So as I've touched upon -- and that's wearing the impost of what's happening in travel at the moment and a weaker workers and students results. So from a capital management point of view and ROIC's number, I'd always look at that. I think we're well placed.

[indiscernible] -- I'm sorry. I interrupted you...

Yes, on the -- sorry. I mean it -- the -- again in terms of the capital generation into the future. The margin should be enough to accumulate capital into the future. It -- but it all depends on where the revenue and margin and the gross profit comes out.

Great, okay. And on travel insurance, you've got $47 million of operational expenditure in that cost base there. How much of that can you address? Are you able to talk to how much is direct versus allocated within that travel insurance business and potentially what the run rate was, given you noted some cost initiatives at the end of FY '20?

Do you want me to take that, Mark?

Well just to restate the initiative we're taking to consolidate all of those back-office operations, which is going to see a lot of costs removed from that business. So we're very determined. Again as I mentioned earlier, we won't make a profit in travel this year. Things are just so dire, but certainly halving that loss is certainly front of mind for me.

Yes. And the run rate is coming dramatically down every month. So we're in -- we're willing, trying in terms of some of that restructuring and those changes. And the run rate, if I'm just looking at the quarter and the monthly run rate, it is coming dramatically down.

And your next question today comes from the line of Siddharth Parameswaran from JPMorgan.

Just a couple of questions, if I can. Firstly, just on the claims experience in arhi against the premium increases that have been coming through. It's obviously -- as you mentioned, Mark, it's very unclear what the impact of COVID actually is, but -- and what it's likely to be on your P&L, but I was hoping you could just give us an idea of what was happening to claims inflation trends per policyholder and premium inflation trends per policyholder before March. So up until March, what were the trends like? Obviously, [ post them ], it's heavily influenced by COVID, but I was just wondering if you could give us some idea of just how the experience until then was tracking just the difference between those two.

I think -- yes. It's a little bit academic now, I think, Sid. I -- to answer your question, I think we were concerned. We were concerned about the rate of claims inflation versus premium growth, to the point that, at one stage out of June, May, we undercooked it at 2.9% as an average increase for this year. If we looked [indiscernible] they had more. So it wouldn't be genuine of me to say that we didn't have some concerns before the arrival of COVID, but as we have in the past, we'll just have to adjust for that through our pricing in the following period. But I believe it's academic in the sense, Sid, that I think -- as with so many other dimensions in society, I think the impact of COVID-19 is going to really disrupt the trajectory of what was the past normal. I think this is creating an opportunity for us to really more assertively promote alternative models of care, things like avoiding major joint replacements where it's where -- more clinically appropriate. Conservative treatment is warranted. And certainly increase our efforts around reducing length of stay and out-of-pockets for our members, as I mentioned. And how the world reacts from here in terms of their willingness to go to a hospital, I think it's anyone's guess. So look, I think we were under a bit of pressure. COVID-19 has changed all that. And what pops out this year and beyond is -- really is anyone's guess.

Okay. Maybe if I can just ask about just the rebound in claims that you are seeing. I mean obviously you've set up large provisions there, $90-odd million in arhi. Could you just comment on, versus normal assumptions or normal levels of claiming, where ancillary actually is right now? I mean I'm conscious you showed us some charts of year-to-date, but it's actually just hard to tell whether you are actually seeing utilization bounce back of 100% right now. And secondly, in the data that you did show, it seemed like hospital claims -- I mean it seems like they were up heaps. So I think you said there it was an 8% increase, an 8.1% increase, in eligibility checks excluding Victoria. Just wondering if you could comment on whether there's anything going on in that data. Because that suggests that the underlying trends are very, very sharp.

Yes, but there's catch-up in that. Don't forget, Sid. So I think -- at a 30,000-foot level, what I think we're seeing is we're seeing a growth in utilization of about 10% at the moment, but that's consistent with this position around providing for the catch-up. And we've straight-lined that over the year, so you can do the math on that. So 10% is a good number to think about in terms of the growth of ancillary and hospital benefits, but that includes the catch-up. But that's been dragged back to a negligible growth rate because of the [ weighting in ] Victoria. [ Like 25% ] of our business is in Victoria.

Okay, great. And just one final question for me, just if you do end up having significant windfall profits in arhi. I mean I'm conscious you've had significant impact in other parts of your business, but would you seek to give that back to policyholders?

It will certainly have a heavy influence on our 1st of April increase next year, yes.

Okay, okay.

I don't think the government is going to be excited about -- if -- look. And if there is a second-round windfall because of the longevity of COVID-19, again as unpredictable as it is, government is not going to be and we're not going to be excited by the prospect of profiteering. We'll be looking to price in a way which delivers that targeted return in arhi of 6% or thereabouts and, as we've been saying right from the very beginning, do the right thing.

And your next question today comes from the line of Ashley Dalziell from Goldman Sachs.

Just an initial question on risk equalization in the second half, of quite a noticeable drop-off in your contribution half-on-half and also on PCP. Is there anything that you'd like to kind of call out there? It's been a train which has been one-way traffic for quite some time. So just the -- appreciate if there's any color that you could provide there.

There was always going to be a bit of a drop-off in risk equalization because of the deferral out of April and May. Nick, to what extent have we provided for that deferral? Is that just trading at similar...

Risk equalization is included in the COVID provision.

Yes. So other than that, look, we saw a spike when we acquired GU because, that business, the average age and risk profile is lower and better than the industry average. And so we're probably just seeing some level of normalization post the GU acquisition. Did you have any other thoughts on that, Nick? Putting you on the hotspot now talking about risk equalization...

Yes. Thanks for that one, as it's sort of 6 weeks in and a crash course in risk equalization. I guess I'd -- the way I'd look at it is just as the largest contributor, when things get deferred. That probably has an impact because, remember, we deferred 80% in the provision. So there's that 20% coming through.

Okay. Maybe just a second question following a bit on from the last. I mean on the data that you've given us for the first 6 weeks of the year, on Slide 25. I mean, on aggregate, would it be fair to assume that you've been able to kind of hold your gross margin through the start of the year without that premium rate increase?

Just a quick confirmation. So that -- on Slide 25, the top part is year-to-date to 14th of August, but the bottom part is only the 1 week of the 16th of August.

Right, okay. I might delay that question then. Maybe just a final one: Could you comment on the kind of what you're seeing within the white label partnerships over the last 3 months or so? Specifically just thinking about the Qantas partnership, which has been a bit of a star performer. The data within the back of the pack does suggest a bit of a drop-off from the white label sales contribution. Perhaps provide a bit of color there.

Yes. So just on your question about the gross margin. I think your premise is correct, although as Nick has pointed out, this is a snapshot of 1 week. But if you look at the [ upward ] data for the Q4, our gross margin was materially better than the industry and is trending better than usually. So we're reasonably confident about that. Nick made the point earlier on about how much of our growth is actually new to category. They are better risk, if only because of [ waiting ] period. So we're reasonably comfortable with where we're -- the way we're selling in terms of risk selection, combating adverse selection and better managing the underlying risk exposure in our population, although we've still got -- that journey is only 5% of the way it started. Question about the white labelings. Yes, they have been weakened and particularly Quanta. So they're very still a fantastic channel for us, but the attraction points at the moment isn't as great as what it was only 6 months ago. Hopefully, that will bounce back, but the really positive story, and we did well 108,000 sales last year, is the resurgence of our own nib-branded products, both direct to consumer but also through our aggregator partners, et cetera. So yes, those white labels have -- are currently weak compared to where they were, but we believe arhi will come back. We are pursuing other very significant white labeling partnership opportunities, but in the meantime our direct -- our own direct-to-consumer efforts with the nib brand is doing particularly well as you can see from those numbers I've presented.

And our next question today comes from the line of Nigel Pittaway from Citi.

Just a question on downgrading. I mean sort of I'm not sure you called out what your number actually is. So if I missed it, I apologize, but if not, maybe you can tell us. And just, I mean, do you sort of fear that downgrading could spike if the economy does sort of go into a bit of a tougher time moving forward?

Yes and no. A good part of the -- I don't think we have called out numbers, so let me think about that. We -- a significant proportion of the downgrading has been around the additional excess opportunity. So that was very intentional and deliberate to improve affordability but not only improve affordability but to improve risk selection, the theory being, the higher the front-end deductible consumers are willing to accept, the more they're self indicating as being of better risk. So look, it is an ongoing trend within our business but the system as a whole as consumers seek greater affordability, but as I've often said, rather they downgrade than leave the system. So downgrading is somewhat of a safety net in that sense. And I -- Nigel, [ rightly ], on the -- I don't worry about downgrading. I think it is a [ save ]. And I think, as so long as you're managing your underwriting book, you're pricing for those developments, it's -- yes, it's okay.

Okay. And then I appreciate it's back in the murky water of what's happening to claims, but I mean obviously, at the half year and before COVID effects really crystallized, you were talking about sort of getting benefits out of prosthesis pricing and also the private room rates for public hospitals in New South Wales. I mean, did those benefits come through as planned? So I guess, ex COVID, would that have led to a lower base?

Look, there has been some benefit. I tend not to talk pretty much about prosthesis pricing because the industry is already talking a lot about that. And Craig focuses on it, quite rightly, whenever he presents, but we have seen some improvement but are still totally unacceptable. And designing a new system for prosthetic pricing is something that's obviously required, such is the idea of an independent pricing authority. Ultimately, though, I think the -- and I've touched upon this before. Ultimately, the solution to prosthetic pricing is to bundle the costs of a treatment, doctor [indiscernible] doing the surgery and prosthetic device [ guys ], et cetera, et cetera; and put accountability back on [ oddly ] the doctor but most likely the doctor or the hospital to manage that bundled costs because [indiscernible] under the current circumstances where the doctor is less likely to care about the cost. He's just [ appearing to untenable ]. And so I think programs like the Clinical Partners program, which is very much at the moment about reducing -- well, removing out-of-pocket costs and improving clinical pathways, principally rehab in the home, not in a hospital, that's exactly the kind of platform which lends itself to going further down the value chain and talking to the doctors about how they may play a greater role in controlling these [ kind of ] costs.

Okay. So I mean you did see some benefit in the second half from those 2 things. Is that basically what you're saying? Or...

Yes but -- yes but not as much as we would have liked. The growth is still quite [indiscernible].

There are no further questions on the line today. I would now like to hand the conference back to Mark for closing remarks.

Okay, well, thanks, everyone, for your time today. As I start off by saying, a bit of a mixed result, but I think other than in travel, fundamentals across all of our businesses are strong. Our flagship arhis are performing particularly well. And on respect of travel, look, it's all hands on deck. We've thought about a range of options with travel. We think the best course of action now -- right here and now is to stay the course; get costs out of the business; get ready for a return to whatever new normal looks like; and then reassess the position in 12, 18 months time, depending upon our progress. So thanks for your time today, and have a good week. Ciao.