QBE Insurance Group Limited (QBE) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to QBE's 2021 interim results briefing. My name is Tony Jackson, and I'm the Head of Investor Relations. This morning, you'll hear from our interim Group CEO, Richard Pryce, who will be presenting from London; and our group CFO, Inder Singh, who is presenting from Sydney. We'll then open up to Q&A. Before I hand over to Richard though, I just remind everyone that you cannot ask questions if you dialed in over the phone. And with that, I'll hand over to Richard.

Thanks, Tony. Good morning, and thank you for joining us today for QBE's 2021 Half Year Results Presentation. I'll start by discussing the key features of the result, provide more granular detail on the current pricing environment and the implications for premium growth and margin expansion before handing over to Inder to talk through the details of the financials. I will then close with our priorities for the second half of the year before opening up for Q&A. So if we move to Slide 3. I would like to start by saying that the Board and the group executives are pleased with the improvement that is clearly evident in the first half results. We have made encouraging progress with the performance agenda the momentum is building across the business. Profitability rebounded strongly during the half, underpinned by a material improvement in both underwriting profitability and investment returns, which contributed to an adjusted cash profit ROE of 11.9%. Our combined operating ratio of 93.3% is encouraging and over 10 percentage points better than the prior period, which is heavily impacted by COVID-19 and the significant unfavorable prior year development. It also shows an improvement on the 2020 exit COR of 95% that we referenced back in February. Just briefly on COVID-19. The COVID-19 current accident year impact during the half was modest by only $20 million, which mainly impacted A&H and workers' compensation attritional claims in North America and a small business interruption impact in Australia. We flagged the likelihood of a further $130 million of COVID-19 related claims in 2021. And while there's still a long way to go before year-end, I would be disappointed if we didn't come in below that. Given the only modest first half impact, we haven't excluded COVID-19 claims from our underwriting result. However, it makes sense to continue to exclude the very significant COVID-19 impact from the H1 '20 comparable figures. In 2020, we set aside significant provisions and risk margins for COVID-19 claims, and we remain confident that these will prove sufficient. Importantly, we have already received some COVID-19 BI-related reinsurance recoveries and currently have no concerns around recoverability. Now turning back to the broader business. Headline gross written premium increased 27% on the prior year or 20% on a constant currency basis. The GWP growth reflects a combination of the ongoing strong premium rate environment, targeted growth and improved customer retention across the group. Premium growth also benefited from significant growth in our Crop business, which I will touch on later. Given the ongoing positive pricing conditions, results unsurprisingly included a further improvement in the attritional claims ratio, which I will discuss by division in a subsequent slide. The only disappointing aspect of the result was catastrophe claims, which were above our increased allowance by 1.6% of net earned premium. Texas winter storm, Uri was a standout event during the period, which led to near record first quarter losses for the U.S. P&C industry and heavily impacted our North American results as well as the result of international markets in QBE Re within the International division. We also saw elevated activity during the half in Australia, including Cyclone Seroja, east coast floods, storm losses and bushfires. While it is early days, it is pleasing to see a modest amount of positive prior accident year development, including a positive outcome in all our divisions. While the stability of reserves in North America is encouraging. But in a fluid operating environment, particularly with respect to claims inflation, we are keeping an extremely close eye on numerous reserving data points. I will talk about inflation a little more later. Premium rates increased further in the first half of 2021, with the group achieving an average renewal rate increase of 9.7%, up from 8.7% in the prior period. Pricing remains strong across all regions and in almost every product line. I will discuss this in more detail later. Although the pricing environment remains attractive, I caution you that there are some signs that momentum is moderating, particularly in the international markets here in London, where rate increases have been particularly strong now for nearly 4 years. While the investment return was impacted by mark-to-market losses on fixed income securities, due to the significant increase in risk free rates during the period, investment income rebounded strongly to $58 million from a loss of $90 million in the prior period. Asset allocation remains appropriately conservative given growth asset valuations and uncertainty around the outlook for global inflation, but also given the opportunities for profitable capital deployment across the group's underwriting businesses. I will leave the balance sheet to Inder to talk about in more detail, but I'm pleased to see that all the balance sheet metrics are moving in the right direction. Now if we move to Slide 4. Most of the charts on this slide speak for themselves. As already noted, we saw a very strong growth during the half with GWP up 27% to $10.2 billion or up 20% on a constant currency basis. As you will see shortly, our Crop business contributed significant growth. But even excluding Crop, GWP was up 14% on the same basis. The trend in premium rate increases is impressive, particularly the step-up in 2020 and then again in the recent half. And there is this compounding effect of rate on rate that is driving the improvement in the attritional claims ratio, so clearly evident in the chart on the bottom left. Inder will discuss our combined operating ratio in a later slide. But suffice to say that the trends we are seeing are encouraging, and we are pleased with the improvement. While it's not impound from the chart, the 93.3% is the best combined operating ratio the group has reported in almost a decade. Looking briefly at large individual risk claims. The net cost of large individual risk claims increased to 8.1% of net earned premium from 7.5% in the prior period. Whilst it's not apparent in the chart, the current accident year results include substantially more IBNR than in previous periods. And so the underlying trend in risk losses could prove to be more pleasing than it first appears. Turning now to catastrophe claims. The recent trend in QBE's catastrophe costs is concerning, increasing to 7% in the most recent half from 5.5% in the prior period and well above the group's first half allowance. The rising frequency and severity of catastrophe costs is one of the more difficult issues that the industry is presently grappling with. As I have mentioned before, we continue to view all catastrophe exposure with caution. We still consider the pricing of catastrophe risk to be merely adequate rather than margin enhancing. And as a consequence, we have not increased our catastrophe exposure during the half. As part of our reinvigorated sell review process, we are reviewing the performance of all our catastrophe-exposed portfolios and reassessing the effectiveness of the models we use. And finally, on this slide, prior accident year claims development. Given the reserve strengthening we took at the end of 2020, particularly in North America as well as adopting more conservative IBNR assumptions for the 2020 accident year and the current accident year, it is pleasing to see the group report a modest demand of positive prior year development. While all divisions reported positive prior actual year development, the early signs of reserving stability in North America is encouraging, noting, of course, that is based only on 6 months development. Briefly on claims inflation. In some short-tail property lines, we are experiencing what at this stage, this appears to be short term rather than permanent structural shift in claims inflation associated with supply chain shortages leading to increased labor and material costs. There has been a small impact on the results for some property classes in North America. In long-tail classes, we have not seen any material change in claims inflation, including social inflation, and our underlying assumptions by division remains sufficient and are largely unchanged from the level we outlined back in February. That said, we are looking closely at trends in claims inflation emerging in new pockets, including liability, Western Australia workers' compensation and New South Wales CTP new scheme claims in Australia as well as bodily injury here in the U.K. Regardless, we remain vigilant on claims inflation and will not hesitate to further increase our pricing and reserving assumptions to any signs of a sustained acceleration in claims inflation emerge. Now if we move to Slide 5. Turning now to pricing momentum in a little more detail. As I said earlier, premium rates continue to strengthen, with the group achieving an average annual rate increase of 9.7% in the half, up from 8.7% in the first half of 2020. While we have seen consecutive quarters of stronger rate increases relative to the prior corresponding quarter, namely 8.9% in the first quarter, followed by 10.6% in the second, there are some signs that rate momentum is moderating, particularly here in some lines in international markets. Turning briefly to each region. Premium rates in North America remained strong with an average renewal rate increase of 10.2% in the half compared with 9.5% in the prior period. Premium rate adequacy continues to improve and rate increases are comfortably in excess of claims inflation across most portfolios. Noteworthy rate increases by class included 22% in financial lines, 17% in aviation, 16% in property programs and 11% in accident and health. In International, we achieved an average premium renewal rate increase of 10.5% compared with 10.1% in the prior period. This included rate increases of 14% in international markets, 13% in the U.K., 11% in Continental Europe, 7% in QBE Re and finally 5% in Asia. Although there are some signs, momentum is moderating, particularly in international markets, which contributed to a slightly lower second quarter increases relative to the equivalent prior period, rate increases remain well above claims inflation. And it is encouraging that rate continues to build the portfolios where significant premium rate connection was -- correction was necessary, such as financial lines and international liability. Noteworthy rate increases included 32% in U.K. financial lines, 20% in Canada, 19% in U.K. property, 18% in European financial lines, 16% in International Markets property, 16% in International Markets Financial Lines, and finally, 12% in European property. The acceleration of premium rate increases in Continental Europe more broadly is also pleasing as the commencement of an upswing in rates in this portfolio, like other territories and supports our growth plans in this region. Australia Pacific achieved an average annual renewal rate increase of 7.7%, up from 5.5% in the prior period. As you'll recall, rate increases in the middle quarters of last year were impacted by COVID-19 relief measures. So it's pleasing to see rate increases recovered this year particularly given the catastrophe experience in recent years. Noteworthy rate increases by class included 14% in professional indemnity, 13% in commercial property, 12% in householders, 11% in strata and finally 10% in engineering. Before I move on, it's worth highlighting the steady improvement in the group-wide customer retention, which reflects the activities included in our customer QBE initiative and reduced remediation activities. In addition to premium rate increases and new business growth, improved retention contributed to the strong growth we achieved during the half. No doubt you're interested where I see rates trending from here. And as always, my response is it's very difficult to predict. While there are some signs that momentum is moderating, there are plenty of factors supporting ongoing increases, including recently elevated and possibly accelerating catastrophe experience, negligible interest rates, the likely short-term claims inflation in short-tail lines I mentioned earlier, and frankly, the need for the industry to build reserving prudence to manage the potential for a more sustained increase in claims inflation. In summary, I believe rates in most products and geographies need to continue to increase to offset the factors I just mentioned above. If we now turn to Slide 6, gross written premium. As I mentioned earlier, gross written premium increased 20% on a constant currency basis, reflecting the strong pricing environment, targeting new business growth and improved customer retention. Our Crop business in North America experienced 48% top line growth during the half, reflecting significantly higher commodity prices and ongoing targeted organic growth associated with our market-leading service proposition. For those of you interested in further details, we've included a slide on Crop business in the appendices, which is Slide 24. Excluding Crop, gross written premium increased by 14% on a constant currency basis, with a growth of 17% in North America, 11% in international and 18% in Australia Pacific. This translates into growth of around 7% in excess of premium rates. Despite the strong headline growth, we've retained our underwriting discipline, targeting new business that is appropriately priced and within our risk appetite. Our priority remains optimizing risk-adjusted return on capital. Turning now to each of our divisions in a little more detail. Excluding Crop, North America achieved GWP growth of 17% underpinned by strong growth in specialty programs, commercial property, A&H, middle market P&C and financial lines. Growth in the middle market is central to our strategy of building additional scale, while at the same time enhancing portfolio balance, particularly reducing our exposure to mono-catastrophe exposed lines. Following our investment in market-leading talent, financial lines portfolio grew [ 14.2% ] in the current period. To be prudent, we have supported this growth with a 50% quota share on the current accident year. International achieved growth of 11% on a constant currency basis underpinned by growth of 25% in Continental Europe business and 15% in QBE Re, driven by specialty and casualty lines. We have seen less than optimal growth in international markets in Asia, which we will focus on these areas in the second half. Australia Pacific achieved premium growth of 18% on a constant currency basis, underpinned by 23% growth in commercial lines. Strong growth was also achieved in LMI, workers' compensation, commercial packages, engineering, commercial motor and farm. Growth in the group's net earned premium lagged gross written premium during the half, reflecting a number of factors, including especially strong growth in heavily reinsurance classes like Crop and financial lines, as well as earning patterns, including Crop and LMI. While overall reinsurance expense will be subject to business mix trends, the gap between written premium and earned premium should narrow somewhat during the second half. Inder will speak to our reinsurance expenses in a later slide. But with the current pace of top line growth, our net burn premium trajectory should move closer to gross written premium in the second half. Now turning to Slide 7, the attritional claims ratio. As I said earlier, given the strong pricing conditions, the further 1.8% improvement in the group's attritional claims ratio to 43.7% is not surprising. North America's attritional claims ratio grew to 1%, reflecting rate increases in excess of claims inflation across most lines. This is despite a modest amount of COVD-19 related claims, which impacted A&H and workers' compensation and short-term inflationary pressures in short-tail property lines due to higher materials and labor costs. International's attritional claims ratio improved by 3.6%, reflecting the compounding effect of especially strong premium rate increases seen over the last 18 months. Somewhat disappointingly, Australia Pacific's attritional claims ratio increased slightly during the half. Improvement in most classes was more than offset by higher weather-related claims in householders, strata's and the Pacific businesses. Given the strength of the ongoing premium rate increases and the rate increases we are still earning through the P&L, it is reasonable to anticipate some further improvement in the group's attritional claims ratio. I will now hand over to Inder to take you through the financials in more detail.

Thank you, Richard. Good morning all. As Richard has highlighted, our first half result clearly demonstrates a strong recovery in earnings, driven by a material improvement in both the underwriting profitability and in investment returns. Pleasingly, the overall quality of the result is strong with headline financials now more aligned with the improving underlying trends we have referenced in recent reporting periods. I'll now provide a bit more detail on our financial performance, starting with the overall group P&L on Slide 9. Gross written premium for the half was $10.2 billion, a 20% increase over the prior period as measured on a constant currency basis. This reflects the benefit of compound rate increases, improved customer retention and good new business volumes. The combined operating ratio improved by around 4 percentage points to 93.3%, reflecting further improvement in the attritional claims ratio, a lower expense ratio and a modest release from prior accident year reserves. I'll step you through each of these components in a bit more detail shortly. Our investment portfolio delivered an annualized return of 40 basis points. Excluding the impact of risk-free rates, the underlying annualized fixed income yield was around 50 basis points. Growth assets delivered a 12% return on an annualized basis. This is well ahead of our long-term assumptions and reflected the supportive market settings for risk assets in the first half. The statutory profit after tax for the half was $441 million, a strong rebound from the $712 million loss we reported in the prior period. It's worth briefly touching on the impact of risk-free rate movements on our P&L during the half. As flagged at the AGM, we modestly shortened the duration of our fixed income portfolio in Q1. So as risk-free rates moved higher, we generated a net P&L gain of $73 million with a $205 million benefit to the claims line, more than offsetting the $132 million adverse mark-to-market impact on investment assets. The annualized cash ROE for the first half was 11.9%. This number equates to 10.4%, excluding the tactical investment gain I just referenced. The Board declared an interim dividend of $0.11 a share, up from $0.04 per share in the prior period. Informing its view on the interim payout, the Board sought to balance the strength of our earnings recovery, the outlook for organic growth and the higher inherent weather-related uncertainty in our second half performance. I'll now turn to Slide 10 and step you through some of the key movements in the group's combined operating ratio. As you can see on the chart, our first half combined operating ratio of 93.3% was around 4 percentage points better than the 97.4% reported in the prior period. Walking from left to right, the first block shows the impact of movements in prior accident year reserves. The 2021 half year result included a modest benefit of around 1 percentage point versus an adverse impact of around 2 percentage points in the prior period. The current accident year combined operating ratio improved by around 1 percentage point in aggregate across the components shown on the chart. The main driver of this improvement was the attritional claims ratio, which was around 2 percentage points lower at 43.7%. This reflects the benefit of earned premium rate increases and are now well-established underwriting disciplines. The 60 basis point improvement in our expense ratio reflects the benefit of our efficiency initiatives over the last 2 years, coupled with disciplined cost control and operating leverage from the higher premium base. The improvement in the commission ratio primarily reflects a shift in business mix, in particular, the strong growth in our Crop business where commissions are reimbursed by the U.S. government and growth in classes protected by quota-share reinsurance, such as North America Financial lines and Lenders Mortgage Insurance. On large individual risk claims, we are seeing a relatively low level of reported claims activity. But we're continuing to hold higher IBNR assumptions to reflect both the inherent volatility in these claims and the higher risk of inflation over the medium term. Catastrophe claims were elevated reflecting the winter storm in Texas, floods and storms in the East Coast of Australia and Cyclone in Western Australia. We have booked our Crop business at our current accident year combined ratio of 95% relative to the 2021 plan of 92% and the prior period comparative of 90%. This reflects both elevated drought risk in the Dakotas as well as in Minnesota and the inherent difficulty in accurately forecasting the Crop result prior to the harvest in November. I'll now turn to divisional performance in a bit more detail. I'll start with North America on Slide 11. Gross written premium for the half was $3.8 billion, an increase of 31% versus the prior period or 17% excluding Crop. Before I talk about the combined operating ratio, I'll just describe what we're showing on the charts on these divisional slides. The left-hand bars show the current accident year combined operating ratios with the Cat claims held an allowance. And then the middle section of the chart shows the impact of actual versus allowance on Cat claims for each half as well as the movement in prior accident year reserves. We think this provides a good view of the underlying performance of the business over the 2 comparative halfs. So as you can see here in North America, the current accident year combined operating ratio improved by around 70 basis points to 95.9%. Within this, the attritional claims ratio improved by around 1 percentage point with the benefit of premium rate increases partly offset by the impact of claims inflation in short-tail property classes related to both construction materials and labor costs. The large individual risk claims ratio improved 40 basis points compared with the prior period. We've seen a relatively low level of reported claims, but are continuing to book higher IBNR assumptions given the inherent volatility in large individual risk claims. It is worth noting that the continued build-out of casualty lines such as financial lines will ultimately shift our business mix slightly towards large individual risk claims and away from attritional claims. Catastrophe claims exceeded our first half allowance by 5.7 percentage points, mainly due to the extreme winter weather in Texas, as Arctic temperatures and power shortages resulted in record insurance claims. Overall, the Texas winter storm has been estimated as a $10 billion to $15 billion loss event for the insurance industry, ranking the first quarter of 2021 as close to the worst first quarter in history and second only to the first quarter of 1994, which included the Northridge earthquake. After we undertook last year, prior accident year claims experience was broadly stable and in line with expectations. We remain vigilant around the risks that could challenge the adequacy of our reserving estimates. In particular, social inflation and the simplifications for casualty claim costs remain a focal point to both us and the industry more broadly. We continue to make good progress in improving the operational efficiency of our business in North America. The underwriting expense ratio improved by 3.2 percentage points to 11.6%, reflecting the benefit of these efficiency initiatives as well as the improved operating leverage from the much higher premium base. I'll now turn to our International division on Slide 12. Gross written premium of $3.9 billion was up 11% on a constant currency basis, reflecting the strong premium rate environment and targeted growth, particularly in European insurance and in QBE Re. On the left-hand side of the chart, you can see that the current accident year combined operating ratio improved by slightly more than 1 percentage point to 91.9%. Within this, the attritional claims ratio improved by around 3.5 percentage points to 39.1%, reflecting the benefit of compound premium rate increases and reduced claims frequency in motor and liability lines hardly assisted by the government lockdowns. The cost of large individual risk claims increased by around 2.5 percentage points to 13.1%, mainly due to higher IBNR assumptions, which in aggregate account for more than 70% of the total cost of large individual risk claims incurred during the first half. Prior accident year claims experience was modestly favorable, with net reserve releases of around $40 million or 1.5% of net earned premium. Favorable experience in U.K. motor and U.K. and European liability lines was partly offset by some further strengthening in legacy financial lines portfolios. On catastrophe claims, we had benefited from a particularly benign experience in the prior period, and this partly normalized during the first half of 2021. Both international markets and QBE Re were impacted by the Texas winter storm that I referenced earlier. Despite this increase, catastrophe claims were within the International division's allowance for the first half. The expense ratio improved 50 basis points to 13.4%, reflecting operating leverage from the substantially higher premium pool, coupled with disciplined expense management. Moving to our home market of Australia Pacific on Slide 13. Gross written premium of $2.5 billion was up 18% in constant currency terms, with premium rate momentum recovering following the expiry of temporary COVID-19 release measures that we put in place last year. Premium growth was broadly based with good momentum in our core SME and mid-market segments of commercial packages, commercial motor, commercial property and workers' comp. The current accident year combined operating ratio remained strong at 90.8%, albeit 60 basis points higher than the prior period. Within this, the attritional claims ratio was around 30 basis points higher with the benefit of premium rate increases more than offset by higher weather-related claims in our householders book, strata book and in the Pacific Islands portfolios. The cost of large individual risk claims was around 60 basis points lower than the prior period. But as I referenced earlier, this is an inherently volatile metric, and we remain acutely focused on the risk of elevated claims inflation particularly in the longer-tail liability lines. Prior accident year claims experience was modestly favorable, with net releases of around $24 million or 1.2% of earned premium. Adverse development in liability lines, workers' comp was more than offset by favorable development in short-tail classes, in CTP and some modest releases in trade credit and LMI. Catastrophic claims remain elevated at around 1.5 percentage points in excess of our allowance, albeit down from the levels we experienced in the prior period, which included the extreme bushfires on the East Coast of Australia. We are seeing higher new business volumes in lenders mortgage insurance driven by historically low interest rates and government incentives, but we remain cautious with respect to the group's net exposure to the Australian housing market, and accordingly increased our quota share reinsurance on this business from 30% last year to 40% for the 2021 underwriting year. LMI credit metrics have remained stable and the combined operating ratio improved to around 49% from 55% in the prior period. This improvement included the benefit of a modest prior year reserve release, reflecting improved economic outlook and the strength of the local residential housing market. Turning now to our investment portfolio and performance. Our investment portfolio remains conservatively positioned with around 93% invested in high-quality fixed income securities and the remaining 7% invested in gross assets, including unlisted property, infrastructure and private equity. We remain focused on quality and resilience across our portfolio. And within our corporate credit book we have seen less incidents of downgrade or negative outlook than the broader market and none of our investments have been downgraded to some sub-investment grade. In the middle table, you can see that our core fixed income book generated an annualized yield of 50 basis points. This excludes the impact of risk-free rate movements and we also saw a 20 basis point benefit from narrower credit spreads. Within growth assets, our unlisted property and infrastructure portfolios delivered strong capital appreciation, while our private equity portfolio kept pace with listed market strength. The net annualized investment return for the half was 40 basis points. In addition, we generated a $73 million net P&L gain from the tactically short duration position that I referenced earlier. As you can see on the chart on the right-hand side of the slide, the running yield on the fixed income portfolio is currently around 40 basis points, which is markedly lower than prior periods due to both lower risk-free rates and credit spreads. Given the currently strong outlook for profitable organic growth on the underwriting side of the house, we will retain a measured approach in deploying towards our long-term strategic investment portfolio settings of a 15% allocation to growth and risk assets. Moving now to reinsurance, balance sheet and capital management on Slide 15. As you can see on the chart on the left-hand side of the slide, our reinsurance expense in the half was $1.4 billion, an increase of $400 million relative to the prior period. This increase was driven by 3 key elements. Growth in the Crop business with higher premiums ceded into the U.S. Federal MPCI program, increases in the level of quota share reinsurance in North American Financial Lines, in lenders mortgage insurance and in trade credit. And as in February, the cost of the group's core-Cat and risk XOL treaties increased by around $40 million. In the middle of the slide, you can see that the PCA multiple has increased slightly to 1.73 from 1.72x at the end of last year and remains above the midpoint of our target range. The positive impact of earnings generated during the half was largely offset by the capital costs of new business stream. We saw meaningful increases in insurance liabilities, premium receivables and deferred reinsurance expense, all of which carry risk charges within the PCA calculation. On capital management, we redeemed $200 million of subordinated Tier 2 notes in the first quarter of this year. This redemption was funded by the Tier 2 subordinated debt we issued in August last year. As a result of this redemption, gearing improved to 31.1% from 34.8% at the end of 2020. We're now closer to the midpoint of our internal benchmark mark range of 25% to 35%. With that, I'll hand back to Richard for his closing remarks.

Thanks, Inder. Before we move to Q&A, I'd like to quickly run through our areas of focus for the remainder of the year, which broadly fall within our strategic priorities of performance, customer, modernization and talent and culture. Starting with performance. As I've said before, market conditions remain attractive and better than we've experienced in more than a decade. So it's incumbent upon us to capitalize on those conditions to maximize the premium rate that we are achieving, but also to lock in as much growth as we can while still maintaining underwriting discipline. While I'm pleased with the overall rate that we've achieved during the half, there are sales where we need to push harder. Similarly, I'm pleased with the targeted premium growth we achieved during the half, but there's always room for improvement. International markets in Asia being pertinent examples. In terms of specific lines of business, I'm hopeful that we can continue to see growth in North American retail, QBE Re and specialty and casualty lines, Continental Europe and core commercial lines in Australia. Moving on to modernization -- sorry, before that, recognizing there's always more to do to improve performance. The focus for the second half of the year will remain multifaceted. Cell reviews, portfolio optimization, especially in catastrophe-exposed areas and further evolution of our Brilliant Basics program including the delivery of our global property pricing project and more development on pricing in financial lines. We are also undertaking a more sophisticated and granular assessment of risk, including reserve, underwriting, catastrophe, credit and operational risk. That is expected to improve capital allocation by cell and region. Thus facilitating a more accurate assessment of premium rate adequacy to better inform our decisions on where to grow. Turning now to the customer. Targeting profitable new business growth and retaining our existing high-quality customers will be key to the future success of QBE. Alongside our committed and talented underwriting and claims teams, the extra ingredient is Customer@QBE. Having launched Customer@QBE in late 2020, recent activity has been around how to better connect with our customers, including quantitative and qualitative research into what is important to our customers, their business mindset, risk management approach, buying behaviors and what they are looking for in their insurer partner. This will underpin our aspiration to build stronger relationships with all our customers via a truly differentiated proposition. We intend to further embed the use of sales metrics to provide better visibility of key pipeline data, but also help identify where to focus our efforts to secure vulnerable renewals and maximize customer retention. And now on to modernization. We continue to modernize the business to improve performance and the customer experience and is fundamental to this is a digital-first mindset. We have detailed rollout plans for technology modernization by function and division, and recently transitioned to a new IT partnership. Outdated and redundant technology and systems are being updated or decommissioned. Applications move to the cloud and customer and distribution partner experiences improved fill automation. But the modernization is much more than just technology. We understand that the business needs to change. So over the last 6 months, we have challenged ourselves around historic operating structures and work practices, including recognition that the working environment will likely be very different in a post-COVID-19 world. To this end, North America has taken some significant steps to sustainably improve operating leverage which is already becoming evident in their expense ratio. They have reduced their real estate footprint in New York and Atlanta in favor of the Sun Prairie campus, and have reset management layers and spans of control. Together, these will deliver a sustained improvement in efficiency and performance. Modernizing our practices and operating structures will remain a priority as we look to build a high-performing company and culture. Finally, talent and culture. We continue to commit time and energy to our culture accelerator program to enrich our culture, while also building a set of key actions for the future success of our business. This work leads to build on the foundations of our QBE DNA to empower and motivate our people to create a consistently high-performing company for all our stakeholders. We have engaged the entire organization in this conversation with input from our people across all geographies and roles. As a result of the work, we have established clear areas of focus, including many ideas suggested by our people for a recent culture hack, that more closely align behaviors to our DNA to build an inclusive workplace where everyone feels respected and supported. Equally important is our desire to acknowledge, embrace the value of consistent high performance. The group executive committee and the group board have invested significant time in the program, and we'll continue to focus on culture as we deliver the actions identified through this important work. Before I open up the call to Q&A, I should say that this will be my final result as Interim Group CEO. Incoming CEO, Andrew Horton, commences his role in September. And I look forward to supporting him before I retire from QBE at the end of the year. It's been a pleasure to serve as the interim CEO, and I wish Andrew, the Group Board and the group executive, all the best for the future. We will now open up for Q&A.

We've got some questions online. The first question is from Kieren Chidgey of Jarden.

A couple of questions, if I could, starting on the combined ratio, which obviously has improved very strongly. Within that the attritional loss ratio component looked pretty flat on second half '20 with a lot of the improvement coming in the expense ratio and commission rate. So just wondering if you can talk to why that's the around the attritional loss ratio? Is it issues like the short-tail property claims inflation in the U.S. you flagged? Or have you also baked in higher accident year loss fix for sub '21?

Well, I think the impact of any short-term inflation is de minimis in any of our attritional loss ratios at this stage. I think there is a reasonably material improvement as we see on the prior year. I think anything when you go through these phases of increasing rates, it always takes a little bit of time for the actuaries to acknowledge exactly what the performance of the business is. They'll take a cautious approach, which we fully support. So you don't always see the improvement in the attritional ratio maybe as much as you would see that corresponds to the rate increase at the same time. But as we said, I think we've seen a decent improvement and the trajectory is good.

All right. And second question on sort of the catastrophe and large risk. And just tying that in with a comment in your outlook statement about considering further strategic reinsurance. Just wondering if you can elaborate on sort of what you're flagging there if that is relating to sort of large risk or if it's more for specific around other initiatives?

Look, I think the #1 thing for us on is to work out to really understand our portfolio and make sure we're selecting and pricing correctly. Reinsurance is not a substitute for doing the proper job on underwriting. And that's why we haven't increased our Cat exposures in the first half of the year. We don't want to be overly reliant on reinsurance. We think we should be able to run our business ourselves. So we'll always look for reinsurance options. But at the moment, I think the key priority as far as we are concerned on Cat is to make sure we optimize the portfolio, get the right price. If we can't get the right price, like we're already doing in some areas, we'll remove our capacity from those particular lines of business. But at the moment, we don't have any plans to materially change our appetite on Cat reinsurance.

All right. And the final question, Inder, just on the investment book. You seem to be flagging a bit of a re -- sort of rerisking or a shift back towards growth assets over the next 8 to 10 months. So just wondering if you can talk to sort of how we should be thinking about the percentage mix at what pace of changes and what the capital implications of that change might be.

Yes, sure, Kieran. So effectively, at the moment, we have 93:7 mix. And I think the -- what we flagged historically is more like 85:15 mix would be the optimal strategic asset allocation when we think about combination of growth and risk assets contributing to that 15%. And we're taking a very cautious approach in building back to that level over the next 18, 24 months. And so in terms of capital consumption, the actual capital consumption itself is modest as you evolve the asset mix. Obviously, it brings a little bit more volatility or risk of a pullback in the market, ex-cetera could impact your capital position. So we're just being cautious at the moment. I think the first call on capital goes towards the underwriting account, and we see plenty of opportunities to continue to grow profitability -- profitably in that underwriting account as we've sort of demonstrated in the first half.

Next question is from Andrei Stadnik from Morgan Stanley.

I wanted to ask 2 questions. Firstly, you mentioned that your ultimate COVID cost system at about $785 million, now might be looking a little bit too high. And what are your plans around that? And also, how comfortable are you with longer tail casualty claims?

So I think we actually -- I said that the current accident year provision of $130 million per COVID is looking on the high side. We didn't make any statement around the prior year. I think the prior year, there's a lot of developing, obviously, with what we provisioned last year. If you look through the key components, U.K. is settling pretty well and within our expectations. And the important point on that is the reinsurance recoveries have started to come in. So that's a good move for us. Australia is in a very different position, as you would know, because we're still a long way behind in having any legal determination. But it's probably fair to say we feel a little bit more comfortable on the valuation of the potential claims if they are covered because our analysis shows that maybe they're may be a little bit less than we initially expected. And also, we haven't got a material uptick in claims notification. So I think as far as that's concerned, we feel pretty good but the area we haven't seen many claims this year that we possibly anticipated in the $130 million provision is on the credit line in LMI and trade credit, and that has been quiet. But there certainly with trade credit. I think we're a little bit nervous as to what may occur towards the end of the year as the government stimulus is around a well -- are withdrawn and there may be some volatility. So trade credit could be more difficult, and that's why we're holding the provision in the second half, but we're optimistic, but that was mainly for credit lines and that has been lighter. As far as casualty, we haven't really seen very much. And we keep a vigilant eye for casualty and COVID impacts, but there's the odd one here and there a little bit in workers comp and so on, but really nothing material.

Andrei, I might just give you a couple of numbers just as it saves you hunting around. So we end the 2020 accident year we had $655 million, of which $355 million was your premium expenses and claims and $300 million was risk margin. On that $355 million, we're now at $343 million, which is about a $12 million release. And then we set up $130 million for this year against which we've incurred $23 million. So when you look at the $23 million incurred this year versus the $12 million release from prior years, that's a net impact of about $11 million. And then risk margins in the round from $300 million to $290 million. Those are the 3 components to just give you the numbers behind kind of the context that Richard just provided.

And my second question, I wanted to ask around costs. So cost control is particularly impressive in this first half. But what should we be thinking about in the second half? Should we be thinking there will be some wage pressures and some bonus pressures emerging given competition for underwriting talent and just the overall very strong results of the business.

I'll let Inder answer that. Just first of all, yes, there's always a battle for talent in different parts of the world, and we deal with that every day. But I think we feel we're well provisioned in the short term to cover that. We have various cost initiatives. Old one we're sort of retiring because we've pretty much delivered on. And as we said, we're starting to challenge ourselves on new operational structures, which certainly started to do effectively in North America, but I'll let Inder talk you through the numbers.

Yes, Andrei, I mean, I think we've been very conscious as we've talked about efficiency initiatives that inflation remains a risk. So as Richard said, we've got a ton of work underway around relooking at our technology and modernization of that a lot program work, shifting infrastructure to the cloud. We're looking at location strategy. We're looking at operating model, we're looking at the functional setup. So there's a ton of work going on, which will drive efficiencies to help offset some of that inflation. And really, our hope is to create some positive jaws as we go forward, right, is to make sure that the expense base grows modestly relative to the premium base and we get that operating leverage come through. So look, we recognize that there are going to be some challenges around wage inflation and also we need to create some capacity to grow. And so as we think about our targets, the target we put out around 13% expense ratio, that's very much framed with the risk of inflation in mind, but also a real determination to go after some of the opportunities we see including efficiency utilization.

Our next question is from Andrew Buncombe of Macquarie.

Just 2 questions from me. The first one, maybe if you can just give us some color on the potential impact of German floods on your book in the third quarter in place. That's something that pretty much everybody globally has been calling out on these calls.

So yes, we've done a piece of work on that. Our initial expectation on that is a reinsurance loss for us more than insurance loss because we have QBE Re, which drives business in that region, particularly through our Belgium distribution point. But we're not going to give a number, but I think you'll probably say that we're -- it doesn't materially in any way really impact the international provisions for Cat so far in this quarter. So yes, it's a decent size loss, but that's not going to materially impact our Cap provisions at this time.

Just to turn the numbers on that, Andrew. So we had a bit of Cat IBNR booked at the end of the first half. Some of that is proving a little bit redundant now, and so it help as part of this. And the other thing is, obviously, it's been taken into account as we think about our premium liabilities that get deducted from capital as of the half year. So it is effectively included in a component of our capital that we reported at the half year.

That makes sense. And then just my other question was just if you could remind us how much business QBE was writing globally? And whether some of the changes recently has impacted that appetite?

Well, interestingly, it hasn't impacted our appetite because I would say the markets largely moved towards our appetite. We had a very tight appetite on cyber, smaller limits, very, very disciplined approach to certain sectors. So our global premium is less than $50 million, and it's probably closer to 40%, 35%, depending on what -- where we are at any moment in time, but it's not a material portfolio. And it's not a portfolio. Most of it is written here, and it's not a portfolio where we have lost money.

Next question is from Matt Dunger from Bank of America. Are you there? We'll come back to you then. Next question from Sid from JPMorgan.

So a couple of questions if I can. Firstly, just on claims inflation. Richard, I was hoping you could make some comments about exactly what you are seeing by region, maybe short-tail and long-tail, obviously, it called out before that I think that you were seeing some elevated signs and certain long-tail lines. I was just wondering if you could provide us an update on your thinking around that? And just maybe some comments just on short-tail as well. You mentioned that you think some of the inflation is transitory. Maybe just help us provide some numbers to what you're seeing and how that's impacting your numbers?

Okay. Happy to, Sid. I think as everybody probably knows from what we said in February where we gave guidance on our inflation assumptions of 3, 3 and 5, being in North America, 3 in the other divisions, which rolled up to about 4% to the group, and we're still comfortable with that assumption. I suppose the area where we've seen the most is short-tail, which we talk about supply impacted labor and materials. And where that's really probably come through the most is in North America and in storm Uri. And a lot of other people in the market have realized that we will just have something called demand surge after a Cat loss with cost of materials and labor went up. That's been more exacerbated this time probably than ever before. And I think that is partly the COVID impact of less supply and difficult to get labor and to get materials. So probably the most heightened place we're seeing it is in catastrophe type losses, and we probably would have seen a bit of that in Australia as well. So -- and the other thing that probably impacts Australia, as you would know better than me is the borders are shut and there's less transitory labor, then that does put some demand on labor as well. So it really is very much a short tail. It's not -- we couldn't call it permanent yet because it may be related to these larger events. I said elsewhere, we talked a little bit about Western Australia, U.K. liability, we're looking at a little bit here. But generally, on the whole, it's okay. I suppose one thing I'd caution everybody is on social inflation. The court has not been that active in the U.S. for a while because of, obviously, the COVID impact. And if there is a heightened backlog of core cases, then you could see some social inflation activity come through sort of the back end of this year going into next depending on where the normal services resume in the course.

Okay. Maybe just a second question, if I can, just around the comments you made around signs of moderating in the cycle, particularly in international. Could you just provide some color as to exactly what is guiding your thinking there and also how that compares with the 3% claims inflation and maybe some comments on the duration of the cycle. I know that's difficult, but to predict, but maybe if you could just make some comments around that.

Yes. Look, I think pretty much everywhere. We -- other than maybe the odd short-tail class that I just referred to, we're comfortable that we're getting more rate than inflation and some areas materially more. The 2 places where we've probably seen -- the 3 places we've probably seen the most moderation of rate in international markets would be in financial lines, international liability and natural resources. Now they're all 10% to 20% rate increase still, but they -- some of them like financial lines would have been materially more double last year. And I think natural resources is now just over 10% and it was 20%. So that's why we say the momentum is slowing because it's still materially above and actually natural resources is an area where we say claims inflation actually is very low. So that is margin enhancing there. So that's where it's happening the most, but it's actually the lines that went up the most are not increasing as much rather than the pressurized lines, it didn't have much rate increase now going back down if that makes any sense. So it's still margin enhancing, and it's not, in any way, eroded the whole grade increase eroded by inflation.

That's very clear. Just the last question for me, just on Crop. Just could you provide us just a little bit more color in the picking of a 95% combined ratio for the first half. Could you perhaps book in how you've seen the development so far of the year versus perhaps your worst year, which I think was sort of 102% combined ratio, if I remember rightly?

2012, I think, was the worst one, wasn't that?

I think so. Yes.

Yes. Well, we're not there, Sid. Look, as you know, North America is bakingly hot in some places at the moment, particularly is in the callout of the Dakotas and Minnesota. And California is a big challenge. But fortunately, it's heavily irrigated and they haven't turned off the water. Inder and I spent some time with the Crop team yesterday going through this. And it's very fluid, is very fluid. I don't view 95 as conservative because it could get worse. But it's very difficult for us to call because we don't -- the profit has got to come through from the profitable state, and Inder can talk to this more intelligent than I can, but some states that are performing very well. And as others are performing very badly. We're pretty much written off the Dakota and Minnesota. But there's some marginal states, which could then cause whether it goes up or down from the 95, but Inder is expert on this compared to me. So I'll pass over to him.