Suncorp Group Limited (SUN) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Suncorp Group Update Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Monday, 11 May. I would now like to hand the conference over to Mr. Steve Johnston, Suncorp Group CEO. Please go ahead, sir.

Thank you, and good morning, everyone. Obviously, at the outset, I'd like to acknowledge the traditional owners of the land on which our business operates and obviously pay respects to elders past, present and emerging. And at the outset, let me also apologize for the short period of time between lodging of our documentation and this call, but we thought it important to convene the call as quickly as we could proximate to the lodgement of the materials. I'm joined on the call today by our group CFO, Jeremy Robson; the CEO of our Insurance business in Australia, Gary Dransfield, they're both in Sydney; and our Suncorp New Zealand CEO, Paul Smeaton, who is in Auckland this morning. By now, you will have seen our announcement that Lee Hatton, the Banking & Wealth CEO will leave Suncorp at the end of the month. Now obviously, it's disappointing, given Lee's been with us for such a short period of time. However, I do understand her reasons and I obviously do wish her well. We're very fortunate to have an experienced and capable executive team in the bank. And I've asked Bruce Rush, who has acted in the role previously and he's known to many of you, to step up while we move through the recruitment process, and Bruce joined me in Brisbane for this call. Now the presentation Jeremy and I will run through will cover our APS 330 disclosure, the impacts of COVID-19 on our broader portfolios and an update on our review of our pay and leave entitlements. We'll then move quickly to Q&A and provide as much time as we can for your questions. I'll turn to the next slide. And before we move into the body of the presentation, I think it's important to outline that Suncorp Group ended the uncertain period of COVID in a very sound financial and operational position. We've highlighted some of these issues on the slide, and I'd like to call out a few of the more notable initiatives now. Firstly, it's hard to believe that it's only a few months ago that we were dealing with the devastating bushfires that have had such a profound impact on our communities. And in the lead up to and throughout this challenging period, we remain committed to supporting our customers through their claims processes. I'm very pleased to report that we've completed around and slightly over, I think, 70% of property claims and 80% of motor claims to the bushfire events. Now both those data points are significantly ahead of the industry. Over the past 18 months, as you'd be aware, the group has also been materially derisked through the exit of the Australian Life insurance and smash repair businesses, with the proceeds of the latter being retained on the balance sheet. And as you know, we're also -- we've also significantly increased our natural hazard allowance and our reinsurance covers. With a low-risk lending portfolio, and that's largely comprised of residential mortgages, our exposure to commercial lending is well diversified from both a sector and a geographic perspective, and it was performing well prior to COVID. More recently, we have realigned the whole of Suncorp around improving the performance of our core businesses. This clarity of strategy has been well received by our team and our full engagement survey, which has just been completed in the midst of all of the dislocation of the COVID activities has reported an 11 percentage point increase in engagement across the group. In December, fortuitously, we accelerated the refinancing of our $400 million convertible preference share, a transaction that otherwise would have been in the market over the past month. And entering COVID, we took the prudent step of putting in place a number of investment market hedges to retain investment market risk within acceptable levels; all decisions, I think, that have served us very well. So turning to the next slide, and this summarizes our response to COVID. To help us navigate what is an uncertain period of time for everyone, the senior leadership team, the Board and I have applied the framework and priorities that are outlined on this slide. Our first and foremost priority has been to protect the health and well-being of our people. The digital capabilities and systems we have in place and we've had in place within the last 5 or 6 years have positioned us well to move the majority of our organization to this new virtual environment. Our second priority is supporting our customers. And we worked alongside industry bodies, governments and regulators to move quickly on financial support measures that are aimed to support families and business owners. We've included a slide in the appendices to summarize our support measures. Our third priority is to maintain the strength of our business, particularly the balance sheet, liquidity and funding. Maintaining the capital buffers that we have built is a key focus for us as we work our way through this period of time. Fourthly, while we've been responding quickly to the changing needs of our customers, we're also looking at opportunities to accelerate our strategy and emerge from this event in an even stronger position with a more efficient, digitally driven business. And finally, we've maintained clear lines of communication with our people, our customers and all of our stakeholders. I'll move to the next slide. And before I get into the discussion around the impacts on our business and our portfolio, it's important to briefly outline our view on the economic scenarios that will guide our responses over the short, medium and longer terms. And these will inform not only our provisioning levels, but also the way we think about all of the portfolios across our 3 business lines. Like all the CEOs you've heard from over the past month, I don't have a crystal ball. In setting our assumptions, we've assembled the best advice available through our internal team, the managers that oversee our investment books and the published data that is available but also the data that's been available to us from both state and federal governments. We then added an appropriate level of conservatism that I believe is appropriate for these extraordinarily volatile times, sort of conservatism that you've seen the way we've managed the business in the lead up to COVID. The outcomes of all this work are reflected in these graphs and they support our assessment of the business impacts that I'll talk to in the following slides. First, to the impacts on the Australian Insurance business. The first is the significant market volatility that we've seen over the recent months has resulted in mark-to-market losses on the investment portfolio to 31 March, albeit protected to some extent by the hedges that we put in place. Jeremy will run through all of this in detail a little bit later in the presentation. The 2 most meaningful portfolio impacts on insurance are on landlord loss of rent claims and on motor claims frequency. Firstly, on landlords, we expect there will be an increase in claims frequency and severity for loss of rent claims. However, as you would be aware, the precise impact is very hard to predict given the legislative responses that have occurred at both state and federal levels. We do expect, however, that many landlords and tenants will reach amicable agreements. And in this scenario, our policies do not trigger. We do expect to recognize an appropriate amount of IBNR in FY '20. And secondly, on motor claims. And since the introduction of mobility restrictions in March, we have observed reductions in claims lodgement in the consumer motor portfolio. This dynamic is also evident in commercial motor albeit to a lesser extent. Now we are cautious about drawing too many conclusions from these preliminary numbers, at least in the short term, in part due to the rapid increase in motor vehicle usage we've seen following incremental easing of restrictions here in Australia, also in New Zealand and in other offshore jurisdictions. We monitor claims lodgments on a daily basis, and we've already observed a rise in lodgements over the past couple of weeks. The reduction in claims volumes to date have been in the form of small, drivable, low-cost and less complex claims. And hence, we also expect the average claim size to automatically increase during this period, a function of those smaller claims being taken out of the outstanding claims provision. We're mindful also of an increase in delayed claims once restrictions have been lifted from customers that have not been comfortable lodging claims, whether that be due to them wanting to avoid a human interaction or in some cases, to avoid paying their excess, which obviously we collect upfront. The lower claims frequency benefits in commercial motor, and to a lesser extent, CTP will not be recognized until we go through our periodic valuation process, and it's likely -- more likely to come through the P&L in the first half of 2021. And finally, we also expect a modest drag on GWP growth in FY '20 as a result of the take-up of hardship relief options and generally a weaker operating environment in the final quarter. So moving on to New Zealand. And the New Zealand government, again, as you're aware, imposed Level 4 restrictions in late March. And that's obviously an incremental level of restriction above those that have been imposed in Australia. As such, motor claims frequency has declined more dramatically than in Australia. However, as I pointed out, since easing has been incrementally moved back, we have observed an increase in motor claims lodgement. And that underpins our reluctance to assume claims frequency will remain depressed to these levels for the full duration of the restriction period. In regards to business interruption, and similar to Australia, COVID is not generally covered in New Zealand. However, there are a handful of New Zealand customers who have tailored policies, which includes some level of cover. However, we don't expect this exposure to be material. As in Australia, again, several financial relief packages are being provided to our New Zealand customers who are experiencing financial vulnerability. AA Insurance has established a $2 million hardship fund for AAI customers, and Suncorp New Zealand has matched this with a $2 million fund for the benefit of Vero and Asteron customers. And finally in New Zealand to Asteron Life, where we see minimal term life exposure with less than 1% of sum insured policies accounted for in the high-risk age group and no evidence as yet of an increase in IP claims. Turning now to the impact on the bank. And I said at the start of the presentation, the bank's lending portfolio is relatively low risk. Home lending accounts for around 80% of the book. It's got a skew obviously to owner occupiers and principal and interest repayments. Around 20% of the book has an LVR of greater than 80% with the majority protected by LMI policies. The average LVR for the portfolio is 57% and over 40% of our customers are more than 3 months ahead on their repayment schedule. Over the quarter, we saw a modest increase in past due loans driven by a reduction in collections activity as we move resources to -- or redirected resources to support COVID-related customer needs as well as an increase in customer hardship following the summer bushfire events. Out of our total lending portfolio, 5% is property investment and 1% is development finance. While these segments have been performing well and are well diversified on both the geographic and sector basis, given our expectations of material declines in property -- commercial property prices, we're maintaining a very strong focus on both of those portfolios. Overall commercial lending is 12% of the book. The residual commercial lending portfolio includes exposures to sectors such as accommodation, hospitality, retail and child care, which are also highly susceptible to the economic impacts of COVID, and lending to these sectors totaled about $1.7 billion. As we respond to COVID, you'll see today that we've included $133 million management overlay within the Q3 collective provision, which includes appropriate amounts for our exposures to all these commercial segments. This overlay takes the total collective provision balance to $234 million, more than double the equivalent at the first half of FY '20. This is underpinned by our view of unemployment reaching 11.5% and 11% reduction in house prices with those property prices remaining depressed for a prolonged period of time. Now our process for modeling the collective provision is different to others. Instead of probability weighting 2 or 3 specific scenarios, we've adopted a distribution approach, which considers a much wider range of possible outcomes around our base case for key economic indicators. This approach, in our view, ensures that we give some weight to the most extreme scenarios for both probability of default and loss given default. We've included a slide in the appendix which gives some more details around this methodology. We've also elected at this time to impair the carrying value of the deposit and transaction modules of the core banking platform. And as we stated before, we've also already commercial -- have successfully implemented the retail lending, personal loans and customer collections modules of CBP but had paused the implementation of the deposits, transaction and payment modules, pending sufficient platform maturity. We believe the significant risk associated with the deployment of this component in the current uncertain environment and to lead the industry deployment of that component means it's increasingly unlikely that we'll roll out the deposits, transaction and payment modules in the near term. Therefore, in our view, it makes sense to write down the carrying value of this component and recognize an impairment charge for FY '20. The current core banking platform for deposits and transactions will remain our system of record, while our proven API infrastructure will enable us to deliver on our digital strategy at a lower aggregate cost and with lower risk rather than a full system replacement. We have a proven track record of successful delivery through our API-driven approach as demonstrated, as you know, by the implementation of digital wallets, real-time payment and our new mobile banking functionality. All of this will result in around $90 million after tax impairment charge that will be disclosed below the cash earnings line in the FY '20 investor packs. So at this point, I'll hand over to Jeremy and come back after Jeremy concludes.

All right. Thanks, Steve, and good morning, everyone. As Steve mentioned, the significant market volatility in Q3 has impacted the Insurance Australia investment portfolio. This came through in the form of a $205 million mark-to-market loss to the end of March. Going into the COVID uncertainty, we were uncomfortable with the market risk outlook and put in place some short-term hedges to reduce our credit and equity exposures in late February. The hedges were closed out in April and provided a benefit for us through this period. The waterfall on the right-hand side of the slide shows the net effect of the mark-to-market impacts across both our assets and liabilities for the quarter ended 31 March. We recorded $43 million of gains from the hedges, which helped contain the overall mark-to-market loss to around $200 million for the quarter. The mark-to-market losses were driven by significant falls in breakeven inflation, a widening in credit spreads and falls in equity markets. This was partially offset by risk-free mark-to-market gains from a decrease in bond yields. The March quarter mark to market does not include any adjustments to the valuations of our unlisted property and infrastructure assets as these have not yet been completed. Importantly, the movements I have shown here do not include any underlying investment income on the tech reserves portfolio, where we continue to target 60 to 80 basis points above risk-free, nor do they include any drag from the lower PV adjustment on new claims. In April, we saw a significant rebound in some of the key market indicators, which resulted in net mark-to-market gains of around $40 million for the month, and that includes a revaluation on property and infrastructure funds in that month, unwinding some of the losses seen during the March quarter. And finally, I note that we have not looked to change our asset allocation, which, in our view, remains relatively conservative with over 94% of the overall portfolios invested in cash and fixed income securities, around 80% of which are rated A or higher. And moving on now to capital, where we are maintaining a very sound position. At the end of the March quarter, the Group's excess CET1 position was $682 million pre any final dividend accrual. On a like-for-like basis, this is circa $300 million reduced from the December position, primarily reflecting the impact of mark-to-market losses in the period which I've covered as well as the increase in bank credit provisioning, which Steve covered. As at 31 March, the Group's excess CET1 position and general insurance CET1 ratio also include a $90 million capital benefit from the investment hedges, which have since been removed in April, as I mentioned on the last slide. Both the divisional CET1 ratios remain within our targeted operating range, with GI at the upper end of the 1 to 1.2x PCA range and the bank at the lower end of the 9% to 9.5% CET1 ratio under APRA's unquestionably strong benchmarks. Importantly and consistent with our policy of holding as much of our excess capital at group as possible, we have $473 million of CET1 capital at Group, equivalent to 143 basis points of CET1 capital for the bank by way of example. This provides us with a high level of flexibility to respond to any further downside risk with this capital readily available to deploy to the businesses if required. Specifically on the bank, when comparing CET 1 ratios, it's important to note the differences between advanced and standardized banks. While advanced banks' risk-weighted assets are sensitive to movements in economic variables, standardized banks apply a minimum risk weighting of 35% across all mortgages with an LVR below 8% and a flat 100% risk weighting applies to business lending. This means we hold more capital against our lending than the majors, and in an economic downturn, risk weight migration is less likely. As I've said, the group's currently well capitalized with capital levels in excess of what is required to cover the expected deterioration due to COVID. However, we acknowledge that there is still considerable uncertainty ahead around the health and economic impacts of COVID. The Board and management have, therefore, made a prudent decision to reinforce the capital position by up to $194 million by exercising our option to exchange the residual convertible preference shares, CPS3, that we partially refinanced in December last year. I also just wanted to cover off the capital impact of the core banking platform impairments Steve mentioned earlier. The core banking platform is an intangible asset. And as such, there is no impact on the group's CET1 capital position from the impairment charge. With that, I'll now hand back to Steve.

Thank you, Jeremy. And in addition to all of our disclosures today, you will have seen that this morning we've included an update on an ongoing review of pay and leave entitlements for our employees in Australia. And we commenced this review in November last year in order to ensure we are meeting all the obligations to -- all of our obligations to all of our employees. We're still in the early stages of the review. As you can imagine, given the complexity of systems and the volume of records involved, this is by no means a straightforward process. To date, the analysis is focused on the Insurance Australia business. And while we only have preliminary analysis and insights available at this stage, we felt it was appropriate to disclose that we have identified some inconsistencies in relation to both our rostering and pay systems. And these may have led to incorrect overpayments and underpayments. It's very difficult to be precise about the expected remediation costs at this time, and we've had to make assumptions based on the data analyzed thus far. And the Board and management have agreed to an estimated range of between $40 million to $70 million, and this obviously includes the cost of remediation for those eligible for additional payments as well as the cost of implementing new processes to ensure this doesn't happen again. We still have a lot more work to do on this matter, but once we have finalized the review, I'm committed -- 100% committed to ensuring any current or former employees that are eligible for additional payments are remediated as soon as possible. We've recently disclosed these matters to the Fair Work Ombudsman and are committed to working closely with her office and our independent adviser. And obviously, we'll keep both our team and the market updated with any further developments. And moving to the next slide. And COVID, I think, in my view, presents us with an opportunity to accelerate the pace that we execute our digital, data and automation strategies. You have previously heard us talk about the further opportunities that are available to Suncorp as we leverage the efficiency and productivity tools we have built over the past decade. We've established partnering relationships and arrangements, a digital capability alongside capability in process improvement, in automation, in operational excellence and AI. COVID presents us with an opportunity to accelerate the pace with which we execute these programs. Over the past month, we have proven beyond doubt that we can execute faster and cheaper in this crisis setting. At the same time, our customers have shown they are willing to interact with us digitally with rates of self-service take-up significantly exceeding our previous expectations, particularly in our insurance business. And we now need to take all of this and institutionalize it in BAU. So to Slide 12, which summarizes the outlook. And quite clearly, there remains a significant amount of uncertainty as to how the health aspect, and therefore, the economic impacts of COVID play out. From an operational perspective, our priority is to safely return our people to their physical work locations when the time is right, while also looking after our customers with their ongoing claims and their financial needs. In terms of the financials, we currently expect the following. For general insurance, we expect GWP growth to be impacted by lower economic activity. This may impact what was a positive unit count up until early March as it rolls through to the full year. At the claims line, there are a number of factors that will largely offset each other. These include reduced claims frequency in motor across both Australia and New Zealand and higher landlord loss of rent claims. We expect natural hazard claims to be within allowance as we remain well-protected by the remaining covers that we have in place. In terms of our reinsurance renewal, which I know is the topic of interest for the market, the reinsurance market, in our assessment, is both open and it continues to function effectively. We're well advanced with the placement of our main catastrophe cover program, and we're currently commencing negotiations for the remainder of the program, which include both the aggregate covers and the quota shares. Recent experience, as you would appreciate, would suggest the aggregate covers will be the most challenging part of the renewal and we're considering a range of potential structures for these 3 covers. Nevertheless, we remain on track in our view to complete the replacement comfortably by the 30th of June. In the bank, we expect lending growth to be negative overall, with some pockets of growth in agribusiness as our customers continue to recover from the drought, offset by negative growth across the mortgage book. Net interest margins should benefit from lower funding costs and be supported by ongoing growth in at-call deposits and a lower BBSW. And therefore, we expect net interest margin to be towards the top end of our 185 to 195 basis points range for the FY '20 year. On costs, there's a number of competing issues. We expect that COVID will result in a net increase in cost, which -- the most material factor there being the rollback of many offshore processes, particularly as the restrictions rolled out around the globe. In addition, we'll also provide for the cost of the pay and leave entitlements review I mentioned earlier. Overall, our expectations of group costs will ultimately be slightly above the $2.7 billion range that we've talked about for many years. On capital, we continue to closely monitor our position. As discussed at the beginning of the presentation, we are focused on ensuring the balance sheet remains robust throughout the period by maintaining conservative buffers and avoiding unnecessary risks as we remain very early in the development of this event, and we're cautious about what lies ahead. And finally, we'll consider any final dividend in the normal year-end process, and consistent with maintaining a robust balance sheet, management and the Board, again, will adopt a conservative mindset when making decisions about any final dividend. In addition to the impacts of COVID on the group earnings, process obviously will involve consideration of our capital position, the general outlook for the economy and APRA's guidance on dividends. So that brings me to the end of the presentation. Thank you for bearing with us as we worked through that. And now it's appropriate we'll move to questions with the team.

[Operator Instructions] The first question comes from Kieren Chidgey with UBS.

A couple of questions, if I can. Just starting on general insurance. How should we be thinking about reserving as we come through 30th of June? You previously flagged you expected sort of a return to sort of more than 2% of NEP reserve releases in second half, but you've noted you'll make IBNR provisions around landlord potential claims; and also motor, some potential allowance for delayed claim reporting there. So is it still your expectation that we should see sort of reserve releases in that order?

Okay. I'll start, and then I'll hand to Gary. And obviously, the caveat on all of this is that we're in the middle of the year-end valuation process now. So it's quite difficult to be absolutely precise about it, is that it's a process that rolls out independently across the organization. I guess, at the highest level, we're not seeing anything particularly. And again, I don't want to presuppose the independent actuary review. We're not seeing anything that's causing us too much concern in any of the statutory portfolios. CTP portfolios, they're behaving pretty much consistent with our expectation. Bearing in mind that we have, over the past few years, incrementally reduced average weekly earnings assumptions. So the volume of releases in aggregate will be, by definition, smaller out of those books. There will be different impacts of COVID through current year and prior year. I think that is best summarized by that commentary that you just repeated to me around are we at the appropriate level of IBNR for the landlord loss of rent. We know that there will be claims that emerge. We know that they won't emerge and can't emerge until the moratorium on evictions is lifted. So we will have to form a view and we'll have to form a view consistent with our economic assumptions as to what that level might be. By definition, it will be very difficult to assume. And then we'll move into other elements of the portfolio where, again, we will take a view on some of those valuations. Summing all of that up, at this -- as we sit here today, given all of those inputs, I think we're still generally comfortable that we will land within our long-term assumptions around reserve releases. But as I say, it's still -- the valuation process still has a little bit of room to run.

Okay. And Steve, what's your sort of approach to premium refunds or any sort of refunds? I know you've announced specific targeted areas of customer support more around people experiencing financial hardship, but should we also be expecting sort of broader-based benefits back to policyholders as sort of you move through the next 6 months? And are you able to quantify some of the net benefits?

Look, I guess, I'll hand to Gary in a minute. Gary has not only been sort of overseeing our businesses in response to this activity but on behalf of the insurance industry more broadly. I think our hardship processes and the relief that we've provided to our consumers and our customers in our Insurance business has been -- both here and in New Zealand, has been absolutely appropriate. We moved very quickly on -- alongside the industry to provide the premium deferrals for -- on the commercial book for our SME customers and give them some leeway around this period of time given the stresses that are going to emerge there. We've been very active in the consumer books as well. We've obviously been able to assess the hardship that's been very clearly evident in the -- in our customer base and provide some premium holidays where appropriate. And I think that's been very well calibrated. In the small number of cases, we're providing some discounts. So we think our response, as we sit here today, is absolutely appropriate. We continue to monitor it. It is very much focused on hardship. We think that our priority is to make sure those that are doing it toughest are protected. The last thing we want to see in this event is people not having insurance because on top of all the issues that the whole community is addressing, if they are absent Insurance, that's another big issue that they have to have sitting over the top of them. So if we can keep people, in the insurance industry, keep them covered, that is our priority. So Gary, I might hand for you to fill that out if you want to add anything more.

No, I think you covered it, Steve. Here, our view is always that there were going to be plenty of moving parts in motor claims frequency and severity. And we clearly need to see what kind of activity occurs as the various phases of lockdown unwind. And if anybody who's out in the road in Sydney on Mother's Day, there have been plenty of cars out and about. So the unwind, it will probably be patchy and unpredictable across the country. And again, our view has always been to look after the people who need the help most and keep them in the insurance system where we cannot lose them to the system. We still think that's the right way to do it. I think the House of Reps Economics Committee hearings a couple of weeks ago were pretty comfortable with that kind of approach relative to small amount of rebate for a lot of people.

And just a final question, if I can, on group costs. The -- Steve, you mentioned sort of you're seeing some acceleration around digital with COVID-19, which is understandable. And that $2.7 billion, I think you said includes the $40 million to $70 million of one-off remediation costs. Given both those factors, as you look out to next year, is there still an ability to hold the group cost base around that $2.7 billion next year?

All right. I think not is it necessary for us to hold it there, it's necessary for us to continue to reduce it, Kieren. I think what we're seeing in the last 3 months is a material -- potentially a material reduction in revenues across the whole of the economy. And at the same time, we will emerge back to our physical workplaces with a different way of working. And that's a great opportunity for us to capture a whole range of benefits right through to our real estate footprint and certainly, the general way that we work and the manner in which we work in a more agile way. So I think what this COVID event has done -- and I do see it. I know it's described as a threat and some negative connotations to it. I think it is a real opportunity for a business like ours. It allows us to reengage with our people in a different way of working, a more agile way of working. We're doing things at the moment that took us quite a deal of time to do. And we put web chat into claims processes, digitally focused activities around many of our contact centers that we had seen in our investment slate, which we thought were going take 3 or 4 months and cost $5 million to $10 million. We're doing them in 2 or 3 weeks, and they're costing a fraction of that. So we can -- we've proven we can do it in this environment. And we've also proven that our customer base is more comfortable interacting with us digitally. And particularly in insurance, where that has been a slower part of our portfolio to move to digital adoption, it is happening now. So all that says, alongside productivity, operational excellence, all things, all the tools that we've got go into a kit bag that says we have to move faster and we have to bring our costs down, move more of our cost to a variable base as opposed to a fixed base. We need to bring our costs down in line with the revenue reduction that we inevitably will see and the economy inevitably will see as we move through the next financial year.

The next question comes from Andrei Stadnik with MS.

Can I ask a couple of questions, one on insurer and one on the bank? Can I ask on insurer -- I appreciate the color in terms of lower motor claims in Australia but potentially higher landlord claim. There may be some other areas where there could be [ higher eventuality ] claim. Look, at this point, is there any indication of whether the net benefit or the net impact of these 2 different impacts, is it going to be positive or negative for earnings?

Andrei, I'll start and then maybe Jeremy can get up because there's a whole range of competing factors sitting through various parts of our business in totality, but in a subset of Insurance. Look, it's very hard to say at this point in time. I mean, for all of the uncertainties that we've outlined through the presentation, the ones that everyone would be aware of, it really does depend on the pace at which the current levels of frequency unwind as restrictions unwind. That means we're dependent upon the pace at which restrictions unwind, which is dependent on the health outcomes. So again, at the moment, we see them sort of netting themselves out. On the landlord loss of rent, as I said before, it's very difficult to predict simply because there's a moratorium that sits over the top of evictions that will, at some point, expire. And I think a lot of the determining factors there around the frequency of claim in landlord loss of rent will occur particularly to the extent to which the economy gets back to an improved capacity and output. So I guess I described them in an offset sense, broadly offsetting each other as we sit here today. We still got 6-odd weeks to work through before we get to the end of the reporting period. And as we know in this environment, things change pretty quickly. So I think the best we can do at the moment is outline the key movers and the key drivers and make a further assessment as we come through balance date. Jeremy, do you want to add anything?

Yes. I think you've nailed the key points there, Steve. There's a lot of uncertainty around all of those items, frequency, landlord; on the landlord side, how much comes through in FY '20 in the IBNR versus potentially future periods. And then the other one I'll add on is we do have our hardship packages. While they're not expected to be particularly material in the P&L sense, but there's some offset there to the frequency as well. So look, it is uncertain and will depend, to some extent, on how long that frequency benefit of severity offset go on for. And our, I guess, best guess at the moment is they probably will tend to offset for FY '20.

Andrei, do you have another question?

Yes, yes. Look, my other question, can you explain a little bit about why are you expecting bank lending growth to go negative? At the moment, all the banks have seen a benefit from the payment holidays and other reductions, which are effectively reducing the gross outflows from banking portfolio. So what is it about the current circumstances that make you think that your portfolio will go negative? Are you seeing particular challenges in terms of the gross inflows on new business that you're writing?

I'm going to make a few comments and then probably Bruce can fill in some of the gaps. Obviously, one of the issues that we've been talking to the market for -- to about the last 18 months has been a generally low level of growth sitting across our portfolio, which, I guess in retrospect, while it wasn't deliberate for us to achieve, that is probably not a bad outcome as we move into this event. We've had a lot of remediation going on in our business, particularly in the way that we interact with our broker community and the way that we improve the productivity of our direct lending franchise. So we were making really good progress on those activities. Our lodgement volumes, on a daily basis, were improving significantly as we moved into this event. But obviously, we're seeing new opportunities, for a whole range of reasons, which are aligned to the property market, reduce as we moved through the first part of COVID. So it's a -- sort of a general decline in economic activity and housing growth, I expect, to be the main contributor. But Bruce, do you want to...

Yes. Look, I think, 2 points from my side, Steve. One is the road map that we spoke about at half year, it absolutely continues. And that is about improving our processes and improving our interactions with broker, that work continues. Look, on the other side, clearly, I mean, our management focus is on supporting our customers that we do have. And we are seeing, as a result of that, on the inflow side, our inflows have slowed down a little bit. In fact, from our perspective, our focus is unchanged, and we will get our processes right. We will be supporting our brokers, and we will see that improve on the other side of this.

The next question comes from Nigel Pittaway with Citi.

First of all, just a question on the mark-to-market losses. Are any of those realized at all? Or are you basically just all unrealized at this point?

Jeremy?

Sure. Yes. It's Jeremy, Nigel. Most of those would be -- by far and away, the majority would be unrealized. We don't turn over our book that frequently. So look, maybe there's a very, very small part in there that's realized as we sort of get that natural turn of the book. But by far and away, the majority of it would be unrealized.

There's no specific activity to realize any of those losses or move out of any particular subset of our asset book, Nigel. This is -- to the extent that it is realizing, it's the fact that's just the general turnover of the instruments.

Okay. Secondly, just on the underpayment provision, are you treating that as a below-the-line item or an above-the-line item?

I think it's early days yet. We've just concluded our assessment of that in the last couple of days, Nigel. I guess, depending on -- irrespective of where we report it, I'm very keen for it to be included in that $2.7 billion cost guidance that I talked about previously. So I'm not trying -- we're not trying to hide it below the line as a means of extracting ourselves from that -- the parameters of those commitments. So we just have to wait a bit of time to see where we actually report it in the P&L. But for the purposes of where we're now analyzing it today, you should assume that it goes into the parameters of that $2.7 billion.

Okay. And then just on the converting prefs, I mean, are you saying you sort of intend probably to convert most of that $194 million, or just some of it or undecided, or...

Well, I mean, this is an opportunity that's been made available to us for a couple of reasons, the first one being that the first call date for this instrument was scheduled to be around about this time or in the past month. Have we not have taken the prudent step of refinancing it early in a window that we felt was available to us in November and December last year and concluded on quite favorable terms, certainly favorable terms relative to today, we would have been steering into the market with a refinancing requirement for that instrument now. We're giving ourselves a little bit of flexibility. In a BAU sense, probably we don't need to convert it, but we think it's prudent. It's available to us, for us to manage over the next couple of weeks, to convert that to equity and to build a further buffer into our balance sheet. We're flexible, given that it's not an absolutely essential requirement for us. We can be flexible at anything between $0 and $190 million. So we'll play it tactically, Nigel.

Okay. Then maybe just finally, I mean, obviously, you've talked about some GWP impact in FY '20. As you look ahead to FY '21, and I realize there's a lot of uncertainty, but I mean, how are you feeling about sort of potential unit growth, particularly once some of the support packages start to unwind? And would your biggest concern -- if you do have concerns, I presume you do, would your biggest concerns there be in the commercial book or in the personal book?

I'll hand to Gary for a bit more commentary in a minute, but you sort of underscored the uncertainty element of it and that makes absolute sense. I think we're all going to be watching very closely the expiry of the government support packages, some of the moratoriums that sit there for the economy. And I guess, in a sense, we're very much watching to see how quickly the economy builds momentum as the restrictions unwind and cash flows start to build up. So again, there's a lot of factors there that we're making assumptions about at this time. I mean, I think the general rule is that if the economy is under some stress, then -- while insurance is reasonably a very resilient industry in general, it won't be immune from that dynamic. So -- and again, it will play out at different paces across the commercial and the consumer book. The fundamental principle for us is that, while -- to extent that, that happens, is to take appropriate action to reduce our costs, particularly on the insurance side, in the claims area, where we continue to have a growth opportunity ahead of us. So difficult to be predicting what revenue trends will look like. Fair to assume it's going to continue to be an amount of -- significant amount of stress in the economy. But the key to all of that, from our perspective, is to continue to make our processes as efficient as we can. Gary, do you want to add to that?

Just in the commercial world, Nigel, you'd expect to see workers have very immediate impact because of the payroll size as a factor in the premium, so we forecast a drop in workers this quarter and next. SME direct, while we've had the relief packages and deferral options in there, quite a lot of the cancellation activity we've seen is at the very small end of SME direct. So we're, in effect, sole traders of putting their businesses into complete hibernation. Many have -- so yes, many of them, it's a side hustle anyway. So those -- when we come out of hibernation, they'll bounce back out and come in as probably new business. So we plan to compete pretty hard for that. And then in consumer, again, you can see what's going on with new car sales. You'll be able to see what's going on in the data around the home starts and the like. But again, we expect to compete pretty hard for whatever market size is out there, particularly with the AAMI brand as a value proposition.

The next question comes from Andrew Buncombe with Macquarie.

Just a couple of questions from me, please. Firstly, in the GI portfolio, just interested to get your insights about what you're seeing for customer acquisition costs at the moment. Is it becoming increasingly competitive? Or has retention gone up so much that, actually, the cost to acquire a customer haven't really changed that much?

Gary, do you want to take that one?

So Andrew, while, I guess, there's not clearly as much new business getting around, what you're seeing financial services companies, and probably a lot of large companies, doing is spending money above the line to communicate messages to consumers and customers broadly around what we've got on offer. So we -- I think it would be fair to say we haven't dialed back the marketing dimension in cost of acquisition because we need to use that to communicate to the existing customer base. Yes, your assumption is probably broadly right, that the increase in renewal rate largely offsets the decline in new business, and we're deploying our advertising chunk of acquisition cost to talk more to existing customers at the moment. So having said that, we launched our AAMI Roadside Assist for free to customers and noncustomers that are health and emergency services workers. And yes, that's kind of driven 10,000 new customer contacts for us that, at some point in the future, we'll come to seek to use to put into our acquisition pipeline. So while a fair bit of the messaging is community service, existing customer, I think it will give us some level of payoff for whatever level of new business is potentially out there in the future.

And then, Andrew, just rolling forward, there's obviously going to be a lot of noise in acquisition costs in the short-term as -- for all the reasons Gary talked about. But going forward, we've seen a significantly increased propensity of our insurance customers to interact with us online. And like everything in this environment, it will bring forward a lot of the consumer behavioral activities that we anticipated might be there in 3 to 5 years' time. We'll bring them forward to 3 to 5 months. And so the challenge for us and the opportunity for us is to significantly improve the way that we interact with our customers digitally on acquisition and convert more of those acquisitions to the digital-based acquisitions as opposed to ones that are managed by voice.

Yes, that makes sense. Second question from me, please. Just interested in the second derivative impact of the reinsurance program. How should we be thinking about the hazards allowance for next year?

Again, I'll hand to Gary, who's deep in the negotiations at the moment. So he'll be -- he's being very cautious about what he says. But in the sense, in terms of the negotiation and the way that we're constructing it, we have obviously worked our way through -- working our way through the replacement of the main cat covers, which are obviously the balance sheet protection. We flagged that around this time, we'd commence the negotiations with the market around the various elements of the aggregate covers or the sideways protections, as they're described, the aggregate stop loss, the drop-downs and the quota shares as a bundle of renewals. We'd also throw in the interaction of all of those things with the aggregate -- with the natural hazard allowance. And we're considering them all as a package. And as I mentioned in the presentation, we'll look to structuring that part of the renewal to get the best outcome for us. And we may well be seeking to trade-off various elements of that as we work our way through to get probably the same amount of protection we had this year, give or take some of the natural movements that will occur in sums insured in the portfolio. Gary, do you want to add to that?

No. Just to say, Andrew, we're now right in the middle of modeling the range of scenarios that kind of drive the interaction between natural hazard allowance and vertical and horizontal covers. So it's kind of hard to give you any steer right at the moment because we've got that range of scenarios that we take to market to price up with reinsurance partners.

That makes sense. And then just a final one for me, please. Just a reminder of how often you revalue your unlisted property portfolio. Should we assume that that's marked at 30th of June?

Yes. So we're now -- we've now moved to getting monthly valuations on most of the investments within that unlisted property portfolio, and we're moving to quarterly on our infrastructure funds. So the April number I quoted, that $40 million month-to-date mark-to-market includes the up-to-date valuations on unlisted property and infrastructure assets.

The next question comes from Matt Dunger with BofA Securities.

I just had a question on the bank's impaired-specific ratios being pretty flat to the end of March. Have you seen a deterioration post March that is driving this collective provisioning outlay? Otherwise, what data are you looking at that's deteriorating?

Yes. I'll talk to -- I'll get Jeremy to answer that in terms of the modeling we've used, the overlay that we provided, which, again, under the new accounting standards, are more through-the-cycle view of expected credit loss. But Jeremy, do you want to go through that one?

Yes. I mean, there's a couple of factors in there. It's less about what you've seen to date and more about what you expect. And so obviously, when we look at our economic scenario that Steve went through, I think it's fair to say that we are taking it slightly more pessimistic, and hopefully, it's more pessimistic outlook than some of our peers. And so I think that's the first differentiator around the input to that collective provision number. There's a couple of other critical ones. One of them is this concept of stage 2 provisioning, which is where you make an assessment around how much of your portfolio you need to account for on a lifetime loss basis. It's obviously a pretty material shift when you go from 1 year to lifetime. I think, speaking to our advisers, we've taken again a relatively conservative position around that in terms of the proportion of those customers that we expect to take up principal and interest deferral, and of those customers, those that we expect to go through to impairment at the end. So there's some conservatism there. And in the model, we do take a slightly different approach to the way we model our credit losses -- our expected credit losses relative to the majors, who tend to take a 3 or 4 reference point, probability-weighted set of scenarios. We run a distribution model that's got thousands of scenarios, and it's obviously tail-weighted towards the up or downside, and I suspect that's got some inherent conservatism there as well. So when you compare our collective provision overlay, the 23 basis points of GLA, relative to peers, I think, from our perspective, there's enough evidence we have that would point to conservatism in our assumptions and the modeling, absolutely, as opposed to anything in terms of the underlying credit quality of the book that's differentiated to our peers. And in fact, to some extent, the inverse because we don't have an institutional book, and we don't have, of any significance at all, an unsecured personal lending book.

Great. Just on the dividend, if I could ask. Obviously, you're talking about it being considered through the year-end process, and you've talked about the capital versus APRA. What's in scope for this review. Is the 60% to 80% payout ratio in scope? Or are you talking about moving back within that sum -- that payout ratio? And what would cause a dividend deferral like we've seen at the major banks?

Look, I think it's absolutely prudent for us, given, unlike some of our peers, we're not in the position at the moment of needing to declare a dividend. And I would point out that our interim dividend, which was a payout ratio of 90% for the half year, which was appropriate at that time, was only paid in early April. Now in retrospect to the point that it was paid, arguably, the payout ratio we would have applied probably would have been significantly below that. So we have put the -- we did put the dividend payment into shareholders' pockets in early April. So we don't have to declare a dividend. We do have another couple of months of trading to work our way through to get to the balance date, and obviously, a 6-week period to reporting date, at the point at which the Board would consider a dividend. And we've laid out, I think, quite openly and honestly all of the factors that you would expect to be taken into consideration. The payout ratio will be one; our future view of where the economy is, which will be far better informed then than it is today; the guidance that we've been provided with by APRA; and how our business is responding to the activities around COVID; and what our plans look like for the next 2 to 3 years. So I don't want to dimensionalize any of those inputs. They're the obvious ones you would expect us to take into consideration. And we'll do that in the cold hard light of day at the time, but we'll be in a far better position to be understanding of what will the inputs look like. But again, you've seen a demonstrated behavior in the way that we're managing the business that errs on the side of conservatism. And that served us well in terms of the reinsurance covers that we bought and the allowances that we've increased. It meant that we took a view that we should divest that smash repair business, and that we should be prudent and hold that capital on the balance sheet. We'll do a similar with the CPS3 that we refinanced early. It's a demonstrated track record, I think, of conservatively thinking about the settings in this business, and we would take that same approach into the full year dividend.

The next question comes from Siddharth Parameswaran with JPMorgan.

A couple of questions, if I can. Firstly, just maybe if I could get your comments on what was happening on pricing and what your intentions are on pricing in both personal lines and commercial lines. I mean, your comments at the last result were that I think your intention was to improve underlying margins. Obviously, there's a fair bit going on at the moment. But maybe if you could just give us a view on the underlying trends, excluding any premium refunds that are more one-off in nature, in personal lines and also just what's happening in commercial lines as well.

I might hand to Gary, and then we might traverse back around to Paul to supplementary answer that, given all the New Zealand dynamics. So Gary?

Thanks, Steve. Sid, just to start with commercial, we intended and still intend to continue to pursue rate increase where we need to. I think it's the expectation of the market in spite of some businesses, obviously, under more cash flow strain. And then where risk requires it, we'll continue to pursue rate. And I think, probably, globally, you're seeing that in the wake of a lot of insurer or reinsurer announcements about costs. So it won't be unexpected for Australian commercial insurance buyers to see rate continuing to come through. On personal, it's probably a bit more of a nuanced story than it is on commercial. We enjoy reasonable margins, I think, on motor, more headwinds to home margins. And again, we're going to have to price in the cost of doing business. We'll have to do that carefully because we obviously do want to take the franchise along with us. But as I mentioned earlier, I think in relation to the question about cost of acquisition, I think we want to make sure at a time like this, when consumers are probably going to seek comfort in the brands they trust and know and that are strong, we can present a really strong value story to them. And particularly strong there, I think, with AAMI on a national basis, that sits between -- we're seeing premium motoring club brands and kind of come across challenger brands. So as I said, we'll have to pursue the rate we need on personal for the margin aspirations, but more pressure on home, I suspect, than motor.

And then commercial, Gary, and then we'll go around to Paul.

Yes. No, look, we're going to start it with -- I started off with commercial. So just in terms of the expectation, we'll still pursue rate where we need to.

Okay. Paul, do you want to add anything on that? Or...

No. Just, Steve, similar theme here. On the personal lines in New Zealand, we've sort of indicated to market that we'll hold our pricing flat for the short period just to help our customers through this period. Similar to commercial, holding our prices flat, but we will remediate certain portfolios where we need to, and all customers within those portfolios. And on the corporate side, it's a case by case, depending on the risk profile of that corporate customer.

Okay. Great. Maybe just a related question to that. We have seen some insurers mentioned -- I can't remember who mentioned it earlier, but we have seen some insurers already announced premium refunds. And actually, I'm not sure if some are, at the moment, given that the amount of driving is so low, whether they're having some sweetheart deals on policies at the moment. Could you just comment on current competition levels? Are they very high for new business? Are there many deals which might actually lead to your lapsed rates picking up, which might be behind some of your comments around a soft outlook going forward, which is above and beyond just what we're seeing on the broader economy?

I don't think we could interpret any of the macro. The broader economy seems to be a significant delta to that from our book. Gary, do you want to talk to the competitive environment?

Yes. No, I think, Sid, where you've seen some players kind of dial up their presence, and in the case of Youi, talking about a rebate program. I think what you're going to find is that is the ones who suffer most when there is a decline in just overall market of new business. So if you're a smaller challenger brand, you are much more geared to a flow of new business to drive your overall portfolio and premium than a larger player like us with big brands. So I'd interpret some of that activity you're seeing as desperately trying to offset the significant impact of the decline in new business for those that are really highly geared to it. Even the rebating activity you've seen, I think QBE did a $50 gift card to what is a reasonably smallish motor book. Youi did a 15% rebate, if you ring and ask for it, for 3 months. So that's a 3.75% on an annualized basis, if you ring and ask for it. They've framed that in the context of kilometers driven. So where you have kilometers-driven rating, as we do across a number of our portfolios, it's always open to a customer to ring midterm and let you know that they've changed their kilometers. So I'd probably see most of what you're seeing above the line by the smaller players, just in that context of really trying to get some activity moving again, where they are so highly geared to it. Whereas the larger players, you see more brands and mass advertising or speaking to the existing customer base. And again, I think we'll be the beneficiaries, particularly if we deploy our brands well, of the level of uncertainty that's been cast in consumers' minds in general.

Okay. Very good. And just the last question for me, Steve, maybe for yourself, just a comment around potential industry consolidation. We have seen some players in the industry mention that they may put some of their insurance businesses up for review. I was just wondering if M&A is possible from your perspective on the insurance side?

Thanks, Sid. Look, again, I think, at the moment, our focus is 100% on the organic issues and challenges and opportunities most particularly that are sitting in our business. Obviously, if there are material opportunities that evolve in the insurance industry, you would expect us to consider them and have a look at them, but I don't want to flag any intent around any of that at the moment. Our focus is on making sure that we organically run this business as well as we can in a very uncertain environment, and we'll continue to do it as conservatively as we can.

The next question comes from Brett Le Mesurier with Shaw and Partners.

Two questions. Firstly, obviously, your profit for the second half is going to be very small. So I presume you won't be going to APRA seeking to get approvals to have a dividend, pay a dividend greater than the profit that you're going to make.

Well, Brett, again, I'll come back to the commentary around dividends more broadly and the way that we will consider it through the full year. And you make the absolutely correct point that if you seek to pay a dividend above the amount of profit that you've generated in the 12-month period, then that requires the approval of the regulator. I suspect, in all dividend processes, there's a high degree of interaction between businesses and -- financial services businesses and the regulator around things like the issue that you talked about, but also stress testing and capital planning. So I think we're not in a position today to have to declare a dividend, and we'll consider all of those things as we come through the full year.

Okay. The second question I had was in that slide where you've described investment market volatility, you've netted off the gain that you would have made on the asset side from the reduction in the risk-free rate. Could you say what that gain was? It looks to me like it was about $100 million pretax. Is that about right?

So what we've done, Brett, is we've netted off the insurance fund's mark-to-market as a gross number. So on that slide, the $27 million mark-to-market loss is a gross mark-to-market, including the risk-free. Where the net-off comes is on the liability -- that column called the liability impact, which is the risk-free revaluation on the liability number, which, as you can see, is just about $140 million.

So you've got the net-off in there, not on the insurance side?

Correct. So the insurance funds to gross -- is a gross investment income number. So that includes those elements I spoke to around inflation-linked bonds, credit and -- insurance funds, it's inflation-linked and credit. There's a small benefit that comes through there from the reduction in -- or the benefit that comes through from the reduction in risk-free that then gets offset on that liability impact column.

So the offset is in the liability column, not in the insurance fund column, is that what you're saying?

On that analysis, correct. Yes.

The next question comes from T.S. Lim with Bell Potter.

I guess life would have been sweeter if you have flogged off the bank years ago. But basically, when I look at the impaired assets for agribusiness lending, it's gone up to $38 million. I mean, I thought the farmers were actually doing much better. What's driving the higher impaired assets?

Well, I'll hand to Jeremy or Bruce to answer the specifics of the -- I think your fundamental principle is correct, T.S., that we have seen some rain through many of those drought-affected areas, and obviously, increased consumption of the goods that are produced in many of our customers' farming operations. So I think the general outlook, I think, on the agri side, is more positive than it might have been 6 months ago. And that's a general trend. But Jeremy, do you want to pick up anything on that?

Yes. No, that's spot on, Steve. I mean, the overall credit quality in ag has improved. And with these sorts of things, I mean, it's the law of small numbers at the end of the day. And I think pretty sure that's just down to a couple if that -- of individual names that just happen to have moved over the period. But the overall credit quality of the rural book is better than it was.

And T.S., you can be assured, I've been following your research for more than a decade.

There are no further questions at this time. I'll now hand back to Mr. Johnston for closing remarks.

Okay. Look, thank you very much for everyone. I do again apologize for how quickly we've brought this to market after our lodgement this morning. You'd be aware that we were very keen to make sure that we covered all the issues that we've outlined today. I'll just reiterate that while we packaged a lot of these efforts in an economic scenario, this is a health event, foremost that will have economic impacts. But also we are very focused, as an organization, on a unique opportunity that emerges for us out of all of these challenging times. So I wish you all the best. Make sure everyone stays safe. And we'll be in touch over the coming days, I'm sure. Thank you.