Insurance Australia Group Limited (IAG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the IAG Auckland Flooding and Financial Update. [Operator Instructions] There will be introductory comments by IAG's Managing Director and CEO, Nick Hawkins, followed by a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Mr. Hawkins. Thank you. Please go ahead.

Good morning, everyone, and thanks for joining us on this call this morning. I'm joining here today from Gadigal land, and I pay my respects to elders past, present and emerging. And with me in the room here today is our Chief Financial Officer, Michelle McPherson. We're holding this call and we made this morning's announcements in response to the severe storms and flooding in Auckland and the North Island that occurred last Friday and has continued since. I think as we all know, the event started last Friday evening, and around 153 millimeters or 6 inches of rain fell in just 3 hours. And that's almost triple the amount that would normally fall in the month of January. So far, we've had over 15,000 claims that have been lodged with us through our AMI State, NZI and partner brands, and we expect that number of 15,000 claims to increase. And of course, we're focused on supporting our customers, and we have a large team on the ground providing immediate support, including temporary accommodation and other emergency arrangements. Longer term, we'll be there to help our customers and the communities as they recover from the significant event. It's obviously still too early to quantify the cost of this event, and it's going to take some time to manage all these claims. But we now have some clarity about the impact it will have on our FY '23 results and the guidance that we currently have in the market. What we know is this is a very large event, and that will mean we will exceed our reinsurance retention. And so the net cost will be our MER of $236 million, leading to an increase in our full year perils assumption of $1.145 billion. Essentially, we've added the $236 million to our existing perils assumptions for the full year. Because of this, we're changing our FY '23 margin guidance. And for context, we're also providing you with some information on our preliminary results to December so that you can see the full story of IAG. So I'll now move to the preliminary results, which are still subject to management, audit and Board review. And we're obviously going to provide a lot more detail on all of this Monday week. We're expecting reported premium growth of 7.5%, and that reflects significant premium increases and new customer growth. Although on an underlying basis, adjusting for some of the portfolio exits we've made and also some significant currency fluctuations with the New Zealand dollar, our underlying premium growth for the half is 9.8%. I'll call out that our retention rates within that growth have remained very high, reflecting the value of our insurance to our customers and trust they place in our products and particularly our very strong brands. And within that, you'll also see some customer growth numbers. We expect natural perils cost for the first half to be $524 million, which is $70 million above our allowance for the first 6 months. Offsetting that, though, we have had a relatively benign perils experience in Australia during January. So excluding the Auckland event, we expect the actual perils experience for the 7 months to January to be broadly in line with our allowances. In terms of claims costs, we have seen inflationary impacts continue to increase, particularly within our motor claims. That said, there are early signs that the impact of supply chain inflation on our claims cost has stabilized, and our forward-looking indicators provide us with more confidence in the outlook. The first half underlying margin is expected to be 10.7%, which has been heavily impacted by the immediate recognition of this claims inflation and the timing of the earnings pattern on strong premium increases. Overall, we expect the first half reported margin of 8.5%, which does include $48 million in prior period reserve strengthening, primarily due to inflation on short-tail personal lines. Pleasingly, we've seen no deterioration in our long-tail claims reserves. Our first half net profit after tax is expected to be $468 million, and that does include the benefit of the post-tax $225 million reduction in BI provision, which we announced in October. And finally, our capital position remains strong. Turning then to our guidance and outlook for FY '23. We now expect our premium growth to be around 10%, and that's an increase from our previous guidance of mid- to high single digit. And that change reflects further increases in premiums in response to inflation, perils experience and additional reinsurance costs that we see flowing through the portfolio. However, in light of the Auckland event, we have revised our reported margin guidance to around 10%, and that's down from the previous range that we had in the market of 14% to 16%. In doing that, we've reflected the combination of the increase in natural perils, where we've included the full cost of IAG of the Auckland event; some additional reinsurance drop-down reinstatement premiums that we'll be paying based upon the Auckland event; and also the anticipated inflationary impact on claims following the Auckland event; and the overall macro environment. The combination of these 3 factors, the largest of which, of course, is the $236 million direct increase in our perils allowance, has led us to revise the guidance. Within this, we do expect an improvement in the second half reported and underlying margins compared to first half. And that's really going to be driven by 3 things. That's an increase in earned premium, reflecting the benefit of higher premiums as flowing through the portfolio; benefits from claims initiatives and moderating underlying inflation across the supply chain, and we're already seeing signs of that in the business today; and expected increased underlying investment yields. And what we've really done there is we've assumed current yields the remainder of this financial year for the next 6 months. Against that, though, is the high perils assumptions together with the reinsurance reinstatement premium that we're going to have to pay. So in closing for the questions, our first half has been challenging, driven by the inflationary environment that we all have to operate our businesses under. The financial impact of the Auckland event has caused us to revise guidance for the full year. But with premium rates flowing through and the flowing through right across our portfolio, continued high retention rates across our business and effective long-term reinsurance that we have in place already, we remain confident in our ability to achieve the 15% to 17% insurance margin over the medium term, and we've got a clear strategy that's going to support delivery against that. With that, Michelle and I are happy to take any questions on any of that. Thank you.

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

A couple of questions, if I could. Maybe, Nick, appreciate sort of the impact of cats on the reported range, but your revised guidance, you're sort of implying around 13% underlying for the full year previously. I guess at the start of the year closer to 15%. So that's got a 200 bp drop. A lot of which appears to be in this first half, that 300 to 400 basis points in this first half results. So it does seem like inflation escalated very considerably through the course of first half. Can you talk to what the trends across key class of business have been in the December quarter compared to the September quarter?

Yes. Thanks, Kieren. And I'll have a go at that and maybe I'll ask Michelle to come in as well. I mean crazy -- I'll just sort of say this crazier thing. I mean, obviously, with the first half underlying margin, with the guidance of 14% to 16%, we were probably not towards the bottom end of that guidance range. So I'm not sure in this sort of underlying further. And I'd probably call it a bit higher on a full year basis. What we're seeing with the Auckland event is obviously the direct natural perils impact, the $236 million, plus some reinstatement premium, plus probably a little bit of post-event inflation, but we're just going to manage our way through it. That's why we come up with the 10%. If I look then to the second part of the question around sort of what we saw quarter-on-quarter. I mean, I said that probably the thing that's most occurred to us, and you'll see this in the detail in 10 days, within our motor portfolio across Australia and New Zealand, I think there's other markets similar that we saw sort of a few things come together. We saw sort of activity back to normal, and what that did is sort of put a bit of a demand into the system, I think. And so the naturally supply-demand type issues within the repair industry. This is for motor, coupled with inflationary pressure on labor and pricing -- sorry, and parts, coupled with delay in parts. So we're also seeing in sort of September, October, a little bit in November as well, just the timing -- the amount of time it takes to repair a car was pushed out. And of course, what time adds money and in an extra high car, things like that. And probably that was more than we were anticipating. And we can see it now. And so what we've done is essentially in that sort of -- in the way you express it, probably in that second quarter, this reflect a lot of that. We are seeing that improve. We saw December a bit better. And now we're sort of looking back in December from here. And so we saw an increase in that cost of motor repair driven by those sort of 3 things: cost of parts, cost of labor and time. All of that added to a bit of a spike. What we're seeing is that moderate a little bit. And what we, of course, have to do, I think this is the real theme for IAG for this half, by the way. We've reflected all of that in the P&L straight away. I mean what we have done is probably accelerated our pricing where in the mid- to high single-digit motor pricing is now double digit everywhere, and what we're seeing through the book today. And so there's a delay, obviously, between the recognition of that claims inflation and the recognition of the earnings on that pricing. And that's what's caused probably a weaker first half than we were originally anticipating. But actually, we can also see the actions that our businesses have already taken. And so we've got confidence in the way that's going to earn through in the second half. And sort of come back to the guidance that we provided today.

I'm not sure you left me much to add, but I'll see where I can go. Probably a couple of call outs from me, Kieren, is what I'd say is in the first half of FY '23, we sort of were seeing motor inflation around 8% in that July, August period. And it's sort of gone up to over 10% in the second quarter of the financial year with a particular spike around November. So it went up more than we'd anticipated with some of the rate increases. We've subsequently identified and put rate through, but you understand the impact of the lag. And in terms of the sort of underlying margins and what we need to be, I think you called out that off the back of the around 10% reported, we'd be around 13% for the full year. I get the same math, so that works. And that's really the fact that we see then the benefit in the second half of the earn-through, together with some moderating inflations and claims initiatives coming through and then some investment income a bit higher than the first half given where we ended the half, those sorts of factors play through to deliver those results. We did in home, it's probably the other call out, have a little bit of large loss experience that was outside of our expectations, again, reflected that in subsequent pricing decisions. But we're always making judgments around expectations of inflation relative to pricing, and that's played through the impact on the first half. But hopefully, that gives you a bit of color as to why we're confident in that implied second half type results underlying. [indiscernible], Kieren?

Just sort of leads me into my second question, which is on the underlying sort of second half outlook sort of which you referred to there, which sort of is around 15.5%, which does read like quite a hockey stick recovery from 10.7% first half to 15.5% second half. So just -- I know you've talked to pricing and view inflation is going to moderate. But how confident are you in your visibility around these issues? Because it does seem like first half, you have been surprised by a number of issues. What's your degree of confidence around this very strong recovery you're talking into second half?

Kieren, I mean, we feel -- Michelle and I are asked a lot of time on this topic. So part of it is math. So the earn through is mostly on pricing actions that have already happened. So we've had quite an increase in those. But pretty much the entire portfolio has been -- this sort of been repriced on average, at least 10% plus at the moment everywhere. And that's not just sort of started now. That's sort of the last couple of months in which it's been leading up to it. So there's a math outcome here, which is the mathematical outcome of those pricing actions coming into earnings. So we're very comfortable on that. We know we're going to see improved investment returns second half versus first half. So that's -- we sort of -- we're confident on that. On inflation, which is probably the middle bucket. We are definitely -- we've put in a range of activity. We're definitely seeing a bit of moderation, if that's the right word, on the acceleration of that in the last couple of months and sort of December and January. And based on that, that's -- the combination of those 3 gives us confidence in that outlook. So we've spent a lot of time making sure we really understand this. And based on those 3 features, which are kind of separate in a way. Combination of that drives a significant improvement in second half underlying the way you've described it, compared to first half.

Your next question comes from Nigel Pittaway from Citigroup.

I might just follow up on Kieren's question there. First of all, on your ability to sort of assess inflation moving forward. I mean at the half year, you were saying you've got a very good view of what inflation is looking like. You've taken prudent steps to address increasingly inflationary pressure. And you're managing that. You're on top of that and mitigating claims inflation. So why do you think this caught you out and caught you by surprise?

Nigel, I mean, it's -- I'm not -- I mean, that's a strong word. I'm not sure I'd say it quite as strongly. But yes, they were definitely in particularly motor. They were more than we anticipated. I mean it's the way I described it. It sort of was -- there was -- we're already assuming some -- so it's not like 0 to 10 we assumed inflation. It was more than we anticipated across a very large portfolio. We saw it across Australia and New Zealand. I mean my understanding is that a few other markets as being similar. And it's sort of a combination of things caused a spike. What we've done is reflect that in pricing. We're not seeing that continue. So we're also seeing evidence of that [ flat line ] as well. So it's not an acceleration curve. So there's plenty of -- we've got plenty of evidence to suggest that, that's not accelerating. And it stepped up, and we've recognized that cost effectively at the mark-to-market that cost straight away on a large chunk of our business. And we're just not seeing an acceleration of that from what we're observing in December, January. And so because of that, we have the guidance that we have.

Okay. Okay. Just in terms of -- you keep reiterating this guidance for the medium term. I mean it looks actually like you do get better in the second half. But I mean in terms of medium term, what's your definition of that? And has that changed as a result of sort of reinsurance changes, et cetera?

I don't think so, no. I mean we don't -- I mean, I use the word medium term because we don't provide year 2, year 3 guidance, as you know. But we're setting up the -- the fact we are -- our intent has been setting up the organization in a financial profile that delivers 15% to 17%. That's our -- that's what we're doing. That equates to around about 12% to 13% ROE. And that -- we were sort of clear on that a couple of years ago. There's been some headwind against that. I must admit, I see some signs that we're heading towards that. Just even the discussion we had about second half margin, it's a very favorable pricing environment right now. And yes, we know we've got inflation. We know we've got reinsurance costs. We've got most of those set for the next calendar year or this current calendar year, sorry. And some of that sets us multiple years. So we feel like we're -- from a financial point of view, we're sort of getting -- the organization is, we sort of, set up to deliver against that.

Okay. And then maybe just finally, I mean, obviously, as a result of the reinsurance environment, you are having to make some trade-offs in terms of taking more risk on your balance sheet. One of the things you had traded off is the New Zealand drop-down cover. I mean how do you feel about the trade-offs you're having to make in this environment? And what impact do you think that will have on the business moving forward?

I mean, they are not just being straight economic decisions. I mean, from our point of view, all of the lower layers of reinsurance are all about managing the volatility of the company for what we believe is for a reasonable economic cost. And what we found, and I think that everyone knows the market is aware of this. Those lower-down, volatility-type covers are becoming a lot more expensive. And we've made sort of economic rational decisions on behalf of our shareholders that it doesn't make sense to sort of pay $0.80, $0.90, $0.90 in the dollar for protection. There might be months we'll take that ourselves. And what we found is that's very expensive, those lower layers. And so we're taking that -- we're taking that on ourselves. And that's -- I think that's the theme going forward. So the availability of certain covers from 5 years ago, it's just -- the market has changed. And at the moment, those types of cover are not available. And we've got the program we've got in place that we have. And then I will say, things like the quota shares make a material difference to this discussion. We sort of locked away 1/3 of the company's protection essentially in the form of these quota shares and they deliver other things for sort of 5 to 7 years. So we've got that set now. But I think the market should assume that those lower-level covers are going to be either unavailable or so expensive that something like us start automatically buy them.

And any hint on what that means for your '24 allowance?

It will definitely be going up. And we were working on them. We're going to have to -- go through the process of inflating and retentions. And -- but yes, we would expect the outlook on perils, assumptions, reinsurance costing going up. And our businesses are not only having to reflect now. They're going to have to reflect looking forward over the next 12 to 24 months, all of that, and reflect that into the pricing of how we're running our organization.

Okay.

Nigel, I think the whole market's doing that. I mean that -- I think that's -- and not just Australia and New Zealand. This is a global challenge right now. The pricing is up everywhere, not just from inflationary pressure but also from perils cost of reinsurance. And I think our industry everywhere in the world is repricing, and we should expect that to continue that in Australia and New Zealand.

Ultimately, there is more risk and volatility for prime insurers, right, so including yourselves. So I guess there's that implication.

Yes. And Nigel, that's a fair assessment. I mean, I think you have a really good sense of the renewal environment, and it's like the price piece, but that low down capacity, there's just more and more reluctance from the reinsurers to play in that space because they get hit so frequently.

Your next question comes from Andrew Stadnik from Morgan Stanley.

It's actually Andrei Stadnik. Apologies if maybe one question asked earlier. I just dialed in a few minutes late. But can I ask that in terms of the pricing you're getting in the second half due to the fair guidance implies, like low teens to repair increases. But what we've been seeing in the regulatory guidance, perhaps the personal lines a bit is still at mid-teens at 15% to 16% price increases, and that was back in September quarter. So what are you starting to see now in terms of the price increases across the business?

Andrei, it won't surprise you, you may have missed the comments. We talked earlier about the inflation we're seeing across the portfolio and what we saw in the motor portfolio sort of going from around 8% in the first quarter to over 10% in the September quarter. We've also seen some inflation in Home in the second half. It was around 7%, but we have seen some marginal experience outside of our expectations. So we are in the double-digit rate increases, and there is more rate increase to come off the back of what we have seen. So if you're looking at September quarter, what I would say to you is we've made some shifts in rates since then. One of the things -- once [indiscernible] we'll be providing more detail on the 13th of February, and there will be a few charts in there that might show you that pattern and trajectory in terms of how we've been thinking about it. So that's what should give you confidence in that full year guidance around GWP growth of around 10%.

Got it. Can I ask my second question around -- look, actually, around the quarter share margin headwinds. So it's very reassuring that the capital side of the quarter share is locked in for quite a number of years. But you hinted in the earlier release there was a margin headwind. Would it be fair to think that, that's somewhere between 0.5% and 1%, which is the level where it's not meaningful enough to tell us what it is, but large enough to say there was something in this? Is that roughly in the 0.5% to 1% point bucket?

Andrei, I love the way you asked the question. You don't have to tell us what it is, but it is range. You know I can't share that. What I said in the release earlier in January is materially consistent financial outcomes and supporting our medium-term target range of 15% to 17%. So we are -- I'd go as far as pleased with the outcomes that we achieved in terms of the whole of account quota share renewals with our 3 most significant hold count quota share partners. And our guidance for the full year has been determined based upon the arrangements that are in place as well as underpinning the 15% to 17% in the medium term.

Okay. And if I can maybe ask the third question. And if something -- I think something that the market will be kind of thinking about as well. Just in terms of management information systems and in terms of running different systems for different brands and from parts of IAG, how egressed are you in terms of streamlining that? And was that a potential factor in what feels like quite a late announcement in terms of a little bit higher claims inflation impacts coming through?

This is Nick. I mean sort of the bigger question on where we are at with sort of simplification of IAG. We are sort of well progressed. We've got almost all of our claims across the enterprise on the same platform, and we're now rolling out. We've built and using the guideline policing admin system across some of our portfolio, predominantly now in WA and South Australia. And we're now starting to introduce it to partners in other parts of the business. And over the next 12 to 18 months, that's sort of rolling across pretty much all our personal lines businesses across Australia and New Zealand. So that, we are extremely well progressed on that. I think -- so your question about, I think, specifically motors. Do we have a delay in understanding that and therefore, delay in some of our pricing because of our complex management information systems. Actually, our personal lines motor businesses are all on driveline already. So I'm not sure that would be the sort of attribution of that. It was more that we had assumptions around what was happening. The combination of those sort of 3 things, parts, inflation, labor -- sorry, parts inflation, labor inflation, delay and delay in parts availability. So that package of things was more impactful than we originally thought. That's caused a bit of margin depression. That's caused more pricing to flow through that portfolio, and we're not seeing a continuation of that. So I'm not sure the complex platform is the sort of the answer -- is the sort of the attribution of that point. We do have a complex platform, and we are simplifying it. So I'm not sort of suggesting that's not the case. It's more -- just for this particular example, I'm not sure that's the key driver.

Your next question comes from Julian Braganza from Goldman Sachs.

Just a quick question just on the pricing strategy, I just wanted specific answer. Just kind [indiscernible], I just want to think about the episode -- understand your pricing strategy? And are we just -- in terms of the double-digit sort of rate increases, is this more of a multiyear type of approach? Or are you expecting a tapering of the sort of level of rate increases over time?

I mean, we're not -- I mean the markets can change, honestly. But I mean at the moment, heard as Michelle said, pretty much across the entire enterprise, we're repricing at 10% plus, which is pretty significant everywhere. Sort of the outlook, if that's a question of the hit. What we know we're going to have to continue to price for is increased perils assumptions to question we had previously increased cost of reinsurance and we're going to continue that. Inflation is not going to drop away tomorrow, so we're going to continue the pricing for that. It seems -- if someone have asked me this 12 months ago, I would have thought it'd be a lot lower than it is now. I think it's hard for -- Over the next 12 months, do I see much of this changing? No. Longer than that, sort of multiyear is your question. I mean, things can change. We'll have to continue to monitor that. We do know the global reinsurance capital is definitely a hardening market. And what that normally suggest is we'll continue to see a hardening market across all of our commercial classes for probably longer than we originally thought. And then on the retail personal lines side, we'll have to manage that based upon what's happening with other parts of our cost structure. But certainly, over the next 12 months, I can't see this changing materially.