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Edited Transcript of IAG.AX earnings conference call or presentation 7-Aug-19 11:30pm GMT

Full Year 2019 Insurance Australia Group Ltd Earnings Presentation

Sydney, New South Wales Nov 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Insurance Australia Group Ltd earnings conference call or presentation Wednesday, August 7, 2019 at 11:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Nicholas B. Hawkins

Insurance Australia Group Limited - CFO

* Peter G. Harmer

Insurance Australia Group Limited - MD, CEO & Executive Director

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Conference Call Participants

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* Andrew Buncombe

Macquarie Research - Insurance and Diversified Financials Analyst

* Daniel P. Toohey

Morgan Stanley, Research Division - Executive Director

* David Ellis

Morningstar Inc., Research Division - Senior Equity Analyst

* Kieren Chidgey

UBS Investment Bank, Research Division - Executive Director & Research Analyst

* Matthew Dunger

BofA Merrill Lynch, Research Division - Research Analyst

* Nigel Pittaway

Citigroup Inc, Research Division - MD of Insurance and Diversified Financials Equity Research and Lead Insurance Analyst

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Presentation

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [1]

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IAG's results presentation for the financial year ended 30th of June 2019. Nick and I have observed over the last number of halves that the crowd that we're able to attract gets smaller and smaller. We still have quite a number of our own staff, senior management, here. But I guess there are a few other things going on today. So -- but we are grateful for those of you who have made the trip across to Darling Park. It's always easy for us to talk to a live audience than it is just to talk to the camera.

Before we start formal proceedings, I'd like to acknowledge that this meeting takes place on the lands of the traditional custodians, the Gadigal people of the Eora Nation and pay my respects to their elders past and present.

So this morning, I'll give you a high-level overview of our results as well as a quick progress update on some key initiatives. And then Nick, as usual, I think for the 24th time, will delve into the detailed numbers. I'll then return and summarize. And of course, Nick and I will be very happy to take any questions that you might have.

So this is another pleasing set of numbers which highlight the ongoing underlying improvement in our business. Importantly, they are squarely in line with expectations we gave you at the outset of the year and which we confirmed 6 months ago. They demonstrate that our strategy based around the 3 priorities of customer, simplification and agility is resulting in robust operational and financial performance. And crucially, this places us in a strong position to increase our focus on customer engagement and growth, and I'll fill you in on some of the things that we're doing on this front shortly.

As ever, this performance speaks to the strength of our brands and incredible passion and commitment of our people, which has been tested at times in a year of reasonably high perils activity, particularly here in Sydney.

At a high level, we've seen another sound performance from Australia with personal lines continuing to perform well and commercial lines displaying some encouraging improvement in profitability. And in New Zealand, we've seen another strong outcome assisted by a particularly benign period for perils.

Overall, GWP growth was 3.1%, just above the midpoint of the 2% to 4% guidance we gave you. And we've produced a greater than 100 basis points improvement in our underlying margin, putting aside any quota share effect.

At a reported margin level, we're also in the middle of the guidance we've provided with our reinsurance program proving its worth and containing our net natural peril claims costs to a small overrun against allowance. And as usual, Nick will provide more detail on all of this shortly.

As we reported at the half, the result includes a profit slightly in excess of $200 million on the sale of our Thailand operations, which was booked at the end of August last year. We are yet to complete the much smaller sales of Indonesia and Vietnam but are confident that these will occur in the coming weeks.

We continue to review options for our remaining interest in Asia, and I can confirm that we are in advanced discussions with a number of bidders for our 26% stake in SBI General in India. But as yet, no transaction has been agreed.

We do remain committed to returning surplus capital to shareholders as our capital management initiative in November of last year demonstrated. We returned a very strong capital position after allowance for the final dividend, which will take the full year payout to the top end of our targeted distribution range.

And finally, we've set out our guidance for the 2020 financial year which reflects further anticipated improvement in our underlying performance.

Turning to some of the specific actions during the year just completed alongside our priorities for the year ahead. This has been a year of considerable progress with our simplification initiatives. As part of the outsourcing and off-shoring program, all targeted activities have now transitioned to our operational partners, and this aspect of our simplification program is now very much business as usual. Our claims system consolidation is largely done, and from here, increasing of the emphasis will be on decommissioning redundant systems.

This current year will also see us begin to tackle the consolidation of our policy administration systems, and this follows the detailed scope and work already conducted. And as we've highlighted before, this will be a much more complex and lengthier task than that for claims.

We've also been busy refining our optimized repair model, which has seen us move to a majority ownership of a number of rapid repair motor workshops, and this model will be expanded more broadly across Australia and New Zealand in the coming year. And I'm pleased to advise that RACV is one of our partners in this initiative.

And just as we've been addressing our systems, we've also simplified our operating profile. Asia is one aspect to this, and underwriting agency interest in Australia is another, where we've divested several businesses which are noncore in nature and which are better owned by other parties.

The strides made with simplification mean we can now devote more attention to how we might grow customers, and specifically customer engagement, and the pursuit of longer-term growth opportunities.

During the year just completed, Julie and her team advanced the digitization of our home and motor claim processes with customer's ability to track motor repairs via SMS updates proving incredibly popular.

We've continued transitioning our data to the cloud, and this will accelerate in the year ahead to allow full access to the associated benefits around speed, efficiency and flexibility in customer decision-making. FY '20 will see a significant step forward in our efforts to build out new businesses that complement our core insurance offering. And this will involve accelerated investment in the data, artificial intelligence and innovation capabilities that we've been establishing in Customer Labs for some years now. Already, this is translating into new business opportunities in the mobility space with our recent investment in the Carbar digital car trading platform, an example.

Expenditure associated with this accelerated investment will be reflected in our fee income line in the P&L, and Nick will guide you to the financial impact in the year ahead in just a moment.

Under agility, we've continued to deploy employee programs that clarify people's roles and accountabilities while building their capacity to participate in our Workforce of the Future.

We've also been actively implementing measures that increase workplace flexibility. After a very successful trial, the Switch shift management tool has been launched across all our large contact centers, and that allows employees to quickly and easily make changes to their rosters in order to accommodate their life needs.

And our Kids@IAG program is now into its fifth year, providing a free school holiday care program for the children of our employees over an expanded number of locations. In our most recent program, we entertained nearly 600 children across 6 separate locations.

We provide a range of flexible working options for our people under our MyFlex program, and we estimate that up to 70% of our workforce now works flexibly. I'm pleased to advise that there's been a continued improvement in our employment brand in the marketplace with our rolling employee efficacy score improving by nearly 30 points over the last 12 months.

So all in all, another busy year and a similarly broad list of priorities in the year ahead as we continue to look for ways to strengthen our customer base and the company's future growth prospects as a whole.

So I now hand you over to Nick to go through the numbers in more detail. Nick?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [2]

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Thanks, Pete, and good morning to everybody. So as Pete indicated, we're pretty pleased with the results that we're announcing today. What I thought I'd do is to just step through some of those at a high level and then a bit more -- after I'll go through in a bit more detail.

So sort of the headline is we've had some sound premium growth delivered in the last 12 months. Pleasingly, we have had an improvement in the group's underlying margin. The reported though is slightly down year-on-year, and that reduction is really driven by a reduction in reserve releases we've seen in '19 versus '18. We've had a strong turnaround in our shareholders' funds performance in the second half of the year, and really, that's being driven by the rally that we've seen in equity markets both in Australia and international, and you'll see that through the group's P&L. And we also have that $200 million-plus profit from the sale of our Thai business that we booked at the half but is obviously in the full year.

Within all of this, below the line, you'll see a small loss in our fee-based income line. As Pete mentioned, that really -- that's really a sort of a net position of a loss that we’ve incurred from building out some of these new businesses, some of the adjacencies that we're starting to build out in our business. And we are going to be -- we are planning to accelerate our spend here a little bit. Really, that's been driven by the confidence on what we've achieved today to give us -- to spend a little bit more next year. So as a result, what we are flagging today, that fee-based income line, which is a small loss this year of $8 million or $9 million, that number is more likely to be income less expenses and loss of something in the order of $50 million pretax for FY '20. And that's really about us investing in the future of IAG.

Just looking at the overall numbers though, the net profit after tax, you'll see that number's up 16% year-on-year. And the cash ROE is just under that 15% target so in the high 14s, and that's sort of how we'll set the company up going forward.

So what I'm going to do now is just step you through some of that in a bit more detail. So starting with growth. We've ended up at the midpoint of our range. We started the year -- in August last year, we said we anticipated IAG to grow somewhere in the order of 2% to 4%. We ended up delivering a number sort of in the middle of that, around 3%. In February, we also said, remember, the second half will be slightly softer than the first half and that has what has occurred. Some of the -- that's driven by some of the exits of businesses that have occurred in the last 12 months as well as a little bit of a spike in the first half from workers' compensation. Second half, we had a more normal experience, that's what's driven that half-on-half impact.

Within that number of growth that we have delivered today, there's a couple of different parts. There's sort of -- the themes are sort of rate-driven growth across our short-tail personal lines businesses here in Australia and New Zealand, and that rate that we've been flowing through those short-tail personal lines businesses is sort of roughly in line with inflation. So that -- you'll see that through the portfolios.

We've had some volume growth within -- some motor volume growth within our AMI brand in New Zealand and within the RACV brand in Victoria. So you'll see some volume growth within the detail happening in our motor business. Across the commercial books, and in particular Australia, we've had average rates flow through around about 6% across the entire commercial portfolio. Against that though, we have had some volume reductions. So there's a net position, you'll see they're not of that 6%. So a pricing of 6% and less some volume reductions.

There's about a $70 million impact in the FY '19 numbers from businesses that we've exited compared to '18. That's in both personal lines and commercial. So there is some strain there. And of course, we flagged this before, but average premiums for New South Wales CTP have been coming down. That scheme reform has changed the way it operates here in New South Wales, and the impact of that has been lower premiums and that's year-on-year a reduction within New South Wales CTP premiums. If I so look through all that, I mean my view would be the underlying growth of IAG is something in the order of about 4%.

In relation to guidance for next year and what we're guiding to for FY '20 around growth within IAG is sort of low single digit. And really behind that with where our view would be, we have rate increases flowing throughout the book. We would anticipate some modest volume growth within our personal lines businesses across Australia and New Zealand. We would -- we're assuming a reduction in commercial volumes although probably at a lesser amount than what occurred in '19, but still a small reduction within commercial volumes, within the business. There's about $100 million additional reduction in premium for -- that's factored into our guidance from businesses that we sold in '19, particularly the agencies that Pete mentioned earlier. There's about $100 million year-on-year impact just from that. And we anticipate again, even compared to '19, lower average premiums from New South Wales CTP. So that's -- all of that is factored into that low single-digit growth for FY '20. I mean the underlying growth I think will be kind of similar to what has just occurred in '19.

Just looking at the margins. So starting at underlying margin, you can see on this what we've got on this page is essentially stepping through a 250 basis points improvement in underlying margin from '18 to '19. If you unpack that, sort of half that story is really the additional quota shares that were put on -- put in place 1 January '18. So remember, FY '18 numbers only had 6 months of the additional 12.5% quota shares where FY '19 had the full year of that. So the maths of that is there's about 125 basis points improvement in underlying margin just from that additional quota share 6 months versus 12 months. But the other 125 basis points is really the key here, which is a genuine improvement in the underlying performance of IAG sort of year-on-year. And really what's driving that is sort of the -- is the progress we're making around the optimization and simplification program and the reduced cost base of running IAG. There is some offset there from some increased risk and compliance type cost, but the net of that is still adding to that margin improvement. Of course, we've also got some improved commercial business and that's impacting the underlying margin of the group. Against that, though, we probably have got, in '19 versus '18, slightly lower profitability of New South Wales CTP as that scheme profitability is now capped under the way the rules of that new scheme work.

At the headline, a reported number. We started the year aiming sort of with guidance of 16% to 18%. We ended up delivering in the middle of that. Behind that, of course, is reserve releases roughly in line with sort of expectations we set. Perils are slightly over and we've had some negative credit spread impact that's affected that number as well. But all in, we're pretty pleased with what -- with how our business is tracking and the performance that has improved in the last 12 months.

Just on reserve releases and it -- what we're showing here is just sort of the 3-year story and you can see how we're tracking down from mid-5s to just under 2%. And we started this year sort of in our guidance of sort of around 2% reserve releases, and we're just slightly under that for the full 12 months. And clearly, the trend here is down. And particularly for IAG where the majority of our reserve releases have been from New South Wales CTP, with the changes in the scheme, we anticipate them coming down further. And in fact, what we've provided within guidance for FY '20 is reserve releases of around about 1%, which is kind of the run rate you'll see in the second half of '19 as well. So that's what we have included within guidance for FY '20, 1% reserve releases.

Looking at perils and the sort of a story in a story here. So the headline here is that we've ended up $19 million over our allowances for the year, but there's probably another story here which is -- and I'll just sort of recap the numbers. We had a perils allowance from assumption in our pricing of, after quota shares, $608 million and we ended up being $19 million. The other story there, of course, is in between that we also had another $101 million of reinsurance protection. Dollar for dollar, that's at above $608 million. So $608 million, $101 million and then $19 million back to IAG. So we fully utilized that additional reinsurance protection that's set above our original perils assumption. You'll see in the detail, we had some large events as you're aware in December but as well as January and March. That ended up having in Australia a relatively high perils year well protected by reinsurance, and we end up having a net number there of $19 million come back to the P&L over and above our original assumptions.

For next year, so for guidance for FY '20, we have increased our perils allowance by around 5%. And I'll just step through those numbers so we don't get confused. So we still think of this as a 100%. So we had an allowance of -- in '19 of $900 million. After quota share, that number is $608 million. What we've done for '20 is increase the $900 million up to $950 million. After quota share, that number is $641 million, quota share being 67.5% of those 100% numbers. So we've increased our allowances and up by around about 5%. So that allowance for FY '20, which is within guidance, is $641 million after quota share.

Reinsurance is sort of the structure of what we've got protecting the group's P&L and balance sheet. It's similar to what we had in last financial year. Although in relation to the stop-loss protection, so that $101 million that we had sitting directly above our allowances in FY '19. So to start again, $608 million, then $101 million above, that $608 million is lifted to $641 million. We then have a small gap now and this was really a pricing discussion of $34 million. And then we have $101 million of protection sitting above that in the FY '20. The reason it doesn't sit exactly on the sort of lid of that allowance was really a pricing discussion, and we ended up sort of -- from a sort of economically rational point of view, we ended up having a small gap and then had bought some reinsurance protection above that. So that's what's within our FY '20 guidance.

On expenses, and I'll just go through this slowly just to recap what we said, where we're at and sort of where we're heading. So just a reminder, we put in place a program of work around sort of optimizing and simplifying IAG, really with making IAG an easier place to deal with from a customer's point of view and really trying to make IAG an easier place to operate within for all of us.

From a sort of a cost point of view, we said there was a cost base in FY '16 of running IAG of about $2.5 billion. And these programs of work that we've been running for a number of years, our aim was to take roughly 10% of that cost base out, call it, $250 million to be delivered fully within the FY '20 financial year. So that was sort of the original setup and the programs at work that we've been running for a number of years.

We've made some adjustments to those, and we've talked about these before. So we have sold some businesses in Asia and we also have closed our New South Wales worker's compensation business, about a $70 million cost that was in the original $2.5 billion. That was part of that. So we've sort of taken that out of our target because those businesses have now been sold or exited. And we also flagged in February, against that, that we had about a $30 million additional cost around regulatory and compliance that we could not fund as part of that program, so effectively some additional costs that were outside of that program.

What we're delivering today in the FY '19 year, sort of stepping through that, the $2.5 billion, $70 million down, $30 million up around additional risk and compliance. We're delivering about $90 million of that additional $250 million through the P&L in FY '19, which leaves us with a sort of run rate now of $2.37 billion, which is on the slide. So we delivered $90 million of the $250 million essentially.

What was that, what we're saying in relation to our expectations for next year and what's within guidance and how we're setting the company up is that the balance of the $160 million will be delivered through the P&L in FY '20 is our expectation. Although against that where we said that additional risk and compliance was $30 million, we see about another $50 million of additional risk and compliance that we're going to be incurring next year that is going to be outside of that program. Really is what we're saying is we can't absorb that as well as everything else that we're doing. So call that $30 million there, another $50 million, so $80 million in total over that period. You can see what -- you can see by -- our expectation is that by June 2020, we would have delivered through the P&L and the run rate of IAG will be that sort of $2.26 billion number sort of going forward.

So we're progressing well here. The programs at work that we have been running have been delivering. We're pleased with where we're at, and we anticipate delivering on that fully in FY '20.

Just on each of the divisions. Firstly, starting with Australia, had a strong consumer result. As I mentioned, sort of rate increases have been flowing through those portfolios in Australia roughly at inflation. There is some strain -- a little bit of strain or reduction in profitability from New South Wales CTP compared to '18. That's really driven by the change of that scheme and the capping the way that works. Within the commercial business within the Australian division, you'll see year-on-year improvement in that underlying margin so we're pretty pleased with that. Really, what that is, is a cumulative impact of rate increases that have been flowing through that portfolio the last couple of years as well as some of those specific portfolio actions that we've taken. Some of that is driving that underlying margin to improve.

I'll also comment that large losses, and we've called this out in the past where we had some spikes in large losses, we've sort of had more normal large loss year within the commercial portfolio, which has taken some of the noise out of that as well. But overall, we are pretty pleased with how the Australia division is going.

New Zealand has also had a strong result. In local currency terms, we grew our New Zealand business by about 5%. Predominantly, we've got rate flowing through the personal lines business. I mentioned before that within the AMI business in New Zealand, we've got some volume growth within motor, which is a pretty good story. The sort of the themes are kind of same as Australia. We've got commercial rates flowing through. We've got some offsetting volume losses within commercial, although our observation is the speed of rate increases in New Zealand in commercial book is slowing down a little bit.

Probably the comment that we'd make, a very benign natural perils experience in New Zealand in the last 12 months, very low. That does impact a little bit underlying margins as well, just the number of claims in the systems has reduced, that does improve underlying so we've had a strong result there. But also headline is very strong by the fact that we had no -- very few perils and therefore that's inflated the headline margin for the last 12 months. Very strong performance within New Zealand, and it's all going very well there.

Just before we go to capital, I thought I'd just step through guidance. And I kind of talked a bit about it already, but on the elements of it, just bring it back to the guidance for FY '20. So we're saying today that we anticipate reported margin for FY '20 to be in the order of 16% to 18%, which is the same numbers as what we had for FY '19. Although, of course, I -- we would say that the quality of that guidance has improved and I'll step you through that.

So behind that, we're seeing an improvement in the underlying margin of IAG. We saw that from '18 to '19 and we're anticipating that again within the '20 numbers. That's what's included in guidance. And really what's driving that is the benefits flowing through from the optimization and simplification program. Yes, we have some additional risk and compliance costs, but the net of that is flowing through and improving the underlying margin of our business. Of course, within that guidance also is a significant reduction in reserve release. We said 2% last year and now we're saying 1%. So the element of reserve releases that are contributing to guidance have come down by 100 basis points as well. But overall, as I said, we see guidance reflecting improvement from '18 to '19 and then again into '20 and that's what's included within those numbers.

Just looking at capital, and we've shown you this before. This is sort of the movement of Common Equity Tier 1 ratio. I think that's the key capital ratio that we would highlight to you around looking at how we think around capital at IAG. So the movement in the last 6 months is sort of profits less interim dividends. We've had some additional relay from quota share come through as well as some utilization of New Zealand tax loss, which is also coming through on the capital. That leaves us at 1.31x that ratio before dividend or just over 1.1x after the dividend. And you can see we're just slightly above the top end of our targeted capital ratios in relation to Common Equity Tier 1. All in, the group is in a very strong capital position.

And then just on dividend. Today, we're declaring a dividend of $0.20 per share, which is a payout ratio of just under 80% of our cash earnings for the last 12 months. As you're aware, we want to maintain a consistent dividend policy of paying out between 60% to 80% of our cash earnings. Although of course, our recent history here has been that we're paying out towards the top end of that range and that's what we've delivered today. What is different today about our dividend is we're franking it only to 70%. Now we flagged this 12 months ago with some of the capital actions and the way we've returned capital to shareholders over the last capital -- last few years. We have been utilizing sort of surplus franking credits out of -- from IAG and we flagged sort of 12 months ago. But because of that, then our dividend payouts will likely to be between 70% and 100% franked because of the -- because we're really more in equilibrium around franking. With the dividend today, we're at 70% franked for FY -- for the final dividend.

So all in, we see this is a pretty -- is a strong set of numbers that we have delivered for FY '19. We're very pleased with sort of the performance and the uplift within how we're going here at IAG. You can see the improvement in the underlying performance in the numbers we've delivered as well as in the guidance that we've got for FY '20.

So on that note, I'll hand you back to Pete.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [3]

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Thanks, Nick. So in summary, we've had another very satisfactory year. We've put in place a plan 3 years ago and we've been working that plan over the last 3 years with a great degree of discipline, and we're very pleased with the progress to date. Our focus, as I think you all realize, has been doing the simple things very well and it is delivering results. We strengthened the business from a customer perspective and from an employee brand perspective. We finished the year on a good trajectory, and we enter FY '20 with good momentum. I'm looking forward to sharing that progress with you in February.

With that, Nick and I will be happy to take any questions that you might have.

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Questions and Answers

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [1]

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And as always, we'll start here in the room. Andrew?

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Andrew Buncombe, Macquarie Research - Insurance and Diversified Financials Analyst [2]

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Andrew Buncombe, Macquarie Securities. A couple of questions if I can, please, particularly on the costs. You mentioned again that you're looking to consolidate the policy systems, and that's very close now. Can you just remind us how you're planning on funding that?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [3]

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Within -- Andrew, so, I mean, I'll take that one. I mean just within the cost of running IAG. So that -- I mean we're not -- I suppose the question is are we anticipating any sort of a spike in costs and deterioration of margins? No. That's -- we see this as sort of our job to continually to be reinvesting back into our business and to be able to absorb that within the cost structure of the company.

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Andrew Buncombe, Macquarie Research - Insurance and Diversified Financials Analyst [4]

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Excellent. Second question on the Slide 11. In there, it's got $160 million optimization benefit coming through in FY '20. How much of that is already in the run rate or how much further work needs to be done to bank that?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [5]

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It's a good point. I mean I use that expression run rate because the $90 million that we -- so to say, the $90 million and $160 million, the $90 million is in the P&L. To your point, a fair chunk of the $160 million would be sort of in the run rate but not fully delivered and that will be flowing through. So we're not -- accounting of any programs, we're starting from scratch now. So a fair chunk of that would be in the run rate at 30th of June 2019 as being delivered in '20. That's probably -- pardon my language, it wasn't quite right in the way I described it.

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Andrew Buncombe, Macquarie Research - Insurance and Diversified Financials Analyst [6]

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No. That makes sense. And then the final question on the reserve releases, that certainly surprised me that the second half number was so low, particularly in the context of superimposed inflation is running at about 0 and wage growth is still pretty low. The scheme changes in New South Wales only came through in the last couple of years so there's a big ramp of back book which should be benefiting from those items. Is there something that you're seeing in average wage growth with superimposed inflation that's different to the rest of the system?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [7]

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I mean I don't think so. I mean I'm not aware of anything. I mean the reserve releases have come from some of those outer years. And I really do think that the changes of the scheme have created a less volatile CTP where our reserve releases have been predominately coming out of New South Wales CTP. That's stabilized, and therefore -- I mean we've been guiding down anyway. I know for various reasons, that hasn't occurred. I mean our view is, and this is not us being super conservative if that's the question. Our view is this is what we anticipate delivering over the next couple of years, sort of more like that 1%, sort of leave it at that.

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Andrew Buncombe, Macquarie Research - Insurance and Diversified Financials Analyst [8]

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Yes. That makes sense. And one final question, please. Just on the high commission expenses in New Zealand and the Australian Consumer Division in the second half, there was a material step-up in both. Is there a change in strategy coming through there because it didn't go through the business division in Australia?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [9]

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I think that there's a -- this is -- sorry, the question is, is the commission income -- the commission expense line increased slightly within the...

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Andrew Buncombe, Macquarie Research - Insurance and Diversified Financials Analyst [10]

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The commission expense ratio in Australia consumer and the New Zealand stepped up by around 200, 250 basis points?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [11]

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Yes. I think within the Australian business, that's just a minor change between some of our NRMA agencies that we now -- effectively we've been paying them commission, they're no longer our businesses. I think we've just reclassified some of that. And I think you'll step through in the detail, I think we've had a go at articulating that. New Zealand, I'll have to come back to you.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [12]

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New Zealand was -- some of the profit commissions that we pay our banking partners come through in the half, so.

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [13]

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So we don't see it yet.

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David Ellis, Morningstar Inc., Research Division - Senior Equity Analyst [14]

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Dave Ellis from Morningstar. I've got a question again on Slide 11, the expenses. Now assuming the FY '20 expense base of $2.26 billion is achieved. As I think investors would like to know, what's going to happen after 2020? Where is the next optimization project going to take the cost base for the 3 or 4 or 5 years after FY '20?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [15]

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I mean obviously, we're in the business of running our company as efficiently as we can. I'd also like to think that we can have some additional growth being generated out of our organization in various places. So we're not sort of forecasting where that line is going to end up other than we would anticipate continued optimization within our business countered by growth in our -- within our current business as well as some of the things we're building out. I'll also say in relation to -- I know some others have been commenting on this as well. I don't see sort of a step-down. We sort of have this additional risk and compliance cost within the cost structure of IAG. So within that $2.26 billion number is about an additional $80 million, I don't see that stepping down. I sort of see that being part of the cost base of our business going down and then sort of see in '21, '22 a big reduction of that, sort of a spike up, spike down. I sort of see that as sort of an investment spend within our company that I see as sort of will end up being embedded in the run rate going forward.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [16]

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Can I just add to that? When we launched the simplification program of work, a big part of that was around messaging to the organization some of the difficult decisions that we needed to make, particularly around things like the simplification of our technology stack. And so with that having been achieved, and we've now restructured the organization quite substantially, created a single Australian division, we feel that there's really good momentum and discipline inside the business. So you continue to see significant work around productivity, but you won't see -- certainly in the next year or 2, you won't see another major simplification style program.

So it's quiet here in the room. We have 3 questions on the teleconference. So we'll go to the phones.

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Operator [17]

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(Operator Instructions) Your first question comes from Kieren Chidgey from UBS.

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Kieren Chidgey, UBS Investment Bank, Research Division - Executive Director & Research Analyst [18]

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Just a couple of questions. Maybe starting on personal lines, be interested in to see your assessment of sort of the competitive outlook in personal lines, home and motor at the current point in time, your rate expectations and also what you're seeing from a claims inflation point of view in both those classes?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [19]

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Shall I take that?

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [20]

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Yes. I think we'd say that we're continuing to see a rational competitive environment. I think as we look forward, we'd expect to see rate going through the book largely to match inflation. And in terms of your question on claims inflation, we're seeing sort of home inflation in the mid sort of single digits and motor a little less than that. We have been pricing to meet that, and we expect to be able to price to meet that into FY '20.

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Kieren Chidgey, UBS Investment Bank, Research Division - Executive Director & Research Analyst [21]

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Okay. And maybe just commercial as well, Peter, to cover off?

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [22]

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I think both in Australia and New Zealand, the acceleration of the rate increases that we've seen over the last 3 or 4 halves will start to ameliorate, but we still expect to see rate going through the book in this coming financial year.

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Kieren Chidgey, UBS Investment Bank, Research Division - Executive Director & Research Analyst [23]

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Okay. And Nick, the $50 million loss you're flagging for the fee-based business in FY '20, can you just provide a little bit more detail behind that and how one-off that is in nature, whether or not sort of as we look out to FY '21, sort of how we should be thinking about the delta in that line?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [24]

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Yes. I mean really it's going to be about -- I mean what we're really doing here is building out sort of adjacent type businesses where in the first couple of years, sort of in simple terms, income versus expenses are going to be ending up being a loss. We've got a couple of those already. I mean I'd like to be -- I'd like to think that those businesses, as we're building out those businesses, they start turning into profitability. Yes, we may invest in others, but I don't see a material change from sort of the type of P&L impact that we're talking about at the moment. And if anything, our current view would be that sort of looking out further, obviously these investments are going to turn into a return and then they'll end up being accretive.

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Kieren Chidgey, UBS Investment Bank, Research Division - Executive Director & Research Analyst [25]

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Okay. Specifically, what sort of investments through the line is what...

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [26]

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A good example is one -- sure. A good example, and I don't want us to overstate this example, this is just one of several is what we've done, we've invested in a business called Carbar. That, no doubt, in the first couple of years as we're investing in that and that business is building out, that there'll be a small loss that's incurred. We're a majority of shareholder of that, so we'll end up having a small loss being incurred. And there are several of those that are incurred. But the aims here is this is not a long-term plan to have a strain within the P&L. This is us sort of flagging that we are investing in some of these adjacencies and that there is some short-term P&L negative as we are making those investments. But the medium-term view is that this is going to be accretive to -- for IAG shareholders.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [27]

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And Kieren, I might just round out your question. We have a very tight focus over these opportunities that we're looking at and very much driven by trying to understand where are the adjacencies that we can move into that can combine with our insurance products that collectively will make our customers safer on the road, in the home and at work. So there's been quite a lot of work taking place within Customer Labs over the last handful of years. We've seen lots of great opportunities through our incubator here in Sydney and our accelerator in Singapore.

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Kieren Chidgey, UBS Investment Bank, Research Division - Executive Director & Research Analyst [28]

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Okay. And just one final quick question on your reserve assumptions. Has there been any change in those -- in the base inflation, the superimposed inflation assumptions over the past 12 months or through the 30th of January reserving?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [29]

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No, Kieren. No, there's no changes of any materiality in any of that.

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Operator [30]

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Your next question comes from Matthew Dunger from Bank of America.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [31]

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Matthew, are you there?

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Matthew Dunger, BofA Merrill Lynch, Research Division - Research Analyst [32]

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Apologies. I had to unmute you. If I can ask a question on the guidance, please, the 16% to 18% insurance margin guidance that you've reiterated. Given you've got these optimization benefits on track, you're talking about 4% underlying pricing increases with benign claims. What prevented you from raising the guidance for next year?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [33]

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I mean we have taken -- Matthew, it's Nick. I mean this is our best estimate of what we're going to deliver next year. I mean we've got probably in the detail some other aspects out there. We've got lower interest rates, which we are absorbing within that guidance as well. And we have sort of -- if I look at the run rate of the company at the moment, that 16% to 18% with lower reserve releases we're able to reprice up for some additional perils. We've got lower interest rates in -- that are flowing through that are going to have some strain year-on-year in relation to that margin and sort of delivering that cost out as well. So I think in the blend of it, if your question is are we overly conservative? I don't believe so. That's our best estimate at the moment, and we really see within that guidance an improvement in the underlying performance of the company.

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Matthew Dunger, BofA Merrill Lynch, Research Division - Research Analyst [34]

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Okay. And on the low single-digit outlook for GWP guidance, previously you were looking at 2% to 4%. Why are you less specific this year on the outlook for GWP growth?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [35]

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I don't know if we're less specific. But sort of in why we're low single digit is because of some of the -- I mean I'll try to sort of step through and I know there's always adjusting for this and adjusting for that in our business. But I think the low single digit is the all-in number. But within that, it's about $100 million of businesses that we had in '19 that we don't have in '20. They're the agencies, so that's more than 100 basis points of growth just that. And we've got -- we're also anticipating lower average CTP premiums again. So you can sort of get from low single digit up to a higher number something in the order of what we guided to in FY '19 just by some of those. And what I was trying to do before was sort of step you through that the headline numbers is going to be low single digit, but the underlying is a bit stronger than that and there are some one-offs that we're flagging already that are impacting the FY '20 year.

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Matthew Dunger, BofA Merrill Lynch, Research Division - Research Analyst [36]

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Okay. And on -- what are you factoring in for repricing for the lower interest rates particularly in the commercial longer-tail portfolios?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [37]

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Yes. I mean we -- I mean across the entire business, our view would be there's probably at least a 50 basis points impact on the group's margin from that with a higher impact in those long-tail classes as you mentioned. Some of them are different. Obviously, within CTP, there's quite a structured process around how repricing occurs around interest rates. On some of the other commercial classes like liability and worker's comp, there's obviously -- I mean that's a factor that comes into it, but obviously market forces play a role there as well around what occurs with pricing. So I think there's a range. But certainly, there's a strain at the group and certainly a strain on all the long-tail classes driven by the lower interest rates, to your point, that we need to factor into repricing and is included within the guidance that we're announcing today of 16% to 18%.

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Operator [38]

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Your next question is from Daniel Toohey from Morgan Stanley.

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Daniel P. Toohey, Morgan Stanley, Research Division - Executive Director [39]

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Firstly, just on the reinsurance. You made a comment I can see the stop-losses no longer flows through the cat budget. There's a comment in there that the MERs fall into $135 million versus $169 million. So if you -- I guess your attention on force majeure events is falling going forward, is that right?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [40]

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Yes. It's Nick. I'll have a go at explaining this one. So I think the main cat program is the same as what was announced at January. What also comes into play, which is why that number is a lower number now, is the way the aggregate works. And so just a reminder, I'll just do these numbers at 100% and then I'll give you the post quota share number. So at 100%, we have cover on a calendar year basis of $475 million of protection above $375 million of events, and events need to be greater than $25 million to qualify as an event. That's on a calendar year basis. So as at 30th of June and probably as at today because we haven't had any more, we consumed about $200 million of that $375 million of sort of deductible, call it, before we can claim under that aggregate protection, which is on a calendar year basis. So we have effectively $175 million of additional events to burn through. This is at 100% plus a deductible of $25 million. So call that $200 million in total to burn through before we start claiming under the ag. If I times all of that by the quota share at 67.5%, that number is $134 million. I'm looking at some of the finance people in the room here in front of me to make sure I got all that right, but I think I have. So hence, that MER right now is a lower number, is at $135 million. But that's just a point in time position. I think the way you should think about the company is -- so we're well protected first half '20 because of all that. But really, we're buying the main cat program deductible at $250 million times 100 times 67.5, so that number is more like $167 million. That's sort of the go-forward number. But I think for this 6-month period, we're more protected than normal because of the way that ag works. Sorry for the long explanation.

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Daniel P. Toohey, Morgan Stanley, Research Division - Executive Director [41]

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Okay. All right. I get that. So point in time for now but probably depending on what happens in cats in the first half, it will reset to the 1 -- to wherever in 1 January?

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [42]

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That's a good way to look at it. 1 January '20, we would expect that to reset to the deductible under the main cat program, which will be that slightly larger number. That's right.

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Daniel P. Toohey, Morgan Stanley, Research Division - Executive Director [43]

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Yes. Okay. Just a question, you pointed out equity stakes in Smash Repairs working with RACV, just the rationale of moving in that direction, sort of a shift in your philosophy.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [44]

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Well, it's all driven by what we believe our customers want in terms of claims experience. I mean working in partnership with RACV, the model that we're building towards is one where our Safer Journeys app will actually notify us that a customer's had a significant impact, we'll be able to push a notification to them to see how they are, whether they need any medical attention and what state the vehicle is in. Based on what the app tells us, we'll actually have some pretty good idea of what state the vehicle is in. Again, we'll be able to use principally nationwide towing, an RACV business, to actually get a tow truck to the scene if the vehicle is not drivable. And we'll also be able to get either a vehicle on the fleet of Carbar or a Thrifty rent-a-car, again owned by our partner and our main motoring services, to the scene to get the customer mobile. The vehicle will then be taken to one of our hubs. We've got a couple in pilot at the moment. We've been looking to scale it up during the course of this financial year. And in the hub, the vehicle will then be triaged into the appropriate repair shop. So by moving into an equity stake with some of our preferred repair partners, we're able to actually provide a high level of quality and certainty for customers. And the pilot has been going particularly well. The interactive NPS scores from our customers is very, very high.

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Daniel P. Toohey, Morgan Stanley, Research Division - Executive Director [45]

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Okay. All right. The slide on the FY '20 outlook post said you've got a thing on the -- our value proposition delivering stronger shareholder returns. You seem to have dropped the point on the 10% compound EPS growth through the cycle. Is there any reason for that? Does that reflect where we are in the cycle or...

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [46]

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Yes. Well, Daniel, when we introduced that metric, we did say that when the full benefits of the optimization program ran through the P&L, it'll be much harder obviously to maintain that 10% EPS growth without significant top line growth. So we're in that position now where we are beginning to sort of gently cautiously shift our focus from simplification. We're not going to take our foot off the accelerator, but we are going to be shifting, transitioning towards more of a growth mindset. But of course, that's going to take a little while to develop and play through the P&L.

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Daniel P. Toohey, Morgan Stanley, Research Division - Executive Director [47]

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Okay. Okay. And just finally, the investments or the investments we're making in adjacencies, I was of the understanding that was being funded or you see it funded through the fee business. I thought there's a small shareholder funds allocated to support the capital needs enclosed in those businesses. So just wondering, is that the -- is the capital -- where's the capital coming from? Is it the capital is coming from elsewhere but the ongoing performance is captured in the fee business line? Just trying to be clear on where the funding ends...

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [48]

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Yes. I mean I think we might have a sneaky comment. I mean we have a venture fund, which is probably -- which is a little bit different. So that is where we're taking off a minority type investing decisions into some businesses. And that sort of is quarantined, and we talked about that being $75 million. I think we spent about $20 million of that so far. That's sort of a discrete mandate that we have. That's sort of -- so I think that sorts of separate that what we're talking about here, which is really -- it was really in addition to that, we're actually now talking about building out businesses that in their initial -- because we don't have anywhere-- and the reason we're mentioning it, by the way, is we talk about insurance margin guidance and we don't want to sort of surprise any -- our investors by -- in February or next -- July, next August with sort of a line, below the line of guidance where we sort of see $10 million, $20 million, say, in February, of additional losses in that line. So we're flagging it early so that you don't sort of -- you have any surprises when we talk about our results in 6 and 12 months' time. I don't think it's overly material. This is rather we just wanted to be -- for the market to be aware that we are investing in adjacencies. These are pretax numbers. And as you'd expect, we're going to be looking to build out propositions to our customers that over time are going to increase value for shareholders.

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Operator [49]

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Your next question comes from Nigel Pittaway from Citigroup.

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Nigel Pittaway, Citigroup Inc, Research Division - MD of Insurance and Diversified Financials Equity Research and Lead Insurance Analyst [50]

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A couple of quick questions if I can, please. Just first of all, one of you competitors yesterday suggested they were broadly happy where commercial margins were but felt there was another 12 to 18 months of price rises needed to consolidate that. Presumably, where your sort of underlying margin is pre-quota share, you wouldn't agree with that at that point, you still think there's a margin expansion to be got? Would that be fair? And can you give me sort of your latest view on that?

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [51]

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Yes. That is true, Nigel. I mean we need -- post quota share, we need that margin to be up around about 15% to 16%. So we're still a little way away from that. And I'm looking at Mark as I answer your question, and he's got a very grim look on his face so I know he's going to continue pushing rate through the book for at least the next 12 months, and possibly we'll be on that, too.

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Nigel Pittaway, Citigroup Inc, Research Division - MD of Insurance and Diversified Financials Equity Research and Lead Insurance Analyst [52]

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All right. Okay. So you're still confident though that rates will sort of move through that book for a considerable period of time, yes?

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [53]

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That's what we're seeing. That is our expectation and that certainly would seem to be the talk amongst our brokers that, that's what they're expecting from the marketplace.

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Nicholas B. Hawkins, Insurance Australia Group Limited - CFO [54]

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And Nigel, it's Nick. I mean it will be a combination or it will be benefit of sort of rate versus rate -- benefit of rate versus inflation and sort of net positive of that adding to margin as well as -- remember our commercial business gets its share of those optimization benefits flowing through as well. So we'll get -- we would anticipate year-on-year commercial underlying -- commercial margins for '20 to be better than '19, which were better than '18. So this combination of those things will be driving that outcome.

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [55]

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And Nigel, I might just add finally on that question that there's also been significant remediation of the portfolio itself. So we've actually walked away from quite a lot of business, individual risks as well as portfolios of business as well. We've got a much tighter, narrower, more disciplined focus now as well. So that will clearly impact performance over time.

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Nigel Pittaway, Citigroup Inc, Research Division - MD of Insurance and Diversified Financials Equity Research and Lead Insurance Analyst [56]

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Okay. And then maybe just on the consumer lines. I mean obviously, as expected, you enunciated RACV as the key source of growth in that division. I mean do you think you've got more potential to go there? Is that sort of something that can be further accelerated from here?

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Peter G. Harmer, Insurance Australia Group Limited - MD, CEO & Executive Director [57]

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Well, we believe so. RACV, under its new management which has been in place now for roughly 3 years, have focused heavily on digitizing their offering with good support from our business. We -- if we look at the relative market shares of RACV in Victoria versus NRMA in New South Wales, we think there's considerable headroom for further growth. RACV impress -- as a distributor is having a really strong focus on growth, and we expect that to continue to play through for some time yet.

Okay. Thanks, Nigel. We have no more questions from either the web or from the telephone lines. So any further questions here in the room? No? If not, look, I hope Nick and I have been able to present what I think is a really great performance by our people over the course of the last 12 months in a way that does reflect their superhuman efforts. We finished FY '19, as I said, on a great trajectory. We feel like we've got really good momentum going into FY '20, and we're really positive about the outcomes that we're looking to produce for this coming financial year.

Thank you for joining us here today, and enjoy the rest of your day.