Good day. Welcome to the ASR conference call on the Q3 2016 results. At this time, I would like to hand over the call to Mr. Michel Hülters, Head of Investor Relations at ASR. Please go ahead, sir.
Good morning, everybody. Welcome to ASR's call on the third quarter trading update. With me is Chris Figee, who's going to present the results and is available to answer all of your questions afterwards. Before I hand over the call to Chris, I would like to point your attention to the disclaimer that we have in this presentation. I would appreciate it if you take a minute after the presentation to go through it. Having said this, Chris, the floor is yours.
Very good, Michel. Thanks for handing me the mic. Ladies and gentlemen, good morning to you. Welcome to the ASR press call on our first inaugural trading update for the first quarter of 2016. The numbers are in the pack, in the press release that you've seen. Our own perspective is in a world where the unexpected and the unplanned is becoming the norm, it's going to be exceptional by delivering on expectations. On page two, you can see the headline numbers. A premium level of EUR three and a half billion, operating result year to date of EUR 442 million, result in the quarter of about EUR 150 million operating profit. Operating ROE of 14.6% year to date. We believe we're proud to present a fairly predictable, you might even say boring, yet predictable and rock solid profit in the quarter.
Operating result, again, of EUR 442 million, EUR 150 million in the quarter, effectively equal or stable to the average quarterly profit in the first two quarters of the year of EUR 146 million. Our earnings power on a quarterly basis is actually stable and very robust in the year. Year to date, combined ratio of 95.7% in the quarter. In the third quarter itself, a combined ratio of 94.4%. Again, to our view, underlining our underwriting focus, our underwriting discipline. To our view, very clean and stable and sensible numbers. We'll give you some more feeling for these numbers in the course of the presentation. This is kind of the headline. As part of a trading update, we only formally present the operating result. We don't have an audited IFRS figure.
If you wanted to estimate the IFRS number, take the operating number, add about EUR 100 million, and change the word pre-tax to post-tax, and you get a pretty clear indication of where the IFRS profit would have come out had we published that number. It's a fair indication. Let me walk you through the presentation. Let me walk you through the numbers. Start with the business update on page three. After all, we're running an insurance business, and we believe the operating performance of the group, operating delivery, is what's behind the operating results. First of all, good progress in one important strategic thrust, namely developing of fee-based capital light earnings business. We got a license for the general pension fund at APF. We called it Het Nederlandse Pensioenfonds.
We obtained our authorization to operate, signed up our initiating customer, we closed two acquisitions, two minor acquisitions in the distribution space. SuperGarant, which is a specialist intermediary in disability, especially in the retail segment. Corins, which is a mid-market commercial lines underwriting brokerage business. They have been closed and thereby strengthening our distribution business. In our strategic objective to build more fee-based capitalized earnings, we made moves, or we closed moves in terms of getting a license for the APF and closing two acquisitions. Other strategic thrust has been to acquire small or mid-sized Dutch insurance companies. Last year, we acquired, for example, the Eendracht and AXENT. As a course of this, we merged the various legal entities, so all the legal entities in our group have been merged into one.
We now have two legal entities, ASR Life and ASR Non-Life, except for the health businesses, which is mandatorily separated. Integrating those legal entities causes a significant operational simplification and increases fungible capital of the group. The completion of the legal mergers of the various non-life entities was completed. We merged Eendracht and AXENT, and would like to point to the integration of AXENT, zoom in on the letter. We're actually pretty proud of the integration performance that was delivered by the teams. The integration of AXENT, the funeral business, was completed in the quarter. We converted about 2.4 million policies on our platform on October 1st. Actually, on plan and ahead of the final due date. To give you an order, if you will, for the amount of work done, we sent about 600,000 letters to clients. Another 185,000 letters to go.
That will be done before the end of the year. 600,000 letters are out. Legal entity merged. In terms of cost savings, we acquired roughly about 75 FTEs. Today, honestly, there are less than 10 still working in this business. The rest has all voluntarily and on a friendly basis, left the combination. We're running this 2.4 million additional policies with less than 10 additional FTEs. The temporary scale-up of FTEs due to the migration will also be scaled down quickly. I've learned in my previous term, I like the word OTOBOS, which means on time, on budget, on schedule. I think the OTOBOS qualification is very much in place when it comes to the AXENT integration. We're proud of our integration skills.
Before we go to the financials, at the end, it's all about running an insurance business, and we're pleased with the progress in building fee-based business and delivering on the integration objectives that we set out for ourselves. Let's move to page 4, premiums. Premiums increased during the year, EUR 3.2 billion year to date to EUR 3.5 billion year to date. In the quarter, an increase by roughly EUR 100 million. Actually, a good performance in what is still a saturated market with maintenance of our margins. In life, the increase in premiums basically took place in the first half-year, so no material movements in the third quarter. Premiums increased due to the acquisition of Nuvema, the funeral portfolio, which is the next one on our list to integrate, to migrate. Growth defined contribution, and there was one larger buyout that we concluded in the first half of the year.
That's no news in this quarter, but reflected in the numbers here to date. In non-life, growth in disability, growth in P&C. I will elaborate more on that when we get to those segments. In P&C, growth in retail and also in the SME space, both at very healthy margins. We're able to keep up our volumes, in what is still a saturated and very competitive market, so pleased with that. Although, of course, part is due to acquisitions and part is due to the integration of or buyout constructions in the life business. Page five talks about our cost base, our operating expenses, up from EUR 379 to EUR 401, 6% up, basically driven by the additional cost base of the acquired companies.
If you correctly board or acquire cost bases, our costs are effectively stable in that we absorbed increased costs for finalization of Solvency II implementation. Some additional costs regarding the IPO, although the IPO costs themselves are classified as non-operational. This is standard. More weight, more work done by people in the finance department, and I can speak from experience. We've absorbed all that, and underlying the cost reduction issues are on track, and we're still on track to meet our longer-term or medium-term cost target. Cost up due to acquisitions, underlying performance in line with what we plan to, what we want to achieve. Operating results. Let's move to page six. On page six, you can see the bridge and the buildup of the operating result of the group. We believe the performance in the quarter was strong.
EUR 442 in the year this year, EUR 443 in the year last year. A profit of EUR 150 million in the quarter. If you compare these two numbers, you have to note that last year, our operating profit displayed a slightly different aberrant pattern, mostly due to timing differences that were very specific to that very period, mostly in the pensions area. You honestly will figure out that operating profit in Q3 last year was EUR 163. In Q4, it was EUR 78. We think it's better to compare the profit in the quarter this year to the average quarterly profit of last year. That means you compare EUR 150 million this quarter to the average, which is EUR 120 million last quarter. A fair comparison, our quarterly profit is up about 25%. Again, we don't publish the IFRS results, but it would be safely above EUR 500 in the year.
That is that you add 100 and change the word pre-tax and post-tax, and you get a pretty good feel for what the IFRS result would be due had we published it. Again, strong performance and to compare apples to apples, compare the 150 this quarter to the average of the last two quarters in last year. Just before we go into the life and non-life, the smaller segments, distribution and services and banking and asset management. In banking and asset management, you can see a decline in profits. That is basically because of two reasons. One was we are making investments into building a commercial asset management operation. We acquired BNG Asset Management. The good news, an asset, that franchise is now fully integrated, actually starts to deliver on its commercial promise, winning its first mandate, but their costs are ahead of revenues.
Secondly, we continue to invest in new real estate products, a real estate product pipeline. Finally, in the bank, our profit this year showed up in the financial result, less in the operating results. The total profit of the bank actually is stable, but it is in financial result rather than operating results. In distribution, earnings up from EUR 5 million to EUR 12 million, basically because of the acquired cost basis, and gradually you will see SuperGarant and Corins kick in during the year. I think this business is on track to become something like a EUR 20 million to EUR 30 million operating profit, fee contributor on a runway business. On the full year basis, distribution segment is in line with our plans. Let us move to non-life, page number seven. Premiums increased while the combined ratio remained stable at a level of 95.7%.
As you can see on this page, continued strong combined operating ratios for all non-life lines. We present the numbers including the water, hail, and water storm impact. There is no disturbance in the numbers and no profit before trouble or what have you. These are the numbers as they are. For P&C, this means a combined ratio year to date of 98.7%. We show the hail and water damage. You could subtract them if you want to, but 98.7% year to date, and actually that is substantially lower. Health 97.2%, disability 89.8%, so continue to run at below 90%. If you were to be interested in the numbers during the quarter. At disability during the quarter, we continue to run below 90%, about 88.9% in the quarter. For P&C, combined ratio in the quarter was 97.3%. For health, the quarterly combined ratio was also significantly below 100%.
The quarterly results without any storms, any reserve releases, clean numbers all ahead of our targets. With that we are also proud to show a growth in volumes, about EUR 68 million growth in P&C while the combined ratio is still below our target and growth of about EUR 14 million in disability at a combined ratio still below 90%. We are very pleased with the combination of maintaining very attractive combined ratios year to date and during the quarter in combination with gradually accelerating growth in top line. Please note that this top line also allows us to further work on margins. You may see in the coming period that we will use the positive volume momentum to further strengthen the margins, especially in the P&C book. There are always lines and sub-lines where you find pricing could be better.
This volume environment, the pricing environment, enables us to, if you want, spend a bit of volume on further improving the margins in the P&C book. With this, very pleased with the non-life performance and there's room for us to further squeeze and improve our combined ratios. Again, these numbers are clean numbers, including the hail and water storm, and there is no meaningful reserve releases too at this point. The numbers are what they are. Clean, possibly even dull, but at least stable and predictive. In life, page number eight, you can see increase in operating results and increase in premiums. Again, premiums up due to the acquisition of AXENT and our Nuvema during the year. The buyout increased volume in defined contribution. Actually, we're moving and migrating the Eendracht customers, remember acquisition last year.
We're moving these customers to either the asset management platform or the defined contribution platform. In terms of results, up EUR 35 million from EUR 365 to EUR 400 year to date. There are two ways to look at this. From an accounting perspective, there is an increase in result from amortization of our capital gains reserve and lower amortization of the swap costs. Think about a plus of around EUR 30 odd million of that magnitude. There is about EUR 20 million additional contribution from the acquisitions. In a negative last year, we had around a EUR 10 million reserve release in the pension space that did not reoccur. The plus in last year did not occur this year, which is a negative in the bridge. From an accounting perspective, it's kind of +EUR 30 +EUR 20 -EUR 10.
That's where you get to roughly the. A slightly higher cost due to the integration of the AXENT business and due to the investment in spending on migration of life. That will bridge from EUR 365 to EUR 400. If you take the organic perspective, result on interest, result on cost, result on mortality, and what have you. You have about EUR 25 million of increased result on interest cost and mortality, about +EUR 25, +EUR 15 result on other and -EUR 5 decrease in a non-technical result, basically because of lower interest rates. It depends on how you want to look at it from an accounting perspective or an actuarial perspective.
I believe we should say like a EUR 30 odd in contribution from capital gains reserve, EUR 20 odd contribution from acquisitions, and there's a -EUR 10 from a non-recurrence of a reserve release and -EUR 5 roughly from gradually one of increased cost base due to integration projects and into the life migration projects. Other point to note, you may know that we're busy migrating policies to target platforms. We had a number of important and successful migrations during the quarter where some of the more complicated products of our internal book were migrated to our target platform with significant success. We're also pleased that the investment into migration skills starts to work out. I guess the page you've all been waiting for, which is on Solvency II. I think there was one analyst, page nine.
I think there was one analyst who said this morning, "Who cares about profits when there is a solvency number?" Page nine, there is Solvency II. Our number about 188% based on the standard formula. You could see our own funds of EUR 6.3 billion, required capital EUR 3.3 billion at the end of the third quarter. During the quarter, a number of things happened. As you may recall, we reported half-year results of a 191 Solvency II number. What is the basically high-level bridge 191? We signed a mass lapse reinsurance contract. That contract is still, the actual solvency recognition is work in progress. Think about +3.5% contribution to the solvency at this point in time. There is still some work to be done there. Think about 191 plus 3.5. The decline in the volatility adjuster and the change in the reference portfolio.
Remember the VA declined from 18 to 10 basis points, including a change in the reference portfolio that took out about 10 points out of our solvency. Think about 191 plus 3.5 minus 10. That will give you to 184.5 as a kind of baseline number. During the quarter, we increased our mortgage book a bit. We absorbed new mortality tables. Together that is another cost us more or less 1.5% of solvency, and the remainder, the delta, is actually organic capital creation, plus reflection of lower costs in our best estimate liabilities because of the integration of the funeral business.
All in all, really, the development from 188 for this quarter from 191 to take into account the mass lapse contract, the 10 points headwind from the VA increase in our mortgage book, is all consistent with the capital generation that we strive for and that we have delivered in the first half-year. We believe we are on track with a resilient solvency level and with an organic capital creation that has been stable and is reflected in the existing number. Please note continued strong tiering. Tier 1 capital alone is about 84% of the own funds. Had we only had Tier 1 capital, a 157% SCR ratio, and still significant headroom for additional restricted capital. We have got a EUR 1 billion Tier 1 ratio and well over EUR 600 million of Tier 2 capital.
Again, the key message from us is a resilient level of solvency, able to absorb headwinds from volatility adjusters due to organic capital generation capabilities in the group. In line with what we reported previously. All our insurance entities after the legal mergers are well capitalized. Think about a number a bit north of 180% for all our insurance entities, so able to upstream capital if and when needed. That brings me to the end of this short presentation. Page 10. Continued strong results. As we said, in principle, an uneventful quarter. We jokingly say people went to the office, sold a policy, paid a claim, created capital, and went home again. Pretty clean, solid, yet boring results in the sense that we produce lines results in line or better than our targets, able to absorb volatility in our Solvency II portfolio.
We believe our results are founded in tangible operational improvements. Witness our operating ratios, our combined ratios, witness the inclusion of the acquisitions, witness the emerging contribution from BNG, witness the on time, on budget, on schedule integration of acquisitions. We believe for the year we are on track to meet or possibly exceed our targets, at least for the first three quarters of the year. We'd like to point that we've managed to grow our non-life premiums by about EUR 75 million, EUR 71 million, about 4%, whilst meeting our combined ratio targets. We see there's room to further improve the quality of our book. Our operating ROE at 14.6%. Our IFRS ROE, think about a number just north of 19%, including capital gains on a high solvency at 188%. Pleased with those results. As again, clean results, not pro forma numbers or profit without misery.
These are the numbers as they are included with the headline work of strong results. With that, I'd like to end this short presentation and short set of comments. Happy to take your questions. Operator. We're happy to take any questions.
The first question comes from Mr. Cor Kluis. Please go ahead.
Good morning, Cor Kluis, ABN AMRO. I've got a few questions. First of all, on the Solvency II ratio after the U.S. elections, can you give some indication what it is? Based on the sensitivity of the half year results and the rising interest rates, it's marginally negative. Equities was positive again, should it be around the current level of 188%? That's my first question. Second question is about the merger of legal entities in the quarter. Did it have any impact on your Solvency II ratio in this specific quarter? My last question is about the non-life business. We've been reading, of course, that companies like Independer.nl have been saying that the premiums on car insurance are rising by around 20 percentage points. We see your growth of non-life premiums.
What's your take on that and can you explain what you see in the non-life insurance market, especially in the motor insurance market? Thank you.
Very good. Cor, thanks. On your solvency, we thought about defining something like a solvency before Trump. I think that's not an official metric yet.
Pro forma.
Pro forma number. No. Hard to say. I guess the impact we had on our solvency after U.S. election was increasing interest rates, slightly increasing volatility adjuster, slightly increasing equities. I think the net is a small negative. We're long duration versus the Solvency II curve as is. We don't do cover prudential hedging using the 4.2 UFR as truth, but we're slightly long duration because we think the economic reality is a little bit different. Which means that if rates go up, that will shave a bit of our solvency. At the same time, the increase in volatility will help us, the VA and credit spread will help us. I think the increase in equity will help us. I don't have the number yet, but I think you have a small downward adjustment to your solvency because of our long duration position.
If you think about a world in an X UFR environment or a low UFR environment, actually, our solvency has gone up. Almost some downward push on your headline solvency, but a significant strengthening of your economic solvency. Ultimately, for this industry, gradually rising interest rates is good. On the legal merger, the legal mergers themselves did not affect the Solvency II ratio as is, but they increased the fungibility of capital. When you merge those legal entities, there is a diversification benefit that was recognized, that holding that diversification benefit is now recognized in the legal entities. The S2 ratio as such doesn't change, but it crystallizes the diversification benefit and pushes it down into the OTOBOS where actually you can grab it and becomes actually something meaningful. That's the positive on that one. On your third number, on the non-life premium development.
Yes, we're seeing premium increases, not with the level Independer sees. Independer is a pure online player and is over-represented in some of the pure direct players. We felt some of the pure direct competitors were severely underpricing business. You see in the price increase across the board in motor, most heavily when it comes to the pure direct players, because they were mostly behind. That increase there, you see that 10%-14% increases are not abnormal. In the broker-based segment where we're active, we're also seeing some premium increases, but not to that extent, simply because that business was less off in terms of its pricing than where the pure direct players were. There is price support, and that will gradually feed in. Price increase is a fact that happened during the year as the year progressed.
You'll see that effect gradually going into your P&C premium levels as the year progresses, as 2017 actually starts.
Okay. Wonderful. Thank you very much.
The next question is from Mr. Matthias de Wit at KBCS. Please go ahead.
Yes, good morning. I had a few questions. The first one is on consolidation. Are you planning to participate in any large in-market M&A transactions? Could you share your view on this topic, please? Would you rather remain focused on smaller deals like you have been in the past? That's the first question. The second is on the organic capital generation in the third quarter. Could you provide the number excluding the impact of the lower cost in the best estimate liabilities you referred to during the presentation? It would also be helpful in this respect if you could provide some sensitivity around rising interest rates on the organic capital generation, because I guess that the number for the organic capital generation is based on the balance sheet at the end of the second quarter.
It could be helpful if you could update us on that. Lastly, could you provide an update on LAC DT? I guess your assumptions are quite conservative now that profits are relatively strong and that capital and liquidity at the holdco is also good. Linked to that, there is a DNB review ongoing on this topic, could this lead to any changes? Thanks.
Very good. On the first question on consolidation, Matthias, I'll give you our group policy, as a matter of policy, we only share our policy. We always look at consolidation opportunities in the market. That's what we're paid to do. That's a fiduciary responsibility. Whatever we do, we do it from a risk perspective, risk appetite, and objectives perspective. A third element of our policy that we never comment on those. I'll leave it with that. No comments on acquisitions, consolidations, whatever, whenever. Secondly, when it comes to organic capital generation, we guided the market at the IPO of a 9% annual capital generation as a guideline. We believe the third quarter was perfectly in line with that guidance. I think personally, when it comes to those numbers, there's less relevance in producing those bridges every quarter. Insurance is a long-term business.
These numbers will fluctuate over time, We shouldn't get carried away. I can share with you that the organic capital generation, based on our own reasonably conservative assumptions, actually were maintained as per the guidance that we gave during the year. Consider that to be very stable and resilient. Impact of rising interest rates, that's in principle good. Although, of course, there's always interplay between stock and flow. If interest rates go up, the way we're hedged in this core set, that will eat a bit into our stock, but improve a bit our flow. In general speaking, if interest rates move up by about 20 to 30 basis points, a significant portion of that will feed into the organic capital generation. It may reduce my market variance. It will be a small drag in market variance.
It will increase my organic capital generation simply because the UFR unwind will be less and in the way the industry models this, the run rate will go up. Increasing interest rates generally pushes up organic capital generation. It's not a one for one, but very close to a one for one comparison. Any one basis point higher government bonds yields is very close to one basis point higher capital generation if all else equal, right? The spreads stay the same.
In Q3, that number is based on the balance sheet at the end of Q2, I guess.
Exactly.
With rates now rising, it's fair to assume that you could do a bit better than your 9% guidance for the year on a yearly basis, or?
It surely helps. It also depends on how frequently do you update your model, but definitely underlying it helps. Yes.
Okay. Thanks.
On LAC-DT, I think our LAC-DT for the group is 53%. We round all the legal entities to either 25%, 50% or 75% and then take the weighted average of that. It is just above 50%. We feel very comfortable with that. I think the DNB review to us could be ongoing, but it is not in my place to comment on any regulatory reviews. I think we feel very comfortable with our LAC-DT. I think our next step is to further underpin or substantiate the LAC-DT by moving the DTLs into our life balance sheet. There are a number of assets where we have deferred tax liabilities, which are held by real estate entity.
We are working on getting those assets which are held indirectly by the life business, having them held directly by the life business, so that the DTL on those assets can actually straight and directly support your LAC-DT. Let us finish that project before we give a further update, but we think at this point in time, the 55% or the 50-odd % is pretty well supported.
Okay. Thanks a lot, Chris.
The next question comes from Mr. Moussad from J.P. Morgan. Go ahead, sir.
Hi. Good morning, Chris. Just a couple of question. First of all, this option related earnings, can you just explain a bit more on what this is? Is it going to stay here? Is it going to increase in next year? Is it going to decrease in next year? Again, I'm trying to understand what this is related to and what will be the moving parts going forward with respect to the EUR 30 million that you flagged. That's number one. Secondly, with respect to your capital generation, just going back to Matthias' point, I just wanted to check one thing. At the IPO, you guided for 9% capital generation. Post the massive decline in interest rate at first half, you said capital generation will be 9%. Now when rates are going up, you're saying capital generation could nudge up higher. What are we missing here?
Is it that you're downside protected on falling interest rate, and you have full exposure to upside on rising interest rates? Any thoughts on that? What are we missing here? That's my second question. Thank you.
On the swaptions, basically, the EUR 30 odd million is the result from what we call a shadow accounting methodology, where basically if you record a gain on fixed income and derivatives that are invested against our life liabilities, that capital gain is moved to a capital gains reserve and amortized over time according to the lifetime of the corresponding liability. The EUR 30 million is actually an amortization of a gain over a multi-year period. Think about this contribution from capital gains to be pretty resilient and stable for the coming years. Eventually, that amortization will run out, but the liabilities that it is put against are pretty long. Think about this capital gains release or lower amortization cost of swaptions to be linked to maturity of the liabilities. That's something that's going to stay here for some time.
Not till the end of our lives, the liabilities in the life book tend to have pretty long duration. It's going to be here to stay.
Sorry, just one more thing, just to follow up on that. Is it based on where interest rates are at the moment? Because, see, the issue is this year, the interest rate has been amazingly volatile, up, down, up, down. How should we think about this number for next year? Should it be going up? Should it be going down? Based on my assumption, if it is linked to interest rate, it should be going up next year.
If you realize a gain, a capital gain on an instrument or a derivative, right?
Yeah.
That capital gain is booked into a capital gains reserve, which is amortized over time. To be very specific, the capital gain on the fixed income bond is amortized at the corresponding insurance liability, the capital gain on the swap is amortized over the lifetime of the derivative instrument. If you realize a capital gain, this adds to a capital gains reserve release. That's the principle of shadow accounting, right?
Yeah. Going forward, it would be great if we can get a bit of color about what you're realizing, so at least we can know what is the stock of capital gain that will be covering the shadow accounting-
Yeah
in earnings. It's very difficult to forecast just without that basis.
Yeah.
Just a request. Thank you.
That's something we will share more around the full year disclosure, which is not something that is useful for a quarterly result.
Right
I think about a capital gains reserve at this point in time that targets a three and a four. It's over EUR 3 billion. The realized capital gains reserve is around EUR 3 billion plus at this point in time.
Yep. Thank you.
In terms of capital generation, look, the way this thing works, it's a bit of a, in all honesty, a quirk in the way the industry thinks about this. You take your asset mix, you multiply by an investment spread over the discount curve. You've got a discount curve in your solvency. For each asset class, you define a spread. You multiply the asset mix by a spread and you add operating results from your insurance business to it. You take out costs, then you've got your organic capital generation. That's what the business generates. Then you add the release of capital from your book, SCR risk margin release, and you subtract the UFR unwind. That's roughly how the industry has defined the organic capital generation.
When interest rates move up or down, if they move down, that increases the UFR unwind, and it generally puts some pressure on the excess spreads that you make over the discount curve. During the first half year, of course, when rates fell, we believe that 9% was actually a feasible number, and we still believe that 9% can be realized. If interest rates go down, there is pressure on that number. If interest goes up, that number tends to be supported. You just don't keep on adjusting your number every week, every day on changing interest rates. Formally, we do this twice a year, beginning of the year and the second half of the year. At that point also, we recalculate the UFR drag to be online or be at market where the UFR drag is.
In the first half year, we took into account some of the increased UFR drag when we presented the half year numbers. I know some of players in the industry only do it once a year and maintain the UFR drag as per 1st of January. We do it twice a year. The number we produce in this quarter actually is still consistent with the 9% guidance that we gave, where we have based ourselves on the balance sheet as per the 30th of June, and at the 1st of January, we'll recalculate the number. Underlying this, 9% is stable with some downward pressure the first half. Actually, if interest rates continue to move like this, support going forward.
Okay. That's clear. Thank you.
Ladies and gentlemen, if you have a question or a remark, you can still press star one. The next question comes from Mr. Steven Haywood from HSBC. Go ahead, sir.
Good morning, Chris and Michel. Thank you for taking my questions. Q4, what kind of seasonality do you usually see in Q4? I'm assuming there's a small pickup in claims in certain business lines due to a winter impact. Considering you're so far ahead of sort of the run rate at the 9-month stage in terms of earnings, also on your operating ROE, I just want to see what kind of potential negative or seasonality there might be in the Q4. I noted that in your holding and other business line, in the Q3, it's reduced from EUR 20 million last year to EUR 15 million this year. Is there any specific thing here? I guess there might be some removal of project costs or Solvency II costs, but if you could let me know what is specific here, that'd be great.
I just wanted to confirm on your shadow accounting. You've got a realized gains reserve of over EUR 3 billion, and I kind of assume that that will be amortized over 15, 20, 25, even maybe longer years. If interest rates go up, you probably won't be realizing any more, and therefore that realized gains reserve probably won't move much in the future. Am I correct on this? Thanks.
First question, Steven. Thank you. Steven, on the limited seasonality in the Q4. Interestingly, we used to have in the Q4, the receipt of any benefits from the health equalization system and the reserves for premiums. That all happened in the Q3. In the Q3, this quarter already, we took in the operating results. The receipts from the health equalization system, previous years, and the provision for future price setting. No health seasonality this year that was already moved into the Q3. Typically, yes, there could be storms in the Q4, history tells that the storms used to be in August. This year, they happened in June. I think there is not so much of Autumn is nearly behind us. I think the storms, by definition, unpredictable, historically, they happen more in Q3 rather than Q4.
Except for U.S. election and Italian referenda, I can't see any seasonal patterns in Q4 happening. There's nothing on the card that I am at this point aware of. No seasonals that we at this point should take into account. On the holding costs, mainly it's lower pension charges. We had lower pension charges in this year that reflected the lower holding cost expenditure. The capital gains reserve, please note, to make the story whole, we have a realization or revaluation reserve that is unrealized and part is realized. The realized portion is over EUR 3 billion and unrealized, which is the delta in market values. If you trade an instrument, reserves go from unrealized into realized, right? There's an overflow in these two buckets. Will it go up? Will it go down?
It depends on whether you trade securities, whether you trade bonds, whether you trade derivatives. As a matter of policy, we don't trade, and really, we do not trade these things to manage that reserve. We only trade securities to optimize our investment position, to optimize our hedging position. The capital gains reserve is a by-product from that. Will it move a lot? I don't know. I don't think so, personally, honestly, because we're pretty comfortable with our current hedging position. We'll amortize over time. It will amortize a little bit less than 25-30 years, probably a bit shorter. Again, if rates go up or rates go down and you change investments, there might be additions or subtractions from that reserve.
For us, I think it's fair to assume it's going to be relatively stable, except if you have very wild swings in interest rate moves and you roll over derivatives, you roll over bonds, then there might be new realizations. It really is a by-product from the way we hedge our book. I like to think about it like this. In a matched book, we don't write a lot of new policies. If rates go up, my direct investment yield goes up, but there may be some drag on my capital gains reserve. Rates go down, the opposite happens. Effectively, the combination of your direct investment of your coupons and your interest rate receipts plus amortization from capital gains actually makes for a pretty stable number. They complement each other, communicating vessels, if you wish.
Think about a substantive unrealized revaluation reserve and a substantive realized capital gains reserve that will amortize. 20-30 years is probably on the longer end, but it depends on the instrument and the life obligation that was backing it. Is that helpful, Steven?
Yeah, that's absolutely brilliant. If I could just follow up on the health equalization reserve. What sort of impact did you see in the third quarter from this?
Net, we have, as a matter of policy, what we receive, we give back to customers.
Okay.
By and large, what we received was given back. Sometimes there's a small difference between it, a small net positive as a reward for our capital. Basically, by and large, at group level, the impact is actually very limited.
Yeah. Thanks very much.
The next question is from Mr. de Wit, KBCS. Go ahead, sir.
Yes. Thanks for taking my follow-up questions. On the Solvency II ratio, could you provide some indication about the legal entities, where we are following the merger of the life and non-life entities? In this respect, is there anything you could share about how we should think about remittances for the second half of the year? You monetized or you can monetize diversification benefits, or could you upstream that to the holdco? Secondly, you referred to Solvency II implementation costs during the presentation. Do they include any costs linked to a fine-tuning of your ECAP model or to the development of an internal model? Do you stick with your standard formula approach for the time being? Thirdly, on the asset portfolio, what were the most important changes during the quarter?
I remember you planned to re-risk a bit following the de-risking at the end of Q2. What happened and what are your plans going forward, please? Thanks.
Hey, Matthias. On Solvency II and legal entities, we merged our legal entities. We have two core legal entities, ASR Schade and ASR Leven, which means that we dissolved effectively AXENT, De Eendracht, De Europeesche and De Amersfoortse. Eendracht and AXENT were merged into ASR Leven. ASR Schade, De Amersfoortse and De Europeesche merged into one. Again, that didn't really boost solvency as such. That boosted fungible capital. Think of a number north of EUR 100 million of diversification benefit that was pushed through or crystallized in those legal entities. The Solvency II standard formula number of those entities per quarter, both above 180%. Very strong solvency. There is no link, as far as we understand, no limitations, no blockage as to the remittance of cash to the holding.
One perspective when it comes to cash at holding, as a matter of policy, as long as the operating entities exceed the cost of capital and create value, I don't need to hold lots of cash at the holding. I think there's an element of, excuse the word, holding cash fetishism out there, where people are like, "Any euro in the holding is worth more than a euro at the opco." As long as we deliver an operating ROE, mind you, not a full ROE, but an operating ROE of 14.something%, then I think there's value to have the capital at the opcos. Secondly, please note, we're in one jurisdiction with one regulator, there's no equivalent rules or issues to transfer money across borders. Secondly, the board of ASR, the executive board, is also the executive board of the opcos.
I can see some of my colleagues moving cash back to holding, moving from one country to the mother country to have it all in one jurisdiction. If you have different statutory boards, that might be a way to discipline boards by upstreaming capital. In our situation, if my left hand were to discipline my right hand because my left hand is at the holding and the right hand would be at the opco, that would be fairly sign of schizophrenia. We believe because we run both the holding and we run the operating companies, there's less need to upstream every single EUR to the holding as long as the business delivers its cost of capital. We've given a group cash target, which we're on track to deliver.
Secondly, as long as the opcos are sufficiently capitalized, as long as remittance is actually acceptable and happens and takes place on a seamless way, I am comfortable to generate value, generate profit, and keep the cash in the opco. Our capital at holding is at a target level. We'll get there, and for rest, I'm happy to make money in the business. When it comes to Solvency II implementation cost, some is spent on ECAP optimization. The most actually is spent on model validation, on data quality, and on installing or creating the ability to deliver quarterly QRTs to our supervisor in a very short time period. Yes, there's always work to be done on ECAP, but it's more spent making sure that all the models are fully validated, that the data quality all is in place. That's very useful for whatever you want to do.
If you ever want to move to a different type of model, internal model, you have to go through this anyway. That's, in principle, money well spent. For that, it's about streamlining the reporting process, because the amount of reporting requirements from Solvency II every quarter is pretty onerous and it has to be sped up as well. It's also investing in, what I would say, speeding up the delivery of a lot of documents every quarter to our supervisor. That whole process needs to be automated, needs to be put in place. That's where most of the spend is. On your final question on re-de-risking, we added some more exposure to our mortgage book. We've added some exposure in equities during the quarter, but it doesn't move the needle as such. We re-risked a bit after Brexit.
We felt spreads and risk rewards was completely out of line. That's why we took some re-risking in the third quarter. It's more an increase in the mortgage book, and that's kind of where it is.
All right. Very good. Thanks a lot.
The next question is from Mr. Van Veen, UBS. Go ahead, sir.
Thank you. Two questions, if I may. Firstly, on solvency and management actions. On the mass lapse at the half year, you said the impact would be roughly five. You're saying it's 3.5 now, and I think you indicated there's more to come on that, just double checking that. Other than LAC-DT, which you referred to, is there other any major things you can do management action-wise to improve solvency? I assume that despite your comments about internal models just now, that that's not really on the agenda on a medium-term basis. The second question is on the life insurance business. It's 80% of your profit, yet you give very little disclosure around that in the quarterly, and also there's less disclosure on that at the half year.
I'm just asking if you can give maybe a bit more color there on the underlying life insurance margin, and also a request, as per one of the previous questions, if you could think about giving a more regular update on the life insurance margin, because at the moment we only get it once per year, and it's obviously a key driver of future earnings. Thank you.
Very good. On Solvency II and management actions, indeed, at first half year, we said Solvency II is now 191%. There is a mass lapse contract pending. Pro forma, we said 5%. The final calculations, the finalization of the contract was around 3.5%, and there is some work to be done to finalize, but this is the order of magnitude where it will come out. We feel more comfortable when we finalize the solvency impact to share something about it, but there is still some work to be done. In terms of LAC-DT asset, we are working on moving deferred tax liabilities into our life legal entity. As we believe, try to stay away from what I say, assumptions-based solvency as much as possible, but base your solvency on tangible elements like a tangible deferred tax liability that is identifiable with an investment entity.
In terms of management action, we believe that the best management action actually is to make money. Think about solvency, do management actions to improve our combined ratio, to improve our investment assets, and to create organic capital. That is why we believe the best way is to manage your solvency at this point. In terms of life disclosure, yeah, we have heard you, we have heard others as well. We will take it into account in the full-year results. I can give you the result. The life business are in line with the life insurance margin that we guided toward IPO, so 3.4%-3.5%. What we are seeing today is actually in line with that number. That is something we will develop more clearly in the full-year result. We have heard you on this item.
Okay, perfect. Thank you.
The next question is from Mr. Horsten, Kempen & Co. Please go ahead.
Yes, good morning. Bart Horsten. I have a few questions remaining. One is on your first APF customer. Congratulations on that. I was wondering, has it changed the capital you have to allocate to this contract? I understood it was an existing contract of Eendracht, and that it now moved to the APF. How are the dynamics in terms of allocated capital to contract, and can we expect more deals like this, or could you give a bit more color on the pipeline? My second question is more on some clarification. If I look on a quarterly basis to your operating result in non-life, I see you report in Q3, EUR 37 million, and in Q2, it was EUR 30 million. I would have expected having a very low combined ratio in Q3 compared to Q2, that the Q3 number would be somewhat higher.
What am I missing here? Was it something in Q2 in terms of investment gains or anything else? Thank you.
Okay, thanks. On the APF, yes, indeed, Essilor has signed up. If they move, that will release some capital. Again, yes, in principle, moving a customer from a DB contract to an APF releases capital. That's in principle good. It's a strategy for us to see if we migrate larger clients to the APF. One contract in itself will not change our capital position. If you've got EUR 3.3 billion of required capital, one new contract will not change our SCR itself. In principle, you're right. If you move customers from DB to APF, that will release capital. I'm even more interested in getting new customers signed up to the group at all on a capital-light basis.
Sure.
Our first effort is to get new customers signed up. There's sales effort going on to engage with pension funds to get them to the APF, and in the same time, we offer this to customers, especially those with expiring DB contracts that have to look at either absorbing a significant premium increase, then the APF becomes a very attractive alternative.
Yeah.
When it comes to the 37 profit in non-life, I guess what you're saying is in the first half of the second quarter, it was EUR 30 million, but you did absorb the hailstorm. How does that work? Well, there are two things at play. One is in the third quarter, the direct investment income on P&C was a bit lower, simply because the short end of the interest rate curve is still under pressure and kept declining, so there's lower direct investment income. Secondly, in the first half, as you may recall, we had a hail and water storm, and we had a small reserve release because the way we account for mandatory agents, and to be very specific, in mandatory agents or volmacht in Dutch, we used a methodology where the premiums were only calculated in part and claims came in in full.
Actually, we understated the profitability of those mandatory agents by fully taking into account any claim, and only taking into account the pro rata element of the premium received. We amended that to give a better view on the profitability of that product. That gave a small one-off reserve release. Actually not that big, but the combination of lower direct investment income plus a one-off in the first half year by moving to a more representative and a more appropriate reserving model, especially in the volmacht and the mandatory agent area, supported non-life profits in the second quarter.
Okay. Thank you. Maybe, if I may, one follow-up on this APF required capital. Could you give an indication, let's say if under the old contract, your required capital would be 100%, what would be the required capital under the APF contract in terms of percentage relative to the 100?
I don't know by heart, but it's something really less than 25%.
Less than 25.
I haven't done the numbers, but I think it's very low. The only old operational risks are probably even much less than that.
Okay. Thank you very much.
The next question is from Mr. Ploeg from ING. Please go ahead, sir.
Yes. Good morning, all. I'd like to come back to some answers given on the organic capital generation. It feels to me that your asset class spreads assumptions are quite conservative, and that you basically are over-earning on what you assume in your organic capital definition. In this policy to roll forward, basically the over-earning part goes into the bucket, I guess, of market developments, where we basically put no value to when looking at ASR. The 9% still is around EUR 300 million capital generation. In reality, is that not higher? Are you not being too conservative? I understand you will not review those kind of policies in the third quarter, but is that something you might contemplate with the full-year results to maybe review your excess spread assumptions? Thank you.
Albert, I fully concur. I think the spreads we gave are relatively conservative, especially when you compare it to what's happened previously in the industry. That means there's overflow in the market variance bucket. I can be very cynical, like we should give a value to it. That's kind of what the analysts are supposed to do. Let's be fair. We are looking at our spreads. I think the quarterly trading update is not the right time or the place to make those amendments. We are reviewing the spreads in light of what actually is actual in our investment portfolio. That's something we'll probably do in the full-year results. I want to make sure that the 9% guidance that we gave is based on those conservative spreads. I'm not in a position. I don't want it to be making my target by changing the model.
We make the target within the model, and then we will change our spreads. I agree that today there is capital generation in the market variance bucket that people attach no multiple to. I wish people would, but that's anyone's choice to do so. For us, it's something we will report back to you on the full-year basis. I think the nine months trading update is not the time to do that. Please note that the 9% is within the existing modeling assumptions.
Okay. Thank you. That's very clear answer.
The next question is from Mr. Petrarque from Kepler Cheuvreux. Please go ahead, sir.
Yes. Good morning, everyone. First question is on the sensitivity to increasing interest rates. I think in H1 you've shown a negative sensitivity, slightly negative. Are you planning to change your hedging policy, looking at what is happening on the market now, or you kind of still keep the hedging unchanged there? Then second question will be on the non-life. You have been talking about stronger volumes and margin improvement potential. How much improvement of combined ratio are you looking for potentially, looking at potential repricing? Thank you.
Okay, very good. On hedging policy, we produced in the first half about half year numbers, our interest rate sensitivity. We believe in the concept of discipline. I don't think we will not be changing our policy based on what we're seeing in the market. I see interest rates go up, but I can also visit scenario where the whole thing collapses and interest go down again. We believe very strong in maintaining our policy in the sense that there's no point in hedging against a curve that implies a UFR that you will not make. We have hedging policy, as we said, where we take into account the solvency curve, but we also take into account other levels of UFRs that we deem to be more economic. The one thing we do and we are doing is reducing the swap spread exposure.
Please note that the swap spread has widened in the last years. That has been beneficial to most insurance companies because liabilities are discounted at swaps and your investment are parked in government bonds. That's something where we feel the swap spread exposure could be, now that gain could be locked in, if you wish. That's something that's on our mind that we're working on. In principle, a directional exposure to curves interest rate as such, we believe in maintaining a very disciplined approach across the cycle. That has helped us in the past, and we will stick to that. In terms of non-life, where do you want your combined ratio to be? Well, as low as possible, I'd say, within what's reasonable to our customers. I think we've given you targets. In Equity Story, we stick with those, and we'll try to outperform those targets.
Far, we've been able to successful in outperforming the target combined ratios and achieving volume growth. That to me is as close to nirvana as you can get being a P&C operator. That's what we tend to do. I think at this point we'll focus on, I think there's room margin improvement, at the end of the day, there's always room to. If margins are like this, it becomes attractive to grow a bit more in volume. Again, we stick to our margin over volume policy, and we're pleased where we are.
Great. Thank you very much.
Next question is from Mr. Musaddi from J.P. Morgan. Please go ahead.
Hi, Chris. Sorry for a follow-up on this shadow accounting again. I'm just trying to understand that bit a bit better. You mentioned that it is nothing to do with. Ultimately what matters is you have a matched book, your yields are more or spreads are more or less locked. If you realize the capital gain, okay, ultimately your current earnings will go down, your shadow accounting will help you to make up for those earnings. I don't see what is the net economic gain here from IFRS's perspective. Why is this a positive delta in your earnings is what I'm trying to understand. Like EUR 30 million is a positive delta. Ultimately, it should go down, come back again. That's first part.
On a simple example on this would be in my view, the way I'm thinking is, let's say you have a bond at the beginning of the year and there is an interest rate collapse, you sold it, realize all the capital gains, put it into shadow accounting. Next day bond yield go back to the same old rate, ultimately you'll be sitting on unrealized loss. Shouldn't that unrealized loss be compensated by that shadow accounting net-net zero benefit on IFRS? What are we missing here? Any thoughts on that would be good. Sorry, it's a complex topic, I just want a bit of clarity. Thank you. Thanks.
I see. Very good. Thank you. On the shadow accounting, I think your first point in the long run, that's true. The rates and direct yields are more or less communicating vessels. Although there may be timing differences in the way a lower coupon works out and the way the capital gain works out. In principle, in the long run, that's actually true. Although in the short term that may be different. There may be developments. At this point in time, I can see a continued contribution from shadow accounting reserve release, capital gains releases into our P&L. Also because, for example, if you sell a bond, realize the gain, move into mortgages, right? The mortgage will deliver a higher spread. It's not completely one for one, if you sold a bond and buy another one.
If you sold a bond and moved to mortgages, there are other effects playing through. Our policy is to keep the direct investment income as high as possible by, for example, increasing our mortgage exposure, by investing in real estate. That supports the direct investment income. There is the realization from the capital gain if you buy or sell a bond. In a like for like transaction, that's actually true. If you sell a bond and move into mortgages, there's an additional effect of a higher coupon. There's an interplay on the investment mix as well.
The combination of that gives us comfort, given where we are and what we know about the capital gains reserve and the projection and the level of our coupons and direct investment income, that there is a substantive contribution to our P&L for the foreseeable future if rates stay where they are. If rates go up, then of course, that only affects the unrealized portion of the capital gains reserve. Only if you realize those, it moves into the capital gains reserve. Please note, if you have a EUR 3 billion capital gains reserve plus an unrealized capital gains reserve of a similar magnitude, it takes a bit of time before you actually move into a very negative contribution from the capital gains reserve. Yes, in principle you're fine. You're right. If rates go up, the opposite happens.
Again, you have a significant chunk of unrealized capital gains before you hit the realized capital gains. Again, noting this, I think there's point in time where we spent probably like an education session, which we did with the syndicate analyst when we IPO'd on explaining how shadow accounting works. In principle, Ashik, your comment is fine, except in reality, there is an investment mix changing coupons that plays through it, changing your investment income plays through it.
Yes. That's very-
Secondly, there is also a significant unrealized capital gains still on our balance sheet.
Okay. That's very clear. Just one thing. Can you just give us some high-level thought on the timing difference? How does it work? Your coupon would be, say, 30 year, your shadow accounting would be 20 year or any sort of that, or too early for that?
Ashik, good question. Shall we take it offline?
Yeah, sure. No worries. That's fine. We'll take it offline later on.
You see the paper in front of you to do this.
Yeah. Sure. No worries. Thank you. Thanks for the explanation.
Chair, there are no further questions. Please continue.
Very good. There are no further questions. I'd like to thank you for being in our call. Thanks for very detailed and well-thought through questions. I think if there's any message I'd leave behind is actually we performed according to plan, slightly better than planned. In terms of management actions, nothing beats capital creation than making money. I think that's what this company is all about. To our point of view, a solid quarter, a clean set of numbers, no management actions in the numbers rather than just selling profitable policies and reducing our costs. We're profitable, and we're pleased with the results and the operating ROE. I hope you are too, any questions in the follow-up, you know where to find us, then, I'd like to thank you for your time and your questions.