Well, good morning, everybody, and welcome to IAG's results presentation for the six months ended the 31st of December, 2019. I can tell by the number of people in the room that it's a pretty busy day today. Again, I appreciate those that have joined by webcast and by telephone, but a special thank you to those of you who are attending in person, because it is easier to talk to people live. It is customary when we have meetings or events at IAG to acknowledge the traditional owners of the land, and today we're meeting on the land traditionally owned by the Gadigal people of the Eora nation.
More specifically, we're meeting at a place that we now know as Darling Park, but traditionally it was called Tumbalong, and it was a place where we know that indigenous people have gathered for thousands of years to collect shellfish and share in a sense of community. In the spirit of reconciliation, I'd like to acknowledge their elders, past and present. This morning, I'll give you a high-level overview of our results, as well as a summary of some of the key activities in the last six months and those planned for the balance of the financial year. Nick will talk, as usual, to the detailed numbers before I return and summarize, Nick and I will be happy to take any questions that you may have.
As we released our headline numbers towards the end of January, some of today's news should come as no surprise. While clearly the bushfires have significantly impacted our first half headline result, the important message that I'd like to emphasize is that our underlying performance has been strong and is in line with our expectations that we held at the beginning of the year. The foundations that we've built over the last few years leave us in a strong position to increase our focus on customer engagement and growth without compromising our underwriting and pricing disciplines. I'm still sure that some of the operational changes that we've made recently to further drive this.
GWP growth in the half was consistent with our full-year guidance of low single-digit growth, taking into account the exit of certain businesses and product lines and lower CTP pricing effects, all of which we highlighted last August. Our underlying margin was well ahead of this time last year and similar to the preceding six months. At a country level, we've seen a solid underlying performance here in Australia and another very strong result in New Zealand, although claim costs were impacted by a large hailstorm event. Perils were again a big feature of the half and have, as we all know, been very prominent since balance date, particularly here in Australia.
Today, we've announced a further downgrade to our reported margin guidance for the full year, lowering it by a further 200 basis points to reflect the heavy rain event, which we expect will capture a cost to us of AUD 135 million. Nick will talk in more detail to this shortly. The large events that we've been dealing with do, however, bring out the best in our organization as time and again, we respond to the needs of our customers in a compassionate and timely manner. As ever, I want to call out the fantastic passion and commitment of our people who look after our customers through these events, often across key holiday periods, which serves, of course, to reinforce the strength and the quality of our brands.
One item that I was less happy to announce at the end of January was the provision we set aside for customer refunds, which at the post-tax level amounts to AUD 82 million. This relates to a specific multi-year pricing issue which we identified where eligible customers did not always receive the full discounts that they are entitled to. We have now addressed the underlying cause of this particular issue, and we are now focused on identifying affected customers, providing refunds to them as quickly as possible. The issue was picked up as part of a broader review of our pricing systems and processes, which we initiated and which is ongoing. More pleasingly, in October, we announced an agreed sale of our interest in SBI General in India.
The associated transactions remain on track to complete in the present half once regulatory and other approvals are in place. We expect to recognize a significant profit on sale and a large positive regulatory capital effect once concluded. In the last half, we also completed a sale of our Indonesian business. The agreed sale of Vietnam failed to proceed. We're now examining alternative exit options. We're in a strong capital position and have declared an interim dividend of AUD 0.10 per share, which represents more than 61% of cash earnings for the half. The dividend is franked to 70%, which is identical to the franking on the preceding dividend paid last September. Looking at some of the key operational activities of the past half and some of those planned for the balance of the financial year.
The devastating bushfires were all too often in the headlines. Aside from meeting the needs of our customers, we were very pleased to be able to help the Rural Fire Service through the use of the NRMA Insurance helicopter. The helicopter is equipped with a fire retardant gel but also participated in more standard water bombing activities, racking up over 200 hours of service before we even got to Christmas. It goes without saying that one of our top priorities in the second half is supporting our customers to recover from these dreadful fires, not to mention the more recent large events. We've also been busy progressing initiatives in the smash repair and new business areas.
We have repair hubs up and running in both Australia and New Zealand now, these are comprehensive motor vehicle repair ventures to improve the consistency and quality of repairs, but also to improve the customer experience through reduced repair timelines and a more efficient process. Of course, they will also reduce the cost of our own claims expenses. There will be further expansion of these in the second half. An associated venture is the recent MotorServe acquisition from NRMA Motoring and Servicing, offering a one-stop mobility shop for our customers, including a car servicing option.
Integration of MotorServe into our offerings will be a priority in the second half. In the new business space, we've just completed the first six months of ownership of a controlling stake in Carbar, the vehicle car trading platform, which will undergo further expansion in the second half as we cater for growing customer appetite for alternative forms of vehicle ownership and mobility more broadly. With the simplification of our claim systems largely done, the emphasis continues to switch to consolidation of our policy and pricing systems. The first major release of this program of work is expected in the opening half of FY 2021. On risk management, our new risk target operating model has been introduced across the organization as we progressively raise our risk capability and capacity.
You might also have seen some recent refinements to our operating model with the appointment of Julie Batch to head our newly created strategy and innovation division, which combines IAG's existing strategy function with some of Customer Labs, and an expansion of Neil Morgan's role to lead the technology and digital division, which adds all the digital teams to his previous group technology responsibilities. These changes were much in the planning, and we see them as a logical step as we transition to the next phase of our strategy, with a greater emphasis on future growth from our core insurance business, as well as adjacent business opportunities. We plan to outline our longer-term plan brand strategy in more detail at an investor day here in Sydney on the 14th of May, and we hope that you'll be able to join us then.
In the meantime, let me hand over to Nick, who's going to run through the numbers in more detail.
Thanks, Pete. Good morning to everyone. I'll start with our scorecard, which as Pete said, is sort of delivering a strong underlying performance for the group in the fixed month period. The quick highlights here that we have on the slide are that we've had some modest premium growth, but kind of in line with expectations. The key drivers there have been some of the things that have occurred around CTP pricing, as well as some of the business exits, and the underlying story is slightly different, and I'll come back to that. At the margin level, the underlying margin that we delivered first half FY 2020, consistent with what we delivered second half FY 2019.
If we go back 12 months, you can see sort of over that period, an uplift in that underlying margin. That's really despite the sort of 70 basis points headwind we have in our results driven by lower interest rates. We've absorbed that and sort of from 12 months ago, underlying margins are up. The quarter has obviously been impacted by the p erils, particularly the bushfires up to 31 December, as well as those lower reserve releases we've already flagged. Shareholders funds income has turned around from 12 months ago, really driven by what's happened in equity markets. Sort of the bottom line of the group compared to 12 months is down, but that's really driven by the fact that in the first half 2019, we had a AUD 200 million profit from sale of the Thai business. That has occurred in this result.
In fact, we have an AUD 82 million after-tax provision for customer refunds that Pete mentioned as a negative. Compared to 12 months ago, that's some of the big drivers. What I'm going to do now is sort of unpack some of the numbers that are on this chart and give you a bit more detail on some of them. Starting with top line, as we said, our premium growth has been modest for the half, and that's sort of in line with our expectations. What we've delivered on premium is what we thought. If I look at what like-to-like is though, it's around about underlying growth of about 2.5%. That's really the run rate of IAG at the moment, a growth profile of about 2.5%.
Within our numbers, there's a AUD 50 million drag from some of the commercial agency businesses that were sold that were in our results 12 months ago that are absent in these numbers. As well as lower CTP pricing that's affected both sort of New South Wales, ACT and South Australia. The three markets that we operate in has driven lower CTP pricing throughout our portfolio. As a positive in this story, we do have some currency gains between New Zealand and Australian dollars that are lifting our number a little bit. The real story for us is within our Short Tail Personal lines businesses, you'll see all the detail in the pack. Our motor and home books, we're seeing rates flow through our portfolio. It's in line with claims inflation.
Pleasingly, we are seeing a little bit of volume growth within the RACV and the AMI businesses in New Zealand in the motor portfolio. You see a little bit of volume growth there. We've got higher commercial rates flowing through our portfolios in Australia and New Zealand. That sort of flows for both. In Australia, you'll see that our volumes are down a little bit within our commercial book. Where in New Zealand we've had both rate and volume growth. There's a slightly different story there between Australia and New Zealand. CTP, I flagged in total our CTP premiums compared to 12 months ago are down 9%, and that's really driven by the changes in schemes that I mentioned before. We would expect underlying growth and sort of our top line to be similar second half to what we've just delivered first half.
Sort of the guidance that we've got in the market we're reconfirming of that low single-digit growth for IAG for FY 2020. On the margin side, the story is that compared to 12 months ago, underlying margins are up. Really that story is all about the delivery of some of those optimization simplification benefits that's flowing through to our P&L. There is an offset though, as you're aware, of increased regulatory and compliance costs that's all within these numbers, but the net of those is still a positive that are flowing through to our results. The Australian commercial lines and New Zealand commercial lines businesses have improved in profitability, so that's a positive. Against that though is this sort of 70 basis point drag from interest rates. The net of all that is driving that underlying performance up even after absorbing the interest rates.
At reported, I think we know this story. Reported margins are driven by two big things around perils for the six months and lower reserve releases are driving the reported outcome for the half. Just in a bit more detail on those two topics. On the releases, we probably should have shown some of these slides in previous halves to sort of understand what's really been happening. The first comment on the releases is, we definitely had an expectation at August that's different than what we delivered for the half. We delivered a reserve release for the half of 0.1% of earned premium. That's lower than we thought we were going to be delivering for this six-month period. Behind that is kind of a few different stories.
Within our CTP, ACT, South Australia, in our workers' comp business, and in our professional risks business, we've just had a little bit more claims development, some of them individual cases than we expected, that are driving a bit of a negative there. We've seen some development across some of those portfolios. We're not seeing signs of superimposed inflation. This is not a systemic problem we're seeing across our long-tail portfolios. We see this as some isolated examples in those portfolios where we're seeing a bit of development. Against that, as a positive, we are seeing reserve releases continue to flow out of our New South Wales CTP scheme. The net of all of that story is this small number of 0.1%.
If you look at the quantum, and of course, that reserve release out of CTP in New South Wales has come down as that scheme has changed. What we really want to show you is what's really happening with our outstanding claims reserves over a five-year period. If we sort of go back five years, we have roughly AUD 9 billion of outstanding claims reserves sitting on our balance sheet. If you look at that number today, that number is closer to five. If you look within that, our long-tail classes have come down by 55%. CTP outstanding claims reserves on our balance sheet are down 60% compared to five years ago. I think we know the story there, but sort of unpacking that is the impact of quota shares have really had a material impact on the amount of liabilities that we have on the balance sheet.
The fact that we have had large reserve releases in the past, we just took that quantum down, so they're just not sitting there anymore. Of course, the changes of these schemes, where the average premium is coming down, the risk profile is coming down. That ends up flowing down to the reserves. It's getting smaller, and the duration has come back as well. The duration is less than it used to be five years ago. The combination of all of that has driven our balance sheet number to come down significantly. Of course, then the quantum of our reserve releases are also coming back. That's kind of the real story that's happening at IAG. What we're guiding you to for the second half is reserve releases of sort of 1%.
The maths of that is sort of not up to first half, 1% second. For the full-year guidance, we're guiding with a 0.5% reserve releases for FY 2020. Also what we're also saying is that over the medium term, you should still assume around about 1% of earned premium being in the form of reserve release as part of our ongoing results. On perils, and I thought I'd divide this into two, sort of looking at the numbers at 31 December , just so we're all clear, and then what we're saying about guidance to June 2020, because there's been a lot happening in the last five weeks. Just on the numbers that are booked for 31 December, we're about AUD 100 million over our peril assumptions for the half. You see that number in the pack is AUD 419 million, but AUD 100 million over our expectations for the half.
Within that, there's about AUD 180 million net cost that we've had through to 31 December from the bushfires. That's the major contributor to our perils cost for the half. What that peril has done is triggered our calendar 2019 aggregate protection. That's kind of the 31 December. With the events that we've then had post-December, we've then revised our perils assumption for the full year up to AUD 850 million. We've significantly increased that from our original assumption in August, which was AUD 641 million. We went AUD 641 million with an interim step, as you were in January, now we're saying today we're assuming AUD 850 million. I'll just go through the elements of that so we can sort of see where we're at. We're at AUD 419 million at December. In the month of January, we had perils. We had significant bushfires.
Much of that was protected from that calendar 2019 aggregate protection program. Not even in the 2020 program, in the 2019 program, we covered much of the bushfires in January. We had a significant hail event that went into our main catastrophe program. Our net cost of that was AUD 169 million. Our position at 31 January was that our net perils cost to our company is AUD 645 million at the end of January. We had a significant event over the weekend, which then goes into our second event coverage under our main cat. Sort of five weeks into the calendar year, we're into our second event on our calendar cat program. That dropdown, as we flagged, it goes from AUD 169 million for first event to AUD 135 million. Our main program comes in then.
Our net cost of the weekend, and in fact, it's still ongoing weather event, will be AUD 135 million, and we believe that the claims that are coming in will be above that. That's our net cost. We've then had to estimate based upon all that information, considering the two catastrophes in the first five weeks, what does that mean for our guidance to June 2020? We've come up with a number of AUD 850 million. Essentially, what we've done there is say, let's look at the run rate normally in February through to June. Let's adjust that for changes of exposure and the normal things we do. We have some additional protection as well from AUD 101 million peril stop loss, and we've assumed that we'll get some recoveries under that, which gives us a net number of AUD 850 million within our assumptions for guidance for June 2020.
We're also saying, you'll see in the pack that the way our program works, we drop down. AUD 169 million first event hail, AUD 135 million second event weekend weather sort of New South Wales. The position as of today is that the maximum cost of an event from today is net AUD 50 million, is the maximum P&L charge that can go through our accounts. You can see the way we structured our program. It drops down the more events we have, the lower that number gets. Of course, this is not an exact science, but what we've done is come up with what we believe is a reasonable assumption for a full year perils condition for IAG. On reinsurance just generally, and we've announced this in early January, we renewed the programs conceptually in a similar structure to what we've had in calendar 2019.
You will be aware that we have lifted the top of that from AUD 9 billion to AUD 10 billion, really driven by growth of our exposure as well as taking some additional coverage for modeling risk. What we can say is we're well served by this program, and we continue to be in a strong place in relation to reinsurance going forward. Just on expenses, this is a good story for IAG and it's been a real focus of our company over the last couple of years. You're aware we set a targeted reduction of AUD 250 million of the cost base of running our company, you can see in this slide, which we've shown you before, that that AUD 250 million has been delivered through the P&L now. It's in our P&L run rate for the six month ending 31 December.
Against that, we've flagged this before, we couldn't absorb all the additional regulatory and compliance costs, that's a negative against that AUD 250 million. You can see the way we've set up the slide, that the AUD 250 million, the original objective we've delivered through the P&L, we're very pleased with that. This has been a main focus of attention at IAG. What we've been trying to do is simplify our business, optimize our processes, make it a simpler place to work in, importantly, make it a simpler place for our customers to interact with. One of the outcomes has been the cost reduction that we can see flowing through to the P&L. We're sort of bringing to an end that optimization program, we're kind of seeing that flowing through.
Of course, it goes without saying, we'll continue to look for efficiencies in how we run our company. At the same time, though, we'll be looking for opportunities to invest where we see opportunities to build out further products and services. That's sort of what we do as the leadership team of the company. Just looking at the divisions, and I'll just sort of go off comment on some of this already. Firstly, starting with Australia, if you look at the headline number, it's flat premium for the period. Behind that is sort of a couple of different stories around the exit of some commercial agencies, which is a drag on the commercial business. We've also got that CTP pricing flowing through all the Australia businesses. Underlying the like-to-like growth is more like 2%. It's pretty good.
Within Personal lines, within Short Tail Personal lines, the Australian motor and home portfolios, it's more like 3%-4%, predominantly price that's flowing through those businesses, matching any sort of claims inflation. It was a good outcome there. Within Commercial, we're seeing rate flow through sort of 5%-6%, but we're seeing something offset against that in volumes. The net number is very modest. We're definitely seeing some volume losses as those prices have been flowing through. Underlying margin compared to 12 months ago is up, and really the benefits of those optimization programs and the net benefits of optimization, regulatory and compliance interest rates, there's a net positive that's flowing through to that business, as well as we're just seeing an uplift in underlying Commercial profitability within the Australian business.
We expect a similar story at an underlying level for Australia in the second half. Our New Zealand business continues to deliver strong results. At a growth level, we grew our business in New Zealand by around 4%. There's some currency. You'll see that when we convert it to Australia, it's closer to 6%, but in New Zealand currency, it's roughly 4%. The commercial New Zealand business grew by about 8%, a combination of volume and price flowing through our New Zealand commercial book. Within the consumer, it was more modest. As I mentioned before, we had a bit of volume growth within the AMI business. Also within New Zealand, there's been some changes to the way the EQC scheme works and a bit of risk transfer back to the scheme.
There's some de-risking of our premiums and therefore they've come down a little bit, which flow through to our business and the entire market. That was a bit of drag within the consumer premium line. Underlying profitability that we've delivered in the first half 2020, similar to the run rate of New Zealand last half, really there's a couple of different stories there. It's also delivering the cost benefits, the benefits of the simplification program are flowing through the P&L. We also flagged this last year. New Zealand had a good run. They had low peril. They just generally had a benign claims environment. We see the run rate of claims, underlying claims in first half 2020 more sort of normal. That sort of underlying claims performance there.
The headline claims number in New Zealand has been impacted by a fairly large hail event that occurred in Canterbury in first half 2020. You'll see that at the recorded line. With New Zealand similar to Australia, we expect the New Zealand underlying performance to be sort of second half 2020 be similar to what we just delivered first half 2020. We're going well. The underlying performance is strong. Something similar, we'd expect something similar second half 2020. Fee and income, this had a bit of attention, so we'll just flag what's in this line. There is a small loss of AUD 2 million that's flowed through the P&L. It's kind of two stories. That's the Victorian workers' comp fee-based business that would have a result of around AUD 8 million profit.
Against that, we had losses of around about AUD 10 million from some of these newer businesses that we're building out that we flagged in August. There's a range of those. For example, we have Ambiata, our data analytics business, Carbar, as what Pete mentioned, we're building out a car subscription service and a car trading platform business and losses that are occurring there. We're building another business called Safer Journeys. What we're going to do is step through this in a bit more detail with you at our sort of Analyst Day in early May. We're also flagging, though, that we do expect this number to be a loss of up to AUD 50 million for the full year.
We're going to continue to invest in these businesses and accelerate those that we think make sense. That will provide you a lot more color on exactly what that is and how we're building our products and services for our customers as they may invest today. Just on capital, the group's capital position continues to remain strong. What we've done on this slide is just a reconciliation of where we were at 30th June and where we're at at 31 December. The big drivers here are how much money we made, earnings plus the dividends we paid. As always, there's a few other ups and downs within here. Just pointing out a few. We've had excess tech provisions.
There's been a bit of drag on that because we have had to include the impact of the peril events of January and February, which we hadn't booked in our accounting P&L, but were booked in our capital accounts. We kind of have to bring forward that bad news into our capital to a degree. We've got a new accounting standard around leases where everything's dressed up in the balance sheet. There's sort of a negative bit of drag on the capital from that, and there's a couple of other smaller things that have flowed through. There's a tiny positive in there from the sort of the last of the quota shares flowing through to the capital count. We point you to Common Equity Tier 1 as the key capital ratio that we want you to look at in relation to IAG.
You can see even after the AUD 0.10 dividend that we're sort of towards the top end of our targeted Common Equity Tier 1 capital ratio. Pete flagged India. We do expect to settle on India in the second half of this financial year, so between now and 30th June. The capital impact of that will be there'll be another approximately AUD 400 million of additional Common Equity Tier 1 capital generated once those proceeds are received. That is a 16 basis point positive impact on our ratio. I'll highlight again, it remains our intent at IAG to operate our businesses within those targeted capital ratios. If we are surplus to those ratios over the medium term, our intention is to return that to shareholders. In conclusion, sort of wrapping up. We see this as a strong underlying performance of our business.
We're super pleased with the simplification program, the focus of that has occurred at IAG and the way we've delivered against what we set up to deliver. We're very proud of that at IAG. You should expect a similar underlying performance of IAG second half to what we've just delivered for the first half. Of course, our reported has been impacted by both the perils we've had up to 31 December, but also over the last five weeks, the significant perils that we've had across Australia that are impacting our reported margins for this current financial year. On that note, I'll hand you back to Pete.
Sure. Thanks, Nick. Before closing off, I'd just like to comment on broader climate and customer equity matters. On climate, we're very pleased to see that the national dialogue has changed.
It's in fact elevated in recent months, even if it has taken the awful bushfire events to prompt this. IAG's had a long commitment to addressing climate-related issues through the activities of the Australian Business Roundtable for Disaster Resilience and Safer Communities, which we founded in 2012. Even well before that, as we started to look closely at what was then seen as an emerging risk in the early 2000s. Today, we released the latest six-monthly update against our three-year climate action plan, and there has been some important progress in the last half. We launched the Severe Weather and a Changing Climate report, co-authored by our Natural Perils team, which using the latest data on the state of the climate, makes predictions on future extreme weather events. A key aim of the report is to establish a central source of scientific information which can be built on.
It does show that climate is changing more rapidly than some predicted, and it highlights our firm view that we need a national coordinated approach from government, from businesses, from industry, to build more resilient communities and reduce the impact of disasters. We've also seen good progress against our emission targets. We're on track to deliver a 20% reduction by the end of FY 2020. There has been a continued shift in our equity investment portfolio to companies that have a lower exposure to climate related risks or that have a forward-looking strategy to manage those risks. As at the 31st of December 2019, high-risk companies now represent only 0.08% of our total investment portfolio or less than AUD 10 million. We also continue to roll out our customer equity framework, improving awareness and understanding of customer needs across our organization.
This includes being able to respond to the needs of customers experiencing vulnerability, as well as understanding how to better design products and services so we can be even more sure they deliver what is intended and what is needed. Our commitment to act fairly with care and compassion must apply to all our customers, regardless of their age, gender identity, mental and physical abilities, culture, language, financial or social situation. We test this commitment through our work with our ethics committee and our consumer advisory board. We see our focus on these areas, climate change and customer equity, as hallmarks of an organization that thinks deeply about its relevance and its sustainability. In summary, we've had a strong underlying performance in the opening half of FY 2020, which matches the expectations that we had at the beginning of the year.
Our FY 2020 guidance has been revised solely for perils and prior period reserve release factors. This leaves us in a strong position to implement the next era of our strategy, and we look forward to sharing that with you on the 14th of May here in Sydney. With that, Nick and I would be very happy to take any questions that you may have, and I think we will start here in the room. Andrew.
Good morning. Andrew Buncombe, on the Macquarie Securities. Three questions if I can, please. The first one's on the dividends. The dividend in the first half was at the bottom end of the payout ratio range. Can you just give us a bit of color as to why that is and maybe more importantly, how we should be thinking about the second half dividend against that range? Thanks.
Hi, Andrew. We think about this as an annual number, not just when we look at the interim. Really, we've got a policy of paying out between 60%-80%, and we'll deliver on that again. I don't think we should overthink the half payout ratio as such. We'll try to generally look at full year earnings. We'll have to revise down full year earnings. Then for the interim to be somewhere between 40%-50%, as a rule of thumb on how we've approached it, not so much just on the actual half payout ratio for the first half. We definitely will rebalance for the full year to be 50%-80% of the cash earnings on a 12-month basis. That's how we'll look at it.
Okay, excellent. The second question is around the topic of reinsurance reinstatements.
Yeah.
Can you just give us a bit of an idea of what sort of scenario you would need to see before you'd be essentially forced to buy a reinstatement, and how far away are you from it?
It depends. At the moment, just to run through, these events that we've had so far this calendar year, the hail event and the weekend weather here in New South Wales and Sydney in particular, they're not causing us to go and reinstate. They're big, but then they're at the bottom end of the program. We would need another significant event for us to then have to go back and look at whether or not we need to reinstate anything. At the moment, let me say that clearly, there's no drag in the June 2020. I think that's the point. There's no drag in the June 2020 financials from some sort of reinstatement. That's the point at the moment. Let's take it slow that way.
Yeah. No, excellent. The last question is on the cost out. I appreciate that the slides show you're getting AUD 250 million.
Yeah.
As I reconcile that back to the expense page, I think it's on page 14 of the investor report. When you net off the gross commissions against the gross underwriting expenses.
Yeah.
There's no improvement there against PCP. Is it fair to assume it's going through CHE or claims?
Yeah, I mean.
How do I reconcile those two sheets?
Yeah. It's a process here, obviously. We have the cost, and we sort of simplify that into a cost base of one and a half to two and a half. There's two things that are happening. Some of those are allocated to, as you said, between claims handling, and some of those are allocated to underwriting. Of course, within those numbers also, we have an allocation of the regulatory and compliance cost that are also because we're putting everything above the line here and into the margins. We're not differentiating that concept. Everything's in the underlying margin. It's really the way we've attributed that, there's probably a greater bias in the claims handling. Some of those benefits are flowing through.
We've tried to, both on the slide that we presented today and also within the pack, sort of unpack that to help everyone through so we can see where those benefits are.
Excellent. Thank you.
Brett.
Just staying on the Brett Le Mesurier, Shaw and Partners . Just staying on the capital issue. I noticed the way you described the IP, you said that the shares are likely to be bought back rather than will be bought back. Sorry for the uncertainty about that.
I think that's more common wording, Brett. Don't overanalyze that point. I think our intention is to neutralize. That's been the form of IAG since I've been the Chief Financial Officer, that we've always neutralized any dividends and not issued any new script, and that's our intention.
Just maybe on the claims inflation, what are you seeing in home insurance, the rate of claims inflation?
To date, relatively modest, low single digits. There's going to be a little bit of pressure in the system. We were talking today, if you add up across Australia and New Zealand, we've had 80,000 new claims in a hurry come our way. By the time we look at hail events in New Zealand, hail in Australia, other property damage, bushfires in Australia. That's probably going to put a bit of pressure in the system in both the motor and the home repair networks. We're not seeing that come through yet, but that's got to be something that we need to be thinking about as we manage it over the next six months. To answer you directly, low single-digit type, 2%, 3%, 4%-type inflation.
Have you allowed for an increase in that in the second half when you're talking about similar underlying performance?
Yeah, it's probably more. The way that would really flow through, I think if there was a risk, it's probably more like first half 2021, with that sort of cumulative impact of all those. We are not seeing that. I'm just highlighting those as a potential risk that us and the industry has in Australia, and we need to be thinking about that also in terms of pricing.
Just moving on to commission insurance, you've consistently had substantial rate increases but your premiums don't grow, and now recognizing you sold a business that requires premiums going backwards. Nevertheless, you consistently don't have growth in premiums while you're increasing premium rates. Are you concerned about anti-selection, which could be occurring?
We worry about that point. We also can't shrink to greatness. We continue to lose volume. We've said this a few times, that we are shrinking this way, less. We feel like we have a more stable portfolio today than we did 12 months ago or 24 months ago to answer your question. We don't believe that we are being selected against in this process. What we do believe is we're creating a platform for growth from the sort of rebalance book. We feel like we're almost there.
Can I add value to that? I think we saw a little bit of increased competitor activity around package pricing in the half. Again, we're not going to give up our sort of underwriting or pricing disciplines just to hold shares.
In the volume loss here in Australia, there's a reasonable proportion that related to package to SME. There's also been, as we all know, just an enormous amount of pressure in the agri sector, rural communities that are doing it very tough. That's been the other portfolio where we've seen some not insignificant shrinkage.
The rate increases are resulting in higher profit for you.
Well, probably the higher margins. Of course, we're losing return in dollar terms are destructive neutral. In margin terms it's up. Because we're shrinking volume at the same time. We would like to think that over time we'll start growing the dollar earnings from our commercial portfolio as we rebalance it. Down trend. We don't have another question in the room. I can see that we have three questions on the phone. We might go to our first caller. Thanks, Terry.
Thank you. As a reminder, if you wish to ask a phone question, please press star one on your telephone and wait for your name to be announced. Your first phone question comes from Shreyas Patel with UBS Investment Bank. Please go ahead.
Hi, guys. It's actually Ciaran Digby here. Just a couple of questions. The commercial portfolio continues to see remediation from a volume point of view, putting aside the agency exit. How long do you envisage that sort of will continue from here? I thought sort of that had largely been completed by the end of 2019.
I mean, Ciaran, hi, it's Nick. I mean, we believe, and you know, this is not an exact science. We believe that that portfolio is pretty stable now. We're going to be disciplined here around price. We believe that we now have a platform that is a lot more stable than it was 12 or 24 months ago. We believe now there's opportunities to potentially even grow it a little bit, that there's opportunity with this. We're cautious on this. We don't want to end up sort of growing into businesses and sort of coming back in margin again. We've been very disciplined with how we've gone about this, and we sort of feel like we've reshaped our book to where we want it to, and I'd say that's kind of now.
All right. Just a second question on underlying margins. Just going back to an earlier question, this in your comments, Nick, that sort of the outlook into second half, fairly flat in both Australia and New Zealand. Obviously, you've got expense efficiencies feeding through and some rate increases still coming through. What are the offsets to that? Earlier you said sort of you're kind of cautious of inflationary trends post recent events, but you don't see that really potentially hitting until sort of 2021. What else is sort of in there that's offsetting some of the tailwinds that should be existing?
I mean, I don't think there's any sort of any big thing that we're sitting around that's different right about second half versus first half. We're cautious about that comment around any sort of inflation post event inflation impacting our businesses in Australia or New Zealand. We're managing a cost profile and in particular sort of regulatory compliance cost profile that feels like it's going one way. We're managing that and there's certainly some strain that we're looking at on that topic. There's some positives flowing through, continuing development that's continuing to deliver the simplification benefits. Pricing has been flowing through the book, and we would expect that to continue. Most of our pricing, I will say, that's flowed through in particular to our short-term book, is really in line with inflation.
I don't sort of see margin expansion from pricing that's occurred in first half in the second half in personal lines. I really see pricing that's flowing through our book in Australia and New Zealand probably matching inflation and sort of that being relatively similar second half to first half. Ciaran, am I answering that question?
Yep. Yep. No, that's fine. Then a final question, just as we look forward into 2021, and obviously it's early days, but you had a small sort of miss on your cap budget in 2019. Obviously a bigger miss this year. Is sort of shaping up in all likelihood that we'll see a bigger increase to that cap budget, as we head into 2021? Will you sort of look through this year as a more unusual year?
I mean, I think we'll do both. We won't overreact to what seems like a unusually high period of perils. At the same time, I think that we will need to look again at the way our perils assumptions are flowing through to our pricing of our business. I think it'll be both. If I think what's been happening the last couple of years, we've been up, lifting up our peril assumptions by about at a sort of gross AUD 50 million per year. Do I feel like the moment we know that assumption is likely to be more than AUD 50 million in 2021? Yes. Are we going to try to reflect all of this?
bad run we're having, in the community for our customers and financially for our company? Unlikely. It'll be somewhere in between. We'll do my thinking at this point.
All right. Thank you.
Thank you. Your next question comes from Matt Dunger with Bank of America. Please go ahead.
Yes, thank you very much for taking my question. If I could go to the catastrophes, the AUD 135 million impact from recent activity, that's about 180 basis points. You talked of the increased frequency back on the 24th of January. Did you not factor some deterioration in back then?
It's Nick again. What we've really done, we had a revised allowance of AUD 715 million end of January. We said at the time, if we have events over AUD 100 million, we'll have to go back and look at that. We literally had an event over AUD 100 million within two weeks or less. We've adjusted for that by the full amount, AUD 135 million. Really we've gone AUD 715 million cover AUD 135 million, which is the net cost of the weekend call at AUD 850 million. Just on the other point of the fact the maths of that are 180 basis points, not 200 basis points, we've simply rounded. There's nothing more to that story other than we just rounded to 200 basis points so it's 180 basis points when we changed the items. No, nothing else to that story other than that.
Okay, thanks. How are you managing the higher costs of claims handling both from a regulatory impact and also from a catastrophes impact?
Well, from a regulatory perspective, that's just built into the guidance that we've already given. We have some of that covered off through the provisions that we've made for what we call RQ, which is our risk transformation program. Some of the increased claims handling costs as a consequence of these catastrophe events is actually covered under our reinsurance program.
Great. Thank you. One last question, if I could just ask. On the customer refunds which you raised in January, you noted you reported them to ASIC in September 2019. Why did it take so long for this to come to light? Also, does this provision draw a line in the sand on remediation?
Well, no, it's Peter. It's quite a complex process for us to go back and unpick all of our sort of rating algorithms. We discovered this, reported it to ASIC, and have been working diligently ever since to try and sort of identify affected customers and quantify the refunds that we're going to make to them. The review is still ongoing. At this stage we have nothing further to add beyond the matter that we've already drawn to attention.
Thank you very much.
Thank you. Your next question comes from Nigel Pittaway with Citigroup. Please go ahead.
Hi, guys. Good morning. Just first of all, if I could, just focusing on the impact, the 70 basis point headwind you say comes to the margins from lower interest rates. The way it's written in the investor report, it does say 70 basis points headwind from lower interest rates impacting investment income. I guess my question is, why is there no offset through the claims line in terms of that 70 basis point headwind?
There'll be the mark-to-market adjustment on interest rates. Hi, Nigel, it's Nick. Sorry. There'll be the mark-to-market adjustment that particularly carries revalued liabilities and one with a lower discount rate. This is really the ongoing business now is We neutralize or sort of hedge that shock from any change of interest rates on the day, as you know. We're in the ongoing business now. The income that is part of that margin is now 70 basis points lower because we now have lower interest rates. Obviously, one of our challenges is reflect that either through pricing or benefits flowing through from optimization or others. That's real, that the earnings of the company are coming down and they're lower, everything else being equal, driven by those lower interest rates.
It's a new business.
We've probably got a shorter card book as well, remember. Therefore, as the liability profiles come back, this issue is actually in a way becomes more relevant because of the comments you're making.
It's a new business strain impact, in effect, is what you're saying?
The duration will come back from two and a half years to two years on our liability for the amount of money that we're holding for dividend come down. Therefore, we're more current today than we were five years ago, if we could put it that way.
Okay. Secondly, there does seem to be a little bit of a softening on the underlying margin guidance for the second half. Are you saying that that's because you do expect some temporary repercussions from the bushfire event that doesn't really affect moving forward? I guess in that context, how are you thinking about this long-tail target you had of getting commercial back to 15%?
Yeah. Nigel, Nick, we've got comment around sort of softening of underlying driven by the guidance of the maths of the perils being AUD 180.
Well, no, just flat. Basically, you're saying flat in both businesses second half versus first half.
Yeah, that's the tone. Don't read anything into that guidance comment between AUD 180-AUD 200. That was just us rounding. The tone, I think it's how we feel. We feel like with everything that's going on, that we would expect an underlying performance similar in second half. That doesn't mean down. Similar means similar in second half to what we've just delivered in first. I don't think we're sort of guiding slightly negative. I think we're saying it really is similar, which will really almost be three halves in a row where we're delivering a similar outcome. I think the real story for us is, which we talked to all our teams around today, was I would like sort of this margin sort of deliver something in this order and create a bit more of a growth profile, simply.
That's sort of what we're trying to set the company up for. You'll see that in a bit of a narrative throughout our investor materials.
In terms of the commercial margin, with the long-term target of 15%, do you think you're on the way to that? The previous suggestion was you might not be too far away, and now if you're targeting more growth and compromising margin, then maybe it's further away.
I don't think we're targeting growth and compromising margin. I think we're trying to run the business roughly at this return profile and create a bit more of a growth profile. On commercial, I think the strategy is probably the same as what we've said multiple times. We've had a bit of uplift that margin, and it's been quite a challenge for us for a whole range of reasons, partly our business, partly the market. Directionally, we're still on the up, I think. It's proved to be quite a challenge.
Okay, maybe just finally. You are treating this weekend event, you say, the second event, so maximum retention of AUD 135 million. Why doesn't the next event fall to the third event you quoted in your reinsurance program of AUD 17 million? Why is it at AUD 50 million rather than AUD 17 million?
We had to pick the number of 200. If I just talk growth, I'll just say this slowly so I'm not misunderstood. The way this works is we have the main catastrophe program, we also have our calendar 2020 aggregate program in place. I'll just use the number that 100%, which is easier for me to talk it through. We had our first event in January, which was a hail event, which at 100%, our retention was AUD 250 million. After quota share, that number is AUD 169 million. The way the aggregate works, which started from zero in the deductible, We keep the first AUD 25 million, then we're allowed to put AUD 225 million to the deductible per event. Event one, being the hail, gross AUD 250 million.
The number is larger than that, in the main program, gross AUD 250 million in the way I've just talked about it, net AUD 169 million. Of that AUD 250 million, we can put AUD 225 million into the aggregate. Second event, we've assumed to be AUD 200 million. If it's at all or larger, we'll just pick the number AUD 200 million. That's AUD 135 million, which is the max. If that number is greater than AUD 200, the AUD 135 million doesn't change. If it's AUD 200 million, we wear the first AUD 25 million, and we can put AUD 175 million to the ag. In total at 100%, I'll be following the math in with everybody, we're now AUD 400 million into our deductible of AUD 450 million at 100%.
Okay.
We wear the first AUD 25 million of every event. We have another AUD 50 million of deductible under the ag. Call that AUD 75 million at 100%, AUD 50 million after quota share, we're into the ag for the next event. Sorry to be that side of everybody. What that means, I'll test everybody after we follow it all up. What that means is the cost of our next event is AUD 50 million, we're into the ag. After that, it's really the way the events unfold, Nigel. After that number comes down to the support. We wear the first AUD 25 million, which is AUD 17.5 million after ag. I'm looking at the IAG people in the room who are shaking, nodding their heads I've got that right. That's kind of how that works.
That's why that's locked down. It's really the way we've picked the number on the second event flows through. I'll say, if the number is greater than AUD 200 million, which there is some risk it could be, our net number AUD 135 million doesn't change. What it would do, though, is reduce down that AUD 50 million to a smaller number. That's why we've said AUD 50 million is the max. It's only going one wa y, which is probably lower.
Great. That's crystal clear. Thank you very much.
Sure.
Thank you. Your next question comes from Ashley Dalziell with Goldman Sachs. Please go ahead.
Thanks, good morning. I just had one question just around the investments that you're taking within the fee income line up to AUD 50 million this year. Just wondering, as you've gone through that process over the past 12 months, are you now in any better place to give us some color as to, I guess, what that might look like into FY 2021? Should we expect it's further investment, obviously more quantum, will the dealings on some of those new business initiatives start to turn a little more positive?
Ashley, it's Peter. On the full information at our strategy session, we'll sort of unpack some of these investments for you and give you some more color then. I think the simple answer to your question is, we would love to be in a position where the success of these investments warrants further investment. At this stage, I think we should look at continuing the current investment profile.
Okay, fantastic. That's all I had.
Thank you. Your next question comes from Daniel Toohey with Morgan Stanley. Please go ahead.
Morning, Peter, Nick. Just a quick first question just on growth. When we look across the portfolio, if you look at some of the words you've used in the business lines, volume slippage, lower volumes, slightly lower retention. When we look into the personal lines business, home, you're putting through, I think 4.5% rate for GWP growth is 4.1%, so you are losing volume. Motor, 3.3% growth, largely driven by rate volume seemingly flat. I guess losing volume everywhere outside of Victoria, it appears. Just trying to get a sense of how the momentum and the story around rate increases is going. Are we at a point now where it's essentially inflation-driven price increases? I guess trying to get that footing and positioning around that story of growth, where does it come from?
Daniel, it's Peter. I think I'll break that question down into some components. Firstly, our intermediated personal lines has been under quite a lot of stress for some time, both from a profitability perspective, but also from a top-line perspective. As we've seen through the Royal Commission, many of our, particularly our financial institution distribution partners, have had significant changes in how they remunerate their own staff, and it's led to some slowdown in, I think, not just the sales, but in fact, people's willingness to engage in cross-selling with their banking customers. That's one issue. Of course, the profitability issue, particularly through our brokered personal lines, means that both in New Zealand and Australia, we should expect to see some continued slippage in those book volumes until we can actually get pricing to a point where we're comfortable with the returns.
I think without looking too far ahead, I think Mark, in particular, would say that he's quite happy with the green shoots that we're showing in our key brands of RACV and NRMA on both home and motor. We've done some, I think, really good work in Victoria, and we're starting to replicate that work in New South Wales. It's early days, but we're quite pleased with the progress to date. In New Zealand, Craig has repositioned both the State and AMI brands. I think historically we've had a little bit of cannibalization, AMI cannibalizing State. We've now arrested that, and we're starting to get just a little bit of growth. Having said that, we also have the same distribution challenge, partner challenge in New Zealand. Craig has, I think, three of the four major banks as partners.
The challenges that they've gone through since the review that followed the Royal Commission here in Australia has left that pipeline just shrinking a little bit. I think the summary would be, we feel in quite a good position in terms of the base we've got. We probably will continue to see a little bit of slippage in South Australia and Western Australia. Again, our strong brands of RACV, NRMA, State, and AMI, we're feeling pretty positive about.
Okay. Just on an underlying basis across personal lines and commercial, it feels like underlying in personal lines is getting tougher. There's a few more headwinds when you roll CTP into that. Then businesses still got a few tailwinds rolling through. Is that how we think about those portfolios?
Look, I think, Daniel, personal lines I think a good outcome would be to hold margin, and we feel pretty confident that we can do that. Obviously, we have got the headwinds of some potential event-based claims inflation. We think the work we've done around our supply chain and our pricing position will enable us to cope with that. Yes, you're quite right, we still have a bit of work that we need to put through the commercial book. At the same time, as I think the expression you used earlier is we can't continue to shrink our way to greatness in commercial. The next six months, I think, is going to be quite challenging for our commercial portfolio.
Okay, thanks. Just a couple of quick ones then. The Malaysian sale, any comment on that?
No, we're in a program of work here. We've hoped to settle on India in this period. Vietnam, for various reasons, as Craig mentioned, didn't go, so we need to look at what we'll do there. Malaysia's sort of in that same category, where we're looking at our strategy there going forward.
Just finally on the reserves. You're still making the comment you're comfortable medium-term 1% is achievable. When you do go back and have a look, I mean, you've held that 1% for some years. The net claims reserves that you have halved. In light of all the CTP scheme changes that New South Wales are heading or are progressing towards, just trying to get a sense of how confident you are on that 1% medium-term, and is medium-term sort of three years, three to five years or?
Yeah, I mean, sort of answering that one directly, yeah. As in everything I know, basically. I mean, there's a slight natural correction here because our earned premium has come down over that period too, as we've introduced quota shares. There's a bit of a natural correction that happens here anyway because we reference 1% of net earned premium. The quota shares have driven down our net earned premium. The AUD involved here naturally come down just because of that. Even if 1% stays the same, there's a bit of natural correction on that total. Yeah, I mean, really the point we want to make is that we have had some one-off negatives. We don't see that as sort of systemic as in a deterioration of long-tail classes in Australia, and that sort of causing other problems.
We really see this as some sort of one-off challenges that we've had in a couple of portfolios. We expect CTP in New South Wales to continue to perform and have some modest reserve releases, and that sort of drives that guidance of 1% of net earned premium. That's the logic of what we're saying.
Okay. All right. Thank you.
Thank you. Your next question comes from Siddharth Parameswaran from JP Morgan. Please go ahead.
Good morning, gentlemen. A couple questions if I can. Carrying on with that theme about reserve releases, I was hoping you could just give us some idea of just where you've actually set your AWE and superimposed inflation assumptions on CTP, and if you can confirm that that is actually where you're expecting most of the releases to come if you're going to sustain this 1% going forward.
Yeah. Hi, Sid. I don't think we've materially changed them, actually. I'm looking at that saying sort of 2%-4%, I think, something in that order. I'm getting signals three. I don't think we've materially changed any of those assumptions. As you know, we don't chop and change around those. They're medium-term assumptions that are still embedded in most portfolios.
Sorry, is that 3% AWE plus superimposed, or is that 3%?
Yes. There'll be an element of both. It'll be 3% inflation and then some additional superimposed on top of that. Honestly, Sid, I don't think we've materially changed those numbers from 30th June. That's sort of a constant.
Okay. Fair enough. Just the second question, just around your views on pricing and personal lines going forward for all these events. You touched on earlier that you'll probably look at increasing your allowance. Presumably, a lot of the business you write today will end up earning through into the next year. Are you taking any action on pricing for this? Are you forward-looking in terms of what you might see?
Sid, the thing is that we're definitely, if we think about what's in front of us as a company and an industry now is, we've had some devastating Natural Perils that's likely to end up, it doesn't just appear straight away, in some event-driven type inflation in some of the claim services that we procure. It's definitely going to have to cause us to look at retained sort of Natural Perils risk or level of pricing for around Natural Perils risk that our customers have, and then likely to flow through to some sort of increase in the cost of our reinsurance. Yes, the bulk of our reinsurance is not renewed till January next year, and I think of our main cat program, sort of almost two-thirds of that has already been multi-year pre-priced arrangements.
I think the tone is going to be clear that there is likely to be an increase in cost of reinsurance. We've sort of got three things going the same way. No doubt Mark and Craig and the teams, we can't just make a decision to make some changes in pricing overnight. We need to be factoring that into everything else that's occurring in our business, and looking around what does that mean to sort of our original pricing. I think that'll be the same issue at IAG as it is for the whole industry across Australia and New Zealand.
I don't think anything I've just said is not, they're industry issues that we would like to think at IAG we're better equipped than most to deal with them, and to be able to deliver some proposition to our customers in a better way than most because of the size and scale and sophistication of our business. I don't think Sid I've exaggerated. I think also the quality issue, and I think as Nick said, with some of the catastrophe tower, we already are multi-year deals. It will provide some level of inoculation.
Yeah. Okay. Just one final question from me. The top of your catastrophe towers has increased materially over the last few years. I think it's gone from about AUD 5.5 billion, from memory, around 2015 to about AUD 10 billion now. Are we done with that increase? Are we likely to have more modeling changes that are likely to continue to add to these pressures on insurance costs?
A lot of this now is New Zealand earthquake risk that's the top end of the tower. I would say that the cost of that reinsurance at the top end of that tower is pretty modest. Remember, we're buying for one in a thousand for New Zealand earthquake risk. That requirement is as high as anywhere in the world. Maybe. We're trying to stay ahead of this, Sid, actually. We're trying to make sure that we're able to provide capacity to the New Zealand markets, in particular Wellington, which drives a lot of this. If your question is, are we now capped at 10, probably not. As sort of aggregates grow and sort of refinements to modeling occurs, and therefore opportunities for growth, will we continue to look for reinsurance to make sure that we can provide our products and services to our customers? Yes.
Okay, great. Thank you.
No, Sid, it's not materially driving the cost of reinsurance at IAG. This is a very modestly finely priced capacity at the top here.
Yeah.
I see we have no further questions on the phone or the webcast, so if there are no further questions in the room, I might just close with maybe two comments, if I can. Firstly, I said this at the last half, I feel IAG has definitely finished the half in a stronger position than how we started. The business has good trajectory and good momentum at an underlying level. I think the second thing I'd just like to call out is the incredible passion and commitment of our people. If you think about the weather events that we've had, they've occurred across a peak holiday period, and our ability to respond to our customers in their moment of need I think is absolutely exemplary.
I just want to take this opportunity to thank them on behalf of our organization, on behalf of our customers in particular. They do a fantastic job, and I couldn't be more proud of them. Thank you for attending this morning. Thank you for joining us on the webcast and the phone. I'm sure we'll see you all again in six months' time. Thank you.