Ladies and gentlemen, welcome to the Zurich Insurance Group Half Year Results 2019 conference call. I'm Sandra, the conference call operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for question at any time by pressing star and one on your telephone. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Richard Burden, Head of Investor Relations and Rating Agency Management. Please go ahead, sir.
Good morning, good afternoon, welcome to Zurich Insurance Group's first half 2019 Q&A call. On the call today is our Group CEO, Mario Greco, and our Group CFO, George Quinn. Before we start with your Q&A, Mario will make a few introductory remarks to the results. When we come to the Q&A, as always, we just ask you to keep to two questions in the first go around, and if we have time afterwards, we'll come back for a second pass. Over to you, Mario.
Thank you, Richard. Good afternoon to all of you, and thank you very much for being on the call, especially since we are in the middle of August, almost. Before we get into the Q&A, let me try to provide a few remarks about our performance and where we stand today. In 2016, as you remember, we set ourselves ambitious targets, and we launch a new bold strategy. The first half results show that the strategy has delivered, and that we're on track to exceed all of our targets. Our BOP has reached the highest level in the past decade, and our BOP at ROE of 15% shows the significant value that we are creating for our shareholders. The performance of our property and casualty business has been very strong, with the business showing growth in gross premiums and improved underwriting performance, but still very low volatility.
The strong improvement in the accident year combined ratio before natural catastrophes clearly shows that the actions that we have taken to change the mix of the business and to improve the quality of the portfolio were the right ones. This is especially the case in our commercial business, where discipline and focus has driven significant improvement in profitability, in contrast to what many have reported. Looking forward, we see further opportunities to improve the results, and we see the current upturn in U.S. pricing as supportive of the future performance of our business. Our life business has continued to perform well in the first half, with underlying growth continuing and with headline results held back only by the strengthening of the U.S. dollar.
The high quality of our life portfolio and our long-term focus on protection and unit-linked savings position us well to manage the ongoing challenge caused by the low yield environment. About Farmers, both our own business and the policyholder on the Farmers Exchanges have continued to grow successfully in the first half of the year. Particularly, the exchanges have continued to build successfully out their presence in the eastern U.S., and they also expanded Toggle, their innovative offering for millennials, to over 20 new states. Our balance sheet remains extremely strong, with our solvency above the top end of the target range, despite the impact of falling yields and the absence of the dampening mechanisms available to peers reporting under Solvency II.
Over the first half of 2019, we continued to develop our strategy, and we strengthen our business through the addition of new partnerships and new and innovative product offerings across a wide range of our businesses. Our innovation has also gained external recognition. The Group had won a number of awards over the first half of the year, and this is, of course, quite relevant for all of us. These results and these developments give me great confidence for the future of the Group and our positioning for the next phase of our development, which I look forward to presenting to you later this year. Thank you for listening, and now we're ready to take your Q&A, and George and I will respond to all your questions. Back to you.
We will now begin the question and answer session. Anyone who wishes to ask a question may press star and 1 on the touchtone telephone. You will hear a tone to confirm that you have entered a queue. If you wish to remove yourself from the question queue, you may press star and 2. Participants are requested to use only handsets while asking a question. Anyone who has a question may press star and 1 at this time. The first question comes from Jon Hocking, Morgan Stanley. Please go ahead.
Good afternoon, everybody. Thank you for taking my question. I've got two questions, please. Could you comment on what you're seeing in terms of large loss trends and if there's anything that's discernible in terms of an underlying pattern there? That's the first question. Secondly, in terms of the trends we're seeing in U.S. pricing, are any of those sufficient yet to change your appetite for particular lines of business over and above others that you've been maybe some of the things you've been de-emphasizing? Thank you.
Jon, it's George. You'll probably remember last year that we resisted the temptation to get too deep into large loss topics, because often we hear that as a reason why businesses haven't achieved the targets they've been given. I think the good news for us is that we haven't had that commentary internally. I think, though, as we do break down the numbers, the outcomes that you see in the first half of this year aren't driven by an absence of large loss. We see more of the improvement driven at the smaller end of the spectrum. We are still seeing large loss. In fact, if anything, slightly higher than our current expectation. On your other question on U.S. pricing. Listen, maybe it's good to just mention where we see U.S. pricing so that we all get on the same page.
If you remember the commentary from Q1, I talked about the fact that overall, for North America, where I gave quite a bit of detail, we were slightly north of two, slightly north of four rather. Ex workers comp, we were around six, if that's a particular measure you like. Overall, things are stronger in Q2. We see things getting quite close to seven for all lines of business. Would that change our appetite? I think for us, we try to be rational about how we set targets. For the business, where they see the right levels of return, they can rate the business for sure. I'm sure that this will take some business at the margins that previously we would not have written, and it will tip it into places where we would rate it. I think on portfolio, that for me is a different topic.
We are trying to shape the portfolio. I think that topic will continue. Certainly the improved profitability in the market overall will increase the opportunity for us in commercial.
Thanks very much.
The next question comes from Peter Eliot, Kepler Cheuvreux. Please go ahead.
Thank you very much. The first question is the obvious one, just revisiting that accident year combined ratio ex CAT. I appreciate, George, you don't want to sort of go too deep or overanalyze the large losses. I was wondering if you could just give us your view on how much of that improvement is sustainable, and to the extent that it's come from pricing improvements and portfolio actions. Those have been ongoing. Should we expect another similar improvement over the next 12 months, or is that far too bullish? Secondly, I was wondering if you could just give us a bit more clarity on, granularity, sorry, on the 8% Z-ECM increase from business profit, because I guess that's 2.5 points higher than the net income contribution. It'd be great just to understand the contribution from new business and any other moving parts.
Thank you very much.
Thank you. On the first one, sustainability. Maybe I'll do the very high level first and then I'll go into some of the factors that will drive what we see now or have driven what we see now, will drive what we see in the future. The obvious thing that you can isolate in the first half results is the impact of CAT. We're about 0.7 points beneath where we would expect to be given where we price things. We don't assume that that's a structural change. If you adjust for that, we would see the underlying closer to 96. If you look at what do we expect for the future, I'd love to be as optimistic as the second part your first comment implied. Clearly there's a rate environment out there that looks as though it will continue to be very constructive.
I mentioned earlier in response to Jon's question that we're seeing acceleration of rate into Q2. Just to be clear, inflation, loss cost inflation, Europe and U.S. they're probably matters most for us in the short term. We're not seeing any significant change. It's slightly higher in the U.S., but I'm talking 10 basis points. Overall, the rate net of most cost inflation should also continue to feed into the results. I think equally importantly for us, there's a whole shift taking place on terms and conditions, which I think is much harder to see, but actually has the promise of something that will benefit us for a period that's longer than simply the typical 12 months that we'll have the contractual relationship in any one of these individual policies.
We see things like attachment points are moving up, line sizes are coming down, more business through wholesale channels where rate is probably even stronger. On commercial auto in the U.S., significant changes in deductibles with the continuation of the rate. I could go on and on. There's a whole series of factors and features that I think are very helpful from a terms and conditions perspective. Be aware there are other things that will go the other way. We have crop in the second half. Crop is a higher loss ratio business. This will certainly not be as positive a year for crop as we had last year for the reasons I think you all know about from what you've seen in the first half.
I think you've heard from the guidance that we've given already that we've guided you all to expect something around 96 on the combined for this year, given the performance in the first half, given the expectations we have for the second. We expect to be a bit better than that, so something between 95 and 96. On the Z-ECM topic, there's always a number of moving parts. I guess you've seen the key features today. We've got business profit generation of eight. That's probably close to a couple of points higher than you would normally expect to see from us. Dividend accrual of four. We knock off about seven for the market movements, and that's mainly interest rate driven, and then a bunch of smaller stuff that explain the rest.
There are always differences between the reported IFRS profits and the impact that you see on the economic view. Typically, more of those come from areas like life, but the picture can be quite different in terms of the almost immediate recognition of new business value versus the spreading forwards of profit under IFRS. Equally, some of the things that we do to reduce risk around some of the legacy parts of the portfolio also has a positive impact. I can't give you a very scientific, very detailed explanation, but broadly, those are the main drivers.
Okay. Thank you very much.
The next question comes from Andrew Ritchie, Autonomous. Please go ahead.
Well, hi there. A simple one, I think, hopefully to start with. OnePath Life contribution, I think in the notes to the financial accounts, it says $29 million pro forma for the first half, US dollars. That seems quite low versus the original expectation. Maybe you could just update us on what's going on there. I guess there's some noise in relation to OnePath. Are there any implications of some of the recent legislation that's been passed post the Royal Commission update? For example, I think Protecting Your Super legislation, does that have any impact on the output for OnePath? The second question is, sorry to return to this topic of sort of loss trends. I guess you are, I think actually the only global commercial lines insurer in the first half that's actually achieved an underlying attritional improvement year-on-year across the U.S. and Europe.
Everyone else has reflected issues of particularly social inflation rather than classical loss cost inflation to do with litigiousness, et cetera. What additional work have you done in the first half in the U.S., in particular, on looking at issues of social inflation in general liability, commercial auto, professional lines, where there's been many of your peers suggesting a real step change in claims trends? Thanks.
Yeah. Thanks, Andrew. On the first one, it's very timely. I was actually down in Sydney last week. I met with the team to go through the completion balance sheet and also to look at the planning for next year. Maybe I'll start with the headline summary. At this stage, we anticipate an outcome for 2020 that's at or around the level that we indicated in the presentation that we published when we announced the OnePath deal back in December of 2017. From memory, that was around $200 million. That's still our expectation today. Now, of course, where we're starting from is a bit different, certainly from the position then. There are DI issues in the local market. We see it in our own book on the Zurich side.
The key thing here is, I think when we talked about the strategic reasons for the OnePath transaction, we pointed to a number of market features and factors that we liked. I won't get into all of them on this call. I think we've talked about the fact that we've acted in the past in Australia to address weaknesses or shortcomings, and we continue to be confident that we can do the same in this portfolio and drive the outcome that we committed to when we announced the transaction. There's a whole bunch of issues. I mentioned DI, you mentioned Protecting Your Super. Protecting Your Super is absolutely a topic that will impact those that are more exposed to group. I think as you may remember from the December conversation of 18 months ago, OnePath is a bit less exposed on the group side of the market.
Having said that, Protecting Your Super will also have some knock-on impact on retail. We don't expect that to be so significant, but there is an impact as trustees get pushed to make sure that people don't have duplicate cover or are not in a forced purchase position. That will mainly impact group, but it will have some impact on retail. For us, overall, the first six months of this year are not representative for a whole bunch of reasons. We're still confident we can drive the level that we committed to. The only thing to watch is it'll be a bit lumpy next year because we have to take some action around the portfolio. Of course, some of that benefit will flow once the action has taken place.
There'll be a tendency next year for that number to be a bit more back-end loaded than front end. Loss trends. I think I gave an answer to Peter. Some of the things that we see from a market perspective taking place. I think our view, without being too arrogant, is that these are not things that we started in the first six months, but we see maybe because of the general pressure on the market, there's more people following the changes that we've made. We look carefully at the trends around losses. I don't see in the data that we have some of the things that you've heard in the commentary from the others.
I guess probably the main driver of that is that if you look at the last 3 years, and you look for other ways in which we don't correlate with the market, probably the presence of growth is the obvious difference. You've seen us act relatively early in the cycle to deal with the challenges that we have. They started with some of the large loss topics that we talked about in 2015. Mario's push to reinvigorate underwriting, and our willingness to give up market share where the returns just didn't justify the capital allocation. I think one of the things that we're happiest about today is the fact that you can really see the benefits of that in the commercial performance. I can't analyze for you in detail again why we're not seeing this step change in social inflation that other people point to.
By the way, I think we have seen it. The point is that since we shrunk, the impact analysis is reduced, and it doesn't make it as visible as it was for the others. We have been shrinking now since 3 years ago, and so everything is much more manageable for us than probably it is for others to grow this. We see the same trends, but the impact is completely different.
Okay. That's great. Thank you very much.
The next question comes from James Shuck, Citigroup. Please go ahead.
Hi. Good afternoon, everybody. My two questions, I just wanted to return to the point around the attritional loss ratio at H1, so it's X the PYD and X the nat cat. If I look at kind of previous half year periods, there doesn't appear to be any seasonality around that number. I appreciate kind of second half of the year, there's more nat cats, it doesn't seem to have been the case in the past, perhaps you've grown in crop a little bit more, maybe that could be a little bit more of a drag this year. I'm just trying to get a feel for really the 61.8 attritional in H1, even if that goes up a little bit in H2.
Am I right in kind of interpreting that the improvement in rate in what you're experiencing on the claims side and the point you made about terms and conditions, that is a pretty reasonable starting point from which we should expect it to continue to improve as we look forward. I guess as a kind of related point around the net earned premium growth that you talk about in the presentation, you're guiding now towards a small reduction for full year. That was obviously down 5% at H1. Small reduction, that to me implies that maybe we should be up a little bit in the second half of the year. I'm not sure whether that's FX related or not. That might have an impact on the attritional loss ratios it earns through as well. Any help on that would be great.
Second question was around Farmers. The sort of tone of what you're saying with Farmers is sort of, it seems to be quite pleased with it. I look at the GWP growth rate. It's up 2% on a continuing basis, and that includes the Uber partnership. Policy count is actually down in H1 versus full year. The life unit business value, which was kind of meant to be a big push around cross sell, APE and new business value is also down. Can you just shed a little light on why you're sort of quite, a little bit more positive than I am on Farmers' performance in the period, please? Thank you.
Thanks, James. First of all, on the attritional, no seasonality. I think that's true in terms of outcomes. I think there are some factors that I think if you think about it from a planning perspective or a ex-ante perspective, that you would expect some. The two most obvious sources of it, you mentioned crop. Certainly in the last couple of years, the second half of the year has been a major beneficiary of, in fact, I think the last three years, we've been a major beneficiary of significantly better crop performance than planned. I think I talked about that earlier in the year, and I mentioned the fact that as we plan for this year, you're going to see about a certain point change as we move back to a more normal crop outcome.
I think crop will be slightly worse than that given the challenges in the first half and the issues around planting. I don't think it will be a big issue. The benefit that we've had from crop that doesn't look likely to emerge in the second half. I think the other thing is the presence of the peak nat cat scenarios in the second half. They do cause seasonality, maybe not for the reason you'd expect. Obviously, we have a lot of reinsurance that's running through, cat protection. The nature of that stuff is that if we have significant events, I mean very significant events, we get recoveries. If we have a more normal year, we don't get any. The reinsurance approach would tend to slightly penalize the second half in most years.
You need to offset those two things against the other things that you mentioned on the positive side of the spectrum. The improvement in rates, the terms and conditions. I guess you called it a reasonable starting point. I would be far more bullish than reasonable. On the premium side of things, that's mainly FX that you're picking up. It's the headline number versus underlying view. Of course, the actual outcome will be determined by how the market develops. Although at this stage, even if volumes were to shift in the second half, you're not going to see a big impact on the end anyway.
Farmers.
Farmers. Why are we pleased with it? From a management company first, so the fee-based part of the business, I think they're still continuing to do exactly what we expected them to do and exactly what I think we've generally guided all of you guys to expect. We did expect to see a bit more rates run through this year. They've had a bit more CAT on the exchange side, so we don't see a significant shift there on the combined. If you compare the Farmers' technical profitability today to just 18 months, two years ago, it's completely different. We do want to see them grow the policy count. We do want to see them expand more. It's a topic of discussion between us and them and how we can support them to achieve that. Everyone on this call appreciates the value of Farmers.
Between us and the exchange, we're trying to manage this for the best outcome for both of us. If there's any hint of something we would like to see improved, it would have been the thing that you commented on last. On the life side, there's evidently more work to be done there. The things that you pointed to that are strategic priorities for us around the cross-sell and the growth, we haven't seen it. We're not giving up on it. We expect the team to deliver it, but we haven't seen it yet.
Let me add something in this. We started a while ago discussing with Farmers and Farmers management all these issues that you raised, plus some others. Things have started to change. Management has been reinforced. Actions have been changed, and taken actions on the agency structure, on the project investments, on the cost basis. They're launching new products. We see these things, so we're confident that by doing the right things, the numbers will come through. I understand that you haven't seen yet the numbers as they should be, but we're confident that they will come, and we see the actions before they drive the numbers right. It takes always a bit of lag to get that, especially when you have an agency model and you have a retail business.
Okay. That's very helpful. Thank you very much.
Thanks.
The next question comes from Kamran Hossain, RBC. Please go ahead.
Hi. Just one question from me. Basically, if price momentum continues in the U.S., how does that make you think about reinsurance purchasing and the actions you've taken over the last few years? Will you still seek to manage volatility? Or if pricing improves considerably, will you then begin to retain a little bit more of that business on your own balance sheet? Thank you.
Yeah. Thanks, Kamran. I'm going to be very careful what I say now. Obviously, we expect to see the price momentum continue. In fact, we saw the price momentum start before the beginning of this year. We made some changes already to the reinsurance program at the very start of the year, especially around the property side of things. If you look at the major programs we have in place, we have a CAT program. We have no intention to change that. I don't think that's a price driven topic, that's a risk appetite issue. Even if we saw this stuff become fantastically profitable, it's not the kind of risk that we necessarily think we're the best carrier of. The other two things which are probably the most significant is we have a very large quota share on property.
We've been clear with the market when we placed that that was a risk that we seem to like less than the market did at large. On the day that things changed, we would definitely retain more of it. We certainly have an option around that topic coming to retain more. There's another large contract, which again, is relatively recent. I think probably most of you are aware we have a very large liability quota share. That's more like the CAT cover. That was intended to be a long-term commitment. It's about the shape of the portfolio that we have. It's a capital allocation topic in the end, but more from a longer term perspective than a short one. Certainly if the market continues to support us in the way it has, we would not intend to make significant shifts there.
The property topic is certainly one that I know that every time we come through the planning process and we start to approach the renewal, we have pretty intense internal conversations about what should be in that quota share. This year will be no different.
That's very clear. Thanks, George.
The next question comes from Michael Huttner, JP Morgan. Please go ahead.
Fantastic. Thank you very much. On cash flow, and by the way, well done. Really well done. That's amazing what you've achieved. On cash flow, for the first time in a while, you've given us a figure at the half year, it implies that there was $1.7 billion in the first half. Can you just explain which of your large entities have still to pay or have paid to give us a feeling for any kind of seasonality here? The second question, which is really a bit lightweight, and apologies for that. Given where markets are today, interest rates have dropped a little bit more, you seem to Oh, sorry. I change my question.
You kind of indicated that the Business Operating Profit delivery in terms of Solvency is about two points ahead where you would normally expect it, and you alluded a little bit to where it came from. Can you say what it looks like for the second half? In other words, are there any changes in those kind of numbers we've seen or those trends we've seen in the first half? Thank you.
Thanks, Michael. Maybe do the first one first because that's the easiest one. Not anticipating any significant shifts. Apologies, I think I said one to two or two to one. It's about 1% above what you would normally see is. There's no major model shift taking place currently. I don't see one planned. No reason to expect anything other than the operating profit and the ability of the life business to generate new business value will be the drivers of capital generation in the second half. On the cash flow side of things, I will resist the temptation to start to flag the people who'll be helping us in the second half of the year. They already know who they are.
We've talked in the past about the fact that if you look at last year, you see this unusual picture between the life side and the P&C side, where P&C was a bit weaker, life was a bit stronger. I expect life to continue to be strong this year. Not only will we see the operating cash generation, but we're still continuing some of those balance sheet optimization topics that we covered back in February, and you'll see more of those in the second half, very likely. The reason for giving a number today, which is unusual for us, was simply to underline how close we are to the overall goal, given that probably the conversation switches fairly soon to what does the next three years look like?
Before that, you have to decide on the dividend, don't you? The cash is the dividend. For me, that was the underlying question. I think it's top line up to you.
No. The only thing to be careful of is that the cash flow is extremely important, cash has never been a constraint, nor, honestly, a driver of the dividend here. It should be about earnings, because that's what defines sustainability for us. We have a whole system at the Group, which is designed to make sure that we convert earnings into cash in a disciplined, and ideally rapid manner. That's not the key factor when it comes to that dividend decision. That'll get made in February of next year.
Absolutely. Super. Thank you so much, and well done again.
The next question comes from Nick Holmes, Société Générale. Please go ahead, sir.
Oh, hi there. Thank you very much. Just a couple of questions. First one is, does the fall in bond yields make you more optimistic about P&C pricing? I'm very surprised nobody's mentioned it, to be honest, because surely that could be an important contributor to getting to a properly hard market. The second question is just coming to the expense ratio, still a bit high. I wondered if you could take us through your plans or remind us where you want to go on that. Thank you very much.
Thanks, Nick. Yeah, it's an important question. If you look at the movement in the markets, even very recently, we're seeing levels that we haven't seen for some time. Although, interesting, if you compare them to the levels that we based the current set of targets on, I think what you would have seen is, just a reminder, the current set of targets was struck based on yields around the middle of 2016. Europe is definitely lower, for sure. It's a bit less relevant for us in Europe, given the portfolio is typically a bit shorter duration in Europe. In the U.S., actually, it's still a touch higher. Not sure that could be true by the end of the week, but it was certainly true very recently. Of course, we have had a benefit in the intervening period from the fact that interest rates have risen.
I think the point you make is important. I think it could well be true that this helps sustain the price trend that we see for longer. I think the only caution I would signal is that one of them is a given today, the other one we've yet to see. I think it's certainly helpful in encouraging the market to underwrite in a very disciplined fashion.
Thank you. Yeah, sorry, expenses.
Expenses. You'll hear a bit of what you've probably heard from me before. You need to break apart the expense ratio. We've tried to do it in the investor presentation. I think you see the continuation of the fall in the, what we refer to as the OUE, the other underwriting expense or overhead component. That's dropped. We're at 13.7, down from 14.1. That's partly offset by two factors. One is premium taxes, which, of course, we don't entirely control, but that impact is quite small. On the commission topic, I think the interesting thing you see on commission, it is slightly higher. I think you've heard today, and you may have read in the press release, that we have some new relationships. We have access to another significant group of clients, this time in Europe actually, as opposed to elsewhere.
The commission ratio or the commission ratio component, that's driven actually by changes in Europe in the first six months. Whereas in the markets that have generally been driving it up in more recent times, typically LATAM and Asia-Pacific, their contribution is actually smaller. There is a net increase, and that's driven by more of that mass consumer business that is slightly more expensive to acquire but is typically less volatile and more predictable, and certainly just helps the overall quality of our portfolio. As you've heard before, it's a trade-off we're happy to make, and the focus of the expenses has to be in the OUE ratio, and we expect to continue that focus in the second half of this year.
Thank you, George. Can you give us any sort of quantification of those numbers? I think OUE is meant to be around about 13%, is your sort of unofficial target. Is that still correct in moving the overall expense ratio down to 31% over a period of time?
On the two things. We're looking to bring it down towards 13%. If you look at where the peer group is, we think that's roughly where they are. I think if you look at what we've still to bring in the second half, I'm not convinced you get all the way from where we are to 13 in one step. You'll certainly see a further move in the second half of the year. On the combined ratio, for the reasons I gave earlier, it's a bit tricky to be really hard and fast on the combined ratio. I mean, all things being equal, if we had done none of the portfolio change that you've seen from us over the course of the last couple of years, we would have an overall expense ratio that would be in the high 20s.
We wouldn't have the outcomes that you'd want from an underwriting perspective. The overall expense ratio will partly be determined by whether we get the opportunity to do more of this. If we see it at the right levels of return, we would do more. Our focus is mainly OUE, and we are expected to bring that down further, but probably not all the way to 13 by the end of the year.
Okay. Thank you very much. Very clear.
The next question comes from Vinit Malhotra, Mediobanca. Please go ahead.
Yes, good afternoon. Thank you. George, one question on P&C, one on Life, please. On P&C, at the Investor Day last year, we talked about the commercial business in North America targeting, I think it was 3% of improvement from HY to 2021. That was before this whole momentum or tailwind from the pricing and claims inflation came in. Would you say that they are likely to change something there? Will they have a higher or better target, or is that number already getting somewhere close, given that we've seen a big change in commercial? If you could just comment on the commercial U.S. Anything you can comment on. Second question on the Life side. There's about, give or take, CHF 100 million lower guidance effect to date for 2019 now, versus previously guided. I understand from speaking to the IR team, that's mostly FX related.
The dollar was also all over the place last year, for example. Is there anything else on Life that we should note regarding this guidance and any commentary there? Thank you very much.
Thanks, Vinit. It's a good point on the first one. Kathleen and the team have slightly overachieved versus the targets that they set at the Investor Day. Remember, there's CAT in that. There is some benefit there, although most of the CAT benefit, so to speak, actually comes in Europe. Obviously, I won't get into what we'll do at Investor Day in November. We need to have a look again at how we performed in the first half of the year. We're in that process currently of preparing the plans and the targets for the next three years, and we'll come forward with another set of ambitious goals for the group when we get to November. On the Life side, you're right. I think it's really important to appreciate that we're happy with what we see in Life.
We think the constant FX performance is pretty much where we expected it to be. The headline guidance topic is entirely driven by foreign exchange. There's also a tough comparison to the prior year. Almost half of the one-off that we saw last year occurred in the first half of the year, if you remember the FX topic around Argentina. There are always positives and moving parts, positive and negative moving parts in the business, but overall, we're happy with what we're seeing in Life. There are always opportunities to improve, and the team are focused on those, but the overall outcome is pretty much in line with plan. Great. Thank you very much.
The next question comes from Johnny Wu, Goldman Sachs. Please go ahead.
Thank you very much. I guess it's good that the shape of the business has changed and has been typified by the fact that 50% of your net earned premiums are now in specialty and property. I guess, does this trend continue to happen or do you see other opportunities in potentially commercial casualty in shifting the business back potentially? The second question just relates to your sensitivity to rates. I've noticed that the sensitivity to a drop in 100 basis points interest rates is very sensitive now as it was compared to the end of last year, where I think end of last year was about three percentage points and now it's about 14 percentage points. Is it because you're opening up the duration? Or what's going on with the sensitivity there? Thank you.
On the first one, I think it was in response to the question earlier around reinsurance. Apologies, I forget who asked it. I made the comment that some of the things we're doing are really about a strategic view of the portfolio. I think portfolio mix is one of those things. That's something a bit like almost at the asset allocation, you should expect to see that change relatively slowly in any given direction over time. We have priorities that we haven't yet achieved around some of the specialty lines, but our view is that the current market conditions are really quite difficult to support those. If we see further price move, maybe you'll see a bit more specialty move into the portfolio. Specialty for us also includes credit, and this doesn't feel at the right point in the cycle to really push credit.
Think of this more of as a strategic view. There'll be some tactical movements, but the overall goals for the portfolio remain the ones that we laid out, I think at least a couple of years ago. On the sensitivities, honestly, I need to go back and look because I don't recall a change of that magnitude. There is a lack of linearity for obvious reasons. As interest rates get compressed, you have a risk of developing higher sensitivities. That scale of change would surprise me. We need to have a look and come back to you. Sorry, Jonny.
Okay. No worries. Thank you.
The next question comes from Farooq Hanif, Credit Suisse. Please go ahead.
Hi, everybody. Good afternoon. Just want to ask one of Vinit's questions in a slightly different way. Going back to the Investor Day, you talked about a potential convergence of your commercial combined ratio. I think you commented on some 99.5% commercial combined ratio in the U.S. with big peers. Can you talk about how you see your relative positioning and profitability in the U.S. versus those peers and whether that closed gap is now sustainable and where it needs to be? Then secondly, just a very quick question on CoverWallet. I see that you're very happy with it and you're expanding into Switzerland. Can you just briefly tell us what the learning's been? Has it given you access to new premium growth or has it been an expense ratio reduction in SME? What is the learning and how far could this go throughout your business? Thanks.
Thanks, Farooq. On the convergence with peers in the U.S., I think you need to give us a bit more time to absorb what we've seen of the peer groups. Of course, one of them only reported last night. We did a lot of work ahead of the Investor Day, so we want to repeat that exercise to get a sense of where we see ourselves relative to others. For obvious reasons, we're really happy with the progress, which driven by commercial, driven by the U.S. It's a great combination. I think we need a bit more time with the peer information before I can really draw any conclusion of depth from it.
Sorry, could you have a combined ratio for the commercial as opposed to alternative markets for 1H 2019?
For the U.S.?
Yes.
We'll get one for you. We have it. It's not a state secret.
I would definitely have it.
Of course.
Yeah. Our team will come back to you. On CoverWallet is pretty new in Switzerland. I can't say much there. It's been running in Spain for a bit longer. It's still at a level where it's not so material to the group. I think most of us have seen what CoverWallet does, how it works. For me, having looked at it, what's impressive is the ability to package something for a buyer in a way that helps them make sure they protect themselves across all the different risks that they might have without them having to stitch that coverage together for themselves or to find an agent to do it for them. It's a fairly inexpensive system, as you can imagine.
Ease of use is really very high, and we have high hopes for it in Switzerland, where we're a bit under-penetrated on the SME side, and we think we have a fairly significant opportunity here. Too early, really, to draw too many conclusions.
Look, in general, the SME opportunity is so big that you can pursue it only with one solution. CoverWallet is very interesting because it allows us to contact the customers who among the SMEs who are already connected online, and they can be reached out of the web. That's a portion of the huge ocean of SME customers in Europe or in other continents. So we're also using every other possible distribution mean to reach out to the SMEs. Switzerland has an SME program which has been developing very nicely in H1, and CoverWallet is part of it, but it's not the program altogether.
Thank you very much.
Welcome.
The next question comes from William Hawkins, KBW. Please go ahead.
Hi. Thank you very much. I'm back on those Z-ECM sensitivities, please, George. Is there any way that you can give us a hint, an idea of what the absolute interest rate is that you're plugging in, around which the sensitivities are being shown? I appreciate that it's going to be fiendishly complicated and based on curves and that kind of thing, but in the back of my mind, there's going to come a point when showing 100 basis point reduction is implying that you've got significantly negative inputs across the curve, which at some point is going to sort of mean that your calculation is technically correct, but possibly economically kind of meaningless. I'm just trying to get a sense about what the absolute rate is, so what you would be at if you took it down 100 basis points.
Secondly, could you give us any kind of qualitative or quantitative update on where your Solvency II ratio equivalent could have moved? Again, the difficulty with both the ECM and the SST is they're potentially exaggerating an awful lot of these market movements. The divergence with the hints you've given us in the past could have moved on. Thank you.
Thanks, Will. On the first one, I think maybe a topic that the IR team could cover in more detail with you after the call. On the issue having significantly negative rates, obviously on the asset side of things, we will have significantly negative inputs in some parts of the model already, especially if you look at Europe. I appreciate there are other aspects of the model where you may well floor things, because in the real world, you're not going to get maybe the same thing you'd see on the borrowing side, on the asset side. Please speak to Richard and the team afterwards, and they can walk you through that in more depth.
I don't have an update at the half year around Solvency II or the potential difference between where we are now, from a Z-ECM or SST perspective and what you would have seen versus the peer group. If you look at us, I think I mentioned in the early part of the call, there's about seven points of market movement. We see that mainly as the longer interest rate in Europe and the impact that that has on some of the very long liabilities we have on the life side. I don't know to what extent we've seen that quite so much in the peer group. There would be some impact from the ultimate forward rates in the Solvency II system that would certainly dampen that more than you would see for us. I think probably that delta on its own, maybe it's a few points.
It's not so significant, I think, in the half year comparison. I think it's the starting point of the basic SST versus Solvency II framework. I did talk about the delta, I think back in the February call, maybe the May call. In the past, we've highlighted differences of up to 50 points or more between SST and Solvency II, and we think they're still valid. In fact, on the most recent data we've seen, it would be higher today.
That's great. Thank you.
We have a follow-up question from Peter Eliot, Kepler Cheuvreux. Please go ahead.
Thank you very much for taking another one. Two more if I may. Maybe just to carry on the life topic. If I just look big picture down, one thing I noticed was that the costs sort of seem to be increasing on a like-for-like basis. That's despite new business being down, it can't sort of really be attributed to the acquisition. I was just wondering if you could sort of comment on that dynamic and if we might see any improvements going forward. The second thing was, I was interested, you flagged IFRS 17 costs of $50 million-$100 million in H2. I'm just wondering if you could comment any further out or in terms of total costs or if you've done a sort of analysis of anything you might expect in the future. Thank you.
Thanks, Peter. On the cost side of it, you've seen most of the benefit flow through the P&C side. There is some benefit that's partly obscured because some of it gets shared with the policyholder, some of it falls to the shareholder. In the second half, I think if you look at it certainly from an operating profit perspective, you will see the impact of, for example, some of the integration, what we're doing in Australia. We do have a synergy goal there, and that will show up on a like-for-like basis with the Australian business in the starting point. The main focus for us has really been on the P&C side and plan to drive most of the expense improvement through there. You have seen life improve certainly earlier in the time series.
IFRS 17. I'm glad we're only talking about costs and not the project itself. Having said that, it's probably worth giving you a sense of where we are. In fact, today is the first delivery day for our tier 1 entities and our first practice run of IFRS 17. We're actually having the companies report up today as we speak. I don't know that the numbers will make too much sense on the first go around, but we have plenty of time to perfect them over the course of the next year or two. We haven't given a total cost number, but we're running between $50 to $100 pretty much every year this project runs currently.
Which is one of the reasons why we're keen to see the whole conversation come to an end and for the thing to get adopted so that we can all start to understand it together and move on. It's extremely expensive. Unfortunately, while it does have benefits, I am not sure they will outweigh the costs.
Okay. Thanks a lot.
We have another follow-up question from Michael Huttner, JPMorgan. Please go ahead.
Fantastic. Thank you so much. In Farmers, you have a surplus ratio, which I think is better than your target, 41%, an improvement of $200 million over the event of $5.7 billion. What can you do with that money? How does it benefit you, given that the growth is still relatively modest? Thank you.
Unfortunately, Michael, that's not our money. That belongs to the exchange. That's their surplus ratio. The one thing I would point out is the exchange has been a big buyer of reinsurance. The capital strength means that they can retain more of it, but in essence, any benefits that flow from the management surplus really will accrue to the exchange and not really to Zurich.
Yeah. Absolutely. Cool. Thank you so much.
Thank you.
Okay. Thank you very much, everybody, for dialing in. If you do have any further questions, please don't hesitate to call the investor relations team. We'd be happy to take any other questions that you might have. Thank you very much, and goodbye.
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