Ladies and gentlemen, welcome to the N1 Results 2018 Conference Call. I'm Cher, the Chorus 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 Q and A session. 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.
Thank you. Good morning, good afternoon, and welcome to Zurich Insurance Group's full year 2018 Q and A call. On the call today is our Group CEO, Mario Greco and our Group CFO, George Quinn. Before we start with the Q and A, can we kindly ask you to keep your questions
to a maximum of 2?
And if we have time at the end, we'll obviously come back round to you for further questions. And with that, I'd like to pass over to Mario to make some introductory remarks before we start the Q and A.
Good day, everybody. Thank you very much for joining us. Before we get into the Q and A session, I just want to provide you with a few remarks from my side. First of all, we're very pleased with our full year results. They demonstrate further progress against the targets and the priorities that we outlined in November 2016, and they have been achieved despite a challenging financial market in the latter part of the year and continued elevated natural catastrophe activity.
Particularly pleasing has been the strength of the results in our Life business, Even adjusting for positive foreign exchange movements, they increased by 23% year on year. The results also show the high quality of our Life business. 90% of revenues are coming from either technical margins or fees and loadings, and there is very little reliance on investment results. This underlines the success of our consistent strategy of focusing on protection, unit link and corporate products. We continue to execute on this strategy over 2018, where 86% of APE came from these products and 100% of new business value was from those products.
Our Property and Casualty business also performed well. We saw an improvement in the accident year command ratio. This was driven by improvement in the accident year loss ratio with our commercial business also seeing improvements in very tough market conditions. Our reserves remain strong as demonstrated by the continued positive prior year development at the slightly above 1 or 2 point guidance. As in 2017, 2018 demonstrated the effectiveness of our underwriting with the below natural share of elevated natural catastrophe events in the U.
S. Investment income in property and casualty has also stabilized as the reinvestment yields have continued to improve. Looking forward, we expect our underwriting performance to be upper end of the 95% to 96% range as the impact of business mix shifts, rate increases and expense reductions continue to earn through. Farmers has continued to demonstrate solid growth in their chosen areas and in their ability to innovate with new business offerings like the commercial rideshare business with Uber and like Togol, which is insurance on demand, quite successful last year. Their customer focused strategy has also continued to drive improved customer metrics.
And this has been achieved with an improved underwriting performance. After many years, Farmers has a double digit combined ratio, and we're very proud and satisfied with that. These trends should continue to support growth in Farmers Management Services. Our balance sheet is strong. The Z ECM ratio is at 125% despite the impact of financial markets in the latter part of the year.
And this reflects the strong operating capital generation within our businesses. Importantly, we continue to turn this capital generation into usable cash to the group with $43,800,000,000 of remittances in 2018, bringing the cumulative total over the past 2 years to $7,500,000,000 which is well on track to exceed the $9,500,000,000 target for the end of 2019. This ability to generate cash underpins our dividend, which has been increased by 6% to CHF 19 per share, and this represents a 76% payout, which is in line with our stated dividend policy. 2018 has also seen us continue to deliver against our key strategic priorities. We have further strengthened our leadership positions in the faster growing regions in Asia and Latin America, And we have built out our leading position in the fast growing traveling assistant business through targeted acquisitions while also continuing to build additional distribution partnerships.
We have continued to invest in innovation. In 2018, we had the inaugural Zurich Innovation World Championship, which saw a wide range of interest covering all aspects of the insurance business with the winners announced last week. We look forward to working with the winners to bring new and innovative solutions to our business. We've also continued to roll out other innovative customer offerings with the launch of our first application under our cooperation with CoverWallet, the launch of Clinc, an innovative provider of on demand coverage for personal possession as well as announcing a strategic collaboration to use Snapsheet's virtual claims technology across the group. These initiatives will help ensure that our customers benefit from simpler interaction with our businesses in greater levels of customer service, while delivering very greater levels of efficiency.
Overall, these results in development give us confidence that we're well on track to fully deliver against our current targets and position us well for the next phase of our development, which I look forward to presenting to you later this year, actually in November in London. With this, I would pass back the line to you for Q and A.
We will now begin the question and answer session. The first question is from Peter Eliot, Kepler Cheuvreux. Please go ahead.
Thank you very much. The first question was, I guess, on the sort of the underlying earnings that you're seeing. I mean, there's lots of moving parts in the numbers, including some positive one offs. But considering the sort of a high level of nat cats we've seen and restructuring costs, I my sort of calculation of sustainable earnings gets me to a couple of €100,000,000 higher than you reported. I mean the fact that you've reported a dividend or opted for a dividend close to 75% of Neas kind of implies that you think Neas is a good estimate of the sustainable run rate.
I'm just wondering if you could sort of comment on that or whether I'm having too sophisticated. The second question is on the impact of the P and C portfolio mix changes. And we've seen a commission ratio hike of 3 percentage points over the last 3 years, which just seems quite a lot to me. And I'm just wondering if you can sort of give us some clarity numbers around sort of the proportion of the business and the extent to which that's driving it. So I guess, we'll continue to drive it.
And I guess, your guidance is flat P and C premiums next year on the back of the portfolio mix change. I'm just wondering if you can sort of say when we should expect to see the end of this and when we could maybe start to see premiums starting to pick up? Thank you.
Peter, thanks. It's George. So on the first one, we actually have a slide in the investor deck today. I don't recall the precise number, 9, 10, something like that. In that, we've tried to break out both for last year and for this year.
What we see is the, I hate to use the phrase, underlying earnings, but certainly if you take out some of the obvious one offs. So and as you may have seen from that slide already, we would see it substantially higher than just $200,000,000 There's 2 obvious things we would adjust for. So one is the extra point in nat cat that we have in the year, so a bit more than $260,000,000 And the second thing is the element of simplification that we have within the operating profit. If you adjust for both of those, you get a number that's
a bit north of $5,000,000,000
for operating profit. There are other items that are one offs. So for example, I'm sure you're aware from the conversations with the IR guys today that there are certainly one offs in the life results that are positive, but equally you'll find other one offs negative, for example, around hedge funds. So we tend to net the rest of it to pretty much 0. So if I was doing the normalization calculation, I'd be adding back something between $400,000,000 $500,000,000 as opposed to $200,000,000 dollars On the second point around the portfolio changes, maybe we covered that a bit at the half year and the picture hasn't really changed so much from then.
I mean, obviously, it's driven by we've talked about 3 things at the half year. So we have the travel business of Carbonmore. I think as everyone knows, that's a pretty high acquisition cost business given the characteristics of the type of product and the low volatility nature that it brings. 2nd was the Finance and Insurance business in the U. S.
So that business grew pretty substantially in the first half of the year. So that was just a driver of that 1.1% increase you really saw in the first half of the year. And then, of course, LatAm, where we've been pretty successful in finding new distribution agreements, particularly on the retail side in Brazil. That's also exerted some upward pressure on the acquisition cost ratio. I think I don't expect it's going to change markedly in the very in the short term.
I think the one thing to bear in mind though is that I mean, we don't obviously don't normally look at the commission ratio. What we're trying to say whether we like the business is the overall performance. So for us, I mean, if we do have to trade a slightly higher commissioning ratio to further improve the characteristics of the book, I. E. A better margin with lower volatility characteristics, that's something we would continue to do.
I don't immediately see that in our future, but I mean, I couldn't entirely rule it out. So I mean, for me, I think you need again to look at the overall technical performance, and we've talked before about, I mean, over time, I expect to see a trade between the loss ratio and the commission ratio.
Thanks a lot. And in terms of some of the overall premium volume, when we might just start to see that tick up? The pressure from portfolio mix go away?
So on the third question. So for us, if you look at what happened last year, I mean, the trend that we've been on, I mean, it's actually continued. Probably the reduction in commercial slowed down a bit. So we dropped by, I mean, very low single digit. The retail portfolio, I guess, you understand the definition of retail for us, so it includes SME and the higher volume commercial type exposures, I mean, that's growing at a level that's, I mean, closer to double digits.
We have bought more reinsurance. We talked about it during the course of last year, especially around casualty. So that obviously has some impact to knock back that higher gross rent premium. At this point, in terms of the large deal reinsurance that we do selling on a core share basis, I don't expect that we're going to be changing that in the short term. So I would expect that this year flattish.
I mean, there's a possibility if we can find the right opportunity on the retail side, we would grow. I think the challenge is, I mean, the market on commercial, I mean, it's a bit hard for us to imagine today that just given the profitability characteristics that that's a part of the portfolio that would be a high priority to grow. Well.
Next question is from Andrew Urichi, Autonomous. Please go ahead.
Hi, there. First question just on pricing. I just was looking for a bit more granularity, mostly in North America. Some of your competitors have been sort of focusing on rate increases ex workers' comp. If we accept that workers' comp is soft, but the claims environment is also soft.
But to be ex workers' comp, I'm interested in what rate you're getting on the problem lines, which continue to be, it seems, a lot of liability lines and particularly commercial auto. So what kind of rate you're seeing in that and whether that's moderating or still hard? And the second question on reserves. I note that for this year, the group reserve release is a bit higher than that from the divisions. I'm assuming that is partly to do with the 2017 cats, which would be collected at the group reinsurance level?
Or is it something else going on? And linked to reserves, which may be linked to my first question, the U. S, North America had a fairly weak or weaker PYD in the second half of twenty eighteen versus last year. Was there some strength in the gain of commercial auto in that line? Thanks.
Yes. Thanks, Andrew. So on the first one, pricing. In the pricing dynamic, I think we talked, I mean, certainly earlier that I mean, we anticipated that things would probably slow down once we were through the renewal of the loss affected accounts. If you look at the U.
S. In detail, if you look at it from the full year perspective, I mean, we see the U. S. Markets pure rates. We can come on to loss cost inflation in a second, a bit north of 3 points, almost 3.5 points.
And through the year, I mean, it was pretty stable through the 1st three quarters, has dropped off a bit on Q4. So we are beneath 3% in terms of rate increase. Within it, I mean, property has come down to that, so we are above 2%. If you look at commercial, so today, Molter is the one that you asked for. I mean, since Q2, Q3, Q4, pretty stable.
So we're seeing it in the high single digit range. And as you point out, workers' comp is a bit soft. So despite the events of last year, workers' comp is changing a very profitable line, and there is more competition there. But the rate that we see on commercial auto seems okay for us at the moment, albeit it still does require some portfolio adjustment to try and drive out the kind of returns that we need. From a claim perspective of an inflation perspective, which, of course, is a really important partner to this, so inflation around the commercial auto line still fairly high.
So maybe not as high as we saw it last year, but I mean, it's still well in the mid single digit range. So the rate at which the margin is expanding is considerably less than maybe the headline rate would apply. And it certainly doesn't make it anything like attractive enough to want to jump back in with both feet. Other workers' comp is soft. The inflationary stats around the claims side of workers' comp are still very benign, to put it mildly.
So I mean overall picture, things have slowed down a bit, which is entirely what we expected just given the way the portfolio was renewing. And I think as we look forward, the pricing trend by line of business is going to probably be quite distinct. So the broad market move in response to the a bit of the claim expense of 'seventeen, I think, is this thing is largely behind us. On the reserve topic, so why do you see a good reserve release? So it's a combination of factors.
I mean, so for example, things like the EL transaction that we did back in December, we held some additional reserves around that line of business up top. And obviously, given that it's going, that's no longer required. There was a small difference between the way the Group RE was seeing things in some of the countries, and we held a Prudential margin. We've been working on that over the last couple of years. We've reached the level of comfort that allowed us to remove it.
I don't think it's the cat topic. I mean, cat is mainly embedded in the local business. We didn't I don't think we had anything significant uptool on cats. U. S.
Experience in the second half on PYD. I mean, nothing really to point out there. The I mean, probably the only thing we did do in the reserve in the second half of the year around the U. S, we did our normal detailed review, I think, around I think it was already ended Q3, but of course, given we
don't have Q3 numbers that
have been visible externally, but the workers' comp business was very strong. By and large, we've taken the opportunity to strengthen more recent years, both on workers' comp and on liability more generally. But I don't recall commercial auto being a particular topic in that regard.
And just to round off, so we're not misinterpreting. I mean, you say you the Prudential margin, I think, was the language you used at the group level, you felt you no longer needed, but presumably there still is a Prudential margin of some guidance or?
Yes, absolutely. So to be very specific, the Prudential margin related to that 1% raise. So the overall group reserve strength, as we assess it, from beginning to end of last year, there's a sale of the same percentile.
Okay. Great. Thanks very much.
Thank you.
Next question comes from the line of James Shuck from Citi. Please go ahead.
Hi. Good morning, good afternoon. So I had 3 questions, but I'll restrict it to 2. But if you don't answer the first one, then can I ask a replacement?
Okay. Keep going then, James.
Well, first question, I'm just interested in what the absolute combined ratio was in both crop and workers' comp, please, for 20172018? For workers' comp, ideally, I'd like the workers' comp ex PYD. So that's my first question. Perhaps you could tell me if you're going to answer that one. If not, I'll choose a different one.
All right. So I'm not just to save your time. I mean, I'm happy to give you color around it, but I'm not going to get into the very detail where you asked for it. So I'll give you half a question. I'll give you half an
I'll replace it with half a question as well. Go ahead with the color then, please. Thank you.
All right. So the if you look at all of last year, crop, another strong year for us. I mean, not as strong as it was in 2017, not quite as strong as some of the figures I've seen from competitor disclosure. So I mean maybe we are 6, 7 points better than we would ordinarily expect to see the business run at. So I mean that clearly has benefited the performance, but it's not at the level that we saw in 2017.
Workers' comp, I mean, nothing particularly special to point out. I mentioned in response to Andrew's question that we did move the sales around a bit. The line still seems to throw off quite a bit of positive development. And to the extent that it's reasonable, we're trying to hold that back in the more recent years. So PYD, I don't actually have a figure for PYD for workers' comp in my head.
But I mean given what we did, I think you could assume that on a net basis, it would be some positive point, not very large.
Okay, great. Thank you. So my other questions then were just on the so on the combined ratio and the kind of guidance towards the upper end of the range, so excuse me, the 90 6% in 2020. So
I mean it
looks like you're normalizing in 2018 around 97.2%, if I give you the benefit of the one offs for expenses. So you got at least 1.2% of improvement to come. Expense delivery is about 75% done. It looks like most of that improvement is set to come from commercial lines, just given the starting point for retail and other. Can you just elaborate a little bit about your confidence in achieving that?
We've seen recently rate is slowing. Some of the peers in the U. S. Have been quite cautious about a guidance for next year. You're likely to get some headwinds on workers' comp.
So perhaps you could just expand a little bit on where that improvement is coming from. And I suppose kind of linked to that, are you is kind of that top end of that range, is that including 1.5 points of PYD? Or is it including a different number? Because I think you normally guide to kind of 1 2. 2nd question, just really a quick one.
This is smart.
I just wanted to understand what the potential is for you to do share buybacks because you have a Z ECM range, you have a target range of 100,000,000 to 120,000,000. We've seen some volatility in Q4. That volatility would have reversed. The range you have should allow for that volatility. And obviously, you've got other binding constraints such as S and P and what have you.
So it does seem as if you're running with a level of capital that is kind of above where you need to be. You did do a buyback quite recently, but it was anti dilutive. Could you just help us understand a little bit whether 2019 is a possibility for a buyback or whether is it more of a medium term question? Thank you.
Thank you.
So that's a complex, multi nested question. So I'm going to start on a high level and then maybe we can descend into a bit more detail. So I think the way that you had looked at things, so you normalize, you come out around 97.2 percent. You pointed out that we had a sustained delivery anticipated this year, which is absolutely correct. I'm not sure that it would be completely reasonable to assume that it's all going to drop into commercial.
I mean, just given the areas where the expense action is taking place this year,
it's certainly in a what
I would describe as one of our more retail heavy regions. So I would expect you'd see expense improvement on both retail and commercial. Having said that though, the 97,200,000, I guess, is connected to the PYD topic. So back at that's again whether it's half year or the Investor Day now. We guided that I mean, just given the pressures that we see, I mean, the positive pressures for the avoidance of doubt, we would see PYD around the upper end of our guidance.
And that's what I anticipate we'll see in 2019. So if you're trying to look at underlying, I agree that the 2.3% that we've seen for 2018 is maybe a touch high, but I wouldn't knock it all the way back to 1.5. And in fact, just to keep math simple for me, I'd point knock it back to about 2. If I do that, then I guess compared to you, I'm ending somewhere around the May 7 for the year. And of course, you guys know where we were at the half year, which was roughly 97.5.
Percent. So I mean the calculation of what the second half must have been is not so difficult. So I mean I would see us running as we leave the year somewhere in the mid-ninety six percent. Now that clearly still requires further delivery to get us to what we need to get to. Expenses will be the largest part of that for sure.
But as far as the market conditions are concerned, I mean, we haven't planned. From the very beginning, we never planned that the market would be a positive driver here. I mean, looking at it did come back to the answer I gave Andrew on pricing. If anything, I mean, if there was margin expansion, it's narrowing because of this reduction in the headline rate and maybe inflation picking up slightly in the loss costs. But I mean, it's not dependent on for us.
We've demonstrated that we are completely focused on profitability. We would obviously like to expand the portfolio, but that's only possible when we can achieve the right returns. And if we can't achieve the right returns, we've also demonstrated that we're prepared to take capital away where it's required. So I mean, we still have work to do this year, but it's not 97.2 to 96. Percent.
That's very helpful. Thank you.
On the capital topic and volatility, I mean, so you're absolutely right. We see it the same way. The range that we have already and the target capital range is designed to address volatility. We've got a bit of it in Q4, a bit more of it than maybe we expected. Some of it is actually self inflicted.
So there's a piece of it, which, of course, is the market, which everyone can see. We actually made a better model change at a time when, I guess, we thought we were richer than we ended up being. But I mean, we still end up in a very strong place. And I think even if you were conservative today, you pointed out at least a couple of points back. So capital is good for us.
So what does that mean? We've obviously just made the decision for the immediate future around capital. So we're not coming forward with a proposal there. I mean, our priorities are pretty much unchanged. We have an acquisition which will close at least, to the best of our knowledge, at this stage, sometime around the middle of the year.
So that will be a piece of it. And we would still prefer to try and use the capital to support organic or inorganic. But again, if that's not possible, I think we will look at alternatives. So I mean, we don't rule anything out or anything in at this stage, but I mean, we have some short term uses for some of that capital.
Thank you very much.
Next question comes from the line of Michael Huttner, JPMorgan. Please go ahead.
Fantastic. Thank you very much. I listened also to
the lovely Bloomberg video this morning. Now struck by 2 things, the focus on delivering and on cash flow and dividends, of course. On cash flow, the EUR 3,800,000,000 can you maybe walk us through a potential like waterfall sales? Because it looked like if
you normalize
for the various items that you have in the box and calculation of the EUR 5,000,000,000 or just to get a feel for where we might be including the 1 plus deal. That will be hugely helpful for 2019. And then the other question is on a different topic. And probably you're asking a completely wrong question, but I noticed and I may be wrong, but there's low nat cat protection or higher expected nat cat weigh on the solvency ratio by about 2 points. And I wonder how that squares with your aim to be to have less volatile earnings and maybe reverse to the 3% in terms of expected nat caps?
But yes, thank you.
Thanks, Michael. Apologies in advance, but I can't give you a forecast for 2019 for cash. I mean, you've seen today that we're well ahead of the implied run rate. We have a number of items that are 1 off positive, 1 off negative. But I think I mean, in comparison to last year, I think when we guided people down around cash to maybe around the 3.3% mark, I don't think I would do that today.
I mean, we've had some for example, I think people are aware that we have the impact at least partially of the hurricanes in 'eighteen. So that pulls down the P and C number. We've also got some, let's call it, optimization we did around the Life businesses. So the cash flow there is very strong, but I mean you can assume that worst case those two things offset each other. So I mean very strong delivery on cash last year across the business.
What could it look like this year if you think of what happens with OnePath? So OnePath timing, of course, is really important here. So if you go back to when we announced the transaction, we were pretty transparent around returns and around cash flows. At this point, I mean, again, to the best of our knowledge, it's likely to close around the middle of the year. But I mean, to be completely frank, we're not entirely in control of that, and it depends on a relatively complex operation that's taking place on the other side of the transaction.
And also one thing that's different from what we had before, I mean previously, we had the restructuring quarter in the old year, and then we have a clean run-in the new year. We're going to have a better the restructuring of OnePath also this year. So mean, I expect it does close in the middle of the year. It will be positive, but I wouldn't take the guidance that we gave back in the investor presentation and simply prorate it. But I mean overall, I'm very happy with where cash is.
It's clearly not an issue for us. The group has done a great job on extracting the earnings as cash from all of our businesses. On the nat cat topic, so well supported, you're absolutely right. So this is small pick up. It's not such a small number, we turn into capital.
We actually have a we've got a small retail business that has expanded slightly its exposure to nat cat in a particular area. And the amount of premium volume involved, I think, might surprise you if I give it to you. But I mean, consistent with the commitments we've made before, I mean, we have bought more nat cat coverage in 2019. We're in short looking to raise our exposure to nat cat. And in fact, I mean, just given the general pricing trends, I guess, what you hear from players that are maybe more expert in that area than we might be, I mean, it's still not an area where you would want to expand capacity.
So I mean you can assume that through the course of this year, I mean we're not looking to grow it, and there's still the possibility that we might shrink the exposure that we have further.
The next question comes from the line of Farooq Hanif, Credit Suisse. Please go ahead.
Hi, Fabrice. Thanks very much. There's more of an emphasis in your presentation and also Mario in your initial comments on innovation now. So you talked about Snapsheet and CoverWallet. I was just wondering if you take this in a package with the improvements you want to make in commercial in the U.
S. So looking beyond 2019, where consensus is already quite close to 96%, kind of thinking, I mean, are you sort of happy with the idea that there are further improvements in profitability that can be achieved from this innovation and from still moving the mix in the U. S. So just qualitatively, can we expect better from the combined ratio going forward? And the last sorry, the second question is on your reinsurance.
I'm looking at Slide 38 where you give the program. I mean, it looks like you've actually made few tweaks. It's more kind of out of the money protection. If you could just comment on that, that would be helpful. Thanks.
On innovation, I think we mentioned it because it is becoming relevant for us, but not necessarily to improve combined ratio in U. S. But if you look at, for example, Cover More today, Cover More came short of $900,000,000 of revenues last year. So it is becoming sizable and it keeps on growing and we're sure that growth would be very strong in 2019 too. So we want to put a light on that because this is starting to become visible.
The biggest source of growth that we had in Spain this year was through CoverWallet and SMEs. And that's why we thought also to extend this into Switzerland starting this year. And again, this is why we mentioned it, Not just I mean, it didn't move the combined ratio, but it is becoming a relevant source of growth and possibly stronger in 2019. Snapsheet, we have an agreement with them to use them in Europe. So we don't plan and we I don't think we can even use them in U.
S. But we are quite interested to see if that can help improving service and eventually cost of claims in Europe. So we mentioned them because they're becoming relevant for us. And we want you guys to get familiar with and to start also looking at the progressive numbers that we achieve on these different innovations. But none of them, frankly, is strictly impacting the combined ratio in commercial U.
S, which is more, I think, benefiting from the portfolio shifts that we have been making over the last 2 years.
Farooq, on the reinsurance topic. So you're right, there are some changes. I think I in a very quick way, I trailed some of them at the Investor Day. So I mean the global cat treaty stands out. We've increased capacity under the global cat treaty.
We've actually put a cover in place. It's an April 1 renewal, but we anticipated the capacity increases have changed already at the end of last year. And that's obviously connected back to the conversation I had with Michael earlier on the rise in some of the incoming cat exposure. Beyond that, I mean, we have a number of things that I mean, I'm not sure I'd said it was tactical, but we talked before that in fact we do have a pretty significant quarter share across the liability book. The intention is that, that will be a long term relationship.
We view it as strategic. And it's not about the performance of that particular book. It's about the mix that we retain. We've tweaked a number of other things. So we have a financial lines program in place that we've tweaked.
I think I've talked before that we have an aggregate cover that we put in place back in early 'sixteen, and that was aimed to try and contain some of the volatility that we had suffered from previously. For a variety of reasons, we've never really come that close to actually triggering that contract. And we've restructured that with a panel of reinsurers starting this year to try and bring it a bit closer to the money and maybe work a bit harder for us. General conditions, I mean, the market is I mean, we're seeing I mean, attractive pricing, so risk adjusted, we are paying same rates as we've paid before. And in general, I mean, we would continue at the margins to buy a bit more reinsurance cover just given what the market currently offers.
That's what we did on reinsurance.
May I just come back? Thank you for that. Can I just quickly come back on the first point? So okay, so I get it that your initiatives are more about service volume and capability. But in the U.
S, quite apart from innovation, clearly, Kathleen set out some ambitious targets for commercial, indicatively bringing that combined ratio down by 3 points or so. So just again, just more generally, beyond the 96%, do you think there's more you can do?
Yes. But remember that the combined ratio also depends on market conditions, right? So is the market going to remain as it is today? Is the market to harden, to soften? Let's now make combined ratio forecast for 2021, 2022 today, right?
I mean, let's get to the end of the year, see where we are, see where the market is, and then we reassess it. But fundamentally, what we have been trying to do in U. S. And also in UK is shift the books out of the upper end of the global corporate customers and the big exposure to long tail liability into the more stable and usually more profitable specialty property business and more towards mid market and SME. That brings a lower and a better combined ratio over time.
And this still has to progress and deliver results in 2 years of that, definitely not enough to measure. Although we see movements and improvements in income ratio, it's still too early because the books haven't low development and these are long term businesses and takes a while to get rid of them.
Thank you very much.
Next question comes from the line of Nick Holmes, Societe Generale. Please go ahead.
Hi, there. Thank you very much. I just wanted to come back on the expense ratio to ask how concerned are you that softening U. S. P&C pricing is going to make it more difficult to reduce the expense ratio?
And secondly, is there scope to take out more costs? Because the expense ratio is, I think, still pretty high. And I'd be interested in your comments on that. Is that something that you would disagree with? Thank you.
Thanks. So on the pricing expense ratio interaction, so I mean, we decided at the start that we would not set a ratio target because it can lead you to do things that have got nothing to do with expenses. And we thought it was clear for you and for everyone within the company that we set a level of resource that we're prepared to allocate to what we do. If P and C pricing softens more than we anticipate today, I mean, that may put a bit of pressure on the ratio, but it wouldn't immediately change our expense plans. I mean, we have a plan in place today across all of the businesses, across the corporate center.
And the number one priority is to make sure we deliver on that thing that we have absolute control of. I think just generally on the P and C pricing topic, I gave a fairly detailed answer to Andrew earlier around the various pricing trends. So I mean, at this point, I don't see it going negative in the short term. But I mean, we don't control it. And it's possible.
But I mean, at this point, it's not something we assume that it's going to impact 2019. On the second comment around is the scope to take out more the perspective that maybe our expense ratio is still high. I think when you look at expense ratio, the thing I would encourage everyone to do, we do it internally. I mean, we obviously, we compare it to peers and competitors in the different markets. Ordinarily, we don't break out the different components.
So there's an acquisition cost ratio in there that's not traditional expense per se. There's also depending on the practice of the company, some things are in premium tax, potentially they include it, potentially they don't. And then you have a core part, which I think is generally more comparable, which is, in our case, the OUE ratio. I mean, the OUE ratio would suggest, I mean, we still have other room to drive efficiency, but nothing like the extent that the headline expense ratio number might suggest if you compare it to the headline numbers of peers and competitors. I mean, we've made a huge step over the course of the last couple of years with 1 more year, too.
Okay. Can I just very quickly follow-up with the OUE ratio, I think 13% was you indicated your sort of target? Is that still the case? Presumably it is.
So the we didn't give a target. No. That's an indication.
We
have 55 different targets that we have to achieve across the entire. But I mean, what we said today is that if you look at and you allow for the one offs, we're about 13.8%. I mean, you guys know how the expense ratio or the efficiency benefits typically fall across the business. And I mean, you can relatively rapidly work out where you would expect that to land. But I mean, we haven't set a target for expense ratio.
We set a target for cost reduction, and that's what we are focused on this year.
Okay, very clear. Thank you very much.
Next question comes from the line of Vinit Malhotra, Mediobanca. Please go ahead.
Yes, good afternoon. Thank you very much. So one on the Life
guidance really because you remember, George, last year, we were discussing about a mid low to mid or mid percentage growth number. And even if I clean up for this 125% one off this year, we're at a very healthy 14%, 15% growth. What's the I mean, is there a sort of conservativeness in your thinking about life that or could we have another repeat year of a good or at least better than expected number for Life? That's just on the Life guidance. And second question is just on the attritional loss ratio.
I mean, the 2H number being below 63, I'll have to go back quite a few years to get that kind of sub-sixty three attritional. Is there something that is worth flagging on maybe to just one business had a very good second half? Or can we get a bit more excited about this line going forward? Thank you.
Yes, it's actually the so on the Life topic, I'm conscious I'm now about to talk down something that I think had a fantastic year, whether you include the one offs or what are you doing? The Life business for us has been going great. And I mean, we did give guidance around the middle of the year around that underlying number. And of course, at that stage, we knew already we had some one off in the number. In fact, we talked about it back at the half year results, principally around the foreign exchange effects that we were seeing in LatAm.
Could we have a better number than the one we guided to? I mean, it's possible. But I mean, I think we're trying we're not trying to game you. We are trying to give you a realistic sense of where we expect it to land. And I think the I mean, where there may be differences between us and what people are assuming, I think probably the larger issue is going to be the timing of 1 pass.
I think I mean, we tried to indicate broadly when we expected that to close back at the Investor Day in December. I mean, today, I don't know anything more around the middle of this year. If it closes earlier, which I think is unlikely, maybe that could have a different impact. I mean, so far at least that day has been slipping rather than accelerating. So we're trying to gauge you to what we actually expect rather than to give you a full sense of the underlying.
And if you look at what we required for the Life business to achieve what we've indicated, that's still pretty strong growth over the underlying performance of 2018. On the attritional, I mean, is there something in there that we should get really excited about or something we should isolate and change. I think, again, I said in relation to I forgot his answer to his question that was answered earlier. I think it was James, and he talked about the how he saw the underlying number for the year. I think it's important because of the connection between some of the elements that we run.
So we talked already about the impact of acquisition costs versus loss. I guess some of you learned today there's also connection in the expense topic and the loss ratio. I'd look at the whole thing in the round. If you look at the second half, I guess I gave commentary to James earlier that gives you a sense of how we see things. I mean, there are certainly elements of that, that are better than we would expect to see continually in the future.
Crop would be one example. But at the same time, there are elements of it that are not as good as I would hope to see them in the very near future. And one of those examples would be Financial Lanes in one of our key markets. So I think it's a reasonable starting point as we enter into 2019. Be a bit wary of crop seasonality.
I mean, it's not going to have a big impact on this. We just need to continue on the path that you've seen from us to deliver on that combined ratio topic that we discussed earlier.
Okay. Thank you very much.
Next question comes from the line of Toni Ulwin, UBS. Please go ahead.
Hi, there. Thanks. Just one for me. So just on P&C, I mean, we can clearly see the underwriting improvement coming through now. And I know it's work in progress.
I know there's some good bits, some less good bits. But I just wanted thinking on a longer term view, how happy are you now with the quality of that U. S. Commercial book? And in your minds, where are you on that re underwriting journey?
I'm not talking about just on the way to the 2019 targets. I'm just thinking, big picture, where do you want to get this business to and basically where are you now?
Look, we are the way we're looking at U. S. Is we need to still continue strengthening our capabilities of mid market. We did something over the last 2 years, but we will continue this in 'nineteen in the next years. Also, we are improving the underwriting strength that we have, especially in U.
K. And U. S. By that, I mean that we are improving the programs we have for underwriting, the attractiveness we have for good underwriting. At the end of the day, in U.
K, in U. S, we compete for the best underwriters, and we have to be able to stand high in that competition. So it's a journey. We're not satisfied. There is more to come and there is more to do in U.
S. Also. And the team there knows it very well. And the programs that we have for 2019 and next years reflect that.
Okay. Thank you.
I think it's worth adding, Johnny, that I mean, you probably saw at the Investor Day back in December, but Kathleen outlined pretty clearly there what our ambition was for that business, and that's a very substantial improvement over where we stand today.
Yes. Okay. Thanks, guys.
Next question comes from the line of John Nivu, Goldman Sachs. Please go ahead.
Johnny?
Mr. Vo, your line is open.
Hello. Can you hear me? Sorry.
Yes, sorry. Yes, sorry. Just a couple
of quick questions. Just the reserve redundancy that you've built in ZIC or the reinsurance group reinsurance business has been quite substantial over the years. So I know that you're talking about the upper end of the range in
terms of reserve release,
but are we going to see reserve you just running down the reserves that you've built up centrally over time? And how long are we expected to do that? Or will that just come through your assessment of the reserve strength of the underlying businesses as a whole? First question. And then the second question is just in terms of M and A.
I mean, obviously, you've done a lot of transactions. You filled in a lot of gaps. Are we coming to a natural conclusion in terms of the M and A activity that you've been undertaking? And then know that you've spoken about capital returns, but how does that feed into if I look at your balance sheet, there is a bit of balance sheet slack. How will that translate into potentially capital returns to shareholders?
Thanks, Johnny. So on the reserve redundancy topic, again, I think it was Andrew's question from earlier, it would be a bit disturbing if all that we did around PYD is simply drain the reserve strength of the group. And you can imagine, I mean, not only would we would I not want to do that, there's a number of controls in place that even if I did, would stop me. So for example, this is a topic that we spend a lot of time with the group Audit Committee. It's a responsibility of the group's chief factory.
We have a policy around where we target in terms of percentile and the reserve range, and there's a band around that. And if we wanted to deviate from it, that would require approval. And I think I've tried to comment both this year and last year, and I try and do it fairly frequently that I mean when we see the effects of reserve release that we saw last year, that did not come at the expense of reserve strength. And in fact, I mean, this is an internal company measure, so I appreciate you need to take it with a pinch of salt. But if we try and measure as objectively as we can the reserve strength at the beginning of the year and the end of the year with everything and including all of the prudential margins that we have, we're in exactly the same place.
Okay. So we just do not intend that, that PYD comes at the expense of some additional future risk. On M and A, I mean, I think it's important to recognize that on M and A, we've not only filled in many gaps, we've also addressed some positions that just didn't make sense for us. So you've seen us certainly up to the ANZ deal, I mean, essentially, dispose or release capital in roughly the same amount as we had invested. That's a process that for us is probably continuous.
I mean, we continue to look at the portfolio on a regular basis. I mean, to ask whether or not it fits with strategy, whether we the market is offering the right types of returns, we have the right types capabilities in place. If we don't, you'll see us do what we've done in the past around Morocco, Taiwan, the annuity business in the U. S. And the U.
K. And I think, I mean, you all know from prior conversations that we've had that there are parts of the capital base that are currently locked up in risks that we don't think are well remunerated. And this is a topic I highlighted at the Investor Day that this will be a priority for us in 'nineteen and not just in the context of legacy or noncore as it's referred to publicly, but across the entire portfolio. This is another year where we're going to devote ourselves to looking at the capital allocation and seeing what steps we can take to improve the overall portfolio. How does that feed into capital return?
I can't add more on that topic beyond the answers I gave to the earlier question to James.
Okay, clear.
Next question is from Niccolo Della Palma from Exane. Please go ahead.
Hi, good afternoon. Two questions left for me. 1 on the Z ECM model changes. Is this bringing the view closer to the rating view? Is it closing the gap between the 2?
And therefore, is it a good guide for that at this stage? And secondly, a bit more practical on the capital gains that come through outside BOP. Given where the AFS reserves have fallen, what can you tell us to help us getting our heads around the structural part of gains versus what may have been a bit in excess of normal? Thank you.
Yes. Thanks, Nicolas. So as to the first question, no. I wish it was yes, but it's no. I think the I mean, it was a change that we made to how we look at subordinated debt.
I think the change is justified. We've been looking at it for some time. Just it would have been more convenient to do it when the markets didn't move, but the markets moved as we did it. So we think it's the right thing to do. On the capital gains outside BOP, it's tough to tell you in any given year the number is going to be X because, of course, it's a function of not just that EFS starting point, it's a function of how much the portfolio turns over, a function of how the markets perform in the year.
I mean, what we tend to guide people is that, I mean, from a medium, longer term perspective, I mean, you can assume and we assume that the numbers about 400 maybe slightly higher. That's the level that we have typically in planning.
Thank you.
Thank you very much everybody for dialing in today. We're aware that there are a couple of questions outstanding, but unfortunately, we've run out of time for this call now. The IR team will reach out to you and follow-up with the further questions. If you've got any other questions, obviously, the IR team is available. You know where to reach us.
Thank you very much.
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