RSA Insurance Group's (RSAIF) CEO Stephen Hester on Q2 2016 Results - Earnings Call Transcript

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RSA Insurance Group PLC (OTC:RSAIF) Q2 2016 Earnings Conference Call August 1, 2016 7:00 AM ET

Executives

Stephen Hester - Group CEO

Scott Egan - Group CFO

Steve Lewis - CEO RSA UK and Western Europe

Analysts

Thomas Seidl - Bernstein

Andy Hughes - Macquarie

Olivia Brindle - Bank of America

Nadine Van Der Meulen - Morgan Stanley

Stephen Hester

Welcome everyone thank you for joining us for our half year results presentation, standard format. I will start and go through what we have been up to. Scott will add the numbers to it and then we’ll move to Q&A. As ever I'd like to welcome my colleagues here in particular, Martin Scicluna, our Chairman who is sitting here on the front, and they will of course be available to help out, either with telling you the truth after we finished speaking, or helpful interventions for questions we can’t answer. So we’ll crack straight on into it.

This we will -- so I suppose the four points that I think we will bring out of our results today are the turnaround period of our sales are done. I think it was really done at the end of last year and you see the evidence of the final big pieces completing in the first half of this year with our Latin American disposal. So our strategic refocus is done. We’re focused on our strongest businesses. I think we are able to report very strong performance progress, ahead of even of our demanding plans. We have an all-time record, half year underwriting profits despite the luck of underwriting going against us and we have reached our ROTE target range a year ahead of when we thought we would.

All of this Scott will obviously go on in more details as we go through the presentation. The total disposal program is £1.2 billion that we have reached. The balance sheet you will see again, good news in our results, today top end of our Solvency II range achieved, sub debt retirement achieved, pension scheme risk reduction, helping our pension surplus actually rise during the half, which obviously was not the case for many footsie [ph] companies and in terms of the performance many good points that we’ll talk about as we go through the presentation.

And again Scott will go over clearly the figures. You know them well, flat top line, I think that is the world around us and we certainly are not going to chase top line in favor of bottom line, although we are a lot as we’ll come on to talk about for customers. All-time record underwriting at the headline level, up something like 80% in constant currency, but importantly not driven by reserve releases. Our current year underwriting profits are also an all-time record for us, as is our combined ratio. Every single region is kicking in and the attritional loss ratio is what’s driving it as well as cost.

Costs, we’re increasingly confident of beating our increased £350 million 2018 target. Our operating profit obviously up nicely, investment income behaving itself, albeit in the context of the declining trend of interest rates and of course that drives EPS up 29% and the 43% increase in interim dividend.

We represent and probably we’ll keep representing the strategy slides because the point we want to get across is although RSA is changing a lot. We’re changing a lot according to the blueprint that we set out 2.5 years ago and we’re not changing our blueprint. We know what we are doing. We know why we are doing it. This is the kind of company that we think can succeed and this is the company that we are building, both in terms of what the company should look like in qualitative terms, as you will see, the slide, the focus stronger better slide, the broad balance of business that we have and we will continue to have, both in terms of regions, in terms of channels, in terms of product lines and broadly the profitability mix that achieving our targets gives rise to, influenced of course by the fact that Scandinavia is inherently a higher profit market which is why the insurers there trade at higher PEs at well.

And the essence of all that, clearly in shareholder terms is that we observe that companies with the regional market leadership that we have can often achieve more intense performance focus than those that are more broadly spread with a composites or global giants, and that has in the case of others and we hope ourselves increasingly being able to produce superior performance and superior piece. So that’s what we hope to get to.

Updating you then on what we have been up to, and again the framework hasn’t in anyway changed we’re executing exactly to the plans and to the philosophy that we set out. As we said the turnaround phase, principally strategic refocus capital and balance sheet strengthening done, performance back in the pack, that was done by the end of last year and we set out in February as you will recall our shift in emphasis to move the company we hope to best-in-class position but we are doing all of the different things that we said we would do.

Our approach continues to be and will continue to be constantly looking outside our company to see in the world around us who is doing things better than us, whether in our industry or elsewhere and to figure out how we can do that too. And therefore continually having in mind the ambition of best-in-class. And from that we develop operating plans and then we try to execute to those operating plans. And in essence they come in five performance categories; stuff we do to make customers happier; stuff, we do to be smarter underwriters; things we do to reduce our cost; and the enablers that are of course, people and technology.

Just some vignettes of progress that we're making starting with customers. This is hopefully a mildly interesting slide. As you know for many, many years, too many years RSA was held by its largest market, the UK, or by more particularly by our performance in our largest market in the UK. And we believe that we are beginning to make decisive changes to that historic track record. And some of that is driven by, if you like, real underlying stuff that we do with customers. You will see in here, the net promoter score, both in net promoter score in our UK commercial business, which is 60% of our UK business, and the really impressive trends in that since 2012, up to the present.

And the reason that we care about that you will also see from this slide in terms of people -- customers who like us, do more business with us. It’s as simple as that and of course right across the company these are the things that we are trying to which will show through with different pace obviously, but it’s fundamentally trying to make our top line if not growing a lot in the current environment has high quality and strong as it can be.

And you will see that across the board, the franchise is in good shape notwithstanding all the work we’ve done to improve our underwriting margins and to reduce cost retention is in good shape. Our ambition is to make it better still and everywhere in the business we have activity going on to improve customer capabilities, improve service standards, make more slick the channels through which we operate, digitize the business and so on and so forth.

And it was a conversation I was having earlier, we are determined that if we grow it should not be because we cut price and take underwriting risk. It should be because we move our capabilities to the point that customers want to deal with us because of our effective capabilities. And we’re beginning to see across the business in places where we have dropped in new capabilities, nice improvements either to retention or to new business. But these are things that take longer than if you just cut your price and say I want to write more, which we are not doing. And so you won’t see that really driving the top line for a while but it’s happening and it’s making our top line already better quality and in-turn will improve growth.

Apart from the customer levers clearly the most important lever we have in shareholders terms is how good our underwriting actions and decisions are, and we continue to make really outstanding progress in this area, again broadly portfolio re-underwriting, still some actions ongoing like the roll off of UK broker motor.

We are taking a bit of an axe to some of our unprofitable schemes businesses in the UK and there is other bits and pieces around it although we are in the tail-end of what I will call the portfolio changes. The discipline with which our underwriters apply their knowledge to the marketplaces improving, but right across the group, really big strides now beginning to drop, in terms of sophistication of risk models, many of which have been rebuilt, in terms of the agility that our technology allows that risk model to turn into street pricing and these are things that lie behind the gains, that you will see in attritional loss ratio, which I think you can see are; A, across the board and; B, pretty impressive.

My only cautionary note is that gains and attritional loss ratios are a figment of when actuaries decide to recognize them and so they tend to be really lumpy and you can certainly get intra year movements, according to when actuaries recognize something when they don’t. So last year we got a lot of recognition in the second half not much in the first half. This year we think it will the other way around. The second half will show weaker growth than the first half. But either way it’s coming through and sustainable in our judgment.

And then costs, we set our cost ambitions. We are operating ahead of that. We think we will beat the £350 million. We have no intention of changing targets. At half year process we’ll look again as to whether we should change it at the full year. And it’s all those stuff we said in February we do we are doing.

We picked out on the right hand side of the slide one of the let’s say emerging areas that has not been available to insurance companies historically, which is robotics, which clearly the service industries generally across the world are trying to nick from manufacturing industry as a way to make further gains. And we believe that we are amongst the leading insurers in piloting and rolling out these things, albeit frankly we’ve only just starting in the last 18 months to do it. And this year we’ve now not got pilots running in every one of our regions with some good hopes of rolling that out further.

In terms of looking at our regional performance, we again reiterate today the mission that we’ve set ourselves to get to best-in-class performance for customers, but also for shareholders and of course although there are a rich array of measures you can use, the combined ratio is a simple one of looking at it from a shareholders perspective. And so we do believe that we will try and it is possible to get to better than 85 in Scandinavia, better than 94 in Canada, better than 94 in the UK, all measured in let’s call it a normal year, i.e. without the benefit of tailwinds from reserve releases or large [ph] and weather. And these are the plans and ambitions that we are setting ourselves. And I think you will agree that whatever skepticism was there in February, it might be a bit less today. Albeit I think it’s still right to have some level of skepticism because these are things that our company hasn’t achieved before.

I won’t go in detail through the regions. In every one of our regions we are doing exactly the same thing. We’re pulling the exactly the same levers. Obviously there are nuances in every one of our regions. The cost program is advancing and everyone the underwriting is advancing in underlying terms. From time to time there are weird ups and downs for example in Ontario motor from time to time you have a rate reduction and so on. But basically we are making progress across all of our three regions towards our plan and you can see that in the financial results.

With that Scott, numbers. Thank you.

Scott Egan

Thanks, Steve and good morning, everyone. Delighted to be here presenting what I believe an excellent set of numbers to the marketplace. I will start with a quick overview of the numbers before getting into the detail. So our half year results are very strong driven by our underwriting performance and our continued focus on our self-help performance levers. A record first half underwriting profit of £174 million is up 81% on a constant FX basis on prior year, with an overall combined of 94.7% and 94.3% for our core businesses. And this comes despite the volatility of weather and large losses being around £50 million worse than the first half year in 2015.

The operating profit of £312 million was up 23% with underlying PBT up 29%. Profit after tax was £91 million after one-off costs associated with the restructuring turnaround and as a reminder the first half of last year included the benefit of a significant disposal program. And finally our underlying return on tangible equity was 12.8%, inside the target range of 12% to 15% a year early.

I now quickly go through some of the other areas in more detail, starting with premium. Our core group net written premium of £3 billion was flat on underlying level reflecting a continued underwriting discipline and what remained competitive market conditions.

A very brief comment on each of the regions, in Scandinavia the premiums were down 4% year-on-year. However excluding the transfer of the marine portfolio to the UK and the non-repeat of two large multi-year deals from last year the underlying premiums were flat.

In Canada premiums were down 3%. The portfolio actions over the last two years are now complete. However conditions remain competitive particularly in the commercial broker channel. But despite this we remain disciplined in our approach to pricing and underwriting. In UK our premiums were down 1% although flat on an underlying basis excluding the exit of personal broker motor and the transferring of the Scandinavian marine business.

Household reductions reflect the decision to exit certain unprofitable schemes and there was good growth in Telematics. Of course underlying commercial growth of 2% included good new business performance and price increases in commercial motor. And finally in Ireland the Irish premiums were up 11% reflecting strong price increases, particularly in the motor market. We are seeing rating discipline continue across the regions and we achieve rate increases at least in line with claims inflation at an aggregate levels despite these competitive market conditions and customer retention has remained stable around 80%.

If we turn now to the underwriting result, an excellent improvement in underwriting performance in the first half year. The core group combined ratio was 2.1 points better at 94.3% despite the impact of the Alberta Wildfires and the UK and European flash floods. What’s particularly pleasing is the quality of our first half year result. The current year attritional loss ratio was around three points better year-on-year with good improvements across all the core regions. This improvement contributed over £90 million of additional underwriting profit.

Core group weather and large losses taken together were 2.7 points or £77 million worse than last year and as I said they included the Canadian wildfires at £39 million and £35 million for the UK and European floods. Core group prior reserve releases represented 2.3% of earned premium, 1.6 points higher than last year. If I break the current year performance down by region I will start with Scandinavia. The combined ratio improved from 98% to 88.5% but as a reminder half one 2015 included some one-off reserve strengthening.

More importantly the attritional loss ratio was two points better at 64.5% and our current year underlying profit i.e. excluding weather and large losses was 31% higher or £53 million.

In Canada the combined ratio of 94.5% was two points worse than last year but included the impact from the Alberto Wildfires driving the weather ratio around four points higher than last year. The attritional ratio in Canada was particularly strong at 57.1%, although I would caution that this benefited by around 1% due to benign indirect weather in the first half. What we did see was an excellent current year underlying performance up 26% or £18 million.

In the UK, the UK combined ratio demonstrates increased resilience at 94.4% unchanged from a year ago, but in half one 2016 that includes 3.8% of higher weather and large losses including the European and flash floods in the UK in June. Again the current year underlying profit was up 13% or £30 million with a good improvement of over two points in the attritional loss ratio.

And finally in Ireland we have returned to operating profit driven by a significant improvement in the combined ratio to 100.7% from around 112% last year with a strong improvement in the attritional loss ratio helping drive our current year profit of £12 million at the half year. So to summarize current year attritional loss ratios have improved strongly across all regions really demonstrating a vast improvement in the quality of earnings and this is happening right across our business.

If I turn to cost, our cost reductions remain on course to achieve the2018 target of greater than £350 million. As a reminder at the end of 2015 we have delivered £180 million of this and half year this now stands around £200 million with a 5% cost reduction delivered year-on-year in the first half. We are expecting significant delivery of cost reductions in the second half in particular our transformation program will continue to deliver further headcount reductions and will start to crystallize the run rate benefits of the new Wipro IT infrastructure deal that we announced at year end.

We are confident that we’ll see the momentum in cost reduction continue during the second half and we still expect to achieve around £250 million by the end of this year and our greater than £350 million target by 2018. If I turn to investments our strategy on investments remained unchanged, that is to protect capital for both the policy holders and our shareholders. This means a portfolio dominated by high quality fixed income with around 90% of our bonds rated at A or above.

Our first half income was £187 million with core group investment income of £159 million down 4% on last year. The average reinvestment rate of 1.5% achieved across the first half reflects the mix of assets that have come up for reinvestment during the period, primarily UK corporate debt which attracts a slightly higher yield.

Our investment income guidance for the full year has increased from £330 million to £350 million driven mainly by the benefits from foreign exchange. The £350 million includes around £15 million for Latin American which following its disposal won’t repeat next year. Therefore our guidance for 2017 and 2018 is £320 million and £300 million respectively based on current forward yields and FX.

Unrealized bond gains have increased significantly in the first half to just over £700 million driven by lower bond yield and positive FX. The lower yield and now flatter yield curve mean that we now expect these gains to largely unwind over the next four years.

A very quick word on foreign exchange, given the profit profile of the group with around 75% of profits generated in non-sterling currencies, movements in foreign exchange rates are significant both for earnings and capital. The FX impact on first half year earnings was relatively small given the timing of the FX moves but you can see here from the slide that our first half underlying profit before tax would have been 7% higher had the 1st of August spot rates prevailed throughout the period. Therefore if current exchange rates do prevail there should be similar benefits to come for earnings reported in sterling terms.

Operating profit of £312 million is up 23% at constant exchange. Below the operating result the Latin American sales are now completed ahead of schedule and with the numbers coming through in line with the guidance that we gave at full year. As we’ll see in the next slide this disposal has been highly capital accretive.

We took the opportunity in early July to retire some of our Tier 2 debt which will save us around £19 million of interest cost on an annualized basis and in the second half you should expect a one-time pretax charge of £39 million in relation to this. Non-recurring charges mainly comprise restructuring cost, and underlying the previous guidance given at full year 2015.

Finally the effective tax rate in the period was 39% in line with the elevated rate we flagged at year-end and is largely driven by tax on overseas profits and tax cost on the Latin America disposal. The underlying tax rate for the core group is around 24%.

Our capital position remains very strong. We are at the top end of a 130% to 160% Solvency II target range with a coverage ratio of 158%, up 15% from the year end. Our underlying capital generation, which is equivalent to the profit measure we use in our underlying return on intangible equity and EPS numbers added 12 points. Restructuring costs and other non-operating items together with the bond held at par reduced this by 9 points. As I flagged earlier the completion of our Latin America disposal was capital accretive adding 12 points as expected.

Market movements added 5 points mainly driven by FX movements, yield movements had a limited impact due to the matching of assets and liabilities while equities and credit spreads although volatile during the period closed at similar levels to those at the start of the year. Overall the impact of the market movements was in line with our stated sensitivities. And finally pension movements and the interim dividend reduced coverage by two points and three points respectively.

As I said earlier we’ve now taken the first steps to capital optimization. The continued strong performance of the Group has allowed us to recently complete the early retirement of £200 million of Tier 2 debt with a coupon of 9.4%. This will give us an annualized interest cost saving of £90 million of which we will see half this year.

More important we were able to do this without impacting our Solvency II coverage ratio. We did this by utilizing some previously ineligible Tier 2 debt as well as introducing a small amount of Tier 3 deferred tax asset into our capital structure. Our ambition is to continue to optimize capital and we will look to take further opportunities for early debt retirement as well as exploring options for our UK legacy portfolio.

And finally our outlook, our focused and disciplined approach has delivered excellent first half year results across pretty much all dimensions of our business. We will continue to prioritize underwriting discipline over growth in the near-term, drive further cost reductions and as I just said take any opportunities to optimize our capital structure. I believe we are building a track record of delivery and this gives us increased confidence as we look into the second half of 2016 and into 2017.

With that I will hand back to Stephen.

Stephen Hester

Thank you very much, Scott. So as you can see obviously the numbers are very, very strong, very unusual rates of increase for insurance companies. I hope we’ve shown you that actually the quality of the numbers is perhaps even stronger than the headline numbers themselves. And that certainly gives us significant confidence that the business is responding to the medicine that we are administering collectively, and that the goal of best in class performance is becoming ever more possible. And we believe you will therefore see these performance gains continue into the future and indeed strengthen as our plans suggest with the additional tailwind of the foreign exchange which looks set to allow us extra gains.

So I think, with that I will stop. We all know external environment is going to be tough and slow and therefore our program is very much oriented to self-help. But the self-help seems to be having an impact. Welcome any questions. Thank you.

Question-and-Answer Session

A - Stephen Hester

Down here. Okay, one ahead, and if you could just -- because this has been webcast just give name and company so that for the recording it's all there. Thanks.

Unidentified Analyst

[indiscernible] from HSBC. Couple of questions. Firstly given the Solvency II ratio is now pretty much at the top end and restructuring is coming to an end as in, do you think there is more chance or likelihood for a capital return to happen before 2018? That’s one.

Secondly, if on the legacy portfolio you mentioned you are looking at opportunities. Do you think currently given where the market is as in there is an appetite where you could have an economically viable solution for yourself as well as the buyer? And third, on the investment portfolio seems that cash has gone up. Is there any -- should we expect any investment portfolio changes at this point?

Stephen Hester

I will take the first take the first two and ask Scott to deal with the third. The first two are sort of linked. At the moment you are right, our capital position we are happy with, but at the moment we think that the best thing that we can do with surplus capital, whether surplus capital generated from profits or surplus capital generated from any other transaction like legacy is to retire debt. Partly because it’s very high coupon. So that helps our earnings a lot and partly because it improves the quality of our capital and therefore makes us -- makes the resilience that’s inherence in our capital much greater. And therefore to the extent that we have surpluses you should expect just to channel it there over the next 12 months.

I continue to believe that by the 2018 time frame we will have done everything we can do in that area and we will be in a position to have surplus capital that could be allow us dividend options beyond our stated dividend policy. But you should expect us in the near-term to apply to it to debt retirement. Scott do you want to take the investments.

Scott Egan

Yeah on the investments, I think the simple answer is no. It’s just timing of receipts coming in except for there is as I said in my presentation there is no change to our investment strategy. I think it’s very clear it’s high quality fixed income and it's just timing from receipts particularly of disposals et cetera.

Stephen Hester

Just to be a little clear on, by the way on legacy. We have not hereto formerly explored legacy. We will have a bigger test in the second half of what the market would pay us. We think that, that would manifest itself as an accounting loss and the capital gain, a bit like Latin America but we don’t know whether the balance of that would be an attractive deal for shareholders. If it is we obviously would pursue it and apply the proceeds in the way that I described. But I think it’s premature for us to be able to know that we do expect to know the answer one way or another by the year end. Over here.

Thomas Seidl

Thank you. Thomas Seidl from Bernstein. First question growth is sort of flat again; my first question hence is with this level of growth, according to your plans can you achieve the £ 0.40 and £0.50 EPS target? So is the margin enough to get you to the ambition you stated in February or do you not need let’s say some decent growth to keep…

Stephen Hester

I think that you should be raising your EPS targets considerably not falling them.

Thomas Seidl

So, but can you answer the questions. Do you have growth…?

Stephen Hester

The overwhelming driver of the strong EPS progress we expect to make is profitability improvement. Growth, first of all it feeds through with a year’s lag. So what we write this year as net earned premiums has always a year's lag in it. And secondly if you like the only profit impact of growth comes through the extent of which are levering your expense base, whereas the vast amount of P&L is captured if you reduce your expenses across the whole board or if you improve your underwriting margins. And so we expect our profitability to continue to improve.

We expect our earnings per share to improve as a result of that, and we expect a significant additional boost, something like $0.03 a share at current rates from foreign exchange on top of that. So I think the growth is not an issue now. As I was try to be at pains to be clear in the beginning of my presentation. We can massively [ph], about our customer franchise we are putting in massive efforts to make our customers happy with us, happier with us to improve our customer capabilities. That should increasingly show through, both in terms of retention as well as selectively in terms of the new business.

But I think it will be a lagging indicator. It takes time to improve capabilities. It takes time for those capabilities to be noticed by your customers. It takes time for that to be noticed in new business. What we are not doing is what insurers traditionally do if they are worried about the top line is cut prices or take stupid underwriting risks. This is a dumb market to do that in.

So we see spots all around our business where we've done something. And as a consequence of doing something superior on capabilities we're getting a good better results in terms of either better retention or better new business. So Telematics in the UK we're gaining share even in the Telematics market. There is one or two product areas we've dropped brand new pricing models in Canada, new business hit rates have doubled in the last three months in those areas. We put in retention desks for example in personal lines in Denmark which we didn’t have before, retention is coming up.

So right across the business we can see that when we change the capability it changes a customer outcome. But the only growth we're interested in is growth that comes from capability improvements, not that comes from damaging shareholders.

Thomas Seidl

And I guess with the FX plan I think you're mainly focused on probably one of the few positives on the Brexit. So what about the negatives growth and return on investment one-third of the assets in the UK, how does that balance of this FX impact?

Stephen Hester

So the investment, our new investment guidance combines both. So the effect of lower interest rates is in our new investment guidance, and the effect of foreign exchange on investment portfolios is in our new investment guidance. And so as you can see you can model that through. We do believe that the net of all of it is a significant increase in our earnings net of interest rates and foreign exchange going forward.

The structural impact, too early to be sure because our principal European operations have separately regulated and incorporated subsidiaries in Ireland and in Scandinavia. We don't anticipate any if you like structural issues to us from Brexit. To the extent that UK growth goes down, might there be some impact on the general level of UK premiums, there might. But it seems to us that that's going to be a very slow impacter of what we would otherwise do, since we weren't ever relying on economic growth as our engine in the UK in any event.

Thomas Seidl

Final question on the pension deficits. I mean we seen the dramatic fall of swap rates. How does it impact the economic rather than the accounting value of your pension deficit?

Stephen Hester

I suppose you'd have to try and figure out – I'd have to understand exactly what you meant on the economic benefit -- on the economic basis of our pensions. But I think our picture will be the same. We have an accounting surface that got a bit stronger. We have a [indiscernible] deficit. That's not economic either. And then there are fair value issues, fair value buyouts and we have announced for buyout price so there were no surprises [ph]. But my guess the buyout price is certainly not better and probably worse, I -- to be honest have no idea what it is.

Thomas Seidl

Okay thanks.

Stephen Hester

Up here.

Andy Hughes

Hi, Andy Hughes from Macquarie. I guess also a question on growth [indiscernible]. Obviously on slide 26 you're showing that kind of volume for each of the markets been pretty negative. Is that distorted by the pruning actions that you've been taking and is the underlying volume rate not as bad as there, so does this [indiscernible]. And I guess looking forward to next year, I'm kind a struggling a bit to see where the growth comes from because also in Scandinavia the peers, say if you growth in Scandinavia you have investment strength, which means you guys sacrificed some of your underwriting to grow. And it sounds like it's more profitability over growth focused.

And in the pruning bits, so I guess you've mentioned something about commercial property appetite in Canada. Is that, is it commercial property or is it property as in household then commercial property? And what exactly do you mean there?

And I guess the third question on retention, potentially on Danish retention. But the retention slides we had at the full year showing the numbers by market aren't in here. Is that deteriorating the result of the pruning or is it generally in-line with what it was for the full year? Thank you.

Stephen Hester

I'll ask Scott on the last one. Let me answer some of it first. I think the significant amount of the premium numbers are still impacted by working through earned premiums and premiums past portfolio decisions. Good example being broker motor in the UK, which was a decision we announced a year ago. But this is the year where you see the premiums not being written. And there are other examples where you're trying -- where you're get out of the scheme but you have to give up to 12 months' notice and then you have another 12 months while those premiums rolls off. So there is still a chunk of portfolio change that's going through the numbers.

And -- but underneath that, there continues to be the some growth. So for example Sweden grew 2.5% in the first half. That was offset by Denmark doing less well. But I'm not worried because we are so far of the pace in our margins in Denmark in terms of cost in particular that we are putting Denmark through a very radical transformation, which in the short run is going to cost us top line and in the long run will make us have a terrific Danish business for shareholders as well as for customers.

In Canada it mainly is commercial property. There were some areas we were taking more large losses than we should have done. And so we changed our underwriting appetite. Residential has been fine actually good. Scott I don't know if you have?

Scott Egan

Yeah I mean no, is the answer in terms of not disclosing it. We probably full year I think there is a danger if you keep sort of dropping retention stuff for every quarter or every half year you can get potentially distorted in trend. So there is no significant news to report in Denmark. I think Steven's made the point which is there is a lot of change going on in that business and we're confident that what we're doing are the right things. Denmark itself is subject to the same investment in terms of capability aimed at improving the customer experience, aimed at improving retention.

I think there was little vignette that Steven showed that actually you could see there were some comments in there about Denmark in terms of its broker ratings.

Stephen Hester

We're not -- I should just clarify, you mentioned something on new business trend. We're not at all worried about new business strain. If business is we think is lifetime profitable we're perfectly happy to write it with the new business strain. What we're not happy to write is something where the new business strain, there is always a strain.

So as an example our Swedish attritional loss ratio doesn't look as good in terms of year-on-year improvement, as it really is because we've deliberately decided to do some more new business in motor which we think is very profitable lifetime for us and also make some policy changes to defend our very big market share in PA. We think those are very accretive to us but in the near term they cost us money. But there are some other areas which cost us money in the near term and in the long-term and that's the stuff that we are trying not to do.

Andy Hughes

Yeah.

Unidentified Analyst

Oliver Shield [ph] Deutsche Bank. Three questions, first on solvency. I mean given that most of the market move in solvency was driven by FX. I think you said and in personal [ph] that's just a mixed issue presumably. How do you perceive the quality of your 158? And I mean do you still happy with that 130 to 160 range as being the sort of benchmark we should measure that against.

Secondly I know this is a horrible over simplification but on the basis you’ve given us average increases in each market and you said they were ahead of claims inflation. Can you give us average claims inflation in each market? And then third question is I think some -- in one of the slides you've talked about some of the initiatives that that was going to cut 80% of the acquisition cost of Codan, which sounds a huge trigger.

Stephen Hester

Sounds what, I'm sorry?

Unidentified Analyst

Huge trigger, which was going to cut 80% of the acquisition cost at Codan. I think that's mentioned in the notes in one of your slides. So I just want to…

Stephen Hester

Okay, the two ones I don't know. I'm going to ask Scott to do which he will decide to. On capital quality, we're very happy with the capital quality in terms of the measurement of risk, even happier post the pension de-risking that we did in the first half. And so the area that we think we can improve is the mix of equity versus sub-debt and I including the word sub-debt the tier 1 instruments because this is much of the same stuff. And as we said we want to continue to have a bigger equity element in our total mix which is why capital surplus above our normal dividend policy. And if we release money from legacy would be applied first there. Scott?

Scott Egan

Yes, so on the claims inflation look I don't have the blended here but let me just give you a flavor. In Scandinavia in personal lines, it will be around 1%, the same in commercial. And kind of the personal lines that are in sort of 2% to 4% and in commercial lines again not much different. And in the UK personal lines, again between sort of 3% to 4% blended on and in commercial lines probably around sort of 2% to 4%. But that can be misleading depending on the lines of business. And I do generally caution slightly the use of averages, and sort of arriving at very specifics.

But we're happy in aggregate across our regions. We remained to be price disciplined in line with claims inflation and keeping the focus on the overall profitability of the portfolios. And you need to have -- the last one, could you just repeat it again, here?

Unidentified Analyst

[indiscernible]. I will come back to you later.

Stephen Hester

Okay.

Unidentified Analyst

So it's slide 76. Thanks. [indiscernible].

Stephen Hester

So slide 76 you say eBooks [ph] digital mailbox going live in Codan in October, will blah, blah blah eliminate 80% distribution costs?

Scott Egan

Okay, so distribution in that context means postage. Instead of sending you an email, your stuff you log on and it costs us nothing.

Unidentified Analyst

Okay.

Unidentified Analyst

Thanks, it's James Shark from BBSI [ph]. I have three questions please. Firstly on the UK personal lines, so I just like an update you on your strategy here. If I look at household, could you give me an indication of what percentage of household personal comes from more than for the time being?

And then what you're intending to do to kind of grow through the price comparison channel in particular. In personal motor you'd be shrinking that book. You're quite smaller in personal motor. Just like an update on that strategy, it's loss making still for now. And in past you're one of the few companies that seems lose money in personal insurance, it seems to be, it can be a cash cow, to use a pun for many others.

My second question is on Scandinavia. So historically maybe all of the underwriting profit has come from the sickness and accident product in Sweden, which has operated with a pretty stable combined ratio of about 70%. That combine ratio in recent times has been over 100% at least in the segment as you disclosed it there. So if you could just tell me a little bit about what's going on in that segment that will be helpful?

And then finally this is just a more conceptual point, but can you just help me understand why a 5% margin over actuarial best estimate only translates into a 1% guidance for prior year [indiscernible].

Stephen Hester

Second, in a second I'll ask Steve Lewis to answer the UK personal lines question since he's here. In terms of your other two, on Scandinavia, our most profitable area, our most profitable product line is sickness and accident. I would also say though that there are a lot of other Scandinavian areas that make good money, not just not quite as much more example the motor market in Sweden is very, very profitable. Our commercial lines in Sweden having not been profitable for years is now back in good profit, normally speaking a number of lines in Denmark are as well.

But the most, you're right, has been sickness and accident and perhaps because of our unique position there. Last year we had a significant reserve strengthening. So the current year was very strong. But we strengthened reserves. This year the current year is also very strong. We've also done some reserve strengthening albeit on the net basis Scandinavia last year was negative in terms of PYD and this year is slightly positive. But it continues to be one of our most unique and strongest areas; new business trends, market shares, everything terrific. But the nature of any long-tail line is you can get reserve volatility sometimes good and sometimes bad. But there is no issue there at all.

In terms of your question on margin I think the two there are different. The reserve margin that we disclosed is what I'll call the cushion, which you strictly speaking you actually say you don’t need, i.e. the cushion above best estimate. And I think we are the only insurance company that discloses that. Everyone else uses it to smooth profits and by disclosing it we can't smooth profits unless you know about it, which I think is a good management discipline.

The advent of prior year releases for some insurance companies is because they are digging into margins, but for others is because actuarial best estimate is although conceptually a set of best estimate is often arrived at in a slightly conservative way. And so on balance and on average the actuaries the actual claims experience tends to be better than where the actuaries and that' why you get your reserve release from, if you're not dipping into margin. And that's where our planning assumption is 1%.

But as you can see when you look into our individual regions it can bubble all over the place. When you'll aggregate a lot of things it becomes a bit more stable. But it's unified definition and unpredictable series.

Stephen Hester

Right at the back. I'm so sorry, I apologize yeah. Steve. This is where you're going to get me out of trouble there.

Steve Lewis

So in terms of personal line, so home motor, pet. So if we just walk through those, in terms of personal lines, home runs about 40% in terms of more than 60% is affinity retail. And it goes a little bit to the comment we made earlier in terms of only growing when you got the capability to do so. So if you look at our modern [ph] portfolio we broadly held the line flat year-over-year. What we're doing currently is we are building a complete front-end digital architecture that we're looking to bring to market next year.

First delivery is actually [indiscernible] motor in Q1. Q2 is actually for home in nationwide. And following that will be for are our [indiscernible] home business. And that's about bringing the right capabilities ultimately to compete. And at this moment is to defend position on our home book until we got those capabilities to take the portfolio forward.

So that’s home. In the context motor loss ratio, well we still got some strength there in the context of exiting broker motor last year. Aside of the portfolio in terms of the top line but you got some strength in terms of expense and loss we're actually responding to. Again part of the answer in the fact that one, we are going to be deploy new capabilities next year, Q1 in terms of supporting our [indiscernible] motor proposition. And that is about digital capability is about price optimization capability and is about bringing our flow capabilities up to the level to allow us to grow the motor portfolio on a go forward basis.

Having said that Steven touched on earlier telematics. We've a data led capability in Telematics. We've grown that over the last two years. We have the capability to compete, and this year we've seen that grow by 60% and we're heading towards 10% market share of the Telematics space by the end of this year. And that’s performing well for us.

And in terms of the overall loss position of the Motor. We have seen our motor combined ratio for [indiscernible] increased significantly by around about 20 points year-over-year. It still not where it needed to be. But we do see the path forward to improving the contribution from motor. And then finally on pet. Not sure I'd quite use cash. Actually we had a few prior year issues in terms of recognition. If you look at current accident year it is marginally profitable at 99.5%. Having said that I'd also agree that it should be delivering a greater contribution for us.

We had a significant amount of focus looking at Telematics [ph]. You've recently heard about how we've intervene in the debt space with a referral network And that is all about starting to use our scale. And we do have significant scale. It's about deploy better insight and indemnity management to bring the actual contribution from pet to where it needs to be. So I think we've got a really good clear plan as to how we're going to take up those lines of business forward.

Unidentified Analyst

Okay.

Stephen Hester

thank you very much Steve. So at the back now.

Unidentified Analyst

Thank you good morning. It's Andrew Greene [ph] speaking. Three questions if we can. Firstly on the investment income, what is the reinvestment rate now? And what would your investment income forecast for '17 and '18 if you didn’t use four grades but use continuation of the current investment rate.

Secondly, you made a comment about the improvement in the attritional loss ratios in the second half not being as good as the first. So I wasn't quite sure you meant. I know last year I think it was 87% in the first half and then 84 in the second and then it was 83ish and this is in combined terms in the first half. Are you talking about the improvement second half on second half or second half on the first half this year there will be less improvement?

And then the third question I noticed you've -- the amortization of the [indiscernible] is now been moved to three to four years. Being pedantic about this you basically said you'd look at specials once you'd finished restructuring and once the [indiscernible] had completed. Would that mean that specials get pushed out a further year?

Stephen Hester

Thanks Andrew. In a second I'll ask Scott to answer the investment income on the [indiscernible]. It doesn't mean that, I think the fact that it's more and longer is more than offset by the increased profitability and capital generation that we've got and that we expect to have. So I'm not worried about that.

In terms of what we mean and in terms of work of I think both I think the improvement over the over the second half of last year and the improvement over the first half of this year will be less than the year-on-year improvement that we're producing first half just because of the different things that's happening in the lines and the different periods of what we're anticipated do actuarial recognition. But we believe that the smooth path is continuing to improve and we see no reason why in terms of if large losses and where they are neutralized, why the second half wouldn't be stronger than the first half overall in underwriting terms as it normally is.

Scott Egan

On investment income, so Andrew just two things. So blended rate was -- reinvestment rate was 1.5. I think the discreet in Q1 was 1.6 and discreet in Q2 was 1.3. That was primarily, as I said, driven by the sort of investments that were coming up for reinvestment rather than an underlying rate point. Regarding if you didn't use forwards for the sensitivity -- I don't know we haven't done that. That's not we use -- we basically use.

Stephen Hester

I thought it was in one of the notes isn't it? Isn't it in the notes?

Scott Egan

It's small. It's kind of £10 million. But we use forwards as our kind of market.

Stephen Hester

I think we got a note if we don't use forwards.

Scott Egan

It's sensitive [ph] and it's negligible, £10 million.

Stephen Hester

Terrific next question please? In the middle here.

Olivia Brindle

Hi, it's Olivia Brindle from Bank of America. Three questions, firstly on the better operational progress on both cost and loss ratio. How much of this is just timing and you putting through certain things more quickly than you thought, and how much of it is genuinely sort of new opportunities that you found as you've gone through the process and new areas where you think you can do better i.e. effectively incremental improvements compared to when you first started.

Secondly on the large losses, I mean we've had quite few of those. But obviously you've also got your aggregate cover and that kicks in I think is £150 million of eligible losses for the year. Is there any sense of where we are in that £150 now, if you could update on that? And then finally just on some of the EPS covenants. At the full year you gave us some ball park numbers in the £0.40s and the £0.50s for some of the out years. How would you be urging us to think about that now especially with the FX support that you've mentioned?

Stephen Hester

I suppose the progress in attritional loss ratios, as you say, has been better than even we planned. And at the moment I look at that as de-risking the progress that we were wanting to make to best-in-class, particularly in the light of an external environment which for choice is probably more hostile post-Brexit and so on and so forth. So at the moment I don't think it would lead us to increase our best-in-class ambition targets for combined ratio if you like. But I think it takes some of the risk out of them because we've gone further faster towards those levels.

In terms of large losses, we -- mainly actually it was a weather event. So it was less large losses. But those large losses are slightly above normal. But there is mainly the two weather events we talked about, the forest fires and the floods. As a result of all of those, we are well over halfway through our GVC allowance for the year, which gives us substantial downside protection for the second half which was another reason why I was being cheerful about the second half having a good chance of being nicely stronger than the first half for us this year.

And in terms of EPS, as I say, I wouldn't change our ambitions. So our ambitions in terms of beating those combined, not hitting them, beating the combined ratio remains our ambition. There would be automatically if you think foreign exchange rates will continue where they are now something like £0.03 earnings of share to add to whatever you had before, just on earnings translation. And I think the skepticism discount as to whether we will hit them ought to be a rather smaller discount than it was six months ago.

Olivia Brindle

Thank you.

Nadine Van Der Meulen

Hi, good morning. Nadine Van Der Meulen from Morgan Stanley. Can you give some more thoughts around your plans around the debt retirements in the coming years? So you've retired expenses [indiscernible] that last month in July next year. And there is a first call date I believe in the large debt issue. Do you have a certain -- you mentioned the equity elements of your eligible funds. Do you have a certain target percentage for that in mind or target leverage ratio. So that's first question.

On second question, so in terms also to your pension and UK legacy book are quite a big part of the SCR of the eligible all funds. I think it's over 40% or something. Could you give an indication of what the capital releases that you would expect from that in light of what the impact could be on the capital generation going forward? Thank you.

Stephen Hester

Sure in terms of target capital mix we don't really have one. I suppose we sort of want to be in the pack of where everyone else is for want of anything more intelligent to say. And at the moment we're slightly on the more leveraged end of the pack of where all the people are. So broadly we want to bring ourselves in the pack. Exactly how far depends on how much money we have to spend in terms of surplus capital over the next 12 months.

And obviously we still have some unused deferred tax assets. So there is still the ability to do some more tier 2 without it costing us anything in terms of ratio. So that's the best I can answer on that.

In terms of your other question on SCR. The pension is in the first half numbers. So in other words the pension de-risking I want to say saved us something like £50 million, is it Scott something like that, £50 million or so on the SCR and is in the half year numbers, because we have accomplished that in the first half year. As to what legacy would release I don't know because I don't know what price a legacy deal could be done at. So that's hard to know at this juncture.

The legacy the patent legacy lease will look funny in accounting terms, if there is one because the SCR weighting of legacy diversifies away quite a lot when you take account diversification benefit. But there is a bunch of quite prudent positions on the capital side of how legacies held. So but one way or another I think it will be capital accretive and accounting negative.

Andy Hughes

Hi, it's Andy from Macquarie. Just want to ask question about the just personal lines, some reserve strengthening in Sweden again. Obviously it looks like it's kind of about £30 million this year compared to probably double and hedge [ph] for last year. I'm just trying to work out what's actually happening and why is it kind of deteriorating. Obviously you've released a lot money from this line in the past. Is this something through the aging of those policies as they kind of gain to the working population or is this something else going on those driving the reserve strength in there? Thank you.

Stephen Hester

It's less than £30 million. But it basically changes in some combination of Swedish social security policy, because we follow Swedish social security rules. And when and what I’ll call societal changes in terms of reportable mental diseases and things like that. It's sitting between those type of issues. I don't believe it's an ongoing issue. I think we've caught it. And it's not an issue that we think we're materially exposed to in the long term.

So we're not especially worried about it. But it just is the case when you have long tail business sometimes you very happy with reserve releases and sometimes you're not. If you look at the long-term this is great product area and I'm comfortable that it will be going forward.

Any more questions?

A - Stephen Hester

Okay well look again thank you very much for joining us. Rupert is of course available as indeed are Scott and I, if you have follow-up questions during the day or in the coming days. Obviously it is for us a pleasing moment with our results today, not just because the headlines are good but because the quality that sits beneath the headlines are good.

The 13% beat to consensus because of that earnings quality I think is a very sustainable beat. Looking forward and we'll have tailwinds in addition from foreign exchange, but we're all very conscious of these things don't full into your lap. It's a hostile external environment. We're going to have to work hard for our gains. But that's exactly what we're doing. Thank you for joining us.

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