23 August 2012 INVESTOR REPORT FY12. Insurance Australia Group Limited ABN

Transcription

1 23 August 2012 INVESTOR REPORT FY12 Insurance Australia Group Limited ABN

2 DIRECTORY SECURITIES EXCHANGE LISTINGS ASX Limited: ASX code for Ordinary Shares: IAG (shares on issue, 30 June 2012: 2,079,034,021) ASX code for Reset Exchangeable Securities: IANG (listed January 2005) ASX code for Convertible Preference Shares: IAGPC (listed May 2012) London Stock Exchange: LSE code for Fixed Rate Subordinated Notes due 2026: 70QG ( 142.4m outstanding at 30 June 2012) NZX Limited: NZDX code for Unsecured Subordinated Bonds due 2036: IAGFA (NZ$325m outstanding at 30 June 2012) KEY DATES Final dividend ordinary shares Ex-dividend date 30 August 2012 Record date 5 September 2012 Payment date 3 October 2012 Payment date for IANG and IAGFA quarterly distributions 17 September 2012 Annual General Meeting 23 October 2012 Payment date for IAGPC dividend 1 November 2012 Payment date for IANG and IAGFA quarterly distributions 15 December 2012 Announcement of half year results to 31 December February 2013* Interim dividend ordinary shares Ex-dividend date 28 February 2013* Record date 6 March 2013* Payment date 3 April 2013* Payment date for IANG and IAGFA quarterly distributions 15 March 2013 Payment date for IAGPC dividend 1 May 2013 Payment date for IANG and IAGFA quarterly distributions 15 June 2013 Announcement of full year results to 30 June August 2013* *These dates are indicative dates only and are subject to change. Any change will be announced on ASX. CONTACT DETAILS Corporate Affairs & Investor Relations Carolyn McCann Group General Manager, Corporate Affairs & Investor Relations Telephone: Mobile: carolyn.mccann@iag.com.au Simon Phibbs Senior Manager, Investor Relations Telephone: Mobile: simon.phibbs@iag.com.au investor.relations@iag.com.au Registered Office Level 26, 388 George Street Sydney NSW 2000 Telephone: Website: Investor Information/Administration Computershare Investor Services Pty Limited 452 Johnston Street, Abbotsford VIC 3067 Telephone: iag@computershare.com.au Facsimile: Or by mail to: GPO Box 4709 Melbourne VIC 3001 IAG FY12 INVESTOR REPORT

3 CONTENTS Key Points Executive Summary Strategy Group Results Divisional Overview Australia Direct Australia Intermediated (CGU) New Zealand United Kingdom (UK) Asia Reinsurance Investments Balance Sheet & Capital Appendix A Group Operating Model Appendix B IAG Snapshot Appendix C Key Relationships Appendix D Geographical & Product Diversification Appendix E Key ASX Releases Appendix F Glossary IAG FY12 INVESTOR REPORT

4 FY12 GROUP RESULTS KEY RESULTS FY11 1H12 2H12 FY12 Yr-on-Yr Mvt Gross written premium 8,050 4,318 4,674 8, % Net earned premium 7,238 3,839 4,004 7, % Insurance profit % Net profit after tax % Cash NPAT % Insurance margin 9.1% 7.1% 14.0% 10.6% +150bps Cash ROE 11.1% 7.0% 19.7% 13.3% +220bps Dividend (cents per share) % MCR (X) bps GWP GROWTH INSURANCE PROFIT & MARGIN 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, % 11.7% 9.7% 8,992 8, % 3,936 4,114 4,318 4, % 1.9% 1H11 2H11 1H12 2H12 FY11 FY % 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% % 12.7% 10.6% 9.1% 7.1% 5.4% H11 2H11 1H12 2H12 FY11 FY % 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% - GWP () GWP Growth (%) Insurance Profit () Insurance Margin (%) NET PROFIT AFTER TAX CASH EPS & DPS H11 2H11 1H12 2H12 FY11 FY H11 2H11 1H12 2H12 FY11 FY12 Net Profit After Tax () Cash EPS (cents) DPS (cents) CASH ROE 25% MINIMUM CAPITAL RATIO % % % 5% 16.0% 6.1% 7.0% 19.7% 11.1% 13.3% % 1H11 2H11 1H12 2H12 FY11 FY H11 2H11 1H12 2H12 Cash ROE (%) MCR (multiple) Long term benchmark ( ) IAG FY12 INVESTOR REPORT

5 KEY POINTS FY12 OVERVIEW Insurance Australia Group Limited (IAG) has delivered an improved and strong performance for the year ended 30 June Key features are: Gross written premium (GWP) growth of 11.7%, to nearly $9bn; and An insurance margin of 10.6% (FY11: 9.1%). GWP growth exceeded the updated guidance of 8-10% provided in February This reflected strong growth in Australia and New Zealand, sourced from rate increases, higher volumes and acquisitions, including AMI in New Zealand which was completed in April An improved and strong insurance performance: GWP growth of 11.7%, reported margin of 10.6% The Group s reported margin of 10.6% is within the guidance range of 10-12% provided at the outset of the year. It also accords with the updated guidance provided in February 2012 that, following adverse natural peril and credit spread impacts in 1H12, an insurance margin towards the lower end of this range was expected. The reported outcome has been achieved despite a number of headwinds, including: Significantly higher reinsurance costs; Net natural peril claim costs in excess of related allowances; and Unfavourable investment market trends, including an adverse credit spread impact. A partially offsetting force has been reserve releases in excess of original expectations. Underlying performance represents a clear improvement against FY11. At a divisional level, the result includes: A continued strong performance from Australia Direct; Further improvement from Australia Intermediated (CGU); A significant increase in reported profitability from New Zealand; An improved performance in the UK, coming close to breakeven; and A sound underlying result from Asia. Net profit after tax of $207m was after a $297m write off of all remaining goodwill and identifiable intangible assets associated with the UK business. A second half fully franked dividend of 12.0 cents per share (cps) has been determined, increasing the full year payout to 17.0cps (FY11: 16.0cps). At 30 June 2012, the Group s Minimum Capital Requirement (MCR) multiple remained comfortably above benchmark at OUTLOOK The Group expects to report a further improvement in performance in FY13, and provides the following guidance: GWP growth of 9-11%; and An insurance margin in the range of 11-13%. FY13 insurance margin guidance of 11-13% This guidance assumes: Net losses from natural perils in line with allowances of $640m; Lower prior period reserve releases equivalent to 1-2% of NEP (FY12: 2.9%); and No material change in foreign exchange rates or investment markets. IAG FY12 INVESTOR REPORT 1

6 1. EXECUTIVE SUMMARY FY12 OVERVIEW IAG has produced a strong FY12 performance which has exceeded original revenue (GWP) expectations and met insurance margin guidance, the latter despite notable headwinds in the form of significantly higher reinsurance costs and adverse natural peril and investment market impacts. FY12 has also been a year of substantial progress in realising the Group s strategic priorities: Strong growth has been achieved in the Australian and New Zealand businesses, with combined reported GWP increasing by 13%; There has been material headway in restoring the UK business to profit, with a close to breakeven result; and The Asian business is on course to achieve 10% of the Group s GWP by 2016 (on a proportional basis), aided by several recently announced transactions. IAG delivers on FY12 guidance, in year of significant strategic progress The reported FY12 insurance margin of 10.6% compares to 9.1% in FY11, and embraces a second half outcome of 14.0%. Reported half-year margins have been influenced by natural peril and credit spreads, in particular. On an underlying basis the Group s insurance margin has improved to 10.6% (FY11: 8.0%). This allows for net natural peril claim costs above allowances and the impact of credit spread movements, as well as reserve releases above a recurring level equivalent to 1% of net earned premium (NEP). The Australian and New Zealand operations, which represented nearly 92% of consolidated GWP in FY12, have continued to perform well. The combined reported insurance margin of 12.6% was broadly consistent with FY11. The Group s insurance profit of $832m is a 26% increase over FY11 ($660m), and includes: Net natural peril claim costs of $658m (FY11: $610m), compared to original allowances of $580m and a revised guidance assumption of $630m presented in February 2012; An 18% increase in reinsurance expense to $734m; Reserve releases of $229m (FY11: $328m) which, at 2.9% of NEP, exceeded initial expectations; and A $70m adverse impact from the widening of credit spreads. Group GWP growth of 11.7% reflects the significant rate increases implemented in Australia and New Zealand to recover higher reinsurance costs and natural peril allowances. Recent acquisitions by Australia Intermediated and New Zealand and encouraging volume growth, notably in Australia Direct motor, were also contributory factors. Net profit after tax was $207m (FY11: $250m), and reflected lower investment income from shareholders funds and the decision to write off all remaining goodwill and identifiable intangible assets associated with the UK business. As a result, reported ROE in FY12 was 4.7%, whereas cash ROE improved to 13.3% (FY11: 11.1%). The UK writedown reflects a continuation of challenging economic and industry conditions in that market. A strategic review of the UK business was announced in May 2012, the outcome of which is expected to be announced before the end of 1H13. The Board has determined to pay a final fully franked dividend of 12.0 cents per ordinary share, increasing the full year dividend to 17.0 cents (FY11: IAG FY12 INVESTOR REPORT 2

7 1. EXECUTIVE SUMMARY 16.0cps). This equates to a cash payout ratio of 60.5%, in line with the Group s policy to pay out 50-70% of full year cash earnings. DIVISIONAL HIGHLIGHTS AND DEVELOPMENTS FY11 FY12 Insurance Profit/(Loss) GWP Insurance Profit/(Loss) Insurance Margin GWP Insurance Margin DIVISIONAL PERFORMANCE $m $m % $m $m % Australia Direct 3, , Australia Intermediated (CGU) 2, , New Zealand , Total Australia and New Zealand 7, , UK 546 (181) (33.6) 497 (13) (2.6) Asia 189 (4) (2.7) 219 (59) (38.6) Corporate & Other 5 - n/a 8 (1) n/a Total Group 8, , The Group s largest business, Australia Direct, reported a 10.5% increase in GWP, driven by rate increases to recover higher reinsurance costs and natural peril allowances, supported by volume growth, notably in motor. GWP growth of 7.8% was achieved in the motor portfolio, and 20.4% in home. Underlying profitability has remained strong and consistent with FY11, at a mid-teens insurance margin level. The division s lower reported margin of 14.3% (FY11: 19.5%) reflects an unfavourable variance in net natural peril claim experience, a foreshadowed modest drag on earnings from higher reinsurance costs, lower reserve releases and an adverse credit spread impact. Further improvement in CGU, New Zealand and the UK The underlying performance of Australia Intermediated (CGU) has continued to improve. GWP growth of 12.0% was driven by a blend of acquired business (notably HBF) and rate increases. The reported insurance margin of 10.8% (FY11: 6.5%) has benefited from a considerably better net natural peril claim experience, partially offset by lower reserve releases and wider credit spreads. The underlying performance of New Zealand has remained strong, and the reported outcome has shown substantial improvement against the earthquake-impacted result of FY11. Strong GWP growth of over 26% has been recorded, as significant rate increases counter the sharp uplift in reinsurance costs over the past 18 months. GWP also includes an initial three-month contribution from AMI, acquired in April The UK business has reported a reduced insurance loss of $13m (FY11: $181m insurance loss), in line with the close to breakeven expectations held. Despite difficult market conditions, underlying performance has improved across the year. GWP declined, notably in 2H12, as remedial actions led to volume loss which exceeded the impact of rate increases on retained business. A strategic review of the business has been announced, with an outcome expected before the end of 1H13. At 30 June 2012, a $297m impairment of related goodwill and identifiable intangible assets was recognised. The result from Asia was heavily impacted by the Thai floods in 1H12, which cost the Group a net $62m. Excluding the flood impact, Thailand continued to perform soundly, while the Malaysian joint venture, AmG, reported a strong insurance margin of over 18%. Strong growth was achieved by the IAG FY12 INVESTOR REPORT 3

8 1. EXECUTIVE SUMMARY Indian joint venture, and investments were completed in both China and Vietnam in 2H12. In addition, AmG has announced the acquisition of Kurnia Insurans (Malaysia) Berhad, which would make it the largest motor insurer in Malaysia. This is expected to complete in 1H13. UNDERLYING INSURANCE RESULT The Group has delivered an improved underlying insurance margin of 10.6% (FY11: 8.0%), identical to the reported margin outcome. IAG defines its underlying margin as the reported insurance margin adjusted for: Net natural peril claim costs less related allowances for the period; Reserve releases in excess of 1% of NEP; and Credit spread movements associated with volatile investment markets. Higher underlying insurance margin of 10.6% GROUP FY12 INSURANCE MARGIN REPORTED VS. UNDERLYING 1.9% 1.0% 0.9% 10.6% 10.6% FY12 Reported Margin Reserve Releases above 1% of NEP Natural Perils above Allowances Credit Spreads FY12 Underlying Margin CAPITAL The Group s capital position remains robust, at 1.74 times MCR as at 30 June This compares to the Group s long term benchmark of 1.45 to 1.50 times. There has been a positive movement since 31 December 2011 (1.69 times), reflecting the net effect of: A strong operating earnings performance in 2H12; A partial unwind of the prior year negative impact from significant natural peril events; Increased premium rating strength; The impact of intangibles within the AMI acquisition; and The Group s increased investment in joint ventures, notably in Asia. The Group s capital position is robust On a pro forma basis, after allowing for the expected completion in 1H13 of the acquisition of Kurnia by the Group s Malaysian associate, the Group s MCR ratio at 30 June 2012 would stand at IAG FY12 INVESTOR REPORT 4

9 1. EXECUTIVE SUMMARY The Group s debt to total tangible capitalisation ratio is consistent with that at 31 December 2011, at 38.3%. This places the Group towards the upper end of its targeted range of 30-40%. A number of debt and hybrid capital management initiatives were completed during the year. IAG s key wholly owned operating insurance subsidiaries continue to hold very strong AA- ratings from Standard & Poor s (S&P). At the Group level, IAG retains an A+ rating. The Group s probability of adequacy for the outstanding claims liability remained at 90% at 30 June OUTLOOK The Group expects to report strong GWP growth and a higher insurance margin in FY13. GWP growth of 9-11% is anticipated in FY13. This will be sourced from premium rate increases across the Australian and New Zealand businesses, as well as volume improvement. A full year s contribution from AMI will also be a significant factor. Improved FY13 performance expected: GWP growth of 9-11%, insurance margin of 11-13% The Group anticipates reporting an improved insurance margin within the range of 11-13%. Underlying assumptions behind this guidance are: Net losses from natural perils in line with allowances of $640m; Prior period reserve releases equivalent to 1-2% of NEP (FY12: 2.9%); and No material movement in foreign exchange rates or investment markets. The outlook comprises the following divisional expectations: Strong GWP growth from Australia Direct derived from a combination of rate and volume increases, and a margin similar to FY12, despite anticipated lower reserve releases and continued pressures in NSW CTP; Continued strong GWP growth from CGU, combined with delivery of a double digit underlying margin and realisation of pre-tax cost savings of $25m associated with the new operating model; Significant GWP growth in New Zealand, as ongoing rate increases are supplemented by 12 months contribution from AMI (FY12: 3 months), and improved underlying profitability; Modest profitability in the UK; and A small profit from Asia, assisted by the first-time inclusion of Kurnia and expected strong performances from the established businesses in Thailand and Malaysia, partially offset by higher regional development costs and start-up losses from businesses in developing markets (India, China and Vietnam). IAG FY12 INVESTOR REPORT 5

10 2. STRATEGY GROUP STRATEGY & PRIORITIES PROGRESS AGAINST STRATEGY IAG has clearly identified strategic priorities against which significant progress was made during FY12. Accelerating growth in Australia and New Zealand Significant progress against strategic priorities in FY12 GWP growth from the combined Australian and New Zealand businesses was 13.1% in FY12. This was derived from a mixture of increased rates, volume gains and acquisitions. Australia Direct is demonstrating strong growth, with rate increases augmented by encouraging volume gains, notably in the motor portfolio. The volume improvement reflects a range of initiatives, including improved online capability and ongoing investment in pricing expertise to drive growth in preferred risk areas. CGU generated strong top line growth in FY12, derived from rate increases and bolt-on acquisitions including the HBF general insurance business, and this is expected to continue in FY13. CGU s operating performance continues to improve, placing it on track to record an underlying double digit insurance margin in FY13. Implementation of the business new operating model has commenced and is expected to deliver pre-tax benefits of $25m in FY13 and $65m by FY15. The New Zealand business is recording strong GWP growth, centred on significant rate increases but including improved new business volumes, particularly in intermediated commercial lines. The purchase of AMI was completed in April 2012, reinforcing IAG s market-leading position in New Zealand, notably in direct personal lines. Restoring profitability in the UK The programme of remedial actions in the UK has delivered further improvement in reported performance, and placed the business close to breakeven in FY12. Sufficient progress has been made to allow the Group to consider the future strategic options for the business. A review of the UK was announced in May 2012, with an outcome expected before the end of 1H13. IAG FY12 INVESTOR REPORT 6

11 2. STRATEGY Under the strategic review, the Group continues to assess a number of options, including: A continuing focus on improving the business performance within the current operating model; Refining the business strategy to a more focused specialist motor offering; and The potential sale of all or part of the business. Boosting the Group s Asian footprint The Group made considerable progress in expanding its Asian footprint in FY12, and is on track to reach its goal of Asia representing 10% of GWP by 2016, on a proportional basis. In April 2012, the Group announced the acquisition of Kurnia Insurans (Malaysia) Berhad, via IAG s highly profitable Malaysian joint venture, AmG. This transaction is expected to complete in 1H13 and will result in AmG being a clear market leader in Malaysian motor insurance, in line with AmG s stated strategy. The Group has established a presence in two of the fastest growing insurance markets in Asia, complementing its existing joint venture in India with State Bank of India, SBI General. During 2H12, IAG completed the acquisition of: A 20% interest in Bohai Property Insurance Company Ltd (Bohai) in China. Based in Tianjin, Bohai offers a compelling strategic and cultural fit, with a predominantly motor focus and an established annual GWP base in excess of $200m; and A 30% stake in AAA Assurance Corporation in Vietnam. AAA Assurance is headquartered in Ho Chi Minh City and has grown rapidly to become the sixth largest motor insurer in Vietnam. Mirroring its experience in the more established markets of Thailand and Malaysia, IAG is bringing its capability transfer skills to bear on improving the performance of each of these developing market interests. The Group expects the overall Asia division to deliver an ROE in excess of 15% by FY17, prior to regional support and development costs. IAG FY12 INVESTOR REPORT 7

12 3. GROUP RESULTS FINANCIAL PERFORMANCE GROUP RESULTS 1H11 2H11 1H12 2H12 FY11 FY12 Gross written premium 3,936 4,114 4,318 4,674 8,050 8,992 Gross earned premium 3,938 3,920 4,195 4,382 7,858 8,577 Reinsurance expense (228) (392) (356) (378) (620) (734) Net earned premium 3,710 3,528 3,839 4,004 7,238 7,843 Net claims expense (2,359) (2,730) (3,007) (2,784) (5,089) (5,791) Commission expense (336) (297) (329) (342) (633) (671) Underwriting expense (694) (651) (707) (766) (1,345) (1,473) Underwriting profit/(loss) 321 (150) (204) (92) Investment income on technical reserves Insurance profit Net corporate expense - (1) - (56) (1) (56) Interest (44) (42) (44) (53) (86) (97) Profit/(loss) from fee based business 17 (11) Share of profit/(loss) from associates - (2) (1) (3) (2) (4) Investment income on shareholders' funds (30) Profit before income tax and amortisation Income tax expense (223) (53) (26) (152) (276) (178) Profit after income tax (before amortisation) Non-controlling interests (44) (44) (23) (35) (88) (58) Profit attributable to IAG shareholders (before amortisation) Amortisation and impairment (162) (14) (11) (322) (176) (333) Profit attributable to IAG shareholders Insurance Ratios Loss ratio 63.6% 77.4% 78.3% 69.5% 70.3% 73.8% Immunised loss ratio 66.4% 75.5% 70.0% 64.8% 70.8% 67.4% Expense ratio 27.8% 26.9% 27.0% 27.6% 27.3% 27.4% Commission ratio 9.1% 8.4% 8.6% 8.5% 8.7% 8.6% Administration ratio 18.7% 18.5% 18.4% 19.1% 18.6% 18.8% Combined ratio 91.4% 104.3% 105.3% 97.1% 97.6% 101.2% Immunised combined ratio 94.2% 102.4% 97.0% 92.4% 98.1% 94.8% Insurance margin 12.7% 5.4% 7.1% 14.0% 9.1% 10.6% Key Financial Metrics Reported ROE (average equity) (% pa) 7.2% 4.0% 6.5% 2.9% 5.6% 4.7% Cash ROE (average equity) (% pa) 16.0% 6.1% 7.0% 19.7% 11.1% 13.3% Basic EPS (cents) Cash EPS (cents) DPS (cents) Probability of adequacy 90% 90% 90% 90% 90% 90% MCR multiple KEY FOREIGN EXCHANGE RATES APPLIED Balance Sheet Income Statement (spot rate) (average rate) FY11 FY12 FY11 FY12 New Zealand dollar British pound Thai baht Malaysian ringgit IAG FY12 INVESTOR REPORT 8

13 3. GROUP RESULTS INSURANCE RATIOS EXPENSE RATIOS LOSS RATIO 30% 25% 20% 27.8% 26.9% 27.0% 27.6% 27.3% 27.4% 3.5% 3.5% 3.8% 4.1% 3.5% 4.0% 9.1% 8.4% 8.6% 8.5% 8.7% 8.6% 80% 70% 60% 50% 66.4% 75.5% 70.0% 64.8% 70.8% 67.4% 15% 10% 5% 15.2% 15.0% 14.6% 15.0% 15.1% 14.8% 40% 30% 20% 10% 63.6% 77.4% 78.3% 69.5% 70.3% 73.8% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Levies Commission Ratio Administration Ratio 0% 1H11 2H11 1H12 2H12 FY11 FY12 Loss Ratio Immunised Loss Ratio COMBINED RATIO INSURANCE MARGIN 120% 100% 94.2% 102.4% 97.0% 92.4% 98.1% 94.8% 16% 14% 80% 12% 10% 60% 40% 20% 91.4% 104.3% 105.3% 97.1% 97.6% 101.2% 8% 6% 4% 2% 12.7% 5.4% 7.1% 14.0% 9.1% 10.6% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Combined Ratio Immunised Combined Ratio 0% 1H11 2H11 1H12 2H12 FY11 FY12 PREMIUMS GWP for the Group was $8,992m, up 11.7% from $8,050m in FY11, with growth largely driven by rate increases in Australia and New Zealand, implemented to recover higher reinsurance costs and natural peril allowances. This was supplemented by volume gains in most markets, as well as acquisition-derived growth, notably in CGU and New Zealand. Excluding the AMI acquisition (in New Zealand), which was consolidated from April 2012, GWP growth was 10.8%. GWP grew by 11.7% in FY12 (10.8% ex-ami) GWP FY12 VS. FY11 (A$M) 9,500 9,000 8,500 8, ,500 7,000 8,992 6,500 8,050 6,000 5,500 5,000 FY11 Australia Direct Australia Intermediated New Zealand United Kingdom Asia External Reinsurance FY12 IAG FY12 INVESTOR REPORT 9

14 3. GROUP RESULTS Comparing FY12 GWP with FY11 on a divisional basis: Australia Direct grew by 10.5% to $4,299m, with significant rate increases, largely in home, augmented by volume growth, particularly in motor; Australia Intermediated (CGU) rose by 12.0% to $2,759m, with growth derived from a blend of rate increases and recent acquisitions (notably the HBF business); New Zealand reported an increase in GWP of over 26%, to $1,210m, reflecting significant rate increases to recover substantially higher reinsurance costs and an initial contribution from AMI; The UK business reported a 9% decline in GWP, as reduced volumes were partially offset by rate increases; and In Asia, consolidated GWP (in respect of Thailand) rose by nearly 16%, following a strong recovery in car production and demand. INSURANCE MARGIN The Group s insurance margin was 10.6% (FY11: 9.1%), following a much stronger reported second half outcome of 14.0% (1H12: 7.1%). The full year result was in line with guidance set at the beginning of the year, and was achieved despite significantly higher reinsurance costs and worse than originally expected impacts from both natural perils and investment markets, in the form of credit spreads. A compensating influence was higher than expected reserve releases. Improved insurance margin of 10.6% in line with guidance Compared to FY11 ($660m), the period s insurance profit of $832m contains the following notable elements: Net natural peril claim costs of $658m, which exceeded allowances by $78m. After significant peril activity in 1H12, the second half produced a net claim cost $52m below related allowances; A greater than 18% increase in reinsurance expense, which limited NEP growth to just over 8%; Reserve releases of $229m (FY11: $328m), or 2.9% of NEP; and An adverse credit spread impact of $70m. INSURANCE MARGIN IMPACTS 1H11 Reserve releases Natural perils (134) (476) (396) (262) (610) (658) Natural perils allowance Credit spreads * * (80) 10 * (70) Reserve releases 2.8% 6.4% 2.9% 2.9% 4.5% 2.9% Natural perils (3.6%) (13.5%) (10.3%) (6.5%) (8.4%) (8.4%) Natural perils allowance 5.1% 7.0% 6.9% 7.8% 6.0% 7.4% Credit spreads * * (2.1%) 0.2% * (0.9%) * Negligible impact during the period. 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 10

15 3. GROUP RESULTS INSURANCE PROFIT / MARGIN FY12 VS. FY % % FY11 Reserve Releases Natural Perils Credit Spreads Business Improvement FY12 On a divisional basis: Australia Direct has reported a lower insurance profit owing to materially higher net natural peril costs, lower reserve releases and wider credit spreads. There has also been a modest negative timing impact associated with the implementation of rate increases to recover higher reinsurance costs. At an underlying level, however, the insurance margin is mid-teen in scale and consistent with FY11; CGU has reported a significantly higher insurance margin of 10.8%, with a favourable natural perils experience overshadowing lower reserve releases and an adverse credit spread effect. CGU s underlying margin demonstrated good progress over FY11, placing the business on track to achieve a double digit outcome in FY13; The New Zealand insurance profit is significantly higher than the earthquake-impacted FY11 result, and translates to a reported insurance margin of 10.4%. Underlying performance has been strong throughout FY12; The UK remedial action programme has delivered a further advance in operating performance, enabling the business to produce a close to breakeven result; and The insurance loss of $59m from Asia reflects the extreme flood event in Thailand in 1H12. Excluding this event, the performance of the Thai business remained sound and a second half insurance profit of $8m was produced. REINSURANCE EXPENSE The total reinsurance expense includes the cost of all covers purchased by the Group, including catastrophe, casualty and facultative protection. The FY12 expense of $734m represents an 18% increase over FY11, and includes reinsurance associated with the AMI acquisition from April Increased reinsurance expense includes reinstatement costs Despite the 1H12 reinsurance cost containing approximately $110m of reinstatement costs, a slightly higher expense of $378m was recorded in 2H12. This reflects the growth of the overall business, the addition of AMI IAG FY12 INVESTOR REPORT 11

16 3. GROUP RESULTS and the renewal of the main catastrophe programme, effective from 1 January Following severe regional natural peril experience, the Group s total reinsurance expense has moved from approximately 6% of GWP in FY09, to over 8% in FY12. A similar ratio is expected in FY13. REINSURANCE EXPENSE % 6.2% 6.3% 6.3% 6.0% 6.2% % % % % 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% % - FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 - Reinsurance expense ($m) Reinsurance expense (%GWP) CLAIMS After allowing for the risk free discount rate adjustment, the immunised loss ratio of 67.4% is lower than FY11 (70.8%), reflecting improved underlying claims performance. Improved immunised FY12 loss ratio The FY12 reported loss ratio of 73.8% is higher than FY11 (70.3%), and reflects the combined effect of: A significant movement in the risk free discount rate adjustment, in response to lower interest rates; Higher net natural peril claim costs; Lower prior period reserve releases; and A substantially lower claims expense in the UK. Other influences on the total claims expense were business volume growth across the Group, including acquisitions, and further benefit from claim initiatives, notably in CGU. Reserve Releases The FY12 net claims expense includes $229m of prior period reserve releases, equivalent to 2.9% of NEP. This compares to $328m (4.5% of NEP) reported in FY11, and is higher than expectations expressed in February 2012, of slightly above 2% of NEP. FY12 reserve releases primarily reflect favourable experience in Australian long tail classes, such as professional risks, workers compensation and CTP. Reserve releases were predominantly sourced from central estimates. Reserve releases primarily derived from Australian long tail classes RESERVE RELEASES 1H11 2H11 1H12 2H12 FY11 FY12 Reserve releases Impact on insurance margin 2.8% 6.4% 2.9% 2.9% 4.5% 2.9% IAG FY12 INVESTOR REPORT 12

17 3. GROUP RESULTS The Group believes that reserve releases of around 1% of NEP are a recurring feature of its reported operating results in benign inflationary periods. This reflects the Group s approach to reserving, with long term inflation assumptions tending to be in excess of actual experience in most years. The Group s expectation is for lower reserve releases of 1-2% of NEP in FY13. RESERVE RELEASES IMPACT ON INSURANCE MARGIN 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 Expected long term reserve release level (1% NEP) Natural Perils The FY12 net claims expense included $658m (FY11: $610m) of losses from natural perils (net of reinsurance), compared to allowances of $580m. This also exceeded the Group s revised estimate for the year, of $630m, as outlined in February The net effect of natural perils (after allowances) was a negative impact on reported insurance margin of 1.0% (FY11: -2.4%). Net natural peril claims $78m in excess of allowances NATURAL PERILS IMPACT ON INSURANCE MARGIN 2% 1% 0% -1% -2% -3% -4% -5% -6% -7% 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 Natural perils net of allowances - margin impact NATURAL PERILS 1H11 2H11 1H12 2H12 FY11 FY12 Natural peril claim costs (134) (476) (396) (262) (610) (658) Natural peril allowances Impact on insurance profit 54 (229) (130) 52 (175) (78) Impact on insurance margin 1.5% (6.5%) (3.4%) 1.3% (2.4%) (1.0%) IAG FY12 INVESTOR REPORT 13

18 3. GROUP RESULTS The Group experienced contrasting halves during FY12. 1H12 perils exceeded allowances by $130m, and contained two events of note: the floods in Thailand and the storm activity in Victoria around the Christmas period. Related net claim costs were $62m and $172m respectively. Net natural peril claim costs in 2H12 were $52m below allowances. The most significant incident in the half was the trans-tasman flood and severe wind event spanning February-March 2012, which amounted to a net cost of $69m. While further seismic activity has occurred in the Canterbury region of New Zealand during the year, it has not resulted in significant claim costs. Attritional natural peril events (less than $5m in size) amounted to $138m, compared to $172m in FY11. FY12 NATURAL PERIL COSTS BY EVENT Severe frontal thunderstorms - Australia (July 2011) 10 Extreme floods - Thailand (August - December 2011) 62 East coast low - NSW (September 2011) 7 Frontal squalls and thunderstorms - Australia (November 2011) 15 Squalls and thunderstorms - Australia (November 2011) 6 Margaret River fires - Western Australia (November - December 2011) 7 Rain squalls and thunderstorms - Australia (November - December 2011) 8 Thunderstorms - Australia (December 2011) 9 Heavy rain and flooding - Nelson/Tasman districts (December 2011) 6 Thunderstorms - Australia (December 2011) 9 Severe storms - Victoria (December 2011) 172 Canterbury aftershocks - New Zealand (December January 2012) 23 Heavy rain - Queensland/NSW (January 2012) 7 Heavy rain and flooding - Moree, St George (January - February 2012) 11 East coast flash flooding - Penrith (February 2012) 20 Thunderstorms - Southern Sydney (February 2012) 11 Flooding and severe wind - Victoria, NSW, New Zealand (February - March 2012) 69 Randwick waterspout and storms - SE Australia (March 2012) 8 Townsville tornado and monsoonal rain - Queensland (March 2012) 12 Flash flooding - Sydney/NSW central coast (April 2012) 6 Hail, rain and storms - Australia (April 2012) 6 East coast low and South Island snowstorm - Gippsland, NSW, New Zealand (June 2012) 9 Windstorm - Western Australia (June 2012) 19 Moe earthquake - Victoria (June 2012) 8 Other events 138 Total 658 The Group s natural peril allowance for FY13 is $640m, a 10% increase over the FY12 allowance. In future periods the Group s apportionment of natural peril allowances is expected to be more evenly split between the respective halves of the financial year. This reflects the anticipated reduced seasonal effect of protection provided by the Group s aggregate catastrophe reinsurance cover, in light of higher attachment points as embodied in 2012 s programme. Lower attachment points on prior year programmes tended to result in greater utilisation of aggregate cover in the second half of the calendar year (or opening half of the financial year). This was reflected in prior year allocation of allowances, including FY12. FY13 guidance assumes increased natural peril assumption of $640m IAG FY12 INVESTOR REPORT 14

19 3. GROUP RESULTS EXPENSES The Group s reported expense ratio was broadly flat at 27.4% (FY11: 27.3%). Excluding government levies, the Group s administration ratio has improved from 15.1% in FY11 to 14.8% in FY12 reflecting the combined effect of increased net earned premium and tightly controlled expenditure. Strong expense control in evidence The Group s commission ratio improved slightly to 8.6% (FY11: 8.7%). INVESTMENT INCOME ON TECHNICAL RESERVES Investment income on technical reserves for FY12 was $924m, compared to $489m in FY11. This outcome includes unrealised capital gains associated with the period end discount rate adjustment, of $506m, compared with an equivalent negative adjustment of $37m at FY11. Credit spread volatility returned as a significant feature during the year, and reduced investment income on technical reserves by $70m. The bulk of this occurred in 1H12, when an $80m impact was recognised. Spreads displayed sharp movements during 2H12, but finished the period close to those at 31 December 2011, producing a favourable net impact of only $10m in the half. Significant adverse credit spread impact in FY12, predominantly in the opening half Allowing for credit spreads and the movement in the discount rate adjustment prompted by lower interest rates, the Group continued to generate over 100bps of return above the risk free rate, across the entire technical reserves portfolio. The portfolio continues to be aligned with the average weighted duration of the Group s claims liability, at three to four years. NET CORPORATE EXPENSE A pre-tax net corporate expense of $56m has been identified in FY12 (FY11: $1m). The post-tax impact on reported earnings is approximately $43m. As foreshadowed, the bulk of the FY12 charge emanates from costs associated with the implementation of CGU s revised operating model, as well as acquisition and integration costs attached to the AMI purchase in New Zealand. Net corporate expenses primarily in respect of CGU s revised operating model and AMI acquisition Anticipated CGU implementation costs of approximately $75m will be recognised over the course of FY12 and FY13. A sum of $36m has been identified in FY12, in line with original expectations. The FY12 net corporate expense includes approximately $12m of acquisition and integration costs stemming from the addition of the AMI business in New Zealand in April The balance of the net corporate expense line, of approximately $8m, includes the following items: The profit on sale of the Group s 51% interest in the UK commercial broker, Insurance Dialogue Limited (IDL); A loss on reinsuring to close Syndicate 1208 (previously in run-off) in the UK; Costs associated with the strategic review of the UK business; and The negative foreign currency translation reserve recycled upon disposal of the non-core China Automobile Association (CAA) business early in 2H12. Pre-tax net corporate expenses of around $55m are anticipated in FY13, comprising the balance of expenditure associated with the implementation of CGU s revised operating model and the integration of AMI. IAG FY12 INVESTOR REPORT 15

20 3. GROUP RESULTS PROFIT FROM FEE BASED BUSINESS Fee based business generated a profit of $12m in FY12, compared to $6m in FY11. The improved outcome reflects: A significantly higher result from CGU, despite lower prior period income; slightly offset by A weaker performance from the UK fee based operations owing to challenging market conditions. SHARE OF ASSOCIATES The Group s Asian interests represent a large portion of the share of earnings from associates, and comprise: The 49% interest in the Malaysian joint venture, AmG Insurance, which produced a strong insurance margin in excess of 18%; A 26% interest in SBI General in India, which is still in its start-up phase and produced modest losses that were lower than expectations; and A 20% interest in Bohai Property Insurance in China which was acquired in 2H12, with IAG s share of losses identified from 1 May Improved CGU fee based income Share of associates largely derived from Asian interests The combined contribution from these Asian businesses was a loss of $3m, after allocation of $11m of regional support and development costs. The Group s overall share of associates was a loss of $4m (FY11: $2m loss). INVESTMENT INCOME ON SHAREHOLDERS FUNDS Investment income on shareholders funds was a profit of $89m, compared to a profit of $213m in FY11. The poor outcome largely reflects the direction of equity markets, with the broader Australian index (S&P ASX200 Accumulation) delivering a negative return of 6.7% over the year to 30 June Reduced shareholders funds income reflects weak equity markets At 30 June 2012 the weighting to growth assets (equities and alternatives) within shareholders funds stood at approximately 40%, compared to 41% at 30 June 2011 and 35% at 31 December The increased weighting since 31 December 2011 reflects the outlay of funds held in short term fixed interest and cash to fund acquisitions completed in 2H12 and improved equity returns compared to 1H12. TAX EXPENSE The Group reported a tax expense of $178m in FY12, compared to $276m in FY11, representing an effective tax rate (pre-amortisation) of 22.9%. This reconciles to the prevailing Australian corporate rate of 30% after allowing for increased reinsurance recoveries by captive vehicles domiciled in lower tax jurisdictions, notably in 1H12. A strengthening of gross claim reserves, in respect of large peril events in FY11, occurred in that period. Lower effective tax rate reflects reinsurance recoveries in lower tax jurisdictions Non-recognition for accounting purposes of any future tax benefit in respect of the UK operating losses was minimal in FY12. As at 30 June 2012, unrecognised tax losses in respect of the UK stood at $203m. NON-CONTROLLING INTERESTS The $58m non-controlling interests in the Group s profit compares to $88m in FY11. The decrease reflects lower earnings attributable to the minority 30% interest in Insurance Manufacturers of Australia Pty Limited (IMA), whose short tail business lines form part of Australia Direct. The result of this business was particularly affected by a higher net natural peril experience compared to FY11. Lower non-controlling interests owing to reduced IMA result IAG FY12 INVESTOR REPORT 16

21 3. GROUP RESULTS AMORTISATION The FY12 amortisation charge of $333m compares to $176m reported in FY11, and includes the recognition of a $297m impairment of goodwill and identifiable intangible assets associated with the UK business (FY11: $150m). This reflects the continuation of challenging economic and industry conditions in the UK. Amortisation includes $297m UK impairment The Group is currently conducting a strategic review of the UK business, in which a number of options are being considered. Following the impairment of goodwill and identifiable intangible assets, at 30 June 2012 the carrying value of the business was approximately $200m. In the event of a sale or return of capital from the UK, a negative foreign currency translation amount of around $80m would also be recycled via the profit and loss, but would have no impact on the Group s net asset or regulatory capital position. The Group s amortisation charge in FY13 is expected to be around $35m, and will be skewed to the front half of the financial year. This reflects the short amortisation schedule attached to certain identifiable intangible assets associated with the AMI acquisition. EARNINGS PER SHARE Basic earnings per share (EPS) in FY12 was cents per share (cps), compared to 12.08cps in FY11, a decrease of approximately 17%. On a diluted basis, EPS was 9.96cps (FY11: 12.01cps). Basic EPS was calculated on weighted average capital on issue in FY12 of 2,067m shares (excluding treasury shares). Shares ORDINARY ISSUED CAPITAL (m) Balance at the beginning of the financial year 2,079 Balance at the end of the half year 2,079 Average weighted shares on issue 1 2,067 1 Excludes treasury shares held in trust. Cash EPS was 28.20cps, compared to 23.97cps in FY11, an increase of nearly 18%. Cash earnings are used for the purposes of targeted ROE and dividend payout policy, and are defined as: Net profit after tax attributable to IAG shareholders; Plus amortisation and impairment of acquired identifiable intangibles; and Excluding any unusual items. 18% increase in cash EPS FY12 CASH EARNINGS Net profit after tax 207 Intangible amortisation and impairment 333 Unusual items: - Corporate expenses 56 - Tax effect on corporate expenses (13) Cash earnings 583 Dividend payable 353 Cash payout ratio 60.5% IAG FY12 INVESTOR REPORT 17

22 3. GROUP RESULTS DIVIDENDS IAG s policy is to pay dividends equivalent to approximately 50 70% of reported cash earnings in any given financial year. The Board has determined to pay a fully franked final dividend of 12.0 cents per ordinary share (2H11: 7.0cps). This brings the full year dividend to 17.0 cents (FY11: 16cps), which equates to a payout ratio of 60.5% of cash earnings for the year. The final dividend is payable on 3 October 2012 to shareholders registered as at 5pm on 5 September Cash payout ratio of 60.5% in FY12 The dividend reinvestment plan (DRP) will operate for the final dividend. The issue price per share for the 2H12 dividend will be the Average Market Price as defined in the DRP terms, and there will be no discount for participants. Shares allocated under the DRP will be purchased on-market. Information about IAG s DRP is available at: The listed entity had distributable retained earnings of $1,049m as at 30 June At this date, and after allowance for payment of the final dividend, the Group s franking balance was $405m, giving the capacity to fully frank a further $946m of distributions. RETURN ON EQUITY The Group targets a cash ROE of at least 1.5 times WACC through the cycle. This return is based on net profit after tax attributable to IAG shareholders, adjusted for amortisation and impairment of intangibles and unusual items. Based on the Group s historic cost of capital and current business mix, this target equates to a cash ROE of approximately 15%. In FY12, the Group reported a cash ROE of 13.3%, compared to 11.1% in FY11. Cash ROE of 13.3% RETURN ON EQUITY (ANNUALISED) 7.2% 16.0% 4.0% 6.1% 6.5% 7.0% 2.9% 19.7% 11.1% 5.6% 4.7% 13.3% 1H11 2H11 1H12 2H12 FY11 FY12 Actual ROE attributable to holders of ordinary shares Cash ROE attributable to holders of ordinary shares IAG FY12 INVESTOR REPORT 18

23 4. DIVISIONAL OVERVIEW INSURANCE AUSTRALIA GROUP GENERAL INSURANCE CORPORATE & OTHER Australia Direct External Reinsurance Australia Intermediated (CGU) Investments New Zealand Corporate Costs United Kingdom Asia FY12 DIVISIONAL FINANCIAL PERFORMANCE Australia Direct Australia Intermediated New Zealand UK Asia Corporate & Other Total Gross written premium 4,299 2,759 1, ,992 Gross earned premium 4,072 2,633 1, ,577 Reinsurance expense (262) (245) (149) (34) (40) (4) (734) Net earned premium 3,810 2, ,843 Net claims expense (3,038) (1,624) (601) (370) (155) (3) (5,791) Commission expense (81) (369) (119) (67) (34) (1) (671) Underwriting expense (671) (512) (178) (83) (28) (1) (1,473) Underwriting profit/(loss) 20 (117) 93 (23) (64) (1) (92) Investment income on technical reserves Insurance profit/(loss) (13) (59) (1) 832 Profit/(loss) from fee based business (3) Share of profit/(loss) from associates - (2) - 1 (3) - (4) Total divisional results (15) (62) (1) 840 Insurance Ratios Loss ratio 79.7% 68.0% 60.6% 74.4% 101.3% 73.8% Expense ratio 19.7% 36.9% 30.0% 30.2% 40.5% 27.4% Commission ratio 2.1% 15.5% 12.0% 13.5% 22.2% 8.6% Administration ratio 17.6% 21.4% 18.0% 16.7% 18.3% 18.8% Combined ratio 99.4% 104.9% 90.6% 104.6% 141.8% 101.2% Insurance margin 14.3% 10.8% 10.4% (2.6%) (38.6%) 10.6% IAG FY12 INVESTOR REPORT 19

24 5. AUSTRALIA DIRECT FINANCIAL PERFORMANCE 1H11 Gross written premium 1,919 1,972 2,080 2,219 3,891 4,299 Gross earned premium 1,877 1,902 1,996 2,076 3,779 4,072 Reinsurance expense (71) (114) (130) (132) (185) (262) Net earned premium 1,806 1,788 1,866 1,944 3,594 3,810 Net claims expense (1,201) (1,274) (1,553) (1,485) (2,475) (3,038) Commission expense (37) (38) (40) (41) (75) (81) Underwriting expense (307) (316) (316) (355) (623) (671) Underwriting profit/(loss) (43) Investment income on technical reserves Insurance profit H11 1H12 2H12 FY11 FY12 Insurance Ratios Loss ratio 66.5% 71.3% 83.2% 76.4% 68.9% 79.7% Immunised loss ratio 69.8% 68.9% 74.6% 70.6% 69.3% 72.6% Expense ratio 19.0% 19.8% 19.0% 20.4% 19.4% 19.7% Commission ratio 2.0% 2.1% 2.1% 2.1% 2.1% 2.1% Administration ratio 17.0% 17.7% 16.9% 18.3% 17.3% 17.6% Combined ratio 85.5% 91.1% 102.2% 96.8% 88.3% 99.4% Immunised combined ratio 88.8% 88.7% 93.6% 91.0% 88.7% 92.3% Insurance margin 19.4% 19.7% 12.3% 16.2% 19.5% 14.3% INSURANCE RATIOS EXPENSE RATIO LOSS RATIO 25% 20% 15% 19.0% 4.5% 2.0% 19.8% 4.3% 2.1% 19.0% 4.8% 2.1% 20.4% 19.4% 19.7% 5.4% 4.4% 5.1% 2.1% 2.1% 2.1% 100% 80% 60% 69.8% 68.9% 74.6% 70.6% 69.3% 72.6% 10% 5% 12.5% 13.4% 12.1% 12.9% 12.9% 12.5% 40% 20% 66.5% 71.3% 83.2% 76.4% 68.9% 79.7% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Administration Ratio Commission Ratio Levies COMBINED RATIO 0% 1H11 2H11 1H12 2H12 FY11 FY12 Loss Ratio Immunised Loss Ratio INSURANCE MARGIN 100% 88.8% 88.7% 93.6% 91.0% 88.7% 92.3% 20% 80% 15% 60% 40% 20% 85.5% 91.1% 102.2% 96.8% 88.3% 99.4% 10% 5% 19.4% 19.7% 12.3% 16.2% 19.5% 14.3% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Combined Ratio Immunised Combined Ratio 0% 1H11 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 20

25 5. AUSTRALIA DIRECT EXECUTIVE SUMMARY Australia Direct, IAG s largest business, contributed nearly 48% of the Group s GWP in FY12 and has continued to perform well. It concentrates on direct personal lines insurance products, including compulsory third party (CTP), and operates with single pricing and claims platforms which cover all its state-based brands. Strong GWP growth of 10.5% was recorded, driven by a combination of rate increases, to recover increased reinsurance costs and higher natural peril allowances, and volume growth, notably in motor. GWP has increased in all states and most product classes. Strong underlying performance maintained, as perils and credit spreads impact reported outcome FY12 GWP BY TAIL Australia Direct produced a lower full year insurance profit of $544m (FY11: $702m) owing to an unfavourable net natural peril claims experience, lower reserve releases and an adverse credit spread impact. The reduced reported insurance margin of 14.3% (FY11: 19.5%) is consistent with guidance provided at the outset of the year, which highlighted lower reserve releases and timing differences associated with the pass-through of significantly higher reinsurance costs. The underlying performance of the business has remained strong and is consistent with a sustained mid-teens insurance margin. A stronger 2H12 reported margin of 16.2%, compared to 12.3% in 1H12, included a slightly lower adverse net natural peril cost impact and a modestly positive credit spread effect. In FY13, Australia Direct expects to record strong GWP growth, underpinned by ongoing product initiatives and rate increases. A similar insurance margin to FY12 is expected, despite lower anticipated reserve releases and continued pressures in NSW CTP. 21% Short Tail Long Tail 79% PREMIUMS Australia Direct s GWP increased by 10.5% to $4,299m (FY11: $3,891m), encapsulating increased momentum in 2H12 as rate increases were implemented across the year to recover higher reinsurance and natural peril costs, primarily in respect of the home book. GWP growth of 10.5%, driven by rate and volume Growth was realised in all product classes and states, with the exception of Queensland CTP ($57m GWP in FY12) where Australia Direct continues to restrict marketing efforts following the scheme changes implemented in late Rate-driven growth was complemented by continued volume improvement, particularly in motor, stemming from a range of marketing initiatives and ongoing investment in customer insights and pricing capability, targeting growth in preferred risk areas. Marketing campaigns included the continuation of the successful Experience the Difference brand campaign. Australia Direct's online sales channel registered substantial growth, with volumes increasing by over 25% against FY11 across all retail brands. The Buzz Insurance s market-leading online functionality and related experience has been leveraged across Australia Direct s brand websites, all of which have undergone significant enhancements. The Buzz Insurance ceased to write business towards the end of FY12, as Australia Direct concentrates on its main state-based brands. GWP growth of 12.5% was recorded by Australia Direct s short tail business in FY12, including accelerated growth of 15.0% in 2H12, compared to 2H11. Approximately 70% of the full year growth was derived from the cumulative impact of rate increases, with the balance sourced from volume. This mix was broadly consistent across the year. FY12 GWP BY CLASS 6% 20% 29% Motor Home CTP Other 45% IAG FY12 INVESTOR REPORT 21

26 5. AUSTRALIA DIRECT GWP GROWTH 1H11 2H11 1H12 2H12 FY11 FY12 Motor 3.6% 0.7% 5.7% 9.9% 2.1% 7.8% Home 11.1% 8.7% 16.7% 24.0% 9.9% 20.4% Total Short Tail 6.7% 3.3% 9.8% 15.0% 5.0% 12.5% Long Tail 13.4% 12.9% 5.2% 5.5% 13.1% 5.4% Retail Business Insurance (RBI) 4.4% 3.7% (0.6%) 4.9% 4.1% 2.2% Total GWP 7.9% 5.2% 8.4% 12.5% 6.5% 10.5% Motor GWP increased by 7.8% compared to FY11, and by 9.9% in 2H12 against the comparable half. The majority of growth during the year was derived from higher volume. This growth also reflects Australia Direct s continuing investment in customer insights and pricing capability, which has resulted in a progressive shift towards preferred risk areas over the course of FY11 and FY12. Due renewal levels for motor in FY12 were similar to those of FY11, at around 90%. Motor GWP growth of 7.8%, majority derived from volume Home GWP increased by 20.4%, compared to FY11, and by 24.0% in 2H12. Most of this was derived from rate increases. These have, however, been augmented by healthy volume growth sourced from continued product and marketing initiatives, including the provision of premium options to customers on renewal. Home due renewal levels remained strong, at 93%. FY12 SHORT TAIL GWP BY STATE FY12 LONG TAIL GWP BY STATE 7% 9% 7% 2% 24% 60% 91% NSW/ACT Victoria Queensland Other NSW/ACT Queensland Other Overall long tail (primarily CTP) GWP growth of 5.4% was recorded in FY12, in the face of lower rate increases and reduced volume growth, compared to FY11. In addition to the increases applied in NSW and the ACT during 1H12, a 1.8% price increase was implemented in Queensland in April Rate accounted for the vast majority of increased CTP GWP in FY12. Despite significantly lower investment yields, NSW CTP rate movements were confined to the 2.7% increase approved with effect from September Consistent with all industry participants, Australia Direct s application for a further increase, effective 1 January 2012, was rejected by the regulator. Subsequently, an increase of 4.5%, effective 1 July 2012, has been approved, while the regulator has announced a review of pricing and scheme design. IAG FY12 INVESTOR REPORT 22

27 5. AUSTRALIA DIRECT Total CTP policies in force grew fractionally compared to FY11. Growth in NSW and the ACT continued to be offset by weaker activity in Queensland, where Australia Direct has actively reduced marketing in response to unsatisfactory scheme performance. Overall due renewal rates declined slightly in FY12, but remain above 78%. Australia Direct s share of NSW CTP registrations (on a 12-month rolling average basis) remained around 41%. On a similar basis, Queensland market share has reduced to 5.4%. Australia Direct remains the sole provider of CTP products in the ACT market. GWP growth from the RBI book has improved in 2H12, on the back of improved sales discipline across all channels translating to higher conversion rates, and significant rate increases in underperforming portfolios. REINSURANCE EXPENSE Reinsurance expense of $262m in FY12 was nearly 42%, or $77m, higher than FY11. This reflects the combined effect of: Increased catastrophe cover costs; Amortised reinstatement costs during 1H12; and Overall portfolio growth. Increased reinsurance expense, owing to reinstatement costs and higher catastrophe rates CLAIMS Australia Direct has reported a noticeably higher loss ratio of 79.7% in FY12 (FY11: 68.9%), owing to: A substantially higher net natural peril claim cost, including the major Victorian hailstorm event in December 2011; and A significantly adverse movement in the discount rate adjustment stemming from lower interest rates. On an immunised basis, the higher FY12 loss ratio of 72.6% (compared to 69.3% in FY11) highlights the increased net natural peril claim cost incurred. Reserve Releases Reserve releases of $123m were lower than those reported in FY11 ($158m), with 2H12 releases consistent with the first half. The majority of FY12 s reserve releases were sourced from the CTP portfolios, following favourable experience against existing underlying assumptions. RESERVE RELEASES 1H11 2H11 1H12 2H12 FY11 FY12 Reserve releases Impact on insurance margin 2.8% 6.0% 3.2% 3.3% 4.4% 3.2% Natural Perils Losses from natural perils (net of reinsurance) totalled $372m, which was $73m higher than allowances for the year. Approximately one third of Australia Direct s FY12 net natural peril expense was derived from the Victorian hailstorm event in late December Of a considerably lesser scale, the most significant incident in 2H12 was the storm and flooding event in NSW and Victoria during February and March Higher natural peril costs, influenced by Victorian storms in late December Net natural peril experience in FY11 benefited from reinsurance recoveries, notably via the aggregate cover in 1H11. IAG FY12 INVESTOR REPORT 23

28 5. AUSTRALIA DIRECT NATURAL PERILS 1H11 2H11 1H12 2H12 FY11 FY12 Natural perils (74) (95) (192) (180) (169) (372) Natural perils allowance Impact on insurance profit (46) (27) 42 (73) Impact on insurance margin 0.9% 1.4% (2.5%) (1.4%) 1.2% (2.0%) Claim Experience Excluding natural perils, the FY12 short tail claim experience was characterised by: A slight increase in frequency compared to FY11, centred on theft and collision volumes; An increase in collision costs due to the implementation of the Written Off Vehicles Register in NSW; Continued underlying motor repair claims inflation, which is in line with long term trends; and A greater than 10% increase in home average claim cost relative to FY11, owing to an increased number of severe fire claims, notably in 1H12. Modest uptick in frequency within nonperil claim experience From July 2012, Australia Direct moved to a partner network relationship model, having established strong partnerships with a mix of repairers that provide different skills and specialities. In NSW CTP, an increase in the number of small claims made through the accident notification process was experienced. The proportion of legally represented claims also increased, as was the case in Queensland. The ACT CTP portfolio has experienced an increase in claims frequency, as the impact of past legislative changes is more fully felt. EXPENSES Australia Direct s total expense ratio was slightly higher than FY11, at 19.7%. The increase is wholly attributable to the levies component, which rose from 4.4% to 5.1%, owing to: Higher proportional growth in home GWP; and An increase in fire service levy rates. Strong expense discipline remains in evidence EXPENSE RATIO 22.7% 3.9% 2.2% 21.8% 4.1% 2.2% 19.8% 19.4% 19.7% 4.2% 4.4% 5.1% 2.1% 2.1% 2.1% 16.6% 15.5% 13.5% 12.9% 12.5% FY08 FY09 FY10 FY11 FY12 Administration Ratio Commission Ratio Levies Excluding levies, Australia Direct s administration expense ratio improved by a further 0.4% to 12.5% in FY12. Ongoing cost saving initiatives across the business have contributed to this strong performance, continuing the trend of steady improvement since FY08. IAG FY12 INVESTOR REPORT 24

29 5. AUSTRALIA DIRECT INSURANCE PROFIT Australia Direct has reported an insurance profit for FY12 of $544m, compared to $702m in FY11. This equates to a lower insurance margin of 14.3% (FY11: 19.5%). Underlying performance has remained strong At an underlying level, Australia Direct s performance has remained strong and is in line with FY11. Underlying margin is defined as the reported insurance margin adjusted for: Net natural peril claim costs less related allowances for the period; Reserve releases in excess of 1% of NEP; and Credit spread movements associated with volatile investment markets. REPORTED VS. UNDERLYING INSURANCE MARGIN (%) 14.1% 12.1% 15.9% 14.9% 15.2% 10.7% 12.0% 16.9% 19.5% 14.3% FY08 FY09 FY10 FY11 FY12 Reported Margin Underlying Margin The reduced reported margin compared to FY11 is largely a result of: A greater than $200m increase in net natural peril claim costs, including the major Victorian hailstorm event in December 2011 and the storm and flooding event in NSW and Victoria during February and March 2012; Lower reserve releases; Significantly higher reinsurance costs; and An adverse credit spread impact of $42m, following the resumption of volatile conditions in investment markets. The 2H12 reported margin of 16.2% compares to the 1H12 result of 12.3%. The improved 2H12 outcome reflects: Lower net natural peril activity; A modestly favourable credit spread impact (1H12: $48m loss); and The positive impact on the underwriting result from management initiatives, such as: Increased investment in customer insights leading to effective price, product and customer outcomes; and Pricing discipline applied in targeting growth in preferred areas. IAG FY12 INVESTOR REPORT 25

30 5. AUSTRALIA DIRECT INSURANCE PROFIT FY12 VS. FY11 (A$M) % % FY11 Reserve Releases Natural Perils Credit Spreads Underwriting Result Yield FY12 INSURANCE MARGIN IMPACTS 1H11 Reserve releases Natural perils (74) (95) (192) (180) (169) (372) Natural perils allowance Credit spreads * * (48) 6 * (42) Reserve releases 2.8% 6.0% 3.2% 3.3% 4.4% 3.2% Natural perils (4.1%) (5.3%) (10.3%) (9.3%) (4.7%) (9.8%) Natural perils allowance 5.0% 6.7% 7.8% 7.9% 5.9% 7.8% Credit spreads * * (2.6%) 0.3% * (1.1%) * Negligible impact during the period. 2H11 1H12 2H12 FY11 FY12 MARKET ENVIRONMENT, REGULATION AND REFORM The personal lines market in Australia remains competitive. The industry as a whole is bearing considerably higher reinsurance costs, which has translated into significant and ongoing rate increases, particularly in the peril impacted home class. Concurrently, industry participants are carefully monitoring customer retention levels as the issue of affordability gains greater prominence. Competitive market conditions expected to persist State and Federal governments have continued to initiate reviews and inquiries into natural catastrophes. These include: The Federal government s response to the Natural Disaster Insurance Review and Treasury s consultation on reforming flood insurance, to improve availability and transparency. This includes a standard flood definition, a key facts statement and the issue of flood cover, with insurers being able to choose whether to give consumers the option to opt out; The Federal government s response to the Federal parliamentary inquiry into the operation of the insurance industry during disaster events and, more recently, into residential strata title insurance (and follow-up activities by the Government Actuary); The Productivity Commission s release of a Draft Report on Regulatory and Policy Barriers to Effective Climate Change Adaptation; and Establishment of a National Flood Information database. IAG FY12 INVESTOR REPORT 26

31 5. AUSTRALIA DIRECT Australia Direct expanded its flood cover during January 2012 and now offers flood insurance in all states. It also supports moves to clearer product disclosure and a standard flood definition, and continues to urge governments to increase investment in mapping and mitigation strategies to improve the affordability of insurance cover for flood. There are a number of other regulatory changes and reviews currently underway, which may impact the general insurance industry. These include: Replacement of the insurance-based Victorian Fire Services funding model with a new property-based levy from 1 July 2013; The NSW government release of a Discussion Paper to seek the community s views on alternative funding arrangements for fire and emergency services; A review of pricing and scheme design in NSW CTP. Having initially rejected the filings of all insurers for 1 January 2012, the regulator is now reviewing the scheme with the aim of stabilising prices and improving affordability for all motorists; Review of the Motor Vehicle Repair and Dealers Acts in NSW; Implementation of new damage criteria for managing written off vehicles in all states from September 2012; The Federal government's Consultation Paper, Unfair Terms in Insurance Contracts; The National Disability Insurance Scheme; Insurance Contracts Act amendments; and Amendments to the General Insurance Code of Practice on the determination of insurance claims. FY13 OUTLOOK Australia Direct expects further strong GWP growth in FY13. This will be driven by a combination of rate increases and anticipated volume growth. In CTP, lower investment yields are impacting returns. The regulator s review of the NSW CTP scheme is taking longer than originally expected and it is anticipated that the revised scheme will be in place by mid Australia Direct has had a 4.5% rate increase approved in NSW, effective 1 July Similar margin in FY13, despite pressure on CTP profitability The business will continue to maintain its focus on improving underwriting quality around risk selection. It is also investing in initiatives to improve customer service, product design and people development. Australia Direct expects a strong FY13 margin, similar to that of FY12. This is despite lower anticipated reserve releases and continued pressures in CTP. IAG FY12 INVESTOR REPORT 27

32 6. AUSTRALIA INTERMEDIATED (CGU) FINANCIAL PERFORMANCE 1H11 Gross written premium 1,177 1,286 1,330 1,429 2,463 2,759 Gross earned premium 1,170 1,170 1,307 1,326 2,340 2,633 Reinsurance expense (94) (108) (121) (124) (202) (245) Net earned premium 1,076 1,062 1,186 1,202 2,138 2,388 Net claims expense (591) (824) (854) (770) (1,415) (1,624) Commission expense (159) (171) (188) (181) (330) (369) Underwriting expense (225) (210) (247) (265) (435) (512) Underwriting profit/(loss) 101 (143) (103) (14) (42) (117) Investment income on technical reserves Insurance profit/(loss) 154 (14) Profit/(loss) from fee based business 15 (12) Share of profit/(loss) from associates (1) 2 - (2) 1 (2) Total divisional result 168 (24) H11 1H12 2H12 FY11 FY12 Insurance Ratios Loss ratio 54.9% 77.6% 72.0% 64.1% 66.2% 68.0% Immunised loss ratio 58.5% 74.4% 61.2% 54.9% 66.4% 58.0% Expense ratio 35.7% 35.9% 36.7% 37.1% 35.7% 36.9% Commission ratio 14.8% 16.1% 15.9% 15.1% 15.4% 15.5% Administration ratio 20.9% 19.8% 20.8% 22.0% 20.3% 21.4% Combined ratio 90.6% 113.5% 108.7% 101.2% 101.9% 104.9% Immunised combined ratio 94.2% 110.3% 97.9% 92.0% 102.1% 94.9% Insurance margin 14.3% (1.3%) 6.7% 14.9% 6.5% 10.8% INSURANCE RATIOS EXPENSE RATIO LOSS RATIO 40% 30% 20% 10% 35.7% 35.9% 36.7% 37.1% 35.7% 36.9% 4.9% 4.7% 4.9% 5.2% 4.8% 5.0% 14.8% 16.1% 15.9% 15.1% 15.4% 15.5% 16.0% 15.1% 15.9% 16.8% 15.5% 16.4% 80% 60% 40% 20% 58.5% 54.9% 74.4% 77.6% 61.2% 72.0% 66.4% 58.0% 54.9% 64.1% 66.2% 68.0% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Administration Ratio Commission Ratio Levies COMBINED RATIO 0% 1H11 2H11 1H12 2H12 FY11 FY12 Loss Ratio Immunised Loss Ratio INSURANCE MARGIN 120% 100% 94.2% 110.3% 97.9% 92.0% 102.1% 94.9% 16% 14% 12% 80% 60% 40% 20% 0% 113.5% 108.7% 101.2% 101.9% 104.9% 90.6% 1H11 2H11 1H12 2H12 FY11 FY12 Combined Ratio Immunised Combined Ratio 10% 8% 6% 4% 2% 0% -2% 14.3% 14.9% 10.8% 6.7% 6.5% (1.3%) 1H11 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 28

33 6. AUSTRALIA INTERMEDIATED (CGU) EXECUTIVE SUMMARY Australia Intermediated (CGU) comprises all products sold in Australia through brokers, authorised representatives, motor dealers and business partners. It accounted for nearly 31% of the Group s GWP in FY12. Reported GWP of $2,759m represents an increase of 12.0% over FY11, with the growth momentum broadly maintained throughout the year. This increase was derived primarily from a blend of acquisitions and rate. CGU remains on track to achieve an underlying double digit margin in FY13 The HBF acquisition has been fully integrated as at 30 June 2012 and Accident & Health International is now wholly underwritten by CGU. During 2H12, CGU moved to 100% ownership of Mutual Community General Insurance and entered into a related ten-year distribution agreement with its former joint venture partner, Bupa. CGU produced a total divisional result of $269m (FY11: $144m), comprising an insurance profit of $258m and $11m from fee based income and share of associates. The reported insurance margin of 10.8% included a second half result of 14.9%, which contained a favourable natural perils outcome. On an underlying basis, the FY12 result maintained the trend of improved performance, reflecting continuing enhancement of underwriting discipline and control of expenses. This has been achieved despite the challenge of recouping a significant increase in the cost of reinsurance via rate increases. CGU is implementing a new operating model which will transform the way it interacts with its intermediaries and policyholders, as well as delivering significant business performance improvement. Implementation is tracking to plan, with expected pre-tax cost savings of $25m in FY13, rising to $65m by FY15. The improvement in CGU s performance, bolstered by the impact of the new operating model, places the business on track to deliver an underlying double digit margin in FY13. A hardening rate environment is expected to continue into FY13, driving continued strong GWP growth. PREMIUMS CGU has maintained the top line growth evident since 2H11. Reported GWP of $2,759m represented an increase of 12.0% against FY11, and included growth of 11.1% in 2H12. This was primarily sourced from: Rate increases across a range of personal line and short tail commercial line products, aimed at offsetting increased reinsurance and natural peril claim costs; New accounts won, most notably in workers compensation; and Incremental GWP from recent acquisitions, comprising: Approximately $100m from the general insurance business of HBF, based in Western Australia, which was acquired on 30 June 2011; and Approximately $30m from an additional six months of Accident and Health International (A&HI) business, which CGU commenced underwriting on 1 January Strong rate increases were achieved across most personal line products and larger corporate accounts. Rate increases for the SME segment have remained relatively low, and liability pricing has been flat, although some modest rises were seen in the final quarter. Retention rates have held steady for the majority of portfolios across the year. Portfolios subject to significant pricing action, including home, landlords and farm, experienced retention rate declines of up to 10%, but within expectations. Strong GWP growth driven by rate and acquisitions FY12 GWP BY CLASS 11% 9% 33% 7% Commercial Short Tail Personal Lines Commercial Long Tail Workers' Compensation Other 40% IAG FY12 INVESTOR REPORT 29

34 6. AUSTRALIA INTERMEDIATED (CGU) GWP (A$M) 2,398 2,357 2,264 2,463 2,759 FY08 FY09 FY10 FY11 FY12 REINSURANCE EXPENSE Reinsurance costs of $245m in FY12 were up by over 21% compared to FY11 ($202m). This reflected a combination of: Higher catastrophe cover costs following the programme s renewal in January 2012; Amortised reinstatement costs in 1H12; Reinsurance expense associated with the newly-acquired HBF business; and Overall business growth, particularly in the corporate property portfolio where greater use of facultative reinsurance occurs. CLAIMS CGU s reported loss ratio of 68.0% for FY12 was slightly higher than the 66.2% recorded in FY11. The near-15% increase in net claims expense, to $1,624m, outstripped NEP growth of under 12%, and reflected significantly lower reserve releases, a substantial adverse discount rate adjustment and a partially offsetting improved natural peril experience. Increased reinsurance expense owing to higher catastrophe rates and reinstatement costs Underlying claim performance continues to improve On an immunised basis, the loss ratio has improved significantly, down to 58.0% from 66.4% in FY11. The 2H12 loss ratio of 64.1% was considerably lower than 1H12 (72.0%). While both halves incurred significant adverse discount rate adjustments, the second half of the year enjoyed a more benign natural peril experience. Underlying claims performance has continued to improve. For the majority of portfolios, lower claims frequency more than compensated for claims inflation that was within the expected pricing model range. In addition, CGU realised the benefits of a range of claims process efficiency and cost saving initiatives in FY12, which included the rollout of an online motor vehicle assessing and repair system and an increase in the proportion of claims completed using CGU s recommended repairers. The FY12 loss ratio was also aided by the reclassification of $25m of costs into administration expenses. This followed an independent review of internal allocation processes to bring them in line with industry benchmarks. IAG FY12 INVESTOR REPORT 30

35 6. AUSTRALIA INTERMEDIATED (CGU) Reserve Releases Prior period reserve releases of $85m were less than half those reported in FY11 ($178m). These releases reflect continued favourable claims performance across the long tail portfolios of workers compensation and professional risks. Reduced reserve releases from long tail classes RESERVE RELEASES 1H11 2H11 1H12 2H12 FY11 FY12 Reserve releases Impact on insurance margin 6.0% 10.6% 3.4% 3.7% 8.3% 3.6% Natural Perils Losses from natural perils of $175m (net of reinsurance) for FY12 were $45m lower than related allowances for the period, and $141m below FY11 levels. This favourable outcome is a result of a benign catastrophe period in 2H12, which followed above average activity in 1H12, punctuated by the Melbourne hailstorm event in December Favourable peril experience against allowances, notably in 2H12 NATURAL PERILS 1H11 2H11 1H12 2H12 FY11 FY12 Natural perils (44) (272) (116) (59) (316) (175) Natural perils allowance Impact on insurance profit 28 (169) (27) 72 (141) 45 Impact on insurance margin 2.6% (15.9%) (2.3%) 6.0% (6.6%) 1.9% EXPENSES Reported expenses, comprising commission and underwriting costs, totalled $881m in FY12, compared to $765m in FY11. The expense ratio increased to 36.9% in FY12 (FY11: 35.7%), owing to: A $39m increase in commission expense driven by GWP growth and changing business mix partly associated with recent acquisitions; Reclassification of $25m of costs previously identified in the net claims expense, following an independent review of internal allocation processes to bring them in line with industry benchmarks; Reinvestment of expense savings into business improvement initiatives, primarily systems simplification projects; and Increased fire service levy charges. Increased expense ratio impacted by levies and claim cost reclassification Excluding levies and reallocation effects, the FY12 expense ratio was slightly below FY11. REVISED OPERATING MODEL In March 2012, CGU announced the implementation of a new operating model which is expected to deliver significant pre-tax cost savings of $25m in FY13, rising to $65m by FY15. Related restructuring costs of $36m have been recognised in the Group s net corporate expense line in FY12, with a further $39m expected to be identified in FY13. Significant cost savings anticipated from revised operating model The new model simplifies CGU s structure, making it easier for brokers and agents to deal with the business. The move to an integrated, function based organisation with common approaches to account management, underwriting and claims will remove areas of duplication within the business and enable CGU to provide a more efficient and consistent service to its intermediaries and business partners. IAG FY12 INVESTOR REPORT 31

36 6. AUSTRALIA INTERMEDIATED (CGU) Implementation is proceeding to plan, with actions taken to date including: The establishment of a CGU Service Centre, in Melbourne and Ballarat; The integration of two personal line platforms into one; The restructuring of the core functions of underwriting, claims and account management; The successful separation of all sales and underwriting functions; and The appointment of senior managers and teams across all product lines. INSURANCE PROFIT CGU reported an insurance profit of $258m, up $118m from FY11 ($140m). This equates to an insurance margin of 10.8% (FY11: 6.5%), and includes a second half margin of 14.9%. The result reflects the continuing improvement in performance of the business, which has seen the underlying insurance result increase by approximately $200m since FY08. CGU expects to build on this improvement, particularly as the benefits of its new operating model are realised. Improved underlying performance continues Underlying margin is defined as the reported insurance margin adjusted for: Net natural peril claim costs less related allowances for the period; Reserve releases in excess of 1% of NEP; and Credit spread movements associated with volatile investment markets. REPORTED VS. UNDERLYING INSURANCE MARGIN (%) 7.5% 5.1% 5.8% 10.8% 6.0% 6.6% 6.5% 2.2% 0.4% (0.9%) FY08 FY09 FY10 FY11 FY12 Reported Margin Underlying Margin Underlying margins in FY12 on a half-by-half basis were influenced by the recognition of natural peril allowances in line with anticipated peril activity, which has traditionally been skewed to the second half of the financial year. The heavier weighting of allowance to 2H12 had the effect of creating a 340bps drag on performance relative to 1H12. In addition to the business underlying improvement, the significantly stronger reported margin in FY12 is largely explained by the considerably lower net natural peril claim cost impact of $175m (FY11: $316m). Lower reserve releases and an adverse credit spread movement were partially offsetting factors. IAG FY12 INVESTOR REPORT 32

37 6. AUSTRALIA INTERMEDIATED (CGU) INSURANCE PROFIT FY12 VS. FY11 (A$M) % % FY11 Reserve Releases Natural Perils Credit Spreads Underwriting Result Yield FY12 INSURANCE MARGIN IMPACTS 1H11 Reserve releases Natural perils (44) (272) (116) (59) (316) (175) Natural perils allowance Credit spreads * * (32) 4 * (28) Reserve releases 6.0% 10.6% 3.4% 3.7% 8.3% 3.6% Natural perils (4.1%) (25.6%) (9.8%) (4.9%) (14.8%) (7.3%) Natural perils allowance 6.7% 9.7% 7.5% 10.9% 8.2% 9.2% Credit spreads * * (2.7%) 0.3% * (1.2%) * Negligible impact during the period. 2H11 1H12 2H12 FY11 FY12 FEE BASED INCOME CGU generates fee income by acting as an agent under both the NSW and Victorian workers' compensation schemes that are underwritten by the respective state governments. In FY12, net income from fee based operations was $13m, compared to $3m in FY11. Increased fee based income from workers compensation schemes While the standard fees covering expenses are reasonably predictable, the total reported fee based result will continue to be volatile on a half-by-half basis owing to the receipt of performance fees and prior year experience adjustments paid or charged by the state bodies. These fees tend to be received in the opening half of CGU s financial year. The FY12 result contained $5m of prior period fee income compared to $10m in FY11. Excluding this income, the underlying result was $15m higher than FY11, and includes the effect of: Increased incentive fees in Victoria; A favourable impact from revision to the remuneration model in NSW; and Lower IT project spend. IAG FY12 INVESTOR REPORT 33

38 6. AUSTRALIA INTERMEDIATED (CGU) MARKET ENVIRONMENT, REGULATION AND REFORM Varying growth rates are apparent across different sectors of the Australian economy. As a result, the demand for commercial insurance is not expected to significantly increase. Despite the relatively benign natural peril conditions in 2H12, awareness for the need of insurance in response to such events remains high. The Australian intermediated market remains competitive The intermediated market remains competitive and growth is being driven by rate increases rather than volume. Rate movements differ by risk class with recent catastrophe loss-affected geographies and lines trending relatively higher. Property and home rates continue to harden across the market, albeit with increases beginning to moderate. The commercial SME segment has seen modest rate increases in the property component of packaged business, however strong competition and a subdued economic backdrop continue to provide challenging conditions across the segment as a whole. Long tail classes continue to experience soft premium growth, particularly in liability classes. While the Western Australian WorkCover Authority has increased recommended rates by an average 7.8% from 1 July 2012 to accommodate legislative amendments and scheme cost increases, rates remain highly competitive across this and other risk state schemes. State and Federal governments have continued to initiate reviews and inquiries into natural catastrophes. These include: The Federal government s response to the Natural Disaster Insurance Review and Treasury s consultation on reforming flood insurance, to improve availability and transparency. This includes a standard flood definition, a key facts statement and the issue of flood cover, with insurers being able to choose whether to give consumers the option to opt out; The Federal government s response to the Federal parliamentary inquiry into the operation of the insurance industry during disaster events and, more recently, into residential strata title insurance (and follow-up activities by the Government Actuary); The Productivity Commission s release of a Draft Report on Regulatory and Policy Barriers to Effective Climate Change Adaptation; and Establishment of a National Flood Information database. CGU supports a common definition of flood as well as increased disclosure through greater transparency and accountability. From February 2012, CGU s home, contents and landlords policies automatically include cover for flood on renewal. CGU had not previously provided flood cover, and its decision to do so reflects improved access to flood mapping data from local councils and state governments and the Federal government s commitment to develop a central, consistent source of flood mapping data. There are a number of other regulatory changes and reviews currently underway, which may impact the general insurance industry. These include: Replacement of the insurance-based Victorian Fire Services funding model with a new property-based levy from 1 July 2013; The NSW government release of a Discussion Paper to seek the community s views on alternative funding arrangements for fire and emergency services; Changes to the operation of the NSW Workers Compensation Scheme; The Federal government's Consultation Paper, Unfair Terms in Insurance Contracts; IAG FY12 INVESTOR REPORT 34

39 6. AUSTRALIA INTERMEDIATED (CGU) The National Disability Insurance Scheme; Insurance Contracts Act amendments; and Amendments to the General Insurance Code of Practice on the determination of insurance claims. FY13 OUTLOOK CGU will continue with the implementation of its revised operating model, further embedding the financial turnaround achieved to date. The business is on track to deliver a double digit underlying margin in FY13. Strong GWP growth is expected in FY13, primarily driven by a continuation of rate hardening in short tail commercial and personal line categories. Momentum will be supported by benefits from the recent creation of one account management team for each channel under the new operating model. On track for double digit underlying margin in FY13 As implementation of the new operating model progresses, more streamlined and cost effective operations will result, with a clearer focus on customer needs. These changes are expected to deliver a pre-tax cost saving of $25m in FY13, rising to $65m by FY15. IAG FY12 INVESTOR REPORT 35

40 7. NEW ZEALAND FINANCIAL PERFORMANCE 1H11 Gross written premium ,210 Gross earned premium ,140 Reinsurance expense (29) (90) (63) (86) (119) (149) Net earned premium Net claims expense (237) (341) (298) (303) (578) (601) Commission expense (54) (50) (56) (63) (104) (119) Underwriting expense (78) (79) (81) (97) (157) (178) Underwriting profit/(loss) 86 (97) (11) 93 Investment income on technical reserves (4) Insurance profit/(loss) 90 (87) Profit from fee based business Total divisional result 90 (86) H11 1H12 2H12 FY11 FY12 Insurance Ratios Loss ratio 52.1% 91.4% 65.6% 56.4% 69.8% 60.6% Expense ratio 29.0% 34.6% 30.1% 29.8% 31.6% 30.0% Commission ratio 11.9% 13.4% 12.3% 11.7% 12.6% 12.0% Administration ratio 17.1% 21.2% 17.8% 18.1% 19.0% 18.0% Combined ratio 81.1% 126.0% 95.7% 86.2% 101.4% 90.6% Insurance margin 19.8% (23.3%) 7.3% 13.0% 0.4% 10.4% INSURANCE RATIOS EXPENSE RATIO 34.6% 35% 29.0% 30.1% 29.8% 30% 31.6% 30.0% 13.4% 25% 12.6% 11.9% 12.3% 11.7% 12.0% 20% 15% 10% 17.1% 21.2% 17.8% 18.1% 19.0% 18.0% 5% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Commission Ratio Administration Ratio COMBINED RATIO LOSS RATIO 100% 80% 60% 91.4% 40% 65.6% 69.8% 52.1% 56.4% 60.6% 20% 0% 1H11 2H11 1H12 2H12 FY11 FY12 INSURANCE MARGIN 140% 120% 100% 80% 20% 15% 10% 5% 0% 19.8% 7.3% 13.0% 0.4% 10.4% 60% 40% 20% 0% 126.0% 95.7% 101.4% 81.1% 86.2% 90.6% 1H11 2H11 1H12 2H12 FY11 FY12-5% -10% -15% -20% -25% (23.3%) 1H11 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 36

41 7. NEW ZEALAND EXECUTIVE SUMMARY IAG s New Zealand operations accounted for over 13% of the Group s GWP in FY12. On 5 April 2012, IAG completed the acquisition of AMI which, together with State, NZI and Business Partners affinity brands, reinforced IAG s position as the largest underwriter in New Zealand. The acquisition of AMI has increased IAG s presence in personal lines, with combined market share of approximately 55% in home and contents and approximately 60% in motor. Integration of the business is tracking to plan. Significant rate increases have been implemented to recover substantially higher reinsurance costs. Supplemented by an initial contribution from AMI, these have resulted in GWP growth of over 26% in FY12. AMI acquisition completed in 2H12, reinforces IAG s position as the largest insurer in New Zealand FY12 GWP BY CLASS The reported FY12 insurance profit of $103m is a material improvement over the earthquake-impacted result of FY11 ($3m). This outcome equates to an insurance margin of 10.4%, embracing a 2H12 result of 13.0%. A strong underlying claims performance is a contributory factor to this result. 42% 58% The Canterbury region has entered a period where the ongoing risk of seismic activity is reducing. Commercial claims have progressed in line with expectations, whereas residential claims have been slower to finalise owing to work being completed on land zoning, land remediation and repair methodologies that will ensure a sustainable long term solution for residents. IAG continues to work closely with the New Zealand Earthquake Commission (EQC) and the Canterbury Earthquake Recovery Authority (CERA) in resolving these issues. Personal Commercial Although market conditions are expected to remain challenging, the FY13 outlook is positive as the business continues to focus on its core underwriting, claims and pricing disciplines, and realises benefits from the integration of AMI. While higher reinsurance costs and a trebling of EQC levies will impact customer affordability, IAG is addressing this through underwriting initiatives and a focus on expense management. PREMIUMS New Zealand s FY12 GWP of $1,210m increased by 26.6% compared to FY11 ($956m), and by 24.4% in local currency terms. This strong growth reflects the significant rate increases implemented across key products and channels, largely to offset increased reinsurance costs. Growth was bolstered by an initial 3-month contribution from AMI. 2H12 local currency GWP increased by 34.1% against the same period in FY11. Excluding AMI, FY12 reported GWP rose by 18.6%. Local currency GWP growth of 24% FY12 GWP BY CHANNEL 15% Significant post-earthquake rate increases have been specifically targeted towards material damage and business interruption (MDBI) and domestic home portfolios to reflect catastrophe reinsurance pricing pressure. In contrast, domestic motor continues to experience competitive conditions, with inflationary increases obtained. 32% 53% The NZI intermediated business represents over half of the division s GWP, and in FY12 it registered strong growth, with increased momentum in 2H12 reflecting peak renewal periods. Against the overall New Zealand market, NZI has increased its share slightly, with significant rate rises achieved in commercial lines and some increase in capacity. Despite the scale of rate increase introduced, retention has improved while new business levels are holding. Intermediated Direct Affinity State Insurance, the largely direct personal lines business, recorded an improving GWP growth trend over the course of FY12 as significant rate increases were applied to the home book. Inflationary rate increases in IAG FY12 INVESTOR REPORT 37

42 7. NEW ZEALAND motor and contents have helped address customer affordability concerns, resulting in stable retention rates. State continues to focus on item retention and targeting quality business through operational initiatives centred on improving customer experience. A new brand campaign was launched in April AMI was consolidated with effect from 5 April 2012, and contributed GWP of $76m. The private motor portfolio makes up approximately 47% of its premium base with home (contents and owners) making up the majority of the balance. Significant price increases continue to flow through the home portfolio, coupled with inflationary increases in motor. The impact of these price increases, combined with limited marketing activity since AMI entered the Crown Support Deed in April 2011, has resulted in some policy loss, in line with expectations. The Business Partners affinity channel reported consistent GWP growth across FY12. Price increases continued to flow through the home portfolio, coupled with strong new business growth driven by bank-initiated promotions and a competitive lending market. Retention in the motor and contents portfolios remains steady. REINSURANCE EXPENSE Reinsurance expense of $149m was over 25% higher than FY11 ($119m). The increase largely reflects increased catastrophe cover costs as a result of the Canterbury earthquakes. The New Zealand reinsurance expense also includes amortised reinstatement costs in 1H12, and a small amount in respect of AMI in 2H12. Increased reinsurance expense reflects earthquake effects The AMI reinsurance programme was renewed with effect from 1 July 2012, for a total period of 30 months (up until 31 December 2014). It comprises a main catastrophe cover for losses up to NZ$1.3bn, including one prepaid reinstatement. CLAIMS The FY12 net claims expense of $601m represents a small increase over FY11 ($578m), despite inclusion of three months claims activity from AMI. The loss ratio of 60.6% represents a significant improvement on FY11 s 69.8%, in large part explained by the absence of any significant earthquake events. Natural peril activity within FY12 allowances Net natural peril costs in FY12 were slightly below allowances for the year. This contrasts with the significant overrun against allowances in FY11 following the major earthquake and snowstorm events in that year. Several smaller events occurred during FY12, including a number of aftershocks in the Canterbury region. Underlying claims performance has remained strong, continuing to benefit from the higher excesses rolled through the portfolio in previous years, as well as enhanced underwriting and improved risk selection. Working claims experience has remained favourable owing to continued lower frequency since the earthquakes. This has been slightly offset by modest claims inflation in commercial lines. Large claims (>NZ$100,000) incidence was higher than FY11, but remained below typical experience. As at 30 June 2012, the New Zealand business had paid in excess of NZ$1.3bn of gross claims in respect of the Canterbury earthquakes. Of this, approximately 70% related to commercial claims. Settlement of commercial claims is progressing in line with expectations, with approaching 50% settled by the end of June Residential claims have IAG FY12 INVESTOR REPORT 38

43 7. NEW ZEALAND been slower to finalise owing to work being completed on land zoning, land remediation and repair methodologies that will ensure a sustainable long term solution for residents. The business remains focused on efficiently finalising earthquake claims to ensure inflationary pressures are managed. The FY12 claims line also included a modest reserve strengthening. EXPENSES The overall expense ratio improved from 31.6% to 30.0%, including a sub- 30% performance in 2H12. Total reported expenses in FY12, of $297m, were $36m higher than FY11 ($261m). Excluding AMI costs, the local currency increase was under 6%, as strong expense control continued to be demonstrated. Underlying expense control remains tight Commission expense increased by over 14% to $119m, reflecting the slightly increased significance of the intermediated channel in the overall FY12 GWP mix. The FY12 commission ratio of 12.0% is an improvement on FY11 s 12.6%, while the 2H12 ratio of 11.7% reflected the dilutory impact of AMI s first-time inclusion. Underwriting expenses of $178m were over 13% higher than the prior year. Excluding AMI, the equivalent increase was under 3% and reflects inflationary increases coupled with higher salary and staff related costs arising from the additional resources required for the Canterbury response. INSURANCE PROFIT The New Zealand business produced an insurance profit of $103m in FY12, compared to the earthquake-influenced modest return of FY11. An overall margin of 10.4% included a notably stronger second half performance of 13.0%, as: Rate increases and the initial contribution from AMI resulted in a near- 20% increase in NEP, and over 40% in 2H12; A more benign natural peril experience, within related allowances, contained the increase in net claims expense to a modest level; and Tight cost control resulted in improved efficiency ratios. Strong underlying profitability maintained AMI contributed an insurance profit in line with expectations. Throughout FY12, the business underlying underwriting performance has remained strong. AMI INTEGRATION The AMI integration is well-advanced, and is on track to realise expected annual synergies of at least NZ$30m within two years of acquisition. Actions to date include: The alignment of back office functions; Creation of a dedicated team focusing on synergy realisation; Consolidation of product and underwriting teams; Supplier review and procurement consolidation; Completion of the reinsurance renewal; and The launch, in late July 2012, of a new television campaign supporting AMI s customer care value proposition and face-to-face interaction with customers. In addition, radio, print and direct marketing activity will be used to highlight the local presence of AMI branches, incorporating a strong regional message customised for specific areas. AMI integration on track to deliver synergies of NZ$30m per annum within two years IAG FY12 INVESTOR REPORT 39

44 7. NEW ZEALAND Pre-tax acquisition and integration costs associated with AMI of approximately $12m have been identified within the Group s net corporate expense line in FY12. Further integration costs of approximately $15m are expected to be recognised in net corporate expenses in FY13. MARKET ENVIRONMENT, REGULATION AND REFORM The underlying economic environment remains subdued, but there is the expectation that the Canterbury rebuild will provide increased stimulus in Both inflation and real GDP growth are forecast to increase in 2013, and the unemployment rate is forecast to improve to under 6%. The government is forecasting a return to surplus in Christchurch rebuild steadily progressing While the domestic housing market has been helped by low interest rates, retail spending remains cautious. This has constrained new business prospects over the last year. Customers continue to prioritise personal spending commitments and see general insurance as a key part of household expenditure. While significant affordability issues have yet to materialise, there is growing industry concern over this issue as insurers pass on increased reinsurance costs and the consumer is impacted by the trebling of EQC levies, which occurred on 1 February Ongoing seismic activity remains an active risk, however probability modelling of further damaging aftershocks continues to reduce. As land zoning and individual property land reports are made available, insurers are establishing which residential properties can commence repair or rebuild. The government has completed initial zoning for the vast majority of residential land in Christchurch. As at the end of June 2012, this has resulted in: 7,541 properties being red-zoned, and unfit for rebuild; and 166 remaining in the white zone (hillside suburbs affected by rock fall and/or cliff collapse), with decisions expected on most of these in August All other parts of Christchurch have been zoned green. Land in the green zone has been divided into three technical categories: TC1 (grey), TC2 (yellow) and TC3 (blue). These describe how the land is expected to perform in future earthquakes, and also the foundation systems most likely to be required in the respective categories. On 15 June 2012 the government announced that it will conduct a final check of the red/green zoning boundaries. Commercial claims are following a more typical claims process utilising external loss adjusters, and are progressing in line with expectations. At the end of July 2012 the government unveiled a rebuild blueprint for the Christchurch CBD. In August 2012 the government announced a review of the functions and funding of New Zealand s fire services, with a final report expected in December The review will include consideration of: How improvements could be made to the current insurance-based levy; Whether there are other viable funding sources; and The impacts of those recommendations on other services and how they might be managed. The revised non-life solvency standard that forms part of the new prudential regime requires all insurers to hold sufficient earthquake reinsurance for a 1 in 500 year return period from 31 December 2012, increasing to 1 in 1,000 IAG FY12 INVESTOR REPORT 40

45 7. NEW ZEALAND years by These requirements will significantly increase the level of reinsurance required by New Zealand insurers. The overall Group reinsurance programme already covers New Zealand for a 1 in 1,000 year event. IAG has continued to engage in dialogue with the government regarding its proposal to introduce choice in the Accident Compensation Corporation (ACC) work account and extending the Accredited Employers Programme. If the revised scheme design facilitates true competition, IAG will consider entering this business. FY13 OUTLOOK Strong GWP growth is expected in FY13, from a combination of rate increases and, in particular, a full year s contribution from AMI. A strong reported margin is expected in FY13, as underlying profitability retains a positive trajectory, influenced by a number of key factors: Achievement of rate increases to recover higher reinsurance costs; An anticipated smooth integration of AMI and the realisation of significant synergies; The transformation of the direct insurance operation by taking the best of both the AMI and State businesses in determining the new operating model; NZI continuing to take advantage of growth opportunities as competitors reduce underwriting appetite, while retaining sound underwriting principles and risk selection; Claims disciplines continuing to have a strong impact on containing frequency and claims inflation; and Increased focus on administration expenses across the wider business. Strong GWP growth and improved profitability expected in FY13 It remains the expectation that AMI will be earnings per share accretive in its first full year of ownership, excluding integration costs and amortisation of identified intangibles. IAG FY12 INVESTOR REPORT 41

46 8. UNITED KINGDOM (UK) FINANCIAL PERFORMANCE 1H11 Gross written premium Gross earned premium Reinsurance expense (16) (47) (21) (13) (63) (34) Net earned premium Net claims expense (277) (258) (188) (182) (535) (370) Commission expense (70) (24) (27) (40) (94) (67) Underwriting expense (70) (32) (50) (33) (102) (83) Underwriting (loss) (124) (68) (7) (16) (192) (23) Investment income on technical reserves Insurance (loss) (121) (60) (5) (8) (181) (13) Profit/(loss) from fee based business 2 - (2) (1) 2 (3) Share of profit from associates Total divisional result (119) (60) (7) (8) (179) (15) 2H11 1H12 2H12 FY11 FY12 Insurance Ratios Loss ratio 94.5% 104.9% 72.9% 76.2% 99.3% 74.4% Expense ratio 47.8% 22.8% 29.9% 30.5% 36.3% 30.2% Commission ratio 23.9% 9.8% 10.5% 16.7% 17.4% 13.5% Administration ratio 23.9% 13.0% 19.4% 13.8% 18.9% 16.7% Combined ratio 142.3% 127.7% 102.8% 106.7% 135.6% 104.6% Insurance margin (41.3%) (24.4%) (1.9%) (3.3%) (33.6%) (2.6%) INSURANCE RATIOS EXPENSE RATIO LOSS RATIO 50% 47.8% 120% 40% 36.3% 23.9% 29.9% 30.5% 30.2% 30% 22.8% 17.4% 10.5% 16.7% 20% 9.8% 13.5% 10% 23.9% 19.4% 13.0% 13.8% 18.9% 16.7% 0% 1H11 2H11 1H12 2H12 FY11 FY12 Administration ratio Commission ratio COMBINED RATIO 100% 80% 60% 40% 94.5% 104.9% 99.3% 72.9% 76.2% 74.4% 20% 0% 1H11 2H11 1H12 2H12 FY11 FY12 INSURANCE MARGIN 160% 140% 120% 100% 80% 60% 40% 20% 142.3% 127.7% 102.8% 106.7% 135.6% 104.6% 0% -10% -20% -30% -40% (41.3%) (24.4%) (1.9%) (3.3%) (33.6%) (2.6%) 0% 1H11 2H11 1H12 2H12 FY11 FY12-50% 1H11 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 42

47 8. UNITED KINGDOM (UK) EXECUTIVE SUMMARY IAG s business in the United Kingdom (UK) accounted for 5.5% of the Group s GWP in FY12, compared to nearly 7% in FY11. The main components of the business are: Equity Red Star (ERS), the largest motor syndicate at Lloyd s; The Equity Insurance Partnerships (EIP) affinity business, which works with a number of major financial brands and large motor manufacturers; and Specialist commercial brokers, Barnett & Barnett and NBJ, trading under the name Independent Commercial Brokers (ICB). Close to breakeven result on back of remedial actions The performance of the UK business has continued to improve in FY12, as benefits of the extensive programme of remedial actions have been realised. The business posted a small insurance loss of $13m for the full year (FY11: $181m loss), in line with expectations of a close to breakeven result. While a slightly higher loss was reported in 2H12, compared to 1H12, the underlying performance has improved across the year, after allowing for the timing of reserve release and liability adequacy test (LAT) impacts. The FY12 results continued to be influenced by: The ongoing market issue of bodily injury claim inflation, driven by aggressive claim farming activities and exacerbated by prolonged recessionary conditions; The time taken to re-establish a number of key broker relationships on a financially mutual basis; and The highly competitive nature of the UK motor insurance market, which produced a collective combined operating ratio of 106% in calendar Available reinsurance protection under the adverse development covers (ADCs) acquired in 2H10 and 2H11, for the underwriting years up to and including 31 December 2010, is broadly unchanged. During 2H12, the following transactions occurred, with the net result reported within the Group s corporate expense line: The Group s 51% interest in the commercial broker Insurance Dialogue Limited (IDL) was disposed of, realising a small profit; and Syndicate 1208 (in run-off) was reinsured to close, resulting in a small loss. At 30 June 2012, the Group wrote off all remaining goodwill and identifiable intangible assets associated with the UK business. This reflects the continuation of challenging economic and industry conditions. A modest full year profit is expected in FY13. Subject to the conclusions of the Group s strategic review, the key areas of focus for FY13 are to continue progress in the refining of underwriting, pricing and claims handling whilst seeking efficiency gains across the business. STRATEGIC REVIEW On 17 May 2012, the Group announced it was undertaking a strategic review of the UK business, given the improvement in its performance. The options being assessed include, but are not limited to: A continuing focus on improving the business performance within the current operating model; Outcome of strategic review expected before end of 1H13 IAG FY12 INVESTOR REPORT 43

48 8. UNITED KINGDOM (UK) Refining the business strategy to a more focused specialist motor offering; and Exploring a potential sale of all or part of the business. The assessment of these options is ongoing, and the Group anticipates announcing an outcome before the end of 1H13. PREMIUMS Reported GWP for FY12 of $497m declined by 9.0% compared to FY11. On a local currency basis the fall was a more moderate 4.4%. After a flat performance in the opening half of the year, 2H12 GWP was over 18% lower than that of the comparable half in FY11, driven by a sharper decline in business volumes. While sustained rating increases across all major product areas were a partially offsetting factor, the trend in underlying volume reflects: The impact of the ongoing remediation programme in exiting unprofitable segments and broker relationships; and The re-emergence of price-based competition in certain segments in 2H12, which has suppressed renewal retention and new business volumes. Increased volume loss in 2H12, notably in private car FY12 GWP BY CLASS 7% 8% 6% 5% 4% 1% 27% The ability to apply rate rises came under particular pressure in private motor in the latter part of 2H12. There is, however, continued momentum in the rating environment for commercial motor products (fleet, haulage, taxi) and for motorcycle, which is projected to continue through the remainder of calendar The most significant reductions in volume during 2H12 were seen in the personal lines classes (household, broker sourced private car and motorcycle), where volume counts dropped by around 30%. These were partially countered by rate increases in the period. REINSURANCE EXPENSE FY12 s reinsurance expense of $34m is considerably lower than that of FY11 ($63m). Excluding ADC costs, which were primarily incurred in FY11, the reinsurance expense is marginally higher in FY12. 10% 18% 14% Fleet Private Car & Van Broker Commercial Motor Private Car Direct (Affinity Motor) Household Motorcycle Private Car & Van Bespoke Agricultural Breakdown Personal Accident CLAIMS The UK business reported loss ratio of 74.4% in FY12 compares to 99.3% in FY11. This improvement reflects the combination of: A more adequately priced business portfolio, following further rate increases; Some modest reserve releases; Benign weather conditions, compared to the extremely harsh winter weather experienced in FY11; The recessionary impact of lower car usage translating to lower accident frequency; and Ongoing bodily injury claim inflation. Improved loss ratio, from combination of factors Reserve releases were concentrated in the first half of the year, largely explaining a higher loss ratio of 76.2% in 2H12 compared to 72.9% in 1H12. Residual available cover under the first ADC in respect of the 2009 and prior calendar years, of over $60m at 30 June 2012, is broadly unchanged from the position at 30 June The second ADC, in respect of the calendar 2010 underwriting year, remains unutilised. IAG FY12 INVESTOR REPORT 44

49 8. UNITED KINGDOM (UK) EXPENSES Total reported expenses have decreased by $46m, from $196m in FY11 to $150m in FY12, resulting in an improved reported expense ratio of 30.2% (FY11: 36.3%). This outcome has been favourably impacted by LAT-related movements, as well as lower costs associated with Syndicate 1208 which entered reinsurance to close in 2H12. Expense ratios distorted by LAT effects No LAT fail was recognised at either 31 December 2011 or 30 June 2012, reflecting the impact of increased pricing and better risk selection. On an underlying basis, modest deteriorations have occurred in both the commission and underwriting expense ratios in FY12. Contributory factors are the increased expenditure associated with the strengthening of the local management team and resources in key areas such as actuarial, pricing and regulatory reporting. A review of the efficiency and effectiveness of systems and processes was carried out in 2H12. This included organisational restructures and a review of commission and other expenses. INSURANCE LOSS The UK business has produced an improved result, with the reported insurance loss of $13m in line with the close to breakeven expectations expressed at the outset of the year. This outcome equates to a negative 2.6% margin. Close to breakeven result in line with expectations Although a slightly higher insurance loss of $8m was reported in 2H12 compared to 1H12, the improvement in underlying performance has been maintained across the year. In particular, the 1H12 result benefited from a modest reserve release. The underlying improvement continues to reflect the positive impact of the remedial plan actions, including substantial increases in premium rates. FEE BASED INCOME Fee based operations, comprising EIP and ICB, made a $3m loss in FY12, compared to a $2m profit in FY11. EIP was challenged by lower motor new business volumes across its main affinity partners, notably Santander and first direct where successful promotional offerings in FY11 were not replicated in FY12. Motor renewal volumes were ahead of expectations but slightly adverse to the prior year. Fee based operations experienced challenging conditions in FY12 During FY12 EIP extended its panel of insurers to five, secured contract extensions with several of its main affinity partners and is in discussion with a number of potential new affinity partners. ICB also experienced difficult market conditions in FY12, with new commercial business proving difficult to obtain and margins on renewal business under pressure due to intense competition. ICB produced encouraging results in the latter part of 2H12, with new business exceeding targets. MARKET ENVIRONMENT, REGULATION AND REFORM The tough economic conditions that continue in the UK are exacerbating the issues facing the insurance industry. While a recessionary environment has some beneficial side effects for insurers, such as the high price of fuel encouraging drivers to limit vehicle usage, it also promotes behaviours which are harmful, such as an increase in the prevalence of fraud, which has been estimated to cost the industry 930m per year. The economic climate also Greater evidence of government reform intent IAG FY12 INVESTOR REPORT 45

50 8. UNITED KINGDOM (UK) means that interest rates are at an all-time low in the UK, resulting in a significant decline in investment income. Issues, such as fraud and historically high levels of claims inflation, driven by the increase in the frequency and severity of third party property damage and small bodily injury costs, have led to significant rate increases over the last months. As a result, motor insurance underwriting results for calendar 2011 showed the largest ever single year recovery, with the industry s combined ratio moving to 106%, from 120% in Despite the industry still falling short of profitability, and with claims inflation remaining an issue, premium increases have been slowing. The most recent independent rate monitoring, for the quarter to 30 June 2012, shows a flattening of comprehensive private car insurance prices over the past 18 months, with a modest increase in direct prices in the latest quarter contrasting with a minor fall in aggregator prices. The high cost of private motor premiums continues to draw attention from the government and regulators. Following the recommendations made in the House of Commons Transport Select Committee s second report on the cost of motor insurance, the UK government and the insurance industry have agreed to work together on a series of measures to tackle compensation culture. Following its recent call for evidence, the Office of Fair Trading (OFT) has announced its intention to provisionally refer the UK private motor insurance market to the Competition Commission in the belief that it behaves in a dysfunctional way. The referral focuses on evidence discovered that insurers of at-fault accident claimants have little control over the way in which repairs and vehicle replacement services are carried out, or the associated costs. The OFT is currently consulting on whether it should refer the issue, and expects to reach a final decision by October The industry has welcomed the civil litigation reforms announced by the UK government, which include the proposal for an outright ban on referral fees. These reforms are being introduced as part of the Legal Aid, Sentencing and Punishment of Offenders Bill, which has now been granted Royal Assent. The Act is likely to be implemented in April FY13 OUTLOOK The outcome of the Group s strategic review of the UK business is expected to be announced before the end of 1H13. While subject to the outcome of the strategic review, further management actions are scheduled to take place in FY13, building on the progress evident to date and addressing the cost base of the business. Strategic review outcome expected before the end of 1H13 As previously projected, business volumes have reduced, most notably in standard product areas such as private motor, and this trend is expected to continue as rate movements flatten out in the more competitive segments of the market. There is extensive focus on the much anticipated tort reform, which may address some of the issues of claims farming and referral fees, and on the Office of Fair Trading s investigation into industry practices, which may remove some of the upward pressures on claims settlement costs. Little benefit is expected from this promised reform in FY13. The UK business is expected to produce a modest full year profit in FY13. No material change in interest rates or investment yields is anticipated. Preparation for the Solvency II regulatory regime continues in line with the required timetable. IAG FY12 INVESTOR REPORT 46

51 9. ASIA FINANCIAL PERFORMANCE 1H11 Gross written premium Gross earned premium Reinsurance expense (17) (18) (19) (21) (35) (40) Net earned premium Net claims expense (52) (44) (114) (41) (96) (155) Commission expense (15) (14) (17) (17) (29) (34) Underwriting expense (14) (15) (13) (15) (29) (28) Underwriting profit/(loss) (3) (2) (71) 7 (5) (64) Investment income on technical reserves Insurance profit/(loss) (3) (1) (67) 8 (4) (59) Share of profit/(loss) from associates 1 (4) (1) (2) (3) (3) Total divisional result (2) (5) (68) 6 (7) (62) 2H11 1H12 2H12 FY11 FY12 Insurance Ratios 1 Loss ratio 66.7% 62.0% 156.2% 51.3% 64.4% 101.3% Expense ratio 37.1% 40.8% 41.1% 40.1% 39.0% 40.5% Commission ratio 19.2% 19.7% 23.3% 21.3% 19.5% 22.2% Administration ratio 17.9% 21.1% 17.8% 18.8% 19.5% 18.3% Combined ratio 103.8% 102.8% 197.3% 91.4% 103.4% 141.8% Insurance margin (3.8%) (1.4%) (91.8%) 10.0% (2.7%) (38.6%) 1 Insurance ratios include divisional expense overlays and are not a true representation of the standalone consolidated business (Thailand). INSURANCE RATIOS EXPENSE RATIO LOSS RATIO 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 37.1% 19.2% 17.9% 40.8% 41.1% 40.1% 39.0% 19.7% 21.1% 40.5% 23.3% 21.3% 19.5% 22.2% 17.8% 18.8% 19.5% 18.3% 1H11 2H11 1H12 2H12 FY11 FY12 Administration Ratio Commission Ratio 160% 140% 120% 100% 80% 60% 40% 20% 0% 156.2% 101.3% 66.7% 62.0% 51.3% 64.4% 1H11 2H11 1H12 2H12 FY11 FY12 COMBINED RATIO INSURANCE MARGIN 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 197.3% 141.8% 103.8% 102.8% 91.4% 103.4% 1H11 2H11 1H12 2H12 FY11 FY12 10% (10%) (30%) (50%) (70%) (90%) (110%) 10.0% (3.8%) (1.4%) (2.7%) (38.6%) (91.8%) 1H11 2H11 1H12 2H12 FY11 FY12 IAG FY12 INVESTOR REPORT 47

52 9. ASIA EXECUTIVE SUMMARY In FY12, IAG s Asia division has taken significant steps towards its goal of representing 10% of the Group s GWP (on a proportional basis) by During 2H12, IAG completed the acquisition of: 20% of Bohai Property Insurance Company Ltd, a Chinese general insurer based in Tianjin; and 30% of AAA Assurance Corporation, a Vietnamese general insurer based in Ho Chi Minh City. Significant steps taken in Asia towards goal of representing 10% of Group GWP by 2016 In addition, IAG s 49%-owned Malaysian associate, AmG Insurance Berhad (AmG), has signed an agreement to acquire 100% of Kurnia Insurans (Malaysia) Berhad. The enlarged AmG will be the largest general insurer in Malaysia, and a clear leader in the motor insurance market. The acquisition of Kurnia is expected to complete in 1H13. Following the completion of the Kurnia acquisition, IAG s investment in Asia will be approximately $720m, with around $500m invested in the established markets of Malaysia and Thailand, and $220m in the developing markets of India, China and Vietnam. It is the Group s expectation that the Asia division will deliver an ROE in excess of 15% by FY17, prior to regional support and development costs which are expected to peak at $25m pre-tax in FY13. In FY12 the Asia division recorded a net insurance loss of $59m owing to Thailand s worst flooding in many decades. This single event contributed a net claims cost of $62m to the result, and was one of the largest insured catastrophe events in the world in calendar 2011, causing in excess of $10bn in insured market losses. Excluding the claims cost of the Thai floods, the division posted an improved breakeven result (FY11: $7m loss), after absorption of $21m (FY11: $20m) of regional support and development costs. This outcome includes: A solid performance from Thailand, including strong GWP growth in 2H12; A strong performance from AmG in Malaysia, with an insurance margin in excess of 18%; and Higher start-up losses from SBI General in India, but slightly better than expectations. The overall Asian business is expected to produce an improved FY13 result, of a modest profit. A key element of this will be the first time inclusion of Kurnia within the expanded AmG business in Malaysia. REGIONAL GWP In FY12, Asia represented 3.8% of the Group s GWP on a proportional basis. On a pro forma basis, including Kurnia, this rises to approximately 5.8%. Following the conclusion of all acquisitions, IAG will participate in a gross regional annualised GWP pool in excess of $1bn. IAG will participate in a regional gross GWP pool of >$1bn, post-kurnia IAG FY12 INVESTOR REPORT 48

53 9. ASIA ASIAN GWP POOL (A$M / % OF GROUP GWP) FY07 FY08 FY09 FY10 FY11 FY12 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Thailand Malaysia (IAG share)¹ India (IAG share) China (IAG Share) Share of other parties % Group GWP (proportional) Notes: ¹IAG's interest in AmG increased from 30% to 49% with effect from 1 December ²All amounts have been converted to A$ using the exchange rate at the most recent reporting date to aid comparability. THAILAND Operations IAG s controlled operations in Thailand comprise: Safety Insurance (Safety) a predominantly motor insurer (c.80% of GWP); and NZI Thailand (NZI) a commercial insurer (c.20% of GWP). Thai business is the sole consolidated operation in Asia Following local regulatory approval, Safety and NZI have recently merged and now operate under a single licence (Safety Insurance) whilst retaining the use of both brands. Operating Performance The Thai business reported robust GWP growth of nearly 22% in local currency terms, following a strong recovery in car production and increased demand for catastrophe cover after the prolonged floods, which finally subsided in early 2H12. Reported FY12 GWP of $219m represented an increase of nearly 16%, reflecting the strength of the Australian dollar. Motor accounted for a slightly increased proportion of GWP, at 72%. Improved performance from Thailand, ex-floods impact THAILAND GWP BY CLASS The FY12 result was dominated by the net claims impact of $62m from the extreme flood event which extended over several months. The Thai business incurred a relatively low flood impact, compared to the industry as a whole, owing to product and geographic diversification strategies of recent times, and a restructuring of its reinsurance arrangements 12 months prior to the floods. 13% 12% 3% An improved insurance margin of 9.3% (FY11: 6.1%) was achieved, before captive reinsurance and regional support and development cost impacts, despite inclusion of reinsurance reinstatement premiums following the floods. An improved loss ratio of 60.8% and higher investment income on technical reserves, that included unrealised gains on interest bearing securities, were contributory factors. The expense ratio of 33.6% was reasonably consistent with FY11 (32.3%). The business reported higher commission, a direct reflection of the increased 72% Motor Other Short Tail Liability Short Tail Commercial IAG FY12 INVESTOR REPORT 49

54 9. ASIA proportion of business derived from motor, a class which carries a higher commission rate than other short tail categories. FY11 FY12 THAILAND FINANCIAL PERFORMANCE m 1 2 m 1 2 Gross written premium 5, , Net earned premium 4, , Net claims expense (2,758) (96) (2,847) (155) Commission and underwriting expenses (1,414) (48) (1,575) (52) Investment income on technical reserves Insurance profit/(loss) (49) Allocated support and development costs (10) (10) Reported insurance (loss) (4) (59) Insurance Ratios Loss ratio 62.9% 60.8% Expense ratio 32.3% 33.6% Combined ratio 95.2% 94.4% Insurance margin 6.1% 9.3% 1 Excludes captive reinsurance result and allocated regional support and development costs. 2 Includes captive reinsurance result and allocated regional support and development costs. Market Environment, Regulation and Reform The long term outlook for Thailand remains positive. Domestic demand continues to be strong, supported by the quick post-flood recovery of industrial production and reconstruction. While modest GDP growth in calendar 2011 was tempered by the severity of the floods and the knock-on impact on global supply chains, the economy is expected to grow by around 5% in Post-floods increase in premium rates expected The Thai government is setting up funds for development of infrastructure for sustainable water management. It has also initiated a National Catastrophe Fund of 50bn to extend natural disaster risk coverage to households, small firms and industries. In 2012, the Thai general insurance market is expected to exhibit strong growth, in the wake of significant flood-related claims. This is particularly the case in the motor segment, as car production recovers strongly. International reinsurers have generally affirmed their continued acceptance of business in flood-hit areas, albeit with greater conditions and a call for the authorities to take more aggressive action in guarding against future floods. There is increased prospect of future industry consolidation, given post-flood constrained capital positions of a number of participants and increased regulatory action to enforce risk-based capital rules. This may provide future consolidation opportunities for IAG. MALAYSIA Operations IAG owns a 49% interest in AmG Insurance (AmG), the general insurance arm of AmBank Group, which controls Malaysia s fifth largest bank branch network. The joint venture was established in 2006, and is currently the fourth largest motor insurer in Malaysia. Proposed acquisition of Kurnia to complete in 1H13 In April 2012, IAG announced that AmG will acquire Kurnia Insurans (Malaysia) Berhad (Kurnia) for a purchase price of RM1.55bn (approximately $480m). IAG will contribute approximately $235m, in line with its ownership IAG FY12 INVESTOR REPORT 50

55 9. ASIA of AmG. KSK Group Berhad shareholders approved the sale of Kurnia on 11 July 2012, and completion is expected in 1H13. Following this transaction, the merged AmG and Kurnia businesses will become the largest general insurer in the Malaysian market, with a clear leadership position in motor, in line with AmG s and IAG s stated strategy. Operating Performance AmG has continued to perform strongly AMG FY12 GWP BY CLASS AmG delivered a strong performance in FY12, as the business continues to drive operational improvement from application of IAG s capability transfer programme. FY12 GWP was comparable to FY11 in local currency terms. GWP growth was impacted by lower AmBank lending as a result of changes in the Hire Purchase Act and the exit from some unprofitable business segments. 2H12 GWP was flat, compared to 2H11. 8% 8% 4% AmG s insurance margin in FY12 increased to 18.1% (FY11: 13.2%), driven by a significantly improved loss ratio of 63.2% (FY11: 70.1%). This follows the strategic refresh of significant claim processes which have resulted in reduced claims leakage. Before allocated regional support and development costs, AmG reported an improved contribution of $13m in FY12 (FY11: $11m). Allocated regional support and development costs of $5m were lower than FY11, reflecting their allocation across a broader base in FY12. As a result, AmG s net contribution more than doubled to $8m (FY11: $3m). 80% Motor Fire Other Personal Accident FY11¹ FY12¹ AmG FINANCIAL PERFORMANCE RMm RMm Gross written premium Net earned premium Net claims expense (389) (356) Commission and underwriting expenses (136) (143) Investment income on technical reserves Insurance profit Net profit after tax Net profit after tax - IAG's share (49%) Allocated support and development costs (8) (5) Reported share of profit from associate 3 8 Insurance Ratios Loss ratio 70.1% 63.2% Expense ratio 24.5% 25.4% Combined ratio 94.6% 88.6% Insurance margin 13.2% 18.1% ¹Figures represent AmG's results for the year ended 30 June (AmG reports on a 31 March year end basis). Market Environment, Regulation and Reform The Malaysian economy is projected to grow by 4-5% in 2012, reflecting strong domestic demand, partially offset by export exposure to global weakness. Malaysia s general insurance market is expected to grow by an average 7% per annum until With moderate GDP growth, a strengthening regulatory environment and significant development in insurance penetration to come, Malaysia continues to offer good long term growth prospects. The Positive economic and industry growth outlook in Malaysia IAG FY12 INVESTOR REPORT 51

56 9. ASIA market is currently going through a period of consolidation, of which the Kurnia transaction is part. The Malaysian government has begun to implement reforms to the Third Party Bodily Injury (TPBI) scheme. These include more efficient claim settlement processes and a gradual increase in premiums over a four-year period commencing January 2012, the first such increase in over 30 years. AmG s TPBI book remained stable in FY12, with an improving trend in finalised costs. This line of business, which is mandatory in the Malaysian motor insurance market, represented around 6% of AmG s GWP in FY12. Detariffication of the market is planned to occur by This is expected to impact the competitive landscape, with the larger players possessing a distinct advantage. The impending aggregation with Kurnia will place AmG in a strong position to meet the associated opportunities and challenges that arise. INDIA Operations IAG owns a 26% interest in SBI General Insurance Company (SBI General), a joint venture with State Bank of India (SBI), India s largest bank. IAG appointees occupy a number of key positions at SBI General, including Deputy CEO. IAG also has two Board positions. SBI General expected to reach profitability by FY15 SBI General commenced limited underwriting from April 2010, with an expanded launch in March 2011 following significant investment in the development of scalable, tailored IT systems. The business is building a portfolio with a presence in the corporate, retail and SME markets across India, with the majority in the retail segment distributed through SBI s bancassurance channel. SBI General currently has 25 dedicated branches across the major cities of India. IAG has an option to increase its shareholding to 49%, subject to a change in the Indian foreign direct investment limit. It remains the Group s expectation that, at its current ownership level, no further capital will be required before The Group expects SBI General to reach profitability by FY15, and to achieve a top three position in the private sector, with around 5% market share and the equivalent of approximately $1bn GWP (subject to FX movements), by Operating Performance SBI General currently has over 1,000 employees, compared to 420 at the end of FY11. A small number of IAG personnel remain based in India, but this figure has fallen following the completion of the near term capability transfer programmes and the business moving into the operational phase. For FY12, SBI General generated GWP of $68m (IAG s 26% share being approximately $18m), an increase of approximately 240% against FY11 ($20m). In local currency terms, year-on-year GWP growth was nearly 300%. A significant proportion of this growth was derived from home building business written through the bancassurance channel, where a penetration rate in excess of 90% on related mortgage business has been achieved. Rapid GWP growth, based on home business through bancassurance channel India contributed a loss of $9m to the divisional result, comprising operational losses of $5m, which were lower than expectations, and allocated regional support and development costs of $4m. IAG FY12 INVESTOR REPORT 52

57 9. ASIA By the end of FY12 SBI General had over 45 products in the market, and established agency arrangements with three of SBI s five subsidiary and associate banks late in the year. The other two subsidiary and associate bank agency relationships will be completed in the first quarter of FY13. Together, these subsidiary and associate bank agency relationships expand SBI General s distribution access to encompass an additional 40 million customers and 5,000 branches. FY11 FY12 SBI GENERAL FINANCIAL PERFORMANCE `m `m Gross written premium , Net (loss) after tax (658) (1,013) Net (loss) after tax - IAG's share (26%) (171) (4) (263) (5) Allocated support and development costs (2) (4) Reported share of (loss) from associate (6) (9) ¹Figures represent SBI General's results for the year ended 30 June (SBI General reports on a 31 March year end basis). 2 Prior to the expanded launch of SBI General in 2H11, the costs associated with establishment of the business were allocated across the other Asian operating businesses. From 2H11 those costs are allocated exclusively to SBI General. Market Environment, Regulation and Reform The general insurance market in India grew by over 23% for the year ending 31 March Private sector growth for this period was 25%, compared to nearly 22% for the four public insurers which still represent over half of the market. Average forecast growth for the industry is 16% per annum until Indian market exhibiting strong growth The regulatory framework continues to incorporate reforms conducive for growth in the insurance industry. This includes the discontinuation of the Commercial Third Party Pool in March 2012, resulting in increased reserving from those public sector companies most exposed. The public sector companies have also been subject to government directives issued in May and June 2012, instructing them to cease underwriting unprofitable business in fire, motor and health classes. CHINA Operations In April 2012 IAG completed the acquisition of a 20% strategic investment in Bohai Property Insurance Company Ltd (Bohai Insurance) for a sum of approximately $100m. IAG has an in principle agreement to increase its ownership to 25%, subject to foreign investment regulations. Strategic investment in Bohai Insurance completed in 2H12 Bohai Insurance was established in 2005, and has a predominantly motor insurance focus with annualised GWP in excess of $200m. It is headquartered in Tianjin and has a strong emphasis on the surrounding pan- Bohai region which accounts for around 30% of China s GDP and an equivalent portion of China s annual GWP pool, which currently stands at approximately $70bn. IAG has Board and senior management representation, with IAG s Head of China appointed to the combined role of Deputy CEO and COO. The Group expects Bohai Insurance to reach profitability by FY15, and to achieve GWP of approximately $900m (subject to FX movements) by Capability transfer programmes have already commenced in the areas of IAG FY12 INVESTOR REPORT 53

58 9. ASIA actuarial reserving, motor risk selection, commercial pricing framework development, strategy development, claims management and reinsurance. Operating Performance Following the completion of the acquisition, IAG has recognised its share of Bohai Insurance s results with effect from 1 May BOHAI INSURANCE FINANCIAL PERFORMANCE FY12 (FROM 1 MAY 2012) CNYm Gross written premium Net (loss) after tax (10) Net (loss) after tax - IAG's share (20%) (2) 0 Allocated support and development costs (2) Reported share of (loss) from associate (2) ¹Bohai Insurance's financial results are included with effect from 1 May 2012 (Bohai Insurance reports on a 31 December year end basis). Market Environment, Regulation and Reform China remains an attractive general insurance market underpinned by strong forecast growth. GDP is forecast to grow by 7-8% per annum over the next five years, while the general insurance market is expected to increase by 10-15% per annum over the next decade. The industry recorded strong growth of 19% in Strong industry growth outlook over next decade The Chinese insurance regulator has started moves towards motor market liberalisation. This includes granting foreign insurers full access to the motor market from May 2012, a business segment previously reserved for domestic players in the world s biggest automobile market. The regulator has also allowed some qualified insurers to set terms and premium rates for motor insurance using their own data and market values of vehicles. VIETNAM On 18 May 2012, IAG completed the acquisition of a 30% strategic interest in AAA Assurance Corporation (AAA Assurance), for a sum of less than $20m. IAG has an option to increase its shareholding to 49%, subject to foreign investment regulations. AAA Assurance is a privately held business headquartered in Ho Chi Minh City. It commenced operation in 2006 and has grown rapidly to become the sixth largest motor insurer and ninth largest general insurer in Vietnam. It has an extensive national branch network and has established a brand associated with quality service. 30% investment in Vietnam s AAA Assurance completed in May 2012 IAG has Board and senior management representation. IAG s Head of Vietnam has been appointed to the AAA Assurance executive team. Defined capability transfer programmes are centred on the three key areas of risk, profitability and growth. Vietnam possesses strong economic fundamentals and a low insurance penetration rate, resulting in forecast industry growth of 18-20% per annum until Motor presently represents 30% of general insurance premiums, significantly lower than in other South East Asian countries. The pace of regulatory reform has increased, aimed at building a modern and professional insurance industry. The Group expects AAA Assurance to breakeven by FY15. IAG FY12 INVESTOR REPORT 54

59 9. ASIA REGIONAL SUPPORT AND DEVELOPMENT COSTS As IAG broadens its operational footprint in Asia, the division incurs regional support and development costs which are borne within its reported results. These costs cover a wide range of activities, including the divisional level management, on-the-ground capability transfer teams and the cost of developing opportunities in new and existing markets. The regional support and development costs are, for reporting purposes, allocated between the consolidated businesses and shares of associates. Total regional support and development costs for FY12 increased slightly to $21m (FY11: $20m) owing to additional expenditure incurred in respect of the investments in China and India and the pursuit of new opportunities in Vietnam and Indonesia. Regional support and development costs are expected to peak at approximately $25m in FY13. Slight increase in business development costs, with peak outlay in FY13 FY11 FY12 REGIONAL SUPPORT AND DEVELOPMENT COSTS - ALLOCATION Thailand (Safety Insurance/NZI) Malaysia (AmG Insurance) 8 5 India (SBI General) 2 4 China (Bohai Property Insurance) - 2 Total regional support and development costs % % Total costs/share of regional proportional GWP 6.7% 6.1% FY13 OUTLOOK The overall Asian business is expected to produce an improved FY13 result of a modest profit. A key element of this will be the first time inclusion of Kurnia in the enlarged AmG business, following expected completion of its acquisition in 1H13. Modest profit anticipated in FY13 The modest profit anticipated in FY13 includes the following items: Kurnia integration costs; Higher combined start-up losses from developing businesses in India, China and Vietnam; and Increased regional support and development costs. It is anticipated that the underlying performance in the Thai and Malaysian businesses will remain strong in FY13. Sound organic growth is expected in both markets. The integration of Kurnia in Malaysia is a key focus for FY13. This will concentrate on maintaining Kurnia s agent and broker relationships, as well as consolidating operational capability around processes, distribution, product development and supplier costs. The Group anticipates RM50m of synergies to be realised over two years, partially offset by integration costs. A further priority will be the capability transfer programmes with respect to Bohai Insurance in China and AAA Assurance in Vietnam. These will build the foundation necessary for Bohai s and AAA Assurance s future expansion. SBI General will enter the next level of its business expansion by rolling out further new branches and increasing its product range, all supported by the IT systems already in place. Very strong GWP growth is anticipated, along with further operating losses as the business continues to progress through its start-up phase. With a presence established in five out the six identified priority markets, IAG will continue to assess opportunities in Indonesia. IAG FY12 INVESTOR REPORT 55

60 10. REINSURANCE REINSURANCE STRATEGY IAG s reinsurance programme is an important part of the Group s overall approach to capital management. The Group has a philosophy of limiting its main catastrophe retention to a maximum of 4% of NEP. Its current retentions are below this level. Reinsurance is a key part of IAG s overall approach to capital management The Group determines its reinsurance requirements for Australia and New Zealand on a modified whole of portfolio basis (where modified whole of portfolio is the sum of all correlated risk). The limits purchased reflect a 1-in- 250 year return period. The Group s Australian-based captive reinsurer captures 100% of the total reinsurance spend, both treaty and facultative, of the Australian businesses. A key responsibility of the captive is to capture and manage counter-party and regulatory exposures within a single entity. IAG s international business units continue to place some facultative reinsurance directly with the external market. However, the Group s international captive reinsurers underwrite 100% of New Zealand and Thailand treaty business and a substantial amount from the UK and other parts of Asia. MARKET ENVIRONMENT Following the unprecedented sequence of major natural peril events in Australia and New Zealand since FY10, which resulted in significant claim costs to insurers and reinsurers alike, there has been a marked hardening of reinsurance rates applicable to the region. Reinsurance capacity, however, has remained resilient and continues to be available to the Group in all risk categories, including earthquake in New Zealand. Significant rate increases following increased natural peril activity The Group renewed its catastrophe programme on 1 January 2012, and experienced rate increases in line with those embodied in its insurance margin guidance at the beginning of FY12. At 1 July 2012, the Group also renewed specific reinsurance protection for AMI in New Zealand, with outcomes consistent with expectations at the time of its acquisition. CATASTROPHE COVER IAG s catastrophe reinsurance protection runs to a calendar year and operates on an excess of loss basis. It covers all territories in which IAG has operations, with the exception of AMI which has a dedicated programme. The 2012 programme fully complies with the requirements embodied in the current proposals put forward by the Australian Prudential Regulation Authority (APRA) in its Life and General Insurance Capital (LAGIC) review, which becomes operative from 1 January The Group s catastrophe programme is fully LAGIC-compliant At renewal on 1 January 2012 the integrated programme comprised the following key components: A main catastrophe cover for losses up to $4.2bn, including one prepaid reinstatement. The Group retains the first $250m of each loss, with the lower layer of the main programme ($250m excess of $250m) contracted for a period of three years at agreed prices. Two reinstatements of this layer have been secured; An upper layer, from $4.2bn to $4.7bn, providing earthquake cover in respect of Australia and New Zealand for a period of three years at agreed prices; A buydown arrangement that reduces the maximum cost of a first event to $150m; Subsequent event cover providing protection above $150m; and IAG FY12 INVESTOR REPORT 56

61 10. REINSURANCE An aggregate sideways cover of $250m excess of $300m, with qualifying events capped at a maximum contribution of $125m excess of $25m, per event. IAG s reinsurance protections were extended in 2012 to provide cover for the flood products now being offered by Australia Direct and CGU across Australia. The Group s catastrophe reinsurance cover provided considerable protection during calendar 2011, with remaining aggregate cover exhausted by the Thai flood event in 1H12. As a result of prior programme erosion, the Victorian storms event in December 2011 ($172m) was fully retained by the Group. As at 30 June 2012, peril activity during 2H12 had resulted in only modest erosion (approximately $44m) of the deductible applicable to the 2012 aggregate cover CATASTROPHE REINSURANCE COVER AS AT 30 JUNE 2012 $m Australia/NZ Earthquake (3 years from 1 Jan 2012) Main Catastrophe Programme (3 years from 1 January 2012) Buydown Subsequent Event Covers 25 Aggregate Cover ($250m xs $300m) 0 Event 1st 2nd 3rd 4th 5th At 1 July 2012, the Group renewed reinsurance protection for the AMI business in New Zealand. This was the first renewal since IAG finalised the acquisition of AMI in April The AMI-specific catastrophe reinsurance protection will initially run to a financial year and operate on an excess of loss basis. At renewal on 1 July 2012 the integrated programme comprised the following key components: A main catastrophe cover for losses up to NZ$1.3bn, including one reinstatement, with the Group retaining the first NZ$30m of each loss; An upper layer, from NZ$1.3bn to NZ$1.4bn, providing earthquake cover; and A buydown arrangement that reduces the maximum cost of a first event to NZ$25m. AMI standalone protection renewed until 31 December 2014 IAG FY12 INVESTOR REPORT 57

62 10. REINSURANCE Following the expiration of this cover on 30 June 2013, the Group has secured additional protection for AMI up to 31 December This comprises a main catastrophe cover for losses up to NZ$1.3bn, including one prepaid reinstatement, with the Group retaining the first NZ$20m of each loss. At 30 June 2012, the Group also renewed its reinsurance programme in respect of Thailand. Coverage was restructured in accordance with prevailing market conditions, however the Group s maximum retention for any one event has been reduced to $25m. The Group also provides considerable input to the reinsurance covers concluded by its associates in Malaysia, India, China and Vietnam. The combination of covers in place at 30 June 2012 results in maximum first event retentions of $150m for Australia, $150m for New Zealand, $50m for the UK and $25m for Thailand. The Group has a customised event definition in its catastrophe reinsurance contract wording which ensures that covers provide appropriate protection to the Group, both in terms of geographical exposure and event duration. Group MER of $150m at 30 June 2012 OTHER COVERS IAG has a comprehensive suite of per risk and proportional reinsurances which protect the Group in all territories in which it underwrites. The casualty reinsurances were renewed at 30 June 2012 with minimal price increases. Unlimited cover is purchased on statutory classes where available and for other lines cover was placed up to the original underwriting limits for each class. Cover is also secured for potential accumulations within a class or between classes of business. Casualty reinsurances renewed with minimal price increases COUNTER-PARTY RISK The counter-party credit profiles for the key reinsurances of the Group, as at 1 July 2012, are: Over 87% (2011: 83%) of limits placed with A+ or better rated entities for the property catastrophe programme; and 100% of limits placed with A+ or better rated entities for the casualty programme. Strong counter-party risk profile IAG FY12 INVESTOR REPORT 58

63 11. INVESTMENTS INVESTMENT PHILOSOPHY The Group s investment philosophy is: To manage the assets backing technical reserves and shareholders funds separately, subject to regulatory or other structural constraints; To invest the assets backing technical reserves, wherever possible, in a combination of government and high quality fixed interest securities with interest rate sensitivities that match the underlying insurance liabilities; To invest the Group s shareholders funds to maximise return, consistent with the Group s risk appetite and flexibility requirements; To invest Group assets such that the contribution of investment risk to IAG s earnings volatility should not dominate the contribution from insurance risk; and To maintain portfolio liquidity, invested in accordance with Group policies. INVESTMENT STRATEGIES As at 30 June 2012, the Group s overall investment allocation remained conservatively positioned, with 88% of total investments in fixed interest and cash. Technical reserves remained almost entirely invested in fixed interest and cash, whilst the equivalent figure for shareholders funds was 60%. The Group s allocation to growth assets was 40% of shareholders funds at 30 June 2012 (30 June 2011: 41%). Within the Group s allocation to growth assets, alternative investments accounted for 19% of shareholders funds as at 30 June 2012 (30 June 2011: 18%). These alternative investments typically display a lower volatility than equities, deliver a higher return than fixed income and increase overall investment diversification. The majority of the Group s allocation to alternative investments is invested in global convertible bonds. Technical reserves invested in durationmatched fixed interest securities Distinct investment strategies for technical reserves and shareholders funds In December 2011, the Group reduced its exposure to international equities within shareholders funds for reasons of capital and operational efficiency. GROUP INVESTMENT ASSETS The Group s investments totalled $13bn as at 30 June 2012, excluding investments held in joint ventures and associates, with over 70% represented by the technical reserves portfolio. Total investments at 30 June 2011 were $11.9bn. Total investments of $13bn The increase in investment assets since 30 June 2011 amounts to $1.1bn and is predominantly due to the capital gains arising from the fall in bond yields over the course of the year. GROUP INVESTMENT ASSETS 1H11 A$bn 2H11 A$bn 1H12 A$bn 2H12 A$bn Technical reserves Shareholders' funds Total investment assets Other funds managed on behalf of third parties ASSET ALLOCATION Since 31 December 2011, the most significant change in asset allocation has been the reduced proportion of shareholders funds held in fixed interest and cash. To a large extent this movement reflects the outlay of funds held in short term fixed interest and cash to fund acquisitions completed in 2H12, as well as improved equity returns compared to 1H12. 88% of total investments in fixed interest and cash IAG FY12 INVESTOR REPORT 59

64 11. INVESTMENTS INVESTMENT ASSET ALLOCATION 1H11 2H11 1H12 2H12 SHAREHOLDERS' FUNDS % % % % Australian equities International equities Alternatives Fixed interest and cash Total TECHNICAL RESERVES % % % % Australian equities International equities Alternatives Fixed interest and cash Total TOTAL SHAREHOLDERS' FUNDS AND TECHNICAL RESERVES % % % % Australian equities International equities Alternatives Fixed interest and cash Total GROUP ASSET ALLOCATION 30 JUNE 2012 CREDIT QUALITY 30 JUNE % 12% 2% 41% 88% 45% Fixed Interest and Cash Growth "AAA" "AA" "A" < "A" CREDIT QUALITY OF ASSETS The credit quality of the Group s investment book remains high, with 86% of the fixed interest and cash portfolio rated in the 'AA' category or better. All credit assets are performing and meeting interest and principal repayment obligations. High credit quality maintained IAG FY12 INVESTOR REPORT 60

65 11. INVESTMENTS SENSITIVITY ANALYSIS As at 30 June 2012, the sensitivity of the Group's net profit before tax to market movements in investments was as set out in the table below. INVESTMENT SENSITIVITIES (NET PROFIT BEFORE TAX) AS AT 30 JUNE 2012 Change in Assumption +1% -1% Equity market values: Australian equities 8 (8) International equities 1 2 (2) Total equity market sensitivity 10 (10) Interest rates: Assets backing technical provisions (345) 370 Assets backing shareholders' funds 1 (27) 29 Total interest rate sensitivity (372) Includes indirect sensitivities relating to alternative asset classes. INVESTMENT PERFORMANCE A summary of the investment income and the investment returns generated on the technical reserves and shareholders funds portfolios is set out in the following table. The percentage returns are net of transaction costs, management fees and expenses, but before income tax. FY12 investment returns reflect rallying bond and weaker equity markets INVESTMENT RETURNS 1H11 2H11 1H12 2H12 FY11 FY12 (INCLUDING DERIVATIVES)¹ % 2 % 2 % 2 % 2 % % Technical reserves Shareholders' funds (30) (0.8) Total investment income , Returns are accounting yields, being investment income based on average exchange rates divided by closing funds under management. 2 Half year returns have not been annualised. Investment returns on technical reserves in FY12 benefited from the fall in bond yields over the course of the year. The 3-year government bond yield fell to 2.46%, from 4.76%, as the market adjusted to lower official cash rates (4.75% to 3.50%) and continuing investor demand for high quality AAA-rated sovereign bonds. Credit spreads widened during FY12, driven by a flight to high quality government bonds, detracting from the Group s investment returns. Allowing for wider credit spreads and the fall in interest rates, the Group continued to generate over 100bps of return above the risk free rate, across the entire technical reserves portfolio. The portfolio continues to be aligned with the weighted average duration of the Group s claims liability, at three to four years. Investment returns on shareholders funds were impacted by weaker equity markets, influenced by the ongoing European debt crisis and concerns over slower global growth. The broader Australian index (S&P ASX200 Accumulation) delivered a negative return of 6.7% over the year to 30 June IAG FY12 INVESTOR REPORT 61

66 12. BALANCE SHEET & CAPITAL BALANCE SHEET The total assets of the Group as at 30 June 2012 were $25,132m compared to $24,492m at 31 December This increase largely reflects the net effect of: Increased cash and investment levels, following strong operational cash flow and inclusion of monies held in respect of reinsurance recoveries; Increased premium related assets owing to growth in GWP; and Reduced reinsurance recoveries on major prior year events. 1H11 The other assets category represents the aggregate of deferred levies and charges, deferred tax assets, property and equipment and other assets. The total liabilities of the Group as at 30 June 2012 were $20,608m, compared to $19,979m at 31 December The movement reflects: Increased unearned premium, owing to growth in GWP; and Increased trade and other payables, owing to inclusion of monies held on behalf of reinsurers for future claim settlements. 2H11 1H12 Assets Cash and cash equivalents Investments 11,810 11,893 12,704 12,953 Investments in joint ventures and associates Premium receivable 1,876 2,081 2,069 2,502 Trade and other receivables Reinsurance and other recoveries on outstanding claims 2,264 4,010 4,209 3,928 Deferred acquisition costs Deferred reinsurance expense Intangible assets Goodwill 1,642 1,644 1,647 1,625 Other assets Total assets 20,779 23,029 24,492 25,132 Liabilities Outstanding claims 8,847 10,889 11,826 11,709 Unearned premium 4,117 4,355 4,477 4,942 Interest bearing liabilities 1,380 1,377 1,627 1,659 Trade and other payables ,135 Other liabilities 943 1,002 1,272 1,163 Total liabilities 16,121 18,449 19,979 20,608 Net assets 4,658 4,580 4,513 4,524 Equity Equity attributable to holders of ordinary shares 4,511 4,417 4,367 4,343 Non-controlling interests Total equity 4,658 4,580 4,513 4,524 2H12 IAG FY12 INVESTOR REPORT 62

67 12. BALANCE SHEET & CAPITAL The other liabilities category represents the aggregate of current and deferred tax liabilities, employee provisions, unitholders funds held by external holders of units in IAG-controlled trusts, reinsurance premium payable and other provisions and liabilities. IAG shareholders equity (excluding non-controlling interests) decreased, from $4,367m at 31 December 2011 to $4,343m at 30 June This small decrease reflects the combined effect of: A strong operating earnings performance in the second half of the financial year; The $297m impairment of UK-related goodwill and identifiable intangibles recognised in 2H12; and Payment of the 5 cents per share dividend declared in respect of 1H12 ($104m). GOODWILL & INTANGIBLES Total goodwill and intangibles at 30 June 2012 stood at $1,850m, down from $1,887m at 31 December 2011, comprising $1,625m of goodwill (1H12: $1,647m) and $225m of other intangible assets (1H12: $240m). There were two significant movements in 2H12: The addition of goodwill and identifiable intangibles in respect of AMI in New Zealand, amounting to $236m at the point of acquisition; and The $297m impairment of UK-related goodwill and identifiable intangibles. OUTSTANDING CLAIMS Net Outstanding Claims Liability The Group s net outstanding claims liability at 30 June 2012 stood at $7,781m, compared to $6,879m at 30 June The movement over the year reflects the combined effect of: A significant discount rate adjustment movement, following the decline in interest rates; Underlying business growth; Acquisitions completed during the year, notably AMI in New Zealand; and Reduced reinsurance recoveries on major prior year events. Increased net claims liability reflects higher discount rate adjustment and business growth As at 30 June 2012, the sensitivity of the Group s net outstanding claims liability to a 1% movement in the discount rate, as applied to expected future payments, was: +1%, a reduction in net outstanding claims liability of $255m; and -1%, an increase in net outstanding claims liability of $281m. Claims Development Note 11 of the Group s Financial Report includes a claims development table that shows the development of the estimated net undiscounted outstanding claims liability relative to the current estimate of ultimate claims costs for the ten most recent accident years as estimated at each reporting date. An extract from that table is set out below. The table shows a history of the claim reserves being conservatively stated and demonstrates favourable development across the period, as the ultimate claim costs were settled or became more certain. The table highlights that, as at 30 June 2012, more than 90% of the total estimated liability for the 2003 to 2008 accident years had been paid, for the IAG FY12 INVESTOR REPORT 63

68 12. BALANCE SHEET & CAPITAL 2009 and 2010 accident years more than 80% had been paid, and for 2011 over 70% had been paid. Accident Year Ended 30 June CLAIMS DEVELOPMENT TABLE 2002 and prior TOTAL Development At end of accident year 3,341 3,481 3,591 3,945 4,567 4,507 4,533 4,493 4,819 5,047 One year later 3,164 3,315 3,544 3,872 4,532 4,464 4,562 4,468 4,880 Two years later 3,089 3,342 3,513 3,798 4,496 4,455 4,498 4,367 Three years later 3,058 3,325 3,468 3,806 4,502 4,434 4,490 Four years later 3,004 3,309 3,434 3,793 4,432 4,413 Five years later 3,011 3,298 3,382 3,768 4,358 Six years later 3,005 3,271 3,357 3,748 Seven years later 2,992 3,266 3,349 Eight years later 2,990 3,254 Nine years later 2,985 Current estimate of net ultimate claims 2,985 3,254 3,349 3,748 4,358 4,413 4,490 4,367 4,880 5,047 Cumulative payments made to date (2,944) (3,175) (3,260) (3,549) (4,160) (4,067) (3,892) (3,575) (3,531) (2,723) Net undiscounted outstanding claims ,349 2,324 6,622 Discount to present value (119) (5) (12) (11) (23) (17) (30) (48) (67) (97) (131) (560) Net discounted outstanding claims ,252 2,193 6,062 Claims handling expense Risk margin Net outstanding claims liability 370 1,349 7,781 Gross outstanding claims liability on the balance sheet Reinsurance and other recoveries on outstanding claims Net outstanding claims liability 11,709 (3,928) 7,781 Risk Margins The claims development table also identifies the total risk margin held to allow for the uncertainty surrounding the outstanding claims liability estimation process. The risk margin is set to take into account the correlations assessed between outstanding claim liabilities arising from the various forms of business underwritten by the different entities within the consolidated Group. The aggregated central estimate plus the risk margin is calculated on a diversified basis and this forms the outstanding claims liability. The Group s policy is for the risk margin to be set so as to provide an overall probability of adequacy for the outstanding claims liability of 90%, which has been determined having regard to the inherent uncertainty in the central estimate and the prevailing market environment. The Group s probability of adequacy of the claims liability for FY12 is 90%, which is unchanged from the prior year. Insurers are in the business of accepting and managing risks. A key feature of insurance businesses is diversification between risks and without it the insurance business would not exist. The Group uses diversification to manage the portfolio of risks that arises in the business. The risk margin at the end of FY12 as a percentage of the net discounted outstanding claims liability was 21.0%, compared to 20.6% in FY11. CAPITAL Capital Adequacy The Group retains a target minimum capital requirement (MCR) multiple of 1.45 to 1.50 as a long term benchmark. The Group retains a robust capital position The Group s capital position is robust, with an MCR multiple of 1.74 at 30 June This compares to 1.69 at 31 December 2011, with the positive movement since then largely explained by the net effect of: The Group s strong operating earnings performance in 2H12; IAG FY12 INVESTOR REPORT 64

69 12. BALANCE SHEET & CAPITAL The partial unwind of higher balance sheet values associated with the substantial natural peril activity incurred in FY11; Increased premium rating strength during the period; Disallowable goodwill and intangibles associated with the acquisition of AMI, completed in April 2012; and The increased investment in joint ventures, following the completion of transactions in China and Vietnam. Reflecting the above factors, the Group s regulatory capital has increased to $4,402m, and its MCR increased slightly to $2,531m. GROUP COVERAGE OF REGULATORY CAPITAL REQUIREMENT Tier 1 capital 1H11 2H11 1H12 2H12 Paid-up ordinary shares 5,353 5,353 5,353 5,353 Non-controlling interests Treasury shares (35) (32) (38) (29) Hybrid equity Reserves (91) (84) (100) (68) Retained earnings (692) (795) (828) (887) Excess technical provisions (net of tax) Less: deductions 2 (2,326) (2,430) (2,341) (2,464) Total Tier 1 capital 3,306 3,007 3,025 3,668 Tier 2 capital Hybrid equity in excess of Tier 1 limit Subordinated debt Other Total Tier 2 capital , Capital base 4,184 3,933 4,191 4,402 Minimum Capital Requirement (MCR): Insurance risk 1,315 1,410 1,464 1,495 Investment risk Catastrophe concentration risk Total MCR 2,315 2,496 2,481 2,531 MCR multiple Hybrid equity includes Reset Exchangeable Securities (RES) and Convertible Preference Shares (CPS). The RES are classified under APRA s prudential standards as 'Innovative Tier 1', and the CPS are classified as 'Non-Innovative Tier 1'. Residual Tier 1 securities ('Innovative' plus 'Non-Innovative') are eligible to be included in Tier 1 capital up to a limit of 25% of net Tier 1 capital. The aggregate amount of these securities in excess of this limit is included in Tier 2 capital. 2 Includes goodwill and intangibles, net deferred tax assets, capitalised software and expected dividends. 3 The amount of subordinated debt eligible to be included in Tier 2 capital excludes capitalised transaction costs and discount on issue, and for foreign currency denominated debt, the liability is translated at the current exchange rate excluding any related cross-currency swaps. IAG FY12 INVESTOR REPORT 65

70 12. BALANCE SHEET & CAPITAL The proportion of the Group s capital designated Tier 1 has increased following the buyback of the $350m Reset Preference Share (RPS) issue, concluded in June 2012, and the issue of Convertible Preference Shares (CPS) in May 2012, which raised a total of approximately $377m. Under APRA s current prudential standards, RPS were deemed Innovative Tier 1 capital, whereas CPS are classified as Non-Innovative Tier 1 capital. As a consequence, at 30 June 2012 Residual Tier 1 securities ( Innovative plus Non-Innovative ) eligible for inclusion in Tier 1 capital were capped at the regulatory limit of 25% of net Tier 1 capital. At 31 December 2011, the rule restricting Innovative Tier 1 capital to a limit of 15% of net Tier 1 capital prevailed. The Australian regulator, APRA, has announced a revised regime for Life and General Insurance Capital (LAGIC) which will be operative from 1 January While APRA s proposals have yet to be finalised, the Group does not anticipate a significant adverse impact on its regulatory capital position from application of the new standards. The Group has outlined the following targeted benchmarks under the latest LAGIC proposals: A total capital position equivalent to 1.4 to 1.6 times the Prescribed Capital Amount (PCA), which replaces the current MCR measure; and A Common Equity Tier 1 (CET1) target range of 0.9 to 1.1 times the PCA, compared to a proposed regulatory requirement of 0.6 times. New benchmarks formulated for LAGIC regime Based on the Group s position at 30 June 2012, application of the LAGIC proposals would have resulted in a PCA ratio of 1.68, above the targeted range, and a CET1 ratio of 1.02, within the targeted range. Interest Bearing Liabilities The Group s interest bearing liabilities stood at $1,659m at 30 June 2012, compared to $1,377m at 30 June The increase reflects the net effect of a number of capital management initiatives completed during the year: With effect from October 2011, the Group announced amended terms for its Tier 2 157m subordinated exchangeable loan note issue, including an extended redemption or exchange date of December 2012, and a reduced coupon of LIBOR % (previously LIBOR +2.5%); In December 2011 the Group raised NZ$325m from the issue of unsecured subordinated bonds with a term to maturity of 25 years, a coupon of 7.50% and callable at IAG s discretion on the fifth anniversary of issue and on each interest payment date thereafter; In May 2012 the Group issued $377m of Tier 1 Convertible Preference Shares (CPS) which mandatorily convert to ordinary shares on 1 May 2019, if not previously converted or redeemed, and carry an expected fully franked dividend based on the sum of the 180 day bank bill swap rate plus a 4% margin; and The buyback of the $350m Reset Preference Share issue, concluded in June Range of capital management initiatives completed in FY12 INTEREST BEARING LIABILITIES 1H11 2H11 1H12 2H12 Subordinated debt Reset Preference Shares Convertible Preference Shares Reset Exchangeable Securities Capitalised transaction costs/other Total interest bearing liabilities 1,380 1,377 1,627 1,659 IAG FY12 INVESTOR REPORT 66

71 12. BALANCE SHEET & CAPITAL Yield Principal amount (net of swaps) First Call or Exchange S&P GROUP DEBT & HYBRID CAPITAL m % Rate date rating Subordinated exchangeable term notes % Variable Dec-12 'A' Subordinated fixed rate notes NZ$ % Fixed Nov-12 'A+' Subordinated fixed rate notes % Fixed Dec-16 'A-' Subordinated fixed rate bonds NZ$ % Fixed Dec-16 'A-' Total Debt 728 Convertible Preference Shares (IAGPC) 2 A$ % Variable May-17 'N/R' Reset Exchangeable Securities (IANG) 3 A$ % Variable Dec-19 'A-' 1 Stated yield based on margin of LIBOR %, as amended in October Dividend yield on the Convertible Preference Shares is a cash yield, excluding attached franking credits. The principal excludes capitalised transaction costs. 3 The Reset Exchangeable Securities pay floating rate quarterly interest. The yield shown is the current cash yield, excluding attached franking credits. GROUP DEBT MATURITY PROFILE >20 Years from 30 June 2012 Legal maturity date Call/exchange date Capital Mix The Group measures its capital mix on a net tangible equity basis, i.e. after deduction of goodwill and intangibles, giving it strong alignment with regulatory and rating agency models. It is IAG s intention to have a capital mix in the following ranges over the longer term: Ordinary equity (net of goodwill and intangibles) 60-70%; and Debt and hybrids 30-40%. Capital mix within targeted range At 30 June 2012, the Group s capital mix was towards the upper end of the targeted range, with debt and hybrids representing 38.3% of total tangible capitalisation. IAG FY12 INVESTOR REPORT 67

72 12. BALANCE SHEET & CAPITAL CAPITAL MIX Credit Ratings 1H11 2H11 On 17 February 2012, Standard & Poor's (S&P) affirmed its very strong 'AA-' ratings on IAG s core operating companies and its 'A+' rating on IAG (the ultimate parent entity). The outlook on all entities remains stable. 1H12 2H12 Shareholder equity 4,658 4,580 4,513 4,524 Intangibles and goodwill (1,853) (1,869) (1,887) (1,850) Tangible shareholder equity 2,805 2,711 2,626 2,674 Interest bearing liabilities 1,380 1,377 1,627 1,659 Total tangible capitalisation 4,185 4,088 4,253 4,333 Debt to total tangible capitalisation 33.0% 33.7% 38.3% 38.3% IAG FY12 INVESTOR REPORT 68

73 APPENDIX A GROUP OPERATING MODEL GROUP OPERATING MODEL The Group has a portfolio of end-to-end general insurance businesses aligned around customers, brands and markets. In this devolved model, accountability and responsibility are close to the end customer. This provides the operating businesses with control over the levers needed to execute strategies and manage performance, but within an overall Group framework. The operating model is summarised below. PORTFOLIO OF INSURANCE BRANDS AND MARKETS 1 IAG s short tail personal insurance products are distributed in Victoria under the RACV brand, via a distribution relationship and underwriting joint venture with RACV Limited. These products are distributed by RACV and manufactured by Insurance Manufacturers of Australia Pty Limited (IMA), which is 70% owned by IAG and 30% by RACV. 2 IAG owns 49% of the general insurance arm of Malaysian-based AmBank Group, AmG Insurance Berhad (AmG), which trades under the AmAssurance brand. 3 IAG holds 98.6% voting rights in Safety Insurance, based in Thailand. 4 IAG owns 26% of SBI General Insurance Company, a joint venture with State Bank of India. 5 IAG owns 20% of Bohai Property Insurance Company Ltd, based in China. 6 IAG owns 30% of AAA Assurance Corporation, based in Vietnam. IAG FY12 INVESTOR REPORT 69

74 APPENDIX B IAG SNAPSHOT AUSTRALIA DIRECT Direct insurance products, which include personal insurance as well as business insurance packages targeted at sole operators and smaller businesses, are sold primarily under the NRMA Insurance brand in NSW, ACT, Queensland and Tasmania. SGIO is the primary brand in Western Australia, and SGIC in South Australia. In Victoria, home, motor and other insurance products are distributed through RACV. Products are distributed through branches, call centres, the internet and representatives. Short tail insurance Motor vehicle Home and contents Niche insurance, such as pleasure craft, veteran and classic car, caravan and travel Commercial property Commercial motor and fleet motor Farm, crop and livestock Long tail insurance Compulsory Third Party (motor injury liability) Public and products liability AUSTRALIA INTERMEDIATED Intermediated insurance products are sold primarily under the CGU Insurance and Swann Insurance brands through a network of more than 1,000 intermediaries, such as brokers, agents, motor dealerships and financial institutions. CGU is a leading provider of business and farm insurance, as well as personal insurance through business partnerships, across Australia. It also provides workers compensation services in every state and territory, except South Australia and Queensland. Short tail insurance Commercial property Commercial motor and fleet motor Construction and engineering Farm, crop and livestock Marine Motor vehicle Home and contents Niche insurance, such as consumer credit and travel Long tail insurance Public and products liability Professional indemnity Directors and officers Workers compensation NEW ZEALAND The New Zealand business is the leading insurance provider in the country in the direct channel and a leading insurer in the broker/agent channel. Insurance products are provided directly to customers under the State and AMI brands and indirectly, through insurance brokers and agents, under the NZI brand. Personal lines and simplified commercial products are also distributed through agents and under third party brands by corporate partners, which include large financial institutions. Short tail insurance Motor vehicle Home and contents Commercial property, motor and fleet motor Construction and engineering Niche insurance, such as pleasure craft, boat, caravan and travel Rural and horticultural Marine Long tail insurance Personal liability Income protection Commercial liability IAG FY12 INVESTOR REPORT 70

75 APPENDIX B IAG SNAPSHOT UNITED KINGDOM In the UK, IAG has a specialist motor underwriting operation, Equity Red Star (ERS). Commencing operations in 1946, ERS is the largest motor syndicate at Lloyd s, providing insurance to business and personal lines customers. IAG s UK interests also include the Equity Insurance Partnerships (EIP) affinity business and the specialist commercial broking operation, Independent Commercial Brokers (ICB). IAG has announced a strategic review of the UK business, which is assessing a number of alternative options, including: A continuing focus on improving the business performance within the current operating model; Refining the business strategy to a more focused specialist motor offering, and Exploring a potential sale of all or part of the business. The Group anticipates announcing an outcome of the strategic review before the end of 1H13. ASIA The Group has interests in five insurance businesses in Asia: A controlling economic interest in the merged business of Safety Insurance and NZI in Thailand; 49% of AmG Insurance Berhad (AmG), a general insurance joint venture in Malaysia; 26% of SBI General Insurance Company, a general insurance joint venture in India; 20% of Bohai Property Insurance Company Ltd, a general insurer based in China; and 30% of AAA Assurance Corporation, a general insurer based in Vietnam. IAG s Malaysian-based associate, AmG, has agreed to purchase 100% of Kurnia Insurans (Malaysia) Berhad, a transaction which will result in AmG becoming the largest general and motor insurer in Malaysia. This transaction is expected to complete in 1H13. IAG FY12 INVESTOR REPORT 71

76 APPENDIX C KEY RELATIONSHIPS NRMA MOTORING & SERVICES NRMA Motoring & Services was established in 1920 and is a mutual organisation with over 2.4 million members in NSW and the ACT. Until August 2000 it owned the NRMA Insurance business which now forms the bulk of IAG s Australia Direct division. Under the terms of the demutualisation agreements, from that date NRMA Motoring & Services and IAG co-own the NRMA brand, with the respective parties having the following exclusive rights to its use: NRMA Motoring & Services - roadside assistance and other motoring services (except smash repairs), motoring products, transportation and travel. IAG (NRMA Insurance) - insurance and financial services and any other good or service not specifically reserved for NRMA Motoring & Services. In addition, both parties cannot, under any brand, carry out activities engaged in by the other at the point of demutualisation. IAG continues to provide certain services to NRMA Motoring & Services, notably those in respect of the NRMA branch network which is operated and managed by IAG. The two organisations retain a strong and closely aligned relationship. NRMA Motoring & Services and its members received IAG shares as consideration for the NRMA Insurance business at demutualisation. RACV RACV is a mutual organisation incorporated in It provides a broad range of services to more than two million members. These services include: insurance; finance; roadside assistance; general mobility, road safety and vehicle design advocacy; and leisure, which includes club and resorts, touring and travel products and services. IAG s short tail personal insurance products are distributed in Victoria under the RACV brand, via a distribution relationship and underwriting joint venture with RACV established in These products are distributed by RACV and manufactured by Insurance Manufacturers of Australia Pty Limited (IMA), which is owned 70% by IAG and 30% by RACV. If one of IMA s shareholders were to experience a change of control, the other has a pre-emptive right to acquire that shareholder s interest in IMA at fair market value. The duration of the arrangements governing RACV s distribution of RACV-branded products in Victoria would be a relevant factor in determining this market value, as would the duration of the arrangements governing IMA s reinsurance of NRMA-branded products in NSW and the ACT. AMBANK GROUP With a history stretching back to 1975, the Malaysian-based AmBank Group provides a wide range of financial products and services through various subsidiaries. Its business divisions cover activities across retail banking, business banking, transaction banking, corporate and institutional banking, investment banking including funds management and stockbroking, Islamic banking, general insurance, life assurance and family takaful. IAG has a general insurance joint venture in Malaysia with AmBank, AmG Insurance Berhad (AmG), which was established in AmBank owns 51% of AmG and IAG 49%. AmG is Malaysia s fourth largest motor insurer. IAG FY12 INVESTOR REPORT 72

77 APPENDIX C KEY RELATIONSHIPS STATE BANK OF INDIA State Bank of India (SBI) is India s largest and oldest bank, with origins that can be traced back to It offers a broad range of banking and financial services, and has a footprint which, including associated banks, spans over 160 million customers and 18,000 branches across all states of India. SBI General Insurance Company (SBI General), a joint venture between SBI and IAG, was established in late SBI General commenced operations in 2010 and is building a portfolio in the corporate, retail and SME markets across India, with the majority in the retail segment through SBI s bancassurance channel. SBI General has an exclusive corporate agency agreement with SBI for general insurance business. SBI owns 74% of SBI General and IAG 26%. IAG has an option to increase its shareholding to 49%, subject to a change in the Indian foreign direct investment limit. LLOYD S Lloyd s is based in London and is the world s leading specialist insurance market, conducting business in over 200 countries and territories worldwide. It brings together specialist underwriting expertise and comprises over 50 managing agents and over 80 syndicates. Lloyd's is not an insurance company but a society of members, both corporate and individual, who underwrite in syndicates on whose behalf professional underwriters accept risk. Supporting capital is provided by investment institutions, specialist investors, international insurance companies and individuals. Together, the syndicates underwriting at Lloyd's form one of the world's largest commercial insurers and a leading reinsurer. The Lloyd s underwriting year commences 1 January. Equity Red Star Motor Syndicate 218 is the largest motor and personal lines syndicate at Lloyd s and represents the most significant part of IAG s UK business. IAG s wholly-owned Lloyd s corporate member, Equity Red Star Limited, currently provides approximately 64.9% of the syndicate s underwriting capacity. IAG FY12 INVESTOR REPORT 73