AUSTRALIA AU Price (at CLOSE#, 19 Mar 213) Underperform A$5.7 Volatility index Low 12-month target A$ 4.99 12-month TSR % +3.6 Valuation - Sum of Parts A$ 4.68 GICS sector Insurance Market cap A$m 14,855 3-day avg turnover A$m 56.9 Number shares on issue m 2,93 Investment fundamentals Year end 31 Dec 212A 213E 214E 215E NEP m.... Underwriting Result m.... Investment Income m 128. 67.9 77.6 91.2 Reported profit m 694. 823.1 959.9 1,22.3 Net Op Income m 943. 966.7 1,42.8 1,95.9 EPS adj 32.4 32.4 34.3 36. PER adj x 15.7 15.6 14.8 14.1 PER rel x 1.1 1. 1.4 1.8 DPS 25. 25.7 27.5 28.6 Dividend yield % 4.9 5.1 5.4 5.6 Franking % 6 65 65 65 Total SH Funds m 7,531. 7,965.3 8,3.6 8,475.9 BV/S 253.7 262.7 27.2 275.1 ROE % 13.2 12.7 13. 13.3 ROA %.8.8.8.7 P/BV x 2. 1.9 1.9 1.8 AU vs ASX 1, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, March 213 (all figures in AUD unless noted) 19 March 213 Macquarie Securities (Australia) Limited Lapse undermines life support Event At the FY12 result stated that to improve retention and claims management [] is reviewing its [Australian life insurance] products, pricing and retention and claims processes. This broad review follows experience losses in 4 of the 6 half year results from 1H1. Impact Cyclical & structural factors are impacting Life profits. reduced FY13 planned Life profit margins by ~$3m (~13.7%) at the FY12 result. Better economic conditions would reduce the cyclical drag, and is focused on resolving structural issues (lapses and claims), via 1) reunderwriting, 2) pricing changes, 3) targeting underperforming advisors, 4) changed commission structures and 5) product exclusions. Despite s remedial action, structural weaknesses may prove difficult to rectify. Industry Structural Weaknesses #1 Pricing: Yearly Renewable Terms (unique to Australia, ~9% of Life premiums) see premiums increase as policyholders age. This encourages healthy older persons to move to cheaper policies with potentially better pricing and product structure. Less healthy policyholders are stuck in existing policies, with fixed terms and conditions, as they age. The result is that the residual policyholder pool becomes sicker (higher mortality, morbidity) as healthy people lapse/re-underwrite. IFAs have the added incentive of a second commission. Industry Structural Weaknesses #2 Product Structure: To remain attractive among IFA distribution channels, policies need to remain highly rated on value provided to policyholders by research groups such as Canstar. To achieve this, additional features and more attractive terms & conditions are introduced, including weaker clinical definitions for trauma payouts, and waiving of exclusions, which increase claims costs and, without increasing premium rates, reduce margins. Additional features and improved terms & conditions also encourage lapse among healthy policyholders. Financial sensitivity: The combination of high commissions and no lapse penalties makes Life valuations highly sensitive to lapse rates. The impact of a change in Wealth Protection discontinuance assumptions is $33m on Embedded Value (~11cps/~ one-off impact), $35m New Business Value (~1cps/~ ongoing earnings impact). Earnings and target price revision No change. Price catalyst 12-month price target: A$4.99 based on a Sum of Parts methodology. Catalyst: AGM and March 213 quarter cash flows released on 9 May. Action and recommendation Downgrade to Underperform. We believe improved economic conditions and inflows are reflected in the current share price, and that ongoing negative Life company experience poses a clear downside risk to expectations. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com/disclosures.
1H5A 2H5A 1H6A 2H6A 1H7A 2H7A 1H8A 2H8A 1H9A 2H9A 1H1A 2H1A 1H11A 2H11A 1H12A 2H12A Macquarie Private Wealth Lapse experience drives poor life experience outcomes Figure 1 below illustrates the deterioration in the lapse rate experience since 25. The trend from FY11 includes the impact of the AXA Australia and New Zealand acquisition. Fig 1 Individual risk insurance lapse rates 1 1 1 1 1 only prior to 211 12. 12. 11.9% 11. 9. 9. 9.6% 9.9% 1. 1.% 1. 1. 11. 13.8% 12.9% 14.8% 9% 8% 7% 6% Source: Company Data, Macquarie Research, March 213 Long term discontinuance rate rising but still below peak historical levels. Fig 2 Long term industry individual risk insurance lapse rates Industry Discontinuance Rate 18% 16% 1 1 8% 6% % Jun-9 Jun-92 Jun-94 Jun-96 Jun-98 Jun- Jun-2 Jun-4 Jun-6 Jun-8 Jun-1 Jun-12 Source: Plan for life, Macquarie Research, March 213 19 March 213 2
Sep-6 Mar-7 Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-7 Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Macquarie Private Wealth life company profit/(loss) experience vs peers Fig 3 2H12 experience losses were large ( of API), similar in magnitude to SUN, CBA and ANZ s first period of large negative experience, albeit several periods later. Experience (A$m) 5 4 3 2 1 % -1 - -2 - -3-4 - -5-6 Fig 4 SUN has seen two and a half years of negative experience, albeit reducing in severity Fig 5 As CBA experience losses have been relatively large in three of the past four halves Suncorp CBA % - - - 5 4 3 2 1-1 -2-3 -4-5 -6 % - - - 5 4 3 2 1-1 -2-3 -4-5 -6 Fig 6 While MLC has been relatively immune to date vs. peers Fig 7 and OnePath experience has been negative for 18 months NAB ANZ % - - - 5 4 3 2 1-1 -2-3 -4-5 -6 % - - - 5 4 3 2 1-1 -2-3 -4-5 -6 Source (for all above): Company Data, Macquarie Research, March 213 19 March 213 3
Macquarie Private Wealth EV and net book value Figure 8 below tracks the EV and tangible book value per share back to 24. We also include a Stressed EV and discounted tangible capital per share from Dec 21. The Stressed EV applies a discount to the reported EV based on the EV sensitivities provided by and applies a discount to the tangible capital per share. Fig 8 Discount to EV and tangible book value per share now eroded $12 $11 Share Price EV+Tangible Capital per share Stressed EV + discounted tangible capital per share $1 $9 $8 $7 $6 $5 $4 $3 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Source: IRESS, Company Data, Macquarie Research, March 213 Wealth Protection overview: Risk products: individual and group term, disability and income protection. Distribution: Wealth Protection product is bundled with a superannuation product or distributed by aligned advisors and Independent Financial Advisors. In FY12 4 of in-force and 6 of new business was written within superannuation. Premium growth and product mix: Individual risk Annual Premium Income (API) increased $74m (6%) to $1.4b in FY12 and $61m () in 2H12 vs 1H12. 2H12 API included the annual benefit from Consumer Price Index (CPI) and age premium increases on risk policies held within superannuation in Life. FY12 individual risk API comprised lump sum insurance (7) and disability, including income protection (29%). Group risk API increased to $357m in FY12. Lapse Rates: lapse rates have deteriorated since the beginning of the financial crisis. 2H12 lapse rates were 14.8%, 1.pts higher than 2H11 and 1.9%pts higher than in 1H12. 2H lapse rates are typically higher than in the 1H as annual age and CPI premium increases that come into effect from 1 July each year for policies written within superannuation. Lapse Assumptions: At the Fy12 result Due to this current challenging environment for the Australian risk market, has strengthened lapse assumptions on the Life income protection and Life and NMLA lump sum books, and strengthened claims assumptions on the Life income protection book and Life and NMLA trauma books. Claims and Lapse assumptions: strengthened long term claims and lapse assumptions at the FY12 result and this is expected to reduce profit margins by around $3m in FY 13 with an offsetting impact on experience. Remedial action: has and will continue to take action to improve retention and claims management through product redesign, targeted pricing reviews, increased investment in retention programs at both the customer and planner level, early claims intervention and accelerating claims settlements. Cost performance: Wealth Protection controllable costs were $15m in 2H12, up from $92m in 2H11. 2H12 controllable costs increased partially due to higher claims handling costs. The cost to income ratio increased 11.pts to 41.8% in 2H12 due to the increase in experience losses. Profit margins: Wealth Protection as a percentage of average API were 12.7% in 2H12, down from 13. in 1H12 and 13. in 2H11. 19 March 213 4
Macquarie Private Wealth Limited Source: Company data, Macquarie Research March 213 Price: Year Ending December 31 Consolidated P&L ($m) FY9A FY1A 1H11A 2H11A FY11A 1H12A 2H12A FY12A 1H13E 2H13E FY13E FY14E Operating Margins Financial Services - Wealth management 243 261 14 121 261 135 15 285 162 183 345 385 - Banking 35 42 31 3 61 29 33 62 34 35 69 72 - Wealth protection 164 138 18 17 215 134 56 19 94 96 19 197 - Mature 151 14 76 77 153 76 91 167 81 8 161 155 - New Zealand 54 58 33 43 76 38 35 73 38 49 87 95 Capital investors (Net of minority) 91 87 45 38 83 45 54 99 49 56 15 121 Business unit operating margins 738 726 433 416 849 457 419 876 459 498 957 1,25 Corporate office costs -37-4 -26-31 -57-31 -3-61 -3-29 -59-6 Total operating earnings 71 686 47 385 792 426 389 815 429 47 899 965 Underlying investment income 126 13 83 1 183 113 113 226 79 83 162 176 Interest expense on corporate debt -71-72 -39-43 -82-48 -38-86 -39-34 -73-65 Limited tax loss recognition 16 16 8 8 16 Normalised profit 772 76 459 45 99 491 464 955 47 519 988 1,77 Investment income market adjustment -13-5 -3-47 -5-1 -11-12 1-22 -22-34 Adjusted profit 759 755 456 43 859 49 453 943 47 497 967 1,43 Other items -2-18 -51 1-41 1 24 34 AXA integration expenses -36-69 -15-71 -57-128 -45-23 -68-9 VIF amortisation -25-5 -75-5 -49-99 -46-44 -9-88 Timing differences 1 16 11 58 69 11-28 -17 7 7 14 14 Accounting mismatches -1 22-9 -1-19 -7-22 -29 Reported profit 739 775 346 342 688 383 321 74 386 437 823 96 Divisional Results ($m) FY9A FY1A 1H11A 2H11A FY11A 1H12A 2H12A FY12A 1H13E 2H13E FY13E FY14E Financial Services 718 718 447 458 95 495 45 945 468 51 969 1,27 Capital Investors 11 94 47 41 88 48 57 15 52 59 11 128 Corporate office costs -76-73 -17-223 -33-174 -16-334 -14-131 -271-29 Limited tax loss recognition 16 16 8 8 16 Mismatch items -1 22-9 -1-19 -7-22 -29 Non-recurring Consolidated items NPAT 739-19 775-2 346-4 342 68 688 28 383 21 321-4 74 17 386 7 437 7 823 14 96 14 Investment Fundamentals FY9A FY1A 1H11A 2H11A FY11A 1H12A 2H12A FY12A 1H13E 2H13E FY13E FY14E Reported Profit 739 775 346 342 688 383 321 74 386 437 823 96 Adjusted Profit 759 755 456 43 859 49 453 943 47 497 967 1,43 Normalised Profit 772 76 459 45 99 491 464 955 47 519 988 1,77 EPS (Adjusted) 37.4 36.5 18.4 15.2 33.6 16.9 15.4 32.4 15.8 16.6 32.4 34.3 EPS (Underlying) 38.1 36.7 18.5 17. 35.5 17. 15.8 32.8 15.8 17.3 33.1 35.5 EPS Growth 29. -2. 1.6% -17.% -7.8% -8. 1. -3.8% -6. 7.. 6.% PER (Adjusted) 14.5 14.9 14.7 17.8 16.1 16. 17.5 16.7 17.1 16.4 16.7 15.8 PER (Underlying) 14.2 14.8 14.6 15.9 15.3 16. 17.1 16.5 17.1 15.7 16.4 15.3 PER (Business profits) 18. 17.8 1.3 1.8 1.5 9.2 9.9 9.4 8.7 7.7 8.1 7.2 DPS ( ) 3. 3. 15. 14. 29. 12.5 12.5 25. 11.9 13.8 25.7 27.5 Dividend yield 5. 5. 5. 5. 5. 4.6% 4.6% 4.6% 2. 2.6% 4.7% 5. Franking 5 5 6 6% 6 6 6 6 Payout ratio (underlying) 79% 8 8 8 8 7 79% 76% 7 8% 78% 78% Ratio Analysis FY9A FY1A FY11A FY12A FY13E Headcount Issued shares 249 294 2855 293 2988 Headcount (FTE) EFPOWA 225 282 2663 2915 2982 7, Group Office Book Value ps 1.25 1.4 2.39 2.54 2.63 6, Capital P/BV 4.3 3.9 2.3 2.1 2.1 5, AFS NTA ps.79.96.87 1.12 1.26 4, P/NTA Embedded Value ps 3.65 6.8 3.67 5.6 3.45 6.2 3.54 4.8 3.67 4.3 3, 853 P/EV 1.5 1.5 1.6 1.5 1.5 927 Value of new business 286 244 259 273 285 2, 1, Implied VnB multiple 27.4 32.6 18.7 16.4 14.6 195 ROA.8%.9%.7%.6%.7% ROE 32. 26.8% 13. 1. 1.6% $ 5.7 976 94 992 912 3,844 3,746 3,573 3,551 Balance Sheets ($m) FY9A FY1A FY11A FY12A FY13E Valuation Summary ($m) Assets Wealth management 7,216 Cash 2,49 3,158 4,652 4,27 4,27 Banking 994 Investments 84,55 82,854 96,857 16,182 117,119 Wealth protection 2,42 Other assets 3,366 3,249 8,781 8,362 8,484 Mature 1,938 Total Assets 89,83 89,261 11,29 118,751 129,81 New Zealand 1,55 Capital Investors 1,268 Liabilities Group office (costs, capital and debt) -1,956 Policyholder liabilities 65,619 66,341 84,563 92,13 11,573 Limited tax loss recognition Operational debt 11,161 1,25 1,823 1,914 11,85 Total Group 13,43 Other liabilities 1,416 9,672 8,7 8,133 8,467 Shares on issue 2,87 Total Liabilities 87,196 86,263 13,393 111,177 121,845 Value ps $ 4.68 Share price target $ 4.99 Net Assets 2,634 2,998 6,897 7,551 7,965 Capital Return -1.6% Dividend Yield 4.7% Minority interests 63 6 68 97 116 Total Return 3. Total Shareholders' Equity 2,571 2,938 6,829 7,454 7,849 Recommendation Underperform 1,392 1,362 1,295 1,366 Dec 1 (pre AXA) Jun-11 Dec-11 Jun-12 Dec-12 19 March 213 5
Macquarie Private Wealth Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return > in excess of benchmark return Neutral return within of benchmark return Underperform return > below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+ Neutral expected return from to + Underperform expected return < Macquarie First South - South Africa Outperform expected return >+ Neutral expected return from to + Underperform expected return < Macquarie - Canada Outperform return > in excess of benchmark return Neutral return within of benchmark return Underperform return > below benchmark return Macquarie - USA Outperform (Buy) return > in excess of Russell 3 index return Neutral (Hold) return within of Russell 3 index return Underperform (Sell) return > below Russell 3 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 6 in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4 6% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3 in a year. Low medium stock should be expected to move up or down at least 25 in a year. Low stock should be expected to move up or down at least 15 2 in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 31 December 212 AU/NZ Asia RSA USA CA EUR Outperform 47.87% 54.89% 54.4 41.9 6.86% 44.1 (for US coverage by MCUSA, 6. of stocks followed are investment banking clients) Neutral 37.9 26.4 38.2 52.16% 33.7% 27.7 (for US coverage by MCUSA, 4.9 of stocks followed are investment banking clients) Underperform 14.19% 18.7% 7.3 5.9 5.4 28.1 (for US coverage by MCUSA, 3.3 of stocks followed are investment banking clients) Company Specific Disclosures: Macquarie Bank Limited makes a market in the securities in respect of Limited. Macquarie and its affiliates collectively and beneficially own or control or more of any class of Limited's equity securities. The responsible entities of the Diversified Utility and Energy Trusts (DUE:ASX), CI Macquarie Infrastructure Management No 1 Limited and CI Macquarie Infrastructure Management No 2 Limited, are owned by the Macquarie Group and by Capital Holdings Limited. The Macquarie Group is a substantial securities holder of DUE:ASX stapled securities. The DUE:ASX trusts hold all the ordinary units in POWERS Trust. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 31862) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 2 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 2 574 923, AFSL No. 23754) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 8 583 542, AFSL No. 23752) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. 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The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. 19 March 213 6