INSURANCE AUSTRALIA GROUP LIMITED HALF YEAR REPORT FOR THE PERIOD ENDED 31 DECEMBER 2017 APPENDIX 4D (ASX Listing Rule 4.2A) RESULTS FOR ANNOUNCEMENT TO THE MARKET UP / DOWN % CHANGE 2017 $m 2016 $m Revenue from ordinary activities Up 1.1 % 8,272 8,179 Net profit after tax from ordinary activities attributable to shareholders of the Parent Up 23.5 % 551 446 Net profit attributable to IAG shareholders Up 23.5 % 551 446 DIVIDENDS ORDINARY SHARES AMOUNT PER SECURITY FRANKED AMOUNT PER SECURITY Interim dividend 14.0 cents 14.0 cents INTERIM DIVIDEND DATE Record date 21 February 2018 Payment date 29 March 2018 The Company's Dividend Reinvestment Plan (DRP) will operate by acquiring shares on-market with no discount applied. The last date for the receipt of an election notice for participation in the Company's DRP is 22 February 2018. The DRP Issue Price will be based on a volume-weighted average price for a 10-day trading window from 26 February 2018 to 9 March 2018 inclusive. Eligible shareholders may now lodge their DRP elections electronically by logging on to IAG's share registry, Computershare, on their website at www.computershare.com.au. Additional Appendix 4D disclosure requirements can be found in the half year financial report of Insurance Australia Group Limited for the period ended 2017 (Attachment A). This report is also to be read in conjunction with the annual report of Insurance Australia Group Limited for the year ended 30 June 2017 and any public announcements made by Insurance Australia Group Limited during the reporting period in accordance with the continuous disclosure requirements of the Corporations Act 2001 and the ASX Listing Rules. The report is based on the consolidated half year financial statements which have been reviewed by KPMG. INSURANCE AUSTRALIA GROUP LIMITED ABN 60 090 739 923 1
ATTACHMENT A INSURANCE AUSTRALIA GROUP LIMITED AND SUBSIDIARIES HALF YEAR REPORT FOR THE PERIOD ENDED 31 DECEMBER 2017 INSURANCE AUSTRALIA GROUP LIMITED ABN 60 090 739 923 2
INSURANCE AUSTRALIA GROUP LIMITED ABN 60 090 739 923 FINANCIAL REPORT FOR THE HALF YEAR ENDED 31 DECEMBER 2017
INSURANCE AUSTRALIA GROUP LIMITED TABLE OF CONTENTS Directors' report... 1 Lead auditor's independence declaration... 12 Consolidated financial statements... 13 Directors' declaration... 25 Independent auditor's review report... 26
DIRECTORS' REPORT The Directors present their report together with the consolidated financial report of Insurance Australia Group Limited and its subsidiaries for the half year ended 2017 and the Auditor's Report. The following terminology is used throughout the financial report: IAG, Parent or Company Insurance Australia Group Limited; and Group or Consolidated the Consolidated entity consists of Insurance Australia Group Limited and its subsidiaries. DIRECTORS OF INSURANCE AUSTRALIA GROUP LIMITED The names and details of the Company's Directors in office at any time during or since the end of the half year are as follows. Directors were in office for the entire period unless otherwise stated. INDEPENDENT NON-EXECUTIVE Elizabeth B Bryan AM (Chairman) Duncan M Boyle Catriona A Deans (Alison Deans) Retired 20 October 2017 Hugh A Fletcher Jonathan (Jon) B Nicholson Helen M Nugent AO Thomas (Tom) W Pockett Philip J Twyman AM EXECUTIVE Peter G Harmer (Managing Director and Chief Executive Officer) PRINCIPAL ACTIVITY The principal continuing activity of the Group is the underwriting of general insurance and related corporate services and investing activities. The Group reports its financial information under the following business divisions: DIVISION OVERVIEW PRODUCTS Consumer division (Australia) 52% of Group gross written premium (GWP) Consumer insurance products are sold in Australia through branches, call centres, the internet and representatives, under the following brands: NRMA Insurance in NSW, ACT, Queensland and Tasmania; SGIO in Western Australia; SGIC in South Australia; RACV in Victoria, via a distribution agreement with RACV; Coles Insurance nationally, via a distribution agreement with Coles; and CGU through affinity and financial institution partnerships and broker and agent channels. Consumer division also includes travel insurance, life insurance and income protection products which are underwritten by third parties. Short-tail insurance Motor vehicle Home and contents Lifestyle and leisure, such as boat, veteran and classic car and caravan Long-tail insurance Compulsory Third Party (motor injury liability) Business division (Australia) 24% of Group GWP Business insurance products are sold in Australia through a network of around 2,000 intermediaries, such as brokers, agents and financial institutions and directly through call centre and online channels. Business division is a leading provider of business and farm insurance in Australia. Business division operates across Australia under the following brands: CGU Insurance; WFI; NRMA Insurance; RACV; SGIO; and SGIC. Short-tail insurance Business packages Farm and crop Commercial property Construction and engineering Commercial motor and fleet motor Marine Long-tail insurance Workers' compensation Professional indemnity Directors' and officers' Public and products liability 1
DIVISION OVERVIEW PRODUCTS New Zealand The New Zealand business is the leading general insurance provider in the Short-tail insurance country in both the direct and broker/agent channels. Insurance products Motor vehicle 21% of Group GWP are provided directly to customers primarily under the State and AMI brands, Home and contents and indirectly through insurance brokers and agents, under the NZI and Commercial property, Lumley Insurance brands. Personal products and simplified commercial motor and fleet motor products are also distributed through agents and under third party brands by corporate partners, which include large financial institutions. Construction and engineering Niche, such as pleasure craft, boat, caravan and travel Rural and horticultural Marine Long-tail insurance Personal liability Commercial liability Asia 3% of Group GWP The Group has interests in five general insurance businesses in Asia, comprising the direct and intermediated insurance business underwritten through subsidiaries in Thailand, Vietnam and Indonesia and the share of the operating result from the investment in associates in Malaysia and India. The businesses offer personal and commercial insurance products through local brands. Corporate and other Corporate and other comprises other activities, including corporate services, capital management activity, shareholders' funds investment activities and inward reinsurance from associates. OPERATING AND FINANCIAL REVIEW OPERATING RESULT FOR THE HALF YEAR IAG reported a headline insurance margin of 17.3% for the half year ended 2017 and an improved underlying performance consistent with the expectations held and guidance provided at the outset of the year. Underlying margin improved to 12.6% compared to 11.2% in the second half of the prior year. This reflected the earn-through of past and ongoing rate increases, as well as a return to more normal large loss experience in Australian commercial property and maintenance of improved NSW Compulsory Third Party (CTP) profitability post initial reform measures. Reported GWP growth was 0.6%, after absorbing the effects of discontinued business, changes to the Emergency Services Levy (ESL) in NSW, lower GWP from NSW CTP owing to scheme reform measures and an adverse foreign exchange translation effect. Like-for-like GWP growth was approximately 4% as commercial pricing continued to improve in Australia and New Zealand and rate increases in short-tail personal lines countered claim inflation pressures. Across Australia and New Zealand, short-tail personal lines GWP growth was largely rate-driven, supplemented by modest volume growth in motor. Positive rate momentum in short-tail commercial lines continued, partially offset by reduced volumes as remediation actions and maintained underwriting discipline tempered GWP growth. IAG s reported insurance margin of 17.3% ( 2016: 13.5%) was significantly higher than the corresponding half year owing to a favourable net natural peril claims experience against allowance, which accounted for 370 basis points (bps) of improvement. A higher favourable credit spread outcome also contributed, while net prior period reserve releases were lower than the corresponding half year, but exceeded expectations. Asia reported an improvement in its divisional result to $15 million ( 2016: $2 million). IAG has announced it is conducting a strategic review to assess the options available for its Asian businesses. Separately, a $50 million write-down to the collective carrying value has also been recognised. In the current half year, IAG announced further quota share agreements with three reinsurers covering 12.5% of IAG s consolidated business. The quota shares commenced on 1 January 2018 and have an average initial term in excess of five years. They improve IAG s capital mix through greater use of more efficient reinsurance capital, serving to reduce earnings volatility, lower exposure to catastrophe reinsurance rates and reduce regulatory capital requirements. The new quota share arrangements have not impacted the Group s reported earnings for the current reporting period, but balance sheet effects have been recognised to reflect the portion of the unearned premium reserve, and related balances, that will inure to the benefit of the new reinsurance counterparties. This has resulted in the recognition of deferred outwards reinsurance expense, partly offset by related expense recoveries ( Other liabilities ), with the net reinsurance premium payable presented within 'Trade and other payables'. IAG is on track to achieve its low single digit GWP growth guidance for the year ended 30 June 2018 and has increased its reported margin guidance, relative to the updated position provided in December 2017 after announcement of the new quota share agreements, to 15.5-17.5%. This reflects a higher prior period reserve release assumption of around 3% of Net Earned Premium (NEP) and the favourable credit spread effect recorded in the half year ended 2017. 2 INSURANCE AUSTRALIA GROUP LIMITED
Net profit after tax The Group's profit after tax for the half year was $569 million ( 2016: $491 million). After adjusting for non-controlling interests in the Group result, net profit attributable to the shareholders of the Company was $551 million ( 2016: $446 million) and was over 23% higher than the corresponding half year. In addition to the significant increase in insurance profit, this outcome included the net effect of: a higher contribution from investment income on shareholders funds, incorporating strong equity market returns; a higher effective tax rate of 27.2%, owing to the absence of the favourable tax effect on 2011 Canterbury earthquake reinsurance recoveries by an offshore captive vehicle which reduced the 2016 effective tax rate to 18.2%; and a $50 million increase in 'Fee-based, corporate and other expenses', representing the write-down of Asian asset carrying values. Gross written premium Total GWP of $5,834 million represented a 0.6% increase compared to the corresponding half year. This translates to like-for-like growth of approximately 4%. This increase was primarily driven in both Australia and New Zealand by: further rate response to claim cost pressures in short-tail personal lines; ongoing favourable momentum in average commercial rates, with advances of approximately 5% in Australia and over 10% in New Zealand; and modest volume effects, with growth in personal motor and CTP countered by slightly lower home and commercial levels of business. Insurance margin IAG s current half year reported insurance profit of $743 million ( 2016: $571 million) was over 30% higher than the corresponding half year. The reported insurance margin of 17.3% ( 2016: 13.5%) included: net natural peril claim costs of $262 million ( 2016: $420 million), which were $78 million lower than allowance, as IAG benefited from its aggregate reinsurance cover which, in particular, limited the impact of the major Melbourne hailstorm event in December 2017 to $20 million; higher than expected net prior period reserve releases of $121 million, equivalent to 2.8% of NEP, down from $155 million (3.7% of NEP) in the corresponding half year. These were derived from Australian long-tail classes, principally CTP, partially offset by over $50 million of strengthening in New Zealand; and a more favourable credit spread impact of $47 million, compared to $5 million in the corresponding half year. Underlying margin IAG s underlying margin of 12.6% ( 2016: 12.6%), while similar to the corresponding half year, was a marked improvement on the second half of the prior year. This favourable reversal in trend included: the earned-through effect of past and ongoing rate increases in both personal and commercial short-tail lines; associated reduction of claim cost pressures in short-tail motor, as rate increases at least matched increases in average claim costs; more normal large loss experience in Australian commercial property, after the adverse severity experienced in the second half of the prior year; and maintenance of the improved CTP profitability seen in the second half of the prior financial year, as initial reform measures in NSW result in lower small claims frequency. IAG defines its underlying margin as the reported insurance margin adjusted for: net natural peril claim costs less the related allowance for the period; reserve releases in excess of 1% of NEP; and credit spread movements. 2017 2016 INSURANCE MARGIN $m % $m % Reported insurance margin * 743 17.3 571 13.5 Net natural peril claim costs less allowance (78) (1.8) 80 1.9 Reserve releases in excess of 1% of NEP (78) (1.8) (113) (2.7) Credit spread movements (47) (1.1) (5) (0.1) Underlying insurance margin 540 12.6 533 12.6 * Reported insurance margin is the insurance profit as a percentage of NEP as disclosed in the Statement of Comprehensive Income. Tax expense IAG reported a tax expense of $213 million in the current half year compared to $109 million in the corresponding half year, representing an effective tax rate of 27.2% ( 2016: 18.2%). This outcome was significantly closer to the prevailing Australian corporate rate of 30% and reflects the absence of favourable reinsurance recovery-related effects which were applicable to IAG s captive vehicle in Singapore in the corresponding half year. Contributory elements reconciling the current half year s effective tax rate to the Australian corporate rate are: Differences in tax rates applicable to IAG s foreign operations, principally in New Zealand, Singapore and Malaysia; and Franking credits generated from IAG s investment portfolio. 3
Investment income on shareholders funds Net investment income on shareholders funds was a profit of $138 million, a greater than 30% increase on the profit of $105 million in the corresponding half year. This was supported by the strong equity markets, both domestic and offshore. The broader Australian index (S&P ASX200 Accumulation) delivered a return of 8.4% ( 2016: 10.6%), while the MSCI World Total Return Index (AUD Hedged) registered a gain of 10.0% ( 2016: 10.6%). At 2017, the weighting to growth assets (equities and alternatives) within shareholders funds stood at approximately 53% ( 2016: 48%). A. AUSTRALIA Australia accounted for 76% of Group GWP and continued to deliver a strong, but slightly lower, underlying margin of 11.4% (31 December 2016: 12.2%) and an improved reported insurance margin of 18.8% ( 2016: 16.5%). I. Premiums Australia reported marginally lower GWP of $4,453 million in the first half of the current year ( 2016: $4,483 million), however like-for-like growth was nearly 3% after allowance for impacts from discontinued business, ESL collection changes and the influence of NSW CTP reform. This outcome includes: solid rate-driven growth of 4.9% in short-tail motor, largely in response to claims inflation pressures; ongoing average rate momentum of approximately 5% in commercial lines, as targeted increases were applied in most classes; a $23 million reduction in GWP from exiting motor vehicle and motorcycle dealership activities; significantly lower NSW CTP GWP, with the combination of rate reductions and premium refunds accounting for nearly $80 million, in response to scheme reform; and lower ESL-related GWP of nearly $50 million following its reintroduction in NSW. Consumer division IAG is the largest personal lines insurer in Australia, offering short-tail motor and home products across the country under a range of brands, supplemented by long-tail CTP offerings in NSW, ACT and South Australia. The Australian Consumer division accounted for 52% of Group GWP and produced a strong, but slightly lower, underlying margin of 13.9% ( 2016: 14.1%). Consumer GWP in the current half year amounted to $3,052 million ( 2016: $3,060 million) which was flat compared to the corresponding half year. Excluding the effects of ESL and NSW CTP related changes, like-for-like Consumer GWP growth was over 3%. Short-tail personal lines GWP represented over 86% of Consumer GWP, with nearly 97% of this derived from motor and home classes. Compared to the corresponding half year, overall short-tail GWP growth of 2.3% was predominantly rate-driven, and included an approximately $30 million impact from lower ESL-related GWP. Long-tail (CTP) GWP decreased by over 14%, compared to the corresponding half year, largely owing to rate reductions and refunds associated with NSW scheme reform. Broader reforms to the NSW scheme took effect from 1 December 2017. Changes in scheme design, including defined benefits for low severity injuries and access to common law for the most seriously injured, are expected to reduce future claim costs. In response, IAG reduced its average NSW CTP premiums by an additional 22% from 1 December 2017. Business division IAG sells a range of commercial insurance products across Australia. The Australian Business division accounted for 24% of Group GWP and produced a lower underlying margin of 6.5% ( 2016: 8.8%). GWP declined slightly in the current half year to $1,401 million ( 2016: $1,423 million) compared to the corresponding half year. Like-for-like Business GWP growth was of the order of 1.4%, after allowance for discontinued Swann Insurance activities and an adverse ESL-related effect. The outcome comprised: a continuation of targeted rate increases across most business classes, and notably in commercial motor and packaged product portfolios; underwriting agency-derived growth, primarily from NTI; retention levels slightly lower than the same period last year, however higher than expected; slightly lower new business volumes; an approximately $23 million reduction from Swann Insurance; and an $18 million reduction in ESL-related GWP, following its reintroduction in the current half year. II. Insurance profit Australia reported an insurance profit of $625 million, compared to $542 million in the corresponding half year. This equates to a higher reported insurance margin of 18.8% ( 2016: 16.5%) compared to the corresponding half year and includes the net effect of: higher prior period reserve releases; lower net natural peril claim costs; and a higher favourable credit spread impact. 4 INSURANCE AUSTRALIA GROUP LIMITED
III. Underlying margin Australia s underlying performance was sound, with an underlying margin of 11.4% representing an improvement on the second half of the prior year (10.8%), and a slightly lower outcome against the corresponding half year (12.2%). Contributory factors to the improvement seen relative to the second half of the prior year were: reduced pressure on motor profitability from higher claim costs, as increased premium rates earned through; increased flow-through impact of average rate increases across commercial portfolios; a more normal large loss experience in commercial property classes, down from the elevated level seen in the prior year; maintenance of the improved current year profitability in NSW CTP seen in the second half of the prior financial year, reflecting lower small claim frequency; and some offset from increased expenses. IV. Fee-based business The principal source of fee income for the Business division is its role as agent under both the NSW and Victorian workers compensation schemes, which are underwritten by the respective state governments. In March 2017, IAG decided to withdraw from the NSW scheme by 2017 after assessment of associated risks and returns. As part of the withdrawal, anticipated redundancy costs associated with the exit were fully provided for in the prior year ended 30 June 2017. In the current half year, net income from fee-based operations was $5 million, compared to $2 million in the corresponding half year. The current half year result contained $10 million of prior period fee income for the Victorian scheme, which was $5 million higher than the corresponding half year. This related to a new incentive fee, and the scheme is on track for improved performance. This is the second year of a five-year contract in the Victorian scheme. A secondary source of fee income is Business division s interest in authorised representative brokers. B. NEW ZEALAND New Zealand accounted for 21% of Group GWP and continued to deliver a strong underlying performance, with a higher underlying margin of 17.4% ( 2016: 15.3%) and a higher reported margin of 14.2% ( 2016: 4.3%). I. Premiums New Zealand s reported current half year GWP rose by 5.5% to $1,190 million, compared to the corresponding half year GWP of $1,128 million. This increase comprises an adverse foreign exchange translation effect, with local currency GWP increasing by 9.5%, to NZ$1,299 million ( 2016: NZ$1,186 million). This outcome was the result of: strong GWP growth in the Business division, as rate increases were achieved, particularly in commercial lines, with some offset from lower new business volumes as IAG adhered to its strong underwriting disciplines; and ongoing GWP growth in the Consumer division, led by the private motor vehicle portfolio which achieved volume growth and higher rates. II. Insurance profit The New Zealand business produced a substantially higher insurance profit of $119 million in the current half year, compared to $36 million in the corresponding half year, translating to a reported insurance margin of 14.2% ( 2016: 4.3%) which reflects the net effect of: a positive movement in gross earned premium, reflecting sound growth in the Consumer division (led by the AMI private motor portfolio) and rate-driven benefits in the Business division; subdued net natural peril claim costs and the absence of any earthquake events in the current half year; working claims in line with expectations as initiatives to remediate claims performance begin to deliver; continued focus on disciplined expense management; and some offset from prior period reserve strengthening. Net prior period reserve strengthening of $53 million was recognised in the current half year. This primarily relates to: potential claims under architect/engineer professional indemnity policies relating to residual risk (e.g. negligence) from postearthquake building damage and rebuild activity; and adverse development in prior year storm events. III. Canterbury rebuild The settlement of claims associated with the financial year 2011 Canterbury earthquake events continues to make sound progress. At 2017: over NZ$6.5 billion of claim settlements had been completed; 98% of all claims by number had been fully settled; over 98% of commercial claims had been fully settled; and over 97% of residential claims had been settled, with the balance either in construction or negotiation for cash settlement. During the current half year, IAG continued to receive new claims from the Earthquake Commission (EQC) as they tipped over the EQC cap of NZ$100,000 plus Goods and Services Tax (GST). At 2017, IAG s reserving position allows for further claims exceeding the EQC s cap. IAG has increased its gross reserved position on the three major earthquakes in financial year 2011. This falls to the account of IAG s reinsurers, with no earnings impact to IAG. Following this increase in earthquake reserves, IAG has utilised approximately 10% of the NZ$600 million adverse development cover in excess of NZ$4.4 billion on the February 2011 event. 5
C. ASIA IAG has a presence in five Asian markets: consolidated businesses in Thailand, Vietnam and Indonesia and investment in associates in Malaysia and India. I. Divisional result The division contributed a total profit of $15 million, including shares of associates and allocated costs compared to the corresponding half year profit of $2 million. The improved result reflects the combination of: the absence of large commercial losses in Thailand following reduced exposure to selected segments of this book; the favourable impact of effective portfolio management in Malaysia, along with higher prior period reserve releases; improved profits in India owing to better risk selection following portfolio remediation, a favourable one-off reinsurance effect and the influence of a relatively benign monsoon season; and lower regional support and development costs. As part of its overall Asia strategy, IAG has expressed a strong interest in growth via market consolidation and increased ownership. IAG s current assessment is that such opportunities are limited, resulting in the decision to conduct a strategic review of the options available for its Asian businesses (refer to Note 2.9). This review is expected to be concluded by the end of calendar 2018. II. Controlled entities GWP from the Group's controlled entities was $185 million, which was an increase of 2% on the corresponding half year GWP of $182 million, within this: the Thai business (Safety Insurance) reported a GWP increase of 2.3% to $177 million in the current half year compared to $173 million in the corresponding half year. The increase was mainly driven by a strong recovery in motor, as price competition subsided and market conditions improved, resulting in local currency GWP growth of over 6%, and lower commercial volumes following a planned reduction in exposure to selected segments; AAA Assurance in Vietnam recorded GWP equivalent to $7 million ( 2016: $8 million); and Parolamas in Indonesia, recorded GWP of less than $1 million ( 2016: $1 million). During the current half year, the controlled entities reported an insurance profit of $1 million ( 2016: loss of $2 million) excluding allocated regional development costs. Within this: the Thai business reported an improved insurance profit of $5 million compared to breakeven result at the insurance profit line in the corresponding half year, derived from a relative absence of large losses and prior period reserve strengthening following remediation actions undertaken in the commercial book, partially offset by higher flood claims from a prolonged rainy season and a further regulatory-led increase in compulsory motor claim limits, with no commensurate premium increase; AAA Assurance reported an insurance loss of $1 million compared to a breakeven result at the insurance profit line in the corresponding half year; and Parolamas in Indonesia contributed an insurance loss of $3 million compared to a loss of $2 million in the corresponding half year. III. Share of net profit/(loss) of associates The Group's share of net profit of associates was a profit of $24 million ( 2016: $16 million), excluding allocated regional development costs and before amortisation. This result includes AmGeneral Holdings Berhad (AmGeneral) in Malaysia and SBI General Insurance Company Limited (SBI General) in India. IAG s share of AmGeneral's profit for the current half year increased to $13 million ( 2016: $10 million). The positive outcome comprised the net effect of: effective pricing actions and portfolio management, supplemented by higher prior period reserve releases; partially offset by reduced net earned premium on the back of a reduction in average premiums for motor insurance and lower growth; and additional marketing spend on detariffication-related initiatives. IAG s share of SBI General's profit for the half year increased to $11 million ( 2016: $6 million). This positive outcome comprised the net effect of: an improved loss ratio arising from motor portfolio remediation; a relatively benign monsoon season in the current half year; lower investment income due to an unfavourable mark-to-market movement in the technical reserves fund; and a positive one-off effect from the finalisation of a reinsurance treaty for the long-term home portfolio. D. CORPORATE AND OTHER A pre-tax profit of $16 million was reported, which compares to a profit of $18 million in the corresponding half year. Further details on the operating segments are set out in Note 1.3 within the financial statements. 6 INSURANCE AUSTRALIA GROUP LIMITED
REVIEW OF FINANCIAL CONDITION A. FINANCIAL POSITION The total assets of the Group as at 2017 were $29,456 million compared to $29,597 million as at 30 June 2017. Movements within the overall decrease of $141 million include: a decrease in investments of $556 million from the funds outflow associated with the payments of the 2017 final dividend of $473 million, net settlements on the Berkshire Hathaway (BH) quota share partially offset by sound operating earnings for the half year; a decrease in trade and other receivables of $308 million, predominantly driven by a $136 million reduction in premium receivables driven by the NSW CTP regime changes and $212 million due to lower unsettled investment transactions outstanding at 2017; and an increase in deferred insurance expenses of $827 million, predominantly related to recognition of the new whole-of-account quota share reinsurance agreements covering an additional 12.5% of IAG's consolidated business. The total liabilities of the Group as at 2017 were $22,631 million compared with $22,805 million at 30 June 2017. The decrease in liabilities of $174 million is mainly attributable to the net effect of: a decrease in the outstanding claims liability of $423 million primarily due to the prior year releases from Australian long-tail classes, settlement of prior year natural peril claims and New Zealand earthquake claims partially offset by reserves for the Melbourne storm event; a decrease in the unearned premium liability of $179 million, largely due to the effect of lower GWP growth in the period which embraced the impacts from NSW CTP reform measures, ESL collection changes, discontinued business and lower seasonal renewals; and an increase in trade and other payables of $411 million largely reflecting the increase in the net reinsurance payable associated with the new quota share reinsurance agreements. IAG shareholders equity (excluding non-controlling interests) increased from $6,562 million to $6,598 million as at 2017, reflecting the combined effect of: a strong earnings performance in the current half year, resulting in a net profit attributable to shareholders of $551 million; payment of the final dividend of $473 million declared in respect of the 2017 financial year; and a decrease in the reserves of $43 million predominantly due to the foreign exchange movements between the New Zealand and Australian dollars in the first half of the 2018 financial year. B. CASH FROM OPERATIONS The net cash inflows from operating activities for the half year ended 2017 were $23 million compared with $469 million for the corresponding half year. The movement is mainly attributable to the net effect of: a $206 million decrease in reinsurance and other recoveries due to the period-on-period reduction in collection of recoveries pertaining to the 2010 and 2011 Canterbury earthquakes, partially offset by higher recoveries on BH and Group catastrophe reinsurance covers; a $204 million increase in taxes paid due to timing and quantum of the final tax payment for the year ended 30 June 2017; and a $46 million increase in claim costs due to increased claims paid for the Kaikoura earthquake event and short-tail claims offset by decreased payments associated with the 2010 and 2011 Canterbury earthquakes. C. INVESTMENTS The Group s investments totalled $11.6 billion as at 2017, excluding investments held in joint ventures and associates, with 65% represented by the technical reserves portfolio. Total investments at 30 June 2017 were $12.1 billion. The decrease in total investments since 30 June 2017 reflects the combined effect of: a $0.6 billion reduction in technical reserves, in response to further quota share and prior period reserve release effects; and a $0.1 billion increase in shareholders funds, where operating earnings during the period exceeded dividend payments. As at 2017, the Group s overall investment allocation remains conservatively positioned, with 81% of total investments in fixed interest and cash. Technical reserves were 100% invested in fixed interest and cash, while the equivalent figure for shareholders funds was 47%. D. INTEREST-BEARING LIABILITIES The Group s interest-bearing liabilities stood at $1,608 million at 2017, compared to $1,624 million at 30 June 2017. The small net decrease reflects the foreign exchange movement on a NZ$-denominated debt instrument. E. 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 remains 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%. At 2017, the Group s capital mix stood at the lower end of its targeted range, with debt and hybrids representing 31.1% (30 June 2017: 31.9%) of total tangible capitalisation. 7
F. CAPITAL MANAGEMENT The Group remains strongly capitalised under APRA's Prudential Standards, with regulatory capital of $4,722 million at 31 December 2017 (30 June 2017: $4,526 million). The Group has set the following related targeted benchmarks: a total capital position equivalent to 1.4 to 1.6 times the Prescribed Capital Amount (PCA), compared to a regulatory requirement of 1.0 times; and a Common Equity Tier 1 (CET1) target range of 0.9 to 1.1 times the PCA, compared to a regulatory requirement of 0.6 times. At 2017, the Group had a PCA multiple of 1.81 (30 June 2017: 1.70) and a CET1 multiple of 1.19 (30 June 2017: 1.09). STRATEGY AND RISK MANAGEMENT A. STRATEGY At IAG, our purpose is to make your world a safer place: IAG s purpose means that whether you are a customer, partner, employee, shareholder or part of the communities IAG serves across Australia, New Zealand or Asia, IAG exists to make your world a safer place. IAG believes its purpose will enable it to become a more sustainable business over the long term, and deliver stronger and more consistent returns for its shareholders. The IAG strategy is to optimise our core insurance business while creating future growth options. Financial targets IAG is focused on delivering through-the-cycle targets of: cash return on equity (ROE) 1.5x weighted average cost of capital (WACC); a dividend payout of 60-80% of cash earnings; top quartile total shareholder return (TSR); and approximately 10% compound earnings per share (EPS) growth. 8 INSURANCE AUSTRALIA GROUP LIMITED
Strategic priorities IAG has identified three key strategic priorities, supported by organisational capabilities, to deliver the strategy: I. Customer world leading customer experiences: Create a delivery platform that transforms customer experiences. Better connect our customers and automate processes enabling us to reach more customers in a timely manner. Develop an innovation approach which provides the ability to think differently and deliver quickly. Embed cognitive capabilities and artificial intelligence that anticipate customers needs. Use data to power decision making, allowing us to better understand our customers. II. Simplification simplified, modular and lower cost operating model: Reduce organisational complexity by consolidating technology platforms, harmonising products, simplifying processes and systems, and executing the technology strategy. Leverage operational partners to optimise the operating model and drive scale economies across the value chain. Improve allocation and maximise utilisation of the preferred repairer network to reduce average claim size. III. Agility an agile organisation distinguished by innovation, speed and execution skills: Create a disciplined approach to IAG s management and leadership, including building stronger role clarity and introducing agile ways of working. Build a talent pipeline based on the skills required to deliver our strategy and helping our people transition to the future of work. Be recognised as a purpose led organisation that shapes our internal and external environment. B. BUSINESS RISK AND RISK MANAGEMENT IAG acknowledges that it has to take risk in an informed manner in pursuit of its strategic objectives and to meet industry and stakeholder expectations. This means that IAG needs to manage its baseline compliance obligations and beyond that, take risk in a manner that is aligned with customer, shareholder, industry, regulatory and other key stakeholder expectations. IAG uses an enterprise approach to risk and its risk management framework is a core part of the governance structure, which includes internal policies, key management processes and culture. The Group Risk Management Strategy (RMS) is reviewed annually, or as required by the Risk Committee (RC), before being recommended for approval by the Board. IAG s Chief Risk Office function provides regular reports to the RC on the operation of and any changes to IAG s risk management framework, the status of key risks, risk and compliance incidents, risk trends and IAG's risk profile. IAG s Internal Audit function provides reports to the Audit Committee (AC) on significant audit findings and other audit related matters. Roles and responsibilities of the Board and its standing committees, the AC, the RC, the People and Remuneration Committee (PARC) and the Nominations Committee, are set out in the Corporate Governance section of the IAG website. The Group is exposed to multiple risks relating to the conduct of its general insurance business. The risks noted below are not meant to represent an exhaustive list, but outline those risks faced by the Group that have been identified in IAG's Risk Management Strategy: strategic risk the risk of not achieving corporate or strategic goals due to poor decisions regarding future business plans and strategies and/or a lack of responsiveness to changes in the business environment; insurance risk the risk that the Group is exposed to financial loss as a result of inadequate or inappropriate underwriting, inadequate or inappropriate product design and pricing, unforeseen, unknown or unintended liabilities that may eventuate, inadequate or inappropriate claims management including reserving or insurance concentration risk (i.e. by locality, segment or distribution); reinsurance risk the risk of insufficient or inappropriate reinsurance coverage, inadequate underwriting and/or pricing of reinsurance exposures retained by IAG s reinsurance captives, inadequate or inappropriate reinsurance recovery management, reinsurance arrangements that are not legally binding, reinsurance concentration risk and credit counterparty concentration risk to reinsurers; financial risk the risk of inadequate liquidity, adverse movements in market prices (foreign exchange, equities, credit spreads, interest rates, etc) within the investment funds and a counterparty failing to meet its obligations (credit risk); operational risk the risk of loss resulting from inadequate or failed internal processes, systems or from external events; and regulatory risk and compliance the failure or inability to comply with applicable laws, regulations or codes excluding failure of staff to adhere to internal policies/procedures and meeting contractual obligations. A disciplined approach to risk management has been adopted and IAG believes this approach provides the greatest long-term likelihood of being able to meet the objectives of all stakeholders, including policyholders, lenders, regulators and shareholders. Detail of the Group's overall risk management framework, which is outlined in the RMS, is set out in Note 3.1 in the 30 June 2017 Annual Report and in the Corporate Governance Statement, which is available at www.iag.com.au/about-us/corporate-governance. 9
OUTLOOK IAG expects to report further improvement in its underlying performance in the second half of the current financial year. IAG s GWP guidance for the current financial year of low single digit growth remains unchanged. In December 2017, the Group increased its reported margin guidance for the year ended 30 June 2018 from 12.5-14.5% to 13.75-15.75%, to reflect six months impact of the combined 12.5% quota share agreements which commenced on 1 January 2018. Following finalisation of its current half year results, IAG has further upgraded its financial year 2018 reported margin guidance to 15.5-17.5%. This incorporates an increased prior period reserve release expectation and inclusion of the favourable credit spread impact reported in the current half year. Underlying assumptions behind the updated financial year 2018 margin guidance are: net losses from natural perils in line with an allowance of $627 million (2017: $680 million); prior period reserve releases of around 3% of NEP (previously at least 2%); no material movement in foreign exchange rates or investment markets in the second half of the current financial year; and a neutral impact from optimisation program initiatives, as benefits are broadly matched by related implementation costs. DIVIDENDS Details of dividends paid or determined to be paid by the Company and the dividend policy employed by the Group are set out in Note 2.5 within the financial statements. 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 (non-recurring in nature). 2017 2016 CASH EARNINGS $m $m Net profit after tax 551 446 Acquired intangible amortisation and impairment 79 29 630 475 Non-recurring items: Corporate expenses - 4 Tax effect on corporate expenses - - Cash earnings * 630 479 Interim dividend 331 308 Cash payout ratio * 52.5% 64.3% * Cash earnings and cash payout ratio represent non-ifrs financial information. IAG's full year dividend payout policy is to pay dividends equivalent to approximately 60-80% ( 2016: 60-80%) of reported full year cash earnings in respect of any given financial year. The Board has determined to pay a fully franked interim dividend of 14.0 cents per ordinary share (cps) ( 2016: 13.0 cps). The interim dividend is payable on 29 March 2018 to shareholders registered as at 5pm on 21 February 2018. The Company's Dividend Reinvestment Plan (DRP) will operate for the interim dividend by acquiring shares on market with no discount applied. The DRP Issue Price will be based on a volume-weighted average share price as defined in the DRP terms. The last date for receipt of an election notice for participation in the Company's DRP is 22 February 2018. Information about IAG s DRP is available at www.iag.com.au/shareholder centre/dividends/reinvestment. SIGNIFICANT CHANGES IN STATE OF AFFAIRS During the half year, the following changes became effective: Effective 19 July 2017, IAG announced the creation of a single Australian division to be led by Mark Milliner as CEO Australia. The Australian division simplifies IAG s operating model by bringing together the former Australian Consumer, Australian Business, Operations and Satellite divisions. There has been no change to the reportable segments in the current reporting period as financial information was prepared and reviewed by the chief operating decision maker based on the pre-existing segment structure for Australia. On 1 August 2017, IAG consolidated its nine Australian Insurance licences into two licences following Federal Court approval received in July 2017. The consolidation transferred the insurance assets and liabilities of seven entities into a related entity, Insurance Australia Limited, with no impact to the Group s consolidated financial performance or position. Following the transfer, IAG retains two authorised insurers in Australia being Insurance Australia Limited and Insurance Manufacturers of Australia Pty Limited. The transfer is part of IAG s focus on becoming a simpler, more efficient and agile business. On 8 December 2017, IAG announced it had entered into three agreements to quota share a combined 12.5% of its consolidated business from 1 January 2018. The agreements, with Munich Re, Swiss Re and Hannover Re, are on a whole-ofaccount basis, covering IAG s consolidated business in Australia, New Zealand and Thailand and have an initial average period of more than five years. Expected benefits include reduced earnings volatility, reduced reliance on catastrophe reinsurance cover and exposure to future volatility in reinsurance rates, and reduced regulatory capital requirements. 10 INSURANCE AUSTRALIA GROUP LIMITED
EVENTS SUBSEQUENT TO REPORTING DATE Detail of matters subsequent to the end of the half year are set out below and in Note 2.9 within the financial statements. These include announcements made on 14 February 2018 that: The Board determined to pay an interim dividend of 14.0 cents per share, 100% franked. The dividend will be paid on 29 March 2018. The dividend reinvestment plan will operate by acquiring shares on market for participants with no discount applied. The Group will conduct a strategic review of the options available for its Asian businesses. This review is expected to be concluded by the end of calendar 2018. LEAD AUDITOR'S INDEPENDENCE DECLARATION UNDER SECTION 307C OF THE CORPORATIONS ACT 2001 The lead auditor's independence declaration is set out on page 12 and forms part of the Directors' Report for the half year ended 2017. Signed at Sydney this 14th day of February 2018 in accordance with a resolution of the Directors. Peter Harmer Director 11
LEAD AUDITOR'S INDEPENDENCE DECLARATION UNDER SECTION 307C OF THE CORPORATIONS ACT 2001 TO THE DIRECTORS OF INSURANCE AUSTRALIA GROUP LIMITED I declare that, to the best of my knowledge and belief, in relation to the review of Insurance Australia Group Limited for the half year ended 2017 there have been: no contraventions of the auditor independence requirements as set out in the Corporations Act 2001 in relation to the review; and no contraventions of any applicable code of professional conduct in relation to the review. KPMG Andrew Yates Partner Sydney 14 February 2018 12 INSURANCE AUSTRALIA GROUP LIMITED KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. Liability limited by a scheme approved under Professional Standards Legislation.
CONSOLIDATED FINANCIAL STATEMENTS CONTENTS Consolidated statement of comprehensive income 14 Consolidated balance sheet 15 Consolidated statement of changes in equity 16 Consolidated cash flow statement 17 NOTES TO THE FINANCIAL STATEMENTS 1 OVERVIEW 1.1 Introduction 18 1.2 About this report 18 1.3 Segment reporting 19 2 INTERIM DISCLOSURES 2.1 Investments 21 2.2 Interest-bearing liabilities 21 2.3 Notes to the statement of changes in equity 22 2.4 Earnings per share 22 2.5 Dividends 23 2.6 Derivatives 23 2.7 Investment in joint venture and associates 24 2.8 Contingencies 24 2.9 Events subsequent to reporting date 24 2.10 Net tangible assets 24 PAGE 13
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE HALF YEAR ENDED 31 DECEMBER 2017 2017 2016 $m $m Gross earned premium 5,966 5,868 Outwards reinsurance premium expense (1,663) (1,624) Net earned premium (i) 4,303 4,244 Claims expense (4,143) (4,313) Reinsurance and other recoveries revenue 1,552 1,688 Net claims expense (ii) (2,591) (2,625) Commission expense (534) (526) Underwriting expense (920) (912) Reinsurance commission revenue 358 353 Net underwriting expense (iii) (1,096) (1,085) Underwriting profit (i) + (ii) + (iii) 616 534 Investment income on assets backing insurance liabilities 137 46 Investment expenses on assets backing insurance liabilities (10) (9) Insurance profit 743 571 Investment income on shareholders' funds 146 109 Fee and other income 95 107 Share of net profit of associates 18 8 Finance costs (39) (51) Fee-based, corporate and other expenses (180) (141) Net loss attributable to non-controlling interests in unitholders' funds (1) (3) Profit before income tax 782 600 Income tax expense (213) (109) Profit for the period 569 491 OTHER COMPREHENSIVE INCOME/(EXPENSE) Items that may be reclassified subsequently to profit or loss: Net movement in foreign currency translation reserve, net of tax (29) 2 Items that will not be reclassified to profit or loss: Remeasurements of defined benefit plans, net of tax (2) 21 Other comprehensive income, net of tax (31) 23 Total comprehensive income for the period, net of tax 538 514 PROFIT FOR THE PERIOD ATTRIBUTABLE TO Shareholders of the Parent 551 446 Non-controlling interests 18 45 Profit for the period 569 491 TOTAL COMPREHENSIVE INCOME FOR THE PERIOD ATTRIBUTABLE TO Shareholders of the Parent 520 469 Non-controlling interests 18 45 Total comprehensive income for the period, net of tax 538 514 NOTE 2017 2016 cents cents EARNINGS PER SHARE Basic earnings per ordinary share 2.4 23.32 18.61 Diluted earnings per ordinary share 2.4 22.60 17.92 The above consolidated statement of comprehensive income should be read in conjunction with the notes to the financial statements. 14 INSURANCE AUSTRALIA GROUP LIMITED