Chief
Financial
Officer's
Review
We expect the quota share arrangement will reduce our regulatory capital requirement by approximately $700 million over the next five years, with around $400 million of that reduction to be realised by the end of the 2016 financial year.
Strengthening our balance sheet for the future
The financial strength of our business is a key factor in our ability to deliver on our Purpose, to help make your world a safer place. In managing this financial strength, we regularly look for ways to increase our capital efficiency. This year, two initiatives have allowed us to significantly strengthen our balance sheet.
CTP quota share and adverse development cover
Last year, we entered into a reinsurance agreement called a quota share to cover 30% of Personal Insurance divisions combined compulsory third party (CTP) book for a minimum three-year period. From 1 July 2014, we supplemented this agreement with an adverse development cover for the CTP portfolio which gives the Group additional protection against adverse CTP claims development. The combined impact of these two items gave us $150 million of regulatory capital relief.
Future stability of income stream
In June 2015, we entered into a strategic relationship with Berkshire Hathaway that further transforms a number of areas of our financial structure, including earnings volatility, reinsurance and capital position.
A key element of the relationship is a 10-year quota share arrangement that came into effect on 1 July 2015. Under the arrangement, Berkshire Hathaway receives 20% of IAG’s consolidated GWP and pays 20% of claims. Berkshire Hathaway will also reimburse IAG for its share of operating costs and pay a percentage-based fee, or exchange commission, which recognises the value of our strong core franchise.
Because 20% of our business will be covered by Berkshire Hathaway, we can reduce our exposure to the highly concentrated insurance risk centres of Australia and New Zealand. This lowers our future catastrophe reinsurance needs, and our exposure to potential volatility in reinsurance rates.
We expect the quota share arrangement will also reduce our regulatory capital requirement by approximately $700 million over the next five years, with around $400 million of that reduction to be realised by the end of the 2016 financial year.
The financial impact of this arrangement is a less volatile earnings profile as we lock in a more stable income stream for a portion of our business.
To further demonstrate the strength and depth of our relationship, Berkshire Hathaway acquired just under 90 million shares for a total consideration of $500 million. It will at least maintain this initial shareholding for the term of the quota share arrangement and, under a standstill agreement, cannot increase its shareholding in IAG above 14.9% for the period of the partnership agreement.
We also have an option to place up to a further 5% of IAG’s expanded issued capital to Berkshire Hathaway within 24 months of 16 June 2015.
Capital
Our capital position is significantly strengthened by the $500 million share placement and the estimated reduction in capital requirement of $700 million over time from the quota share arrangement. This provides the Group with greater flexibility to manage capital in the future, including pursuing growth opportunities in Asia.
The Group remains strongly capitalised under APRA’s Life and General Insurance Capital regime. At 30 June 2015, our Prescribed Capital Amount (PCA) multiple was 1.7, compared to the Group’s long-term benchmark of 1.4 – 1.6, and our Common Equity Tier 1 ratio was 1.14, compared to our target range of 0.9 – 1.1 times the PCA.
