Chief Financial
Officer’s
Review

While insurance is inherently volatile, we have strengthened our balance sheet to reduce earnings volatility and provide certainty for our customers that IAG can deliver on the promises we make to them.

Our stronger balance sheet is the result of our innovative way of funding, which sources funds from equity, debt and reinsurance markets.

The reinsurance includes both traditional reinsurance, together with more innovative structures such as the quota share arrangements we have established with Munich Re and Berkshire Hathaway. Our arrangement with Munich Re began on 1 July 2013, and covers 30% of our CTP insurance book. Our agreement with Berkshire Hathaway is much larger, covering a 20% whole-of-account quota share arrangement. It began on 1 July 2015 and will run for a minimum term of 10 years.

In this first year of its operation, the Berkshire Hathaway agreement has:

• reduced our earnings volatility, as we exchanged a portion of our insurance risk for a fee from Berkshire Hathaway to access our strong core businesses;
• enhanced our underlying margin by approximately 250 basis points;
• lowered our regulatory capital requirement by around $400 million; and
• promoted new and complementary business opportunities.

INCREASED RETURNS TO SHAREHOLDERS

Because the quota share arrangements replace a portion of our underwriting earnings with a recurring fee income stream, they contribute to the certainty of our earnings profile, which in turn reduces the volatility in our dividend.

This year, the strength of our balance sheet has allowed us to increase our dividend payment policy from 50–70%, to 60–80% of cash earnings.

The Berkshire Hathaway quota share arrangement has also reduced our regulatory capital requirement by approximately $400 million over the last 12 months, enabling us to return capital to shareholders and retain sufficient funds to invest in the business, notably in potential growth through mergers and acquisitions in Asia.

In March 2016, we paid a special dividend of 10 cents per share and we are now returning additional capital to shareholders in the form of an off-market buy-back to the value of around $300 million which we expect will improve IAG’s future earnings per share and return on equity. The buy-back is open to all Australian and New Zealand resident shareholders registered at 7.00pm on 25 August 2016 and is expected to be completed in mid-October 2016.

DIVERSIFIED CAPITAL TO MATCH OUR OPERATIONS

We operate in multiple jurisdictions and diversify our capital to match our geographical exposures. This year, we raised NZ$350 million in New Zealand, part of which was used to redeem a portion of an existing New Zealand debt, as holders accepted an offer to reinvest in the new convertible note instrument.

CAPITALISED SOFTWARE ACCELERATED AMORTISATION AND IMPAIRMENT

In this year’s statutory accounts, IAG has recognised a non-cash, pre-tax charge of $198 million for the accelerated amortisation and impairment of capitalised software. Further detail about the charge is set out in note 5 in the 2016 annual report.

The amortisation and impairment charge is included in the net corporate expense line for management reporting purposes. Given its non-cash and non-recurring nature, the charge has been excluded from cash earnings for determination of the dividend, however it was included in cash ROE for the determination of executives’ long term incentive outcomes. This charge had no impact on our capital position.

CAPITAL STRENGTH

IAG’s capital position remains strong, at 1.72 times the Prescribed Capital Amount (PCA) at 30 June 2016, which is above the Group’s targeted range of 1.4–1.6 times. The Common Equity Tier 1 (CET1) ratio stood at 1.06 at 30 June 2016, against a target benchmark of 0.9–1.1.

Nick Hawkins
Chief Financial Officer