Financial and operations overview
QBE’s 2015 result demonstrated positive momentum with improved underlying earnings, stable reserving, a very strong capital position, healthy divisional dividend remittances and a 35% uplift in our dividend.
The Group reported a 2015 statutory net profit after tax of $687 million, down 7% from 2014, with a healthy increase in underwriting profit tempered by weaker investment returns and an increase in the effective tax rate.
Cash profit after tax was $893 million, up 9% from the prior period but up by a more impressive 21% on a constant currency basis supporting the 35% uplift in dividends to shareholders.
Cash profit return on equity increased to 8.3%, from 7.7% in 2014.
Book value per share increased 6% to A$10.51 from A$9.91 at the end of 2014 or 10% including dividends paid in 2015.
A number of material items relating to the disposal of businesses were not included in our published 2015 targets or plans and so the profit and loss commentary following refers to the Group’s results adjusted to exclude those items. Details of the nature and impact of these transactions are provided in note 7.1 to the financial statements and on page 13 of this report.
Despite a very competitive insurance pricing environment and volatile investment and currency markets, I am pleased to report that the Group delivered a 1% increase in net profit after tax to $807 million, with lower investment income essentially offset by reduced borrowing and amortisation costs.
Allowing for the significantly stronger US dollar and more reflective of underlying performance, net profit after tax increased 12% on a constant currency basis.
Consistent with last year, I have commented on three broad areas of ongoing focus:
- 1. Driving financial performance
- 2. Investment strategy and performance
- 3. Financial strength and capital management
We have again made good progress in all three areas, but there is still room for improvement.
1. Driving financial performance
We aim to run a tightly controlled business that is stable, predictable and profitable.
Notwithstanding the challenging environment, we are delighted to have achieved our financial targets for the year. Our 94.0% combined operating ratio was at the better end of the 94%-95% target range and our 9.0% insurance profit margin was comfortably within the 8.5%-10.0% target range despite investment yields falling significantly short of expectations after a weaker than budgeted second half return.
Key themes from the 2015 full year result include:
(a) Demonstrating reserving adequacy with three consecutive halves of positive prior accident year claims development
It was pleasing to once again demonstrate reserving adequacy with the 2015 full year result marking our third consecutive half of positive prior accident year development. We recorded net positive prior accident year claims development of $68 million in the second half of 2015, bringing the full year favourable claims development to $147 million or 1.2% of net earned premium.
European and Australian & New Zealand Operations again recorded positive prior accident year development which was partially offset by adverse development in Equator Re and North American Operations.
(b) Reduced volatility through enhanced reinsurance
At the beginning of 2015, we took the decision to significantly reduce potential underwriting volatility by purchasing additional reinsurance. In particular, we acquired a unique large individual risk and catastrophe aggregate reinsurance program designed to limit the cost of these claims to less than 9% of net earned premium under most scenarios. Similarly, we elected to reinsure the majority of our crop hail risk by way of an extensive quota share reinsurance program and expand the quota share reinsurance protecting Equator Re’s net account.
While 2015 proved to be a relatively benign year in terms of catastrophe and crop hail experience, these covers remain in place in 2016 and underpin our confidence that we can achieve our 2016 combined operating ratio target in most large individual risk and catastrophe claim scenarios.
In the same vein, for the 2016 underwriting year we have significantly reduced the tail risk on new business in our Australian mortgage insurance business through a unique reinsurance program. This program is designed to reduce down-side exposure to severe economic events in the 1 in 20 year to 1 in 250 year probability of occurrence range.
(c) Portfolio enhancements
During 2015 we completed a number of non-core asset sales including distribution businesses in Australia and North America, underwriting businesses in Central and Eastern Europe, the workers’ compensation business in Argentina and the Mortgage & Lender Services (M&LS) business in North America. Exiting the workers’ compensation and M&LS businesses in particular will reduce earnings volatility and will be beneficial to both forward earnings and return on invested capital.
(d) Improved crop result
After three years of underwriting losses it is pleasing to report a strong performance by our North American crop insurance business. The crop portfolio produced a combined operating ratio of 83.6% on the back of improved industry conditions including good harvest yields and stable commodity prices. The result also benefited from the implementation of enhanced underwriting analytics to better determine which risks to retain and which to cede to the government reinsurance fund, which resulted in outperformance relative to the industry average.
(e) Improved results in North America and Emerging Markets – both returning to underwriting profit
The result was also pleasing from a qualitative perspective as it included a return to underwriting profitability for North America and Emerging Markets, both of which recorded combined operating ratios of 99.2%. The improved result in North America reflects the culmination of a significant change program including leadership renewal, extensive portfolio remediation and enhanced underwriting practices, a very significant cost-out program and, of course, a better crop result. The improved result in Emerging Markets primarily reflects an improved result in our remaining Argentine business and the early signs of improvement in the Colombian SOAT portfolio.
(f) A few areas require attention
Although perhaps not surprising given the competitive pricing landscape, we were nevertheless disappointed to report an increase in the Group’s underlying attritional claims ratio to 48.1% from 47.0% in the prior period, with a few ‘problem’ areas deteriorating by more than the beneficial impact of portfolio remediation.
The attritional claims ratio in Australia & New Zealand increased appreciably primarily due to a simultaneous increase in both the relative quantum of NSW CTP insurance (which naturally incurs a higher attritional claims ratio relative to other, short-tail classes) and an industry-wide increase in claims frequency during the second half of 2015. We recently filed for a significant rate increase that will become effective from 1 May 2016 which should improve CTP profitability.
North American Operations also experienced an uptick in its attritional claims ratio, largely reflecting an increase in claims frequency in commercial auto classes, broadly consistent with industry trends. We remain optimistic of arresting this trend with a combination of premium rate increases and the cancellation of a number of commercial auto programs.
Underwriting expenses remain a key focus. While we reduced costs by 8% in absolute terms (inclusive of foreign exchange impacts) in 2015 and have delivered cost savings of nearly $400 million since 2012, our expense ratio has deteriorated as a result of reduced net earned premium due to remediation initiatives and increased reinsurance spend. There is much more the Group can do to improve efficiency and, to that end, we have committed to reducing operating expenses by $150 million in 2016, thereby improving the 2016 expense ratio by 1%.
A return to modest premium growth will also assist in this regard.
(g) Strong cash remittances from subsidiaries
Cash remittances from subsidiaries remained strong at $715 million compared with $770 million in 2014 and represented 80% of Group cash profit and dividend coverage (net of DRP) of 2.0x.
Group head office cash flows
2. Investment strategy and performance
The past year was characterised by significant investment market volatility which made for an especially challenging environment for investment returns. Global equities were down 4% and global bonds only returned 0.86%, one of the lowest annual returns in almost two decades.
Against this backdrop, we were pleased to deliver a net investment return of 2.2% which comprised a blended cash and fixed income return slightly less than 2% and an overall blended return of 5.7% from growth assets. Each growth asset segment delivered returns in excess of comparable market benchmarks and overall we succeeded in adding 100 basis points of return above the weighted average market reference rate due to timely duration extensions and our defensive style bias.
Given the likelihood that 2016 will be characterised by heightened macro-economic uncertainty and market volatility, we will be taking a modestly more cautious stance in our investment portfolio, favouring increased exposure to asset classes with greater stability of earnings and performance, such as property and infrastructure, and less exposure to potentially more volatile emerging market debt and equity.
We favour taking advantage of wider prevailing credit spreads to capture additional running yield in our fixed income portfolio and may do so in tandem with modest duration extensions should the level and slope of yield curves reach appropriately attractive levels.
3. Financial strength and capital management
Despite investment market volatility and strong foreign exchange headwinds, we have maintained capital at a very strong level throughout the year. Our multiple of APRA’s prescribed capital amount (PCA) increased to 1.72x at 31 December 2015 from 1.67x a year earlier and, more importantly, our excess over and above S&P’s minimum AA capital requirement further increased.
Given the extent to which our capital position now exceeds S&P’s minimum AA capital requirement, the Board has revised the Group’s benchmark PCA multiple to 1.6x – 1.8x from 1.7x – 1.9x previously, and we remain comfortable with our regulatory capital position at around 1.7x PCA. Consistent with this and commencing with the payment of the 2015 final dividend, the Board has elected (subject to APRA approval) to satisfy the demand for shares under the dividend reinvestment programs by acquiring any shares to be issued under the plans on-market.
Operating and financial performance
Summary income statement
Overview of the 2015 result
The Group reported a 2015 statutory net profit after tax of $687 million, down 7% from $742 million, reflecting a 15% uplift in underwriting profit more than offset by weaker investment returns and a significantly higher effective tax rate.
Excluding amortisation of intangibles and other non-cash items, cash profit for the year was $893 million, up 9% from $821 million in 2014 or up 21% on a constant currency basis.
On 24 February 2015, QBE published the Group’s 2015 target combined operating ratio of 94%-95% and target insurance profit margin of 8.5%-10.0%, both of which were reaffirmed with our interim result on 18 August 2015. To assist comparison of our performance against these targets, the statutory result in the table above has been adjusted to exclude the following material items that were not included in our published 2015 targets or plans:
- the realised gain on sale of $149 million in relation to the Australian and US agency businesses and other non-material disposals;
- the sale of the Argentine workers’ compensation business which completed on 10 August 2015 giving rise to a loss of $58 million, of which $53 million was reclassification of foreign exchange losses from FCTR into profit or loss. In addition, we incurred a $6 million foreign exchange loss on repatriation of funds from Argentina. The financial impact of the sale and the results of this business have been excluded from both the 2014 and 2015 adjusted results above to assist comparability with our targets and to assist year on year comparability; and
- the sale of M&LS to National General which completed on 1 October 2015 and resulted in a $41 million deferred acquisition cost write down and a $92 million loss on sale. Until such time as National General obtains an insurance license, M&LS business will continue to be underwritten by QBE and fully reinsured to National General. While the reinsurance agreement has no profit impact, the impact on premium and claims expense has been excluded from the adjusted result above.
Unless otherwise stated, the profit and loss and underwriting result commentary following refers to the Group’s adjusted results as per the table above.
Net profit after tax increased 1% to $807 million from $801 million in the prior period, with significantly lower investment income essentially offset by reduced interest and amortisation costs.
On a constant currency basis, net profit after tax increased 12%.
Gross written premium decreased 7% to $14,782 million from $15,944 million in the prior period but was up 1% on a constant currency basis.
The Group’s reinsurance expense ratio increased to 16.4% from 12.7% in the prior year, due to the increased cost of the Group’s enhanced large individual risk and catastrophe aggregate protection coupled with the purchase of crop quota share reinsurance, which more than offset premium rate reductions and reduced aggregate exposures.
Net earned premium fell 14% to $12,213 million from $14,210 million or 6% on a constant currency basis reflecting the slight increase in gross writings more than offset by the increase in reinsurance spend and unearned premium.
The Group’s combined operating ratio improved to 94.0% from 94.9% in the prior period, due to a significant improvement in the net claims ratio to 59.8% from 62.7% previously. This was partly offset by an increase in the combined commission and expense ratio to 34.2% from 32.2%, primarily caused by the reduction in net earned premium and the sale of the Australian and US agencies which more than offset a significant reduction in operating costs.
The Group reported an insurance profit of $1,099 million, down 8% from $1,198 million in the prior period, due to significantly lower investment income on technical reserves. Notwithstanding lower investment income, the insurance margin improved to 9.0% compared with 8.4% a year earlier reflecting the stronger underwriting performance.
The net investment yield on technical reserves fell to 2.1% from 2.4%, contributing 3.0% to the insurance profit margin compared with 3.3% in 2014. Period premium held or insurance asset leverage remained relatively stable at around 1.3x.
Investment income on shareholders’ funds declined to $239 million from $252 million in the prior period, reflecting significantly lower fixed income returns due to a widening in credit spreads, partially offset by higher income on growth assets and the non-recurrence of $18 million of prior year losses associated with the repurchase of QBE debt securities.
Although borrowings reduced by only $50 million or 1% since 31 December 2014, interest expense fell 18% to $244 million from $297 million, mainly reflecting the full year benefit of the reduction in borrowings in 2014.
The Group’s income tax expense fell to $186 million from $214 million in the prior period and equated to an effective tax rate of 19% compared with 21% in 2014. This is below the Group’s expected longer term underlying tax rate of 21%-22%, reflecting increased UK profits (where the corporate tax rate is only 20%) and favourable prior year tax adjustments.
Significant items in adjusted 2015 result
The results and financial statements include a number of significant items that should be highlighted.
Realised and unrealised gains on investments increased slightly on the prior year while the remaining significant items tabled below are discussed in the incurred claims section later in this report.
Significant items in adjusted profit before tax
Gross written premium decreased 7% during the year to $14,782 million from $15,944 million in the prior period.
On an average basis and compared with 2014, the Australian dollar and Euro depreciated against the US dollar by 16% and Sterling depreciated by 7%. Coupled with other intra-divisional cross currency movements against the US dollar, foreign exchange movements adversely impacted reported premium income by $1,307 million including a $735 million adverse impact in Australia & New Zealand Operations, $354 million in European Operations and $214 million in Emerging Markets.
On a constant currency basis, gross written premium increased 1% reflecting modest underlying growth in European Operations, Australia & New Zealand Operations and Emerging Markets, largely offset by contraction in North America due to portfolio remediation coupled with the sale of the M&LS business.
The global pricing landscape has become increasingly competitive. Group-wide premium rate reductions averaged around 1.3% across 2015 following a 1.6% reduction in the first half of the year and an increase of 0.1% in the prior corresponding period. This compares with expectations of broadly flat premium rates on average at the beginning of 2015. Premium rates are under pressure globally but especially so in Europe, Australia, New Zealand and increasingly Asia Pacific.
European Operations recorded gross written premium growth of 5% on a constant currency basis, an especially encouraging performance in light of an average premium rate reduction of 3.2% and the fall in the price of commodities and crude oil which adversely impacted insured values and project activity in the International Markets business. Premium growth was underpinned by a material improvement in retention and new business activity, particularly in the Retail business and the successful execution of a number of strategic initiatives across the business.
Despite an average premium rate reduction of 2.4%, Australia & New Zealand Operations recorded gross written premium growth of 3% on a constant currency basis. This represented a significant turnaround from the 1% reduction in gross written premium reported in the first half of 2015. In addition to improved retention, a number of large new business opportunities were finalised in the second half including wholesale broker and bancassurance deals. This growth coupled with strong growth in our traditional commercial markets was partly offset by a 29% contraction in lenders’ mortgage insurance premium income due to regulatory pressure on banks to slow lending and the loss of the Westpac account.
Emerging Markets reported gross written premium growth of 9% on a constant currency basis with growth in Asia Pacific and Latin America of 3% and 13% respectively. Asia Pacific growth slowed appreciably in the second half of the year reflecting reduced demand for commercial insurance in Hong Kong and Singapore as a result of mainland China’s economic slowdown. Asia Pacific growth was also impacted by premium rate reductions averaging 3.4% across the region.
Excluding the now sold M&LS business, gross written premium in our North America Operations fell 4%, largely due to standard commercial lines where, in addition to an increasingly competitive rate environment, volumes were impacted by corrective underwriting actions including the termination of underperforming programs. Crop premium also fell 7% as a result of lower commodity prices. Conversely, especially strong growth was achieved in Specialty as we continue to launch new products while the consumer business continues to grow on the back of the housing market recovery.
Gross earned premium fell 10% during the year to $14,606 million from $16,285 million in the prior period. On a constant currency basis and excluding the impact of the sale of the M&LS business, gross earned premium increased nearly 1% and broadly in-line with gross written premium growth.
The Group’s reinsurance expense ratio increased to 16.4% from 12.7% in the prior year, primarily due to the $289 million incremental cost of the Group’s enhanced large individual risk and catastrophe aggregate protection coupled with the crop quota share reinsurance, which more than offset premium rate reductions and reduced aggregate exposures.
Net earned premium fell 14% to $12,213 million from $14,210 million, or 6% on a constant currency basis, reflecting the slight increase in gross writings more than offset by the increase in reinsurance spend.
Key ratios – Group
Contributions by region
The Group’s combined operating ratio improved to 94.0% from 94.9% in the prior year reflecting a significant improvement in the net claims ratio which more than offset an increase in the combined commission and expense ratio due to reduced net earned premium.
The following table provides a summary of the major components of the 2015 net claims ratio on a statutory and adjusted basis. To assist comparability, the 2014 adjusted numbers also exclude the one-off impact of the medical malpractice reinsurance transaction.
Analysis of net claims ratio
QBE has historically provided an analysis of the Group’s underlying current accident year attritional claims ratio excluding various influences that distort the apparent year-on-year movement in the reported attritional claims ratio.
Excluding US crop, the recently sold M&LS business and the incremental cost of the Group’s enhanced aggregate reinsurance protection, the Group’s underlying attritional claims ratio deteriorated from 47.0% to 48.1% reflecting:
- overall premium rate movements lagging claims inflation more broadly;
- a change in divisional business mix, principally a contraction in Equator Re’s contribution to Group net earned premium, which adversely impacted the Group’s attritional claims ratio by 0.3%;
- a deterioration in North America, mainly within standard lines reflecting pricing pressure and an industry-wide increase in severity trends in commercial auto lines, which adversely impacted the Group’s attritional claims ratio by 0.5%;
- a deterioration in Australia, largely due to increased frequency within the NSW CTP portfolio and exacerbated by the weaker Australian dollar, which adversely impacted the Group’s attritional claims ratio by 1.3%; partly offset by
- an improvement in Europe, primarily due to portfolio remediation initiatives and improved claims management practices which more than offset premium rate pressure and improved the Group’s attritional claims ratio by 0.8%.
The following table provides an analysis of the year-on-year movement in the adjusted attritional claims ratio.
Analysis of adjusted attritional claims ratio
The total net cost of large individual risk and catastrophe claims fell to $1,067 million or 8.7% of net earned premium compared with $1,351 million or 9.5% in the prior period.
Although the gross cost of large individual risk and catastrophe claims before aggregate reinsurance recoveries was broadly in line with the prior period, the net cost fell significantly due to material recoveries under the Group’s enhanced large individual risk and catastrophe aggregate reinsurance protection.
The weighted average risk-free rate (excluding the Argentine peso) used to discount net outstanding claims liabilities increased slightly from 1.45% to 1.62%, primarily due to higher US and sterling risk-free rates while Australian risk-free rates fell. This gave rise to a positive underwriting impact of $38 million (including a $45 million benefit in the first half) that reduced the net claims ratio by 0.3%, compared with a charge of $324 million in the prior period which increased the 2014 net claims ratio by 2.3%.
The 2015 result included $147 million of positive prior accident year claims development which benefited the claims ratio by 1.2%, similar to the $152 million of favourable development (excluding Argentine workers’ compensation) experienced in 2014. Encouragingly, the $68 million of positive prior accident year claims development in the second half of 2015 marks the third consecutive half of development, following $79 million of favourable development in the first half of 2015 and $149 million in the second half of 2014.
The Group’s overall positive prior accident year claims development of $147 million mainly comprised:
- QBE’s European Operations experienced particularly strong positive prior accident year development of $254 million, up from $158 million in 2014, with favourable development occurring broadly across most portfolios;
- Australian & New Zealand Operations enjoyed $120 million of positive development, up slightly from $114 million in the prior corresponding period, reflecting continued favourable trends in wage inflation and claims frequency;
- North American Operations recognised $85 million of adverse development, up from $41 million in 2014, largely reflecting industry-wide development on commercial auto classes coupled with development on 2014 weather events in the consumer and agri portfolios; and
- Equator Re experienced $120 million of adverse development, up from $28 million in the prior year, reflecting adverse development from the Brisbane storms in December 2014, adverse development on various casualty covers and a $53 million reduction in assumed aggregate risk reinsurance recoveries due to claims falling below the (US dollar denominated) program attachment point, primarily as a result of foreign exchange movements.
The 2015 result also included a $19 million risk margin release which reduced the net claims ratio by 0.2% compared with a $184 million risk margin release in the prior year. Equator Re benefited from a risk margin release which was essentially offset by a modest net risk margin strengthening in North America.
Material large individual risk and catastrophe claims reported during the year are summarised in the table below.
Large individual risk and catastrophe claims
Commission and expenses
The Group’s combined commission and expense ratio increased to 34.2% from 32.2% in the prior corresponding period.
Numerous factors contributed to this increase including a 1.3% impact from increased reinsurance expenditure (0.8% due to the enhanced aggregate reinsurance and 0.5% due to the crop quota share), 0.2% due to the sale of the Australian and US agency businesses and 0.2% due to changes in divisional net earned premium mix.
The commission ratio increased to 17.3% from 16.5% in the prior period, primarily reflecting a 0.6% adverse impact from the sale of the Australian and US agency businesses and a 0.6% impact from increased reinsurance expenditure (0.4% due to the enhanced aggregate reinsurance and 0.2% due to the crop quota share), partly offset by a minor, largely business mix related reduction in the underlying commission ratios in all divisions except Equator Re.
Despite delivering an additional $126 million of operational transformation efficiencies and benefiting from $105 million reduction in implementation costs (to nil in 2015), the Group’s expense ratio increased to 16.9% from 15.7% a year earlier. This was primarily due to a 1.5% adverse impact from lower net earned premium, including a 0.7% impact from increased reinsurance expenditure and 0.8% attributed to generally lower gross writings consistent with the more competitive 1 premium pricing landscape. The expense ratio was also adversely impacted by ongoing investment in systems and growth initiatives including Emerging Markets (0.9%) as well as the reduction in M&LS fee income (0.3%).
Income tax expense
The Group’s statutory income tax expense of $260 million compared with $182 million in the prior period and equated to an effective tax rate of 27% compared with 20% in the prior period. The significant increase in the effective tax rate is principally due to the derecognition of deferred tax assets in Australia and Europe following a change in the outlook for 2 their recoverability.
QBE paid $347 million in corporate income tax to tax authorities globally in the year to 31 December 2015, including $173 million in Australia. Income tax payments in Australia benefit our dividend franking account, the balance of which stood at A$391 million as at 31 December 2015. The Group is therefore capable of fully franking A$913 million of dividends.
The combination of a higher payout ratio and increased profitability of non-Australian operations is anticipated to reduce the franking account balance and shareholders should therefore expect the franking percentage to reduce to around 50% in 2016 and 2017.
As a significant proportion of our underwriting activity is denominated in US dollars, the Group’s financial statements are presented in this currency. Assets and liabilities of all our foreign operations that have a functional currency different from the Group’s presentation currency are translated to US dollars at the closing balance date rates of exchange and income and expenses are translated at the cumulative average rates of exchange for the period.
Key exchange rates used in the preparation of the financial statements are set out in note 1 to the financial statements.
During 2015, the US dollar strengthened against all of the Group’s major currencies.
As at 31 December 2015, the Australian dollar, Euro and Sterling had depreciated 11%, 10% and 5% respectively against the US dollar compared with closing rates at 31 December 2014. On an average basis, the Australian dollar, Euro and Sterling depreciated by 16%, 16% and 7% respectively against the US dollar relative to the prior period.
The impact of exchange rate movements on the 2015 result was an operational foreign exchange loss of $20 million compared with a $17 million gain in the prior period.
The table below shows the impact of foreign exchange on the 2015 result and balance sheet on a constant currency basis.
Impact of exchange rate movements
Capital management summary
Consistent with a significantly strengthened capital position, during 2015 the major ratings agencies, Standard & Poor’s, A.M.Best and Fitch, reaffirmed the Group’s financial strength and issuer credit ratings and revised the Group’s outlook from “negative” to “stable” with Standard & Poor’s referring to QBE Group’s capital adequacy as being “at the AA level”.
Moreover, Moody's Investors Service recently upgraded QBE Insurance Group Limited's senior unsecured debt and long-term issuer ratings to Baa1 from Baa2.
Other than senior debt refinancing by way of capital qualifying tier 2 debt issuance as discussed overleaf, no new capital management initiatives were undertaken or deemed necessary in the current period.
At 31 December 2015, the Group’s indicative APRA PCA multiple was 1.72x, up from 1.67x a year earlier and our excess over and above S&P’s minimum AA capital requirement further increased.
Significant retained profit growth during the year, coupled with the beneficial capital impact from the sale of the Argentine workers’ compensation, M&LS and agency businesses, were partly offset by the impact of the weaker Australian dollar and a $463 million gross increase in the asset risk charge. This followed an increase in the exposure to growth assets to 11.9% (excluding 1.1% index derivative overlay) of the total cash and investments portfolio from 8.9% at 31 December 2014.
Excluding the impact of the weaker Australian dollar, the indicative APRA PCA multiple would have been around 1.80x.
In light of the extent to which our capital position now exceeds S&P’s minimum AA capital requirement, we remain comfortable with our regulatory capital position at around 1.7x PCA.
Key financial strength ratios
As at 31 December 2015, the Group’s total borrowings stood at $3,529 million, down a modest $52 million or 1.4% from $3,581 million a year earlier.
Group Treasury was active in the capital markets during the year executing the following transactions:
- repayment of GBP 300 million of senior debt that matured on 28 September 2015;
- issuance of AUD 200 million of 25 year non call 5 tier 2 subordinated debt securities due 29 September 2040; and
- issuance of USD 300 million of 30 year non call 10 tier 2 subordinated debt securities due 12 November 2045.
At 31 December 2015, QBE’s ratio of borrowings to shareholders’ funds was 33.6%, up marginally from 32.5% a year earlier but within our benchmark range of 25%-35%. Gearing would have reduced to around 30.8% except for the adverse impact of the stronger US dollar on closing equity. Debt to tangible equity was 51.1%, up marginally from 49.7% at 31 December 2014, also adversely impacted by the stronger US dollar.
Interest expense for the year was $244 million, down 18% from $297 million for the same period last year. The weighted average annual cost of borrowings outstanding at the balance sheet date was unchanged from the prior year at 6.2%.
Debt issuance in 2015 was undertaken by way of capital qualifying tier 2 subordinated debt. In addition to achieving a modest absolute reduction in the level of the Group’s borrowings, the weighting towards capital qualifying tier 2 within the Group’s overall borrowing mix increased to 74% at 31 December 2015 from 61% at 31 December 2014, with incremental duration being built in to the term structure.
Consistent with the prior year, the Group did not incur any regulatory capital decay on any of its outstanding tier 2 subordinated debt during 2015. During 2016, $1,478 million of the Group’s tier 2 subordinated debt will be subject to regulatory capital amortisation resulting in an estimated $240 million of amortisation.
In 2016, QBE’s regulatory or ratings agency capital position is not expected to be impacted by the amortisation reflecting the Group’s current excess tier 2 capital position.
The table below summarises our provisions for outstanding claims and unearned premium, separately identifying the central estimate and risk margin.
As required by Australian Accounting Standards, insurance liabilities are discounted by applying sovereign bond rates as a proxy for risk-free interest rates and not the actual earning rate on our investments.
As at 31 December 2015, risk margins in net outstanding claims fell 7% to $1,260 million from $1,353 million at 31 December 2014. Risk margins reduced by $93 million during the period reflecting a risk margin release of $19 million and a $74 million foreign exchange impact. As the net discounted central estimate fell by a proportionally larger 9% from $15,595 million to $14,119 million, risk margins increased to 8.9% of the net discounted central estimate from 8.7% at 31 December 2014.
Since 31 December 2014, the probability of adequacy increased by 0.3% to 89.0%, mainly due to the increase in the margin above central estimate outlined above, partially offset by an increase in the Group coefficient of variation (CoV). The increase in the CoV largely reflects a lower level of short tail claims (in particular crop) as a proportion of net outstanding claims liabilities at 31 December 2015.
The probability of adequacy of total insurance liabilities was 91.8% compared with 94.7% at 31 December 2014, with the level of risk margins deemed appropriate to cover the inherent uncertainty in the net discounted central estimate.
As at 31 December 2015, the carrying value of intangible assets (identifiable intangibles and goodwill) was $3,604 million, down 6% from $3,831 million at 31 December 2014 and down 20% from $4,480 million at 31 December 2013.
During the year, the carrying value of intangibles reduced by $227 million primarily due to a $217 million foreign exchange impact. Additions and reclassifications of $144 million during the period were more than offset by $33 million of intangibles disposed of through the sale of the M&LS business and a charge for amortisation and impairment of $121 million, of which $26 million was charged to the underwriting result relating to assets supporting the Group’s underwriting activities.
At 31 December 2015, QBE reviewed all material intangibles for indicators of impairment, consistent with the Group’s policy and the requirements of the relevant accounting standard.
The updated valuation of goodwill in North American Operations indicated that the headroom (being the excess of recoverable value over carrying value) at the balance date increased slightly to $196 million compared with $158 million at 31 December 2014. The valuation remains highly sensitive to a range of assumptions, in particular, the forecast combined operating ratio used in the terminal value calculation and changes in the discount rate and long-term investment return assumptions.
Details of the sensitivities associated with this valuation are included in note 7.2.1 to the financial statements.
Reconciliation of movement in intangible assets
Investment performance and strategy
A range of geo-political, financial and policy events combined to create significant market volatility and a challenging environment for investment returns during the year. Despite these events, the investment portfolio generated an overall investment return of 2.2% net of expenses.
Despite significant intra-period volatility, bond yields finished the year relatively unchanged with monetary policy for major central banks remaining extremely accommodative. Throughout the year we took advantage of volatility in global bond markets, actively moving duration to enhance fixed income returns. The modified asset duration ended the year at 0.9 years, up from 0.6 years at 31 December 2014. We will continue to monitor yield curve expectations for opportunities to sensibly extend duration in line with our commitment to having the duration of our assets more closely match the duration of our liabilities.
To combat low bond yields, the diversification of our fixed income portfolio continued with exposure to infrastructure debt and structured credit increased. These holdings performed very well, helping to cushion the portfolio against mark-tomarket losses on our corporate bond holdings caused by wider credit spreads. Investment grade credit underperformed sovereign debt as the market digested large amounts of supply prior to the US Federal Reserve’s rate increase. Higher corporate leverage and the risk of a spill over of defaults from the energy sector remain headwinds for credit; however, the credit quality of the portfolio remains conservative relative to our global peers and retains a focus on sector and individual corporate name selection where balance sheets are strong.
Growth assets experienced a volatile year resulting in return shortfalls against expectations across all asset classes with the exception of unlisted property. Notwithstanding this, all of our asset class exposures delivered a return exceeding their comparable market indices. Moreover, growth assets generated an overall blended return of 5.7% which was well ahead of the blended cash and fixed income return of slightly less than 2%. Throughout the year we successfully employed tactical asset allocation changes to take advantage of mispricing in markets and relative value between asset classes.
We expect that global policy divergence will continue to manifest in market volatility in 2016 and therefore our maximum exposure to growth assets will remain below 15%.
Total net investment income
Gross and net investment yield
Total investments and cash
Interest bearing financial assets
Our dividend policy is designed to ensure that we reward shareholders relative to cash profit and maintain sufficient capital for future investment and growth of the business.
The final dividend for 2015 will be 30 Australian cents per share. Combined with the 2015 interim dividend of 20 Australian cents per share, the total dividend for 2015 will be 50 Australian cents, up 35% compared with the 2014 dividend of 37 Australian cents per share.
The dividend will be franked at 100% and is due to be paid on 14 April 2016. The dividend reinvestment programs continue at a nil discount.
The payout for the 2015 full year is A$685 million or around 56% of cash profit calculated by converting cash profit to Australian dollars at the closing rate of exchange. The calculation of cash profit is shown on page 14.
As announced in conjunction with the release of the Group’s 2015 interim result, the Board has increased the maximum dividend payout ratio to 65% of cash profits, up from the current maximum of 50%, commencing with the 2016 interim dividend.
Moreover and commencing with the payout of the 2015 final dividend, the Board has elected (subject to APRA approval) to satisfy the demand for shares under the dividend reinvestment programs by acquiring any shares to be issued under the plans on-market.
QBE’s 2015 result showed positive momentum with improved underlying earnings, stable reserving, a very strong capital position, healthy divisional dividend remittances and a 35% uplift in our dividend.
While we have made good progress over the past 12 months, there is still room for improvement.
Our priorities for 2016 remain similar to those we have delivered against in 2015, namely:
- deliver earnings and reserve stability and predictability;
- reduce operating expenses by $150 million thereby reducing the 2016 expense ratio by 1%;
- achieve modest organic growth in the business;
- reflecting the above items, achieve a meaningful improvement in our expense ratio;
- maintain strong divisional dividend remittances – again greater than $700 million;
- maintain a strong capital position consistent with an S&P AA level of capital; and
- strongly grow the dividend to our shareholders.
Group Chief Financial Officer