Transitioning to profitable growth
In 2015 we successfully balanced further improvement in short term performance with investment for the future. As we move into 2016 and look to the future, we are confident our strategy will deliver profitable growth, allowing us to increase earnings anddividends over time.
We faced a number of headwinds during 2015, including challenging markets for both insurance pricing and investments, the significantly weaker Australian dollar and continued low interest rate environment. Despite these headwinds, we are pleased to have produced an adjusted underwriting result at the better end of our target range and an insurance profit margin towards the middle of our target range.
Our strategy of rationalising the business to focus on our strengths has further improved performance by removing the drag from underperforming and non-core businesses. We have continued our emphasis on underwriting and claims excellence, recording our best combined operating ratio since 2010. Importantly, during 2015 we also invested heavily in infrastructure, technology and our people, creating a stable platform for continued success.
As we move forward, our strategy will allow us to grow in those areas where market opportunities exist and where we know we can lead. By doing so, we believe we can provide our customers with a service unrivalled in the market.
As we transition from a period of business remediation and refocus on profitable growth, it is timely to remind ourselves of what we believe is QBE’s purpose – to give people the confidence to achieve their ambitions. That means understanding the needs of our many stakeholders – our customers, our investors as well as our own people – and providing products and services that fulfil these needs. Our refreshed vision captures how we will achieve that – by being “the insurer that builds the strongest partnerships with customers”.
This vision will drive our strategy of customer-centric growth and operational excellence through a series of initiatives which will help us deliver medium and long term growth and efficiency.
Importantly, we also need to deliver on our short term promises and that means delivering on our 2016 plan. Consequently, our business plan for the coming year takes into account market opportunities and challenges, as well as our own short, medium and long term aspirations.
In 2016, an unwavering focus on five clear priorities will ensure we execute on our published near term targets as well as investing to achieve improved performance and profitability over the medium to longer term.
- 1. Performance management. Through 2014 and 2015 we demonstrated underwriting discipline. We anticipate 2016 will be a more challenging underwriting year than 2015 and accordingly, have further improved the rigour of our business plan review and remediation activities to ensure our performance objectives are met.
- 2. North American Operations. We will continue to refocus as a specialist insurer and reinsurer in this important market, integrating and streamlining our operations to lower our expense ratio and further improve profitability.
- 3. Profitable growth. We are investing $150 million in products and territories where we believe profitable growth opportunities exist. As one of the few truly global non-life insurers, we will use our geographic footprint, our extensive range of products and services and the quality of our people, to drive an attractive organic growth trajectory.
- 4. Cost management. We are targeting a reduction in operating expenses of $150 million in 2016 that will result in a 1% improvement in our 2016 expense ratio. Moreover, we are developing plans to eliminate a further $150 million of costs in 2017–18, thereby improving our expense ratio by 2% over the three years to 2018. Excluding asset sales, this is expected to result in a total reduction in the Group’s gross operating expenses of approximately $700 million over the six year period to 2018.
- 5. Claims transformation. We are making substantial investments in our claims management systems to improve the cost of claims indemnity and reduce the cost of managing claims, while simultaneously improving our customer service capabilities. These actions are intended to assist in maintaining a stable attritional claims ratio despite an expectation of further modest premium rate softening.
QBE is known for strong underwriting discipline and robust capital management. With a renewed focus on our customers, our strategic initiatives will drive further profitable growth, while at the same time delivering excellent products and services to our customers and their brokers globally.
Excluding the sold Argentine workers’ compensation business and the one-off impact of other non-core asset sales, our adjusted profit increased 1% to $807 million, or up 12% on a constant currency basis. This was despite substantially lower investment returns and reflected improved underwriting profitability.
Cash profit was $893 million, up 9% from $821 million in the prior period, or up 21% on a constant currency basis.
Cash profit return on equity increased to 8.3% from 7.7% a year earlier.
Our adjusted combined operating ratio of 94.0% is at the better end of the 94.0% – 95.0% target range we set at the beginning of 2015 and represents the Group’s best underwriting performance since 2010.
During the past 24 months, and most notably in 2015, we have:
- executed a series of remediation initiatives that have substantially improved the quality of our underwriting account;
- restructured and considerably strengthened the quality of our balance sheet, a fact acknowledged by the major rating agencies in assessing our capital strength;
- returned our North American Operations to underwriting profit;
- created a rhythm of operational excellence throughout our business with significant cost reductions achieved and more to follow;
- attracted high quality talent to our executive, underwriting and business function teams;
- strengthened our reinsurance programs with a focus on reducing volatility in our profit and loss account (notably from large individual risk and catastrophe claims activity); and
- returned the Group to earnings stability and predictability.
Our 2015 adjusted result included $147 million of positive prior accident year claims development. We remain disciplined with robust reserving controls and claims management practices, a fact reflected in the Group reporting its third consecutive half year of positive prior accident year claims development.
Financial strength and flexibility
In 2015, we completed the final elements of our comprehensive capital plan which further strengthened our already robust capital ratios. This resulted in the key credit rating agencies affirming our strong financial security ratings and deeming our capital position to be “stable” while Moody’s upgraded QBE’s senior unsecured debt and long-term issuer ratings to Baa1 from Baa2. Significantly, Standard & Poor’s referred to QBE’s capital adequacy as being “at the AA level”.
More specifically, during 2015 we:
- completed the sale of our workers’ compensation business in Argentina and our Mortgage & Lender Services business in North America;
- replaced £300 million of senior debt with $300 million and A$200 million of capital-qualifying tier 2 subordinated debt;
- placed an innovative aggregate reinsurance program (for both 2015 and 2016) designed to limit the cost of large individual risk and catastrophe claims to less than 9% of net earned premium under most scenarios;
- purchased quota-share reinsurance and commodity-price derivatives to supplement the existing stop-loss reinsurance arrangements for our North American crop business; and
- reduced tail risk on new business in our highly profitable Australian lenders’ mortgage insurer with a unique reinsurance program designed to substantially reduce down-side exposure to economic events in the 1 in 20 year to 1 in 250 year probability of occurrence.
Coupled with retained profit growth, the above initiatives have seen the Group’s debt to equity ratio stabilise at 33.6% and reserving probability of adequacy increase to 89.0%. Coverage of APRA’s prescribed capital amount (PCA) increased to 1.72x (the highest level since 2010) with a further increase in our excess over and above S&P’s minimum AA capital requirement.
We remain very comfortable with our regulatory capital position.
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 reflecting:
- excluding the now sold Mortgage & Lender Services, North American Operations’ gross written premium was $4,578 million, down 4% from the prior period but in line with half year expectations. Encouragingly, we continue to see strong growth in the consumer business within Standard Lines which grew by 11% and our Specialty Lines business grew by a further 32%, consistent with plan;
- despite competitive market headwinds and the impact of the dramatic fall in commodity prices, European Operations reported encouraging growth of 5%;
- Australian & New Zealand Operations grew by 3% underpinned by pleasing growth in our traditional commercial lines portfolio; and
- our profitable growth strategy contributed to 9% growth in Emerging Markets, including 3% growth in Asia Pacific and 13% growth in Latin America.
Gross written premium of $14,782 million and net earned premium of $12,213 million fell slightly short of our gross written and net earned premium targets of $15.2 billion – $15.6 billion and $12.3 billion – $12.7 billion respectively. This was due to a combination of adverse currency movements, a second half slowdown in Asia on the back of Chinese economic deceleration, further remediation in North America, particularly in commercial motor, and a larger than expected industry-wide reduction in Australian lenders’ mortgage insurance new business volumes.
Pricing remains challenged across the globe with rates down by around 1.3% overall and forecast to fall by a similar amount in 2016.
At this point in the insurance cycle and given prevailing interest rates, it is critical that we continue to reduce both claims costs and operating costs.
Our operational transformation program commenced three years ago and, together with additional savings associated with the right-sizing of our North American Operations, has generated cost savings approaching $400 million including a further $126 million of incremental benefits in 2015.
Having reduced the Group’s operating expenses and having reported positive prior accident year claims development over three consecutive half years, we are committed to achieving further savings in both claims costs and operating expenses as discussed later in my report.
Simultaneously, we are investing in four very important areas to ensure the future well-being of our business:
- transformation of our global finance and technology processes;
- development of claims management systems to reduce the indemnity cost of claims and the settlement costs associated with claims management as well as improving our service proposition to customers;
- implementation of global people management systems; and
- significantly strengthening our data and analytics capabilities through development of an integrated onshore/offshore model.
From an investment market perspective, the second half of 2015 proved to be as challenging as any period in recent history with a precipitous fall in oil prices. This was compounded by China recording its slowest pace of economic growth for a quarter of a century. Against this back-drop, we were pleased to deliver an adjusted net return of around 2.2% from an investment portfolio that remains defensively positioned to protect against the continued macro headwinds we are seeing in early 2016.
Our people are our key competitive advantage and developing their skills and providing fulfilling careers is therefore a prerequisite for our success.
Our Leadership Academy is in its third year of operation with over 1,800 of our leaders participating in a series of education and development programs. In the first quarter of 2016, we intend deepening our global focus on technical capability with the launch of our Underwriting Academy. Our medium term objective is to underpin that capability with an aligned global approach and to continue to lift the percentage of our underwriters who are formally accredited by leading insurance institutes.
All of our senior roles have structured succession planning in place and we were delighted to promote Tim Plant to Chief Executive Officer of our Australian & New Zealand Operations, succeeding Colin Fagen.
1. North American Operations
Dave Duclos and his senior team have achieved a strong turnaround of our North American Operations, improving the combined operating ratio from 111.5% in 2013 to 99.2% in 2015, thereby returning the business to underwriting profit. A number of actions taken during 2015 give us confidence we can deliver further meaningful improvement in underwriting profit in 2016 and beyond. These include remediation of our Standard Lines business, the successful restructuring of our Crop business, continued build-out of our profitable Specialty business and the sale of our Mortgage & Lender Services business.
2. Australian & New Zealand Operations
With the backdrop of the considerable catastrophe claims activity in the first half of 2015, ongoing price competition and a significant increase in NSW CTP claims frequency, Australian & New Zealand Operations’ combined operating ratio of 91.3% is a solid outcome. By repricing our NSW CTP portfolio, and implementing important operational changes designed to build scalability in to the acquisition cost base, we aim to hold underwriting margins steady despite continued challenging market conditions.
3. European Operations
Richard Pryce and the team in Europe achieved the standout result in the Group, delivering 5% growth on a constant currency basis and recording a combined operating ratio of 89.1%. Notwithstanding highly competitive market conditions, European Operations recorded an improvement in its attritional claims ratio on the back of a reworking of the underwriting account over the past two years. Ongoing favourable prior accident year claims development is indicative of our disciplined approach to underwriting and reserving, particularly in the challenging International Markets and Reinsurance businesses.
4. Emerging Markets
Underpinned by an improved performance in both Asia Pacific and Latin America, David Fried and team grew our Emerging Markets business by 9% on a constant currency basis in 2015 while recording an improved combined operating ratio of 99.2%. The decision to hub these businesses in Hong Kong and Miami respectively has strengthened our governance and control framework, increasing confidence in our ability to simultaneously deliver further growth and improved profitability.
5. Equator Re
Equator Re provides excess of loss reinsurance protection and proportional cover to our four operating divisions. Despite further softening of reinsurance premium rates during 2015 and the impact of large individual risk claims from the divisions, Equator produced a solid combined operating ratio of 89.0% in a relatively benign catastrophe claims year.
2015 was a year of transition, closing off our remediation phase and beginning our return to profitable growth. Our disciplined approach in difficult market conditions has allowed us to balance improvement in underwriting profitability and performance with a clear desire to invest for the future, leaving the business well positioned for sustained success.
On behalf of our Group Executive, I want to thank all of our stakeholders for trusting QBE and having the confidence that we will deliver on our promises. As I consider our business today, the future looks bright and I look forward to meeting our promises again in 2016 and beyond.
Group Chief Executive Officer