THE 2008 YEAR HAS BEEN ONE OF IAG’S MOST CHALLENGING, WITH A WIDE RANGE OF FACTORS SEVERELY AFFECTING OUR FINANCIAL PERFORMANCE. WE HAVE TAKEN DECISIVE ACTIONS TO IMPROVE PERFORMANCE AND, ULTIMATELY, SHAREHOLDER VALUE.
During the past year, a wide range of factors adversely affected IAG, resulting in a very disappointing financial performance in 2008. The board accepts responsibility for those factors within its control, and as a result has initiated a program of decisive changes, outlined in this report.
Difficult trading conditions were experienced across the entire Australian general insurance industry. More severe and frequent weather events caused higher levels of claims costs. At the same time, the commercial insurance markets saw soft conditions with very competitive premium levels. In an unfortunate coincidence of timing, returns on investments in the share market were negative and extra costs have been incurred from wider credit spreads. All of these pressures reduced profitability across the industry.
In addition to these industry challenges, part of IAG’s operations in the UK, the mass market underwriting and distribution businesses, performed poorly. These businesses represent around 6% of the Group’s revenue (GWP).
We entered the UK market at a time when pricing and underwriting conditions were widely expected to improve. However, the rate of recovery in the market has been slow and we now expect it will take several years for profitability to be restored.
After considering a range of alternatives, the board and management decided the best option would be to take action and exit from the mass market underwriting and distribution businesses in the UK, and this process is underway.
The other major part of our UK operations, the specialist motor insurance underwriter Equity Red Star, continues to perform well and operate profitably.
The board clearly recognised the need for major changes to occur to improve our profitability in terms of realising the potential of our valuable brands and businesses.
Following the resignation of Michael Hawker, Michael Wilkins was appointed as CEO. Michael Wilkins has more than 25 years of insurance and financial services experience. Before joining IAG in November 2007 as chief operating officer, he was managing director of Promina (the former owner of insurers AAMI, Vero and Australian Pensioners Insurance Agency). He is well qualified to lead IAG as it embarks on a new direction.
In early July, Michael Wilkins outlined to the market a revised strategy and business operating model, changes in the management team, substantial cost reductions, and the exit from some parts of our UK operations mentioned earlier.
We believe this revised strategy and operating model will restore value and profitability. Further details on this, and the Group’s results for the 2008 financial year, are contained in the CEO’s review.
On behalf of the board, I would like to convey my thanks to former CEO Michael Hawker, who made a significant contribution to the Group.
In addition to the management team changes mentioned above, the board is also undergoing renewal with the retirement from 31 August 2008 of Neil Hamilton and Rowan Ross. These directors were instrumental in guiding the Group through a period of growth and development after demutualisation, and I thank them for their contribution.
A new non-executive director, Philip Twyman, has been appointed.
Philip has extensive business experience, particularly in the insurance sector, working in significant roles in both Australia and the UK. He was formerly a director of Insurance Manufacturers of Australia, a joint venture between IAG and the Royal Automobile Club of Victoria (RACV), and a group executive director of Aviva plc, one of the world’s largest insurance companies. Previously, he held a number of senior executive positions in Aviva, AMP and General Accident plc.
We will also continue to look to strengthen the composition of the board through the appointment of new directors with relevant experience.
I intend to stand for re-election at the annual general meeting in November 2008, on the basis of providing continuity and stability during the major changes in management and strategy. At the same time the board is aware of the need for a planned and orderly succession in the Chair role and is addressing this issue in accordance with proper governance principles.
QBE Insurance, which mainly operates in international commercial insurance markets, sought to take advantage of the current better insurance cycles in its business to attempt to acquire IAG at a low price in this current negative cycle in Australia.
Whilst QBE described its approach as a ‘friendly merger’, it required control, without offering a satisfactory premium to IAG shareholders for the significant benefits it sought to capture. There was little discussion by QBE on quantifying these benefits and how they should be shared.
QBE did not make a formal or complete offer at any stage, but instead stipulated it required a unanimous recommendation from the board of IAG to provide the support necessary to carry a Scheme of Arrangement with shareholders. QBE declined to put a general takeover offer to IAG shareholders, which could have been judged on its own merits.
The IAG board acknowledged (and still believes) that substantial benefits could result from combining these businesses and indicated its willingness to explore these. However, the proposed price was too low to adequately reflect the inherent value of IAG’s businesses and brands. The board could not recommend this takeover proposal and, as a result, QBE decided to withdraw it.
The acquisition formula proposed would have been mainly paid in QBE shares, which meant that the implied value of the proposal fluctuated depending on relative movements in the two share prices.
The IAG board did not consider it was being offered sufficient transparency or time to properly assess the QBE share value as a basis for recommending such an exchange to IAG shareholders.
Since the proposal was withdrawn, we have focused on driving forward with our new strategies to enhance shareholder value.
IAG’s capital position remains strong. At 30 June 2008, we had a multiple of 1.62 times our minimum regulatory capital requirement.
We also maintain the highest financial strength ratings from Standard & Poor’s of any Australian based insurer, despite a one notch downgrade to our ratings during the year. Our very strong rating of ‘AA–’ for each of our key wholly owned insurers is a reflection of their financial condition.
Your board has decided not to continue paying dividends which exceed 100% of our profit in these difficult times.
As a result, we will pay a fully franked dividend of 9 cents per ordinary share (cps) on 3 October 2008. This brings total dividends for the year to 22.5cps, fully franked, down 7cps from the previous financial year.
I am confident we are implementing the right strategy and operating structure and have the management team to improve our financial performance.
For the 2009 financial year, we are targeting an insurance margin in excess of 10% and dividends will be based around a target payout range of 50%–70% of reported cash earnings, and will continue to be fully franked for the foreseeable future. This guidance is subject to no material movements in foreign exchange rates or credit spreads, and no catastrophes or large losses beyond our allowances.
I believe the actions being taken should give shareholders confidence that we are building a stronger future for your company.
James Strong
Chairman
