Hiscox Ltd (OTC:HCXLF) Q2 2022 Earnings Conference Call August 3, 2022 5:00 AM ET
Company Participants
Aki Hussain – Group CEO & Executive Director
Joanne Musselle – Group Chief Underwriting Officer & Executive Director
Paul Cooper – Group CFO & Executive Director
Conference Call Participants
Andreas van Embden – Peel Hunt
Darius Satkauskas – KBW
Andrew Ritchie – Autonomous Research
Ivan Bokhmat – Barclays Bank
Tryfonas Spyrou – Berenberg
Iain Pearce – Crédit Suisse
Faizan Lakhani – HSBC
Nicholas Johnson – Numis Securities Limited
Ashik Musaddi – Morgan Stanley
Freya Kong – Bank of America Merrill Lynch
William Hardcastle – UBS
Aki Hussain
Good morning, everyone, and it’s great to see you all here. I’m sure you’ve all seen the presentation materials we released earlier this morning, so I’m going to keep my introduction to the Q&A quite short, so we can maximize the amount of time we have to answer any questions.
So in summary, I’m really pleased with our business performance. I’m really pleased with the results that we’ve achieved for the first 6 months of this year. The strategy I laid out at the start of the year is delivering, and you can see that in the numbers. We’re growing where we see attractive opportunities.
In our Retail business, we are accelerating growth, whilst we continue to invest in marketing and technology. And in our Reinsurance and ILS business, we’ve delivered really strong growth into a much improved market supported by significant net inflows into our ILS funds of around $0.5 billion in the first half of the year.
In our London Market business, we’ve delivered selective growth as we continue to increase our participation in well-priced lines, whilst we reduce our exposure to underpriced risk in the property segment.
If I just turn to profit for a moment, we’ve delivered an excellent underwriting result. We’ve seen underwriting profit increase by 23% to $123 million. So the underwriting actions that we put into place are working, and we’re in a positive pricing environment. So I’m really pleased with the 91% combined ratio and the much improved combined ratio for our Retail business at 95.5%.
But of course, the superb underwriting result has been offset by the investment income. And as you know, that’s a function of the challenging financial markets and, in particular, the steep rise in interest rates. As you also know, much of this is noneconomic, noncash.
And actually, one of the upsides of the events over the last 6 months is the significant increase in reinvestment rates, which are now at 3.4% compared to just 1% at the start of the year. So that’s a 240 basis point increase. And I’m sure you’ve all done the math, given our short duration of our assets, what that means for prospective investment income and returns on equity in 2023 and beyond.
If I turn to inflation for a moment. Inflation is a risk that’s really well managed at Hiscox. Our back book is well protected because of our conservative reserving methodology. The significant margin we hold above our actuarial best estimate, the 4 legacy portfolio transactions we’ve completed, which, as a reminder, provide significant additional protection to around 20% of our gross reserves from 2019 and prior.
And just as a further reminder, they tend to be focused in on the longer-tailed casualty lines. Now we’ve also seen significant positive reserve development in the year as well as organic capital generation. And that’s enabled us to set aside a further precautionary reserve within our best estimate of $55 million. So we feel really good about our back book.
When it comes to the front book, the business that we’re writing today, pricing trends are ahead of loss cost trends in every single business unit. So we’re feeling really good about the business that we’re writing today.
If I turn to our U.S. business for a moment, our U.S. DPD technology transition is going well. As of June, all of our direct customers are now on the new platform across all 50 states in the U.S. So that’s about 1/3 of the total U.S. customer base.
That’s well over 200,000 customers, now new business renewing onto the new platform, so we’re really pleased with that. And the process to migrate our partners onto the new platform has now commenced and will be substantially complete by the end of the year, with the bulk of the work being done in Q3.
Now you’ll also remember from when we last reported that in order to reduce the complexity of the technology transition, we were deliberately switching off some new business opportunities and pausing the onboarding of new partners. So as a result, I expect DPD growth for this year to be in the middle of the 5% to 15% range before it accelerates to above the 15% range in 2023.
And finally, when it comes to people, I’m really pleased that my leadership lineup is now complete. So the vacant positions have now been filled. And you have seen from the presentation earlier today that we have a blend of deep-rooted Hiscox experience on the Group Executive Committee combined with some fresh perspectives provided by fantastic external hires.
So in summary, I’m pleased with what we’ve been able to achieve over the first 6 months of this year. So as I look forward, the global economic outlook is somewhat uncertain as a result of macroeconomic and geopolitical concerns. But it’s those 2 concerns themselves that are providing further demand for our products and creating opportunities for disciplined underwriters.
So as we look forward, we expect positive pricing momentum to continue into the second half of this year and into 2023. And as you’ve seen in the performance of the first 6 months, our big-ticket businesses are now able to take those price increases, transform them into margin and positive earnings momentum.
As far as Retail is concerned, the operational improvements that we’ve made, combined with the portfolio adjustments we’ve completed, I mean we’re on track to achieve a 90% to 95% combined ratio in 2023. And the ongoing investment in marketing and technology provides a solid underpin to accelerate our Retail growth in 2023 from the midpoint that we expect to deliver in 2022.
So I’ll close there. So thank you very much. And as ever, I’m joined by Jo and Paul here, and we’re happy to answer any questions that you have. I believe you have a mic in your seat. Please give your name, firm, and then ask your question. Cameron?
Question-and-Answer Session
Q – Unidentified Analyst
It’s Cameron from JPMorgan. A couple of questions focused on U.S. DPD. I guess in terms of the — I guess, I kind of understand the slowdown in U.S. DPD given the replatforming. But I think you’ve always told us there’s a strong kind of opportunities there for growth, and I expect that’s still there.
Could you maybe help to give some color around what the underlying demand trends are for U.S. DPD? So then when you do kind of replatform fully, and it does kind of turn on what potentially this could look like. I know you’ve talked about 15% for next year but maybe some demand trends?
And the second question related to this as well. In terms of the kind of parts of business, of this business where you kind of had to turn off on new business, is this focused on selected partners? And what impact does this have potential on onboarding new partners?
Aki Hussain
Sure. So in terms of — the U.S. opportunity remains extraordinary. Really, really exciting. You have seen from the presentation, there are around 33 million customers in our potential target base and 11 million with our current product set, of which we have about 0.5 million today, so pretty small market shares. So the opportunity remains extraordinary.
The demand remains really strong. We have a significant number of partners who are in the queue to be onboarded starting Q1 next year once the replatforming has been completed. And in terms of then — I guess, the other indicator would be the organic searches or the searches online for small business insurance in the U.S. and so on. They have not dissipated. New business formation continues to remain strong.
So if you think about the contextual backdrop, the opportunity is extraordinary and actually continues to grow. So — and we’re going to be growing into that. So very pleased with how the transition is progressing, and we’re really looking forward to the end of this year and early next year when we switch on the new business opportunities and also when we switch on the partners.
In terms of where we’ve turned things off, yes, it will be some select partners where we’ve been able to switch things off and some new business opportunities that we’ve — in some states that we would just have to switch off just to reduce the complexity. And we know this is the right thing to do because this is not our first rodeo, right?
We’ve done technology transformations before. We’ve got lessons from having done them before. And it is really important to, insofar as possible, maintain fantastic service to customers and reduce the complexity for our colleagues who are undertaking the implementation.
But it’s going well. We now have over 200,000 customers on the new platform buying product, renewing product, making midterm adjustments. We’re already seeing significant benefits. I think you’ve seen that — well, the magic — somebody – the magician does put the slides up. Yes, you’ve seen the benefits that we’re already beginning to see whether it’s through increased conversion, reduced time to quote, efficiencies or just the ability of customers to navigate the new digital shop front.
And we’re beginning to see something really interesting is actually just a slight tick up. It’s not yet a trend but a slight tick-up in triple bundles being purchased. So it’s a really exciting sort of future that we’re fitting into.
Will?
William Hardcastle
Will Hardcastle, UBS. I guess the first one is, on the inflation loading, can you talk us through how that’s been determined, how granular you’ve got at this stage, lines of business which is overweight.
And how much of this do you think is who’s got specific or a bigger industry dynamic? We’ve got to think about it from a perspective that you’ve got a big reserve buffer, you’ve got LPTs in place, but it’s Hiscox essentially that’s come out with the loading today.
And then second, on DPD, yes, the U.S. DPD, the U.S. — there’s a small growth reset today, I guess, for current year. You’re very clear on the growth outlook in excess of 15% and beyond. But I guess the slide that’s still present there, if we were to take the opportunity as is today,beyond versus where you’d have been thinking 6 to 12 months ago, is it the same opportunity? Or is the replatforming opportunity that the new system, does that enhance the opportunity long term?
Aki Hussain
Okay. Thank you, Will. So in terms of the detail of how we’ve constructed the inflation load, Jo will take that. I’ll give you an overarching comment about whether this is industry specific goal or — sorry, Hiscox specific goal industry. But let me start with DPD.
The opportunity, again, just to repeat, the opportunity is really exciting, and the opportunity set hasn’t changed. It’s going to become more interesting. What the new technology platform does, it gives us the tools. That gives us — provides even more confidence that we can capture this opportunity.
And I kind of focus back on this slide that you can see in front of you now in terms of some of the operational benefits and growth benefits that the new technology will provide. This is meeting — this is us meeting a gradual change in customer preference. So these are products that if you go back 10 or 15 years, customers were not dreamed of buying online.
Now not only do they buy them online, they want to make changes online. They’re comfortable buying triple bundles online. Okay? So you can try and do the old way or you can access this huge market of potentially 33 million customers. But the way to access it is to have fantastic underwriting and understanding of insurance but then to have the right tools that provide fantastic customer journeys and creates a digital shop front where customers can navigate.
And if that’s the way they want to buy it, we’re ready for them. But if they want to talk to us, we also have call centers in place, right? We still take 100,000 calls a month in our call centers in the U.S. So this is about providing an omnichannel approach for our customers. And this is just another route to access that fantastically exciting market.
So I would say relative to 6 months ago, my confidence levels are up. 6 months ago, we had a technology platform that we had soft launched, now it’s properly launched across the 50 states. It’s working. Our customers are — our customer experience has improved. And over the next few months, we will be migrating the long list of partners that we have onto the new platform.
As far as inflation is concerned, look, in terms of — inflation isn’t new news, right? So I’m sure you read about it in the press on a daily basis. All of you have been writing about it on a pretty regular basis. So the Hiscox philosophy is to front run things, right? So — and to be — and to take a very cautious approach. And that is a philosophy that runs through everything we do. And what you see with respect to inflation, whether it’s the precautionary load, the reserve margin that we hold or indeed the LPTs that we executed, it’s because we have a cautionary approach to these factors. We like to front run things, and we want to put this in the — to use one of the — to paraphrase one of our colleagues, to put this in the rearview mirror. So now we’re focused on growing the business and looking forward.
But Jo, do you want to provide a bit more detail on how we’ve got to the numbers?
Joanne Musselle
Thanks, Aki. So as Aki said, I mean, inflation risk is clearly not unique to Hiscox. This is a market-wide issue. I think the way that we look at inflation, we always look at inflation, looking at inflation and the impact in terms of the business we’re writing and the claims that we have to pay is part of our normal planning cycle.
I think the difference this time is that the inflation risk is slightly heightened. So we look at it in 2 ways. We’ve run a really, I would say, robust process across our group, whether that be underwriting pricing, capital, actuarial, it’s a joined-up process. And we really look at the sort of business we’re yet to write and then the claims we’re yet to pay.
So on the business we’re yet to write, what we look at is each one of our lines of businesses on a ground up, we look at how they’re correlated, what type of things they correlated to. We use both internal indices. We look at our history. But we also use external indices, and we look at sort of market indices and, where possible, forecasting indices.
We then look at those indices, so as an example, CPI, one of our lines is correlated to CPI. And not all of the drivers of CPI would be correlated to our products. So things like food, not necessarily a driver of our products, so we sort of tailor those. And obviously, we then come up with an estimate.
Now I’d be really clear, and I’ve been really clear on, I think the slides — in the inflation side, so I think it’s 27, 28. What we’re assuming is not what we’re seeing in our claims. What we’re seeing is materially less than what we’re assuming. But what we’ve said is even assuming multiples of prior claim inflation, that assumption is still being offset with both premium inflation and rate inflation.
So premium inflation is the premium that we get by update on our underlying sums insured, things like bills and sums insured, waiver or turnover. And then rate is obviously the rate that we applied to those. So in both — in all lines of — in all parts of our business, both big ticket and retail, we’re making reasonably prudent assumptions. We’re not seeing that claim come through in our case reserves. But notwithstanding that, we’re still offsetting those assumptions with both rate and premium.
In terms of our business that we’ve written, so the uplift, the precautionary uplift we took at the half year, which is the $55 million, we’ve taken that same intel and we’ve looked back at our portfolios. And again, this is not something that we’re seeing in our case reserves, but we’ve made a precautionary uplift.
As Aki said, we do like to front load risk, and we’ve taken a proportionary uplift into our reserves. I highlight that, that plus our reserving methodology, which is quite prudent in terms of casualty, where we hold on to good news sooner, as we have held on to good news in terms of our reserve and methodology, plus obviously the buffer that we’re running on our reserves.
And then also, as Aki said, the 4 loss portfolio transfers that we’ve completed, which I know 2 of them have been announced this year, but those 4 loss portfolio transfers have actually been — we’ve been working on those for a while.
And they have different drivers. Some of them is to protect businesses that we’re no longer in. Some of it is releasing capital to focus on the go-forward opportunity. Some of it is to protect back year reserve volatility. But also we have, and again, another buffer for inflation because they attach the sort of best estimate reserves.
So overall, I hope that gives you a little bit of insight into how we’re looking at it. It’s a very detailed process that we go through. We’ve made some, I think, pretty conservative assumptions within both the business that we’re yet to write and the business that we have written. And I think that the overarching thing is this is — the uplift is precautionary and it’s not what we’re seeing in our case reserves.
Aki Hussain
Andreas?
Andreas van Embden
Andreas van Embden from Peel Hunt. Two questions, please. One on the London Market business, the binder book, I see in the back, your property portfolio is down 19% in terms of gross written premiums. Is this all driven by the continued reduction in your binder book? How much longer will it take to reunderwrite that portfolio?
And finally, how much fall are you releasing by pulling out of that sort of binder CAT type risk? And how will you redeploy that fall? Is that within Lloyd’s? Are you going to take it out of Lloyd’s and redeploy it elsewhere?
Second question is on Bermuda, the ILS business. I can see nearly 2 billion of asset under management, quite strong inflows. Are these inflows, is this institutional investor money that’s coming in? Or is it trade capital?
And what is the tenure of that capital? How long can you hold on to those assets under management? And how are you deploying it? Because I can see your premiums increasing 37%. Is this taking a larger share on your existing business, existing relationships in the reinsurance market? Or are you writing new business?
Aki Hussain
Okay. So I’ll take the London Market question. In terms of file release, the specifics I think we’ll get back to you on. But in terms of more general capital allocation, Paul, if you want to talk about how we redeploy that between the different platforms. And I’ll take the ILS one.
In terms of London Market, the bulk of the reduction in the property GWP is driven by the re-underwriting in our binder portfolio. We’ve been gradually re-underwriting that portfolio coming off binders over the last few years as, frankly, markets have changed, whilst pricing has improved.
And I have to say the property portfolio as a whole and the binder book specifically is now profitable. If you go back 4 or 5 years, it had become unprofitable. It is now profitable. Now the question for us is capital allocation and is it generating the appropriate return on capital. So I would say we are probably coming towards the end. There’s a bit more work to do but coming towards the latter stages of that re-underwriting.
That property portfolio, in particular, the binder book is now quite different in terms of composition and risk profile. I think over the last 4 years, we’ve reduced our property CAT exposure in that segment by about 50% and increased rate by 50%. So just to kind of rebuild your mental model of what that business looks like, it is quite different in risk profile and earnings potential to what it was 3 or 4 years ago.
In terms of ILS, I mean we don’t disclose who the investors are. That’s our agreement with our investors. What I can assure you of it’s institutional, it’s investors that have been with us for a long period of time, many, many years. And this is an asset class they like, and they have been reallocating capital. They’re not new to this space. They’ve been reallocating from other ILS funds to concentrate more on the Hiscox fund.
We’d like to think that is largely because of the fund performance. I mean overall, for the last 8 years, anybody who’s been in this space, performance has been challenging. But the relative performance of Hiscox has been very, very good, so we have been able to attract significant inflows, as you’ve just read about.
Paul, do you want to comment on the capital allocation?
Paul Cooper
Yes, sure. So from a capital allocation perspective, I think there’s 3 important things to consider. One, which you can see on the screen, is just around how we think about capital within London Market itself and what we’ve been very deliberate about is growing where we see well-priced opportunities. So we’ve grown in those classes is the first point.
The second point that’s sort of to consider is really how we’ve rotated out of property in London Market. And you can see we’ve retrenched from there where rates haven’t been as attractive and really been deploying capital into Re & ILS, the other division. And you can see that’s very deliberate with the 37% growth in the Re & ILS business unit. It’s a very strong first half of the year.
And I think that brings 2 benefits. One is we’re seeing better rated business in reinsurance, property CAT than the typical property CAT exposed business in London Markets, so we can write more on our own balance sheet more attractively. I think the other aspect is the growth on Reinsurance enables us to capture more capital-light fees, and you can see that coming through in terms of growth in AUM and the management fee that, that will trigger and derive.
And I think the last part goes really to a fundamental part of the business is the Retail business has very strong prospective growth opportunities, and we’ll continue to deploy capital into that aspect of the business, be it technology, be it data and the likes of those aspects.
Aki Hussain
Andrew?
Andrew Ritchie
It’s Andrew Ritchie from Autonomous. A couple of questions. One, just a clarification, I should know this, I’m being a bit simple, I think. But the inflation load is now part of the best estimate. In other words, when I look at the 11%, it’s the denominator — is that the case? I just wanted to clarify that.
Secondly, just remind us, stepping back on Retail combined ratio, just remind us what the original trajectory was. I know it’s 90%, 95% in 2023. I can’t remember what it was for this year. And just remind us, because you’re more or less matching claims inflation with pricing, what’s the other driver or just update us on those drivers to get to that glide path from where we are today?
Another question, dividend growth. Your predecessor always used to sort of reflect on 60% of the business grows at roughly 10%, and then the rest is cyclical, and you can work out what the long-term growth of the business might be from that and the dividend should match that. I mean maybe I felt the dividend growth was a bit parsimonious in the first half. Maybe just update us on your philosophy on that?
And the final question, IFRS 17, that’s delightful topic. I think this theory is that as far as you’re concerned, any reserve management can be incorporated in leeway within the risk adjustment. Is that what you’re saying?
Aki Hussain
Great, Andrew, that’s a bit of a record 4-part composite question — so Paul, if you can think about the IFRS 17 dimensions, and we’ll kind of rattle through the rest. The first one is pretty quick. The inflation load is part of the best estimate, not part of the margin.
In terms of Retail combined ratio, the sort of loose guidance that we provided for ’20 — at the time we made the announcement, which was a number of years ago was 2022 would be 95% to 97%. And therefore, the current performance is at the better end of the guidance that we provided at the time.
The drivers are, in essence, two- or three-fold, if you recall, and those drivers have not changed. Firstly, it was to improve the operational efficiency within our U.S. claims function, and you have read within the statement that is showing it’s taking time because these things do take time but it’s showing dramatic improvement in efficiency and simply the recomposition of that team to deal with the business that the U.S. now is, which is a high-volume, lower-value individual claims.
So that was the first part, reducing the amount of claims, the number of claims that were sent to third-party expensive legal departments, that has now happened. Some portfolio readjustment, which you’ve heard many times from Jo, and Jo can elaborate on that.
So those were the kind of major drivers. Those are all in play and, as you’ve heard, largely now complete, so pretty confident about getting to the target. In terms of dividend growth, look, we’re a growth business. And you’ve heard my predecessor and me talk about the significant opportunity that we have.
So for us, it’s always a balancing act where the dividend is really important. We know it’s important as a sign of health of the business. We know it’s important to many, many of our shareholders. And therefore, we are keen to pay a dividend. But I do balance that against the significant growth, profitable growth opportunities we are seeing.
And I think right now, given the work that we’ve completed in our Retail business, and we’re poised for really accelerating that growth in 2023 and beyond and the significant opportunities that we’re seeing in our — in the reinsurance market, which is becoming really interesting, I have to say, now and it could be potentially quite exciting when it gets to 1/1. Now is not the time to really be expansive about — in respect to the dividend.
But what you can be rest assured of is our interests are entirely aligned. There is no interest in hanging on to equity when we can’t deploy it effectively. So you can rest assure that’s exactly what’s in our mind.
Jo, I thought if you could maybe elaborate a little bit more on the work that we’ve done in the U.S. And then, Paul, if you could then take on IFRS 17.
Joanne Musselle
Sure. So Andrew, just to pick up on your point in terms of the inflation and what’s the improvement, I think the key in the slide is this is our underwriting year versus what you see in the results, which is our calendar year.
And as Aki has said, clearly, we’ve made material reposition in our U.S. business, which obviously has taken time to earn through. And actually, obviously, when you look on an underwriting year, you have a clean view versus a revenue year, which still has some earnings from prior years.
We’ve repositioned the portfolio, as you know, in our U.S. business. Our U.S. business was really a hybrid of the small Retail business, which should we be more akin to our U.K. and our European portfolio, and then some larger ticket business written on our U.S. excess and surplus carrier. And going back to a couple of years, we took the strategic decision to say, yes, that portfolio was remediating. That portfolio was repricing.
But actually, our long-term opportunity in U.S. Retail was very much focused in that small ticket business where we have differentiation, right to win, significant investment in digital and operational capability. And quite frankly, we wanted our management time and effort to be focused on that opportunity, and hence, we exited around — I mean, it’s around about $116 million of business in totality and about $100 million of that from the more recent what we — the smaller business with portfolio repositioning.
So within the Retail, I’m really happy with the underwriting year results. And so therefore, you can see — we’ll see that come through. I think what’s also not in this slide is just ordinary course correction. So we talked historically about remediation, repositioning. That is once and done. That’s behind us.
But what we do have in all of our portfolios is just ordinary course correction, where we slightly tweak change portfolios, slightly reposition them. So you can’t see that in that slide, and that might have a bit of a tick in terms of sort of by cost management’s action. So that’s in Retail.
I thought I’d just pick up, while I have the mic, just on the big ticket business as well just in terms of the portfolio. I think we sort of focused the sort of the London Market on the binder part, and I’d say a couple of things on that. One, this is not unique to us. Our portfolios are actually performed better than Lloyd’s in those 2 areas. But as Aki said, whilst we’ve repriced, they’re just not as profitable as we would hope, and therefore, we’ve repositioned.
And I’m delighted with the work that Paul and Kate have done to actually, at a headline level, yes, it looks like a growth written premium down. But actually underneath that, we’re definitely growing areas of the market where we see attractive opportunity, where we see attractive rate.
And more importantly for me, we’ve really repositioned that portfolio for, I would say, not insulation through the cycle. We will never insulate ourselves in the cycle, but we definitely repositioned that portfolio for resilience through the cycle, getting less exposure, more premium, reducing our line size and actually creating a portfolio that actually leading more, delegating less, where we just have far more control.
So I’m really delighted with the shape of both the big ticket portfolios, and you obviously heard the opportunity in Re, but also the Retail portfolio as well.
Paul Cooper
Yes. So turning to, Andrew, your question around IFRS 17 in reserves, I think the first thing to state, and you would have heard it earlier on in the questions, is we are well reserved. And we’ve made that point prudently from a sort of best estimate perspective but also from a margin perspective.
And if you sort of just think we are in pretty uncertain and volatile times, so we’ve had COVID, we’ve had a war, we’ve had inflationary pressures, that’s what the whole industry has seen and experienced. So our margin of 11% should be realized in the context and that precautionary inflationary loading that we’ve put on seen in that context.
Notwithstanding that, you’ll know that the 11% margin is above where we would typically travel. That’s above the upper limit of the 10%. If you then sort of see how that translates into IFRS 17 considerations, there’s not a read across.
What we do is we look at the reserves, the volatility within those reserves on a period-by-period basis, and we determine the level of strength that we want in there. And as I said, I’ll come back to the point that we are well reserved. IFRS 17 doesn’t feature.
Aki Hussain
Ashik?
Ashik Musaddi
Ashik Musaddi from Morgan Stanley. Just a couple of questions. Sorry to go back on inflation. I mean how should we think about reserve releases going forward? I mean if I add back the inflation load, I mean the reserve releases would have been about $135 million, which is pretty large. Would you say it’s a good run rate going forward because things have stabilized a bit on an adjusted basis?
Or would you say probably we should still stick with the current numbers of around $70 million, $80 million on a half yearly basis. And just on that — again, on inflation, this $55 million, have you assumed any progressive inflation?
Or would you say that the inflation load is basically based on the inflation that you’re seeing right now? Just trying to understand if there is any further risk of what if inflation goes up another 2% from the current level, so how should we think about risk around that?
And just last one on commercial lines and reinsurance. I mean there is a bit of mixed message that we are getting from the industry. Some people are retrenching from reinsurance.
Some people are getting a bit more on property cat reinsurance. And what you are trying to say is, okay, you are reducing London Market but going on your own capital on the property cat. So what would be your net position on that would be helpful to know?
Aki Hussain
Okay. Thank you, Ashik. So in terms of inflation and the interaction with reserve releases, Paul, could you take that? And the $55 million or indeed just the — how we’ve developed our inflation assumptions, Jo, if you could take that?
In terms of how we think about property cat overall and exposure, we’ve had a — over the last few years, we’ve adopted a cautionary stance, and you’ve seen that in the work that our London Market leadership team, led by Paul and Kate, have undertaken, and Jo just elaborated on that. We’ve had a relatively cautionary stance in Re & ILS. But that’s because of the market circumstances we were facing at the time. Those are changing, right?
So we are — we have seen significant rate increases in property cat, retro, cyber, actually in the reinsurance space. And that is driving the 37% growth you’ve seen in the first half and the property cat and retro in particular because of the capacity crunch because some markets have decided this isn’t the right place for them. So there’s a real expectation at the moment that we could see further increases.
I mean just to put into context what’s been happening and if I give you one very specific example, in Florida, which is a big buyer of property cat, insurance and reinsurance, the reinsurance rates last year, I think we saw — I’m trying to quote from memory. I think they were up 20% or 30%. They’re up again plus 30% this year, right? So it’s beginning to get interesting, beginning to get very interesting.
So we deploy capital depending on market opportunities. So when you look at the group overall, I would expect on our own balance sheet that the property cat exposures will not decline. There will be flat to slightly rising. They will probably rise in the reinsurance platform but not in London Market. So that’s the way you should think about it. It is becoming a very interesting market.
Paul, do you want to take reserve releases? And then Jo?
Paul Cooper
Yes. So your point about the question about reserve releases going forward and how to think about it, so firstly, I’d sort of repeat my earlier comment, is we start off from a prudent reserving position. If you look at — Slide 20 is very helpful, but we’ve got a good track record of prior year releases consistently through history.
And then again, the slide shows that from a margin perspective, we are above the upper limit of where we typically travel. So if you take consistent reserve releases from a historical perspective, prudent positioning margin above where we’d sort of traditionally like to be. You can draw some conclusions from that about a go-forward position.
Joanne Musselle
And then just speaking to the point on inflation and the $55 million, as I said, this is — proportionally it’s not what we’re seeing. If you think about the actual case reserves, some inflation is already priced in.
So as an example, one of our homeowners who needs to follow in a flood or a fire, your base in your case reserves is only estimate to actually put that policyholder back in the position they were. So you’ve already got inflation — current inflation baked into your case reserves. This is on top.
I think your point of is it progressive, what if we see it persist, it is. I mean what we’re looking at, if you think about our portfolio, pretty short duration, probably less than 2 years on average.
So — and as we mentioned, some of our longer-tailed casualty lines, there are — would be higher than 2 years, we do have significant protection in our loss portfolio. So again, this is a precautionary uplift that we’ve taken in our best estimate, but that’s over and above what we’re seeing in our reserves.
Aki Hussain
Yes, if I just add to that, just to remind you what Jo has said before. As we came into this year, whatever our inflation assumptions were, we doubled and then effectively in many lines quadrupled. So that gives you an idea of how we’re thinking about this. This is not putting in what we’re seeing today.
This is really taking a forward-looking view of what could happen. And if it doesn’t happen, then actually to your point, it will come through in reserve releases. If it does happen, we have priced our risks appropriately, and we’re well protected.
Tryf?
Tryfonas Spyrou
[Technical Difficulty]
Aki Hussain
Sorry, Tryf, could you maybe hold the mic a little bit closer?
Tryfonas Spyrou
Sorry, I was wondering whether you can give us some guidance sort of on the fee income we should be expecting in the next couple of years. And the second question is on the solvency capital generation, taking everything into consideration the higher inflation, higher nominal premiums from inflation.
Can you perhaps comment on what is sort of your expected normalized capital generation on a solvency basis? I think previously, you mentioned this was around 15 to 20 basis points per year, so we’re keen to get an update on that number.
Aki Hussain
Great. Okay. So in terms of capital and capital generation on a normalized level, Paul, if you could take that? In terms of fee income in ILS, we don’t typically disclose fee income. I know we’ve reported a figure, I think, of $23 million.
So think about it in this way. The ILS funds come with — it’s a little bit more complex business but essentially come with 2 forms of fee. There’s a fixed fee, which you get effective throughout origination; and then a profit commission component.
The last few years have been somewhat challenging, as you know from performance. And therefore, the variable component, the profit commission has been pretty meager, right? So the fee income that we’ve generated is typically the fixed.
Now you’ve got 2 things at play now. You’ve seen the reinsurance platform combined ratios for the last 18 months, significant improvement, okay? Combined with that, you’ve got an increase in funds from roughly $4.5 billion to close to now $2 billion.
So prospectively, there should be a very material increase in fee income because the fixed component increases. And now because of both the new money and the improved performance, it should generate significant variable profit commission coming through as well. But that won’t be until next year.
Paul Cooper
Yes, and then so just turning to capital, what I’d say is I’m very pleased with the BSCR position. It’s 200%, as you know. And you can see on Slide 21, I think it talks to 2 things. One is the strength of the balance sheet. It’s also well funded. We’ve got lots of liquidity.
And I think to the specifics of the question, you’ll see that the capital generation that we’ve achieved in the half year enables us to do 2 things: one is fund the dividend and also fund our growth plans. And that’s true for the first half. It will be true of this year. And into next, we’re confident of that position.
Aki Hussain
Iain?
Iain Pearce
Iain Pearce from Credit Suisse. A couple on U.S. DPD. Firstly, on the guidance change between Q1 and now in terms of the 15% to 20% coming down to sort of in the midrange of 5% to 15%, really, what’s changed since then in terms of why you feel the need to lower that guidance?
And then similarly, on the 15% growth for next year, if we look at the original guidance for this year, 15% to 20%, taking into account a U.S. replatforming and then growth of 15% for next year, that does look like a slowdown.
So what’s driving that? Has anything changed? Are you seeing more competition? Because when we’re just running those numbers through, it does appear that U.S. DPD growth expectations are lower.
And then on the inflation side, could you split out the inflation loading that you’ve taken between the different segments? If possible, that would be great.
Aki Hussain
Okay. So thank you for that, Iain. So answering it in kind of reverse order, no, we can’t split out the inflation loading between the different segments, but it’s pretty broad-based.
In terms of the guidance for this year, I guess the — relative to what we thought back in March compared to now, I mean, the key difference is actually the partner migration. So direct to customers kind of done, it’s — they’re on the new platform working well.
Partner migration, as you know, is a 2-way affair. We require development to , and we develop — require development at our partner’s end as well. And frankly, what we’ve had is a change in scheduling between us and some of our big partners as to when they can do the development at their end. But that scheduling is now complete.
So the numbers that we’re — or the guidance that you’re providing has a degree of contingency as to when that migration will occur. But that is the key differential. It just means that some of the new business that we’ve turned off just stays off for a little bit longer, which is the key driver.
And as you heard earlier, the opportunity remains extraordinary. It’s growing. The demand is strong. We still have a long list of some really exciting partners who are willing to onboard the platform coming January, next year.
In terms of the go-forward sort of guidance, the guidance isn’t 15%. It’s above 15%. So I don’t want to be more specific and provide lots more as exactly what it is going to be. It is a big opportunity. It’s going to be above 15%. We’re really excited about it.
We have back-end loaded the marketing for this year, so you’ll see a significant increase in our marketing in the second half of the year relative to the first, somewhere between upwards of 30%, 40% increase in marketing in H2. And that is setting the ground for what will be a material uplift in U.S. DPD growth into 2023.
Faiz? Have you got a mic? Do you want to move down a couple of seats — a couple of rows, sorry.
Faizan Lakhani
First question — Retail combined ratio.
Aki Hussain
Sorry, can you just start that again?
Faizan Lakhani
Just trying to understand the shape of the profitability in the Retail long term. Given if you do reach the top end of your Retail combined ratio guidance, is that going to hit your sort of profitability sort of hurdles? Or would you look to improve that further?
And the second question is just trying to understand the growth in the London Market. When I strip out the property binder work, which makes sense, the growth still seems fairly below sort of rate. Just trying to understand what the shape of growth will be in the London Market business going forward?
Aki Hussain
Okay. In terms of profitability for the Retail business, as you say, we’re on track to meet the 90% to 95% combined ratio for 2023. Profitability in that range, combined with modest investment income, hits the right ROE range for the group. So we’re — in that range we’re very, very happy traveling.
You can travel at the bottom or the top, but it’s a range we’re very happy. That combined with good solid growth, a couple of points of investment income. And I think you as investors and shareholders would be very happy with the return on equity we can generate.
In terms of growth of London Market, look, we grow where we see attractive opportunities, right? So we’ve never had a growth target for our London Market business. It is already one of the biggest businesses in Lloyd’s, right? So we’re not talking about a small syndicate.
On a controlled income basis, the London Market business is already at $1.6 billion. This is a big, big business. And what we are doing is growing where it’s attractive. And if opportunities present — are presented to Kate and Paul and the underwriting leadership team in London Market, they have. And if they have the conviction, they’re going to grow.
We have the capital to deploy. You’ve heard that from Paul. We’ve got a strong balance sheet. We’ve got strong capital generation. There is — the only thing we want from the business is if they see the opportunity and they’ve got conviction, they will grow.
Faizan Lakhani
Sorry, just to add a last one, so do you have a differentiated view on the profitability of the London Market business relative to some of your peers who have grown above rates of recent?
Aki Hussain
I can’t talk to anybody else’s book. I’m going to talk to our own. We have choices, right? So we have a diverse portfolio within London market. And then across the Hiscox Group, we have a significant degree of diversity within the portfolio.
So we have choices as to where we want to put our capital, where we want to put our human resource, where we want to grow. And given the choices that we’re facing, I’m very happy with the progress that the business is making.
Freya Kong
Freya Kong from Bank of America. Three questions, please. So your previous guidance for overall retail growth was to approach the middle of your 5% to 15% range in ’22 and accelerate beyond this in ’23. Are you still happy to reiterate this overall growth guidance given the slight change in DPD?
And Aki, you earlier comment suggested your writing business where rates are ahead of loss cost trends. But Jo, you were saying you expect rates to largely be offset by higher claims inflation. Could you clarify what we should take from this?
Do you expect — should we still expect to see margin improvement? Or does extra conservatism mean you will hold your margins flat for now? And just finally, could you give us some guidance on the effective tax rate given the global corporate tax implementation has been delayed?
Aki Hussain
Okay. So Paul, if you could take the question on tax? And in terms of growth rate, I’ll take that. I’ll clarify what I mean by loss cost trends and so on and so on. Maybe I’ll take that one first.
So when I say pricing is ahead of loss cost trends, this is just repeating essentially what Jo has said, which is the inflation that we’re seeing today is significantly below the pricing that we’re seeing. What we’ve then done is building, and Jo has elaborated on this and I’m sure Jo can elaborate again, building a much more conservative view in our — reserving, in our loss picks, in our pricing decisions of what prospective inflation could do.
So to your point, what’s going to happen to margins, margins will remain good. So we still believe, I think, you’ve heard me previously say that in Re and London Market, we believe we’re writing at an expected margin of 80% combined in Re and about 85% in London Market in a normalized year.
We’re still there or slightly better now. Particularly in Re, with what’s happening in the market, we believe we’re slightly better. And frankly, if the — if we’re being overly conservative on inflation, that will come through as margin expansion but probably not in 2023.
In terms of growth guidance and being in the middle of the 5% to 15% for this year and accelerating beyond that into 2023, that still stands. You’ve seen that underlying growth rate adjusting for the U.S. portfolio remediation is at 8.5%. I expect that to be a solid number for this year.
The U.S. DPD guidance. Remember, it’s a really, really important part of our business, and it’s really exciting. But today, it’s less than 20% of the portfolio, and we’ve made a small adjustment. So in terms of the overall group, it is not such a significant impact.
But as I said, and really, we as a team are really excited about where the business is going to go in 2023 once all the new business opportunities are switched on, the technology is working across all partners and customers.
And I spoke about reinsurance. That is also another really exciting opportunity. So I suspect the group overall will see income growth, and Retail will see an acceleration from where we are today.
Paul, do you want to cover the tax rate?
Paul Cooper
Yes. So on the effective tax rate, you’re right, the global minimum tax rules have been sort of delayed for a couple of more years at least. And I think it reveals the challenges of trying to implement this on a global basis.
But certainly, in the near term, our guidance on the ETR is really around the 12% to 15%. And then I think should and when that does get implemented, you’ll see it around 15% and above.
Aki Hussain
Okay. Ivan? Ivan, and then I think we’ll go to — I think there are some calls on the line — questions on the line.
Ivan Bokhmat
It’s Ivan Bokhmat from Barclays. A quick question on the investments. Just wondering whether you have made any changes to the portfolio, whether you need to put in some hedges or, in any way, which would affect the profitability or the capital charges for the investment book.
Aki Hussain
Okay. Thank you, Ivan. Paul, can you take that?
Paul Cooper
Yes. So in the short term, if you look at the portfolio, it is very conservatively positioned. I’d say 2 things on it. One is, if you look at the duration of the bond portfolio, it’s less than 2 years. And then just in terms of the sort of strategic asset allocation, you’ll see we’ve got modest exposure to risk assets, modest exposure to below investment-grade bonds.
So in the short term, I don’t see any need to change that strategic asset allocation. I think the portfolio is very well positioned from where we are now. And as Aki mentioned in the introduction, you’ll see that 2021, we’re achieving a yield of 1% on a go-forward basis in excess of 3%, so the investment return pickup on 2023 on should be pretty meaningful.
Aki Hussain
Okay. Shall we take the calls from — on the line?
Operator
[Operator Instructions]. We will now take our first question from Nick Johnson with Numis.
Nicholas Johnson
Just one question, please, on ILS. Looking forward to 1/1 next year, presumably, there’s going to be very strong demand capacity. Just wondering, based on your conversations with investors, how strong would you say investor appetite is to deploy more capital onto the ILS platform? How are you feeling about scope for further inflows at 1/1 next year?
Aki Hussain
Thank you, Nick. Look, we’re always talking to our ILS investors, and there is a degree of excitement. I think it’s fair to say that particularly our ILS investors, as you may have heard earlier, they’ve been with us for quite some years. They’re reasonably sophisticated. And they are, again, becoming more interested because the pricing is better.
So compared to, I guess, where the market was 5 or 6 years ago, there is much more greater understanding of what is the right price for these risks amongst those investors. We’re talking to them. There is the potential for further inflows in the second half of the year, but I can’t make any promises.
I think there was one more.
Operator
Next question comes from Darius Satkauskas with KBW.
Darius Satkauskas
First question, you mentioned the natural capacity experience outside of Russia and Ukraine was normal or as expected. Could you maybe provide some — a bit of color on what is normal [indiscernible] for the quarter for the second quarter specifically? That would be very helpful.
And the second question on ILS [indiscernible]…
Aki Hussain
Sorry, Darius, really difficult to understand.
Joanne Musselle
I did understand.
Aki Hussain
You got it, did you?
Joanne Musselle
Yes.
Aki Hussain
Okay. Well, Jo has got better hearing than I. She’d figure out what you said. Sorry, keep going then. Go.
Darius Satkauskas
Okay. The second question on ILS inflow, I found it interesting that inflows were material when some in the market were expecting sort of alternative capital capacity to remain limited. Do you think this is Hiscox specific or ILS funds more broadly, I think, investor demand right now?
Aki Hussain
Okay. That’s great. So given Jo heard the first question, you can take that. I’ll respond to the ILS one. Look, Darius, you probably have various statistics on exactly what’s going on with alternative capacity around the world.
The — what I can tell you is that specific to these investors who’ve provided us with just over $0.5 billion of funds, they have increased their capacity in this space but only with us. And some of it has been new money. Some of it has been money that they’ve pulled from other funds.
So if this is a — if this microcosm reflects the wider market, I wouldn’t be surprised if the — at our overall market level that capacity hasn’t increased, maybe even slightly shrunk. But we’ve been able to increase ours.
And as you may well have heard earlier, it is entirely driven by the 8-year track record that we’ve been able to demonstrate for these investors, which, as I mentioned, the last 8 years have been tough, particularly the last 5. But on a relative basis, the Hiscox ILS ones have done very, very well.
Joanne Musselle
So the first question was we said that the nat cat experience was as expected in the first half and what is as expected. I’d say a couple of things. One, we don’t disclose our actual nat cat budget for the year, but clearly, it is back loaded towards the latter 6 months where we see the most exposure. So in terms of what we are anticipating for the first half, our nat cat budget was what was on our estimates.
What’s driving that? We’ve had things like the Australian floods. There’s been some European winter storms in our Retail portfolio. So yes, as in the expectation for the first half was on — clearly, we’ve backloaded the nat cat budget for the second half of the year when obviously we have more exposure.
Aki Hussain
Okay. We are now out of time. Thank you very much for all your questions. And we’ll draw this to a close. Thank you.
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