Zurich Insurance Group AG (ZURVY) Q4 2022 Earnings Call Transcript

Zurich Insurance Group AG (OTCQX:ZURVY) Q4 2022 Earnings Conference Call February 9, 2023 7:00 AM ET

Company Participants

Jon Hocking – Head, Investor Relations and Rating Agency Management

George Quinn – Group CFO

Mario Greco – Group CEO

Conference Call Participants

Andrew Sinclair – Bank of America Merrill Lynch

Michael Huttner – Berenberg

Andrew Ritchie – Bernstein Autonomous

Peter Eliot – Kepler Cheuvreux

William Hardcastle – UBS

James Shuck – Citi

Kamran Hossain – JPMorgan

William Hawkins – KBW

Dominic O’Mahony – BNP Paribas Exane

Ashik Musaddi – Morgan Stanley

Vinit Malhotra – Mediobanca

Operator

Ladies and gentlemen, welcome to Zurich Insurance Group Annual Results 2022 Conference Call. I am George, the Chorus Call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. The presentation will be followed by Q&A session. [Operator instructions]

At this time, it’s my pleasure to hand over to Mr. Jon Hocking, Head of Investor Relations and and Rating Agency Management. Please go ahead.

Jon Hocking

Thank you. Good afternoon, everybody, and welcome to Zurich Insurance Group’s full year 2022 results Q&A call. On the call today is our Group CEO, Mario Greco, my Group CFO, George Quinn.

Before I hand over to Mario for some introductory remarks, just as a reminder for the Q&A, we kindly ask you to keep it to two questions each. Mario?

Mario Greco

Thank you. Thank you, John. So good afternoon everybody and many thanks for joining us today. Before George and I started asking — answering your question, please allow me to give you a few remarks on this year results.

This morning we reported our highest business operating profit since 2007 and also that we exceeded all our financial targets for the second consecutive three year period. This is despite several tough years where we have had to deal with many unexpected challenges. We remain agile, we focus on our goals. We continue to execute against our consistent strategy to transform Zurich into a simpler, into a more innovative and to a customer-centric organization.

I’d like to thank all of my colleagues, our customers, our partners for this remarkable achievement. We ended the most recent cycle with the BOPAT ROE at 15.7%. That indicates the strength of the underlying business performance improvement and significantly exceeds our target of greater than 14%.

The combination of robust profitability, strength of capital position, and predictability of cash remittances allowed the board to recommend a 9% increase in the dividend to CHF24, which will correspond to compound annual growth rate in the dividend of 6% over the most recent three year cycle. In US dollar terms to compound annual dividend growth would be 8%.

As we set out back in November, we will continue to focus on customer needs transforming Zurich into linear and more agile insurer, that’s prime for the future. Results continue to be seen in our growing customer’s number and loyalty with more than 2.1 million net new customers added during 2022 and an increased retention rate of 82%.

Now let me turn quickly to our business segments and start as usual with the Property and Casualty. Property and Casualty today reports an excellent combined ratio at 94.3% and record premium levels. Gross written premiums grew by 14% on a like-for-like basis with a strong growth achieved in both commercial insurance and retail business. Lower catastrophical losses and the benefits of earned rate in commercial were offset by the impact of inflation in retail motor and business mix shift towards crop in commercial.

While we expect rate increases in commercial insurance to moderate from the 8% seen in 2022, we expect to see further margin expansion in 2023. In retail and SME, given the rate increases that we have already actioned in 2023, we should see results starting to improve. In key European retail markets like Switzerland and Germany, where January renewals are important, we are seen encouraging signs.

Live; 2022 was another year significant progress for our life business. We achieved the highest profit ever despite unfavorable currency movement due to the US dollar appreciation and announced a complete sale of the Italy life back book, which boosted the SST ratio by nine points in the fourth quarter.

We also announced the sale of the life back book in Germany. That is on track to be completed in the second half of this year. Together, this transactions for the reduced balance sheet volatility and enhance our already industry-leading capital light business model.

We remain focused on profitable growth in our target segments of protection and unit linked with 2023, bringing new distribution opportunities in both Italy and Germany, markets where we remain committed despite our portfolio optimization activities.

Farmers; now. 2022 was a strong year for farmers against the challenging backdrop for US personal lines insurance. Gross written premiums at the farmer exchanges increased by 9%, driven by the inclusion of the MetLife business for the full year and accelerating levels of rates across lines of businesses. Overall, the farmer segment pop increased by 18% over the priority — the priority year period, also helped by lower COVID claims in the life unit.

Given the challenging market environment, the farmer’s team led by the new COO, Raul Vargas are laser focused on improving the underwriting performance of the exchanges, which in turn will help rebuild the surplus. As you will have also seen this morning in order to support the exchanges, effective December 31, 2022, Farmers Re has tactical increased its participation in the farmers’ exchanges Online Quota Share Treaty.

Sustainability; now sustainability continues to be a key focus for Zurich and we look forward to discussing our initiatives with you in more detail at our dedicated ESG at Zurich webcast, which will be held on the 30th of March.

Looking into the future, finally, we remain absolutely committed to deliver the strategic ambition in the financial targets that we set out in Zurich back in November for the next three year cycle. The new plan looks for us to grow EPS at a compound rate of 8% to 2025, while further increasing the BOPAT ROE in excess of 20%. We also expect to achieve further step up in cash remittances. The package as whole should allow us to reward shareholders with continued attractive growth in our dividends.

Thank you very much for listening, and George and I are now ready to take all your questions.

Question-and-Answer Session

Operator

[Operator instructions] The first question comes from the line of Andrew Sinclair from Bank of America. Please go ahead.

Andrew Sinclair

Thank you very much. Two for me please. Firstly is on the reinsurance program and just really wondered if you can talk through the changes here in a little bit more detail both in terms of cost of the program and in terms of what it means for earnings volatility, protection from the group and I suppose how much it’s actually renewed on 1st of January versus how much is still turning you through the year?

That’s my first question and then my second question is just looking at Slide 27 of the pack, the commercial lines accident year combined ratio ex times and ex COVID flat year on year at 88.2%. Just really wondered if you can give us an idea of what that would be, ex crop as well how much improvement we’ve seen, I guess I’d expect to see a bit of improvement given pricing momentum and given we saw 1.7 points improvement year on year in H1. So just what we’re seeing really ex crop? Thanks

George Quinn

Andy. It’s George. So on the reinsurance program, first we’ve made two changes. So two changes to the CAT piece of the program? So I think as I’d suggested prior to the end of the year, we haven’t renewed the CAT aggregate. We couldn’t find a reasonable economic proposition. So in the end we’ve kept that. That believe on note the expected outcome is actually a small improvement to the expected Brazil, but the expense of slightly more volatility.

So, it’s a relatively immaterial change. The volatility could be plus minus a CHF100 million, CHF150 million. Having said that, though, what we’re doing on to reduce CAT capacity on the incoming side, I think that’s more significant than that. And if you look at the more recent estimates on the events like Ian or Elliot, I expect that the efforts that we are undertaken to cut CAT exposure on the incoming side, probably more significant than the small negative impacts from giving up the CAT aggregate.

At the same time we’ve added a bit more coverage at the top of the program. So, that’s — it’s not a replacement for the CAT aggregate, and it’s more I was thinking about in particular events we haven’t seen yet. So things like quake and where our covers exhaust and particularly in the context of very significant events.

So having looked at that, with some support from some advisors, we concluded that we wanted to have a bit more coverage up top. Overall for us, we’ve seen a relatively modest change in the reinsurance program. Most of what we’ve done its non-CAT January 01, with the exception of the two things I’ve mentioned. And they’re not really that significantly impacted by the current market conditions.

Probably the key date for us is April 01. That’s when we renew the US tower. So, you guys already have seen the impact on some of the US companies that renewed January 01. As you would expect, the argument that we advance to our reinsurers is that again the actions that we’re taking on the incoming side of CAT means that there’s already a fairly significant reduction in exposure. We would expect that to be part of the consideration when we look at the renewal of our US CAT tower on April 01.

So still to renew that piece but so far, no significant impact and certainly no impact and excess of what we assumed when we put the targets together back in November.

Andrew Sinclair

Any Solvency any solvency impact as well. George?

George Quinn

It’d be tiny. The — if you look at what we pay for CAT cover overall, a 10% rise and, what we pay is something like CAT10 on the combined ratio. So, you need massive changes to have massive impacts on the group’s numbers, and we just — we just don’t see that. And we’re not dependent on reinsurance in that way.

So, commercial year-over-year, so if you look at crop so, crop has actually had — it’s had a decent year? It’s slightly higher than we would’ve assumed in our plan. So maybe we are about a 100 Bps higher overall. There’s a small issue of first half, second half comparison. There’s a bigger issue of 2022 versus 2021.

So last year was actually a pretty good year for crop. And if you look at the gap between last year’s outcome and this year, you’ve got about a 200 basis point difference. If you are low for the fact that crop is, somewhere about 12%, 10%, somewhere 10% to 15% of premium volume across all the commercial and you’re going to end up with somewhere in the mid double digit basis point impact. So if you take it 88.2, we would be in the high 87 once you adjust for crop.

Mario Greco

So not a bad year for crop, but certainly a weaker one that we had last year and a weaker one that we expected.

And, the number on the page you mentioned is includes crop. It does. Just to be completely clear on that,

Operator

The next question comes from the line of Michael Huttner from Berenberg. Please go ahead.

Michael Huttner

Good afternoon and thank you and well done for beating all your records. I had two questions. The first one is on cash maintenances. I was actually hoping for more, it seems a tiny improvement. I know I’m being really demand — probably wrong or headed or something, but CHF4.4 billion rising to CHF4.6 billion doesn’t sound like a record year in many of your business lines. I just wondered if you can give some color of what drives the cash from instances.

And the other thing is also a very general question, 265%, what are you going to — you bathe in this every morning. I would love it, but what you going to do with all this money? I saw, on the tape, and maybe I’m misread, but buybacks are not your big thing, so that’s fair enough. But I just wondered if you — and I know you did have a couple markers then, and you kind of addressed this, but 265% is extraordinary. Thank you.

George Quinn

Thank you, Michael. So, in cash remittances for us yeah, I’m a better like you. I always want more for businesses as well. I think if you look at last, I think the outcome overall is really good. So we’ve certainly landed where we wanted to land.

I think there were — there were upsides that we have not yet taken on the cash side. So if you look around some of our businesses, and some of you who’ve been on this call for longer will know that we’ve certainly got one business that just seems to have a slight structural issue around being able to remit all of its earnings in the form of cash after one of our more significant businesses. And it means that periodically we go looking for a special dividend from that business. That’s something we’re still working on.

That offers upside to 2024 and 2023, I hope. I think on the — it’s not a big negative, but one of the small challenges actually in a rising interest rate environment is that some of the local statutory balance sheets on the life side can end up being a bit long. And therefore this can exert a wee bit of pressure on life cash remains.

But, overall, we are really happy with the outcome. We’ve still got a number of pockets or pocket, they’re not small pockets. We’ve got a number of pockets that we need to address and increase the cash remits going forwards. So there’s room for more, but I think we’re pretty happy with, we achieved last year.

On the capital topic, so, you absolutely rate, it’s a huge number. It doesn’t yet include obviously the impact of Germany, which is still to come, but again, I think you’ve probably read on the wires commentary that was entirely consistent with what we said back in the Investor Day in November.

As everyone knows, we’ve got a buyback that’s underway to address the expected dilution from the sale of the German business. There’s a bit more to go on that. We were not quite halfway through that by the beginning of February. Beyond that, our preference would be to deploy it on growth.

We’ve talked before on these calls about the dynamics of SST and the extent to which organic growth drives it. It’s nice to have the option given what we expect in terms of growth over the course of the next three years. I don’t expect it to be that capital intensive. So that again gives the business freedom to look at other ways to deploy capital again, to support growth, to deliver more in terms of earnings and deliver more in terms of dividend. So, a preference beyond what we’re doing at the moment is growth.

Michael Huttner

That’s gross. Lovely. Thank you very much.

Operator

The next question comes from the line of Andrew Ritchie from Autonomous. Please go ahead.

Andrew Ritchie

Hi there. First question, just on the underlying accident loss ratio 60.8 in the full year, I just want to understand if there’s anything I should do to that as a starting point. I think it looks like crop was running around 96, so there’s a small adjustment down if I, if I assume crop is mid-nineties normally. Is there anything else?

For example, was there a particularly you know, maybe a, a conservative booking on some more inflation exposed classes in the second half? Or, and I guess maybe, you know, was there any particular negative one-offs on retail? So really it’s just to understand, is that the right starting point, obviously adjusting maybe 50 bits for crop.

The second question on farmers, I’m just trying to understand why, why is eight and a half percent the additional quota share the, the right, the right number? It looks like you’re just replacing a third party reinsurer who’s — who’s come off is, is therefore 35% surplus.

Do you think that’s fine from this point for farmers and you are confident there’s organic capital generation from here, or, or do you still think there’s more capital actions need to take place rather than just waiting for the earnings to come through? Thanks.

Mario Greco

Hey, thanks Andrew. So on the, on the underlying, crop would be the obvious thing, I think on, on the lost picks around what we’ve booked. We haven’t deliberately been any more conservative than the commentary I gave already at the half year. So we maintained the stance we had around things like GL and commercial auto.

So we didn’t change the direction on those topics. The only one, the only one, it’s a small number, but it’s, it’s quite hard to judge and that’s first half, second half on commercial. So if you look at the two, two half second half is about a hundred bits higher. It looks as though that’s just the kind natural fluctuation of the book, given that we can still see underlying improvement on the lost reserve picks versus lost cost trend.

So maybe on commercial, the, the answer is somewhere in between H1 and H2, but it’s going to be a small impact at the end. So I think crop assuming we take the cat the equation and we adjust for the COVID topic and the prior year, which is also quite small that I think gives you a reasonable indication of what the underlying is and there’s no reason to think crop isn’t still a mid-’19 business.

Yeah, no, so her view hasn’t yet, we planned this somewhere around the 94 level. So it’s a bit more than a hundred basis points higher than we would expect currently. Last year we were about 92. We’ve been lower than that and we’ve been higher than that over the course of the last five years on farmers. So yeah, we have increased our participation on the quarter share.

Obviously the market is a bit more challenged for the exchange currently. I think in the end I think our view, and I think the view of the exchange is too, is that in the end, this, this is not a surplus issue. This is a profitability challenge that they need to solve. And by solving that profitability challenge all the other things that connected to the exchange that would including the surplus which would read questions at 35, they go away at that point.

So I think overview is that that there’s no need unless there was a, so, so maybe I’ve explained what the exchange is doing, and then I’ll come on to the, the more positive side of it. So obviously the entire US auto market has a bit of an issue. There’s lots of rates being pushed through at the moment you’ve seen already in today’s release what we see in terms of what the exchanges have been doing.

Exchanges have a bit of a challenge as anyone would, that’s got more of a concentration in California because that’s a bit slower on rate approval. But, having said all of that, we can see the we can obviously see trends on a shorter time horizon than the ones that we publish. We start to see some improvement, although it’s still got a long way to go on the exchange. And therefore us supporting the exchange to the capital level that they’re targeting, I don’t think it needs more than that.

If on the other hand, and I think I said this at the investor day already if the exchange get to the point where they’re in line with their profitability targets, and to put it in context, somewhere around 101 is kind of neutral, you need somewhere closer to 98 for the growth.

If there was a really attractive opportunity for growth and the exchange needed support for that, then obviously that would be something we would consider because of the benefits that would bring us. But we’re, we’re not at that point today.

Andrew Ritchie

And just to be clear, does the exchanges renew its CAT program at mid-year?

George Quinn

So the exchange has a staggered CAT renewal. So you’ll see that get renewed over the course of several years. So they’re not completely exposed to the impact in a single year.

Operator

The next question comes from the line of Peter Eliot from Kepler Cheuvreux. Please go ahead.

Peter Eliot

Thank you very much. Two for me please. The first one was on the outlook. I guess I was a, just a bit surprised that you refrained from giving your sort of many of your usual outlook items. And I know we’ve got IFRS 17 but even given the change in framework, I’m sort of thinking year on year comps are probably still relevant for premium growth, investment income, etcetera.

So, I’m just wondering if you could sort of elaborate on your thoughts and, and in particular whether there’s any help you can give us on the, the life outlook.

Second one non-core, just really what you did say in the outlook, it, it sort of sounds like you’re possibly expecting further reserve strengthening given the comment of, you know, less negative.

So just wanted to check whether that’s the right understanding. If I can be very cheeky and just ask for a clarification on the, the answer you just gave to Andrew as well on the commercial George because you said H2 commercial is about a 100 basis points higher than H1, which is natural fluctuation.

I’m just thinking, given the margin expansion that’s flowing through, I would’ve expected that to be lower. So the delta is more than a 100 basis points, but I maybe you could just clarify those dynamics would be very helpful. Thank you.

Mario Greco

So on your sneaky question, you’re absolutely right. So there’s — but I guess I would characterize a slightly more than a hundred basis points you would expect to see more on the first two questions. I, so, I think that the challenge on Outlook is it’s got nothing to do with our clarity of visibility of where we’re headed.

And in fact, of course, that’s incorporated in what we said back in November. It’s just that we could be dealing with different metrics even if the substance is the same we’ve got changes to headline things like revenue coming away.

We’re going to have a different treatment of combined ratio. So there’s a whole series of things I think we need to restate for people, which is the mathematical and mechanical part of the process. And we’ll have that all in front of you come q1.

And I think that’s just an easier point at which to get a bit more detailed around where we’re headed from an IRS 17 perspective. So we, we avoided doing it today, not because of a lack of clarity about where the business is headed. It was really that we’d be talking a slightly strange language.

I think for most people who are not yet familiar with it. I, I think on the life topic, again, we’ll cover it in more depth when we get to Q1 so that you guys can prepare for the first half. But, there’s a, there’s a relatively simple logic.

In the current models the insurance companies apply under IFRS, you’ve got a combination of a book of business that’s pretty locked in, generally pretty stable. There’s a consistency to that that flows into the new system, albeit in a different way.

So volatility is also dampened. But the dynamics around that piece, I don’t really expect to be, to be vastly different from what you’ve seen today. And I guess most people are setting up to try and make sure that they’ve got the right risk adjustment to make sure that we don’t get unexpected amounts of volatility from CSM amortization on the thing that is different, it’s different. No, I think over time it converges.

So again, a pretty characteristic a pretty consistent characteristic of life businesses, the impact of management actions, I guess it’s analogous to P Y D on the p and C side. That part will get smoothed. So eventually once you’ve smoothed enough of it, you’ll get a similar impact to what you see today but you don’t have it in the starting point.

So I think the way to think of this is there’s an underlying core component that I think behaves in a similar but not identical way to IRS four. And it will take time to build the same effect from management action as you have an four. But, having said that one of the comments we made back in, one of the comments I made back, I think already in September was that if you look at the group overall of man earnings trajectory, I’m not expecting a significant change.

You might see some change, relatively modest changes between the segments and non-core. So I think we’re just in artfully worded the commentary. So if, if you look at what we’ve got and non-core, you’ve got two components that are driving the, the outcome today.

We’ve got something that I think you’ve seen in the past from us. There’s a di book in there, it’s got some market related features. So there’s a, there’s a Weber market volatility. Typically it’s been relatively modest. We’re talking low tens of millions positive or negative in any given year.

I think what’s different this year, so you saw it in the first half, we, we moved a booker business into non-core with the intention of disposing it during the pandemic, well, not disposing it during the pandemic, but we had moved it during the pandemic with the intention to dispose of it afterwards.

And I think what we discovered there is that the experience that that book had during the pandemic was not as representative as we would’ve liked it to be of future claims experience. So it’s taken us a couple of bites to correct that this year. But I think at this point, I, I don’t expect to see a thud on this topic.

Operator

The next question comes from the line of William Hardcastle from UBS. Please go ahead.

William Hardcastle

Hi, afternoon everyone. Thanks for taking the question. I guess first of all, just thinking about motor on the retail side, could you talk through those geographies that are causing the greatest strain in motor inflation? And is this part or bodily entry related? And I guess, what is it that’s changed reasonably significantly? Two H versus one H here? And, and as an extension to that, but I, I will let this be the second question. Are you able to give any updates on the outcomes of the major renewals at January for Switzerland and Germany in these retail portfolios? Thanks.

Mario Greco

Yeah, thanks Will. So yeah, I’m going to, I’m going to focus the comments on motor retail. I, I, I think that there are similar issues on commercial. So you could read across but I think there is one reasonably significant difference. So anyway, more retail. I, I think the, the big driver it continues to be the CPI, the inflation driven component which means it’s still mainly a whole or issues connected to whole issue.

We’re not as big as some of the other markets where there are bi severity issues. So for example, if I look at a market, we can see data on, which is the us but we don’t have the direct exposure to maybe the mix of maybe the issues that are driving the market are slightly different to what we see in Europe.

And I guess that’s probably more a function of the, the health and legal system there. So Europe mainly a very traditional challenge. And the reason you see deterioration in the second half it’s just a continuation of trends that we saw in the first and the inability to take rate to offset it.

So, to some degree that’s what we expected to see in the second half of the year. So anyway, so that, that’s how we get to the second half of 2022. So what about 2023? So, at this stage, we’ve got pretty good insight into renewal for Germany and Switzerland as of Jan one, for both of those books, we’ve got a reasonably significant renewal. So we’ve got a good understanding of where we think it’s headed.

So I think Germany first, the way I would characterize Germany would be that assuming that assuming that we see inflation levels that are similar to what we saw last year Germany has achieved the price increase that will address that, and we’ll start to address part of what we saw last year.

I think it’s a most likely a multi-year process. Maybe, maybe there’s a couple of years of rate increase required to get this business where we think it needs to be, but there is a significant step in Germany as of Jam one.

It’s what we expected, so it’s not, it’s not a surprise to us but it’s obviously we’re very pleased to see it take place in reality rather than forecast. Switzerland’s a bit different. So in Switzerland it has, so obviously it hasn’t seen the same levels of inflation that we’ve seen in other European markets.

Having said that, by Swiss standards, we’ve seen some pretty chunky numbers, but we’re talking two and a half, 3% rather than nine, 10% in other markets. And the team here they’ve taken a more targeted approach to the renewal. Again, they’ve put some fairly significant rate through for some key parts of the portfolio.

It’s a pretty significant proportion of the portfolio overall, and again expect that also to address what will happen this year plus start to catch up on what we saw in the prior year. However, in both markets, we expect more price action required. But the, the first steps we’ve seen on January one this year it’s a good sign of where the retail market is headed.

Operator

The next question comes from the line of James Shuck from Citi. Please go ahead.

James Shuck

Yeah, hi good afternoon. I just wanted to spend a bit more time on that retail deterioration app full year, please. So the fully accident, year loss ratio in retail up 1.9 points at full year and I think you’re saying that’s used to the frequency and inflation, and some of which you’ve talked about just now that that’s up from the 1.3 points at 1H. At 1H you really called out expenses and loss ratio actually being better.

So just like to focus a bit more on the discreet second half of the year because it seems as if the, the crossover between rate and claims inflation seems to have happened the most at that time. And I hear the comments about the outlook going into ’23, but I guess my theory is that this seeing nominal rate increases but not rate in excessive claims inflation once we adjust frequency as well.

The second question was just returning to farmers. So again, I, on the eight point a half percent closer share why is it you’ve chosen to do a closer share? Because it, it farmers as a volatile business and, you know, 10 points plus or minus on that combined ratio is not an insignificant number to the Zurich group earnings.

So can you just talk us through a, is that a multi-year close share why you settled on that and, and, and why you didn’t do other alternatives such as surplus mode, for example? Perhaps I’m also interested in why it didn’t actually require any extra capital in the, in the target capital that you have in the denominator of the sst, thank you very much.

Mario Greco

Yeah, thanks James. Yeah, so, so on the first one so to put in, I don’t really want to quote a number today in Germany but it’s in double digits, not high double digits, but it’s in double digits. So in our opinion, it’s enough to deal with nominal frequency and part of the prior year, not enough though, to put Germany in a position where we would be satisfied with the return again, on that line of business.

And the German team themselves identified that in the conversations that we were having with us last September. So there, there’s definitely be, there’s definitely more to be done, but we think it not only addresses what we’re currently seeing addresses part of what we had last year, so, and we feel pretty confident by that on the farmer’s question, so, yep.

So maybe I’ll start from the end. So it’s a, it’s a very good question. So target capital, it, it will have a relatively small impact on target capital, but it will build as the reserves build.

So that’s why you’re not seeing it yet, but we’re talking, something that’s in the up to mid single digit impact on sst. So it’s pretty small overall on the, on the why this and not something else.

So, guess that if you, if, if you cast your mind back to, to 2015, which was probably the last time we were a very significant participant on the quarter share, some of you will remember that we actually had some pretty significant amounts of capital up against that. Again, I think many of you aware that the nature of that contract has changed significantly over the years because of discussions between the exchanges and their reinsurers.

And the particular form of that contract that worked for both the exchange and for the reinsurers. The nature of the risk that the contract carries is a bit different than it was before and therefore the amount of capital required would be more modest than it was in 2015.

It would also be reflected in the fact that the potential volatility would be more modest than it had been previously. In particular, CAT is capped and cat is now more dealt with through the CAT covers that these changes place. So I, I think it’s an overall Zurich perspective.

This is probably the simplest the most straightforward and sound Zurich will benefit from the, the way the exchange and its reinsures have changed the structure of the contract over the course of the last several years and I think that combination is really why we’ve done what you’ve seen us do.

It’s a simple and straightforward way of addressing the the challenge that they currently face and gives them some time to deal with their plans around the improvement in the combined ratio.

Operator

The next question comes from the line of Kamran Hossain from JPMorgan. Please go ahead.

Kamran Hossain

Hi. Afternoon everyone. Two questions. The first one is on just back on the farmer’s quota to share, could you maybe talk about the profitability assumptions you’ve made in I guess the increase there? Is it 101% as you mentioned, as kind of the target level, or is it, or is there something else there?

The second question on the commercial line cycle, could you talk about the impact that the reinsurance market changes, you know, changes in terms of price, structure, etcetera, it’s likely to happen in that market, I think at the investor day in November.

You said you expect the cycles to probably, you know, tail off in, you know, by the time we get halfway through 2023, do you still think that will be the case with all the changes in the reinsurance market? Thanks.

Mario Greco

Yeah, so thanks Cameron. So I want to avoid that I end up giving out the plan for the exchanges on the combined ratio. I think probably the best way to look at this would be that, we’ve significantly increased our participation in the quarter share but we’re still a, a small minority compared to the others, and the others are there because they expect to make money.

So maybe if you combine that with the comments I gave earlier around where the neutral points is, that that gives you some sense of what the market anticipates from the exchanges. On, on the second comment on the, or the second question on rate.

So, I think if you go back to the comments that I made earlier around the, the more differentiated view of what’s happening on rates at the moment, so if you look at what we see in the market towards the end of last year, somewhat predictably property is the one that maybe sees the maintains a fairly strong trend.

And if fact, if we look at our numbers from a, an North American perspective, we would see property rate ticking up at the end of last year. So that, that may be partly connected to reinsurance may be partly connected to the continuing concerns around risk of inflation at that point; difficult to attribute it entirely.

But you certainly see the line of business that it probably impacts the most in the strongest position. I think in general, one of the things I think as we look out through the remainder of this phase of the, the commercial cycle, it’s going to get very differentiated. I think I mentioned this earlier, if you look at the different lanes things like property motor they’re still in pretty good shape also in good shape workers comp specialty, they’re around the same positions they were at before.

So, slightly negative, fairly flat towards the end of last year and you’ve got primary gl somewhere in the middle of all of that. The more negative one is financial lines in particular d and o. So that is softening currently mean it’s probably the part of the market that’s all the biggest run up. It’s not the biggest part of our book, so we’re, we’re not as exposed to it. But that part of the business or that part of the market is showing a different price characteristic to most of the other lines at this point.

Operator

The next question comes from the line of William Hawkins from KBW. Please go ahead.

William Hawkins

Hello. Thank you very much. Judge, is there any evidence that you point to for building prudence into your current accident? Ear loss picks. Normally that’s very much what will be, would be expected at this stage in the hard market.

But when you’ve been discussing, the flat commercial lines combined ratio or the underlying loss ratio, I haven’t really kind of heard you emphasize that potentially quite positive points. So could you talk a little bit about prudence and how it may or may not be changing in the loss picks?

And then secondly, please, on slide 21 so we’ve now got the 6% rate increase across the book. Can you tell us a comparable inflation figure that we should be netting off against that? And just to make sure I’m gauging it correctly, I think this time last year that 6% was seven. So if you could remind me what the inflation equivalent would’ve been a year ago as well, please. Thank you.

Mario Greco

Yes, sorry. Well, I didn’t understand the second part of the question. You said the 6% was…

William Hawkins

6% to 21. What’s the inflation and can you just remind me the inflation figure equivalency here?

Mario Greco

Okay, so, all right, I got it. So on prudence. Apologies. I should have spent more time on that topic. The so, again, to take you back to the some of the reserving decisions we make made at the end of Q2, end of the first half we touched a number of, again, probably the more social inflation exposed lines of business.

Not necessarily because we saw experience that was a source of concern as a precautionary step. So I think I may have mentioned earlier, primary GL and commercial auto were two targets for that. And we haven’t changed that stance through the end of the year. It’s also a characteristic part of our reserving process that we don’t accept as a basis for reserving the lost pick chosen by the underwriter.

We and certainly for most of the last two, three years have added a margin to that. And that’s designed to build up within a range of acceptable levels of prudence additional assurance that we have less exposure to the risk that we see adverse development on some of the reserve lines. And then finally, if I tell you the usual worker’s comp story.

So, I think, from the prior conversations that we’ve had that if you look at rate on workers comp again for the end of last year, beginning of this year, kind of flat-ish, slightly negative, if you look at lost cost strain for in the mix that we think is for our book, something similar to that, so not vastly different we’ve still maintained a relatively long run view on the parameters that we choose to include for the reserving decision.

If you chose a shorter term perspective, so say you took five years rather than 10 years, that’s a very significant surplus to reserves. So I think the traditional areas of prudence that you’re familiar with in our book continue to be there.

We continue to follow the same processes around trying to make sure that we we add appropriate prudence to the assumptions that the underwriters make when they write the business. But, but in terms of our overall philosophy, nothing has changed. So we’re doing the same things in the same way on the, so on the inflation topic.

So it varies a lot by line of business. So maybe if I focus on the area where I think it’s probably you have most transparency for all of last year we’ve talked about the fact that for the US business we’ve got a lost cost trained a, sorry, we’ve got a rate increase that’s around 8% across all lines of business inflation.

So if, and if I exclude exposure changes from that so look purely at severity and frequency excluding, we still see it somewhere around the 5% mark for commercial picture in Europe is different. In the conversation I had earlier with James he highlighted the fact that obviously retail in Europe in particular did hear it in the second half of the year, which is a saying that lost cost strain is an excess of the pricing that we’re achieving here. But that’s probably the best guidance I can give you.

5% is the same as what you would’ve said a year ago for North American commercial. Isn’t that strange? Shouldn’t it almost inevitably be higher? So, so if you break out where we were on commercial last year and you look at the loss picks we’ve added to it, it’s still around 5%, but we’ve added a point to commercial auto and a point to primary gl.

Operator

The next question comes from the line of Dominic O’Mahony from BNP Paribas Exane. Please go ahead.

Dominic O’Mahony

Hello folks. Thanks for taking questions. I just got a couple of questions on, on Capital Generations. I’m on Page 45. Just looking at economic profit business growth. The first thing I just wanted to check on is the AFR generation 5.0% this year?

I think it was 5.5% last year. So that’s defining despite the op profit in I going up, just trying to help, I wonder if you could help me bridge why one is going down a bit and the other, the other one’s going off a bit. Second question is on the target capital. George, I think earlier you, you were saying that you expect the growth to be pretty capital light.

And I think actually the third capital went down a little bit in H2 is up 0.5 in H1. On a run rate basis, are you expecting this sort of 0.4 to be roughly 5%-ish? I realize that the quota share will increase it in 2023, but is the rough expectation that this will be flattish? And broadly does this matter for, for cash REITs or, or is actually the Swiss solvency lens? Not really very useful to think to thinking about your, the cash REITs. Thank you.

George Quinn

Yeah, thanks Dom. So, so on the second question first, the so, so obviously part of what’s driving the dynamics that you see on AFRS versus target capital is impact of interest rates. So it’s part of what impacts the first half of the year. It impacts it again in the second half of the year. So if, if we end up in a reasonably in a slightly more stable environment, I think it would be flattish. I’m not sure we’re going to be in an entirely stable environment.

I guess the outlook seems to anticipate that we’ll see a bit more rise potentially followed by some reduction at some stage in the future. But if we don’t see it at the same pace as we’ve seen, whether some of the historic changes we’ve seen last year, it should be pretty flat on SST is a, it’s a good guide to the overall risk appetite perspective the firm has and how we manage capital from a consolidated perspective.

But it doesn’t say much to cash remittance certainly in short term periods. Cause of course those cash remittance numbers are typically driven by the local statutory requirements. And they can and frequently do deviate significantly from SST over time, though again in a stable environment. So if we keep interest rates relatively stable, given the relatively short gen duration nature of the book, the two things should be more in sync than perhaps we’ve seen last year.

On the capital generation topic, so five AFR versus where we are from a reported profit number. You can obviously get a number of differences at the margin. I think the way I would look at this I would probably work off of the operating profit number and tax it, the impact of in particular gains that appears in the NEAS number can really distort this because of course we, we’ve got a mark to market perspective on AFR. And I think if you work off the bulk number, you’ll get, you’ll get something that’s probably a bit closer, is my expectation.

Dominic O’Mahony

Thanks, George. And just to understand, given the bot went up but the AFR went down, is that just an anomaly to do with rates or, or is that something else?

George Quinn

So the rates are going to have an impact on that because of what you saw in the prior year, partly through the impact of discounting the discounting, that’s lately to be the main driver, but I, I need to look at it in more detail and come back to you with a bare answer.

Operator

The next question comes from Ashik Musaddi from Morgan Stanley. Please go ahead.

Ashik Musaddi

Thank you and good afternoon, Georgia. Just a couple of questions I have is first of all, again, sorry, going back to this retail inflation topic. I agree Italy and Spain is relatively small for you, but the combined ratio in both Italy and Spain has gone up significantly in second half versus first half. So could you just give us some color as to what is driving that?

Is it just like general auto industry or is it anything specific to Zurich here? So that’s the first one and second one is going back to the capital question again, clearly you have a very big solvency ratio at the moment, two 65%, but what is your view of excess capital in that? And I would say excess capital, which is fungible as well, not necessarily just a ratio perspective.

If you want to deploy some, some cash to do m and how much cash you can extract out of that two 65%. The reason why I’m asking is, your leverage looks like more or less full, at least on the current FS four basis. So I just want to understand how much of cash liquidity you can gather within the business. Yeah, please two questions. Thank you.

Mario Greco

Ashik, I need to tell you that we’re all smiling here on the other side of the, at your question. Yeah, because we’re, we’re all probably all thinking of ways we’re not going to answer the second part.

Ashik Musaddi

Yeah, obviously ask questions at the risk of Yeah. With this, but yeah, worth trying, I would say for

Mario Greco

Yeah, so let me try to be more helpful than just a straight out I’m not giving you an answer that anyway. So let me start on the retail thing. I, I don’t think it’s different from the store there are some local dynamics and both businesses that are relevant.

So for example, in Spain we have a pretty significant investment program running in the business to try and expand and it’s just increase our geographic coverage in the market. In Italy, it’s probably more the traditional effects that we’re seeing elsewhere driven by lost cost trend. But in both markets inflation is likely to be the principle driver of what you’ve seen in the second half of the year. And it, and, and it is auto that’s prime, home is not much definition.

If you look at Germany in particular you don’t see a very different outcome on home. So I would pick out both of those lines of business as the prime factors. So it’s on the SST topic. So, again, given the comments that I made back at the investor day around our ambitions around leverage and the fact that we’re probably lowly to dele a bit, given that the cost of financing is increasing.

We don’t have an awful lot that’s maturing over the course of the next year or two. But it’s going to get more expensive to run that and we’ve certainly got enough cash to lowers that option if that’s what we choose to do. More generally the company obviously has significant flexibility given the way we generate cash across the group.

Obviously I, I want to avoid, I’m going to get into a number that I need to specifically update on a regular basis, but it’s a feature of the group that we tend to we have a strong preference for businesses that we can measure, not only in terms of the actuarial judgment, but also in terms of the cash they can provide to the group to underpin that actuarial judgment. And that that’s not something that’s going to change.

So I think when you look at as necessarily from an earnings perspective it’s pretty clear how much of what we generate we distribute. So, you’re getting 75% more or less back on a regular basis. We retain the additional piece and we also retain, of course, any cash we generate an excess of the earnings levels.

And I think I mentioned earlier in response to Michael’s question that, we regularly undertake exercises to, I guess I would say liberate cash that’s not needed in the various businesses and bring it back to the mother ship. But, mean as you would expect with such a significant capital level, we, we have significant flexibility.

Operator

The last question comes from the line of Vinit Malhotra from Mediobanca. Please go ahead.

Vinit Malhotra

Oh, thank you for the opportunity. Last question. Sorry. The, the life side, just, I often ask this, George, your life numbers frequently hit the ball out of the path, particularly when you look at the guidance and again, it’s happened again and again. The guidance is very weak. I don’t know, which is very light, very cautious looking.

I’m just curious about the life fighter, but also you know, there’s a shop for an NBV, there’s some assumption changes. Are you not happy with the mix mean setting protection? And, and, you know, are you trying to de-emphasize protection a little bit in this high interested environment? So that’s one of life. And just very quickly follow up this slide 25 the 60.8 underlying cost ratio.

When I compare to 59.8 ex COVID last year, is this, this one percentage is seems to be mostly explained away by drop. And then there’s also mortar, there’s also, you know, effects of pricing. How should we think about this? Sorry, just to be very clear, 60.8 minus one point of crop make. Is that how we should think of it and then we apply some margin or how should we think of it? This one, thank you.

So, I think the, to the, to the last part of your question, more or less yes, would be the approach. I think to the first part of your question, it would imply a lack of satisfaction with a life business if I was to agree with any of it. And I don’t suffer from that. I think we’re really happy with how the life business performs. We’re really happy with the, the transformation that the life business has undergone.

So if you think of it what the firm, what are life businesses achieved against what they were doing alongside supporting the clients? I think it’s a fantastic outcome. Again, I think the implied criticism around the life guidance is entirely valid. But it doesn’t make me any less happy about the overall outcome on the fallen NBV.

That’s really a 2021 topic in the end. So if you, if you think back to the end of 2021, we talked about the fact that we were, we were positioning afr for I a 17 because of the, the, the requirement for a certain level of consistency and best estimate assumptions.

So we were trying to make sure that we had the life AFR and exactly the place that we wanted it, and we’d reduced life AFR at that point that then gets caught up in the new business models that come into production for jam one and the following year. So part of what you’re seeing in the fallen new business value is really that decision that we made in 2021. There’s a, there’s a secondary impact. With interest rates rising, there’s a bit more competition around the, you know, length business.

So that has a bit of pressure. But I think if you look at the new business margin even after the change, it’s still, we think pretty good. It’s pretty strong. So from a, from a mixed perspective given that we make a big song in dance every time we produce a presentation about the mix of our life business, it’s a saying that we actually really like it. And we’ve got no intention to deemphasize protection.

I think in our philosophy, emphasize underwriting, whether it’s p c or in life and therefore we like protection in life where we get the chance to, to underrate it in the right way. It’s a strong preference to do that. So really happy with life. I think the caution on the guidance, just going back again to, I think it was Peter’s comment.

It’s got nothing to do with what we expect for the year and just the fact we, we’ve got a change of metrics coming up and about I was thinking it maybe in three months, it’s probably a bit quicker three months.

So, you’ve seen, I hope the the supplement, at least the structure of the supplement we’re going to, we’re going to hand out. So you’ve got a sense that even if the business is not changing, some of the, the ways that we describe it are about to. So rather than out some IRS four guidance, which, I’m sure most of you could probably interpret I thought it’s, it’s just more helpful to give you more general guidance lean on the fact that we’ve given you already an outlook as far as targets from last November concerns. And then we can have a more detailed conversation when we get to q1. And we actually have the new structure in front of us.

Operator

Ladies and gentlemen, that was the last question. I would now like to turn the conference back over to Mr. Jon Hocking for any closing remarks, please go ahead.

Jon Hocking

Thank you all for dial in. If you’ve got any external questions please get in touch with one of the IR team. Thank you very much.

Operator

Ladies and gentlemen, the conference is now over. Thank you for choosing CHO score and thank you for participating in the conference. You may not disconnect your lines. Goodbye.