By Jenny Ruth
Monday 26th June 2006
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Sharechat: Can you elaborate on what your "stretch targets" are for 2008? How achievable is a 15% return on equity? Judging from their forecasts, analysts seem to be sceptical?
Tower managing director Jim Minto: We were trying to re-establish the relevance of Tower - and I think Tower did have a relevance issue. In a breakup, the businesses would be more valuable. We either had to break it up or redefine Tower and show shareholders Tower could perform with the composition of the assets as they were. We set those goals which forced us to take the right direction and grow value for the future. When we first announced those goals, the analysts said this is a long way from where you are and this sounds very interesting. They took note of it. Ever since then we've referenced back to it. That was as soon as I became managing director in March 2005. We started announcing those goals then. We've been repeating them ever since, this is where we're going to over the three-year period. When I went to Australia, we had the same relevance problem. We had a business that had no market presence. It didn't have a respected market position from a growth perspective. It was an asset that was not performing. The business needed to redefine itself. What I said to the management at the time was we need to re-establish this business and grow it. We set a new business target which ended up being 71% higher than the previous year. Everyone was shock, horror. We didn't do 71% be we got 55%. We started setting aspirational goals to try and break ourselves out of that non-performing mode. We said we not only have to improve, we have to improve dramatically. When I got to be managing director, I tried to do that across the group. One thing was the return on equity issue. We've started to make big inroads. It's now over 11%. When we set it, we were something like 5%. The market did devalue our aspirational goals and said, this is all very nice but we're going to value the business at this level. There's been a gap between market expectations and our internal targets. What's happened with the share price after the result at the end of May shows that the market's closing that gap. It's saying, we're now taking a higher confidence that you can achieve those goals. There's still some gap there, but the market has marked us up. Growth rates 50% ahead of the market - that's a real challenge for us, but we've been getting those. We've been well in excess of those in Australia and PrefSure, our acquisition, has too. We think consumerism is going to have a big impact on the Australian and New Zealand financial services market. We need to be in positions where the growth's going to come from. Our customer service must be better than the market. We want productivity improvements of 10%. Our lapse rates for each of our businesses can't be worse than our market position. What's happened in the past, especially in Australia. Early on, we had market share X but we had lapse rates of X plus 5. Our book was running off faster than it was growing. That's a key goal for us. The other one is just being more productive. We've largely done that. It requires technology investment. In Australia, we brought our costs down by a third. We've been trying to hold those costs down while strong growth rates come through. Year on year, in our financial results, you can see those costs didn't go up anywhere near as strongly as our revenue went up. Revenue was up 21% on the prior period but our costs were up a much lower rate. We're looking for those productivity improvements to come through at 10% per annum. The final one is meeting that return on equity target. We're saying, let's publish our aspirational target and then we're happy to be judged by our performance. Analysts are still a bit sceptical. The result was 55% up and that was in line with market expectations.
SC: What went wrong in the New Zealand life and health business?
JM: We lost the plot. We made changes in the management team in New Zealand and we had people running it that didn't really understand the lines of business. We had a lot of general insurance experts running the health and life business. A lot of people came in who didn't have a background in the business. Our competitive position steadily deteriorated, our service levels deteriorated. We made some mistakes in the way we managed our operations. That included moving staff out of eight sites in Auckland into the Viaduct, which is very nice, but many people lived on the Shore and didn't want to come in for transport reasons. We lost a lot of skilled, experienced people in the latter half of 2004 and 2005. We lost a lot of business. To some extent that happened with the health side as well, but because we have a strong market position in health we weren't so badly affected. We still got a good share of business because we're number two. We did a poor job in 2004 and 2005 of managing margins. The underwriting margins were much poorer than those being experienced by our competitors. We weren't managing our clients well. Well over 50% of our claims team had been in the company less than 12 months and most didn't have a background in claims. For two years we didn't make any money out of our health business even though today we've got $106 million in premiums. This year is the first period where we've returned to a solid level of profitability. What we've done is recruit a very strong team and got that business back on the road.
SC: How are you trying to improve lapse rates?
JM: When a business gets into strife, once that becomes public, once your customers and advisers find you're in this trouble, sometimes that leads to a loss of confidence in your business so your lapse rates actually increase at the very time you want them to improve. That was certainly the case in Australia. They were bad in 2002 but in 2003, once we went public in the press as being in strife, lapse rates went up. Some advisers said to their customers, Tower's in bad shape, you might be better to move your policy somewhere else to make sure they're going to be around to meet your claims. The same thing happened in New Zealand. They didn't improve. In fact, they got worse. In the health business we managed to get them to improve. They're slightly different markets with different distributors. In life, a fair amount of business moves from company to company. That doesn't happen so much in health. If you take out health insurance and you might acquire some illness, it's not as easy, once you know you've got a condition, to transfer your policy to someone else. That tends to limit lapse rates. Our health business is generally a strong competitive business. We bought the Axa business in December 2000 and it was a good business. Once we had spent six to nine months building a new team and doing a lot of remediation work, we were able to get the business stabilised more quickly. On the life side, there's far more intense competition and we weren't able to improve lapses as quickly as we would've liked.
SC:Apart from that, are all the operational issues that emerged in 2002 now behind the company?
JM: In Australia in 2002 the operational issues were many. Yes, we've made very strong progress. That's a business that's got a lot of momentum. New Zealand at that stage was in pretty good shape operationally. It deteriorated in late 2004, early 2005. The operational issues we have today are different ones to 2002. We've made a lot of progress fixing those. We've got very good teams of people. The New Zealand employment market is very, very tough. It's very hard to find people, especially to work in the Auckland CBD. It's expensive to live here and many people don't want to travel into central Auckland to work. We've made really good progress, but they aren't completely behind us. We're investing in technology, things like work flow to improve service. For instance, we don't have automated work flow around claims management in New Zealand. Really that's best practice now.
SC: Can corporate expenses be cut further or are they about right now?
JM: They will come down a bit more. Although we've having to spend money to invest for the future at the moment. We're looking to see our costs remain favourable relative to growth. If we can get our costs down while we grow, that's a great outcome.
SC: How is the integration of PrefSure progressing?
JM: We had different goals for different timeframes. It's going very well. We have one management team across the two businesses that's working well. The Part 9, the legal transfer where the two statutory funds are merged is scheduled for completion by 30 September. That requires court approval. We've basically got the two businesses running together as one business. Some things take longer. I'm talking about systems integration here. We want all the Tower group business to be on the PrefSure system. We want it done by September 30 but that might be a bit ambitious. The day after we settled the purchase we had one group risk product. We tried to do as much as we could as early as we could. We feel very positive about how that's going. We've developed a goal to reduce the number of systems. Those things will take time to implement. Two retail product sets will become one retail product.
SC: What is driving PrefSure's growth and can its momentum be maintained?
JM: PrefSure was very complimentary to Tower's business. It was strong in strategic alliances and the group risk market. Tower was strong in the retail adviser business. Putting the two together gave us a great distribution footprint. Generally the market has accepted that. The analysts have bought that story. They asked questions in the market to test the validity of it. In Australia, a lot of insurance is sold off master trust platforms. Often people buy their insurance through their superannuation or have it deducted from investment balances. It's very tax effective. You can, in fact, make it tax deductible. There's a lot of growth in that area and PrefSure is very strong in that platform area. That's part of this consumerism. Consumers are tending to access their insurance, buy their insurance in different ways. PrefSure is well-positioned to that change in consumer buying patterns. They're two of the fastest growing businesses in Australia. The new life statistics to 31 March show PrefSure has continued to grow at a very strong rate. Tower continued to grow as well, although not quite as strongly. Over time, it's a challenge to keep those high rates of growth up. When we first looked at PrefSure, we though we would be number five in the market. We're now number three. We've just got the Commonwealth Bank and National Bank/MLC (ahead of us). We're ahead of all other players now. It's hard to maintain spectacular growth rates when you become much larger. It's easier when you're small. That strong growth is a very important aspect of our value proposition to our shareholders. We aspire to much stronger than market growth rates. We've talked about 50% more than the market, but we expect our growth rates will come under pressure over time.
SC: You talk about under-insurance in both Australia and New Zealand - what are the reasons for this and how do you think it can be addressed?
JM: People's mortgages have increased substantially and generally their insurance hasn't kept pace. In Australia, everybody has insurance through superannuation, often for very small amounts - they call it units of cover. Often people have $50,000 or $100,000 cover. Trustees are saying, we recognise that's not enough. They're increasing their default cover to higher levels. There are also other consumer patterns. Far more people are now working for themselves. They're working in contract-type roles. Our people, for instance, in Australia are contractors working for themselves. With those sort of people, their greatest asset is their ability to produce future income. It's really important that those people insure their future income producing capability. If they were to have an illness or be unable to work, they need income protection insurance in place.
SC: But that kind of insurance is so expensive?
JM:The reason it's expensive is so many people claim on it. In Australia and New Zealand, this kind of product hasn't met return on capital requirements because there's been a lot of claim pressure, simply because they deliver so much value. Another aspect of living insurance is critical illness, often called trauma experience, heart attacks, strokes or events like that. They find if they buy this cover, it triggers a capital payment. While they're rehabilitating, it gives them money to pay down their debt levels. Overseas, particularly in the UK, this is a hugely successful product. In Australia, only 2% of people have it. There's going to be a lot more demand for it. Once again, it's a very expensive product because of the claim demand on it. The New Zealand life market isn't growing. We have 3 ½% growth in premiums. When you consider premiums are going up because people are getting older, in reality the market isn't growing. It's probably going quietly backwards. That's going to turn around because it simply must. Logic says it should do. I think we will see more people buying insurance in different ways. In the health market in New Zealand, the number of people covered is reasonably static. The cost of medical procedures is growth at a spectacular rate. We've got medical inflation running at 8%. That's the case in Australia too. Premiums are going up period on period because there's more technology available. In New Zealand, even after six years of strong growth, there's an inability by government to fund hospital waiting lists. New Zealanders have held onto their health insurance. They want to be in control. Every day, people are reminded on radio and television why they need health insurance. If the economic position means government has to start slowing it's spending on health, the waiting lists will inevitably start to push out again.
SC: Would you consider selling the Tower funds management business in New Zealand?
JM:We recognised we had a valuable asset in our funds management business in New Zealand but it wasn't producing anywhere near sufficient returns. Our goal has been to tidy up that business and improve returns. It's close to 50% up on the prior period last year. We see the environment becoming more attractive with the tax changes and KiwiSaver. We certainly aren't considering selling that business. When you're running an operation like our's, you can't ever rule anything out for any part of your business. We certainly don't have any parts of the business for sale. We see a lot of opportunity to add more value to our businesses. These tax changes are well overdue.
SC: Given the huge amount of consolidation, restructuring and rationalisation in the industry over the last decade, aren't the opportunities for further acquisitions for Tower limited?
JM: Where we think there's some special value that we can secure by making an acquisition, as we did with PrefSure - we accessed a different part of the market and capability that we didn't have. If there was something like that in the market, we would continue to look long and hard. Our goal is to organically grow and improve our operations and improve our profitability. We will keep focused on that but we will keep looking at opportunities to see if we can do something that adds more value for shareholders.
SC: Perennially, analysts have talked about Tower as a takeover target itself. What's your view?
JM: I quite like that. If you're a takeover target, you're seen as an attractive opportunity. Our share price has risen very strongly. We're not aligned to any major bank or offshore institution. Our shares are listed and we have one major shareholder, GPG.
SC: Isn't it inevitable that GPG will want to move on at some stage?
JM: That's the reality. They owned Tyndall for six years. They've had an investment in Tower for three. They've done very, very well out of their investment in Tower. It would be close to three times that they've multiplied value because they purchased at the low point in 2003. The reality is you can't expect they would want to hold forever, but they will want to hold as long as they see Tower's continuing to add to shareholder value at a very strong rate. They're very happy with the continuing returns that are coming through. I say to our staff, lets just see that we build a very strong, valuable business. If in the long run anybody purchases it for it's strength and capability that they could add to their own, that should ensure a future.
SC: How do you rate the prospects for organic growth?
JM: There certainly has been (organic growth) in Australia. We've had very good strong organic growth. We have to secure organic growth in all our businesses or really we shouldn't be holding our businesses. The challenge in New Zealand is to get organic growth coming through. So far our strategy's been more about remedying our business. Our market share of health sales, our in force share of health cover, is 16%. Our sales last year were up 22% so we're selling ahead of our market share. That's good organic growth. People are saying it's hard for us to do it but we're doing it even in the midst of our problems. We're not doing it well enough in life but we're very pleased with the momentum. Everybody said in Australia we were gone for all money. Most of the people who say that sort of thing listen to the big companies. This is a time when consumerism is going to change buying patterns and big companies aren't necessarily well-placed.
SC: Have you a target date for getting the share price above the float price ($5.65)?
JM: If you take the total shareholder value that's been delivered since the float at $5.65, if you add in dividends, share price growth, the value of rights including the Australian Wealth Management rights, you're now over 50% ahead of $5.65 at the start. Fifty percent isn't much when spread over a period since 1999. I said at the AGM, they were 4% ahead. They're now 50% ahead.
SC: How do you imagine the industry will look like in five year's time?
JM: (In Australia) the second tier companies, the Towers and PrefSures and some other ones, have in recent years been growing much faster than the larger companies because they're more flexible and they're better positioned for changing distribution patterns. Our ability to out-perform the larger companies which don't find our parts of the market very attractive - AMP and Axa, how on earth did they let us become bigger than them in life insurance? It's because their business is funds management. I think the biggest impact's going to come from consumerism. For instance, in the UK between 6% and 8% of life insurance is sold by the Tesco chain, a supermarket chain. If that happens here, what happens to the major embedded companies? What's the future for advisers? Will the public be prepared to access products as they're doing their shopping? I think we will have a far more modern market than it is today. Some industries have modernised to consumerism a lot quicker than the life or general insurance industry has. I think financial services will change its distribution patterns and modernise itself to meet changing consumer demands. People will still want advice, but they will want more control and accessibility. They will want to access balances through their cell phones as they can with bank accounts. Companies will need to be really light on their feet. I wouldn't want to be a company that had very entrenched and embedded views. They will be out-flanked, just as the Australian life sector has been. The industry will be a much more interesting and exciting place.
SC: What has kept you at Tower?
JM: I started on 14/11/88. I've had a number of different appointments in Tower and different market positions: the trust company, managed funds, health and life in New Zealand, then I ran New Zealand and then I ran Australia. I've just had opportunities and challenges. I like turn-around situations and I like growing businesses. I just really enjoy what I'm doing. I've been very lucky to have been given those opportunities. That's what's kept me here. I'm enjoying what we're planning for the future now. You get talked to by headhunters from time to time, everybody does. They talk about people and what it takes to be successful. There are a lot of people out there with impressive CVs but there aren't a lot of people in the business world who can demonstrate they've achieved a lot if sufficiently challenging circumstances. That's something I'm proud of. I felt humiliated in New Zealand when I was running New Zealand and Australia fell over. I felt utterly humiliated. It was pride as much as anything else that I wanted to sort that out in Australia. Similarly, when New Zealand fell over, I felt humiliated again. A very high number of our shareholders are also clients. It's important to them and they expect us to deliver results to them both as customers and as shareholders. I've been very pleased we've been able to earn respect. You can never command respect but you can earn respect. And we have positions to continue to improve. We've got a really good team here now. We've come through some dark spots. There's always some movement in your team. They're hungry to be successful. It's easier to be a good manager when you've got good people around you.
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