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Gjensidige Forsikring ASA
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Good day and welcome to the Gjensidige Q2 2018 Results Presentation. Today's presentation is being recorded.At this time, I would like to turn the conference over to Ms. Mitra Negard.
Thank you. Good morning and welcome everyone to Gjensidige's third quarter earnings presentation. My name is Mitra Negard and I'm Head of Investor Relations. As always, we will start with our CEO Helge Leiro Baastad who will go through the highlights of the quarter, followed by our CFO Jostein Amdal who will run through the numbers in further detail. And we will have plenty of time for a Q&A at the end of the session.Helge, please?
Thank you, Mitra. Good morning and welcome, everyone. This has indeed been an extraordinary year for Gjensidige. The currents of extreme weather events continued into the third quarter, this time with a heat wave we have not seen in Norway in a long time and a dry summer since 1947. This took us all by surprise and naturally impacted our results significantly compared with the extraordinary strong results in Q3 last year.Our results are summarized on Page 2. Profit before tax amounted to NOK 964 million in the quarter. This result does not include the pre-tax profit of NOK 93 million from Gjensidige Bank, which is recorded as a discontinued operation from this quarter. We had the premium growth of 1%, 0.8% in local currency. The underwriting result amounted to NOK 573 million and the combined ratio was 90.6%. For the third quarter in a row, extraordinary weather conditions drove frequency claims high above last year putting pressure on our underwriting result in Norway. Large losses were also considerably higher, partly due to weather adding to the deterioration of results.The intense heat waves and the drought led to significant crop failure in Norway having a significant position in the agricultural sector and customers with crop insurance, we do expect sizable claims currently estimated to NOK 80 million. Our property insurance line in Norway was hit by fires as well as damages from heavy rainfalls and storms during the quarter. And in general, nice and warm weather lead to higher leisure activity and more accidents. We estimate the weather-related deviation in frequency claims in the third quarter related to property and crops compared with historical third quarter average to be in the range of NOK 130 million to NOK 160 million.This means we have had a total of NOK 530 million to NOK 660 million in claims so far this year related to the extraordinary weather in Norway. Preparing for unexpected events is part of our business. This is the nature of insurance. But of course, when several events occur within a short span of time and with such, such force, it temporarily challenges our results. And listening to the experts in this field, it is prudent to expect more volatile weather conditions and a higher frequency of extreme events going forward. We acknowledge this and will need to reflect it in our pricing as well. This will apply particularly for the property insurance lines which are most exposed to weather effects, meaning price increases will have to exceed the building index to reflect more frequency going forward.Large losses were significantly higher compared with the third quarter last year reflecting property damages from fires, heavy rains and storms. Profitability in motor insurance continue to deteriorate as expected driven by the lag effect from pricing measures relatively to claims inflation. I will comment on status for our ongoing mitigation actions on the next slide. Outside Norway, we continue to deliver significantly improved results. Our results were also impacted by provisions of NOK 80 million related to restructuring measures. I will come back also to this on the next slide. Financial results came in at NOK 426 million corresponding to a 0.8% return. Annualized return on equity year-to-date was 15%. And [ you'll stand ], we revert with more detailed comments on the results.Then turning to Page 3. Some comments on the operational highlights year-to-date. Starting with the recent changes in the group management team, I am convinced that given the rapidly changing business environment we are operating within in turn rotation improves dynamics in the group, increases engagements, adds new perspectives, develops management talent and ultimately it leads to a stronger force of innovation and process efficiency. I'm very pleased with the new team which is fully dedicated to getting Gjensidige back on track in Norway and continuing of a strong progress outside Norway.We are convinced of this strong rationale in selling Gjensidige Bank allowing us to focus on our core insurance operations, while broadening our reach through banking distribution with Nordea. Closing is still expected during the first quarter of 2019. In Norway, we have continued to raise our prices for motor insurance and we are very pleased to see that our efforts are proving effective. We will continue to increase prices beyond the 6% expected claims inflation in order to close the gap. We are fully committed to stabilize and ultimately also improve profitability for motor insurance in Norway, meaning that we are willing to sacrifice some volume to achieve this if necessary.So far, we have been able to put the price increases through without any negative impact on churn, approve of our strong brand and position in this important market. We still expect the motor profitability in Norway to marginally decrease further through 2018 before seeing a turning point during the first half of 2019. We are very pleased to see that customer retention in Norway continues to be high, meaning low distribution cost. In the private segment, we have a retention rate above 92% among our affinity and loyalty customer which represent around 85% of the premium volume.Our possession in this segment was further proven by renewal of our partnership agreement with Tekna recently. We are also very happy with our strong retention rates for the commercial segment currently at around 90%. Our operations outside Norway have gone through nothing less than a transformation. And there is more to come. Our achievements so far are evident in the numbers we have presented today. We have put strong efforts in improving our risk selection and risk pricing pruning and repricing our portfolios. This has somewhat reduced volumes. However, we have managed to improve our portfolio quality significantly. Although our focus is profitability before growth, we are starting to reach a profitability level where we, to a larger extent, can participate in the markets of real growth going forward.We will continue to implement cost efficiency measures gradually bringing profitability closer to the overall group targets. We have a strong focus on efficiency across the whole value chain and continuously seek value enhancing measures. In the third quarter, we have decided to close further 8 branches in Norway. And in Denmark, we have discontinued the use of external sales representatives. Gradually moving distribution from physical to call centers and online is still on our agenda. Some restructuring is also made in the Swedish distribution. And all in all, we have made a provision of NOK 80 million related to the restructurings and reduction of 58 FTEs.By constantly bringing down the underlying cost base, we create room for investments in technology, brand and skills within our cost ratio target. As communicated earlier, we are planning to upgrade our core IT system to be ahead of development, securing improved internal efficiency and long-term competitiveness. A new system will provide us with greater agility and then enable us to quickly adapt to new technology and changes in products, markets and completely new ecosystems. We are introducing a blueprint version of the new core system as we speak and planning to launch in Denmark first before moving onto Sweden. Investments will be made within the limit of our cost target.Then turning to Page 4. I am very proud to present the results of this year IPSOS Reputation survey related to last -- released last week. Once again, we ranked #1 in terms of reputation in the Norwegian financial industry. And we also achieved the best scores in our sector, in the category social responsibility and moral. We have had a steady increase and the highest ranking in our industry since 2009. Independent of sectors, Gjensidige ranks number 8 and among the top 10 companies in Norway for the third year in a row. And we are very pleased to note that 7 out of 10 Norwegians have a good overall impressions of Gjensidige.And with that, I will leave the word to Jostein to present the Q3 results in more detail, as well as talk about the update on our capital strategy and financial targets.
Thank you, Helge, and good morning, everybody. I will start on Page 6. We reported profit before tax of NOK 964 million in the third quarter. Starting from this quarter, Gjensidige Bank is recognized as a discontinued operation and thus moves to a separate line in the P&L after tax. The results are, therefore, not included in this table. Including Gjensidige Bank, the pre-tax result would have been closer to NOK 1.1 billion.The decline in the pre-tax profit for continued operations compared with last year was primarily driven by the underwriting result. The underwriting result was significantly impacted by the extraordinary weather conditions, driving claims in both the private and commercial segments in Norway. The result also includes a provision of NOK 80 million related to the restructuring measures Helge mentioned.We estimate the weather related deviation in frequency claims in the third quarter compared to the historical third quarter average to be in the range of around NOK 130 million to NOK 160 million. The results in Norway were also impacted by the continued deterioration in motor profitability as has been the case over the past quarters.Results also in Norway continued to improve. The increase in Denmark was a result of lower large losses, higher round of gains and lower operating expenses, partly contracted by a weaker underlying frequency claims that opened. Our Swedish operations generated significantly improved results for the quarter, reflecting lower underwriting frequency claims and a favorable cost development, partly contracted by higher large losses and lower run-off gains.The Baltics reported considerably higher underwriting results, driven by an improvement in underlying claims and cost development as well as higher run-off gains. The pension business reported record quarterly earnings again. The financial results from the investment portfolio declined, reflecting our asset allocation and market development.Turning to Page 7. Premiums rose 1% compared to the third quarter of 2017 and 0.8% adjusted for currency effects. All the main product lines in Norway recorded higher premiums during the quarter, mainly driven by premium increases. We continue to increase prices for motor insurance in Norway in line with what we have communicated and this is reflected in our numbers for the quarter.A common theme outside of Norway is that when measured in local currency, we see negative top line growth. This is an effect of various pricing and portfolio pruning measures, aimed at creating long-term profitability in all segments. In Denmark, the measures have been most pronounced in the commercial lines. In Sweden, the effect in Q3 was mostly within private lines, whereas in the Baltics, it's in concerns both private and commercial lines.Turning over to Page 8. We can see that the loss ratio rose from 66.3% to 75.1% year-on-year. To start with, it is important to remind you that Q3 was a very strong quarter, making comparison challenging. Large losses were significantly up, but still not far from the normal level we normally expect, resulting in a 4 percentage point increase in the loss ratio. Run-off gains, nominally higher than expected, had a positive impact of 1.5 percentage points in the loss ratio compared with Q3 last year. A more adverse underlying frequency claims development was the main driver for the increase in the loss ratio and this was mainly related to Norway, as our operations in Sweden and the Baltics reported improved underlying frequency claims development.Our Danish operations reported a small increase in frequency claims impact compared to last year. Higher frequency claims impact in Norway related to the extraordinary weather conditions and difficult comparables due to particularly favorable underlying frequency claims situation in the Q3 last year. The weather impact was related to our property and agricultural insurance lines, estimated at NOK 130 million to NOK 160 million above an average Q3, corresponding to 2.1 6 percentage points to 2.6 percentage points on the total group claims ratio.Still adjusted for this, the underlying claims ratio deteriorated by around 4 percentage points. This can partly be explained by the strong result in Q3 '17 and partly by the underlying deterioration in motor insurance in Norway. The pressure on our motor insurance line continued as expected in the third quarter. As mentioned earlier, the high claims inflation for this product is related to the structural change in Norwegian vehicle fleet and related dynamics. We have put a number of measures in place and continue to do so to secure correct to risk selection and risk pricing. And we're happy to see that our pricing power continues to be strong as Helge touched upon.In addition to the mentioned price increases in the private segment, we also operate with significant price increases in the corporate segment, especially for larger accounts and from alternate property.Let's turn to Page 9 for an overview of large losses. Total large losses amounted to NOK 319 million. Some of the above are expected long-term average of NOK 295 million. The losses translate into 5.2 percentage points on the combined ratio. The large losses were primarily related to commercial and private property in Norway. The latter is significantly influenced by the storms and heavy rainfalls in Norway during the quarter.Moving onto Page 10 to comment the run-off gains. Run-off gains for the quarter came to NOK 341 million, which is higher than our planned reserve releases of NOK 250 million. The deviation is due to random variation. The run-off had a positive impact of 5.6 percentage points on the combined ratio. We maintain our estimate of approximately NOK 250 million in run-off gains per quarter through 2022.Let's turn to Page 11. The cost ratio for the quarter was 15.6%. The increase over last year primarily related to the one-off provision of NOK 80 million in the corporate center related to the restructuring measures already mentioned by Helge. Cost development excluding this provision was favorable due to the cost ratio of 14.3%. This proves cost discipline, and we're particularly pleased to see continued positive effect from our restructuring efforts in Sweden and the Baltics. The cost ratio excluding the one-off and the Baltic segment was 13.5%. Contingent digitization automation and our timed effects of a new core system will enable us to remain cost efficient as we [ turn ] business further in terms of our cost ratio, and will revert to this shortly.Page 12 illustrates highlights from the pension and bank operation. The pension company recorded a profit before tax expense of NOK 40 million. Assets under management in the pension operations amounted to NOK 32 billion and 68% of the customers in our pension business are general insurance customers as well. Annualized return on equity amounted to 14.3%.Gross lending in the bank at the end of the quarter was NOK 49 billion. The bank reported a pre-tax profit of NOK 93 million in the third quarter. The decrease being due to higher operating expenses following growth, increased acquisition costs and lower gains on financial instruments, as well as a one-off charge of NOK 11 million related to the termination of the agreement for the distribution through the financial offices in Gjensidige's private segments. Annualized return on equity for the bank was 11.4%.Moving onto the investment portfolio on Page 13. The investment portfolio of NOK 52.7 billion yielded a return of 7.8% in the quarter. The match portfolio yielded a return of 0.6% on a portfolio of NOK 34 billion. A large part of the match portfolio consist of bonds at amortized costs, which yielded a return of 1.0%. The running yield in this portfolio was 3.8% at the end of the quarter, and the average reinvestment rate year-to-date was close to 3.3%. Unrealized excess value amounted to approximately NOK 0.8 billion. The free portfolio which amounts to NOK 18 billion yielded a return of 1.2% in the quarter. The positive return was primarily driven by returns on the investments in equities and property.Looking at the capital position on Page 14. Our capital position is still strong. The legal perspective gives a solvency margin of a 181%, while on calibration of the internal model gives a solvency margin of 197%. Note that from this quarter, our planned reserve releases are treated as legible capital when calculated the solvency margin. This gives a better picture of the solvency margin. The principle change is made after recommendations from the Norwegian FSA. The solvency margin is somewhat lower compared to last quarter.Eligible capital shows a stable development and a positive contribution from retained earnings offset by among others lower market value of bonds due to increased interest rates and credit spreads. The capital requirement increased somewhat this quarter mainly due to underlying growth within the business. Given the sale of Gjensidige Bank, the pro-forma solvency margin as of September 13 was 262%. We'll continue to balance our capital structure in a disciplined way in order to support a target return next year, while at the same time allowing us some leeway for further bolt-on acquisitions and stabilization of dividend.Turn to Page 15, I'll comment on our financial targets. Our financial and solvency targets as well as our dividend policy have been subject to our review this quarter. Except for change in the cost ratio target from around 15% to below 15%, the targets and dividend policy are only adjusted to reflect that Gjensidige Bank will be excluded from the group from early 2019. The group's annual financial and solvency targets for the period '19 to '22, given disposal of the bank, are combined ratio between 86% and 89%, still assuming average annual run-off gains of around NOK 1 billion to 2022. This corresponds to 90% to 93%, given share of run-off gains.A cost ratio below 15%, a solvency margin based on the partial internal model between 135% and 200%, return on equity after tax about 20%. This corresponds to above 16% given 0 run-off gains, which is comparable to the previous 15% target including the bank. Bear in mind that these are targets and should not be regarded as guidance for any specific quarter or year. The dividend policy stays the same. The technical adjustment to reflect the bank sale, it means the minimum pay-out ratio moves from 17% to 18%.Our financial targets are ambitious, but achievable. We work to strike a balance between good profitability and increased investments in order to transfer a strong competitiveness moving forward. Organic growth is expected to be in line with normal GDP growth in the [ NCDS ] market areas in the Nordic countries and the Baltic states overtime. In addition, profitable growth will [ proceed ] by pressing a disciplined acquisition strategy as has been done successfully in the past. The sale of Gjensidige Bank will upon closing have a temporary negative impact on the group's return on equity and the proceeds have been reinvested in value enhancing opportunities or return to shareholders.I will then hand the word back to Helge for some concluding remarks.
Thank you, Jostein. To sum up on Page 16. Our Q3 results were significantly impacted by extraordinary weather conditions. We continue to generate improved results outside Norway proving successful restructuring measures. Our results so far this year have been hit by the weather conditions and the pressure on the motor insurance line challenging our ability to deliver on all our financial targets this year. However, we have a strong focus on getting our business back on track in Norway, with price increases across several product lines. We will also continue to have a keen eye on cost control and implement efficiency measures.We will continue our strong efforts to mitigate the claims inflation in motor in Norway and expect the turning point for profitability in this insurance line during the first quarter next year. Our capital position is strong and supports our vision to seek value accretive M&A opportunities. And if such opportunities do not materialize, we will distribute excess capital over time in line with our dividend policy.So with that, thank you very much. We will now open the Q&A session.
[Operator Instructions] We can now take our first question from Jony Urwin from UBS.
So firstly, just on claims inflation. So in Norway, I guess motor claims inflation is still tracking around 6%. Are you seeing any upward pressure on this at all? And just to clarify, you are expecting group loss ratio stabilization in 1Q next year. What's the confidence level in this please? And then secondly, how do you think of the ordinary dividends ex the bank sales, the pro-formas for the bank earnings being removed? Would you be happy running a higher payout ratio on the ordinary temporary period until you can potentially replace the earnings?[Audio Gap]
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All right. We will proceed with the Q&A session.
, can you move on?
Certainly. We did have a question. Did you receive that question already?
No, we haven't heard anything.
Okay, no problem. Just bear with me. And if I could ask the speaker to -- the questioner to please repeat your question.
All right. Can you hear me?
We can indeed.
Yes.
It is Jon Urwin from UBS. So I just have 2 questions. So firstly, is the claims inflation environment in Norwegian [ mates ] are still tracking around 6%? Are you seeing any upward pressure on this? And just to clarify that you are expecting the loss ratio to stabilize in the first quarter 2019. What's the confidence level in this please? And then secondly, how do you think about the ordinary dividends ex the bank sales, the pro-forma to the bank earnings? Would you be happy to run a higher payout ratio on that ordinary dividend for a temporary period until you can potentially return the earnings?
Yes. It's yes on the first question. The motor inflation level is still expected to be around 6%. A combination of 5% coming from underlying claims cost inflation and 1% effect from increased frequency due to the changes in the bonus system. We still think that we'll reach the turning point in the first half of '19 as we have previously communicated. So that means that's unchanged. The last question on the dividend, we are comfortable running with a high payout ratio in 2018. The dividend policies stays the same. It's high and stable normal dividends being as the starting point for looking at the dividend for 2018 is last year's dividend of NOK [ 7.03 ] per share. If we go above 100% of this year's result, we will need to apply to the financial services authority to get approved. But we have a very high solvency margin even before the sale of the bank. So we do expect that to be okayed.
Next question please?
We can now take our next question from Sami Taipalus from Goldman Sachs.
My first question is just on the repricing in Norway. You got a slide there on the high customer retention. I guess usually when companies do these sorts of efforts, the retention goes down a bit. So I'm wondering if there's room for you to push a little bit harder on the right set to make sure that you definitely get on top of claims inflation. So that's question #1. And question #2 is, you've got -- you've disclosed that a pro-forma solvency ratio of the bank or solvency ratio pro-forma of the bank sale. And is that -- all I can think that's on the legal basis. Could you just tell us what that ratio is also in the partial return on normal basis which is what I think your forward looking solvency ratio target is based on?
The effect on the retention, yes, it has been -- it has actually seen Norway increasing in churn based on the pricing ratios, we have that true so far. We are, of course, profit maximizing. We'll try to do what we think is the best at all times in terms of hitting the gas pedal here like [ hitting ] pedal. So it's -- we take of what we think is doable here and look at the situation weekly related to what we can take out. Still remember, it is dynamic and very differential approach where the good customers get best increase and the bad or more risky customers get higher increase in the rates. And we will monetize. If it's possible to take up more, we will take up more.
I think it's important also to mention that the frequents development is a Norwegian overall problem. So it's not only Gjensidige meeting this. And you have seen communication and also inputs from our competitors. So the climate is absolutely much better this year compared to previous years when it comes to price increases. That's actually both for private lines and commercial lines.
So sorry, can I just interject? So if you look at where you are now versus where you were maybe 6 months ago, do you feel that there is room for more price increases than what you may perhaps initially anticipated?
I think I can start maybe. And compared to 6 months ago, we have a more holistic view looking at products, terms and of course, maybe a more offensive view when it comes to price increases overall. And you also heard what I said regarding frequents -- expected frequency development going forward for property lines due to more volatile weather. So instead of meeting the building index which we have done for a period, we have to increase prices in both the building and index to meet more volatile weather, also for the property lines in Norway. So the climate is better and we are slightly more offensive today compared to 6 months ago I would say.
In terms of the solvency margin, our target solvency margins are based on the legally approved partial internal model to start there. These are not that different necessarily. And the change in the effect from the sale of the bank will have a percentage wise, more or less same effect on the legal approved partial internal as to our own partial internal model. Yes, that was your question I guess.
We can now take our next question from Blair Stewart of Bank of America.
I've got 3 questions. One of them is actually just a clarification. Helge, you mentioned in your opening remarks a total of NOK 530 million to NOK 560 million of additional claims year-to-date. I'm just checking, is that a purely frequency related or have you also included the deviations in the large claims within that as well? That is the clarification. My second question just relates to the last question that you answered. Could you give us an indication as to what the excess capital above 200% -- above your 200% threshold? For what level of excess capital does that imply that you have at this time? My third question is really just on M&A and the potential deployment of that excess capital. You've sold the banking business which has led to a reduction in profits. I'm just interested in what type of M&A you would be considering. What sort of timeframe we'd be talking about in terms of either potentially replacing those lost earnings with an acquisition or the decision to give that money back?
Thank you, Blair. The span was NOK 530 million to NOK 660 million actually and it's purely frequency. So that's your first question. Your last one and Jostein can prepare the question regarding the excess capital and the solvency ratios. M&A, as we have commented before, we want to grow outside Norway, preferably Sweden because we have the weakest position in Sweden and a small fragmented market in Denmark. It's dynamic in Denmark also. So both Sweden and Denmark, if it arise opportunities, we will look into that. I think I also commented last quarter that it should be somewhat sizeable because it's hard work every time we take onboard new companies. And then you were asking me when -- if it doesn't arise M&A opportunities, when do we want to pay back to shareholders? I can't be exactly regarding that timing. I guess we will use next year at least. And then if nothing arise, I guess we have a discussion again when we come into early 2020.
And on the second question, the excess capital. I mean I think you referred to the NOK 135 million to NOK 200 million solvency margin range and then...
Yes.
And when we're above that kind of how much is...
Right.
We quite actually do ask in [ normal ] amount of -- it's about...
If that's possible, just an indication what if it be above NOK 200 million?
Yes. Exclude the bank, yes, we are around numbers NOK 10 billion capital requirements. We've got 13.8 legal capital requirements as of now according to the partial internal model. And then the bank, of course, seems approximately NOK 4 billion. Is that okay?
We can now take our next question from Vinit Malhotra from Mediobanca.
So my question was around the -- this property and frequency claims or the frequency claims in property. Have you conducted some internal studies which would make you change some underwriting practice here or would you attribute this to purely bad luck? And do you also have plans to put in place some frequency covers for reinsurance or some such measures do you think are necessary for this problem?
In terms of underwriting criteria or terms and conditions for our product, it's obvious that offshore this quarter we are looking to the terms and conditions of the agricultural product to see if we have the right price for this type of damages in crops or whether we should do something about the terms of this. But remember, it has been really very few claims on this -- of this type anytime really and this is the first time we have had this type of damage. So it is natural to relate. There will actually be a claim on [ extra ] cover. And other criteria, please bear in mind that if you have unnatural perils type as a storm or flood or something, that is actually covered via the Norwegian Natural Perils Pool, which has its kind of own criteria and we can't really change that in those criteria. And it's a common criteria for the whole Norwegian market. Otherwise in terms of reinsurance, it is always constantly evaluated but it's actually would pay off to buy kind of lower level reinsurance to protect this -- against this type of short-term volatility. Usually it doesn't payout and we have a really solid capital position which makes us confident to put -- bear this type of short-term volatility.
Just to add -- excuse me, just to add the overall comment on the property situation, just to remind you past, present and the future perspective on that. If you look back on that, we have had very benign winters and actually very benign situation for many, many years. We could say that the situation in 2018 is bad luck, but we do not want to take that bet going forward. So the weather related climate changes is a long, long-term trend. But we have to take into consideration that we will see maybe more volatile weather also for short, medium term. Therefore, I commented that price increases have to be above the building index to take into to prepare for more volatile weather going forward. But of course, we could meet the '19 and '20 and '21 like '14, '15, '16, but we do not want to take that bet.
And can you just summarize the motor situation from what I've understood please, just to follow up? That the -- from bank in August till now, things are going as per your expectations in the direction of claims or pricing and there's nothing to -- there's no change on that. That's a good summary of the motor situation?
That's correct.
We can now take our next question from Kevin Ryan from Bloomberg Intelligence.
It's just a point of clarification. The solvency margin target you've given is quite a big range. Can I press you to come up with a solvency margin that you would really like to base yourself around because that has a huge impact on your dividend paying capacity? That's the angle I'm looking at here. So any additional help you could give us of what the ideal solvency margin for the companies would be greatly received.
I think we've -- that one indication. I think we have given and I can give you. It is actually sure to be in the upper half of that range to be consistent in long term A rating. But that is really -- the rating agencies and the regulators look at capital very differently and capital requirements very differently. So that's not necessarily a stable relationship over long time, but given where we are at the moment, I would say upper half of that range.
And now we'll take our next question from Youdish Chicooree from Autonomous.
I've got 3 questions, please. The first one is really on your combined ratio target. You've improved your -- you lower your expense ratio target but kept the combined ratio target unchanged. So if you could just comment on which areas you expect the loss ratio to be weaker going forward? And then secondly on your comment around more volatile weather and property claims going forward. Can you just remind us what level of inflation you are seeing at the moment and confirm whether so far you've been -- I think you said in the past you'd been pricing around 4% increases? So if you could just give us an idea what you're expecting going forward, that's be very helpful. And then finally on -- again coming back on the ordinary dividend. I mean you raised your payout ratio range, but already with the earnings this year, it looks like keeping the dividend flat will be quite a challenge. So how confident are you that the -- as I say will give you the approval to pay in excess of earnings this year?
On the first question, we have raised our ambitions, expressed ambition at least, in terms of cost ratio. And we still have, as you know, an [ intro line ] in terms of the combined ratios. We will be within that [ intro line ]. It's not the several percentage points change in the cost ratio. So we'll still keep the same ratio in terms of combined ratio. Doesn't necessarily mean a significant decline in the loss ratio. Second question is inflation in property. As I understood, your question is mainly related to property?
Yes.
As Helge has already has commented, over time the building index is volatile, but over time we expect something like 4%. But then we also need to price to meet the increased frequency due from what we think is might be a change in the pattern of the kind of weather related claims and so on. So we will aim or our aiming higher now in terms of price increases than the building cost index. And that is a change from if you look 1 or 2 year back. Third question was on the ordinary dividends. We -- when we or if we apply for the -- to the FSA for an ordinary dividend above this year's profits, then they will look at the solvency situation both at the moment and forward looking. We have a very strong solvency position, both now and after the sale of bank even a stronger ratio as you know.
In terms of the sale of the bank, what approval is standing so far?
The Competition Authority has given their approval and waiting for the financial services authority.
So the quick taking decision was, while it's in their hands to decide whether the sale goes ahead and then at the same time they can make a choice on whether it will have the necessary capital after the approval basically?
I didn't quite catch what you're asking. Are you asking about the timing of the different decisions or...
Yes. I'm saying that, well, at the end of the day, it all depends on the FSA then, whether you can pay in excess of 100% and whether the bank sale would add?
Of course, that is -- that is I believe the requirements are. They need to approve both the bank transaction and any dividend above 100%.
We can now take our next question from Steven Haywood from HSBC.
Just a quick clarification. You said your solvency ratio will be reducing by 10 percentage points by the end of this year. Is that both Solvency II ratios that you provide?
Well, that is to legally approved partial internal model.
And so your own partial internal, you won't reduce by 10 percentage point?
It might change, but this what you are referring to is some specific requirements from the FSA to change to legally approved model. And I think it's the same we actually communicated externally and at the same time as we got the model approved earlier this year. So there's nothing new in this. It's been planned all the time.
So pro-forma for the bank sale and looking at your excess capital position here, if you were to use the bottom of your new target range, you may have over NOK 12 billion of excess capital or if you use the middle range -- you say you want to be in the middle to the or the upper half, you may have NOK 10 billion or more excess capital to use for M&A opportunities. Is this the right sort of size that you would use or would you not be willing to go down to 135%? And then also can I ask, what's the willingness of your foundation to partake in a capital raise?
Not commenting on that. Remember, the target solvency range is there for a reason and that's kind of where we are, and use that as a guiding post for where our capitalization should be. Our foundation needs to speak for itself, but it has a ownership policy. States that kind of in terms of kind of value creating transactions, they will be participating if that means new money or if it means selling down and reducing their ownership stake in this area. That is kind of something they are waiting to consider if they deem the case to be correct.
And I got just a final question in your claims inflation. You say 6% is for 2018. Can you give us a figure for 2019 expected claims inflation on your motor book? And also if you're having a buildings index at 4% currently, what is your claims inflation level that you are expecting here?
The 6% is the forward looking estimate on the model. It is not the last 12 months or 2018. It's what we expect going forward. And in terms of the building property index, we are not precise on kind of our expected inflation going forward. We are saying that opposed to earlier, there's probably more than the building cost index of 4%.
We can now take our next question from Niccolo Dalla-Palma from Exane.
My first question is on the frequency related weather losses. Can you give us some indication of what the deviation was in Q4 last year, so that we can take that into account when we do our estimation on Q4 this year? And the second question is on your [ closed ] M&As. How do you think about your own cost of equity in terms of relative point for value creation? And you just increased your ROE target. Are you then ready to decrease it again in case you have to pay a price that for an asset that requires that? How should we think about again hurdle rates for M&A given what your cost of equity and given your retargets? And the third question is on the bank disposal, would you just clarify, is there any other impacts on your shareholders equity other than the gain of NOK 1.9 billion that you disclosed? I mean is there any tax implications there?
We do not have a number, sorry for that, Q4 '17 and extraordinary weather effects. I think we didn't disclose that at that time. Obviously in the winter in '17 in the last quarter was more than the '16 and the average of the last years because this year it's kind of extraordinary winter situation started in the last part of '17. So there was something there. I'm sorry, we might look at that before the Q4, but we don't have the number, no. And we didn't disclose it at that time. In terms of hurdles for M&A, our -- when we look at a target, it's the first and foremost is of course industrial logic and the second, as you mentioned, needs to be of some size because there are integration costs, and it takes some focus away from running the day-to-day business. Our cost of capital as we see it, cost of equity capital is 7.5% after tax. That is what we use for our calculations. And of course, there needs to be value creation above that cost of capital for us to be willing to enter into transaction. If we did something of a meaningful size, it will of course have a negative effect on the ROE in the short term, that of course relates mathematically. Please remember the 20% return on equity is based on 2 assumptions. First, 1 percentage point is just due to the sale of the bank and based on that assumption. And the other part, just 4 percentage points increase is based on including the expected run-off gains through 2022, and thus consistent with 86 to 89 combined rate for target. Best to clarify that. It does not directly related to your question, but just to be able to -- just to avoid any misunderstandings. The sale of the bank does not give us any tax implications. It's tax exempted.
So the ROE target that you gave is actually -– that's there for a target of average ROE on 2019 - '22 and therefore it benefit from '19 when you have a big gain, is that right?
No, no. It's not related to the gain of the bank. It's just related to that without the bank in the book. Their return on equity is higher.
But then you said that, that's 1 point. And then sorry, I didn't then get the other 4 points.
It's the run-off gains that we're planning through 2022.
And one more question, please. On the large losses, Slide 23 specifically, if you look at the long run, the left hand side chart, it seems that with a few exceptions, you typically are at expected level or below with very few exceptions. How should we think about the large loss budget? Is it still the right number? Should we assume it's always a bit less than this? How do you set this large loss budget?
The large losses is based on the partial internal. And you use the same data and the same type of modeling. And large losses -- the typical large loss year would be below the expected level, but the -- every now and then, we will have an average that's much worse. So the average will be as we expect, the expected level, but the median or the typical year will be lower. That makes sense?
We can now take our next question from Wajahat Rizvi from Deutsche Bank.
Wajahat Rizvi from Deutsche Bank, 3 questions from me, please. The first one on the weather losses which you said NOK 530 million to NOK 660 million for first 3 quarters. Firstly, are you able to break that between your motor book property, agriculture and other books, please? I'm guessing that's most of it is in property and agriculture book. And secondly, given the visibility you have, how are you driving comfort that all of these extraordinary weather losses are definitely weather related and there isn't any attritional impacted in behind these losses? That will be the first question. And second is bit of a clarification. So you alluded to pricing for extra volatility in the property book. So the current 6% sort of price increase level you have guided for, does that already include the price increase you need to put forth for this volatility or is that something you need to take account into your future pricing and you haven't done that yet? And the final question would be on IT system update. I think Helge talked about it in his remarks. So will that be included within your expense ratio guidance which you have given or will you capitalize it on your balance sheet?
The first one. The split between different lines. Let's start with the last, the new -– this quarters claims. That's divided only between property and agriculture. '18 agriculture and their [ esteemed ] property more or less. No more through in the third quarter estimate. The previous quarter estimates, I need some help to remember this, but in Q1, there was more or less a even split between motor and property. In Q2, it's mainly related to property. So if you add that up -- someone need to add that up. But if we go back and look at the numbers, that's kind of -- the first quarter, evenly split between motor and property, second quarter property, third quarter, agriculture and property. Yes. Are we sure that this is weather related and not some other reason? It is based on looking back at the average of these types of claims. We go down to each type of claims and look at what this average was over the years before, and these are typically types of claims that are related to weather losses, either that heavy snow which makes roofs falling, it's based on the water, forcing the rain to houses and so on. So it's typical weather related loses. And the forecast for indications, you also then see these weather statistics that we have given you, in terms of snow depth and precipitation and changes of weather during these first 2 quarters, and then the heat and the dryness in the third quarter. So I think it's -- you can't be 100% sure. And we try to give you ranges to indicate that, but it's fairly [ sort out ], this is weather related. Big question is of course what's going to be going forward? Is this a pattern that is going to repeat itself, or what's the [ trend ] in 2018? And we don't want to take that pattern. This is all returning back to benign situation in 2019. So we will take that into account for pricing. This applies mostly to property. I think for our motor estimate, we think that considered weather related effects will be handled within these 6% expecting going forward. But of course, these are estimates based on certain around those estimates, so things might happen. IT system. When we invest in a new core system, the investments will be capitalized and depreciated over approximately 10 years. That is -- these depreciations are handled within our 15% -- below 15% cost rate for targets.
We can now take our next question from Blair Stewart from Bank of America.
This is Blair again, and apologies. It's just another clarification. Just on the question I asked on excess capital. I think you mentioned the NOK 10 billion number, I just wanted to check what that was. I think that was -- you said the -- I think that was an implication that the capital requirement was NOK 10 billion because you said it was NOK 13.8 on the legal basis today and you take off around 4 from the bank. Is that correct?
Yes. That was, I think.
Yes. Just a rough number, so NOK 10 billion of capital requirements. So at 200%, the top end of your range that will be NOK 20 billion of capital requirements. I think we can work out a pro-forma end of the year ratio over by 250, which is the 262 less 10 points, so 250. So it imply that you've got available capital of about NOK 25 billion against capital requirement at 200% of NOK 20 billion. So it'd be about NOK 5 billion of excess capital at the upper end of your ratio. Is that -- I just wanted to check my calculations are correct?
I'm not kind of vouch for your calculations, but I mean the reasoning is correct I think. It's -- as a remainder, the [ excess capital ] actually moves from quarter to quarter by any other reason as well, so it might not necessarily be the numbers that you refer to, but I think your reasoning is valid.
[Operator Instructions]
Blair, yes, a clarification. Best a reminder. In terms of when we -- from the present, the solvency margin every quarter, bear in mind that we assume 70% pro-forma dividend ratio, which is kind of our stated dividend policy. So if the -- when it came to the fourth quarter, and the actual dividend payout ratio is higher than 70, that means kind of a -- a drop in the solvency margin as of yearend.
We have no further questions in the queue at this time. I'd like to turn the call back over to you for any additional or closing remarks.
Thank you, operator. We will be meeting with investors over the next couple of days. We will be meeting investors in Oslo today, Frankfurt and Copenhagen tomorrow. I would like to remind all of you our Capital Markets Day in London, which we will be holding on Tuesday the 27th of November. Looking forward to seeing you there. Thank you for your attention and good bye.