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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen, and welcome to the Analyst Call on Talanx' 9 Months 2018. For your information, today's conference will be recorded. At this time, I would like to turn the conference over to Mr. Carsten Werle. Please go ahead.
Yes. Thank you, Bettina. Good morning. Welcome to Talanx' 9 Months 2018 Results Call from Hannover. I'm here together with our CEO, Torsten Leue; and our CFO, Dr. Immo Querner, and the 2 will lead you through the presentation document that we have published together with the interim report and the release on our web page this morning. You may follow this call via phone and via webcast, and there are replay options for both channels. And with these remarks, I'd like to hand over to our CEO. Torsten, the floor is yours.
Yes. Hello, good morning also from Hannover from our side here. I guess today's call is a bit less news value for you as the main things we communicated already a couple of weeks ago, and as well, you heard last week from Hannover Re, so I guess today is more about details, I guess, if you have questions there. So I would start with Page 2. And you see the main -- I think the main thing that we headline is except the Industrial Lines, all the other lines really significantly contributed to our operating result, which is up by 33%, and group net income, double digit by 10%, which was affected by the BEAT tax, the American special tax now this year, as well as positive one-off items in the tax area in 2017, but still double-digit growth in the group net income.As I said before, we have 4 divisions, and 3 really performed very nicely and on track, and one is Industrial, where we've tried a cleanup scenario with large losses, and frequency losses were impacted significantly this year. We informed you with -- we informed you about the 20/20/20 initiatives on the Capital Market Day, which basically meant until 2020, 20% premium increase by 20% of the portfolio. We informed you in the Capital Market Day that we achieved more than 60%. This was a couple of weeks ago. Now we can tell you it's already over 70%, 7-0, so this is a nice development as this program is working well and is on track. The outlook for this year, the EUR 700 million around, is confirmed at this stage. And we have a dividend as well, EUR 1.40, equal to last year's dividend. Well, next year, the outlook as well, around EUR 900 million. It was significantly up with 28.5%, and we believe it's a realistic scenario. As you can imagine, those investment incomes generally are going down, and extraordinary effects on investment income you don't see every year. I will come on Page 4. There, you see the details of our profit/loss account. You see top line, and I think even the market to show in these days a growth of 7% organically and even currency adjusted with 11%, double digit, we could say this is a good performance and fast-growing in that market environment. We have then the net underwriting result P/C. We have a turn of, let's say, from EUR 384 million (sic) [ minus EUR 384 million ], up to EUR 163 million, so this turn, for sure, is explained by the same claims of last year. Net investment income is 12% down. And this again, what I mentioned before, is besides the Hannover Re extraordinary effect we had last year of the disposal of the equities against and as well the ZZR change this year already meant that extraordinary items are less and this will continue to be less in the future, we believe. Operating EBIT, we have 33%, a nice growth. And again, everybody was contributing except Industrial Lines to this nice growth. And net income, 10% up, as I mentioned before, basically tax effects, which now we have a normalized tax ratio of 29.8%, around 30%.On next, Page 5, you see who was contributing to the EBIT. So Industrial Lines, down. And Immo Querner will show you more details on that. But look at the other ones, Retail Germany, 34% up; Retail International, 13% up, and this is again we had a lot of strong headwinds of the currencies, so without currencies, stronger. We have Reinsurance, and they were most impacted by the [ HIM ] claims last year but up by 45%. So all over, we have 33% up. And I think the message to say, everybody contributed except Industrial. You can see very nicely how this was developed. If you see on Page 6, the next page, the quarter stand-alone. It's very volatile. In our industry, third quarter normally are these NatCat events. This year, not much. So we grow an 8%, let's say, like-for-like 9 months, with 11% currency adjusted, so this growth even in the third quarter stand-alone is on track. We have -- net investment income here is much more down, and this is again due to extraordinary items. Last year's disposal gains of Reinsurance was in the third quarter, so therefore, this base effect of last year, which you see as well, reflected in the tax ratio. EBIT is up to EUR 259 million, again, everybody contributing except Industrial Lines and, respectively, net income after minorities.So now Page 7. This is more details on the large losses, Immo Querner, when we introduce you to him, will give you maybe a bit more information. On the Reinsurance side, I will not say much because you got everything already last Thursday, I guess, from my colleague. But on Industrial Lines here, you see basically the main things that -- it's not -- this 9 months is not a question regarding NatCat events. You see NatCat was with EUR 61 million, probably lower last year of EUR 214 million in the column, but it was more a manmade thing. And here, you see that we have in fire/property EUR 199.1 million, and that has exactly explained why we had come out with a profit warning and here, this kind of large loss in that area, manmade. And this is not just -- I think it's an industrial topic. We talked about this on the Capital Market Day that in positive cycle of economy, consequential claims plus frequency are very much higher than in normal times because basically, machinery breakdowns in a high market, economic cycle, break much faster down. And as well, these consequential claims to your interrelated, interconnected world is really exponentially increasing and not priced into the product. So therefore, we have this manmade, and I think it's an industrial topic, as you know, and sees in the last weeks that -- what the market is reporting.So that was leading to Industrial Lines to EUR 266.8 million total large losses after 9 months. And this comparable to the large loss budget below last figure of EUR 260 million meant we already, after 9 months, have consumed the whole budget for the whole year, and that leads to our message with the changed outlook end of the year.I would then come to on Page 8. And here, you see the, in our opinion, nice development of all the other segments. I start first with the Talanx Group, 98.6% as a combined ratio, so we earn technically some money. Seeing as well, Industrial Lines, with 111%, for sure not satisfying. And our smallest segment, but still, we really have to work hard on this as we have launched the 20/20/20 program, where we will talk in a second on that because it's working very nicely, where we really have much more in then already a couple of weeks ago in our pricing. But seeing the other segments, look to Retail Germany, we're talking about a combined ratio of 98.2%, so really down after 9 months compared to last year. And even in this third quarter stand-alone, 96.6%, we believe a quite nice development. And then I come to Retail International. It's even lower ones, 94.4% for 9 months, respectively, 94.1% after I look at stand-alone on quarter 3. And Reinsurance, I will not say much. But coming to Retail International, we have 3, the biggest portfolios, it's Poland, Italy and Brazil. These are the main profit drivers. And there, you see really nice development in the combined ratio as you see in WARTA, we talk about 93-around percent after 9 months. So even in the third quarter, and this is our biggest entity from the contribution point of view, 90.5%. I think not much to say here. And Italy as well, significant with 88.4% quarter stand-alone, nice track. And Brazil, there were many years above 100%. Now they really came down to even in the stand-alone quarter, already 95.9%. I think we like this development. So again, all segments, except Industrial Lines here, really contributed nicely to our bottom line. And now Immo will tell you a bit more details.
Yes. Good morning to all of you. As usual, I'd like to start with the Industrial Lines, and I think this cycle is anyway in the spotlight of today's telephone call. Perhaps you move on to Exhibit 10. Top line has been slightly up. This is mainly driven by the long-term business. I think the important news, of course, has already been out. It's been a very disappointing quarter as far as claims is concerned, and that led us to the ad hoc statement. If you run through the figures, sort of the EUR 150 million, that are the difference between the old guidance of EUR 850 million and the new EUR 700 million, translate roughly into EUR 225 million of EBIT. And it's just the Industrial Lines business and 90% of the effect can be attributed to 2 factors. The smaller one is large losses that are above average and it's manmade; and the other one is high frequencies for all the reasons that Torsten already indicated.What has improved though is the cost ratio, which is good because it helps us to be adamant as far as our 20/20/20 project is concerned. I'll come back to this in a second. The runoff result is positive, although a bit weaker than last year. Q3 has benefited from one extraordinary item. That's probably new to you. It's a disposal gain because we realized some hidden reserves on our real estate portfolio in order to manage our concentration in certain locations in Germany by benefiting from the very friendly real estate market in Germany. Investment result in general is down. And this is -- I think that that's probably worth to dwell on this issue for a second. I think we're talking about a tale of 2 currency rounds. This is the eurozone and anywhere else. Anywhere else, mainly the dollar realm is far advanced in its interest rating increase cycles. This -- we're far away from that in the eurozone. Whenever we invest new money, the likelihood that we would buy in rates that are smaller than the maturing coupons that are now out is very high. There is a continuous pressure on our structural underlying ordinary investment income in the eurozone. At the same time, we see that rates, yes, they're creeping up. It will take some time. But this certainly bites into our hidden reserves that makes it now harder to realize hidden reserves. And if you don't want to play too aggressively and if you want to adhere to a low-better strategy, then you've got to bite the bullet and accept reality that the investment income will go down. And I'll come back to this topic at the end of my presentation. Net income-wise, it's just a reflection of what we've seen in the EBIT. It's been a disappointing quarter. It's been a disappointing 9 months as far as the Industrial Lines segment is concerned. The U.S. tax reform, though, is mainly a thing that occurred in the first quarter, but still, it drags -- kind of drags on and puts the downward pressure on the 9 months figures. What has worked nicely is the 20/20/20 project that we discussed at great length on the occasion of our Capital Markets, and this is something that I'd like to share with you in greater detail.On Page 11, you find exactly the same chart that we shared with you in Frankfurt. The gray shaded part is what we thought should happen and could happen. And essentially, we thought that by year-end, we should have implemented 2/3 of our 20/20/20 project by the end of this year. In reality, we have over-accomplished. Rather than just talking about 13.3% structural condition improvement by year-end, we're talking about 14.3% as of today, being, of course, P&L effective 1st of January. And that means, although it's still probably 10% or so of negotiations going on, we're already ahead of our plan.The premium base is just a tad softer, and that means that roughly EUR 120 million of business that we've lost as a result of our firmness when it comes to walk-away prices. The best part of that was offset by higher premiums for the part of the portfolio that stayed with us; that's part of the 14.3%. Although, as we said, that 14.3% is a combination of higher premiums and, for instance, high deductibles also supporting the better economics of the underlying business, the bottom line, the premium base is fairly stable.One of the greater challenges of this 20/20/20 project is to manage and intellectually to avoid anti-select. There are, of course, 100,000 ways of looking into the issue. One very intuitive way of getting a feeling whether there is something cooking or not is to look at the composition of our risk structure. We've normally assigned a risk class to any of our short tail of property risks, risk class 1 being the lowest one and risk class 10 being the highly exposed, very difficult, the hard stuff. Now if you look at our portfolio before the 20/20/20 project, that is on the left-hand side of the chart, you would see that roughly 22% of the portfolio was made up of difficult, 9 and 10. If you look into the composition of the business that we dropped or people didn't accept our conditioning reviews, more than -- so roughly 27% of dropped business is made up of these difficult classes. 9 and 10 tell you that, on average, we have lost the more difficult bit and thus have, on average, retained the lighter bit, which is probably good news as far as the structure of our portfolio is concerned. And at least this perspective does not suggest any kind of anti-selection. Exhibit 13, Retail International. It's essentially just the same story that we have communicated over the past couple of quarters. Premium structure is moving into more P&C. While P&C -- while the -- sort of the additional business in P&C did not fully compensate the low top line that we see in the Life business, which is not that much of a problem. And operating results and net income, structurally up. I think what is interesting to see is that given that that's really running well, we managed to digest even slightly higher cost-related expenses, transitional expenses, in order to speed up the transformation. As far as the net income is concerned, I think Torsten already mentioned that we benefited last year from a favorable one-off in one of our Life Insurance carriers that had to be shared there with the policyholders, and that meant that, that EBIT development is more friendly than the bottom line which is the higher tax rate that we see now coming back to normal, so to speak, is a significant increase of the EBIT in 2018.Talking about the segment in greater details for the segments within Retail Germany. Let me start with Retail Germany P&C, and this is Slide 14. The gross written premium is up by 2%. The sources is this higher top line is SMEs, self-employed professionals, so that is very -- quite exactly what we wanted the world to be like. And while the top line is up by 2%, the operating result is up by 35%, which is nice. Investment income though is down, again for the same reasons that the Retail Germany nonlife exclusively operates in the eurozone, and that means continuous pressure on reinvestment yields and kind of vanishing hidden reserves that could be used to generate extraordinary results. Yes, I think that's about it, what we can say about the nonlife business, and we are very satisfied with the development. Exhibit 15 now gives you some more details on the Life Insurance business that we do in Germany. The top line is down by 3%. And the part of the shareholder-friendly policy that we sell is roughly 75% or 3/4, as sort of that's nice. We sell more capital-light savings products, which is also nice. The investment income is down. This is, so in this case, not so much a reflection of the ongoing pressure on the yields as such. The main driver here is that the ZZR has been changed, and you're probably all aware of that. And that means that there's lower pressure on the companies such as us to realize hidden reserves. This is good in a sense because it means that there will be lower transaction costs. It's also good because it means that there will probably more fairness between policyholder generations. But it's also good for us because it means, going forward, it's a better way to manage the shareholders' funds. Just to give you a feeling about the ZZR level. By the end of the third quarter, we'd be talking a little bit less than EUR 3.3 billion, which is, of course, much less than we originally thought for 2018. By year-end 2018, we would foresee a figure that is slightly north of EUR 3.3 billion. So essentially, we are done and I don't anticipate any need to further realize significant amounts of hidden reserves as far as 2018 is concerned.Yes, the KuRS, the cost -- related costs for Life, and you may recall that KuRS is not just a program to improve the profitability and the efficiency of the nonlife business and equally very important, to support the profitability of the cost ratio of the Life business. It's broadly unchanged, and I already mentioned in passing the historic tax effect that helped us push up the EBIT, but again, really helped by the bottom line.Exhibit 16, Retail International. I think I'll make it very brief. Premiums are up by 3% in euro terms. If we were to adjust for a stronger euro, it would be 9.3% (sic) [ 9.1% ] higher than original currencies, mainly driven by top line growth in the nonlife business, something that we like. So the currency-invested growth of the top line is 10.2%. The operating result is up by 13%, which is actually quite remarkable given the headwind that we see in the exchanges, and net income is also up by 13%. And the return on equity for this segment is also up, and it is now 8.2%. Please do recall that whenever we report on return on equity figures, we do not fiddle around with the definitions and would rather exclude OCIs nor would we include goodwill that you see in the balance sheet. Talking about the markets. I think Poland is still running very nicely, although it's probably fair to say that we've now seen the peak. Turkey, yes, it's -- on the one hand, it's immaterial, but it still makes money, so something that we like. And what we don't like, of course, the inflation rate because it's bad for the loss ratio, we benefit from a very favorable interest rate environment that offsets this to a large extent. Mexico, and I think this is something I should mention, is up by more than 20% in euro terms and more than 30% as far as the top line is concerned 9 months on 9 months.Let me move on to the Reinsurance Division. Nothing new here. Probably you all have digested the news that you got from Mr. Wallin and Mr. Vogel last week. Their premiums are up. The Life business has done much better than anticipated. And while we have realized the extraordinary effects of the U.S. mortality business, the underlying Life business has been much more profitable. And as far as the nonlife business is concerned, I think we're talking about a very decent combined ratio and have not yet eaten up the full budget that we've put aside for the large losses. So I think that's been a very favorable 9 months and third quarter. Investment capital, and this is now Page 19. The extraordinary income is still robust, plus 2%. This is, of course, very much supported by a high amount of investments we could invest because we're still talking about a positive cash flow. The realized net gains, and this is the fourth line, is down. It's down by almost 50%, and there are 2 main reasons -- or actually 3 reasons. Reason number one is the baseline effect in the Reinsurance segment. Third quarter last year, we realized roughly EUR 200 million of extraordinary gains by selling equities. Then we've got the ZZR effect. There is no need to realize more, significantly more hidden reserves in the third quarter in the German Life carriers. And then there is the structural challenge of lower hidden reserves because of the fact that interest rates slowly creep up because of the pull-to-par effect. This is also equally important. Bottom line, I think we are satisfied. But I think it needs to be clear to everyone that you have can't have a cake and eat it. And that means, in our case, you cannot pursue a low-better strategy, something that we're committed to do, and still hope that interest rates would be skyrocketing. You've got to face reality, and this is particularly true in the euro realm. The U.S. dollar looks a little bit brighter because they're further advanced in their hiking cycles. And this is something that essentially will be reflected also in the bottom line, and we're certainly talking about a double-digit billion euro amount. Equity and capitalization, Exhibit 20. The OCI is slightly down. This is due, a, to higher risk rebates and higher spreads in some markets. Otherwise, the picture is more or less unchanged.Exhibit 21. If you compare the equity sort of under the microscope, you see that the net income has supported the stock. The dividend has depleted it. And the other comprehensive being the result of higher rates and higher spreads in some markets and lower foreign and ForEx exchange effects has also -- that lead to -- into the OCI, that takes us to EUR 8.45 billion (sic) [ EUR 8.54 billion ].A word on solvency. The Q2 figure is, and I think we also already communicated this in Frankfurt, it's 204%. For the third quarter, we expect, again, a sort of figure that's a tad softer, while the figures that we expect for the German Life carriers should be somewhat higher because these are -- this is the area of our business that would benefit from higher rates, and it's certainly good news for our German Life business.Page 22. Here, again, this is a breakdown of the hidden reserves from a P&L perspective and a balance sheet perspective. The shaded part is the balance sheet reserves, and then you've got the unrealized gains in the unshaded part that is not yet seen in the P&L. If you compare these figures to year-end, you see what you would expect, that as a result of slightly higher rates, as a result of pull-to-par effect and as a result of currency exchange effects, the figures are lower than at the beginning of the year, but that should not come as a surprise.Page 23. Just a roundup on the -- sort of the solvency history. I think the 204% and the EBIT were a tad softer by the end of Q3, as well support our target range. And there's no reason why one should be concerned. Well, that's it from my side, and the future, this is a topic for Mr. Leue.
25, outlook 2018. Well, as we have seen after 9 months, our growth and I think even the market will show a growth on this basis, 7%. I think it's a quite stable good growth. And so we believe the 5% -- more than 5% is absolutely realistic. So group net income, as you know, around EUR 700 million, nothing changed, which would mean -- and around return on equity of 8%, which is above our 750 basis points, but for sure, it's not satisfying due to industrial development. We had dividend payout ratio stay in the same level.Coming to the 2019 outlook on Page 26. Well, gross written premium is around 4%. As we said, return on investment, around 2.7%. As Immo mentioned before, less extraordinaries and pressure on the yields continuously, so eating our EBIT and our return on investment as a market development. Group net income, around EUR 900 million. We believe it's realistic, one, because of the return on investment development, but -- so therefore, I think absolutely realistic and we stay with our low-better strategy. We don't want to change it here, so we stay there. This was mentioned as well. This would mean that we have given the target of earnings per share of 5% on the basis of EUR 850 million, which was the original outlook for this year. So this would be on track what we have said. And the average to grow is 5 percentage points, and so 22, when the -- around EUR 900 million of next year, and as well on return on equity, around 9.5%. Again, we have communicated 800 basis points above risk-free as our new targets, which will be totally in line with what we see here. Dividend payout, nothing has changed. And with that unchanged picture, what we have said already, I will hand over now to your questions.
[Operator Instructions] Our first question today comes from Michael Huttner of JPMorgan.
I have 3 questions. The first one is on the Industrial Lines. You had a plan in terms of raising prices on your portfolio. And, I mean, I wonder whether this means that this 20/20/20 target you have might be exceeded, so not just reached earlier but rather, exceeded in the sense of more rate rises or rate rises from all of the portfolio? The second question is you've got an excellent combined ratio in Germany, in Retail Germany. I wondered how much of that is due to the market and how much to self-help? Maybe you can say something about the trends in Retail Germany in merchant terms, in terms of competition and things? And my last question, just so I can -- is -- sorry, it's here -- is on the cash position. When are you likely to reach the target cash buffer, which is around EUR 700 million?
Okay, Michael. So I will start with the first one. And the 2 segments, Immo will take over. I mean, regarding this 20/20/20, we are very satisfied with the actual development. But before we grew somewhere else, we just had to get the targets in and then we will communicate something different. But let's focus on the 20/20/20, and then let's get the target and then we will see. And regarding the Germany and the cash position, as you know, the 1.5 to 2, I think it's -- until EUR 700 million, we have to get our cash coverage ratio up and we'll tell you the details.
Come back to the first part of the Germany question, and I'm going to give you an answer that's probably equally good for the third question and our investor research team is going to kill me for that. Please do not get carried away. Yes, 20/20/20 has been sort of -- has been running better than we had thought. But on the other hand, we see many quarters of disappointments in the Industrial Lines segment so I think it's good to see some good news, some good surprises. One point that one should not get carried away, and this is equally true for the combined ratio in Retail Germany. The -- yes, it's been a good quarter, and yes, we have come closer to our 95% objective, and this is all very good news. And yes, we've also benefited from a higher underwriting reserve quality because some run-off results have also supported the -- now this is not because we made them invest commerce just because they occurred. At the same time, we know that we've got to invest, probably we've got to invest more in the long term because the world has changed, sort of the digital environment and perhaps we call the -- all this talk about get ready, get bundled and get smarter would require significant investments. As far as the Motor business is concerned, I think it's going to be a challenging renewal round in the German market. I have not heard of travel rates, but I have heard of growing competition. And, I mean, this is too early now as far as this year's renewal round and the Motor business is concerned, but it's going to be a tough one. Yes, the cash position, I should cite one of the questions that was raised in Frankfurt. I equally want to cite the answer that the CFO gave at that time, that the ingoing figure was EUR 240 million. At year-end, it's probably going to be somewhat lower because we're going to import losses from the -- on a local GAAP basis from the Industrial Lines business and then we take it from there. But I cordially invite you to ask for the precise figure. The starting point on the occasion of our next call when we discuss the Q4 realized results because then we know what the starting point for the 1.5 to 2.0 initiative is. It's probably below the ingoing 240. I think this is relatively sure. Well, thank you.
Our next question comes from William Hawkins of KBW.
Two points of detail on Industrial Lines, please. On Slide 7, you've kindly given us that EUR 199 million of fire losses in the 9 months. Can you give us a quarter-to-date experience for the equivalent number please, second quarter to date? And then secondly, Immo, you've labored this point about challenges to investment returns at the group level. Could you try and be clearer about what that means for Industrial Lines? When I look in the notes to your interim report, and sorry to throw too many numbers at you, but on Page 30 of your interim report, we see investment income going up, presumably because of gains, we see investment expenses also going up presumably because of realized losses. Netting all that out, we've probably got about a 5% to 10% decline. But it's not clear in your disclosure how much of that is coming from income and how much of that is coming from realized gains because they've clearly been quite kind of big in Industrial Lines. So the question is, really, from the baseline of where we are in the Industrial Lines investment return, how much downside or upside is there in the context of what you've said at the group level?
Thanks. So to give you a flavor, sort of the Industrial Lines is sitting on roughly EUR 6 billion or EUR 7 billion worth of assets. And if you just assume that the average duration is, let's say, 5 years for the sake of the argument and you would invest the new investments at a rate that is 1% to 2% lower than the coupon that matures, gives you a feeling that there's really significant downward pressure on the underlying ordinary investment income. As far as the extraordinary investment income is concerned, I think it's actually down, if I recall it correctly. But that's been offset by the disposal of the -- some of the property that is used by the company for its own purposes, which is not recorded under investment income but other income. The 2 roughly offset the decline and the extraordinary capital gains is roughly EUR 37 million, and this is roughly sort of -- it's roughly the same figure that we realized by disposing of property and areas where we've got too much -- where we're overexposed. Going forward, I think we're also going to see more downside than upside as far as the extraordinary results are concerned and the reason is very simple. At the end of the interest rate decline cycle, now where sort of rates are creeping up, that means you: a, suffer from sort of deposit par effect because the old investments have got structurally a lower residual maturity quarter-by-quarter; plus the interest rate bite into the hidden reserves and that's not just driven by the risk-free rates. If you've seen yield hunting for the past couple of years, now you're going to probably see something like yield unhunting, i.e. people kind of quickly make their investment income minimum returns by resorting to lower-risky assets and that creates less demand for higher-risky assets and that then contributes to a higher equilibrium price for risky spreads. And that supports this -- the "erosion" in [ better commerce ] of hidden reserves also when it comes to riskier assets. So I think this really should be factored in when trying to pencil out the anticipated profit contribution of the Industrial Lines. And coming back to one of the first questions, they're certainly at least as important as the above-plan performance as far as our 20/20/20 project is concerned.
And large losses?
I forget to take the other question, sorry, sorry. The -- sorry, I was so focused on investments that I completely forgot the large loss. Well, large loss, we are still within the amount that we've set aside when we issued our profit warning, so the figure that led to the EUR 700 million profit guidance. We know that Q4 can be difficult. Traditionally, it is certainly not the large loss' lightest quarter in a year and we've allowed for this. And so far, it's certainly not been a brilliant large loss Q3 -- Q4 so far, but we're still within the numbers that we've entered into our own guidance preparation.
We will now take a question from Michael Haid from Commerzbank.
Just one question on Retail International. The combined ratio in the third quarter was very good, 94.1%, better than what I had expected. Still, the operating result in the third quarter was only, yes, roughly flat. What is the explanation for that? Is there any -- are there any issues in the Life business? Or is it just foreign exchange? What is the explanation here? That's my question.
I think you basically answered the exchange ratio. And I think Immo can give you the figures without the exchange ratio, and so basically, if he can bring up the details, but it's about this one, currency basis.
Yes. You were talking about Retail International or...
Yes, International. Totally Retail International, yes.
That's with currency.
Yes.
EBIT would be up 5 percentage points currency adjusted.
We will now take a question from Paris Hadjiantonis of Crédit Suisse.
Firstly, on Industrial Lines. If I look at Q3 in isolation, there is a bit of reserve strengthening going on, I think about EUR 25 million. Could you please explain what exactly is going on there and give us, I guess, some reassurance that in terms of reserving and then your reserve buffers, you are happy with those? And then just a point of check, on your outlook for 2019, you obviously gave that with the announcement, the profit warning announcement, a few weeks ago. Can you just confirm that that's based on Hannover Re net income of EUR 1.1 billion for 2019 as well?
Okay. I'll start with the second one. The answer is yes. And the first one, Immo is going to give you information.
Yes. Thank you for the question. And I'm to blame. I should have mentioned this when talking about the Industrial segment. Your calculation is perfectly right. And I think the run-off result is driven by 2 factors. A very expected and ordinary run-off result in all the major lines, and that's both fire and liability, very healthy, according to plan. And 2 little issues, one in our Swiss branch and the other one in another European branch, where we had to correct an internal assumption that was done when we transferred the business from a branch onto the carrier. This was a very stupid technical issue. And as far as the Swiss issue is concerned, this is an isolated effect that should not reoccur. And I think you raise a very interesting and important, I would call it, moral question. And the answer is very simple. Whenever we see some portfolios that should require high reserves, we shall handle the issue immediately. And while sort of the overall run-off result is still positive, it's only slightly below what we see in the 9 months 2017. I think there is -- we've no inclination to compromise with a reasonable reserve setting. I want to make this crystal clear.
We will now take a question from Frank Kopfinger of Deutsche Bank.
I have also a question on the Industrial Lines and then on German Life. So on the Industrial Lines, you seem to be ahead of your repricing actions and time line. And when you came also to the profit warning of Industrial Lines, you had it or you aimed for a combined ratio for Industrial Lines for 2019 of around about breakeven. Is this still the case despite being ahead of your repricing plan, it seems? And then secondly, on German Life. One of your bigger peers just changed their shareholder/policyholder share within his assumptions in German life, which led to a significant one-off, positive one-off. Is this something you could also imagine? If not, then why?
Regarding the first question, Frank, answer is yes, around 100 is still the guidance for Industrial. Again, as I said before, we would first get these things done, and then we can think. But first, we have to get the things done. We're not yet there. And it's over 70%, which is good, but still 30% or roughly 30% to go, and then we will see. So guidance, again around 100%, that's absolutely the case. And the second more interesting question, probably, Immo?
Yes. Yes, and sort of I read through the writeup of the discussions with Re with some interest. No, there is no such extraordinary effect as far as we are concerned. We are sticking to our RfB quotas, or the shadow RfB quotas. What we see is probably a structural shift towards more shareholder-friendly quotas because of the composition of the different quotas that we assume for different pockets of the business and different carriers' moves in the favorable direction that we've no inclination to change the shadow rates as such for a variety of reasons. And a, if you look into the interest rate environment, I think it would really be premature to state that we are back to normal, that we're back to an environment that we used to be in the old days. That'll take some time. Second, I think this is in the federal RfB quota, certainly, it's difficult. This is an area where we would apply what we call in Germany accounting language, [Foreign Language] or [Foreign Language] keep it steady and then do not move around too quickly. If we were to change this, and perhaps there are areas where we could change it, we'd certainly run the risk of either later disappointing the shareholders or the policyholders, the policyholders perhaps earlier than the shareholders. But I think the downside risks are signaling something that may occur in the future is probably would be very high. Plus I think it's also important to realize that whatever we do as far as the federal RfB ratios are concerned are generally in line with our assumptions that support our Solvency II calculations or Solvency II calculus. And here, again, we want to play it continuously and cautiously. And of course, I could ask or could answer the remaining questions, but the one thing I could -- would not be in a position to answer and this is all details that occurred at ERGO, so this, I don't know.
[Operator Instructions] We will now take a question from Andreas Schäfer of Bankhaus Lampe.
There's one question left from my side. It's regarding Poland, TUiR Warta. And the combined ratio improved strongly compared to the last couple of quarters. And as far as I remember, you applied a very conservative reserving policy at the beginning of the year. So my question is really, has this changed now in Q3? And is, let's say, the combined ratio in Q3, the true, let's say, underlying combined ratio?
The answer is clearly no. I mean, simply, the business is very good. They have benefited -- we mentioned, they have significantly grown in the last year. So economy of scales are jumping in as well with the cost ratio side. And this very conservative approach to the reserving is absolutely not changed in Warta. So this is just riding the curve on a hot cycle still very nicely.
So let's put it this way, you might have some sort of reserving buffer if price increases are not any longer that good in Poland.
There is a case that's absolutely possible.
The answer was clear enough, no? Thank you, Andreas. And perhaps I may step in because we got an email from Vikram Gandhi who indicated to us that he dropped out of the call and he asked for a potential early effect of the ZZR changes in the German Life business.
Very limited because the -- whatever we realize as far as ZZR really was essentially eaten up by the share of RfBs. And long term, it's probably positive because we save transaction cost. It is certainly structurally positive as far as the solvency calculations are concerned because it means that there are few scenarios in which the shareholder has to step in. That is something that's -- and I think I alluded to this in Frankfurt, part of this is probably to be seen by year-end, and the SCR-related effect is going to be seen in 2019 probably. It's not a complete game-changer, but is certainly a tailwind. But P&L-wise, it's neutral.
Okay. So any more questions, Bettina?
We do have a follow-up question from Michael Huttner of JPMorgan.
I had 2 little. One is on the budget for large losses in Industrial Lines. And you might have said, but I just wondered if given this has been such a big year and last year was big as well, were you planning to raise it? And the second is, you're talking in German -- Retail Germany on potential extra investment in digital and things. Can you say what is the payback on these investments? I mean, if you decide to put in, I don't know, whatever figure it is, EUR 50 million or EUR 100 million today, when do we see the profits and when would we see the full payback on that?
Okay, I'll leave it to Immo.
Let me start with the first question, which is the easier one. Yes, we have slightly increased the large loss budget for 2019 for the Industrial Lines. That is also driven by the inclusion of the Specialty business that used to be sort of at -- in the Hannover and the part that flows into the self-retention after Reinsurance is, of course, reflected in a higher budget. Otherwise, we've more or less left it unchanged, perhaps slightly increased, but only slightly. But economically, it is more conservative. And the reason is very simple. If we lose, let's say, 10% of property book at the EUR 120 million that I mentioned that we've lost so far would point into this direction, that means that there is less business that we could have called a NatCat and a large loss budget against. And when we keep this constant, it means that there is more prudence as far as the business that we keep is concerned and this is part of our derisking, a derisking exercise that is not translated into -- and it's not reflected by a lower NatCat or lower large loss budget. And therefore, I would claim that this is more conservative than we see in the figures. As far as IT and digital investments are concerned, I think that this is a more complicated question, what the exact return on investment is. Sometimes, we've just got to do it. If we've got to live up to the new standards of the data protection regulation, then it's not a question of whether it's in payback or not. We've just got to do because lawmakers will require us to do so. When we invest in GAAP-connected initiatives, then I think we would apply our standard return on investment procedures. And at the end, it all boils down to the fact that we want to see at least the cost of equity being earned by such initiatives. And this is for the entire -- for the average of the group cost of equity or the -- it's not just the cost of equity, it's our hurdle rate, it must support the 800 basis points above risk-free but all kinds of expenses that we incur.
And the 800 bps above risk-free, and I know you said it before, I just missed it, that's equivalent to how much at the moment?
Sorry?
The 800 bps plus risk-free, what does it equate to as a kind of final hurdle rate at the moment?
That is 8.5% something.
8.5%. Okay, lovely. Super.
We now have a question from Thomas Fossard of HSBC.
Two questions for me. One -- I mean, actually 2 are related to the Industrial Lines. The first question would be related to the 16% growth in GWP reported in Q3. Could you tell us what has been the drivers behind? Actually, the price increase is expected to have an impact on the '19 result -- on the '19 accounts, so I've been struggling to understand why it's been so strong. And actually, yes, the second question would be regarding the higher frequency in the Industrial Lines. Actually, you described the reasons. I would say strong economic growth, maybe less maintenance of machinery, and this is all -- this is leading to some business interruption claims. Why is this trend which has been picking up in '18 would not be, I would say, repeated on the same level or maybe higher in '19? Any visibility you may have on this?
Let me answer the first question first. The top line increase is, to a certain extent or to a smaller extent, driven by higher price, particularly in fire because you're right, that the bulk of the conditional improvement will only be seen as per the 1st of January, 2019. There's a little bit of this already in there, but this is not a game-changer. The main drivers were more liability business, longer period of business, a little bit of transport business has also contributed to this, and this is essentially it. I think it's certainly not a great appetite to write high-risk Property business. And the second question was the...
Higher frequency, I think...
Higher frequency, will it go away? Probably not, and this is the reason why we've implemented the project 20/20/20 because we've got to live up to this new reality. And the question is, I think as well then, we've also communicated this, if the combination of the higher frequency as a result of the economic cycle in combination with the secular trend driving sort of increased severity as a result of the business interruption risk, the question is then rather whether we've got to go back to the drawing board at one point and ask for more. I think this is our ingoing hypothesis. I think calling off sort of the problem as being solved is certainly too early and this is also sort of the reason why being ahead of the plan as far as 20/20/20 is concerned for the end of per -- as of today should not lead to us being carried away. It's a necessity, period.
Question answered, Thomas?
Thank you.
Thank you very much. Any more?
There are currently no further questions. As there are no further questions in the queue, I would like to turn the call over to Mr. Leue for any additional or closing remarks.
Well, just thank you very much for dialing in and surely participating in our call. And if I don't see you until end of the year somewhere around, I wish you a Merry Christmas and Happy New Year, and thank you very much again. Goodbye from Hannover.
This concludes today's call. Thank you for your participation. You may now disconnect.