Could The Quake Actually Benefit QBE?

This story features QBE INSURANCE GROUP LIMITED. For more info SHARE ANALYSIS: QBE

By Greg Peel

Is the world about to end? Fans of the Book of Revelation may be somewhat inclined to believe so, but seismologists recently interviewed by the media have played down the implications of the seemingly endless stream of seismological events the world has suffered over the past couple of years, noting that such activity usually occurs in clusters. Eventually the earth will settle down again, they say.

For Australian insurance companies, the end just never seems to come. If the pre-Christmas floods in Queensland weren't enough then came Brisbane, followed by Cyclone Yasi, and while insurers at that point were still comfortably within annual catastrophe provisions the warning bells were sounding that there wasn't a lot left in the kitty. Earnings forecasts would not be largely impacted, analysts noted, as long as the catastrophes stopped.

Then came Christchurch, and provisions were again stretched. Then came the big one. (Let's hope it still proves to be “the big one”.)

Yesterday QBE Insurance ((QBE)) announced it was estimating US$125m of insurance losses stemming from the Japanese earthquake. QBE has reinsurance exposure through its Lloyds stake as well as some marine and energy insurance cover. JP Morgan was surprised at just how quickly QBE was able to arrive at this figure given past delays, and as such is assuming it to be a worst case scenario.

Analysts note the figure is only around 0.9% of QBE's net earned premiums (NEP). QBE operates on a calendar financial year, so unlike peers operating on June financial years QBE still has plenty left in the kitty of annual catastrophe provisions. After all that has occurred in 2011, the company's claims now total US$550m against the full-year provision of US$1.65bn incorporating aggregate reinsurance protection. About a third of the provision has thus been accounted for already in the first quarter of the year.

Again we say, if it all now stops…

The bottom line is that analysts have not deemed it necessary to make any meaningful adjustments to earnings forecasts based on QBE's assessment. JP Morgan queries whether QBE can reach even the bottom end of its 15-18% profit growth guidance, but it, too, left forecasts unchanged this morning.

But the Japanese quake throws open a wider question for discussion.

The global insurance business is a competitive game, and as such margins need to be carefully managed. One cannot just put up premium prices willy-nilly given (a) the level of competition and (b) the destruction of insurance demand high premiums will spark. We recall that many Brisbanites had decided not to buy flood insurance on their houses given the high cost. The cost of flood insurance is understandably high for houses built in a flood plain.

An industry body has estimated the cost of the Japanese quake to reinsurers could be as high as US$35bn, which moves to US$50bn or so if you then add in the actual tsunami. After a shocking couple of years, when is enough enough? The question is as to whether global reinsurers will now simply have to raise their catastrophe premiums and damn the demand destruction given the extent of mounting claims. Were this to happen, QBE would be a beneficiary of higher prices.

“The key question for the stock,” notes JP Morgan, “is whether the losses for the global industry could lead to a turn in the insurance cycle. In this there could be a strong silver lining for QBE”.

Macquarie's take is, “whilst this tragic event will almost undoubtedly give rise to a massive economic loss, it is still too early to determine whether the insured loss will be of sufficient scale to turn the global reinsurance pricing cycle”.

Deutsche Bank thinks not. The bottom line is that building a house on the Ring of Fire is not dissimilar to building a house in a flood plain. Insurers either don't want to know you, or price their premiums so high as to make insurance untenable. Hence the number of householder and small business claims in Japan will not be nearly as extensive as one might expect. The real cost will be on infrastructure claims, and for that the Japanese government pays the premiums.

Macquarie notes that following the 1995 Kobe earthquake, losses totalled some US$100bn for infrastructure and property and another $50bn for economic disruption, yet the insured loss totalled only US$3bn.

Following Kobe, the Japanese government instituted the Japanese Earthquake Reinsurance fund which covers residential policies. BA-Merrill Lynch notes there is low insurance penetration outside Tokyo. It is the Japanese government which will cop the brunt of the cost, and not the global insurance industry. And as Merrills notes:

“With insurance losses estimated at 1-3% of the global reinsurer capital base and large amounts of surplus capital even today, the jury is out as to whether this loss will be enough to tip broader global commercial insurance pricing more positive”.

RBS makes note of competition in suggesting, “abundant global insurance capacity may limit more broad based price increases”.

On that summation, it would seem analysts are leaning away from the notion of industry-wide price increases and thus benefits for QBE. Without, that is, fully dismissing the possibility.

In the meantime, for QBE the wait continues for the day global interest rates start to rise again, to which the company's fortunes are highly levered.

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