Insurers On A Tight Rope

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

-Growth targets too optimistic?
-Large players losing share
-Wealth management most positive
 

By Eva Brocklehurst

The ability to balance sluggish fundamentals against ambitious growth targets is central to the 2014 investment case for insurers. UBS thinks so. Insurers expect to grow gross written premiums (GWP) by around 6-7% in 2014, which to UBS seems reasonable based on long-run growth rates. Still, this does imply an acceleration in the second half. Something which the broker thinks is quite optimistic in a soft pricing cycle. Is there enough premium growth to go around? Across the majors, should premiums grow at 3%, the shortfall relative to targets exceeds $500m, a big ask in UBS' opinion.

Credit Suisse observes the recent reporting season had investors trying to pick the insurance cycle for general insurers. The broker suspects a pricing peak is nigh. Underlying margins improved in the December half but the broker notes, despite improving profitability, the focus was on the slowing of GWP. The three largest Australian general insurers, Insurance Australia Group ((IAG)), Suncorp ((SUN)) and QBE Insurance ((QBE)) all underperformed over the past three months. Credit Suisse takes a view that QBE's earnings recovery will continue, but the road will be rocky. The broker finds the valuation undemanding and has an Outperform rating. IAG is awaiting approval for the acquisition of the underwriting business from Wesfarmers ((WES)) and the broker thinks this may hold the stock back in the near term, so a Neutral rating is maintained. Suncorp was upgraded to Neutral by the broker after its result in February as earnings have now re-based and the downside risk is reduced.

Insurer trading multiples are attractive, Morgan Stanley concedes. Suncorp is targeting 7-9% growth and IAG 3-5%, but the broker thinks it more likely they will grow at less than GDP. The broker is comforted by IAG's more conservative target. Morgan Stanley also observes margins remain strong but slower top line growth will dampen the earnings outlook. The broker believes the listed players are lagging the market. Suncorp's and IAG's large share in the Victorian property market hurt relative growth in the December half but even adjusting for this, they are still lagging. Morgan Stanley compares growth of 1.4% and 1.1% respectively in the December half comparing this with system growth of 5.7%. QBE compares more favourably with 3.4% but that includes New Zealand.

Cutting out two distractions to the thesis – the Victorian Fire Service Levy and NZ dollar – UBS believes it is beyond dispute that the majors, particularly Suncorp and IAG, continue to lose share. Outside of the five majors, others grew at 11.5% in the December half, materially higher than the market at 6% and more than twice the 4% growth rate achieved by the five majors. UBS concurs that IAG appears to have the least aspirational, or perhaps most realistic, target. The broker maintains that sub 5% growth may seem bearish but it is not unlikely in a soft commercial market where claims inflation is benign. The broker observes the two major domestic general insurers have managed pricing and margins well since early 2011. Still, it's a delicate balance between premium growth and margins.

Suncorp is the stand-out for UBS, given its capital return initiatives, but a marginal preference is retained for IAG given recent price moves. UBS has a Neutral rating for both Suncorp and IAG. Valuations are now more compelling but the broker is cautious, given the likely tipping point for the price cycle. QBE offers most upside and UBS rates the stock a Buy.

UBS has noticed life insurance trends are stabilising and individual in-force growth for the three largest in this market – AMP ((AMP)), Commonwealth Bank ((CBA)) and National Australia Bank ((NAB)) – has now fallen to 2-4%, as re-pricing is balanced against the risk of further aggravating high lapses. With the exception of Suncorp, all others are growing in-force at above the industry average of 9.1%. This growth rate for "others" highlights for UBS the switching nature of many policy lapses and the impact of ongoing price pressure. Moreover, total new business may have been up 48% in the December quarter but this was driven by two large mandate changes. In the individual market, sales stagnated. AMP's individual rate slowed to 4.3% from 7.3% over 2013 and the broker thinks the stock will struggle to generate material in-force growth given the insurer said at the results briefing that lapses would continue at a "shock" level before improving.

Morgan Stanley prefers the wealth managers over the domestic insurers as there's more upside for earnings, supportive markets and regulatory tailwinds. Fourth quarter statistics showed a continued recovery in fund flows with growth now at levels that UBS thinks could be considered normal for the current stage of superannuation evolution. 2014 is shaping up as the first year for some time where fund flows could positively surprise. Life earnings risk is now manageable from a group perspective for AMP and UBS thinks that company's ability to attract considerable and meaningful flows will support wealth management earnings. AMP's funds under management growth of 6.4% in the December quarter places it at the top of the peer ladder but this was at least half driven by acquisitive growth in self managed super funds. UBS thinks, as positive sentiment continues, a 3% flow growth assumption for AMP is achievable.
 

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