Challenges Abound For Oz Insurers

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

-Youi outperforms on profitability
-Mixed views on IAG vs Suncorp
-NSW CTP changes canvassed
 

By Eva Brocklehurst

Challenger brands are gaining ground on Australia's established insurers, winning a substantial slice of premium such that market share losses among the top three traditional carriers in Australia are now larger than market growth.

Macquarie's analysis of growth and claims data for one of the upstarts,Youi, which recently published its 2015 results, suggests that not only is the upstart gaining share it is also gaining a share of the more profitable segments.

Youi has materially outperformed the industry on profitability, Macquarie notes. Moreover, on the broker's calculations, challenger brands', which includes the banks, gross loss ratios have outperformed weighted industry gross loss ratios by 1,670 basis points over the last nine years.

One offset to be considered is that both challenger insurers and the banks have expense ratios which are not as low as the major insurers, because they do not as yet have the scale advantages.

Macquarie estimates the competition will step up in the next three years, with banks attaining a market share for addressable products of around 10% (from 8.2% in FY15) and challenger brands attaining 13% (from 9.0% in FY15).

The broker's data suggest the banks have captured risks that have performed better than the system in low catastrophe environment while matching system in periods of high catastrophes. Macquarie suspects that the bank home insurance product distribution, sitting as it does alongside residential mortgages, may provide them with a positive selection bias.

Meanwhile, challenger brands typically have a higher portion of motor risks but as they grow they are underwriting an increasing proportion of home risks, which are more exposed to natural catastrophe than motor insurance.

Youi has now captured 2.6% of its addressable market in home and personal motor insurance and Macquarie observes the company is showing signs of approaching scale, with 22.9% gross written premium (GWP) growth in the first half. While Youi may be the leading example of challenger brands the broker highlights that its performance reflects the broader experience as well.

Macquarie suggests that despite a perceived acceleration in Australian GWP growth, the margin decline at traditional insurers is not stabilising. Average premium spending continues to be in a downward trend and is continuing in negative territory in home and motor insurance.

The broker remains concerned about the 12-month outlook, as all traditional insurers are struggling to grow and hold market share. As a result, Macquarie reduces its FY16 GWP growth forecasts for Insurance Australia Group ((IAG)) to a negative 1.1% and Suncorp ((SUN)) to growth of 1.1%. QBE Insurance ((QBE)) is expected to do relatively better, supported by a weaker Australian dollar and a shift higher in US/global interest rate expectations.

Citi has juggled its order of preference for the insurers, placing QBE, AMP ((AMP)) and Medibank Private ((MPL)) in its Buy camp. The broker expects QBE's margins will improve in FY16 and, allowing for 1.2% of reserve releases, expects a margin of 10.3%. AMP is considered attractively valued and offers leverage to a market rebound, while more claims cost savings are expected at Medibank. Citi also believes the regulatory risk is overplayed.

Suncorp, IAG and nib Holdings ((NHF)) are rated Neutral. The broker suspects the speed of improvement at Suncorp could prove disappointing, while IAG and nib appear fully priced.

Morgan Stanley believes IAG's solid franchise, upside earnings risk and capital options make the stock attractive in contrast to the weak momentum overhanging Suncorp. The broker’s adjusted FY16 margin expectations, excluding reserve releases, is 13.1% for IAG and 8.8% for Suncorp. Restoring underlying margins appears challenging for Suncorp in the near term, in the broker's view, as the market competition heats up.

Meanwhile, on the subject of compulsory third party (CTP) motor insurance, the NSW regulatory authority has published an options paper to canvass possible changes to the structure of compensation in the state. The paper recommends moving to free rating of major risks, rather than a capped, gross subsidised system, and reducing the gap between filed profit margins and actual margins achieved by insurers.

Overall, Ord Minnett envisages risks to insurer profitability in this class going forward, although the reforms in the near term could actually boost margins from their current low levels. The most exposed to changes is IAG, in the broker's opinion, given it has 7.0% of its premiums coming from NSW CTP, versus 6.0% for Suncorp and 2.0% for QBE.

UBS suspects the proposed changes may limit the current high claims frequency, reduce volatility and generate surplus capital, but premiums and return will be lower for insurers. Over the longer term this is considered a net negative, given the substantial support reserve releases have provided for IAG and Suncorp profits over the past decade.

Still, the broker envisages IAG's exposure as the number one insurer could be mitigated by an effective 50% quota share. Suncorp has 23% share across its AAMI and GIO brands.

The government last reviewed the scheme in 2013 but made no changes, Credit Suisse notes. This time the options are similar but the government has adopted a softer approach and the broker believes, at a time when insurer profits from NSW CTP are falling, the review should be a small positive. In conjunction, a new task force to address CTP fraud has been set up which should also assist in repairing insurer profitability.

In commercial lines, Macquarie also notes that Australian Prudential Regulatory Authority (APRA) has begun looking at the pricing of upper commercial property risks. Should APRA find that certain carriers are incorrectly pricing these risks the broker believe they will push them to hold more capital. Yet, given the cost and abundance of capital at present Macquarie does not believe this will be a material deterrent.
 

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