Australia | Aug 02 2023
This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG
Tim Boreham takes a look at the fortunes of Australia's listed insurers and insurance brokers.
By Tim Boreham
“Revenge trading” is the dubious practice of doubling-down on a loss maker to recover one’s deficit. But in these inflationary times the term could also refer to buying the consumer-facing stocks of companies that have been exacerbating the cost of living.
After all, if they are inflicting pricing pain on the masses, surely they are making a motza for investors?
The general insurers readily come to mind: hands up if you have been slugged a double-digit rise on your home and contents because of cyclones or hailstones in a distant geography?
Of course, the insurers themselves have been battling the headwinds of cost claims inflation, the result of rising labour and input costs, but also the elevated price of used cars.
On the risk side, the frequency of local insurable catastrophes has been higher in the last decade than in the previous ten years. The 2020 East Coast bushfires and Queensland floods and cyclones spring to mind.
Interestingly, none of these disasters eclipse the -$6.5bn insurance payout for the 1990 Newcastle earthquake, but the trend of “100 year” floods and fires becoming regular events is clear.
On the flip side, insurers are attractive in a rising interest rate cycle because the premiums are collected up-front and invested mainly in cash and bonds.
“The insurance sector is one of a handful that benefits from higher interest rates, with a one per cent increase in rates equating to 10-20% earnings upside,” writes Tyndall portfolio manager Malcolm Whitten.
Also, insurance is a non-discretionary purchase. And because insurers are selling a financial product – risk mitigation – they don’t need to worry about raw material inventories, energy cost and the like.
In times of elevated claims and sluggish premium growth, insurers rely on these investment returns to maintain profitability. But their ability to push through premium increases means their margins are looking healthy.
The biggest pure-play insurer, IAG, operates through brands including the NRMA and the RACV, CGU and SGIO.
In a mid-June update, IAG said it was confident of gross written premium (GWP) growth of 10% for the year to June 30, 2023, reflecting “material improvement” in the second half.
IAG’s home premiums are up 20% – they weren’t just picking on your columnist – with commercial and motor premiums rising 15% and 14% respectively.
The real proof of the pudding is that IAG expects an insurance margin – in effect premiums minus claims – of 10%.
The company also refers to claims cost inflation and the (wet) La Nina cycle “amplified by climate change, which is making reinsurance more costly.”
The owner of the AAMI brand, bancassurer Suncorp achieved GWP growth of 9% for the December (first) half. At the time of the half year results announcement in February, management guided to “mid to high single digit” GWP growth for the full year and a “underlying insurance trading margin” of 10-12%.
La Nina also features in Suncorp’s commentary, or specifically eight “significant events” that cost the insurer -$679m in natural hazards coverage. This impost -$99m more than allowed for.
Suncorp has “prioritised margins to ensure pricing independently reflect natural hazard related costs and inflationary pressures.”
Translated into consumer speak, that means “prepare to be whacked with more premium hikes”.
From an investor viewpoint, Suncorp’s fortunes are harder to gauge because the business also consists of the Suncorp Bank (formerly known as Metway). The ANZ Bank ((ANZ)) proposes to acquire Suncorp Bank, with a (delayed) Australian Competition and Consumer Commission adjudication pending.
In the December half year, Suncorp’s insurance business contributed $276m of the group’s net profit of $560m – almost exactly half.
Focused on commercial cover, QBE Insurance ((QBE)) is always a harder beast to understand because of its overseas reach and its breadth of exposures such as crop insurance. We might not be in Kansas anymore, but a mid-west tornado can be more impactful than a Sydney hailstorm.
Updating investors ahead of QBE’s half year results on August 10, management remains confident of gross written premium growth for the year of 10%. Given premiums grew 13% and 14% in the March and June quarters respectively, this implies some moderation.
QBE has also increased its own catastrophe allowance by US$155m to US$1.33bn, which reflects the tightening cost of reinsurance.
For risk-averse investors, another way to play the game is by way of an exposure to the insurance brokers which intermediate cover for mainly commercial clients.
By taking a cut along the way, the brokers benefit from premium growth but they usually don’t bear any underwriting risk.
These stocks have had a decent run over the last 12 months, led by AUB’s 50% share appreciation. They are trading on earnings multiples of 40 to 50 times, so need to continue to find new organic and acquisitive growth paths.
IAG, Suncorp and QBE shares have gained 31%, 25% and 35% over this period. They’re trading on earnings multiples of 22 to 24 times, but these may moderate if the insurers’ August earnings updates prove to be more bullish than expected.
With Suncorp, the ACCC’s August 4 decision will either clear the air on the banking deal or further muddy the valuation metrics.
In the case of IAG, we wonder whether its most famous shareholder – Warren Buffett’s bargain-hunting Berkshire Hathaway – would be a buyer or a seller under current conditions.
While the outlook for the sector appears upbeat, investors should not forget the inherent risks beyond what the clever actuaries have accounted for.
For instance, IAG and QBE were forced to pay out pandemic-related business interruption claims they thought they weren’t on the hook for, resulting in IAG raising $776m in equity in late 2020.
Tyndall’s Whitten cautions that insurers are hard to value because large catastrophes can take years to resolve and injury claims can be stuck in the court for years.
“As a result, errors in claim loss forecasts can impact a company over many years.”
This article does not constitute share recommendations and readers should seek their own financial advice from a properly qualified party.
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For more info SHARE ANALYSIS: ANZ - ANZ GROUP HOLDINGS LIMITED
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For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED
For more info SHARE ANALYSIS: PSC - PROSPECT RESOURCES LIMITED
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For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED