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2 insurers tread diverging profit paths

Glenn Freeman  |  29 Jun 2017Text size  Decrease  Increase  |  

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It's a case of one upgrade and one downgrade from these two insurers as we enter the home straight ahead of profit reporting season for fiscal 2017.


Earlier this week, one of Australia's largest general insurers, Insurance Australia Group (ASX: IAG), issued a surprise profit upgrade ahead of its fiscal 2017 results, which are due 23 August 2017. Management attributes this to higher reserve releases, which are tipped to be at least 5 per cent of net earned premium for FY17--more than double the 2 per cent figure for the corresponding period in 2016.

This prompted a 300-basis point increase in guided insurance margin for fiscal 2017, with management now expecting an insurance margin of between 13.5 per cent and 15.5 per cent, up from previous guidance of between 10.5 per cent and 12.5 per cent.

"The significant increase in margin boosts our fiscal 2017 cash profit forecast 24 per cent to $1 billion," says David Ellis, Morningstar's senior equity analyst covering banks and finance.

This contrasts with an investor announcement from QBE Insurance Group (ASX: QBE) a week earlier, when it "disappointed again with another earnings downgrade, just when confidence was rebuilding in management's ability to return the previous market darling into the status of a well-run business".

In response, Morningstar has reduced both its long-term and short-term earnings forecasts for the business, dropping its fair value estimate 13 per cent. Ellis outlines this in greater detail in his latest report titled, "The serial downgrader does it again," available to Morningstar subscribers.

"Our forecast cash profit for 2017 reduces to US$831 million from our previous forecast of US$934 million. Our earnings forecasts beyond fiscal 2017 are reduced by similar amounts," says Ellis.

QBE's reduced outlook is related to the firm's emerging markets division which, according to CEO John Neal, "has experienced significantly higher than expected claims activity during the first five months of the year".

"This is due to a combination of increased frequency of medium-sized risk claims in Asia,-weather related claims in Latin America and adverse experience in legacy portfolios in Latin America," Neal says.

This highlights one of the considerable differences between QBE and IAG. The latter is predominantly focused on the Australasian market, while the former is a global business. The multi-national insurance operations of QBE afford it a more favourable competitive position, with its superior underwriting profitability a key factor in its holding a narrow economic moat, in Morningstar's view.

Conversely, IAG's more localised operation faces stiff competition from the likes of QBE, Suncorp (ASX: SUN), Allianz, Wesfarmers (ASX: WES), along with the four major Australian banks. As such, it is not awarded an economic moat.

"Large insured events occur without warning and IAG lacks meaningful geographic diversification outside of Australia and New Zealand," says Ellis.

While it does have a well-defined Asian strategy across established, emerging and developing markets--Thailand and Malaysia; India and China; and Vietnam and Indonesia, respectively--such forays can be expensive and risky, even via joint ventures.

"There is some customer loyalty to the heritage brands, but many consumers switch insurers on the basis of price ... [and] there are limited barriers preventing large foreign insurers from entering the market," Ellis says.

IAG and QBE are in good financial health, both well within the target debt-to-equity ratio of between 30 per cent and 40 per cent. QBE booked US$844 million in net profits after tax in February this year, and IAG is expected to hit A$1 billion in cash profit for fiscal 2017.

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Glenn Freeman is a Morningstar senior editor.

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