Suncorp’s 37% fall in fiscal 2022 profit kicked off the August earnings season. And while the insurer’s $673 million profit missed Morningstar’s forecast by 20%, price increases and higher rates underpins Morningstar’s view. Indeed, the main contributor to the weaker-than-expected result was the mark-to-market write down on its bond portfolio. However, as analyst Nathan Zaia highlighted, these losses are unrealised with higher rates expected to support higher income in the future.

“Price increases, modest volume growth, and the ability to use its scale to keep claims inflation down were positives, and much more important to our long-term view than volatile moves in investment markets,” Zaia said.

Indeed, momentum in insurance pricing and volumes remains positive for Suncorp across Australia and New Zealand. Gross written premium, or GWP, increased 7% in Australia year on year. Price has been a key driver, for example, up 10% in home and 5% in motor. In line with Morningstar’s expectations, Zaia believes Suncorp’s refocused effort on the digital offering and multiband strategy are also supporting volume growth with motor up 4.5% and home up 1%.

He also believes the insurer’s target insurance margin of 10% to 12% in fiscal 2023 – up from an underlying margin of 9% is achievable. “The benefits of recent repricing to recoup claims and natural hazards will continue to be recognised in future periods, and investment income is expected to be materially higher, both of which will help lift margin,” Zaia notes.

However, cost of claims which Suncorp has managed extremely well in fiscal 2022 will be harder to avoid in the future.

“Suncorp has successfully used its scale to negotiate better terms with auto repairers and trades involved in residential construction and maintenance, but as contracts come up for renewal, it is likely some of the pain the repair network has incurred will be shared by the insurer.”

The final dividend of 17 cents per share was disappointing but was underpinned by a combination of lower earnings and less headroom to lift is dividend payout ratio. And while it may become a moot point if its bank business is bought by ANZ, Zaia expects this part of the business to grow profits strongly over the next five years.

Strong profit growth for QBE

QBE also reported a profit fall, with its first-half 2022 cash NPAT of USD 151 million falling around 65% from last year.

However, for Zaia there is but is no cause for alarm with shares traded up 3% post the result.

“We think the market is more than pricing in the future benefit of higher income on its USD 27 billion investment assets, and recent improvements in claim expenses being maintained,” he said.

Similar to Suncorp, losses to its bottom line were because of volatile markets, with QBE attributing investment losses of USD 840 million to higher interest rates result in lower bond prices.

However, Zaia notes, the higher cash rate environment, QBE is expected to generate stronger returns on its policyholder and shareholder funds in the second half and beyond.

On the insurance premium front, GWP, increased 18% on first-half 2021. The result benefited from price increases across all regions, averaging 8% in the half, new business wins, higher customer retention, and existing customers increasing their coverage.

The North American business has been a stand-out for QBE, as has improved profitability with GWP increasing 24% underpinned by its combined operating ratio improving to 96% from 101% over the previous 12 months. Underwriting profit was USD 89 million, up from a loss of USD 17 million in the prior year which was due to the severe storms. This could provide further headwinds for the insurer. US Crop makes nearly half of QBE’s GWP and with crop heavily exposed to weather changes, Zaia is hesitant to assume the profits for its North American business can be sustained at current levels through the cycle.

Closer to home, Zaia expects premium rate increase to be moderate highlighting management guidance of 10% GWP growth for 2022 which is also in line with Morningstar’s forecasts.

With insurance margins having improved, and investment income expected to rebound, the need for price increases is slowing.

In terms of future challenges for QBE, costs remain a risk given labour shortages, wage pressures, higher commodity prices and supply chain issues, not to mention the ever-present threat of more severe and frequent large natural hazard events, according to Zaia.

Despite the sharp drop in profit, the interim dividend was reduced by a much smaller 20% to AUD 0.09, franked at 10%. Morningstar forecasts full year dividend of AUD 25 cents per share, implying a dividend payout ratio of about 60%

CBA grows market share

Despite economic challenges, Commonwealth Banks’ full-year cash profit increased 11% to $9.6 billion, just shy of the bank’s record profit in 2017. Commonwealth Bank's fully franked dividends for the year of $3.85 per share were 15 cents below Morningstar’s expectations.

Zaia expects rising cash rates to further support earnings in fiscal 2023 and even beyond, however, likely higher bad debts will provide a damper. 

There was no benefit to the recent rate increase on its margins with, net interest margins (NIM) falling 18 basis points to 1.9% for the year off the back of stiff price competition.

Zaia also expects the trend by CBA and the other banks to pass on full cash rate rises to borrowers but not to savers to cash rates are expected to rise.  

Australia’s largest lender even managed to take market share in both retail and business deposits. In the last 12 months, the bank grew loans by 8%, but grew customer deposits by 12%.

“The bank is not doing it with price either, benefiting from investment in digital offerings to differentiate and headcount to ensure a positive customer experience.”

The emerging risk for the bank is of course the likelihood of bad debts with even CBA’s CEO Matt Comyn acknowledging that the bank’s customers have been impacted by devastating natural disasters and rising cost of living pressures.

However, for Zaia, a tight labour market, large loan repayment buffers, and the ability to cut back on discretionary spend should help mitigate widespread stress on the bank's loan book.

“Homeowners could surprise with how much they can cut discretionary spending.” In fact, CBA highlighted that it is already seeing spending on debit cards fall indicating that recent rate increases are having an impact on discretionary spending.

And while it is a challenging outlook, the bank chief at least remains optimistic.

“It is a challenging time, but we remain optimistic that a path can be found to navigate through these economic conditions,” Comyn said.

“We remain of the view that the medium-term outlook for Australia is a positive one.”