The investment case for the Australian general insurance sector remains attractive, supported by:
The latest updates from the ASX-listed general insurers during reporting season, and the declaration of an El Niño event by the Bureau of Meteorology (BOM) have reinforced our constructive outlook for the domestic insurance sector, with our investment thesis for Insurance Australia Group (IAG) remaining intact.
The listed Australian general insurers, IAG, Suncorp (SUN) and QBE Insurance (QBE), have highlighted a continuation of favourable pricing conditions in the domestic general insurance sector.
Repricing trends have gathered momentum with SUN and QBE guiding to ~10% of Gross Written Premium (GWP) growth in FY24, while IAG has guided for ‘low double-digit growth’, which will drive insurance margins (and therefore profits) higher over the coming financial years as repricing ‘earns through’ to the bottom line.
Encouragingly, the industry backdrop has remained rational this cycle, with the four major general insurers all generally moving in tandem with an overarching focus on improving profitability after a significant increase in reinsurance and perils costs/allowances, rather than vying for market share.
There is upside risk to IAG’s premium growth in FY25E, in our view, with consensus forecasts currently implying a relatively quick easing of this rate cycle, although hardening cycles can last several years (and we are only relatively early into this cycle).
While consensus expectations have materially increased for FY24 GWP over the last 12 months, analysts are still only forecasting more or less ‘trend’
premium growth in FY25, which could prove conservative.
The premium rate hardening cycle has been driven by the significant costs insurers have incurred in recent years.
The recent declaration that Australia has entered an El Niño climate pattern, following 3 years of La Niña, strengthens the investment case for general insurers, as this environment increases the likelihood that natural perils cost inflation will ease over the medium term.
The differences between the two systems include:
During El Niño systems, the costs associated with an increased frequency and severity of bushfires has historically been more than offset by a reduction in the occurrence of cyclones, storms, hail, and flooding, which are on average much costlier to insurers.
Since 1967, bushfires have accounted for only ~12% ($20bn, real terms) of the insurance industry’s total catastrophe losses, compared to cyclones’/hail/flooding/storms’ combined contribution of ~76% ($122bn, real terms).
Given insurance industry catastrophe losses are, on average, significantly lower during El Niño periods, we have become increasingly confident in our thesis that natural perils cost inflation should ease over the medium term, and could surprise consensus expectations to the downside.
The ‘earn through’ of ongoing premium increases, combined with cost disinflation, should drive an improvement in IAG’s insurance margins and its return on equity (ROE) over the coming years, supporting attractive shareholder returns.
IAG has guided to an insurance margin of 13.5% - 15.5% in FY24, compared to 9.6% in FY23. This aligns with the company’s ‘through the cycle’ aspiration of achieving insurance margins of 15% and a ROE of 13-14%.
There is further cyclical upside to IAG’s margins and ROE over the medium term, in our view. In prior cycles, these measures have peaked in the ‘high teens’, although this is not currently being reflected in consensus estimates, which look conservative, creating the potential for analyst upgrades down the line.
After years of subdued investment returns, the insurance industry is now poised to generate strong investment profits, following this year’s run up in interest rates and bond yields.
IAG’s ~$12bn investment portfolio consists predominantly of its technical reserves (i.e., its float of collected premiums), which are invested into cash and fixed interest securities. Over the medium term, we will see a significant uplift in investment earnings reflective of the higher available returns from cash and fixed income, allowing insurers to once again generate attractive, annuity-like investment earnings that supplement their underwriting profits.
In FY24, IAG is expected to generate net investment income of $524m (57% of IAG’s total net income), which is close to a threefold increase on FY21 ($139m).
Cost of living pressures have not had a material impact on customer churn across the general insurance sector. IAG’s retention rates remain ‘very strong’ at ~90-95% for its Direct Insurance Motor and Home segments, and the business continues to add customers, in spite of the significant increases in premiums paid by policyholders.
This is consistent with our view that general insurance is a largely non-discretionary expenditure item that will remain relatively resilient through consumer slowdowns, with recent natural disasters ultimately highlighting the value of being insured to safeguard assets against catastrophes.
The degree of demand inelasticity among policyholders gives us confidence the industry is well placed to pass on future cost inflation as it occurs (such as structural growth in catastrophe losses due to climate change).
IAG is held within the Focus Portfolio as our top insurance pick, given:
|Company Name||Ticker||Fundamental metrics (NTM)||Industry metrics||Consensus earnings||Company description|
|P/E||P/B||ROE||Combined ratio||CY24||CY25||3 yr CAGR (FY0-FY3)||EPS revisions - last 6 mths|
|Insurance Australia Group||IAG||15.3||1.9||14%||89%||29%||9%||37%||7.6%||IAG is the leading personal lines insurer in Australia (~30% home/motor market share) and New Zealand (~60% home/motor market share). IAG is the only 'pureplay' exposure to the Australia-Pacific general insurance sector on the ASX and therefore, offers the most leverage to the attractive underlying fundamentals of this market.|
|QBE||QBE||9.2||1.4||18%||98%||25%||3%||27%||7.4%||QBE is a large global general insurance and reinsurance company with a diverse service offering throughout ~50 countries, including ~25% exposure to the Australia Pacific market. QBE's track-record has been mixed historically with a number of unprofitable acquisitions offshore destroying shareholder value, albeit the new CEO is generally well regarded.|
|Suncorp||SUN||13.1||1.3||10%||92%||8%||5%||7%||5.6%||Suncorp operates the 2nd largest general insurance business in Australia and New Zealand, and owns a 'sub-scale' regional bank. We are cautious towards regional banks at this point of the cycle. Uncertainty remains around SUN's planned spin off of its retail bank after the ACCC made the decision to deny authorisation of the sale of Suncorp Bank to ANZ.|
Source: Refinitiv, Visible Alpha, Wilsons.
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