Usually its hard not to be a bit cynical about insurance companies and the many ways they have to produce results. So when Insurance Australia Group (IAG) revealed yesterday that its reserves releases for the year to June will be larger than expected, the first reaction was hmmmm.
But the insurer’s explanation and size of the potential release (more than double the forecast 2% of net earned premiums) was convincing enough to investors who chased the shares to a record of $6.97 in the expectation of a better than expected result for 2016-17.
That will be despite the small fall in profit at the December 31 half way mark.
As a result of the higher reserves release it has lifted guidance for its insurance margin for the year to June 30 because of after a better than expected year of claims in compulsory third party, workers compensation and other businesses.
With the company forecasting modest growth in Gross Written Premiums and higher investment returns, the sharp rise in reserves returns and higher insurance margin is pointing to a better than expected result for the year to this Friday – June 30.
But oddly, IAG didn’t upgrade its overall profit guidance for 2016-17, even though there are only two days to go, so the market optimism might be a bit ahead of itself.
IAG, which sells insurance under brands including NRMA and CGU, will report its full-year earnings on August 23, but some analysts reckon there could be an update from the company before then.
IAG said in its statement to the ASX that it now expected margins between 13.5% and 15.5%, up from 10.5% to 12.5%. The insurance margin for 2015-16 was a very solid 14.3%.
IAG now says it will be able to release more reserves than expected, because of lower claim costs than it had budgeted for in Australian insurance lines including compulsory third party CTP), liability, professional risks and workers compensation.
Some of these are ‘long tailed’ policies in that the potential payouts come a year or more after the policy is written Short tail policies are generally insurance where claims are made within a year. In fact the reserves release could be as high as 5% of net earned premiums instead of the usual measure of around 2% as guidance for the year.
“IAG advises that, as part of its regular year end processes, it has just completed a preliminary review of prior period reserve releases for the financial year ended 30 June 2017 (FY17), IAG said yesterday.
"This preliminary review indicates an outcome equivalent to at least 5% of net earned premium (NEP). This compares to previously held guidance of at least 2% of NEP.”
"The higher indicated outcome, compared to previous expectations, reflects further favourable experience against underlying assumptions for claim size and inflation.
"It remains IAG’s long term expectation that reserve releases will represent around 1% of NEP in any given year, as embodied in its underlying margin calculation.
“As a result of the expected increase in reserve releases, IAG has raised its reported margin guidance range for FY17 from 10.5-12.5% to 13.5-15.5%,” it said yesterday.
“Other underlying assumptions behind IAG’s FY17 reported margin guidance are unchanged: Net losses from natural perils of $850 million; no material movement in foreign exchange rates or investment markets in 2H17; and a small net negative from optimisation program initiatives, as early benefits are outweighed by related costs.”
In February the company reported a first half insurance profit of $571 million (down from the $610 million earned in the first half of 2015-16) and a reported insurance margin of 13.5% (1H16: 14.9%). IAG slightly lifted its estimate for Gross Written Premium growth for the year “to low single digit growth” compared to its previous forecast for a flat outcome. That was after a result of a rise in the first half to $5.8 billion from $5.5 billion
