In late June, Insurance Australian group shares jumped to an equal all time high of $6.97 after a confident earnings upgrade for the financial year that was about to end on June 30.
The shares then drifted lower to end on Tuesday night at $6.76 as investors awaited the release of the full year results for 216-17 yesterday.
They were solid – profit jumped by nearly half to $929 million, helped by stronger investment income and capital reserve releases thanks to the very low inflation environment.
Final dividend was 20 cents a share (up from 13 cents a share), taking the full year payment to 33 cents a share, but down 3 cents from the 36 cents a share paid for 2015-16.
Despite all that the shares were sold off solidly, losing 8% of their value to end the day on $6.22, the lowest they have been since late April.
Not helping investor sentiment was the suggestion in the report that the local insurance market is getting tougher.
IAG’s preferred underlying measure of insurance margins narrowed from 14% in 2015-16 to 11.9%, which was a worry for analysts
That fall was due to higher claims costs in its Australian and New Zealand motor vehicle businesses, higher large losses in its commercial classes of insurance and its natural peril claims costs of $822 million which exceeded its allowance for the year by $140 million.
That was offset to a degree by the positives of strong equity markets, which helped boost IAG’s net profit due to an increase in its investment income on shareholders’ funds, and the improvement in the prior period reserve releases.
Prior period reserve releases relate to expected claims and inflation for its Australian ‘long-tail’ insurance classes being much lower than expected because of lower inflation. Those releases totalled $457 million which was equal to an unusually high 5.4% of the company’s net earned premium.
The same figure for the 2017-18 financial year is expected to be at least 2%, hence some unease among investors about the 2017-18 profit outlook.
The company’s cash return on equity also improved from 13% in 2015-16 to 15.2% in the latest year, and its combined ratio fell to 88% from 91.3% – which was a solid effort.
The unease about the result’s quality and the outlook was added to by directors saying in their commentary that they are looking for more insurance protection for the year ahead – a sure sign they fear a rise in claims and need to bolster capital.
“As part of its broader capital management program, IAG is exploring additional reinsurance quota share opportunities with its counterparties which have the potential to further strengthen IAG’s regulatory capital position"
The company’s main capital measures look a bit low as well.
IAG already has a big 20% quota share deal with Warren Buffett’s Berkshire Hathaway insurance group which sees it paying the first 20% of claims for 20% of IAG’s premiums. Berkshire also owns 3.7% of IAG’s capital and would be expected to be interested in a new deal with its biggest customer in Australia.
Until this is sorted, IAG shares will suffer some volatility.
