Earlier this week an insurance analyst at a leading investment bank wondered where the downturn would come in the general insurance industry after solid performances by Promina and the GIO arm of Suncorp-Metway.
The point to the wondering was that with all reporting insurers mentioning rising competition and falling premium income, especially in some lines like motor vehicle, someone had to be having problems.
The analyst had noted that the results had been affected positively by the release of millions of dollars of reserves ($149 million in the case of Promina).
Yesterday the country’s leading general insurer, Insurance Australia Group appeared to answer the analyst’s question with a 25 per cent fall in net profit for the December half.
Net profit fell to $345 million ($273 million) in the December half from the $461 million earned in the same half of the 2006 year.
But the impact of the price cutting and higher marketing was amplified by a downturn in investment returns from shareholder funds as IAG adopted a more conservative approach to the stock market.
That cost it a substantial amount of money in the half whereas it had made an outsized profit in the 2005 half year from the higher exposure to a surging market.
And yet the shares weren’t trashed as those of Fosters group or Tabcorp were when they surprised on the downside this week. IAG shares closed down just 5c at $6.25, though turnover was a heavy 14.5 million shares.
Other analysts had noticed that Promina’s key AAMI brand and even GIO had picked up some market share in NSW, especially in motor vehicle (and in some home and property insurance) policies.
So IAG cut prices and boosted marketing costs to fight off this more intensive competition and the bottom line paid the price.
The price cutting and lower investment profits impacted the company’s insurance margin (underwriting profit plus investment returns as a percentage of premium income).
That fell to 13.3 per cent from 15.1 per cent in the first half of 2006. The margin was up from 12.4 per cent in the last half of 2006.
Total group revenue fell 3.5 per cent in the half to $4.08 billion and policy revenue in Australia fell half a per cent in the six months to $2.69 billion, thanks to the price cutting.
But the key factor was the lower investment returns on shareholders’ funds which decreased to $166 million (December 2005: $345 million; June 2006: $194 million).
The Group reduced its exposure to equities in the final quarter of 2006. Despite this, IAG was able to achieve an ROE of 19.5 per cent (or 16.8 per cent based on normalised equity market returns).
That was a 52 per cent fall as the company trimmed its holding of shares to 45 per cent of its portfolio from 80 per cent previously.
And that seems to have caused more damage to the bottom line.
CEO Michael hawker said in a statement that “In our largest business, Australian personal lines, we’re in a far better position than we were 12 months ago with a sustainable business model based on reinvigorated customer service, product focused marketing and a more competitive price position.
“And the results are clear – renewal rates in the direct NSW car comprehensive and home portfolios are over 93%, we’re winning new contracts from third party distributors in our indirect portfolio which increased its renewal rate to 85%, and our share of NSW CTP registrations in December was close to our June 2007 target of 38%.
“At the same time, our Australian commercial lines business delivered a strong margin benefiting from continued favourable developments in long-tail classes and a focus on managing our relationships well, adhering to underwriting disciplines rather than pursuing unprofitable market share.
“And we’ve made real progress on our strategy to diversify our risk by becoming an international insurance company with the acquisition of two UK-based motor insurance businesses, Hastings and Equity, which together make us the UK’s 3rd largest personal lines broker and 4th largest motor insurer by premium.
“This result includes the first contribution from Hastings, as well as growing contributions from our Thailand and Malaysian businesses.”
And that’s probably why the company’s shares weren’t given a hiding.
“The company has had a defined strategy, has stuck to it, and has expanded into Asia and the UK with some benefits starting to emerge. So when Mr Hawker indicated that the second half would be better, his forecast was accepted.
Also helping was the absence of reserves releases to muddy the quality of the result.
He said yesterday that looking to the second half of the 2007 financial year, the group’s earnings base would continue to improve.
“We’ve got solid momentum back in our Australian business and were starting to see the benefits of our strategy to be an international general insurance group,” he said.
Mr Hawker said IAG was confident of meeting its guidance of 12 to 14 per cent gross written premium growth for the full year.
Mr Hawker also said he expects IAG’s return on equity to exceed its target of 1.5 times its weighted average cost of capital, subject to the usual caveat of no losses beyond its allowances.
“The acquisition of the Hastings and Equity businesses, as well as growing contributions from our Thailand and Malaysian businesses, will add greater scope to our offshore revenue potential and we’ll continue to pursue international expansion opportunities which meet our stringent investment criteria.”
