After bad weather, insurers may hit more storms as premiums rise and margins fall

When the insurers IAG and Suncorp publish their results this week shareholders will get a greater insight into the depth and duration of the drag on insurance earnings across the industry.

When the insurers IAG and Suncorp publish their results this week shareholders will get a greater insight into the depth and duration of the drag on insurance earnings across the industry.

They will also get a sense of the amount of pain they will have to dish out to policyholders in the form of premium rises.

Last Friday the QBE boss, Frank O'Halloran, got the ball rolling when he said average premiums had risen close to 3 per cent, compared with a target of 2 per cent, and that they would increase further in the second half of this year.

Wesfarmers's insurance business was more oblique, warning that "significant" increases in reinsurance costs and higher retentions from July 1 would put pressure on insurance margins. Margins are already under pressure, falling to 1.2 per cent for the year to June 30, compared with 7.2 per cent in 2010.

This profit season will go down as one of the most challenging for the insurance industry. Queensland storms, Victorian storms, earthquakes in New Zealand, cyclone Yasi, Japan and eight catastrophic tornadoes in the US, and volatile global equity markets have contributed to the tough times for the insurance and reinsurance industry.

Reinsurers face tens of billions of dollars in claims, so are taking their pound of flesh when it comes to policy renewals with insurers.

Suncorp, QBE and Wesfarmers have already run the gauntlet and renegotiated their reinsurance policy renewals. How the soaring prices will be passed on to policy holders is still to be decided.

In the case of Suncorp, its retention rate (the portion of a reinsurance claim that is paid by the general insurer rather than the reinsurer) increased from $200 million to $250 million as it signed an 11th hour deal.

It will be interesting to see how much detail Suncorp supplies in relation to its reinsurance renewals. Last year it had an aggregate reinsurance cover that was wiped out by the catastrophes. Without this cover, Suncorp's 2011 insurance results would have been far worse. If the company hasn't managed to place this cover, or much of it, and 2012 is as bad as 2011 in terms of frequency of catastrophes, it will have a big effect on the group's bottom line.

The next round of reinsurance renewals is in January and if the hurricane season is as bad as forecasters predict, then reinsurers will turn the screws even further.

But for QBE, while the latest results were worse than expected, they are just part of a strategy that has been stumbling for the past four years.

Since December 2006 QBE has suffered from nine insurance margin declines from the last 10 half-yearly earnings announcements. Over the same period, the group's share price has fallen more than 50 per cent, compared with a 25 per cent fall in the overall market, and its return on equity has more than halved from 30 per cent to 14 per cent, which is barely giving shareholders a return above the market cost of capital.

Falling margins and ballooning net earned premiums - which have more than doubled in size over the same period to $6.8 billion - raises questions about O'Halloran's strategy of acquisitions.

Premiums have increased, but his insurance profits have not. (QBE bought eight new businesses in 2010 and 2011, costing $US3.4 billion [$3.26 billion]. This brings the total to more than 100 since O'Halloran took the top job 13 years ago.)

In a report a BBY analyst, Brett Le Mesurier, believes if the US has as bad a hurricane season as predicted, this insurance margin might fall below 10 per cent in the second half.

"We hope for the company's sake that the decline is over but there is no guarantee," Le Mesurier wrote. "The company is beholden to its desire to grow. The strain this places on [it] appears to be taking its toll."

The sudden management shake-up at QBE Insurance Group last month when its second most senior executive, Vince McLenaghan, resigned has reignited the issue of succession at QBE.

Sources close to the company say it is now a two-horse race between Steven Burns, who runs London, and John Neal, who is in Sydney. The word is that Neal is the frontrunner as Burns will throw in the towel when O'Halloran retires.

But the talk is that when O'Halloran goes there is every chance there could be a bump in reserves.

"The acquisition thing is like a drug habit ... the more you do the more you want, and the bigger the doses have to be to satisfy Frank and shareholders. I have always felt that the number of deals every year muddies the financial waters," an industry source said.

The QBE chairman, Belinda Hutchinson, batted off questions at the group's annual meeting about O'Halloran's retirement plans. "He doesn't look as though he is going anywhere," she said. Hutchinson may be right, but with a share price chronically underperforming the broader market, no signs of an uplift in earnings, and a strategy that doesn't appear to be working, O'Halloran's willingness to stay put may not be a virtue.

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