Heavy claims, but profits still surge

Insurance companies have defied a year of fire and flood, writes Clancy Yeates.

Insurance companies have defied a year of fire and flood, writes Clancy Yeates.

After years of disappointment for investors, there are growing signs insurance companies are turning the corner. Despite 2013 beginning with more damage claims from ex-Tropical Cyclone Oswald and bushfires in many of the eastern states, share prices have shot out of the blocks, rising as much as 20 per cent this year after bumper profit results.

Two of the biggest players this week underlined the rapidly improving conditions.

Suncorp shareholders, who have endured a wild ride in recent years after the Queensland firm was pummeled by claims for flooding, saw net profits jump by almost a half to $574 million.

Its arch rival, IAG, said profits had more than tripled to $461 million in the half, with dividends doubling.

The bumper results raised hopes among some analysts that the industry may be entering a sweet spot for profit growth, which should also benefit QBE's when it hands down its results next week.

But with Suncorp and IAG each delivering total shareholder returns in excess of 50 per cent in the past year, the question on many minds is whether the growth is sustainable.

The rapid expansion in profit margins at IAG - the nation's biggest car and home insurer - illustrated just how much money the sector is making.

Helped by its dominant position in what is essentially an oligopoly, its insurance margin surged from 7.7 per cent to 19.19 per cent, which brokers said was the highest in living memory.

"Profitability simply does not get any better than this, at least not sustainably," an analyst at Bank of America Merrill Lynch, Andrew Kearnan, wrote in a note.

Kearnan argues IAG's prospects look "solid" for the next year or so, but it could be entering a period of "peak earnings" and at current share price it is already priced at 2.5 times its book value.

RBS Morgans made a similar argument, saying that although IAG had hit a "sweet spot," much of the good news has been factored into its share price, its highest in more than five years.

Instead, RBS and Kearnan both have Suncorp as a preferred pick. For one, Suncorp has built up substantial excess capital from the profit rebound and is tipped by some to reward shareholders with a special dividend, as it did last year.

Deutsche Bank's Kieren Chidgey said the company was unlikely to keep all its surplus capital and he expected a 31¢ final dividend plus a special dividend of 15¢ at the end of the year, compared with its interim dividend of 25¢.

Despite the rebound, things have not always been as positive for insurance firms. In recent years a horror run of natural disasters here and overseas has pushed up costs through billions in claims and global increases in the cost of reinsurance. At the same time, investment returns have been crimped by skittish sharemarkets.

Suncorp endured a double-whammy during the global financial crisis when its banking arm had a near-death experience after funding markets froze.

This year, however, recent flooding and bushfires are within insurance industry allowances, and profits are being bolstered by a buoyant sharemarket and hefty rises in premiums. IAG said home and car premiums could rise 5 to 10 per cent this year .

But just as some question how banks can continue to prop up profits by re-pricing mortgages, there are also doubts over how much insurance companies can continue to boost earnings through higher premiums.

An analyst at Nomura, Toby Langley, cautioned that if wage growth were to slow it could result in increased "consumer activism" with individuals becoming more discerning about their insurance policy purchases.

Insurance chief executives are also keen to present an image of caution. And as always, it seems mother nature is the wildcard.

Asked if the industry was seeing the light at the end of the tunnel this week, IAG's Mike Wilkins said he was pleased with the company's results, but added: "We are still open to the volatility and the vagaries of mother nature as well as investment markets and other extraneous factors."

Or as Suncorp's Patrick Snowball put it when asked by JP Morgan analyst Siddharth Parameswaran to update his view on the company's allowances for natural disasters: "Sid, would you like to tell me what's going to happen with the rains for the next six weeks?"

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