Insurers' New Climate

Background, by Eureka Report editor James Kirby: Australian insurers are bracing for the fallout from long-term climate change. One of the first senior insurance executives to spell out the industry’s biggest threat is Michael Hawker, the chief executive of Australia’s largest home and motor insurer, Insurance Australia Group (IAG).

In today’s video interview with Robert Gottliebsen*, Hawker confirms the insurance industry has accepted climate change as a reality. Hawker says there is “unified scientific evidence” to confirm climate change as a fact. Moreover, he says climate change '” triggering unprecedented storms '” will be a major issue in the future, particularly in coastal Queensland.

IAG '” along with arch-rival QBE '” is one of the most widely held financial service stocks among retail investors. As Hawker grapples with the repercussions of climate change, the Sydney-based group, which was formed from the old NRMA Insurance, is on the expansion trail again.

Hawker, a former Westpac executive, has already formed a merger and acquisitions unit within the company, recently hiring two Asian specialists '” Paul Clark of Deutsche Bank, and former diplomat Michael Cripps of legal group Allens Arthur Robinson.

In its latest results, IAG reported a 1.3% drop in first-half profit to $461 million and detailed plans to return $200 million to shareholders. The result was below market expectations. The top result of the sector came from QBE, which recently posted a very strong 27% increase in annual profit to $1.09 billion.

Hawker tells Eureka Report he believes the insurance market will grow at 16% a year for the next decade, offering long-term investment opportunities for retail investors.

IAG is trading on a price/earnings multiple of 11 times at about $5.57, up from lows of about $5 earlier this year.

Faced with low premium growth and tightening margins in the home market, Hawker says he may have run out of takeover options in Australia and that future acquisition-led profit growth will now come from offshore. The insurer has already taken stakes in Malaysian and Thai insurance companies.

Robert Gottliebsen: You’ve made about five takeovers in the past seven years. Are you going to keep this up?

Michael Hawker: We think we need to keep that up because the economics of our business are driven through scale '” primarily through the scale of diversifying our risk, so we believe the overall insurance market is growing at about 16% per annum over a 10-year period, and to maintain our competitive position we need to grow at that sort of rate to give ourselves diversification of risk. So, yes, we believe we will have that sort of growth rate through acquisitions over the next five years.

Will you make those takeovers in Australia or abroad?

I think they’re more likely to occur abroad than in Australia. We’ve had a history in Australia of a number of takeovers since 1997. We now have market shares in Australia and New Zealand where material takeovers are harder to make and we now need to diversify offshore. So I think you’ll see the majority of them offshore, going forward.

Is Asia the most likely area?

Our focus is Asia and we’ve made a number of forays into Asia. We’ve bought 30% of Amasurance, which is the number two motor insurer in Malaysia. We’ve just taken ownership of Safety Insurance, the number five insurer in Thailand. We’ve bought Royal Sun Alliance’s business in Thailand and we’ve signed a memorandum of understanding with the number two insurer in China. So Asia is our primary focus. However, we do have a vanguard of people looking at other markets around the world for further opportunities.

We’ve had a lot of Australian companies who have got into trouble abroad. What skills do you bring and what are the chances of you going wrong too?

It’s an interesting comment. I think there’s some wonderful examples of Australian companies performing well offshore. I think the characteristic of them performing well offshore is that they need to have a core competency that is competitive on an international scale; and the second thing you get out of insurance that is unique to the insurance world is the diversification of risk, which comes through geographic diversity. The great example of that in our industry is QBE, which has 84% of their business offshore and they’ve been buying companies offshore for years and that’s really driven around diversification risk. I think there are other great examples of Australian companies that have gone offshore. People such as Macquarie Bank. CSL, the blood products people. Westfield. The mining companies. So it’s the core competency and they’ve gone on a core competency.

What is your competency? What do you add?

Our core competency is around the ability to price the risk inherent in motor car insurance; that’s our heritage through NRMA Insurance, and through the history of insurance in this country we have developed world-leading capacity in pricing risk both in terms of the [body ] NGPs, the CGP as well as the comprehensive motor insurance risk and the combination of those two capabilities in motor insurance pricing is what we can take into the Asian markets.

If you get one of those takeovers wrong you could be a target yourself.

I think if we manage the business poorly, we’ll always become a takeover target and growing the company is critical for the economics of the business. So, yes, if we make a mistake in growing the company '” whether it’s organically or in acquisitions '” then of course I think we become a target for other predators in the insurance market, because all our economics are the same.

They want to grow too.

They want to grow too. You need to grow. The challenge in our business, as I keep saying, is diversification of risk and what keeps you competitive and your ability to price premiums very efficiently for your customers is the ability to diversify your risk, so you need less capital per unit policy. You can only do that if you can expand your risks across a whole different geographic base, different markets and different [tails] of risk, and so our business is all about risk management and the mathematical skills around risk management.

You mentioned QBE. Are they your most likely suitor?

You better ask them that.

It does make sense for them to have a go.

Well you better ask them that.

What effect will climate change have on insurance risks and claims?

In our view, climate change is the single biggest risk that’s facing communities today. It’s fundamentally from the insurance world’s perspective we are seeing that climate change is increasing the frequency and ferocity of natural disasters. Hailstorms, cyclones, hurricanes, tornadoes, wind storms'” all those natural disasters are increasing in frequency and ferocity '¦ flooding, droughts. And that’s all due to our view of climate change. and that’s a very common view within the insurance sector. Global re-insurers have been talking about this a long time and now you’ve got, I think, unified scientific evidence that this is a fact globally. Our concern is that unless action is taken by communities to try and reduce what is increasing the climate change risk, then that risk is just going to keep accelerating and will be a major cost to the communities.

What area frightens you most in Australia?

The biggest issue is around climate change, so storms and flooding and storm surge. We would say the warmer climates are typically the ones that are more likely to have a higher incidence than the cooler climates.

Do you mean the Gold Coast and Sunshine Coasts?

I think the eastern coast of Australia, up our north-eastern coast of Australia and the north-western coast of Australia. The north-eastern coast is of more interest because there’s a greater population moving there than there is on the north-west coast. So I think the challenge we have globally and insurers in this country is you’ve got a demographic trend where our older generations are wanting to move to warmer climates and those warmer climates are exactly where the increased ferocity of storms is occurring, so we’re actually seeing two moving forces creating risk peaks which are getting larger.

* Robert Gottliebsen is a business commentator with The Australian.