Prognosis critical for QBE

After suffering their worst year of catastrophes ever, general insurance companies will do it tough again this year.

After suffering their worst year of catastrophes ever, general insurance companies will do it tough again this year.

AFTER suffering from their worst year of catastrophes ever, general insurance companies will do it tough again this year, particularly QBE Insurance, which is in the unenviable position of watching its profits be crushed by the mounting costs of the Thailand floods, yet is unable to backfill its profits with price hikes in Europe and the US.

A general insurer like IAG, after the Victorian storms in late December and the recent New South Wales floods, will have to pull a rabbit out of a hat to meet its 2012 target of an insurance margin of 10 to 12 per cent. And for Suncorp there will be further reinsurance cost increases this year given its New Zealand losses have moved up since its last reinsurance policy renewal.

But QBE is likely to bear the most pain given more than 75 per cent of its gross written premium income and insurance profit is generated overseas. While there has been some movement in prices in the affected areas of Australia and New Zealand, there is no widespread movement anywhere else that matters, such as Europe and the US.

This will put pressure on chief executive Frank O'Halloran to accelerate his strategy to grow through acquisition.

As one British reinsurer said: ''My old boss used to say that if you're driving a speed boat fast enough the wave never catches up to you, but if you slow down or stop, the wave could wash over you. The problem is Frank's been running fast on the growth path for a long, long time now and at some point the tsunami behind him will catch up as the company slows down.''

The talk is that O'Halloran is about to do a large deal to try to get the boat moving again. QBE is on the short list to buy HSBC's $US1 billion ($A938 million) non-life insurance business. He is also believed to be looking at a few other insurers. But any purchase will require a capital raising.

O'Halloran recently ruled out taking another tilt at IAG, after a failed cash-and-scrip bid pitched at $4.60 in 2008 when QBE was trading at more than $25 a share. QBE is currently trading at $11.82 and IAG is trading at $2.86, which makes it doubtful that QBE can afford it. Another reason could be a wariness of IAG's British motor car insurance book, which has become a poisoned pill.

The talk is that IAG's British motor book, which is written through Lloyd's Equity Red Star, was booked at a loss when the business plan was filed for 2012, which suggests a return to profitability is a forlorn hope.

QBE releases its annual results for the year to December 31 on February 28 and, while the market has already been warned that profit will be down and dividends slashed, investors are waiting for the full accounts to see if there is more to the write-downs than the recent spate of catastrophes.

What they will see is that QBE's margins have been on a slippery slope for the past few years. Back in 2006 and 2007, QBE was generating margins of 21.9 per cent and 22.2 per cent. Since then, they have fallen steadily each year to an overall level of 15 per cent in 2010 and between 7 and 7.5 per cent in 2011. Leading insurance analyst Brett Le Mesurier at BBY forecasts a margin of 9 per cent in 2012 and 2013, partly due to potential problems with QBE's forced placed mortgage insurance business in the US, which is part of an industry-wide investigation by New York State's Department of Financial Services.

The upshot is falling insurance margins, rising gearing levels and a weaker capital position at a time when catastrophe claims are rising.

To put it another way, insurance profit has flatlined. In 2006 insurance profit was $US1.7 billion, in 2010 it was $US1.7 billion and when it reports its 2011 figures on February 28 it is expected to be $US1.1 billion, while premiums have increased by more than a third. This shows the extent of the margin decline and why O'Halloran needs to keep making acquisitions.

The secondary problem is the profitability of its acquisitions. So far they don't seem to be helping much. Between 2007 and 2010, QBE bought more than 10 businesses costing $US6.8 billion, adding $US7.5 billion to gross written premium.

Succession is the real issue. QBE chairman Belinda Hutchinson batted away questions about O'Halloran's retirement plans at the group's annual meeting last year. ''He looks hale and hearty to me and he doesn't look as though he is going anywhere,'' she said.

Hutchinson needs to think again. With a share price chronically underperforming the broader market, earnings going backwards, dividends being slashed and a strategy that doesn't seem to be working, the clock has been ticking for the past few years for change at QBE, at both executive and board levels. Insurance is a complex business and having a dominant CEO and only two non-executive directors with insurance backgrounds goes a long way to explaining the current state of QBE.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles