QBE changing sails in an insurance squall

That John Neal was prepared to say that QBE remains on track to deliver a top-quartile performance in the global non-life insurance market even as his shares were getting hammered in the wake of the group’s interim earnings announcement speaks volumes about both where QBE is in its attempted transformation and the nature of the insurance industry.

QBE announced a 37 per cent fall in interim earnings and halved its dividend in recognition that its second half traditionally brings with it a much greater exposure to catastrophes than the first.

One suspects that of greater consequence in the thinking of investors than the dividend was the disclosure of continuing issues within QBE’s troubled US operations, where Neal has put a new senior executive team in place after a series of unforseen problems has made it a serial underperformer.

QBE has lowered its forecasts of gross written premiums in that business for the full year by $US600 million, from $US6.5 billion to $US5.9 billion, citing lower premium volumes from its lender-placed business as a particular factor.

More broadly there was a "disappointing" blowout in adverse prior year claims of $US178 million and QBE was also adversely affected by lower investment earnings and the weaker Australian dollar, although even though investment income was 42 per cent lower than the first half of 2012 it was in line with QBE’s expectation.

The result reinforces what the market suspected – that the task ahead of Neal in implementing his transformation strategy is quite a demanding and complex one in the context of the volatile global insurance sector in which QBE operates.

Neal is attempting structural change within QBE within a quite cyclical industry, moving from loose ‘’federation’’ of the multitude of businesses his long-serving predecessor, Frank O’Halloran, acquired over the years to a simpler and more unified operating model that better leverages QBE’s global scale and reach. There have been wholesale changes to the leadership team and Neal has embarked on a program to take $US250 million out of the group’s cost base by the end of 2015.

Neal remains confident that the group will emerge in better shape, saying that it was on track to deliver the 92 per cent combined operating ratio and 11 per cent insurance profit margin he has targeted for the full year.

QBE’s combined operating ratio in the first half was 92.8 per cent and its insurance profit margin was 10.8 per cent. The insurance margin was affected by the steep fall in investment income relative to the same half of 2012, when the group experienced big gains on a narrowing of credit spreads. QBE’s investment yield more than halved relative to that earlier period.

Neal has strengthened the group’s balance sheet and its core Australasian businesses are performing strongly, with an insurance margin of 17 per cent. He is also fine-tuning the group’s investment policy – traditionally highly conservative and therefore very exposed to the environment of low interest yields from its investment portfolio – shifting it slightly up the risk curve.

He clearly needs to execute the restructuring of QBE’s North American business effectively and to get a better handle on prior year claims.

He will also be hoping that the spate of major catastrophes that have afflicted QBE in recent years doesn’t continue and that the increases in premiums that followed those earlier major spikes in claims as a result of the series of natural disasters are allowed to flow through to his bottom line without his earnings being disfigured by yet another blowout in large claims.

The decision on the dividend – QBE has a stated policy of paying out 50 per cent of its cash profit but will distribute only 37 per cent of the interim earnings – suggests he and his board aren’t prepared to bet on that outcome.