QBE set to go from one bad year to the next

After the Victorian storms in December and the recent NSW floods, management of a general insurer like IAG will have to pull a rabbit out of a hat to meet its 2012 target of 10 per cent to 12 per cent. For Suncorp there will be further reinsurance cost increases this year because its New Zealand losses have moved up since its last reinsurance policy renewal.

But QBE is likely to bear the most pain as 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 the QBE boss, 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."

There is speculation in insurance markets that O'Halloran is about to do a large deal to try and get the boat moving again. QBE is on the shortlist to buy HSBC's $US1 billion ($939 million) non-life insurance business. Whether he buys it or not, he is understood to be looking closely at a few other insurers. But to do so 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 at $2.86, which makes it questionable whether QBE can afford it. Another reason could be concerns over IAG's British vehicle insurance book, which has become a poisoned pill.

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

QBE releases its annual results for the year to December 31 on February 28 and, while the market has been warned that profits 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. 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 last year.

Insurance analyst Brett Le Mesurier, at BBY, is forecasting a margin of 9 per cent this year and next, partly due to potential problems with its forced placed insurance 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, QBE's insurance profit has flatlined over the period. 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, showing the extent of the margin decline and why O'Halloran needs to keep making acquisitions.

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

Succession is the real issue. At the group's annual meeting last year, the QBE chairwoman, Belinda Hutchinson, batted off questions about O'Halloran's retirement plans.

"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 appear to be working, the clock has been ticking for the past few years for a change at QBE - at both the executive and board ranks.