IAG confirms profit guidance

Insurance Australia Group (IAG) has announced its insurance margin for the year ending 30 June will fall between 18.0% and 18.3% – significantly higher than its previous guidance of 14.5-16.5%. That's a remarkable achievement given last year's impressive margin of 17.2% seemed unsustainable. While it reflects excellent management and temporary factors such as a benign claims environment, it also shows the industry oligopoly of IAG, Suncorp and QBE Insurance. 

Net earned premium (the industry measure for revenue) is expected to be around $8.6bn and gross written premium should increase about 3%, which is at the lower end of previous guidance of 3-5% due to a lack of premium rate increases. More storms in New Zealand were offset by fewer natural disasters in Australia which led to overall claims $85m lower than expected. Reserve releases were slightly below 3% of net earned premium and broadly in line with previous estimates due to ‘continued favourable experience in long tail classes in a low inflationary environment’. In layman's terms, claims and the cost of reparing your car or boat remain benign. Lower interest rates in Australia and tighter credit spreads (as investors accept more risk for less yield) produced a near $100m gain on the company’s conservative fixed interest investment portfolio.

IAG’s $1.9bn purchase of Wesfarmers’ insurance business is complete and management will now focus on cutting costs (see IAG buys Wesfarmers' insurance arm from 16 Dec 13 (Hold – $5.70)). Combined with an internal restructure, management expects $220m of one-off pre-tax expenses over the next two years to produce $230m of ongoing pre-tax savings. This is classic behaviour from Michael Wilkins, who is one of Australia's best chief executives.

IAG is going from strength to strength and we've slightly increased the Sell price in the recommendation guide to reflect the company's performance and Wilkins' ability to cut costs from the Wesfarmers business. As insurance is a highly cyclical business we're a long way from an upgrade, but Wilkins continues to impress and with the stock up 5% since 10 Jan 14 (Hold – $5.85) we're sticking with HOLD.