IAG: Interim result 2015

Insurance Australia Group's (IAG) share price has fallen 9% since it reported its interim result. The insurer's net profit for the six months to December fell 10% to $579m due to intensifying competition and a jump in natural disaster claims.

Disaster claims of $421m exceeded the company's expectations by $71m, mainly on account of $165m in claims following Brisbane's November hail storm – the worst seen in 30 years.

Gross written premium (the industry's measure of revenue) increased 17% to $5.6bn, mainly due to the addition of Wesfarmers' insurance operations, which was bought for $1.85bn in late 2013 (see IAG buys Wesfarmers' insurance arm from 16 Dec 13 (Hold – $5.70)). Management said the company is on track to shave $80m of costs by the full-year result, which will increase to $230m of ongoing savings beyond 2016.

However, the acquisition lowered IAG's underlying underwriting margin, which fell from 13.7% to 13.3%, due to the company's higher exposure to the commercial insurance market. 

Chief executive Mike Wilkins said: 'While Commercial Insurance has continued to enjoy strong retention levels and solid volume growth, it hasn't been immune from the tougher market conditions that are now prevailing. New business opportunities are proving to be limited, while rate reductions are now being seen across the market.' This could be a sign we've reached the turning point in the insurance cycle, with today's unusually high margins likely to be squeezed as competition drives down prices.

The company's personal insurance lines fared a little better with gross written premium increasing 4% due to higher volumes of direct motor and home policies being sold while maintaining stable prices. This implies IAG is taking market share from Suncorp, which reported lower volumes and prices for these business lines in its latest result (see Suncorp: Interim result 2015).

New Zealand

IAG's New Zealand business delivered a 26% rise in gross written premiums, though entirely on account of adding Wesfarmers' NZ-based operations. The underlying profit margin increased from 14.2% to 15.9% due to a period of few natural disasters but the company is still feeling pain from the massive 2011 Canterbury earthquakes.

IAG recently increased its estimate of the total claims cost arising from the earthquake by NZ$950m. The company has settled over NZ$3.9bn in claims and total quake claims costs are expected to be just shy of the NZ$4bn limit where IAG can start recovering expenses from reinsurance.

Income from IAG's $15bn investment portfolio fell 40% to $137m due to a relatively flat share market during the period and lower yields on the company's fixed-interest investments. We don't expect investment income to rebound any time soon thanks to the Reserve Bank's recent decision to maintain interest rates at their lowest level since the 1960s .

Management said the company remains on track to deliver an insurance margin between 13.5% and 15.5% for the full-year, but that growth in gross written premium was now likely to be at the lower end of a 17-20% range.

The insurance industry is notoriously cyclical, and we're at the peak. Margins are likely to fall. But IAG is a well-managed company and the Wesfarmers' acquisition should provide some support to earnings as Wilkins continues to do what he does best – strip out costs. With the share price down 11% since we downgraded the stock in IAG: Result 2014 from 26 Aug 14 (Sell – $6.45), we recommend you HOLD.