IAG: Interim result 2017

Insurance Australia Group (IAG) has posted a decent interim result despite net profit for the six months to December falling 4% to $446m. Gross written premium (GWP) – an insurer's measure of revenue – was up 5% to $5.8bn, predominantly due to improved pricing on commercial and personal lines.

The increase in GWP was considerably better than management's prior expectation for no growth, with good performances from Motor and Home lines, up 6% and 8% respectively.

It was a different story at competitor Suncorp, where Motor and Home lines both increased only 2% (for more, see Suncorp: Interim result 2017). IAG has been nipping away at Suncorp's market share, despite already accounting for 27% of the general insurance market compared to Suncorp's 21%.

IAG's underlying insurance margin was 12.6%, down from 14.2%, due to slightly worse than expected natural peril claims. On the bright side, management said there are signs that commercial pricing has likely passed the bottom of the cycle, which bodes well for margins in future years.

Business strength

IAG's Business division also achieved a respectable result. Excluding the sale of the Swann Insurance motor dealership operations, GWP rose 4%. Management noted retention levels were above expectations at higher average rates. A decline in underlying margins from 10.7% to 8.8% was the result of poor rates and volumes in previous years flowing through.

IAG's New Zealand business continued to deliver strong profitability, with an underlying margin above 15%, despite higher claims. GWP increased 5%, or 1% after removing the effect of currency fluctuations. Good premium growth in personal lines was offset by a decline commercial business.

And that's where the good news ends. Unfortunately, IAG experienced a marked decline in the Asian division, where GWP fell 8% due to growing competition in Thailand and unfavorable foreign exchange movements. The contribution from the developing markets of India, Vietnam and Indonesia improved, but this was more than offset by higher claims in Thailand and Malaysia.

Investment pain (and pleasure)

IAG's $13bn investment portfolio took a battering too, with total investment income falling 33% to $142m due to rising bond yields causing capital losses on the company's fixed income securities. This was partially offset by strong performance from equity markets. Rising bond yields cause pain in the short term, but benefit shareholders over the long haul as they eventually flow through as higher returns from IAG's portfolio (see Can IAG float our boat?).

Management said it is making progress in its drive to cut $250m in costs from the business over the next three years and grow earnings per share at 10% a year. We admire the ambition – the trouble is that IAG's major competitors are also scraping around for savings: Suncorp has earmarked $170m in cost cuts over the next two years, while QBE has a US$700m cost-cutting plan underway. Unfortunately, the industry is extremely competitive on price, so we expect most of the savings will wind up in the hands of customers, not in the pockets of shareholders (see IAG: Cutting costs to stand still).

Management raised its forecast for GWP to ‘low single-digit growth' in the 2017 financial year, up from ‘relatively flat'. It also expects an insurance margin of 12.5 – 14.5%, with consensus estimates for earnings per share of 36 cents. That puts the stock on a forward price-earnings ratio of around 17, with a fully franked dividend yield of 4.2%. IAG is a leading insurer, with strong brands and economies of scale, which is why we're sticking with HOLD.