Insurance Australia Group

Insurance Australia Group (IAG) is taking larger strides in order to produce 10% of its total gross written premium from Asia by 2016. Since August last year major acquisitions have included $100m for a 20% stake in China’s Bohai Insurance (reportedly at an estimated multiple of 4.5 times net tangible assets) and $288m for New Zealand’s AMI on a multiple of three times book value.

Now IAG is planning to acquire Kurnia Insurans (Malaysia) Berhad through its 49% interest in Malaysian joint venture partner AmG. The price is two times book value and IAG is on the hook for $235m, making AmG the largest general insurer in Malaysia with a 13% market share.

To justify the prices chief executive Mike Wilkins is paying, operating costs must be slashed and large write-offs avoided. Neither outcome is guaranteed. Also, with most businesses focused on motor insurance, opportunities to sell additional policies to existing customers are probably limited. For context, exceptionally well-managed, highly profitable overseas insurers with formidable balance sheets such as Berkshire Hathaway, Munich Re and Fairfax Financial Holdings are currently selling for around book value or less.

Rather than pay top dollar for Asian assets, we’d prefer IAG widen its competitive moat in Australia, return surplus capital to shareholders and keep its balance sheet in mint condition, particularly at a time when the NSW government is investigating compulsory third party (CTP) premiums. CTP premiums account for around eight percent of IAG’s gross written premium, and reportedly produce average profit margins across the industry of 24%. These high margins could prove unsustainable.

Due to the high prices Mike Wilkins is paying for Asian assets of questionable quality, we’re increasing the fundamental risk rating and lowering the portfolio limit from 6% to 5%. There’s certainly no need to panic if your limit is slightly higher, you have a well-diversified portfolio and you keep your exposure to the insurance sector to 10% or less (including any income securities issued by insurance companies).

We’ve avoided finessing the prices in the recommendation guide for now, but with the share price increasing 4% since 24 Feb 12 (Long Term Buy – $3.33) we’re downgrading to HOLD.

Note: The model Income portfolio owns shares in Insurance Australia Group.