QBE Insurance: Result 2017

The world suffered more than its fair share of natural disasters in 2017 and the destruction caused insurance losses to reach an all-time high of US$135bn industry-wide.

This reporting season was never going to pretty for QBE, Australia's largest insurer and one of the top 20 in the world. Even Warren Buffett's Berkshire Hathaway – arguably the best run insurer of all – reported its first full-year underwriting loss in 15 years when Buffett published his annual letter last week.

QBE operates in 37 countries and many of them were affected by unusually large natural catastrophes. Hurricanes Harvey, Irma, and Maria in the US, earthquakes in Mexico, Californian wildfires, and cyclone Debbie here in Australia all caused substantial property and infrastructure damage.

QBE is still tallying the final cost of last year's natural disasters but so far the company has recorded catastrophe losses of US$1.2bn in 2017 compared to US$439m in 2016. That pushed it to a statutory net loss of US$1.2bn for the year to December.

The result was also affected by a US$700m goodwill write-off from its North American operations and a US$230m reduction of the company's deferred tax assets following a lowering of the US corporate tax rate. Stripping these out, along with other non-cash items, produces an underlying net loss of US$258m.

Gross written premium (an insurer's measure of revenue) rose a paltry 1% to US$14.2bn, with all regions posting lacklustre numbers. QBE's local operations increased premiums by 6% but lower volumes meant that overall gross written premium was down 1% after adjusting for currency swings. The insurance profit margin, however, rose from 12.3% to 12.6% making the local division QBE's most profitable. It was pleasing to see that policy retention rates were largely unchanged despite rising premium prices.

Adiós Latin America

QBE's Latin America division had a poor year. Gross written premium was up 4% to US$863m due to growth in motor policies but the division is QBE's worst performer in terms of profitability: the insurance margin fell from a meagre 6% in 2016 to negative 7% due to higher than expected claims.

What's more, the business deteriorated across several unrelated segments – Asian property and marine insurance, fire claims in Mexico, workers' compensation in Hong Kong and Brazilian travel insurance. Management seems to have let underwriting and pricing get out of hand – which is probably why the head of the Emerging Markets division was ousted mid last year (see QBE: Interim result 2017).

With this as a backdrop, we were pleased to hear that QBE has agreed to sell the Latin American operation to Zurich Insurance Group for US$409m, excluding the small Puerto Rico business, which will be absorbed into the North American division.

Latin America was always a thorn in QBE's side and probably distracted management far beyond its 6% contribution to gross written premium. The sale of this attention-hogging division should allow management to focus on the company's core markets in the US, Australia and Europe where QBE's competitive advantages and opportunities for growth are stronger. 

QBE's US$26bn investment portfolio had a reasonable year, with net return on investment rising from 2.9% to 3.2%. The short-term nature of QBE's insurance policies means that the company's portfolio is conservatively invested in mainly bonds and cash, with only around 10% allocated to equities, property and other growth assets. The portfolio hasn't benefited much from the run-up in stock markets this year, but rising interest rates in the US should mean higher investment income as the current portfolio is rolled into higher yielding bonds and securities.

QBE's stock trades on a forward price-earnings ratio of around 15 based on consensus estimates for 2018 earnings and a partially franked dividend yield of 2.5%. We're sticking with HOLD. 

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