Low interest rates do two things very well: drive up asset prices, and screw up insurers. QBE Insurance has reported a 46% fall in net profit to US$265m mainly due to changes in how the company calculates its outstanding claims.
As interest rates fall, QBE is forced to reduce the risk-free rate used to discount projected future liabilities. And as that discount rate falls, the liability effectively gets bigger – which, in this case, led to a US$283m pre-tax adjustment.
Low interest rates bite
Australian GWP declines
Margins lower, but to recover in second half
To make matters worse, low interest rates meant QBE earned a pitiful 1.65% on its US$25bn investment portfolio. QBE has reduced its exposure to risky assets from 12% of the portfolio this time last year to 10%, though this is still twice the exposure it had two years ago, and up from zero at the end of 2013.
Management said the UK’s recent decision to leave the European Union also had a negative impact on the business and would add to administrative costs. Management said the long-term impact of Brexit was still unknown but that it could encourage lower global interest rates, which would further reduce QBE's investment returns. However, management also noted that these lower investment returns could trigger competitors to raise prices to maintain profitability, which would benefit QBE.
Gross written premium (GWP, an insurer’s measure of revenue) fell 7% to US$8.1bn, although it was unchanged after removing the effect of currency fluctuations.
QBE’s local operations had a rough time, posting a 4% decline in GWP and a 40% fall in insurance profit. Price declines and higher claims were to blame. Management said it had changed the Australian management team and was ‘responding decisively with price increases, revised terms and conditions and other portfolio adjustments’.
|Six months to June||2016||2015|| /(–)
|Insurance profit (US$m)||326||536||(39)|
|Net Profit (US$m)||265||488||(46)|
|EPS (US cents)||19.2||35.5||(46)|
|Interim dividend||21 US cents, 50% franked, (up 5%)
ex date 26 Aug
The company’s European operations didn’t fare any better, posting a 5% decline in GWP and a 70% decline in insurance profit.
Overall, the company’s underwriting profit from writing policies (but excluding investment income) fell from US$295m to just US$54m. That’s a poor result any way you cut it. Management said it would focus on improving the operating margin, even if it came at the expense of growth in the second half of the financial year. QBE’s long-term objective is for GWP growth of 3% a year.
Management expects net earned premium of US$11.5 –11.9bn in 2016 (down from earlier guidance of US$11.6–12.0bn) with a profit margin of between 8.5% and 10%. As we explained in QBE: Transformation or turnaround myth?, we consider that a sustainable underlying level over the medium term.
We’re lowering our price guide slightly to reflect the reduction in QBE’s book value that resulted from the revaluation of its liabilities and continue to recommend you HOLD.