General Insurers Face Tight Claims Budgets

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General insurers IAG and Suncorp have outlined the expected losses from February's hail storm in Sydney. Several brokers review the impact on FY17 natural peril budgets.

-Natural peril losses close to, or exceeding, allowances for FY17
-Positive outlook for general insurance and scope to re-price some lines
-Potential for Insurance Australia Group and Suncorp margins to converge
 

By Eva Brocklehurst

General insurers Insurance Australia Group ((IAG)) and Suncorp ((SUN)) have outlined the expected impact of the recent Sydney hail storm. Those brokers which have reviewed the latest news suggest, for Insurance Australia Group, the impact is straightforward, while there is some divergence regarding the impact on Suncorp.

UBS suspects both insurers are now likely to exceed their FY17 natural peril budgets. IAG's additional reinsurance cover could mean it escapes without an impact on FY17 earnings per share, assuming the absence of further large events. The company has stated it expects the cost of the Sydney hail storm to be $160m.

At the end of February the business had experienced $650m in natural peril losses compared with a full-year expectation of $680m. With current reinsurance treaties the company can absorb a further $130m of natural peril losses for the remainder of FY17 and stay within guidance.

Morgans believes the worst of the peril season is behind the insurers and is optimistic that the remaining allowances are within assumptions, and that IAG remains on track for its reported insurance margin forecasts of 12.5-14.5%.

Deutsche Bank reduces FY17 estimates for IAG by -3%, to reflect the impact of the hail and an over-run for the remainder of the period. The broker remains positive on the outlook for general insurance in Australia and believes there is scope for the industry to re-price certain lines such as NSW CTP (green slip) or commercial lines.

Suncorp's expected costs for the hail storm are between $150-170m. The company's natural hazard cost has now risen to $610-630m to the end of February. This compares with a full year budget of $600m. The insurer is protected against further deterioration from large natural hazard events because of its aggregate cover. This provides $300m in reinsurance protection once natural hazard losses exceed $460m.

For the current year, the company's total natural hazard losses are between $420-440m. As a result, Deutsche Bank expects Suncorp to be protected from further deterioration at this point.

The deterioration in Suncorp's natural peril costs have surprised Citi, which notes the company has already used 87% of the second half budget with four months of the year to go. The broker was not surprised by the hail storm cost but by attrition in claims of $75m in just two months. Citi expects Suncorp will, yet again, exceed its hazard allowance in the second half and questions the adequacy of the recently-reduced hazards allowance, and the validity of the underlying margin calculation.

Ord Minnett believes, because of seasonality, that Suncorp would have allocated around 20% of its perils allowance for the last quarter of the financial year and is inclined to expect there should be greater reinsurance protection for the remaining months until the end of FY17. Morgans is more in Citi's camp, suspecting Suncorp is likely to exceed its second half hazard allowances overall and now forecasts hazard losses of $50m above allowances in the second half and a reported insurance margin of 10.7%.

Outlook

At this point in the cycle Morgans continues to believe the insurers are fair value. The broker would like further evidence of upside from price increases in order to become more bullish. UBS flags possible indirect impacts for Suncorp: motor claims inflation is likely to be further aggravated and this was a key challenge for the sector in the first half; and upcoming reinsurance renewals could be less beneficial compared with recent years.

Macquarie notes Suncorp won market share in the first half, with the majority of this in CTP, while IAG grew home and motor insurance in NSW & Victoria. The broker expects IAG's top-line growth will strengthen in FY17 but slow in FY18, while Suncorp should grow in both years with pricing and market share in CTP the key drivers.

As far as margins are concerned, the broker expects these will converge for the two companies. IAG has a highest margins in what Macquarie describes as the second most profitable general insurance market in the world. The broker expects margins will continue to decline amid an oversupply of global capital as well as local economic headwinds. At the same time, the broker expects Suncorp to take more market share and improve margins through self-help.

Macquarie believes the window for abnormal growth is also closing for the insurers. To combat claims cost inflation challenger brands moved first to raise premium rates around 12-18 months ago. This helped established insurer growth and market share in the first half, but the broker believes this opportunity will diminish after FY17.

FNArena's database has seven Hold ratings and one Sell (Macquarie) for IAG. The consensus target is $6.00, signalling -2.1% in downside to the last share price. The dividend yield on FY17 and FY18 forecasts is 4.8% and 4.5% respectively.

For Suncorp, there are five Buy ratings, to Hold and one Sell (Morgan Stanley, yet to update on the hail storm). The consensus target is $13.73 suggesting 4.4% upside to the last share price. The dividend yield on FY17 and FY18 forecasts is 5.6% and 5.8% respectively.
 

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