Australia | Mar 23 2021
This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG
Just over a year ago it was bushfires, now floods in NSW have put the spotlight once again on the insurance industry
-Has increased reinsurance mitigated downside risk
-Aggregate reinsurance cover proving costly
-Pressing need to re-price insurance premiums
By Eva Brocklehurst
Rain, more rain and flooding, largely in heavily populated coastal NSW, has put the wind up the insurance industry, with the Insurance Council noting storm-related claims have started to flow although it is too early to estimate the amount of damage.
The damage appears to be manageable, although brokers are well aware the situation could deteriorate. The Insurance Council is yet to call it a "catastrophe", the highest grade of disaster. JP Morgan also notes listed insurers have reduced their exposures to flood significantly over the years.
A similar event a year ago, albeit with stronger winds, caused $900m in gross claims although, while acknowledging this is already a 1-in-50 year event, Macquarie points out floods historically cause fewer losses compared with cyclones, hail damage or earthquakes.
The broker calculates Suncorp can absorb a maximum large event in its allowance while two maximum events would result in FY21 earnings downgrades of -3-5%. In the case of IAG, a maximum large event can be absorbed, but if there were two in FY21 there would be an earnings downgrade risk of around -10%.
Credit Suisse believes the market is not ascribing sufficient value to future earnings growth, as confidence has been affected by too many “surprises”, yet earnings risk is manageable because of increased reinsurance cover and natural peril allowances.
The broker expects investor scepticism will ease as higher earnings are realised and the focus turns towards the upside potential going into FY23. Industry profits have been cut substantially and it should take a few years to recover meaningfully.
IAG's next large loss is capped at $169m by reinsurance while, Suncorp's is capped at $250m. Morgan Stanley suspects the former's is below the company's FY21 catastrophe budget while the latter's is above.
QBE Insurance's ((QBE)) Australian flood budget is capped at $125m. Goldman Sachs notes QBE Insurance's share of any industry loss is likely to be a fraction of the home/contents damage claims for the other two, as at this stage the event does not signal material risk of commercial property claims.
Although there is likely to be “sticker shock” should any further announcement be made regarding these events, Macquarie encourages investors to look through any potential losses. Morgan Stanley is not so confident, amid feedback from all reinsurers suggesting aggregate cover is proving costly so the current event adds to pressure on the July renewals.
UBS also suspects, if two or more large events occur before the insurers need to renew aggregate reinsurance cover on July 1, 2021, questions regarding earnings could be raised. The broker allows for -20-30 basis points of insurance margin headwinds in its FY22 forecasts and an additional -100 basis points for a higher natural perils allowance for IAG.
UBS points out IAG is transitioning its reinsurance cover to a financial year end from a calendar year, which has resulted in overlapping aggregate protection. Meanwhile, Suncorp has done some substantial work on its natural hazard allowance in recent years and bought additional reinsurance.
This has come at the cost of the underlying insurance margin but, UBS believes, it should help minimise the downgrades resulting from weather events that the company suffered over the past decade.
Credit Suisse agrees with Macquarie the current scenario presents opportunities and disagrees with a view that the current depressed cycle has at least 12-18 months to run.
Buying when the market is capitalising cyclically low earnings levels could result in outperformance. The broker has resumed coverage on the three major listed general insurers with Outperform ratings, anticipating improving premiums and underlying claims ratios will stand them in good stead.
Moreover, multiples are favourable. IAG has sufficient reserves for its recent covid-19 event and capital levels support future dividends, in the broker's opinion.
In the case of Suncorp, the earnings predictability is higher than general insurer peers while Credit Suisse notes QBE has the most leverage to premium increases, given a bias to commercial lines. More so, too, because of its international exposure where hardening rates are even better.
There is a pressing need to re-price higher because of increased natural perils, reinsurance costs, provisions for covid-19 claims and lower investment yields. At least one of these factors has driven a hard premium cycle historically and now, Credit Suisse asserts, all factors that drive hard markets are occurring simultaneously.
The broker notes risk capital, mainly from overseas insurers, has been withdrawn from parts of the commercial market in Australia in recent years so there is less insurance capacity available.
This capital is unlikely to return any time soon to compete away higher margins, the broker adds, because these insurers have suffered heavy losses. Channel checks also reveal some small insurers have had to sustain extremely large increases when renewing reinsurance premiums.
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