Feature Stories | Oct 19 2023
As we begin a period of El Nino, analysts suggest Australia’s general insurers are set to enjoy a period of significant earnings upside.
-El Nino to reduce insurers’ catastrophe risk
-Higher rates mean stronger income
-Inflation easing on cost of repair/replacement
-Significant upside risk to earnings
By Greg Peel
After three years of La Nina conditions, the Bureau of Meteorology has officially declared Australia has now entered a period of El Nino. From cold and wet to hot and dry.
This implies catastrophe costs for insurers should now be more benign than they were in the previous years, which brought floods, hailstorms and cyclones.
Ah yes, I hear you think, but El Nino means bushfires. Remember the summer of 2019-20? And we’ve already seen fires break out across the country and it’s only October. Surely, catastrophes during El Nino are just as bad.
Well, apparently not.
During El Nino systems, notes Wilsons, the costs associated with an increased frequency and severity of bushfires has historically been more than offset by a reduction in the occurrence of cyclones, storms, hail, and flooding, which are on average much costlier to insurers.
Since 1967, bushfires have accounted for only around 12%, or $20bn in today’s money, of the insurance industry’s total catastrophe losses, compared to the combined contribution of cyclones, hail, flooding, and storms, accounting for around 76% or $122bn real.
Given insurance industry catastrophe losses are, on average, significantly lower during El Nino periods, Wilsons has become increasingly confident in its thesis that natural perils cost inflation should ease over the medium term, and could surprise consensus expectations to the downside.
Jarden has also studied the data going back to 1967, but given growing climate change impacts, has focused more on the past 5-10 years in assessing catastrophe (CAT) budget adequacy, enabling the analysts to “independently and more effectively” assess a key component of underlying insurance trading ratio (ITR) margin guidance.
Put simply, the ITR measures an insurer’s payouts and expenses as a ratio of premium income and investment income, ie profitability. The lower the ITR, the better.
Insurers hold provisions for potential payouts in the form of CAT budgets.
For Insurance Australia Group ((IAG)) and Suncorp Group ((SUN)), Jarden concludes estimated FY24 CAT budgets appear adequate relative to trailing ten-year trends, with IAG 15% above its ten-year average to FY23, and Suncorp sitting 6% ahead. While budgets appear more in line or slightly below trailing five-year trends (IAG 0%, Suncorp -4%), Jarden notes this included three higher activity La Nina years.
Best Income Outlook in Years
Insurance companies collect premiums from customers and invest the proceeds into cash and fixed income instruments. Claims payouts draw upon the income derived from investments. To be profitable, an insurer needs to earn more in premiums and investments than it pays out in claims.
Up until 2022, the investment side of the equation has been tough for insurers given low and near-zero rates prevailing since the GFC and through covid. In the shortest space of time ever experienced, interest rates are now back at levels not seen since before the GFC, providing insurers with historically more normal investment income.