Capital Choices

Insurance Australia Group delivered a first-half FY19 insurance profit of $496m, in line with Ord Minnett’s forecast, reflecting benefits from the cycle and some cost savings. An interim dividend of 12cps was declared.

 

  • The group underlying margin picked up in 1H19 by 0.7% on 2H18 to 16.2%. New Zealand increased a lot and the Australian business division improved, while the Australian consumer deteriorated. The margin improvements were driven mainly by underlying loss ratio improvements – from the cycle and clearing of their commercial book – as well as expenses to a modest extent from its optimisation program. We expect there will still be tailwinds helping margins from continued cycle benefits and cost savings.

     

  • One concern from the result was the continued substantial loss of units and market share in the commercial segment. The company said it was remediating its book, although the improvements in margin appear slow versus the quantum of premium being shed. Perhaps those benefits lie ahead?

     

  • Despite a $592m capital management initiative in 1H19, IAG’s capital position is still very strong. We see the prospect of further capital management in the not-too-distant future, from releases from its quota share reinsurance arrangement and realising capital from its tax losses in New Zealand. We estimate there is more than $660m of capital to be released from those currently identified sources, as well as perhaps another $1bn from divesting its remaining Asian operations, which earned about $19m in 1H19 for IAG.

We note IAG stands to benefit from: 1) expense savings of $250m (of which it claims $170m lies ahead); 2) a favourable insurance cycle (as per the recent general insurance survey suggesting 4.9% rate increases in FY19) – and this result suggesting about 4.5% group rate increases; 3) very little risk from the Royal Commission; 4) strong reinsurance protections including quota share, aggregate and stop-loss covers, suggesting more predictable earnings than peers; and 5) a very high return on tangible capital.

 

We believe the stock should benefit from further boosts from the insurance cycle, expense savings and offers the prospect of further future capital management. We maintain our Accumulate recommendation with a target price of $8.00.

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