In this note, we assess the risks and resilience of general insurers relative to the major banks in times of increasing regulatory/other constraints as well as political distraction. The objective in uncertain times is to ensure decent growth and stable and predictable earnings. At the macro level, an easing bank credit growth multiplier effect suggests this is possibly headed towards 2x GDP growth or below (vs. the 12-year average of 3x GDP growth) due to ever increasing prudential and home lending constraints. On the other hand, general insurer growth rates have averaged ~1x GDP growth as is the norm and these are set to improve as rates begin to harden in offsetting claims inflation. Fewer operating constraints relative to the major banks and a more stable growth multiplier effect should add to the insurers’ earnings stability and predictability.
In terms of reported margins, the major banks’ downward trend could still eventuate. Although recent mortgage repricing initiatives should provide some short term stability in the next 6-12 months, the low rate environment is expected to persist for some time and would continue to dampen margin expectations. Insurer underwriting and insurance margins in contrast have been trending upwards since 2012 and would have been higher if not for lower investment yields on the float. Insurer cost ratios are largely unchanged since 2003 and cost initiatives should be positive for margins.
The average loss ratio for the major banks over the last 12 years is around 25-30bp and is also in line with their “through-the-cycle” views, although there appears to be further catching up to do in the next 6-12 months. On the other hand, general insurer losses have reached the 12-year average although we believe this is due to prior year adjustments. Current benign conditions in addition to the end of the cyclone season lead us to believe there will be stability in this space until summer. Underpinning earnings stability and predictability in the general insurance space would also be ever increasing loss buffers that are in stark contrast to the banks’ decreasing provisions.
We also reimagine the major banks and general insurers on a level playing field. Using margin income as a percentage of earning assets, we derive notional margins for the insurers in the 6.1-9.4% range vs. 2.0% for the banks. While the insurers appear disadvantaged on the cost front, we see this as a huge opportunity in streamlining and eliminating legacy costs. The more important item is that the insurers’ ROA remains ahead of those at the banks while the banks’ higher ROE is only due to higher leverage. More resilient in any crisis, the general insurers are also better placed than the banks in terms of earnings quality and value upside. The reimagined general insurers are wholly funded by interest-free debt and invested mainly in low risk assets. They would also not be subject to the usual constraints given their superior capital, leverage and liquidity positions, much lower reliance on expensive offshore wholesale funding and minimal balance sheet mismatch.
It may seem like “Chalk and Cheese” but the general insurance sector remains fundamentally sound and we favour them over the major banks in the next 6-12 months based on fewer operational distractions and regulatory constraints. Our ratings, forecasts and price targets for IAG, QBE and SUN are unchanged.
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