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INSURANCE AUSTRALIA GROUP LIMITED

Feb 08, 2016

IAG:ASX
Investment Type
Large-cap
Risk Level
Action
Rec. Price ($)
Company Overview - Insurance Australia Group Limited is an Australia-based company engaged in underwriting of general insurance and related corporate services and investing activities. The Company operates in six segments: Australia direct insurance, Australia intermediated insurance, New Zealand insurance, Asia insurance, and corporate and other. Australia direct insurance consists of insurance products distributed through a network of branches, franchises and country service centers. Australia intermediated insurance consists of insurance products sold under the CGU and swan insurance brands through brokers and distribution partners. New Zealand insurance consists of general insurance business underwritten through subsidiaries in New Zealand. Asia insurance consists of intermediate and direct insurance business underwritten through subsidiaries in Thailand. Others include Corporate services and financial activities.



IAG Dividend Details
 
Catastrophe reinsurance program update for 2016: Insurance Australia Group Ltd (ASX: IAG) recently reported an update of its catastrophe reinsurance program for this year. IAG intends to maintain its gross reinsurance protection of up to $7 billion for 2016, at par with last year. The group handed over renewal rights of its huge corporate property book to Berkshire Hathaway. With regards to the breakup of the included components in the catastrophe reinsurance program, Insurance Australia would retain the initial $250 million of each loss ($200 million of post-quota share), with three prepaid reinstatements secured for the lower layer of the main program ($200 million excess of $200 million, post-quota share). The catastrophe reinsurance program also comprised an aggregate sideways cover which decreases the cost of a second event to $175 million ($140 million post-quota share) and a following event to $25 million ($20 million post-quota share). The aggregate also covers the protection of $450 million further to the $375 million ($360 million excess of $300 million, post-quota share), wherein the qualifying events are capped at a maximum of $225 million excess of $25 million per event ($180 million excess of $20 million, post-quota share). The group’s catastrophe reinsurance also comprised all the regions cover, excluding the joint venture interests in China and India as they have a separate reinsurance arrangements. Meanwhile, IAG reported that the credit quality for the program was almost maintained at 88.5% during the year, wherein the entities had A+ and even better ratings, close to 89% in 2015. Insurance Australia also had distinct natural perils cover of $80 million apart from the $680 million (post-quota share). With regards to the regional breakup cover of the overall catastrophe program’s post-quota share of first event retentions, Australia and New Zealand comprised $200 million and NZ$200 million respectively, while Thailand had $20 million. Vietnam and Indonesia’s first event retention was less than $1 million while Malaysia had $25 million (which is not related to the Berkshire Hathaway quota share agreement).
 

IAG Group Catastrophe Reinsurance Cover highlights (Source: Company Reports)
 
Asia remains a priority except China: Insurance Australia Group reiterated that they would continue to focus on the Asian market, as a part of their long term strategy and intends to leverage the potential opportunity from the booming middle class prosperity and consumption in the region. Accordingly, IAG already achieved a Gross Written Premium (GWP) growth of over 11.4% to $353 million in Asia during fiscal year of 2015 driven by ongoing penetration in the Indian market and a better contribution from Thailand. Thailand and Malaysian markets’ strong performance led to a contribution of over $60 million in dividends to the group during fiscal year of 2015. The group also reported that the improving collective performance from its developing markets would enable them to reach a breakeven soon. The group already has a gross regional (Asia) annualized GWP pool of around $1.7 billion (based on its FY15 investors report). On the other hand, management reported that they would not be pursuing any more investments in China, giving a respite to investors as the region is facing with challenging economic conditions.
 

Capital Position and Dividend Policy Retention (Source: Company Reports)
 
Efforts to strengthen brand to boost growth: IAG’s management is making efforts to transform IAG into a more customer and a data driven firm to further enhance the client service, given the rapidly changing demands. The group is launching three divisions, namely Customer Labs, Digital Labs and operations which would support IAG’s customer-facing interface. The customer Labs division would be dealing in customer experience strategy as well as product innovation via new business incubations and venturing, data and insights, and brand architecture across the firm. With the Digital Labs division, the group intends to offer a better digital and design innovation from the existing ones and accordingly develop digital apps and eco-systems. Operations would be dealing with the claims and operational functions like procurement and supply chain management. Insurance Australia Group intends to have two customer-facing divisions in its core Australian market, to offer better sales and services as well as further strengthen its marketing execution. Meanwhile, IAG launched InsureLite in July to address the families who have home insurance affordability stress in Queensland. The group launched ShareCover in September which is an insurance solution for those who are renting out all or part of their home on a recognized sharing economy platform. IAG also partnered with Good Shepherd Microfinance to launch Insurance 4 which is an accessible and low-cost insurance solution. The group intends to shift its Asia and New Zealand businesses into a new International Division, and is focusing to further penetrate in Thailand, Malaysia, Indonesia, India and Vietnam. IAG also announced a new brand identity and is positioning itself to target the potential growth from New Zealand and Asian regions, while maintaining its Australian market presence.
 
Delivered reasonable FY15 performance excluding huge natural perils impact: Insurance Australia Group incurred over $1.05 billion of net natural peril claims, which is more than the allotted allowance by $348 million, leading to the Insurance profit decline to $1.1 billion in the fiscal year of 2015 as compared to $1.6 billion in the fiscal year of 2014. On the other hand, IAG delivered a strong GWP growth by 40.7% in Commercial Insurance, driven by the first time contribution from the former Wesfarmers business. The commercial Insurance’s underlying margin was able to achieve 10.5% during the year against 12.1% in prior corresponding period (pcp), in spite of a huge natural peril events’ impact and challenging market conditions. New Zealand GWP delivered a rise by 22.8% during FY15 driven by the contribution from local Wesfarmers Lumley business. Despite the net profit decrease of 41% to $728 million during fiscal year of 2015 against pcp, IAG issued a dividend payout of around 70% of cash earnings, which is the higher side of the group’s target payout range of 50% to 70%.
 

Insurance Australia Group’s fiscal year of 2015 performance (Source: Company Reports)
 
Guidance: IAG issued an estimate insurance margin in the range of 14% to 16% for the fiscal year of 2016, a slightly better estimate as compared to fiscal year of 2015 while the forecast also includes the impact of competition and other factors. Insurance margin also includes a minimum of 200 basis points positive impact via the execution of the quota share (with Berkshire Hathaway). Moreover, the Insurance margin guidance includes the assumptions of net losses allowance of $600 million from natural perils and earlier period reserve releases of a minimum of 1% of Net Earned Premium. Insurance Australia Group estimates a flat GWP growth due to foreign exchange movements. Nonetheless, IAG expects a strong contribution from India as the group increased its ownership to 49%from 24% in its general insurance joint venture, State Bank of India (SBI) General.
 
Stock Performance: The shares of IAG have been affected since last year and fell over 18.15% (as of February 05, 2016) in the last fifty two weeks, as tough market conditions in China coupled with the natural perils event impact in Australia had hurt investor’s sentiment for the stock. On the other hand, the group clarified investors that they are not interested in China in future investments and are targeting other high growth regions in Asia like India, Malaysia and Thailand. Moreover, IAG forecasts to decrease its earnings volatility via the implementation Berkshire Hathaway quota share agreement for around 20% of its overall group’s business. We remain bullish on Insurance Australia Group and believe that long term value investors could consider adding the stock in their portfolio as the heavy correction opened a bargain opportunity. Moreover, IAG is also trading with a reasonable P/E and has a strong dividend yield. Based on the foregoing, we give a “BUY” recommendation on the stock at the current price of  $5.37
 
 
IAG Daily Chart (Source: Thomson Reuters)



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