Some positive tailwinds building
Despite a broad flattening of the shares over the past few months, QBE Insurance (ASX:QBE) shares have staged a solid recovery year-to-date, supported by a strong set of 1H21 results that included several positives. The continued high relative level of catastrophes continues to be a headwind for the industry but the powerful macro drivers of higher bond yields on the horizon and firming premiums, along with some positive company-specific developments are supportive.
The underlying QBE business has improved in quality in recent years in our view even as headline numbers sometimes obscured progress and there were tough blows from Covid-19, investment losses and elevated catastrophe levels on different occasions.
Management moved to simplify the business, sell non-core or underperforming portfolios. The surprise exit of Pat Regan in late 2020 after an external investigation found his workplace communications did not meet company standards saw a new high-quality CEO in Andrew Horton (ex-Beazley boss in the UK with a strong track record) hired from outside of the business and take over the helm in September 2021.
QBE (ASX:QBE) typically provides a market update in December and coming a few months after a new CEO has joined the business the risk of a “new broom” approach has likely weighed on the shares recently, along with continued elevated catastrophe activity and uncertainty over Covid-19 related business interruption claims. We note in October that there was a favourable ruling for the insurers on the business interruption claims front, but an appeal is already underway from businesses.
Often a new CEO may be tempted to write down parts of the business to set the bar lower for outperformance going forward. There have been no indications Mr Horton has this in mind, although the market will be looking for new insights from a seasoned executive joining the business from outside. The AFR reported that Mr Horton has already alluded to looking to improve idea flow across the group internationally after finding the flow across the US, European and Australia-Pacific businesses had been sub-optimal.
We are looking forward to the first major market presentation from Mr Horton as CEO of QBE to get more flavour on what direction he will seek to take the business. We believe he has a good core on which to build at QBE, albeit with continued elevated levels of catastrophe activity. We would not be surprised to see QBE increase its catastrophe budgets this month.
Underlying operational efficiency has been improving and the 1H21 results swung back firmly into profit territory (NPAT; US$444 million) from a steep US$710 million loss in 1H20, with the 1H21 result driven by good underwriting and better investment outcomes.
Premiums have firmed over the past few years across most regions due to several reasons and we expect to see this continue for some time on a more rational pricing environment for the industry, due to the reduced capacity in the market and the need to recover losses from elevated catastrophe activity. Although there have been some signs of moderation, QBE has reported strong premium rises over the past couple of years and average premium increases came in at 9.7% in 1H21, 100 basis points higher than a year ago. This helped Gross Written Premiums (GWP) jump 20%.
Source: QBE (ASX:QBE)
The combined operating ratio (a core measure of profitability) improved to 93.3% (versus an unprofitable 103.4% a year ago or 97.4% excluding the 6.0% impact from COVID-19), and despite higher catastrophe claims, reinsurance costs and provisioning. As a result, QBE’s underwriting result swung from a $189 million loss to a $642 million profit in the first half of 2021, pointing to the good underwriting discipline.
Source: QBE (ASX:QBE)
Despite higher weather-related claims in Australia Pacific, attritional losses – losses experienced from policies that don’t relate to major catastrophes or exposures – also improved due to better underwriting discipline. This contributed to a 1.8% improvement in QBE’s combined operating ratio in the first half and at the group level, there have been impressive improvements in the attritional claims’ ratio over the past two years – lower is better – as shown in the following graphic.
Source: QBE (ASX:QBE)
QBE’s efforts in recent times to identify cost efficiencies bore fruit in the 1H21 result, and there should be more on the horizon as QBE updates IT systems and continues digitisation. While this will require an investment of $150m, management hopes to reduce QBE’s expense ratio from 13.7% to 13.0% by 2023.
As an insurer, QBE is leveraged to rising rates and we expect central banks to lift rates in 2022 (although the RBA might be late to the party) as inflation has risen above expectations and proving stickier than policymakers hoped. Most of QBE’s $27.9bn investment portfolio is invested in bonds and other fixed income instruments, providing headwinds in recent years as interest rates have been pushed to historic lows, with the running yield on the company’s fixed income investments plummeting from 1.7% two years ago to 0.4% during the first half of 2021. The relatively low duration bond portfolio though offers leverage as rates rise in coming quarters/years.
Regulatory capital of 1.73x for 1H21 ticked up marginally from 1.72x for FY21 and was a little above the midpoint of its 1.6x to 2.0x target range.
Summary
QBE (ASX:QBE) and more broadly, the insurance industry is enjoying firm premium growth and pricing to restore sustainable profitability, with the pricing cycle set to be positive for some time yet in our view. We are also confident in the prospects of improving investment income from QBE’s huge ‘float’ due to rising bond yields as inflation picks up. QBE’s valuation remains very undemanding. The first major market presentation from new CEO Andrew Horton will be keenly perused by the market. We are content with his strong track record and expect a steady hand.
We continue to recommend QBE Insurance (ASX:QBE) as a buy to Members without exposure and a medium to long term investment horizon.
Disclosure: Interests associated with Fat Prophets hold shares in QBE Insurance (ASX:QBE).
