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Morningstar | Genworth’s FVE Reduced on Higher Claims

Moderately higher expected claims results in a reduction in no-moat Genworth’s 2018 underlying net profit after tax, or NPAT, to AUD 93.9 million from to AUD 99.7 million, with its fair value estimate reduced to AUD 2.70 per share from AUD 2.80. The company also continues to experience lower earned premiums due to its earnings curve review implemented in October 2017 but by progressively lower amounts. This review lengthened the time over which premiums are recognised but does not impact the expected quantum of revenue. More fundamentally, net earned premiums, or NEP, were also impacted by continuing tightening credit standards by major bank customers as well as the continued impact of stronger macro prudential regulations. Excluding the effect of the earnings curve review, NEP would have fallen 7.2% from third-quarter 2017. However, the company maintains a strong capital position which we expect will allow it to continue to pay ordinary and special dividends of AUD 24.5 cents per share for 2018.

We forecast the company will have a loss ratio (net claims incurred divided by NEP) of 53% for fiscal 2018, which compares with a loss ratio of 38.3% in fiscal 2017. The increase in the loss ratio is driven by lower NEP as well as the company’s cautious outlook on cure rates (loans in arrears that are rectified without an insurance claim). Genworth increased its fiscal 2018 loss ratio guidance to between 50% to 55% from 40% to 50% made at the half-year results in August 2018. The company was seeing a reduction in cure rates in August 2018 which it believed was due primarily to changes in lenders' hardships policies. These lower cure rates extended into third-quarter 2018. The company still believes this is because banks are extending hardship processes to be more responsive to customers following the negative fallout from the Royal Commission hearings into financial services. We expect this to extend into the fourth quarter.

The company also experienced an increase in delinquencies, with its delinquency rate (that is, loans in arrears as a percentage of loans in-force) increasing to 0.55% in September 2018 from 0.50% in September 2017. This was primarily driven by an increase in delinquency rates in Western Australia and a normalisation of rates in New South Wales. The major driver of delinquencies, claims and cure rates is the unemployment rate. Consequently, we expect the recent improvements in the unemployment rate should provide some general support to delinquencies, claims and cure rates, although there maybe region-specific issues such as the continued mortgage stress by borrowers in mining areas in Western Australia.

On a more positive note, Genworth continues to maintain a strong capital position, which includes AUD 3.2 billion in cash and investments. Its regulatory capital base is 1.85 times its prescribed capital amount, or PCA, coverage ratio, which continues to be well above its target PCA coverage ratio of 1.32-1.44 times. This provides it with capital management options in the face of lack of growth investments. In August 2018 it completed its AUD 100 million on-market share buy-back which it commenced in May 2018. We expect it to report further capital management initiatives at or before its full year results announcement, expected in February 2019.