Morningstar | IAG Finalises the 2019 Catastrophe Reinsurance Program. AUD 7.50 FVE Unchanged. See Updated Analyst Note from 14 Jan 2019
No-moat Insurance Australia Group’s catastrophe reinsurance program for calendar 2019 is in place and is broadly in line with 2018. Gross reinsurance protection increases to AUD 9 billion from AUD 8 billion to provide additional cover above internally modeled exposures. There is no change to the first event retention of gross AUD 250 million, or AUD 169 million post quota share. The maximum retention of a second event increases to gross AUD 175 million, or net AUD 118 million, for calendar 2019 from AUD 125 million, or net 84 million in calendar 2018. The maximum cost of a subsequent event is unchanged at gross AUD 25 million or net AUD 17 million. The catastrophe reinsurance program is effective Jan. 1, 2019 providing post quota share first event retentions of AUD 169 million in Australia and NZD 169 million for New Zealand.Insurance Australia Group benefited from relatively flat reinsurance rates for 2019 compared with 2018, with the overall cost of reinsurance in line with the insurer’s assumptions incorporated in its fiscal 2019 reported insurance margin guidance of 16-18%. The reported insurance margin for fiscal 2018 of 18.3% is unlikely to repeat in fiscal 2019 and following the blow out in first-half catastrophe costs, we expect a reported insurance margin closer to 16%.
Despite the increase in natural hazard costs for fiscal 2019, our positive view is intact with the firm supported by a strong capital base, robust profitability, and a positive business outlook. Our fair value estimate of AUD 7.50 is unchanged and at current prices, the stock is fairly valued trading 7% below our valuation. First-half fiscal 2019 results are due Feb. 6, 2019. Equity capital is well above internal targets and regulatory requirements with limited material operational demand for capital. The unfavourable net natural peril claim cost outcome for fiscal 2019 results in a decrease in our forecast cash profit to AUD 1.02 billion from a previous forecast of AUD 1.14 billion.
Our fiscal 2019 forecast dividend reduces to AUD 37 cents per share, or cps, including the previously announced AUD 5.5 cps special dividend. We estimate a franking rate of 85% for the final fiscal 2019 dividend declared in August 2019 and subsequent dividends.
Following the Sydney hail storm natural hazard update in late December, Insurance Australia Group confirmed fiscal 2019 year-to-date natural peril claim costs total AUD 410-430 million pretax post quota share. The full-year fiscal 2019 allowance is AUD 608 million, meaning only AUD 178 million, based on the top end of year-to-date costs incurred, is available for the second half. Second-half natural peril costs have averaged AUD 350 million for the past three fiscal years, so we have increased our fiscal 2019 natural hazard claims costs by AUD 200 million to approximately AUD 800 million.
Our fiscal 2019 dividend declines in line with the lower earnings forecast based on a payout of 87%. Excluding the AUD 5.5 cps special dividend, the underlying payout is 74% in line with the through the cycle target of 60%-80% of cash earnings. We are confident the firm can deliver on its mid-term financial targets of a cash return on equity of 15% and approximately 10% compound EPS growth. Based on our updated forecasts, we expect negative EPS of 2% for fiscal 20019, but for the following five years we forecast average annual EPS growth of 10% ending fiscal 2024.
Insurance Australia Group employs a 32.5% whole of account quota share position, where the firm retains 67.5% of premium income and incurs 67.5% of claims costs. The quota share reinsurers are Berkshire Hathaway at 20% effective July 1, 2015 and the combined 12.5% quota share agreements with Munich Re, Swiss Re, and Hannover Re effective Jan. 1, 2018.
Insurance Australia Group is engaged in the underwriting of general insurance and related corporate services and investing activities. Co.'s business divisions are: Consumer, which includes short tail insurance such as motor vehicle and long tail insurance such as compulsory third party, as well as travel insurance, life insurance, income protection and funeral products; Business, which provides business and farm insurance, and workers' compensation services; New Zealand, a general insurance provider in New Zealand; Asia, which provides personal and commercial insurance products through local brands in Asia; and Corporate and other, which includes placement of Co.'s reinsurance program.
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