Morningstar | QBE Continues the Simplification and Derisking Process. FVE AUD 12.50 Unchanged. See Updated Analyst Note from 10 Dec 2018
No-moat-rated QBE Insurance Group continues the slow and painful simplification and derisking journey. The global business model continues to shrink with announced sales of underperforming businesses in Puerto Rico, Indonesia, and the Philippines added to the growing list. In addition to derisking the business, simplification allows an operational efficiency program, with the firm targeting net cost savings of USD 130 million by 2021.We maintain our AUD 12.50 fair value estimate and at current prices the stock is undervalued, trading 20% below our valuation. QBE reports 2018 results in late February 2019. Management’s financial targets for 2018 are unchanged with the combined operating ratio expected to be in the 95-97% range and investment returns in the middle of the 2.25-2.75% range. We maintain our cash profit forecast for 2018 of USD 773 million, or AUD 1.05 billion, based on a combined operating ratio of 96% and investment return of 2.6%. We adjust forecast expenses and claims costs in 2019 and outer years, but the impact on our valuation is immaterial.
Despite the focus on groupwide derisking, at first glance, the 2019 reinsurance program looks to increase catastrophe and large loss risk exposure compared with the 2018 program that was more prescriptive. But in our view, the new, cheaper reinsurance program is better suited for the firm’s simplified portfolio and improving underwriting risk profile. Reinsurance programs are always a delicate balance between cost, balance sheet protection and capital preservation. The 2019 reinsurance program saves about USD 125 million on 2018, but the saving is more than offset by an increase of USD 200 million in the 2019 budgeted allowance for large individual risk and catastrophe claims to around USD 1.4 billion due to greater uncertainty around reinsurance recoveries. The 2019 program will release an estimated USD 100 million in capital providing better reinsurance recovery outcomes in extreme catastrophe years.
In “normal†catastrophe years, the new reinsurance program will be less attractive as higher amounts of catastrophe and large loss claims costs will be borne by QBE. We are not concerned with the net increase in approximately USD 50-100 million in potential claims expense as the firm expects to deliver an improved combined operating ratio and higher profits in 2019 compared with the yet-to-be-announced 2018 results. Improved profitability is expected from further modest and selective premium rate increases, a lower attritional claims ratio and improved productivity.
Improved productivity is expected in part from the rationalised global business with three regional divisions of North America, International Markets, and Australia Pacific. Improved operational efficiency is expected from streamlining operations, consolidating technology platforms, reducing IT run costs, and automating processes and procedures. The program of work is targeted to deliver more than USD 200 million in gross saving by 2021. The group annual expense base is estimated to decline approximately 7%, or USD 130 million, to USD 1.67 billion from 2018 levels, with an expense ratio target of about 14% by 2021, an improvement of around 150 basis points on an estimated underlying result for 2018. The expense ratio has averaged 15% per year for the past decade. QBE is incurring a below the line one-off restructuring provision of USD 95 million with 60%, or USD 57 million, in 2019 and the balance in 2020.
We like the plan to simplify and reduce expenses on top of moving to a far simpler operating model. But as usual, there are ample execution risks and QBE has been driving hard down this path for several years with only modest success. We think new CEO Pat Regan and his senior executive team are well placed to leverage the hard, remedial work done by previous CEO John Neal.
QBE Insurance Group engages in underwriting general insurance and reinsurance risks, management of Lloyd's syndicates and investment management. Co.'s segments are: North American Operations, which writes general insurance and reinsurance in the U.S.; European Operations, which writes general insurance in the U.K., Canada and mainland Europe; Australian and New Zealand Operations, which underwrites general insurance risks in Australia and New Zealand; Emerging Markets, which writes general insurance in North, Central and South America and provides personal, commercial and general insurance covers in the Asia Pacific region; and Equator Re, which provides reinsurance protection in Bermuda.
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