EUR 850.00 For Business Accounts Only

Morningstar | QBE on Track for Strong Profit Recovery in 2018. FVE AUD 12.50 Unchanged. See Updated Analyst Note from 11 Nov 2018

No-moat-rated QBE Insurance Group's performance update for the nine months to Sept. 30, 2018 confirmed the much-maligned global general insurer is firmly on track to deliver the long-awaited profit recovery. Despite the positive update, our AUD 12.50 fair value estimate is unchanged and at current prices, the stock is fairly valued, trading 8% below our valuation. Financial targets for 2018 are broadly unchanged with the combined operating ratio expected to be in the 95%-97% range and investment returns in the 2.25%-2.75% range. Management will provide an update on the 2019 reinsurance placement and the firm’s cost out program on Dec. 11, 2018. We maintain our cash profit forecast for 2018 of USD 775 million, or AUD 1.05 billion, based on a combined operating ratio of 96% and investment return of 2.6%. We liked the update particularly the absence of negative surprises and no deterioration in the outlook. Underlying fundamentals continue to improve, and we expect further good progress with legacy issues during the next 12 months.

Update highlights included further improvement in global pricing with third-quarter 2018 average price increases of 5.9% up on the first half uplift of 4.6%. Group third-quarter 2017 premium increases were just 1.4% on average. Year-to-date average pricing is up 5.0%, boosting top-line premium growth. Our 2018 gross written premium growth rate forecast of 4.0% reflects the impact of discontinued businesses in 2018.

Group wide retention rates are stable despite higher premiums rates. North American average rates are up 4.3% in the third quarter, with retention steady at 78%. European rates are up an average of 4.6% with retention at 84%. Australia and New Zealand rates are up an average of 6.9% with 85% retention and, importantly, Asia Pacific rates turned positive, up 1.0% in the quarter compared with negative 2.3% for 2017. Retention in the Asia Pacific was lowest in the group at 68%.

Significant work is underway in scrutinising underwriting standards, improving hazard analysis and ensuring pricing is appropriate for risk. The outcome of the extensive business reviews is improved underwriting, with positive trends continuing in third quarter with attritional claims ratio improving, large risk and catastrophe claims within management allowances and the firm’s hazard index reducing. Attritional claims are claims with a net cost of less than USD 2.5 million.

The combined operating ratio is a key measure of insurance performance and is calculated by dividing total insurance costs (claims cost, acquisition and underwriting expenses) by net earned premium and is expected to improve from the disastrous 105% reported in 2017. A combined operating ratio above 100% means an insurer is making an underwriting loss, and 2017 was the first underwriting loss QBE Insurance had reported since 2001.

Investment returns are improving, with guidance updated to the upper end of the 2.25%-2.75% target range for 2018 from previous guidance of toward the bottom end of the target range. Annualised investment returns of 2.8% were achieved in third quarter 2018, including the risk-free liability benefit, with the investment portfolio steady at USD 23.4 billion at Sept. 30, 2018 compared with USD 23.3 billion at June 30, 2018. The fixed-income portfolio generated an annualised return of 2.2% in the quarter with average portfolio duration increasing modestly to 1.8 years. Global interest rates are increasing with the increase in risk-free rates expected to benefit investment returns in 2019 and outer years. Higher risk-free interest rates increase discounts rates used in the mark-to-market of future insurance liabilities, with the positive offset reducing claims costs.

The balance sheet continues to strengthen, with regulatory capital levels benefiting from the sale of QBE Insurance’s Latin American assets. Regulatory capital levels remain at the upper end of the firm’s target range. The on-market share buyback program is complete for 2018 with the firm’s yearly target of AUD 333 million fully utilised. The three-year AUD 1.0 billion buyback program was announced in February 2017 and to date AUD 472 million of shares have been acquired.

The reinsurance program for 2019 is progressing to plan with details expected to be announced on Dec. 11, 2018. QBE Insurance is returning to a more traditional catastrophe reinsurance structure with non-renewal of the in-the-money risk and catastrophe aggregate treaty. The change in reinsurance structure provides more earnings volatility with increased upside and downside risk, and a positive impact on attritional and expense ratios. Despite the increase in earnings volatility, the proposed structure provides a good balance between balance sheet protection, regulatory capital utilisation, and reinsurance costs.