EUR 850.00 For Business Accounts Only

Morningstar | QBE’s Recovery Gaining Momentum. FVE AUD 12.50 Unchanged

No-moat-rated QBE Insurance’s restructuring and rebuilding continues with 2019 earnings guidance reiterated at the global insurer’s AGM. Despite lower global interest rates and slowing economic conditions, the firm’s underlying fundamentals are improving. Insurance premium rate increases continue to feature, and first-quarter investment returns rebounded from a disappointing end to 2018. The heavily weighted fixed interest investment portfolio benefited from positive revaluations as global bond prices increased (yields fell). The strong recovery in global equity markets since end of 2018 has also boosted returns on the firm’s portfolio of riskier assets. Following the strong start to the year, investment return guidance for 2019 of 3%-3.5% net is confirmed.

Earnings tailwinds of premium rate repricing, restructuring benefits and strong investment returns are partially offset by expensive catastrophe costs and softening economic activity in key markets. Despite the challenges, our AUD 12.50 fair value estimate is unchanged. Our regular post-result catch-up with management reinforced our view the previously troubled insurer is making good progress in its business improvement program with individual business unit reviews, known at QBE as “cell reviews,” well underway across the group. The goal for each cell review is to deliver returns on risk adjusted capital of at least 12%.

The downside of lower interest rates is the discount impact on the firm’s gross outstanding claims liability that stood at USD 18 billion at Dec. 31, 2018. QBE’s fixed interest investment portfolio has a weighted duration of 2.1 years while the liabilities weighted duration is 3.1 years. The impact of the lower interest rates will be a lower than expected insurance profit due to the upward revaluation of the outstanding insurance claims liability. But this negative is offset higher investment earnings, both for policyholder funds and shareholder funds.

We like the way senior management have reshaped insurance portfolios, cut costs, tightened underwriting standards and increased accountability across the group. Global repricing remains firm despite plenty of capacity in global reinsurance markets. We believe the big global insurers are increasing rates to deliver appropriate returns on capital. The past decade has been characterised by very low returns caused by excess reinsurance capacity, devastating catastrophes and the increasing prominence of alternative insurance capital provided by large global hedge funds. In certain categories, commercial insurance pricing has been too low for too long.

CEO Pat Regan is doing a good job at invigorating the diverse global general insurer after many years of disappointments and the changes across the organisation make his intentions clear. He is exerting considerable leadership, personally leading cell reviews, reinforcing the old way of running the business is unacceptable and increasing accountability across the group. Achieving rigorous financial hurdles, high levels of management accountability and aggressively improving underwriting discipline at the expense of top line growth is key to the future.

Guidance is confirmed for a combined operating ratio, or COR, of 94.5%-96.5% for 2019. Our 2019 COR forecast of 95% equates to an insurance margin of 9% and if achieved will be comfortably ahead of the 7% margin achieved in 2018. Longer term, we forecast the insurance margin to improve to around 11% based on modest growth in gross written premium, improved risk selection, higher pricing, strong customer retention, better claims management and more cost out-outs.

Adjusted return on equity was 8% for 2018 and based in improved profitability we expect a result around 10% for 2019, comfortably above our allocated cost of equity of 9%. To achieve the through-the-cycle target of 12%, the firm needs to get the COR down to 93%-94%. From 2021, we expect QBE will get close to its 12% return on equity target.

We expect top line premium growth to increase only modestly during the next one to two years as unprofitable businesses are sold or wound down. The upside to this clinical approach to reshape the business is already captured in our forecasts with higher insurance margins and improved returns on equity. The insurance premium rate cycle is continuing to strengthen with QBE estimating average increases around 4%, excluding CTP insurance portfolios, in first-quarter 2019, consistent with a similar outcome in first-quarter 2018. QBE has experienced rate increases in all three divisions due to a combination of positive market conditions and disciplined pricing and risk selection.

Australia and New Zealand continues to be a major contributor with rate increases up 6.6%, excluding CTP. North America is reporting rate growth increasing to almost 5% in the quarter, consistent with QBE’s U.S. peers. The Europe division benefited from rate increases around 2.5% in the quarter and expect stronger increases during the remainder of 2019.

Benefits from higher rate increases has bee partially offset by a number of catastrophes during the quarter, notably in Australia with the Townsville floods, severe weather and hail storms in New South Wales, and bushfires in Tasmania. The financial impact has largely been offset by relatively benign catastrophe experiences in the northern hemisphere.

QBE confirmed good progress in the quarter from operational improvement with the group on track to achieve its full-year target of USD 40 million in cost savings, as part of the three-year program to reduce costs by a net USD 300 million.

Our forecast net investment return of 3.3% for 2019 is unchanged. Based on an exchange rate of 0.74 cents, our 2019 forecast cash profit of USD 952 million equates to AUD 1.28 billion. Our 2019 forecast dividend of AUD 57 cents per share franked at 32% is unchanged. The franking rate is guided to decline to 10% from the start of 2020 as the proportion of international income increases, underpinned by an expected strong improvement in the group’s North American operations.