Investment implications
Global insurance focus: QBE operates in the global insurance market providing both underwriting and reinsurance services. The global insurance market is fragmented, with QBE competing against large industry players. The business of insurance is primarily based on; 1) the ability to access capital/liquidity; and 2) the ability to accurately price insurance risk.
Global excess liquidity weighed on insurance companies. Between 2010-2019, global commercial insurance premiums remain largely flat. This was a function of global excess liquidity. The large QE programs of central banks created a world awash with liquidity – limiting the ability of global insurers to push through price rises. Benign claims inflation also made the task even harder. Both these headwinds for insurance companies are now fading as inflation and rates rise.
Rising global insurance premiums. Commercial insurance premiums are seeing their strongest uptick in pricing in 20 years. Prior to 2020, US Commercial premiums (the most important insurance market globally) had remained flat for over a decade. In contrast, US CPI grew at just ~2% pa in the years prior. Commercial premiums today are rising at high single-digit, low double rates. This is expected to continue into 2023. QBE is also experiencing the same tailwinds.
Do premium increases translate to stronger earnings? Higher claims inflation is providing an offset to higher insurance premiums, which creates some debate around the near-term outlook for margins. We expect over the medium term, insurers including QBE will be able to retain some additional margin. Most global insurers we track at 1Q22 updates spoke to improved profitability outlook in 2022/23.
Can QBE deliver consistency of earnings? QBE has a poor track record of earnings consistency. The Group’s insurance margin has never been higher than 7% over the last decade, vs an expected margin of closer to 10%. In recent years divestments of LATAM, Asia and removal of unprofitable accounts have provided pathway to improved margins – albeit interrupted by Covid-19.
Management execution remains in focus. With four CEOs over the last 5 years, we remain hopeful of improved execution. Non-core assets sales are complete but changing the culture to a performance oriented, dynamic, client centric focus will take time. Andrew Horton (CEO, Sept 21.) mandate is around delivering earnings consistency and with improved culture and accountability.
QBE guidance is baked into market forecasts. For 2022 QBE continues to guide to an improved Combined Operating Ratio (COR)1 of ~94%, and a 1% improvement in 2021. New CEO conservatism may also be at play here. Guidance is reliant on both premiums rising through 2022 and QBE being able hold down claims inflation and reinsurance costs. QBE reiterated guidance at the May AGM. Updates from key US peers in late July will provide a read-through on current industry conditions, with premium rises and claim inflation the key focus. Stronger rises in global interest rates create upside surprise potential in 2023 (higher investment earnings). QBE has longer-term guidance to be able to achieve a COR in the low to mid-90s. Market forecasts currently assumes ~92% COR by 2024E.
How is QBE positioned for weather risks? QBE CAT2 budget for 2022 is ~6.5% of group premium, up from the 2021 budget of 5.5%, but below the actual experience of 6.7%. The pending Atlantic Hurricane season (Aug-Oct) – a key period of risk for North American exposed insurers, is expected to deliver an above-average hurricane season of 20 named storms vs an average season of 14. The National Oceanic and Atmospheric Administration (NOAA) forecasts bake in the ongoing impacts of La Nina. Any financial impact on QBE is dependent on both the severity and frequency of storms through the season.
Valuation does not look stretched. QBE offers prospects >20% EPS CAGR over the next three years, as margins improve. ROE should also lift from ~9% to 10-13%. QBE currently trades at ~10% discount to peers on both a PER and P/B basis. This gap can close in our view, if QBE can demonstrate improved earnings consistency.
Investment view
We have a Buy recommendation on QBE. Rising global premiums are likely to stay strong into 2023 providing opportunities for both revenue growth and margin expansion for QBE. Positive leverage to rising interest rates should also help QBE’s earnings from 2023 onwards. We see the prospect for a period of strong earnings growth into 2023/24.
There remains a clear opportunity for QBE to lift its core margins from 5% to ~10%, which is in line with global peers. Whilst the market earnings forecast currently assumes an 8% margin is achieved in 2024E, in our view, the current share price discounts this prospect. QBE is trading at a discount to both the global insurance peers, and the Australian peers of IAG and SUN.
Whilst insurance companies inherently carry a level of investment risk above that of the market, the structural changes QBE has made in its asset and client mix over the last 4 years should help deliver more consistent earnings. We see a favourable risk/reward dynamic in QBE, simply by QBE returning to an industry ROE and level of earnings consistency.
Risks to investment view
QBE operates in the global insurance market, where it is difficult to build a sustainable competitive advantage. The company has refocused its operations and exposures into core markets of AU/NZ, North America and UK/Europe. This should lower earnings volatility vs the prior exposures into parts of Asia and LATAM. QBE has a poor history of earnings resilience, but recent self-help initiatives and divestment in non-core assets should help.
Key risks include slow-down premium growth rates, large catastrophe claims or insurance events and insufficient reserves. QBE is a large global organisation that can be unyielding to manage at times. The company is undergoing a cultural reset program under the new CEO – the third in 4 years. Longer-term the potential for increased occurrence of large weather claim events needs to be carefully managed.
1 Combined Operating Ratio (COR) is a measure of insurance companies underwriting profitability. COR compared claims, costs and expenses to total premiums. COR >100% implies insurance underwriting is unprofitable.
2 CAT = Catastrophe. Single large-scale asset losses resulting in many insurance claims. Often associated with weather events. CATs can challenge the profitability of an insurer. i.e. cyclone, hailstorm, earthquake.
Figure 1: QBE Simplification: Geographic spread has shrunk over the last 5 years - this should assist insurance margins in moving towards ~10%
Figure 2: QBE combined operating ratio: the focus on core geographic regions should assist in the COR reaching low 90%
Figure 3: Global insurance industry is pushing through the highest premium increases in 20 years
Figure 4: US insurance premiums - most important insurance market in the world has seen positive premium grown for 18 quarters in a row
Figure 5: QBE per 12.5, despite strongest outlook for earnings outlook in over a decade
Figure 6: QBE price to book at trading around the long-term average at 1.3x
Figure 7: QBE ROE can return to 10-12%, which is in line with global peers
Figure 8: QBE Dividend yield based on payout ratio of 50%
Figure 9: QBE vs global insurance peers. QBE offers a strong EPS growth outlook
