Investors have ramped up their bets on the general insurance stocks ahead of reporting season with Insurance Australia Group continuing to stake its claim for the quality play of the sector.
While investors have piled into IAG and Suncorp Group sending their multiples skyward, they remain reluctant to back QBE Insurance Group even though it's entirely possible for QBE to achieve its targets, avoid further blow ups and deliver above-market returns.
“If we could trust our numbers, then QBE looks a stand-out on value,"argued Citi's Nigel Pittaway
However, he said, the global insurer's continued track record of disappointment and associated issues for management credibility make it very difficult to have faith.
“QBE’s recent profit downgrade from losses in emerging markets seems to have destroyed whatever credibility management had rebuilt following a succession of prior disappointments.”
With Suncorp group kicking off profit results on Thursday, Pittaway has turned a spotlight on what he sees as the big three issues for the sector - an uptick in commercial pricing, compulsory third-party insurance woes and reinsurance.
On the first topic, his talks with industry players as well as his analysis of APRA statistics suggest the SME commercial pricing cycle has turned.
Broker commentary is suggesting rate increases of between 3 and 5 per cent with some companies holding more aggressive intentions that, in the shorter term, could push increases higher.
It also revealed that many insurers appear to be seeing the need to restore profitability after a period of heightened competition.
In his view, IAG is more leveraged to this dynamic than Suncorp while QBE should also benefit as it targets recovery in its Australian and NZ divisional margin.
“However, it is far from clear the commercial turn will be sustained for a long period given competitive tension seems to remain in 1 July Australian reinsurance renewals, and SME margins remain well above levels seen in overseas markets, where pricing remains under pressure."
And, of course, on the downside, personal premium growth will likely be matched by claims inflation.
“However, for IAG and Suncorp their higher exposure to personal lines is actually more relevant to profitability even despite likely flatter margins in these classes. Here, prices also appear to be growing strongly but we expect price increases to be offset by claims inflation.
“For IAG it will be interesting to see whether pricing is a little ahead or a little behind claims in motor, with at least one industry player suggesting they are behind. There may also be modest margin expansion in compulsory third party insurance.”
Suncorp faces particular headwinds in next year from regulatory-driven price reductions in Queensland CTP, according to Pittaway.
The shift to a lower-risk, defined benefits style CTP scheme in New South Wales will also lower premiums.
“However, the NSW reforms will likely lift current year profitability for all three insurers though the extent of this will likely depend on how much recent repricing has already restored some profitability.
“Given IAG and QBE seem, until recently, to have been suffering worse current year underwriting profitability than Suncorp, we believe they may benefit more. However, IAG's move to shed market share just ahead of the new scheme coming in force is potentially overly conservative."
Following another year of exceeding its natural hazards allowance, the Queensland financial services group conceded that an increase is "inevitable". And how far the allowance will rise will likely depend on the level of reinsurance coverage it has been able to get.
The analyst pointed to particular question marks over whether Suncorp has been able to secure aggregate cover on acceptable terms for 2018.
“In contrast, IAG's calendar year aggregate cover will continue to shield it into the 2018 first half, perhaps suggesting it will be able to increase its perils allowance by a lower percentage than net earned premium.”