27 October 2014
Asia Pacific/Australia
Equity Research
Property & Casualty Insurance (Insurance (AU))
QBE Insurance Group
(QBE.AX / QBE AU)
Rating
Price (24 Oct 14, A$)
Target price (A$)
Market cap. (A$mn)
Yr avg. mthly trading (A$mn)
Last month's trading (A$mn)
Projected return:
Capital gain (%)
Dividend yield (net %)
Total return (%)
52-week price range
NEUTRAL*
11.14
12.20¹
15,205.49
1,339
1,157
9.5
3.8
13.3
16.0 - 10.2
* Stock ratings are relative to the relevant country benchmark.
¹Target price is for 12 months.
Research Analysts
Andrew Adams
61 2 8205 4106
[email protected]
FORECAST INCREASE
The waiting game continues
■ Margin stabilisation: Following a number of years of margin improvement
potential, QBE is now facing a global softening of premium rates and the task of
actually delivering an improved margin is getting tougher, in our view. We allow
for some margin improvement on the back of a lower expense ratio in coming
years for QBE, but we caution an expectation of significant improvement from
the current ~10% margin. We maintain our NEUTRAL rating.
■ Top-line pressure: The GWP pressure for QBE has changed from
'remedial action' to 'competitive pressure' and hence growth remains a
challenge. QBE is targeting selected growth, including US casualty, which
will assist in offsetting the declines elsewhere in the near term.
■ Balance sheet strength at a cost: QBE is taking action to improve the
strength of their balance sheet and we have increased confidence that the
reserving issues are largely addressed. But this comes at a cost, with over
100bps of margin pressure from business sales and an ROE of only ~10%.
■ Earnings changes: Following a review of our QBE forecasts, we increase
FY15 EPS by 1.9% and lower FY16 by 2.9%. Our FY15 increase is driven
by an increase in investment income on shareholders' funds, while in FY16
we reduce our insurance profit by 6%.
■ Valuation: The step change in QBE's ROE no longer justifies a valuation
premium to its peer base, in our view. If anything, given the position of the
core business, a discount could be expected. Longer term, QBE is certainly an
interesting investment proposition, but with macro tailwinds continuing to be
delayed along with the margin turnaround, we maintain a NEUTRAL rating.
Total return forecast in perspective
Financial and valuation metrics
60%
40%
20%
Mean^
CS tgt^
Sh Prc
0%
-20%
-40%
12mth Volatility*
Performance over
Absolute (%)
Relative (%)
52wk Hi-Lo
1M
-5.8
-6.4
IBES Consensus
target return^
3M
-6.1
-3.0
12M
-22.1
-22.8
Relative performance versus S&P ASX 200.See Reference
Appendix for a description of the chart. Source: Credit Suisse
estimates, * Consensus, mean range from Thomson Reuters
Year
Reported profit (US$mn)
Cash Earnings (CS) (A$mn)
Cash EPS (CS) (A$)
Change from previous EPS (%)
Cash EPS growth (CS) (%)
Cash PE (CS) (x)
Dividend (Ac)
Dividend yield (%)
Franking (%)
Book value per share (Ac)
Price/book (x)
12/13A
-254.0
1,024.1
0.85
n.a.
-10.9
13.2
32.00
3.2
100
931.35
1.2
12/14E
867.5
1,021.9
0.79
-0.1
-12.4
14.1
33.00
3.1
100
1,038.88
1.1
12/15E
1,234.6
1,493.0
1.09
1.8
30.9
10.2
45.00
4.0
100
1,138.93
1.0
12/16E
1,397.6
1,720.4
1.25
-2.9
12.0
8.9
54.00
4.7
70
1,240.44
0.9
Source: Company data, ASX, Credit Suisse estimates, * Adj. for goodwill, notional interest and unusual items. Relative P/E against
ASX/S&P200 based on pre GW in AUD. Company PE calculation is based on displayed EPS Currency.
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST
CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do
business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a
conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.
CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS
BEYOND INFORMATION®
Client-Driven Solutions, Insights, and Access
27 October 2014
Table of contents
Executive summary
GWP growth
Underlying insurance margin
Balance sheet
Valuation
Earnings changes
GWP – remedial action versus soft market
North America – long road ahead
Latin America – future unknown
Europe – globalisation and localisation
Australia and New Zealand - softening
Asia Pacific – growth opportunity
Outlook – downside risk
Underlying insurance margin
Attritional loss ratio – patchy improvement
Large risk and catastrophe allowance - appropriate
Expense ratio – the silver bullet
Impact of business sales – margin compression
Investment income – surprisingly resilient
Outlook - challenging
Balance sheet – addressed
ROE
Macro leverage – one day
Discount rate
Currency
Valuation – longer term appeal
4
4
4
5
6
7
8
9
10
11
12
13
13
14
14
15
17
20
22
23
25
26
28
28
28
30
QBE Insurance Group
(QBE.AX / QBE AU)
2
27 October 2014
Figure 1: QBE Earnings Summary
QBE Insurance Group Limited
Share Price:
$ 11.14
12-month target price:
$12.20
Year ending 31 December
Profit & loss (US$m)
Gross written premium
Net earned premium
FY12
FY13
FY14F
FY15F
FY16F
ASX code:
18,434
17,975
16,616
16,009
16,431
No. of shares (m)
QBE.AX
1,365
15,205
15,798
15,396
13,870
14,159
14,206
Market cap (A$m)
Net claims incurred
-10,428
-9,931
-8,582
-8,634
-8,681
Market cap ranking
Acquisition costs
Administration costs
-2,560
-2,357
-2,580
-2,544
-2,358
-2,303
-2,368
-2,094
-2,329
-2,064
Weighting - ASX200
Weighting - insurance
Underwriting result
453
341
626
1,062
1,132
Insurance inv income
809
500
514
441
455
Insurance result
1,262
841
1,140
1,503
1,587
Interest expense*
-324
-345
-258
-213
-213
410
301
285
369
-407
-1,245
-60
941
-448
-161
-19
Inv income on SHF
Amortisation of intangibles
Pe-tax profit
Income tax
Outside equity interests
NPAT
Share price:
NEUTRAL
Target price
14
$12.20
TSR
0.8%
20.3%
13.3%
12mnth Fwd PE
10.1x
FY12
FY13
FY14F
FY15F
FY16F
EPS
65.1
-21.0
67.1
90.2
101.5
EPS (pre-gw)
91.9
81.9
69.6
92.8
104.0
497
EPS (pre-gw, AUD)
88.7
85.3
79.0
109.1
124.5
-50
-50
PER
12.6x
13.1x
14.1x
10.2x
8.9x
1,107
1,609
1,821
31%
-11%
-15%
33%
12%
204
-232
-367
-415
-10
-8
-8
-8
867
1,235
1,398
761
-254
-
-
AUDUSD
1.04
0.89
0.87
Average exchange rate
1.04
0.96
0.90
-
Key ratios:
$11.14
Rating
EPS growth
DPS (A$ cps)
50.0
32.0
33.0
45.0
54.0
Payout ratio (%)
56%
38%
42%
41%
43%
4.8%
Net Dividend Yield
4.5%
2.9%
3.0%
4.0%
-
Franking Level
32%
100%
100%
100%
70%
0.85
0.85
Gross Dividend Yield (%)
5.1%
4.1%
4.2%
5.8%
6.3%
0.85
0.85
Tax rate (%)
11.9%
-25.6%
19.9%
22.1%
22.2%
1,169
1,271
1,210
1,210
1,293
1,322
1,368
1,368
1,377
1,377
10.35
0
Avg Shares (basic)
Avg Shares (diluted)
Key ratios:
FY12
FY13
FY14F
FY15F
FY16F
GWP growth (%pa)
0.8%
-2.5%
-7.6%
-3.7%
2.6%
NAV p/share
9.51
8.30
9.06
9.69
NEP growth (%pa)
2.9%
-2.5%
-9.9%
2.1%
0.3%
Price to NAV (x)
1.2x
1.3x
1.2x
1.1x
1.1x
NEP / GWP (%)
85.7%
85.7%
83.5%
88.4%
86.5%
ROE (%pa)
7.0%
-2.3%
7.6%
9.6%
10.1%
Reinsurance ratio (%)
13.9%
13.9%
18.9%
13.1%
12.4%
NTA p/share
4.32
4.71
5.76
6.45
7.16
Loss ratio (net - %)
66.0%
64.5%
61.9%
61.0%
61.1%
Price to NTA (x)
2.6x
2.4x
1.9x
1.7x
1.6x
Commission ratio (%)
16.2%
16.8%
17.0%
16.7%
16.4%
ROTE (%pa)
16.3%
-4.6%
12.6%
14.8%
14.9%
Expense ratio (%)
14.9%
16.5%
16.6%
14.8%
14.5%
MCR ratio
Combined ratio (%)
97.1%
97.8%
95.5%
92.5%
92.0%
Debt / equity
Insurance margin (%)
8.0%
5.5%
8.2%
10.6%
11.2%
Divisionals (US$m)
FY12
FY13
FY14F
FY15F
FY16F
Australia
Gross written premium
Combined ratio (%)
4,987
90.6
4,786
87.4
4,640
88.6
4,491
89.1
4,626
90.0
Insurance margin (%)
18.9
18.8
15.7
14.0
13.2
Asia Pacific
1.69x
1.62x
1.76x
1.79x
1.93x
43.3%
44.1%
34.9%
32.5%
30.2%
BALANCE SHEET (A$mn)
FY12
FY13
FY14F
FY15F
FY16F
Cash
2,025
1,238
1,340
1,414
1,488
Receivables
5,232
5,119
2,640
3,227
2,659
29,586
4,377
29,427
3,461
30,792
4,508
32,475
4,798
34,177
4,835
DAC
2,606
2,221
2,171
2,311
2,329
Intangibles
6,068
4,480
4,500
4,450
4,400
Investments
Reins Recoveries
Gross written premium
Combined ratio (%)
578
85.8
730
84.0
766
92.4
804
89.5
845
89.3
Other
ASSETS
868
50,762
1,325
47,271
1,196
47,148
1,212
49,887
1,229
51,116
Insurance margin (%)
15.9
17.4
9.8
13.6
13.9
Outstanding Claims
22,789
21,669
20,572
21,896
22,065
Unearned premium
8,559
8,184
7,422
7,899
7,960
Borrowings
Other
4,946
3,051
4,591
2,424
4,337
2,408
4,337
2,408
4,337
2,408
LIABILITIES
39,345
36,868
34,738
36,540
36,770
NET ASSETS
11,417
10,403
12,410
13,346
14,345
Shareholders' Equity
11,417
10,403
12,410
13,346
14,345
Share capital
10,002
9,195
10,831
10,918
11,030
Equity component of hybrid securities
Reserves
133
-1,859
0
-1,470
0
-1,672
0
-1,672
0
-1,672
3,082
2,631
3,201
4,051
4,938
59
47
49
49
49
5,290
5,876
7,861
8,847
9,896
North America
Gross written premium
Combined ratio (%)
Insurance margin (%)
6,569
106.8
5,854
115.8
5,285
99.8
5,036
95.5
5,215
92.5
-4.9
-14.6
3.1
7.6
10.6
Latin America
Gross written premium
Combined ratio (%)
1,223
94.8
1,380
99.7
1,298
117.2
1,363
94.7
1,431
94.2
Insurance margin (%)
11.9
8.2
-9.6
8.5
9.2
Europe
Gross written premium
Combined ratio (%)
Insurance margin (%)
5,077
5,225
4,627
4,314
4,314
94.9
96.4
96.0
94.6
94.3
9.8
5.3
7.4
8.9
9.2
Equator Re
Retained Profits
Outside Equity Interests
Net Tangible Equity
Net earned premium
Combined ratio (%)
Insurance margin (%)
3,410
99.7
3,057
96.8
2,541
91.0
2,955
92.2
2,664
92.0
4.1
5.2
12.6
10.9
11.2
MSCI IVA (ESG) Rating BB
Credit Suisse View
TP ESG Risk (%): 0
TP Risk Comment: We value increased earnings
pressure from regulatory change with further downside
pressure from global regulatory reform and inability to
price in a cost-focsued global environment.
10.1
Share Price Performance
52wk range: 10.16-15.95
9.1
8.1
17.00
16.00
15.00
14.00
13.00
12.00
11.00
10.00
Oct-13
7.1
6.1
MSCI IVA Risk (%): Negative
5.1
MSCI Risk Comment: Recently downgraded from 'AA'
to 'A' which is justified based on environmental risks, but
we consider a further downgrade likely as the company
has reported provision top-ups for prior year claims and
the continued volatility of weather events impacting the
balance sheet.
4.1
Environment
Stock
Jan-14
QBE.AX
Apr-14
Jul-14
XJO
Oct-14
Social
Local Sector
Governance
Country
Global Sector
Source: MSCI ESG Research
XXJ
Andrew Adams
Source: Reuters
Share price as of 24-Oct-14, 17:02
+612 8205-4106
[email protected]
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
3
27 October 2014
Executive summary
Following many years of margin improvement potential, QBE is now facing a global
softening of premium rates and the task of actually delivering an improved margin is
getting tougher, in our view. Despite QBE's share price falling by ~25% in the past 12
months, this has been on the back of outer year earnings downgrades and QBE is still
trading at roughly fair value versus it global peers and a discount to the high-quality
domestic financial names.
We look at the key earnings drivers for QBE, along with the balance sheet and valuation
impact. There is certainly longer-term valuation appeal in QBE at current prices should
management be successful in turning the business around. However, in the face of
challenging market conditions, we highlight that the turnaround is no certainty.
Following many years of
margin improvement
potential, QBE is now facing
a global softening of
premium rates and the task
of actually delivering an
improved margin is getting
tougher, in our view
GWP growth
QBE's GWP experienced strong growth for over ten years, before hitting a peak in 2011,
when insurance margins collapsed. The GWP growth was driven by acquisitions, primarily
in the Americas division. While the decline in recent years has come largely from the North
America division, the current FY14 pressure is also coming from increased competition in
the market across all of QBE's regions.
While commercial lines has enjoyed premium rate increases in recent years, primarily in
Australia and North America, we have observed a slowdown in the rate increases in 2014
with the potential for rate decreases as we move into 2015. This was echoed by QBE
management comments at the 1H14, noting that "market conditions became slightly more
challenging as the first half of 2014 progressed. Competition and overcapacity kept
premium rate increases low in many of the markets in which we operate."
QBE's GWP was down 2.5% in FY13 and was expected to be down a further ~5% in
FY14. Based on the movements in exchanges rates in 1H14, this should have improved
the guidance to a ~4% contraction, but weakness in commercial lines globally resulted in a
revised guidance of a ~6.5% decline in GWP in FY14, an additional US$450mn of GWP
lost. The additional US$450mn of GWP decline was due to a reduction in expectations in
North America and Australia commercial lines. Interestingly, despite the competitive
pressure accelerating over 1H14 and resulting in QBE falling ~5% short of its 1H14
budget, QBE have made little adjustment to their 2H14 budget.
Interestingly, despite the
competitive pressure
accelerating over 1H14 and
resulting in QBE falling ~5%
short of its 1H14 budget,
QBE has made little
adjustment to its 2H14
budget
Figure 2: QBE FY14 change to Group forecast
US$mn
1H14
2H14
Original budget
Revised forecast
Change
8,900
8,491
-4.6%
8,400
8,309
-1.1%
Source: Company data, Credit Suisse estimates
Underlying insurance margin
There is increasing comfort that QBE's reserving issues are largely addressed, but we
highlight that the underlying insurance margin remains under pressure and is unlikely to
demonstrate any significant improvement in the near term. In fact, unless QBE can
effectively pull out more costs from the business, we see further downside risk to QBE's
insurance margin. We note:
■
QBE reported an underlying insurance margin of 10.0% in 1H14, with a similar level
assumed in 2H14 based on their FY14 guidance.
■
QBE's 1H14 underlying margin calculation used an expense ratio of 32.8% (31.5%
was used in FY13). We assume 31.5% as the base case expense ratio, implying
130bps of improvement from 1H14.
Unless QBE can effectively
pull out more costs from the
business, we see further
downside risk to QBE's
insurance margin
QBE Insurance Group
(QBE.AX / QBE AU)
4
27 October 2014
■
We have assumed a slight improvement in QBE's underlying loss ratio on the back of
recent remedial action, which also assumes that LPI and Argentina do not deteriorate
further at an underlying level.
■
We assume margin contraction from stripping out LMI and half of the agency
business.
Figure 3: QBE underlying insurance margin drivers
% of NEP
FY14 underlying insurance margin
Expense ratio improvement
Further remedial action on loss ratio
LMI removal
Removal of agency income
FY15 insurance margin base
10.0%
1.3%
0.6%
-0.9%
-0.5%
10.5%
Source: Company data, Credit Suisse estimates
Adopting an insurance margin much above 10.5% in FY15 requires a lot to work in QBE's
favour in our view. With premium rates now in decline globally, there is additional
pressures that a soft market brings.
Balance sheet
QBE's balance sheet has been under pressure in recent years and while in our view the
previous actions taken by management put QBE on track to be in a strong position by the
end of 2015, management decided to take immediate action to increase the strength of the
balance sheet at the 1H14 result.
The capital initiatives announced by QBE will result in a stronger balance sheet and higher
capital buffers, but with earnings remaining under pressure, this will ultimately result in a
lower ROE for investors. On our calculations, a normalised return for QBE in FY15 is
~10%, well below its historical returns.
The capital initiatives
announced by QBE will
result in a stronger balance
sheet and higher capital
buffers, but with earnings
remaining under pressure,
this will ultimately result in a
lower ROE for investors
Figure 4: QBE ROE workings
US$mn
FY15 Cash NPAT - Core
Plus LMI (60%)
FY15 Cash NPAT - Reported
1,318
68
1,386
FY15 pro-forma equity
FY15 retained earnings
FY15 equity
Intangible
Net Tangible Assets
13,000
762
13,762
4,525
9,237
ROE
RNTA
10.1%
15.0%
Source: Company data, Credit Suisse estimates
The step change in QBE's ROE no longer justifies a valuation premium to its peer base for
QBE, in our view. If anything, given the position of the core business, a discount could be
expected, if not for some macro leverage.
QBE Insurance Group
(QBE.AX / QBE AU)
5
27 October 2014
Figure 5: Australia financials – P/BV vs ROE
Figure 6: Selected global insurers– P/BV vs ROE
PTM
CPU
PPT
IRE
3.0x
1.75x
Expensive
2.5x
P
- =
E
Expensive
P
BV
/
E
BV
P
E
BTT
CBA
=
2.0x
AMP
Price / Book Value (x)
Price / Book Value (x)
PER = 13.4x
WBC
IAG
HGG
IFL
ANZ
ASX
NAB
MQG
1.5x
CGF
SUN
1.0x
TWR
P
E
- / BV
BV
Suncorp
Arch Capital
1.25x
Chubb
Allstate
Hiscox
RSA
QBE
XL Capital
Catlin
AXA SA
Hannover Re
Allianz
ACE
0.75x
Amlin
Munich Re
BOQ
BEN
QBE
Inexpensive
0.25x
5.0%
Inexpensive
0.5x
5.0%
7.5%
10.0%
12.5%
15.0%
17.5%
20.0%
7.5%
22.5%
10.0%
ROE %
12.5%
15.0%
Return on Equity (EPS / BV)
Source: ASX, Reuters, Bloomberg. * IBES – Cash EPS 12mth forward
rolling
Source: ASX, Reuters, Bloomberg. * IBES – Cash EPS 12mth forward
rolling
Valuation
The scope for an improvement in QBE's underlying earnings is likely to be driven by
expense control in the near term, with the risk that this is partially offset by softening
premium rates and a lower GWP base. For this reason we expect QBE to trade closer to
its global peers on a P/E basis, i.e., at a discount to IAG and SUN. Should QBE start to
demonstrate the ability to lower their expense ratio and improve the insurance margin, it is
likely that the stock will then re-rate closer to an IAG and SUN multiple, in our view. The
valuation range and upside potential for QBE is quite large, but the ability to improve the
insurance margin is no easy task.
There is certainly longerterm valuation appeal in
QBE at current prices
should management be
successful in turning the
business around
The risk to our cautious stock view is a more favourable macro environment and a
significant turnaround in the QBE business, driven by:
■
GWP growth – if QBE can stop the premium decline and start to generate growth
again, ideally in its core business, this would assist in addressing the high cost base.
■
Insurance margin recovery – QBE is committed to pulling out costs and achieving
these goals while also improving the business mix favourably would drive the margin
quicker and higher than our base case assumptions.
■
Currency – Over 75% of QBE's business is offshore and a lower AUD assists EPS
(AUD), a ~6% EPS uplift from a 10% decline in the AUD on our calculations.
■
Yields – every 100bps increase in the discount rate adds ~25cps to the valuation.
Figure 7: QBE – scenario analysis
Scenario
Share price fair value
Current share price
Upside %
Fair value assumptions
Bear
$7.29
$11.00
-34%
Base
$12.19
$11.00
11%
- Further GWP decline in coming years
- Lack of insurance margin improvement
- AUD remains high and no increase in global
bond yields in near-term
YE Dec
NEP growth
Insurance margin
AUDUSD
Discount rate change (bps)
EPS (AUD)
2015E
-10.0%
9.0%
0.90
0.84
2016E
-10.0%
10.0%
0.90
0.84
2017E
0.0%
10.0%
0.90
- GWP decline stops
- GWP growth in coming years
- Gradual insurance margin improvement
- Insurance margin improvement
- AUD at 0.85 and gradual increase in global - AUD continues to fall large increases in
bond yields in near-term
global bond yields in near-term
2015E
-3.0%
10.0%
0.85
0.84
Bull
$20.68
$11.00
88%
1.04
2016E
0.0%
10.5%
0.85
50
1.09
2017E
0.0%
11.0%
0.85
50
1.13
2015E
0.0%
11.0%
0.85
100
1.17
2016E
5.0%
12.0%
0.80
100
1.40
2017E
10.0%
12.5%
0.75
100
1.69
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
6
27 October 2014
Earnings changes
Following a review of the QBE business we have revised our earnings forecasts, with the
main points as follows:
■
No changes to our FY14E earnings, with benign natural peril claims currently offset by
crop loss expectations and discount rate movements.
■
Lowered GWP by 2.6% in FY15 and 3.4% in FY16, resulting in GWP decline in FY15
(on the FY14 base) and small growth in FY16.
■
Lowered insurance profit by 1.8% in FY15 and 5.9% in FY16, resulting in an insurance
margin of 10.6% in FY15 and 11.2% in FY16.
■
Increased investment income on shareholders' funds in FY15 by 20.1% and 10.5% in
FY16, allowing for an increase in allocation to growth assets and a higher return on
these assets.
■
Overall impact is a 1.9% increase to our FY15 EPS and a 2.9% decrease to FY16.
Figure 8: QBE earnings changes
FY14F
FY15F
Profit & loss (US$mn)
Old
New
Change
Old
New
Change
Gross written premium
Net earned premium
16,616
13,870
16,616
13,870
0.0%
0.0%
16,430
14,536
16,009
14,159
-2.6%
-2.6%
Net claims incurred
Acquisition costs
Administration costs
Underwriting result
Insurance inv income
Insurance result
-8,582
-2,358
-2,303
626
514
1,140
-8,582
-2,358
-2,303
626
514
1,140
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
-8,869
-2,424
-2,158
1,086
445
1,531
-8,634
-2,368
-2,094
1,062
441
1,503
-2.6%
-2.3%
-2.9%
-2.2%
-1.0%
-1.8%
Interest expense
Inv income on SHF
Amortisation of intangibles
Pre-tax profit
Income tax
Outside equity interests
NPAT
-258
285
-60
1,107
-232
-8
867
-258
285
-60
1,107
-232
-8
867
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
-213
307
-50
1,575
-359
-8
1,208
-213
369
-50
1,609
-367
-8
1,235
0.0%
20.4%
0.0%
2.2%
2.2%
0.0%
2.2%
Insurance margin
8.2%
8.2%
0.0%
10.5%
10.6%
0.1%
67
66
70
33
67
66
70
33
-0.1%
-0.1%
-0.1%
0.0%
89
89
91
45
90
90
93
45
1.9%
1.9%
1.9%
0.0%
Basic EPS
Diluted EPS
EPS (pre-gw, diluted)
DPS (A$ cps)
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
7
27 October 2014
GWP – remedial action versus soft
market
QBE's GWP experienced strong growth for over 10 years, before hitting a peak in 2011,
when the insurance margin collapsed. The GWP growth was driven by acquisitions,
primarily in the Americas division. While the decline in recent years has come largely from
the North America division, the current FY14 pressure is also coming from increased
competition in the market across all of QBE's regions.
We have been supportive of
the remedial actions taken
by QBE's management in
recent years, but further
business lost may be
needed as we head into a
global softening of
commercial premium rates
While we have been supportive of the remedial actions taken by QBE management in
recent years, with the underlying business not yet in shape, further business lost may be
needed as we head into a global softening of commercial premium rates.
Figure 9: QBE GWP and NEP versus insurance margin
GWP growth rate (% p.a.)
20,000
34.2%
0.8%
18,000
Figure 10: QBE GWP by division
20,000
24.0%
-2.5%
-6.5%
18,000
21.5%
AUD
12,000
-11.2%
10.2%
16.5%
2.0%
7.3%
5.0%
14.0%
8,000
11.5%
6,000
9.0%
4,000
6.5%
2,000
Net Earned Premium (A$m)
19.6%
Insurance Margin (%)
Premiums ($m)
19.0%
21.3%
14,000
10,000
USD
16,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
0
4.0%
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY00
FY01
FY02
Australia
Gross Written Premium
Net Earned Premium
Source: Company data, Credit Suisse estimates
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14F
FY14F
Asia Pacifc
Total European
Americas
Latin America
Insurance Margin (%)
Source: Company data, Credit Suisse estimates
While commercial lines have enjoyed premium rate increases in recent years, primarily in
Australia and North America, we have observed a slowdown in the rate increases in 2014
with the potential for rate decreases as we move into 2015. This was echoed by QBE's
management comments at 1H14, noting that "market conditions became slightly more
challenging as the first half of 2014 progressed. Competition and overcapacity kept
premium rate increases low in many of the markets in which we operate."
We highlight below the pressure that a soft market can have on QBE's insurance margin,
but we also flag that there is continued downside risk to QBE's GWP base in coming
periods. This was demonstrated in QBE's adjusted FY14 guidance. While most of the
result focus has been on the margin issues in LPI, Latin America and pockets of Europe,
the downgrade to GWP was driven by mainstream commercial lines and increased
competition putting pressure on premium rates.
QBE's GWP was down 2.5% in FY13 and was expected to be down a further ~5% in
FY14. Based on the movements in exchanges rates in 1H14, this should have improved
the guidance to a ~4% contraction, but weakness in commercial lines globally resulted in
revised guidance of a ~6.5% decline in GWP in FY14, an additional US$450mn of GWP
lost. The additional US$450mn of GWP decline was due to a reduction in expectations in
North America and Australia commercial lines. Interestingly, despite the competitive
pressure accelerating over 1H14 and resulting in QBE falling ~5% short of its 1H14
budget, QBE have made little adjustment to their 2H14 budget.
Interestingly, despite the
competitive pressure
accelerating over 1H14 and
resulting in QBE falling ~5%
short of its 1H14 budget,
QBE have made little
adjustment to their 2H14
budget
QBE Insurance Group
(QBE.AX / QBE AU)
8
27 October 2014
Figure 11: QBE FY14 change to Group forecast
US$mn
1H14
2H14
Original budget
Revised forecast
Change
8,900
8,491
-4.6%
8,400
8,309
-1.1%
Source: Company data, Credit Suisse estimates
We note also that Latin America benefited from a US$99mn one-off gross-up of Argentine
workers’ compensation premium written on an annual policy basis but previously reported
as written on a monthly policy basis. Excluding this, the 1H14 GWP would have fallen
short by 5.7%. This highlights that the decline in QBE's GWP guidance was due to the
actual numbers coming in below expectations in 1H14, as opposed to conservative
allowance for further weakness in 2H14.
Figure 12: QBE Group FY14 guidance changes
FY14 guidance
Local currency
North America
Latin America
Europe
Australia
Asia Pacific
Total GWP
Original exchange
rates
US$bn
Revised exchange
rates (1H14)
US$bn
5.6
1.2
4.6
4.8
0.8
17.0
5.6
1.2
4.8
4.8
0.8
17.3
5.6
1.2
2.9
5.3
0.8
FY14 at 1H14
FY14 at 1H14
Local currency
US$bn
5.3
1.3
2.8
5.2
0.8
5.3
1.3
4.7
4.7
0.8
16.8
Source: Company data, Credit Suisse estimates
Looking specifically at a divisional level we highlight the following:
North America – long road ahead
Following a reduction of over 20% in GWP over the last two years, the decline in QBE's
North America GWP is expected to continue in FY14. Original guidance implied a 2.6%
decline on FY13, but this has now been adjusted to a ~10% decline.
The revised guidance at QBE's 1H14 result was driven by trimmed expectations across
the portfolio – reinsurance, intermediary, program, crop and QBE First, all areas are falling
short of expectations.
QBE's management noted that "competition in P&C and specialty has increased over the
past six months, contributing to a premium rate increase of less than 2% in these
businesses. Specific lines of business are seeing intense competition and rate decreases,
while other lines have been able to sustain stronger rate increases."
Figure 13: QBE North America GWP analysis
US$mn
Reinsurance
Intermediary
Program
Crop
QBE First
Total GWP
FY11
actual
2,000
2,200
7,529
FY12
original
guidance
FY12 at
1H12
FY12
FY13
actual guidance
Change
FY13 at
1H13
FY13
FY14
actual guidance
FY14 at
1H14
500
1,400
1,500
1,800
1,900
7,100
420
1,300
1,550
1,630
1,700
6,600
400
1,600
1,500
1,800
1,200
6,500
-80
-100
50
-170
-200
-500
300
300
1,600
1,500
1,600
900
5,700
200
1,400
1,400
1,500
800
5,300
6,569
1,700
1,000
5,900
5,854
Source: Company data, Credit Suisse estimates
QBE's investor day in North America in October also highlighted the pressure on GWP
with management calling out:
■
Commercial property premium rates now negative
QBE Insurance Group
(QBE.AX / QBE AU)
9
27 October 2014
■
Speciality lines premium rates trending down and no better than flat premium rate
changes
■
Conditions to continue to deteriorate across all product lines in 2015
■
Crop prices down ~25% in 2014 will likely put additional pressure on GWP in 2015
In addition to a softening of premium rates putting pressure on GWP, we are not of the
view that QBE's North American business has completely rebased its GWP at this stage.
We see downside risk in a number of areas, namely:
■
As mentioned above, Crop is ~27% of QBE's North America GWP, and 10% downside
due to crop prices reflects ~3% GWP pressure in 2015.
■
Middle market is ~US$1bn of GWP (17% of North America) of which just under half is
personal lines and small business. These portfolios remain at risk in our view while
QBE attempts to pull out costs and streamline their offering.
■
Mortgage and Lenders Services (M&LS) portfolio is only ~US$500mn currently and
downside risk remains in a difficult regulatory environment.
■
Agency business in the US accounts for US$354mn (~6% of North America) and a
sale of these agents could result in a loss in GWP for one or more of the agents.
In addition to a softening of
premium rates putting
pressure on GWP, we are
not of the view that QBE's
North American business
has completely rebased its
GWP at this stage.
We note that QBE's management have outlined some 'growth' areas, primarily US
casualty, which may assist in offsetting some of the GWP pressure in the next 2-3 years.
This will likely impact QBE's COR (increase it) and brings a new layer of risks to the QBE
North American operations, the detail of which is best left for another report should QBE
be successful in expanding in this area.
Latin America – future unknown
QBE's Latin America business had an increase in its FY14 GWP target at 1H14, driven by
higher inflation in the Argentina business, which was also the key driver in the need to
increase claims reserves in Argentina during the period. Elsewhere within Latin America,
premium growth expectations have been upgraded slightly in Brazil, Ecuador and Puerto
Rico while tempered slightly in Colombia, Chile and Mexico.
Despite the 15% increase in GWP guidance for FY14, the revised guidance represents a
2% decline on FY13.
Figure 14: QBE Latin America GWP analysis
US$mn
Argentina
Colombia
Brazil
Ecuador
Mexico
Chile
Puerto Rico
Total GWP
FY12
original
guidance
300
260
75
160
65
10
45
915
FY12 at FY12 actual
1H12
605
260
65
150
65
10
45
1,200
1,223
FY13
guidance
Change
850
300
70
160
70
20
50
1,520
305
0
-10
-10
0
0
0
285
FY13 at FY13 actual
1H13
850
300
70
160
70
20
50
1,520
1,380
FY14
guidance
FY14 at
1H14
540
250
80
160
80
0
60
1,170
700
230
85
165
75
25
70
1,350
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
10
27 October 2014
Europe – globalisation and localisation
QBE's European business delivered 4% GWP growth (in local currency) in FY13, despite
an expectation of minimal growth in the period. Management noted that most of the growth
was attributable to distribution initiatives in the London market property portfolio and the
Canadian liability business. Growth was diluted by softening property rates for inward
reinsurance, competition in Europe and remedial action on the energy & marine and
professional indemnity portfolios.
The original outlook for FY14 was a ~13% decline in GWP, with management noting that
this reflects ongoing portfolio remediation and the disposal of non-core activities,
combined with expected deterioration in market conditions for QBE Re and international
markets. This has been revised down further to a ~16% decline in GWP in FY14.
Figure 15: QBE Europe GWP analysis
£mn
P&C and motor
Marine, energy & aviation
Retail
International
Reinsurance and credit
Total GWP
FY12
original
guidance
1,700
700
700
3,100
FY12 at
1H12
FY12
actual
1,800
700
700
3,200
3,203
FY13
guidance
Change
FY13 at
1H13
2,048
640
100
0
2,158
589
512
3,200
0
100
458
3,205
FY13
actual
FY14
guidance
FY14 at
1H14
3,324
1,450
946
504
2,900
1,461
852
487
2,800
Source: Company data, Credit Suisse estimates
As highlighted previously (QBE – Chalk and cheese comparison, 22 January 2014) we
expect that the FY14 reduction will come from the portfolios that QBE has previously
flagged as performing poorly, short-tail business.
Figure 16: QBE Europe poor performing portfolios
GWP
Property - London market/Lloyds
Property - UK and Europe
Motor
British Marine
Aviation
£mn
US$
320
220
300
105
112
528
363
495
173
185
Source: Company data, Credit Suisse estimates
QBE European management at their investor day in October outlined a difficult
environment that continues to deteriorate in Europe. Average premium rates across
Europe are below QBE's original expectations and have deteriorated by the quarter. In
addition to premium rates, QBE management described the 'globalisation and localisation'
of insurance which has reduced the need for insurance to be written out of London.
QBE's management outlined some growth opportunities in Europe going forward, namely
the opening of a Bermuda Re office and Miami distribution, but these are small
opportunities, in our view, with the net impact of flat GWP growth in FY15 likely to be a
positive outcome if achieved.
QBE's management
described the 'globalisation
and localisation' of
insurance which has
reduced the need for
insurance to be written out
of London
We note also that the business being lost by QBE is not necessarily poor quality business
that they are happy to let go, there is also high quality business that is not being renewed.
Often this is due to quality corporates and insurers retaining more risk on their own healthy
balance sheets and hence less of a need for insurance/reinsurance. This is important in
the context of 'margin improvement' which we discuss below, in the sense that business
lost can continue to put pressure on the insurance margin as opposed to improve it.
QBE Insurance Group
(QBE.AX / QBE AU)
11
27 October 2014
Figure 17: European premium rate experience versus FY14 plan
Full Year Plan
Q1 YTD Actual
Q2 YTD Actual
Brussels
Dublin
London
USA
Reinsurance
0.6%
-2.2%
-2.8%
-1.1%
-1.4%
0.6%
-2.6%
-4.4%
-4.0%
-2.2%
0.5%
-4.8%
-6.2%
-4.8%
-3.5%
Canada & Middle East
Marine
Energy & Political
International P&C
BM
International markets
0.1%
0.9%
-5.0%
0.3%
2.7%
-0.6%
-0.1%
1.8%
-4.1%
-1.1%
0.3%
-1.0%
-1.0%
0.5%
-5.0%
-3.2%
-1.1%
-3.0%
Europe
UK&I
F&SM
Retail
0.8%
3.1%
0.8%
2.5%
1.3%
3.2%
0.4%
2.6%
0.6%
2.6%
2.2%
2.2%
Total
0.7%
0.5%
-0.9%
Source: Company data, Credit Suisse estimates
Australia and New Zealand – softening
QBE's Australia and New Zealand business delivered GWP growth of 4% (in local
currency) in FY13, in line with expectations. The business was originally expected to grow
GWP by ~6% in FY14 (in local currency) driven by an improvement in retention rates and
modest rate increases (noting FY13 was impacted by the removal of FSL). This has now
been adjusted down to ~4% GWP growth in FY14, with management noting that they
expect the market environment to remain competitive and premium rates under pressure.
Figure 18: QBE Australia and New Zealand GWP analysis
A$mn
Intermediary distribution
Corporate partners & direct
LMI
Credit and surety
NZ
Total GWP
FY12
original
guidance
2,330
1,845
300
150
230
4,855
FY12 at
1H12
2,330
1,845
300
150
230
4,855
FY12
actual
FY13
guidance
Change
FY13 at
1H13
4,815
2,273
1,848
400
148
257
4,926
0
0
0
0
0
0
2,270
1,858
413
103
310
4,954
FY13
actual
FY14
guidance
FY14 at
1H14
4,985
2,418
1,868
549
110
330
5,275
2,198
1,868
659
110
330
5,165
Source: Company data, Credit Suisse estimates
The comments by QBE's management are consistent with other players in the market and
demonstrated by industry data which highlights a slowdown in premium growth across the
Australian general insurance market. While company reporting is by half years, the
industry data is quarterly and demonstrates an acceleration in the GWP slowdown in
recent quarters.
QBE Insurance Group
(QBE.AX / QBE AU)
12
27 October 2014
Figure 19: Australia General Insurance market total
Figure 20: Australia General Insurance market total
premium growth on pcp (by quarter)
premium growth (rolling 12 months)
14.0%
12.0%
12.0%
10.0%
10.0%
8.0%
8.0%
6.0%
6.0%
4.0%
4.0%
2.0%
2.0%
0.0%
0.0%
Sep11/Sep10
Mar12/Mar11
Sep12/Sep11
GWP
Mar13/Mar12
GEP
Sep13/Sep12
Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13
Mar14/Mar13
Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14
GWP
NEP
Source: APRA data, Credit Suisse estimates
GEP
Jun-14
NEP
Source: APRA data, Credit Suisse estimates
Asia Pacific – growth opportunity
QBE's Asia Pacific business had GWP growth of 26% in FY13, in line with expectations
and assisted by the Hang Seng acquisition. QBE expected further growth in FY14, ~12%,
benefiting from economic growth in the region. This has been increased slightly to ~14%.
Figure 21: QBE Asia GWP analysis
US$mn
Asia
Pacific
Total GWP
FY12
original
guidance
400
110
510
FY12 at FY12 actual
1H12
460
110
570
FY13
guidance
Change
565
125
690
60
0
60
578
FY13 at FY13 actual
1H13
610
120
730
FY14
guidance
FY14 at
1H14
700
120
820
710
130
840
730
Source: Company data, Credit Suisse estimates
Outlook – downside risk
In recent years the pullback in QBE's GWP has been largely driven by the decline in
specialist lines (LPI and crop) and remedial action in selected North America and
European portfolios. However, as highlighted above, QBE is now facing a soft premium
market and the weakness in FY14 is being driven by their more mainstream commercial
lines portfolios.
As a result of recent year GWP declines, QBE's business mix has shifted back towards a
commercial lines skew. With over 50% of the business in commercial lines and
reinsurance, there is a risk of GWP pressure in coming years for QBE due to both
premium rate declines and volume lost.
Figure 22: US commercial lines premium rate changes
Figure 23: QBE GWP split
35%
30%
25%
Change in rates (%pcp)
20%
15%
10%
5%
Reinsurance
4%
Australia LMI New Zealand
2%
3%
US commercial lines
17%
US First
5%
Asia Pacific
5%
Australia commercial
lines
15%
Australia personal lines
8%
0%
-5%
Latin America
8%
-10%
-15%
-20%
Sep-01Mar-02Sep-02Mar-03Sep-03Mar-04Sep-04Mar-05Sep-05Mar-06Sep-06Mar-07Sep-07Mar-08Sep-08Mar-09Sep-09Mar-10Sep-10Mar-11Sep-11Mar-12Sep-12Mar-13Sep-13Mar-14
Source: MarketScout, Credit Suisse estimates
Europe international
8%
Europe retail
15%
US crop
10%
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
13
27 October 2014
Underlying insurance margin
While there has been a lot of noise in QBE's reported earnings in recent years, impacted
largely by discount rate changes and reserving issues, the underlying performance of the
business has also been impacted by the changing business mix. As the highly profitable
LPI business has declined, QBE's Group COR has suffered. The significant changes in
business mix have resulted in a lot of volatility in QBE's underlying COR.
The significant changes in
business mix have resulted
in a lot of volatility in QBE's
underlying COR
Figure 24: QBE underlying COR
% of NEP
Reported COR
Less PY development
Change in risk margin
Change in discount rate
Large claims above/below allowance
Expense above allowance (OTP)
Other
Underlying COR
1H12
2H12
1H13
2H13
1H14
92.9%
-1.6%
100.8%
-4.1%
-1.0%
0.0%
-0.2%
-0.3%
-0.7%
94.4%
92.8%
-2.4%
-0.9%
2.4%
0.2%
-0.6%
-0.2%
91.3%
102.3%
-4.6%
-2.5%
1.2%
1.4%
-1.1%
-3.2%
93.5%
96.5%
-1.9%
0.8%
-1.7%
-1.4%
-0.6%
1.3%
93.0%
-1.4%
0.5%
-1.0%
0.0%
89.4%
Source: Company data, Credit Suisse estimates
Attritional loss ratio – patchy improvement
In prior years QBE's loss ratio benefitted from the business mix change away from long-tail
lines of business, however in more recent periods this has stabilised.
Figure 25: QBE Group business mix
Figure 26: QBE Group short versus long tail business
100.0
80.0
90.0
70.0
80.0
60.0
70.0
50.0
60.0
50.0
40.0
40.0
30.0
30.0
20.0
20.0
10.0
10.0
-
FY04
Propery
FY05
Motor
FY06
Liability
FY07
Workers comp
FY08
M/E/A
FY09
Credit
FY10
Agriculture
FY11
FY12
Accident
ProfIn
Source: Company data, Credit Suisse estimates
FY04
FY13
FY05
FY06
FY07
FY08
Short tail
Other
FY09
FY10
FY11
FY12
FY13
Long tail
Source: Company data, Credit Suisse estimates
The improvement in the attritional loss ratio stopped in recent periods, and while the
business mix change has stabilised, QBE should be benefitting from premium rate
increases in its core business and the flow-through from remedial action which is clearing
out the loss-making business. This is not playing out and at the 1H14 result QBE provided
some additional detail, highlighting the impact that crop, LPI and Argentina is having on
QBE's attritional loss ratio. This highlights that while the attritional loss ratio has
deteriorated slightly, the rest of world ratio continues to improve.
Figure 27: QBE attritional loss ratio breakdown
% of NEP
1H13
2H13
1H14
Rest of world
47.9
47.0
46.6
Crop
FPS (2012) / LPI
Argentina
Total
67.0
45.9
71.5
49.4
67.0
40.3
59.7
49.8
67.0
46.9
106.4
49.8
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
14
27 October 2014
While the additional detail does provide some comfort that the actions QBE has taken in
recent years has been of benefit, it is also worth highlighting the further improvement in
the attritional loss ratio is likely to be limited, noting:
■
QBE's management noted at the 1H14 result that current premium rate increases are
slightly below claims inflation, implying that further loss ratio improvement in the rest of
the world is unlikely. This was highlighted again at the QBE investor days in October
with management outlining the difficult premium rate environment across most of
Europe and North America. The ability to achieve a positive premium rate change is
limited currently.
■
As the Group GWP declines, crop contributes a larger per cent to the total mix and
hence will continue to have a negative impact on the total loss ratio for the Group.
■
While specific targets were not provided, at the 1H14 result QBE management noted
that LPI will become more challenging due to loan reductions and lower penetration
rates.
■
QBE's management noted at the 1H14 result that although no further material adverse
claims reserve adjustments is anticipated, the COR of the Latin American Operations
is expected to remain high over the medium term largely reflecting the underwriting
and interest rate dynamic currently impacting the Argentine operations and especially
the Argentine workers’ compensation portfolio.
Therefore, the QBE
breakdown of the attritional
analysis assisted to explain
the deterioration, but it
provided little comfort that
this would be addressed in
the near term
Therefore, the QBE breakdown of the attritional analysis assisted to explain the
deterioration, but it provided little comfort that this would be addressed in the near term.
Large risk and catastrophe allowance - appropriate
While the change in business mix over time has assisted QBE's attritional loss ratio, it
does mean that QBE is now more exposed to weather events and hence earnings
volatility. Despite this, QBE has only exceeded its 10.5% allowance once in the last ten
years, noting that in recent years the experience has been closer to the allowance than
historically.
Figure 28: QBE large and risk claims history
2004
% of NEP
2005
2006
2007
2008
2009
2010
2012
2013
6.6% 10.1%
8.9%
6.6%
7.7%
7.4%
9.5% 15.3% 10.4%
2011
9.7%
Source: Company data, Credit Suisse estimates
Historically QBE's disclosure around large and catastrophe claims has been minimal,
however in recent periods it appears that large claims has been an issue. While most
investors appear to focus on weather claims, the benign global experience has led to an
element of disappointment in QBE's reported claims due to a frequency of large risk claims
in recent periods.
We note that QBE defines large single risk claims as claims over US$2.5mn, which in our
view is too low an attachment. Their reinsurance for large single claims covers claims over
$5mn, an obvious cut-off to use in our view. In breaking down QBE's annual 10.5%
allowance, QBE does not explicitly split this out but based on their commentary and
reinsurance structure we assume the following:
The benign global
experience has led to an
element of disappointment
in QBE's reported claims
due to a frequency of large
risk claims in recent periods
QBE Insurance Group
(QBE.AX / QBE AU)
15
27 October 2014
Figure 29: QBE large and catastrophe claim allowance breakdown
Category
Allowance US$mn
% of Group NEP
Crop
Large individual (US$2.5mn to US$5mn)
Large individual (greater than US$5mn)
Total
161
100
550
811
1.1%
0.7%
3.8%
5.6%
Comments
16% is the normal crop allowance for cat claims
Management normal allowance
Remaining - catastrophe claims
705
4.9%
Aggregate cover kicks in at US$750mn
Source: Company data, Credit Suisse estimates
In regards to reinsurance covers protecting the 10.5% allowance we note the following:
■
QBE have not provided details on their 2014 crop reinsurance attachment, however
we note that at the FY13 result crop delivered a COR of 102.8%, which was increased
by a further 200bps in 1H14, highlighting the uncertainty in the exact reinsurance
retention for this complicated line of business. If we assume a COR of 100%, the
downside risk from an extreme event is ~1.5% of Group NEP.
■
Large individual claims between US$2.5mn and US$5mn we commented on above.
This appears to have been an issue in recent years and we are of the view that these
claims should be included in the standard attritional loss ratio anyway. There is no
reinsurance cap on these claims but should experience be twice as bad the impact is
still just over 0.5% of Group NEP.
■
In 2013 QBE had aggregate reinsurance in place for large single claims, claims
greater than US$5mn qualifying. QBE had US$200mn xs US$50mn XOL cover in
place for large claims and hence we assume that the aggregate cover is for the
retained exposure, US$45mn xs US$5mn. The aggregate cover for FY13 was
US$200mn xs US$400mn (81% placed). In FY14 the aggregate cover attachment
point increases to US$550mn (from US$400mn), with cover of US$250mn 80%
placed.
■
QBE’s Group Aggregate Catastrophe Cover (GACC) in FY13 provided protection for
events greater than US$25mn. The FY13 GACC, which included all classes besides
crop and retro, provided US$400mn xs US$800mn (per event deductible of
US$25mn). In FY14 the attachment point has dropped US$50mn, with the cover being
US$400mn xs US$750mn.
The large risk aggregate
cover for FY13 was
US$200mn xs US$400mn
(81% placed). In FY14 the
aggregate cover attachment
point increased to
US$550mn (from
US$400mn), with cover of
US$250mn 80% placed.
Looking at the experience to date in FY14, QBE reported US$690mn (US$609mn in
1H13) of large and catastrophic claims in 1H14, or 9.9% of NEP (8.3% in 1H13), above
their FY14 assumption of 9.4% (excluding crop) and their seasonal expectation of 8.5% in
1H.
As mentioned above, while catastrophe claims were relatively benign in the half, QBE
continues to be impacted by a frequency of risk claims, with the 1H14 experience almost
exceeding the FY14 allowance.
QBE Insurance Group
(QBE.AX / QBE AU)
16
27 October 2014
Figure 30: QBE 1H14 large and cat claims
Event
US$mn
UK floods (Jan and Feb)
North America storms (5 Jan)
European hail (15 June)
North America tornadoes (3 April)
Cyclone Ita (13 April)
Victoria bushfires (8 Feb)
Othe cat claims and IBNR
Total cat claims
142
31
28
14
13
10
35
273
Forge Group (11 Feb)
Bo Kwang Printing (29 May)
Brian Bell & Co (23 Jan)
Shih-Teng Hsu (22 March)
Atlantic Ltd (4 Feb)
Buckby's Coaches (13 Apr)
Other risk claims and IBNR
Total risk claims
47
33
14
12
12
11
288
417
Total
690
Source: Company data, Credit Suisse estimates
QBE have maintained their historical allowance of 12.5% for 2H14 (net of med mal
reinsurance), equating to an 11.2% FY14 allowance, above their previous guidance of
10.5% (inclusive of crop).
As with SUN, following a year of claims experience slightly below their allowance, it is
difficult to suggest that QBE requires a higher large and cat allowance. However, we note
that one large natural peril event would likely see QBE exceed its allowance in a year.
We note also that while 2H14 weather claims to date remain benign globally, there has
been a continuation of large risk claims across the industry and the outlook for crop
appears to be weaker than the base case assumption. The crop prices continue to fall,
triggering revenue protection claims, which was the issue that led to a COR over 100% for
QBE in FY13 in its US crop portfolio.
While 2H14 weather claims
to date remain benign
globally, there has been a
continuation of large risk
claims across the industry
and the outlook for crop
appears to be weaker than
the base case assumption
Figure 31: US crop insurance revenue protection prices
Corn
Soybean
Wheat
2013 Prem 2013 harvest 2013 Change
price
price
$5.68
$4.34
-24%
$12.77
$12.77
0%
$8.44
$7.02
-17%
2014 Prem 2014 harvest 2014 Change
price
price
$4.62
$3.42
-26%
$11.52
$9.84
-15%
$6.51
$5.73
-12%
Source: Company data, RMA, Rainhail, Credit Suisse estimates
Expense ratio – the silver bullet
While QBE's underlying loss ratio has held steady in recent periods, the underlying margin
has been impacted by the expense ratio. In recent years the underlying expense ratio has
increased and some of the one-off costs appear to have been absorbed within the ongoing
business. Improvement in the expense ratio has been a key 'potential' driver of future
earnings recovery for QBE for ~5 years now, with consistent 'one-off' efficiency
improvement spend yet to deliver on an improved base ratio.
QBE Insurance Group
(QBE.AX / QBE AU)
17
27 October 2014
Figure 32: QBE expense ratio history
35.0%
32.5%
30.0%
Ratio (%NEP)
27.5%
25.0%
22.5%
20.0%
17.5%
15.0%
12.5%
10.0%
1H02
1H03
1H04
1H05
1H06
1H07
Commission Ratio
1H08
1H09
Admin Ratio
1H10
1H11
1H12
1H13
1H14
Expense Ratio
Source: Company data, Credit Suisse estimates
By way of background, QBE delivered an expense ratio of 28.6% in FY11 and provided
guidance at the FY11 result for an expense ratio of less than 29.5% in FY12, an increase
due to some one-off operational transformation spend. At the FY11 result QBE noted the
following:
■
The major IT and transformation program in Europe due for completion in 1H12 is set
to deliver a return of around 40% over 5 years on an approximate £100mn investment.
■
The Americas change program is on schedule to complete in 2014. QBE upgraded the
forecast 2012 claims leakage and expense savings to US$50mn from US$20mn
reported 1H 2011.
■
The QBE plan to deliver additional annualised benefits of around 1% of COR or
US$200mn by 2014 was all in train – with a further update at 1H12 expected.
Technically the US$250mn
of operational excellence
savings should have
resulted in a target expense
ratio of ~29% by FY16
At the 1H12 result QBE increased the FY12 expense ratio target by 1% to 30.5%, noting
some non-recurring expense impacts. QBE commented that the US$200mn of savings (or
2% COR improvement from the FY12 base) were on track for 2014 but they included the
words “run rate” suggesting that the full US$200mn will not be seen in full in FY14. In
addition to this management noted that the expense ratio was also impacted by brokers
pushing for higher commissions the decision to shed more business than anticipated in the
US.
Effectively, the FY12 expense ratio target allowed for a 1% lift from FY11 due to one-off
spend, this increased by a further 1% at the 1H12 result. The final expense ratio delivered
in FY12 was 31.1%, with QBE noting a delay in the non-recurring expenditure.
In providing guidance for FY13, QBE shifted the underlying ratio to 30.5%, up 200bps from
previous years, citing a change in business mix as the reason for the change. QBE also
increased the expected benefits from the 'operational excellence' initiatives, outlining a
US$250mn (~160bps on COR) benefit by the end of FY15, with an additional US$90mn
(~55bps on COR).
Technically the US$250mn of operational excellence savings should have resulted in a
target expense ratio of ~29% by FY16.
QBE Insurance Group
(QBE.AX / QBE AU)
18
27 October 2014
Figure 33: QBE operational excellence initiative plan (July 2013)
FY13
FY14
FY15
FY16
Implementation costs
Benefits in the year
Net impact
% of FY13 NEP
-156
25
-131
-0.8%
-140
190
50
0.3%
-14
240
226
1.4%
0
250
250
1.6%
Expense ratio
31.6%
30.5%
29.3%
29.1%
Source: Company data, Credit Suisse estimates
At the FY13 result QBE noted an underlying expense ratio of 31.5%, up again on the
previous definition of the underlying ratio, with an expectation of improving the ratio by
100bps in each of the next two years, i.e., back down to 29.5%.
At the 1H14 result, having delivered an expense ratio of 33.4% in the half, QBE's
management commented that while they are targeting an expense ratio 'below 30%', this
was more of a medium term target and in the next two years ~30.5% would be the target.
While QBE's expense ratio could be a source of future upside potential, with a constant
delay in the turnaround and further cautious comments by management recently, in
addition to the softening premium rate environment, we caution expecting an expense
ratio below 31% in coming years for QBE.
Figure 34: QBE expense ratio movements
% of NEP
Underlying ratio
Guidance
Reported
FY11
FY12
FY13
FY14
28.5%
28.5%
28.6%
28.5%
29.5%
31.1%
30.5%
31.5%
33.3%
31.5%
32.0%
While QBE's expense ratio
could be a source of future
upside potential, with a
constant delay in the
turnaround and further
cautious comments by
management recently, in
addition to the softening
premium rate environment,
we caution expecting an
expense ratio below 31% in
coming years for QBE
Source: Company data, Credit Suisse estimates
Our expectations on the expense ratio were confirmed at the recent QBE investor days,
with management targeting an expense ratio improvement by FY17, some four years
away. We note also that management in Europe were less explicit on the COR base and
hence exact improvement by FY17, while also acknowledging that they are targeting an
absolute reduction in costs which itself may be diluted if NEP continues to decline.
QBE's management team in North America were more explicit on their expense ratio
targets, outlining a ~300bp net underwriting expense ratio improvement to 14-15% by
FY17. While explicit on the targets, we note that the expense ratio used by QBE
management in North America does not reconcile to any of the numbers or splits disclosed
in QBE's Group accounts. This will no doubt impose some issues over the next few years
in reconciling the expense ratio improvement achieved. The key areas of operational
improvement outlined by QBE North America were offshoring and outsourcing. QBE
highlighted that this approach gives them greater flexibility in their cost base and has
accounted for a 31% reduction in headcount in the last 18 months. It is worth noting that
the large reduction in headcount for QBE was delivered in FY13 (20% reduction), however
the expense ratio increased by ~550bps due to the decline in NEP. As noted above,
pressure on premium rates and volumes can result in a large portion of the cost reductions
being diluted away i.e., taking costs out to simply maintain the margin as opposed to
improve it.
QBE Insurance Group
(QBE.AX / QBE AU)
19
27 October 2014
Figure 35: Impact on staff changes to date
Figure 36: Expense ratio improvement target
Source: QBE North America Investor Day – October 2014
Source: QBE North America Investor Day – October 2014
We highlight also that QBE delivered US$34mn of procurement savings in 1H14, or
~50bps of insurance margin benefit. This largely went unnoticed and certainly did not
result in an underlying COR improvement for QBE. While technically there is a further
$56mn of savings to be delivered, we expect that these savings will also have minimal
noticeable impact on QBE's insurance margin
Impact of business sales – margin compression
In conjunction with a number of other capital initiatives announced at the 1H14 result, QBE
flagged the potential partial IPO of the Australian LMI business and the partial sale of the
Australian and United States agency business units. We highlight that these business
units have a positive contribution to earnings and will likely lower the base insurance
margin post a sale.
These business units have a
positive contribution to
earnings and will likely lower
the base insurance margin
post a sale
Agency business
Throughout 2008 and 2009 QBE gradually acquired a number of underwriting agencies
with a strategy of acquiring distribution of new niche products as well as reduce the cost of
doing business through intermediaries. By the end of 2009, QBE had spent US$1.5bn on
acquiring 14 underwriting agencies (excluding contingent consideration), with the vast
majority of the cost being goodwill.
The owned agency business delivered an underwriting result of US$248mn in FY09, which
is treated as a recovery at the underwriting expense line and hence benefited the FY09
insurance margin by 2.6%. The underwriting profit contribution in FY10 was similar, with a
2.2% benefit to the insurance margin. However in FY11 QBE decided to remove the
disclosure around agency profit commenting "we no longer consider it appropriate to
identify the agency results at the divisional level as they are now fully integrated into their
respective businesses." We highlight that agency income was significantly lower in FY11,
disclosed in the notes to the accounts.
Agency income recovered in FY12 and has contributed ~1.0% to the insurance margin in
recent periods.
Figure 37: QBE Agency underwriting profit contribution
Underwriting result US$mn
FY08
FY09
FY10
FY11
FY12
FY13
1H14
Australia
North America
Total
% of NEP
32
42
74
0.8%
40
208
248
2.6%
71
174
245
2.2%
137
0.9%
219
1.4%
169
1.1%
67
1.0%
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
20
27 October 2014
QBE did not disclose further information at the 1H14 result beyond flagging the partial sale
and while technically there has been no sale to date, we highlight that the eventual sale of
the these agencies will likely impact the insurance margin by 50-100bps, in our view.
At their investor day in October, the North America management team noted that their
desired outcome in regards to the sale of the US agency businesses would be a sale of all
three agents combined, in 2014 and a deal that retains QBE as the underwriter. The three
agencies in the US currently contribute ~7% to the North America GWP base and add
~60bps to the insurance margin.
Figure 38: North America agencies up for sale
Agent
CAU Deep South
FY14 GWP
% of North America GWP
FY14 EBITDA
% of North America NEP (insurance margin impact)
SII
Total
204
95
55
17
5
4
354
6.7%
26
0.6%
Source: Company data, Credit Suisse estimates
Australian LMI
QBE announced the acquisition of PMI Australia (and PMI Asia) the Australian Lenders
Mortgage Insurance business in August 2008 with a purchase price of NTA, A$1,027mn.
We note that allowing for future payments and acquisition adjustments, the purchase price
included A$770mn of goodwill in the 31 December 2008 accounts.
At the time if the LMI acquisition QBE noted that they would be able to lower the capital
needs of the LMI business by more than half (from A$1bn+ to less than A$500mn). While
this has not been called out separately since the acquisition, we note that 2013 QBE LMI
accounts show a PCA amount of A$1.0bn, not too dissimilar to the original amount. We
assume that the QBE Group PCA from LMI is only slightly below the A$1.0bn in the
subsidiary accounts.
In announcing the partial IPO of QBE LMI, management noted that "with the longer term in
mind, the introduction of third party shareholders offers QBE LMI enhanced capital
flexibility to support its growth ambition.” While we don’t envisage significant growth
opportunities for this business in the near-term, we appreciate the downside risk and
capital pressure that this business could one day impose on QBE shareholders and hence
the logic in moving the risk off QBE's balance sheet.
Despite the capital risk that LMI brings, it has been a solid earnings contributor in recent
years and will result in a further drag on QBE's insurance profit once removed. The
business has contributed only 1-3% to Group GWP in recent years, but has been a 7-10%
contribution to underlying insurance profit.
Despite the capital risk that
LMI brings, it has been a
solid earnings contributor in
recent years and will result
in a further drag on QBE's
insurance profit once
removed
Figure 39: QBE LMI insurance profit contribution
A$mn
GWP
Insurance profit
NPAT
Insurance profit % NEP
GWP % of Group
2009
2010
2011
2012
2013
231
192
194
226
359
361
271
136
129
339
133
155
453
140
132
2.0%
2.1%
3.2%
1.7%
0.9%
1.4%
0.8%
1.8%
0.9%
2.5%
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
21
27 October 2014
Investment income – surprisingly resilient
In addition to a declining underwriting profit margin for a number of years, QBE has also
experienced a significant drop in the contribution of investment income to their insurance
profit.
Figure 40: QBE insurance margin drivers – underwriting profit and investment income
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
2002
2003
2004
2005
2006
2007
2008
Investment income / NEP
2009
2010
2011
2012
2013
Underwriting profit / NEP
Source: Company data, Credit Suisse estimates
Despite the decline in investment income for QBE, given their short duration (~0.5 years)
asset portfolio with ~70% exposure outside of AUD, QBE is actually delivering an
investment yield well above expectations. As we have highlighted previously, despite the
duration headwind, QBE is generating an investment yield in line with IAG and SUN. While
based on additional disclosures in 1H14 the net investment yield benefited by ~60bps from
Argentina, ~2.0% remains above the yield on QBE's portfolio mix in our view.
Figure 41: QBE technical funds net yield calculations
US$mn
1H11
2H11
1H12
2H12
1H13
2H13
1H14
Net investment income
Unrealised (gains)/losses
FX gains reversed
Normalised investment income
471
(54)
(150)
267
120
219
(38)
301
436
(200)
3
239
373
(132)
9
250
260
24
(35)
249
240
(6)
11
245
298
(30)
0
268
Total policyholders' funds (b/s)
Total policyholders' funds (avg)
19,183
18,158
18,960
19,072
19,257
19,064
21,261
20,259
19,901
20,581
20,332
20,117
20,387
20,360
5.2%
2.9%
1.3%
3.2%
4.6%
2.5%
3.7%
2.5%
2.5%
2.4%
2.4%
2.4%
2.9%
2.6%
Net yield
Normalised net yield
Despite the decline in
investment income for QBE,
given their short duration
(~0.5 years) asset portfolio
with ~70% exposure outside
of AUD, QBE is actually
delivering an investment
yield well above
expectations
Source: Company data, Credit Suisse estimates
Despite credit spreads contracting in recent periods and the AUD yield falling, QBE has
held its net yield relatively flat in the last two years. There has been a slight reduction in
QBE's asset mix from USD to Sterling in the last 12 months but we assume that the yield
has been held up by QBE's longer-dated maturity assets. While QBE disclosed an
average duration of 0.5 years, almost 50% of their investments are in floating rate notes
(FRN), with maturities of various years. While we cannot replicate QBE's investment
portfolio and generate an underling yield of ~2.0%, we highlight that the spread on the
FRN maturities may offset the short-end yield rate improvements initially as QBE looks to
reinvest these instruments.
QBE Insurance Group
(QBE.AX / QBE AU)
22
27 October 2014
Figure 43: QBE maturity profile of investments – 31Dec13
Figure 42: QBE currency mix of investments
4 to 5 Yrs
3%
35
30
>5 Yrs
3%
3 to 4 Yrs
7%
25
20
2 to 3 Yrs
18%
15
<1 Yr
52%
10
5
1 to 2 Yrs
17%
0
USD
AUD
Sterling
30-Jun-13
Euro
Other
30-Jun-14
Source: Company data, Credit Suisse estimates
Source: Company data, Credit Suisse estimates
Allocation to risk assets
QBE has previously flagged an intention to increase the allocation of their investment
portfolio to risk assets and while this started to play out in 1H14 QBE gave a more
definitive comment on the timing of this move. QBE management noted that they
"envisage increasing our allocation to around 10% of the portfolio by the end of 2014, with
a further move to 15% exposure anticipated during 2015." While not providing an exact
split by technical and shareholders' funds, QBE management noted that the incremental
increase in risk assets was likely to come from shareholders' funds, with a policy of more
closely matching the technical funds over time.
We note that based on QBE's current investment portfolio, a 15% allocation to risk assets
would imply ~40% of shareholders' funds in risk assets (assuming an income assets
matched approach in policyholders' funds). In addition to our comment above on the yield
pressure from the potential unwinding of longer-dated FRN's, we note also that the
policyholder funds yield could experience slight pressure as the risk assets allocation is
reversed in coming periods.
We note also that the
policyholder funds yield
could experience slight
pressure as the risk assets
allocation is reversed in
coming periods.
Figure 44: QBE investment portfolio allocation by asset type split
Policyholder funds
Income assets
Risk assets
Total
Shareholder funds
Total
Dec-13
Jun-14
Potential
Dec-13
Jun-14
Potential
Dec-13
Jun-14
Potential
98%
2%
95%
5%
100%
0%
97%
3%
94%
6%
57%
43%
98%
2%
95%
5%
85%
15%
100%
100%
100%
100%
100%
100%
100%
100%
100%
Source: Company data, Credit Suisse estimates
Outlook – challenging
There is increasing comfort that QBE's reserving issues are largely addressed, however
we highlight that the underlying insurance margin remains under pressure and is unlikely
to demonstrate any significant improvement in the near term. In fact, unless QBE can
effectively pull out more costs from the business, we see further downside risk to QBE's
insurance margin. We note:
■
QBE reported an underlying insurance margin of 10.0% in 1H14, with a similar level
assumed in 2H14 based on their FY14 guidance.
■
QBE's 1H14 underlying margin calculation used an expense ratio of 32.8% (31.5%
was used in FY13). We assume 31.5% as the base case expense ratio, implying
130bps of improvement from 1H14.
■
We have assumed a slight improvement in QBE's underlying loss ratio on the back of
recent remedial action, which also assumes that LPI and Argentina do not deteriorate
further at an underlying level.
Unless QBE can effectively
pull out more costs from the
business, we see further
downside risk to QBE's
insurance margin.
QBE Insurance Group
(QBE.AX / QBE AU)
23
27 October 2014
■
We assume margin contraction from stripping out LMI and half of the agency
business.
Figure 45: QBE underlying insurance margin drivers
% of NEP
FY14 underlying insurance margin
Expense ratio improvement
Further remedial action on loss ratio
LMI removal
Removal of agency income
FY15 insurance margin base
10.0%
1.3%
0.6%
-0.9%
-0.5%
10.5%
Source: Company data, Credit Suisse estimates
Adopting an insurance margin much above 10.5% in FY15 requires a lot to work in QBE's
favour in our view. With premium rates now in decline globally, there is additional
pressures that a soft market brings.
QBE Insurance Group
(QBE.AX / QBE AU)
24
27 October 2014
Balance sheet – addressed
QBE's balance sheet has been under pressure in recent years and while in our view the
previous actions taken by management put QBE on track to be in a strong position by the
end of 2015, management decided to take immediate action to increase the strength of the
balance sheet at the 1H14 result.
The initiatives announced by QBE at the 1H14 result included:
■
An equity raising of A$850mn, with proceeds primarily used to repurchase and cancel
$500mn of sub debt (we note that this is sub debt that was raised in December 2013).
■
Divest the US agency business and joint venture of two Australian agency businesses.
Values of which were not disclosed explicitly.
■
Partial IPO of QBE LMI in 2015. We note that GMA is trading at ~1x NTA versus QBE
at over 2x NTA. QBE LMI has NTA of $1.2bn, or 18% of the Groups $6,752mn.
■
Group D/E target lowered to 25-35% (FY14 goal was below 40%) and PCA target of
1.7-1.9x (up from 1.5x currently).
■
QBE is retaining the US mid-market business, the business previously flagged to be
making inadequate returns (in a hard market). QBE will look to significantly reduce the
cost base of this business.
■
Increase the risk asset exposure of investments from 2% to ~15%. QBE is increasing
their capital to allow for this additional charge.
Previous actions taken by
management put QBE on
track to be in a strong
position by the end of 2015,
management decided to
take immediate action to
increase the strength of the
balance sheet at the 1H14
result.
These changes should result in a pro-forma D/E ratio of 29% on our calculations (target
25-35%) and a PCA multiple of 1.85x (target 1.7-1.9x).
Figure 46: QBE D/E pro forma position
US$mn
Debt
Equity
D/E ratio
1H14 position
Equity raising
Repurchase and cancel sub debt
Issue Tier 2 debt
Retire senior debt
Repay short-term debt
Sale of agencies
Partial LMI IPO
Pro-forma
4,306
11,277
750
38%
(500)
700
(400)
(410)
3,696
400
500
12,942
29%
Source: Company data, Credit Suisse estimates
While the PCA multiple is at the upper end of QBE's target range on a pro-forma 1H14
basis, after the increase in allocation to growth assets, the PCA ratio falls to ~1.64x on our
calculations. Assuming the move to growth is phased in over the next 18 months, retained
earnings should see the ratio back in the target range.
QBE Insurance Group
(QBE.AX / QBE AU)
25
27 October 2014
Figure 47: QBE pro-forma PCA calculations
US$mn
1H14 APRA capital base
Equity raising
Repurchase and cancel sub debt
Issue Tier 2 debt
Retire senior debt
Sale of agencies
Parital LMI IPO
Pro-forma
9,690
750
(500)
700
400
500
11,540
1H14 PCA
Pro-forma multiple
Pro-forma CET1 ratio
6,227
1.85
1.45
Additional PCA (growth assets)
Pro-forma PCA
Pro-forma multiple
Pro-forma CET1 ratio
800
7,027
1.64
1.29
Source: Company data, Credit Suisse estimates
ROE
The capital initiatives announced by QBE will result in a stronger balance sheet and higher
capital buffers, however with earnings remaining under pressure, this will ultimately result
in a lower ROE for investors. On our calculations, a normalised return for QBE in FY15 is
~10%, well below its historical returns.
Figure 48: QBE ROE workings
US$mn
FY15 Cash NPAT - Core
Plus LMI (60%)
FY15 Cash NPAT - Reported
1,318
68
1,386
FY15 pro-forma equity
FY15 retained earnings
FY15 equity
Intangible
Net Tangible Assets
13,000
762
13,762
4,525
9,237
ROE
RNTA
10.1%
15.0%
Source: Company data, Credit Suisse estimates
The step change in QBE's ROE no longer justifies a valuation premium to its peer base for
QBE in our view. If anything, given the position of the core business, a discount could be
expected, if not for some macro leverage.
QBE Insurance Group
(QBE.AX / QBE AU)
26
27 October 2014
Figure 49: Australia financials – P/BV vs ROE
PTM
CPU
PPT
IRE
3.0x
Expensive
P
- =
E
2.5x
P
BV
/
E
BV
BTT
CBA
Price / Book Value (x)
PER = 13.5x
WBC
IAG
AMP
2.0x
HGG
IFL
ANZ
NAB
ASX
MQG
1.5x
CGF
SUN
1.0x
BOQ
BEN
QBE
TWR
Inexpensive
0.5x
5.0%
7.5%
10.0%
12.5%
15.0%
17.5%
20.0%
22.5%
Return on Equity (EPS / BV)
Source: ASX, Reuters, Bloomberg. * IBES – Cash EPS 12mth forward rolling
Figure 50: Selected global insurers– P/BV vs ROE
1.75x
Expensive
P
E
=
P
E
- / BV
BV
Price / Book Value (x)
Suncorp
1.25x
Arch Capital
Hiscox
RSA
Chubb
Allstate
QBE
Catlin
XL Capital
AXA SA
Hannover Re
Allianz
ACE
0.75x
Amlin
Munich Re
Inexpensive
0.25x
5.0%
7.5%
10.0%
ROE %
12.5%
15.0%
Source: ASX, Reuters, Bloomberg. * IBES – Cash EPS 12mth forward rolling
QBE Insurance Group
(QBE.AX / QBE AU)
27
27 October 2014
Macro leverage – one day
As outlined above, the core QBE business remains under pressure and while we support
the actions taken by management to date, the road to recovery remains slow and bumpy.
Despite this, there is upside to QBE's earnings from favourable movements in currency
and bond yields. On our calculations:
■
A 50bp increase in the discount rate (long yields) would result in a one-off ~12%
increase in NPAT.
■
While we are using 0.85 (AUDUSD) in our FY16 and outer year earnings forecasts, a
10% decline in the AUD from current levels assists QBE's AUD earnings by ~6%
Discount rate
QBE currently has a mismatched technical funds portfolio, with the asset duration being
close to six months and the liability duration ~3 years. Management have commented that
they will look to lengthen the duration on the fixed income portfolio when markets permit,
reducing the asset liability mismatch risk.
With global bond yields at historically low levels, the current risk for QBE is likely to be
upside earnings as bond yields rise. QBE's FY13 annual report disclosed an earnings
sensitivity of US$164mn of NPAT benefit from a 50bp increase in the weighted average
discount rate. This is equivalent to ~12% of our normalised FY15 cash NPAT calculation.
QBE reported a 60bp increase in their discount rate in 1H14, however this driven by the
increase in the Argentine rate which appears to be asset/liability matched and hence is
offset at the claims line. For other currencies we estimate that the weighted average
decline in the discount rate in 1H14 was ~25bps, resulting in a US$118mn hit to QBE's
insurance profit (consistent with the FY13 annual report sensitivity).
To date in 2H14, if we
assume that Argentine peso
movements are cancelled at
the claims line, the move in
other currencies will
negatively impact insurance
profit by a further
US$200mn on our
calculations (~25% hit to
2H14 NPAT)
To date in 2H14, if we assume that Argentine peso movements are cancelled at the claims
line, the move in other currencies will negatively impact insurance profit by a further
US$200mn on our calculations (~25% hit to 2H14 NPAT).
Figure 51: QBE discount rate change reconciliation
%
AUD
USD
Sterling
Euro
Peso
Wtd Avg
2H11
1H12
2H12
1H13
2H13
1H14
22Oct14
3.65
0.95
1.20
1.95
2.90
0.85
1.15
1.75
13.85
2.12
3.04
0.87
1.27
1.26
17.78
2.16
3.27
1.30
1.66
1.67
19.56
2.67
3.52
1.53
2.06
1.74
19.03
2.77
3.12
1.42
2.02
1.19
27.00
3.37
2.37
1.25
1.48
0.83
27.00
2.36
2.32
Source: Company data, Credit Suisse estimates
Currency
QBE reports in USD with ~70% of earnings derived outside of Australia While a
weakening AUD is negative for earnings, QBE's share price is in AUD and hence
converting to AUD EPS is a positive. Based on our calculations, a 5% decline in the AUD
versus USD benefits QBE by ~3%.
QBE Insurance Group
(QBE.AX / QBE AU)
28
27 October 2014
Figure 52: QBE NEP split by division
Equator Re
21%
Figure 53: QBE insurance profit by region
Aus & NZ
27%
Equator Re
22%
Aus & NZ
36%
Asia-Pacific
4%
European
21%
Latin America
8%
European
17%
Asia-Pacific
5%
North America
19%
Source: Company data, Credit Suisse estimates
North America
14%
Latin America
6%
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
29
27 October 2014
Valuation – longer-term appeal
The scope for an improvement in QBE's underlying earnings is likely to be driven by
expense control in the near-term, with the risk that this is partially offset by softening
premium rates and a lower GWP base. For this reason we expect QBE to trade closer to
its global peers on a PE basis, i.e., at a discount to IAG and SUN. Should QBE start to
demonstrate the ability to lower their expense ratio and improve the insurance margin, it is
likely that the stock will then re-rate closer to an IAG and SUN multiple in our view. The
valuation range and upside potential for QBE is quite large, however the ability to improve
the insurance margin is no easy task.
There is certainly longer
term valuation appeal in
QBE at current prices
should management be
successful in turning the
business around.
The risk to our cautious stock view is a more favourable macro environment and a
significant turnaround in the QBE business, driven by:
■
GWP growth – if QBE can stop the premium decline and start to generate growth
again, ideally in its core business this would assist in addressing the high cost base.
■
Insurance margin recovery – QBE is committed to pulling out costs and achieving
these goals while also improving the business mix favourably would drive the margin
quicker and higher than our base case assumptions.
■
Currency - Over 75% of QBE's business is offshore and a lower AUD assists EPS
(AUD), a ~6% EPS uplift from a 10% decline in the AUD on our calculations.
■
Yields – every 100bps increase in the discount rate adds ~25cps to the valuation.
Figure 54: QBE – scenario analysis
Scenario
Share price fair value
Current share price
Upside %
Fair value assumptions
Bear
$7.29
$11.00
-34%
Base
$12.19
$11.00
11%
- Further GWP decline in coming years
- Lack of insurance margin improvement
- AUD remains high and no increase in global
bond yields in near-term
YE Dec
NEP growth
Insurance margin
AUDUSD
Discount rate change (bps)
EPS (AUD)
2015E
-10.0%
9.0%
0.90
0.84
2016E
-10.0%
10.0%
0.90
0.84
2017E
0.0%
10.0%
0.90
- GWP decline stops
- GWP growth in coming years
- Gradual insurance margin improvement
- Insurance margin improvement
- AUD at 0.85 and gradual increase in global - AUD continues to fall large increases in
bond yields in near-term
global bond yields in near-term
2015E
-3.0%
10.0%
0.85
0.84
Bull
$20.68
$11.00
88%
1.04
2016E
0.0%
10.5%
0.85
50
1.09
2017E
0.0%
11.0%
0.85
50
1.13
2015E
0.0%
11.0%
0.85
100
1.17
2016E
5.0%
12.0%
0.80
100
1.40
2017E
10.0%
12.5%
0.75
100
1.69
Source: Company data, Credit Suisse estimates
QBE Insurance Group
(QBE.AX / QBE AU)
30
27 October 2014
Reference Appendix
Our new “Total return forecast in perspective” chart helps visualize Credit Suisse and consensus views of a company’s 12-month return within the
context of forecasting risks and its historical trading pattern:
12mth Volatility is calculated as the annualised standard deviation of weekly total return series over the past 12 months. It illustrates variability of
stock returns; in other words, risk. The way to think about it is that one would rather take 10% forecast return from a stock that has 20% volatility,
than from the stock that has 40% volatility. The shaded area shows the one standard deviation range based on past 12 months volatility. In statistical
terms, once you make a number of brave assumptions, there is a 68% probability that the share price will end up inside that range in 12 months time.
52wk Hi-Lo is maximum and minimum daily closing price over the past 52 weeks. It is often handy to know the price momentum especially when the
stock is trading close to its highs and lows: Is the stock trading close to its peak? Is the momentum against the stock?
*Consensus is IBES consensus supplied by Thomson Reuters. IBES is a survey of sell side research analysts, collecting a few dozen data
points such as EPS, DPS, Sales, Target Price, ROE and so on. *Mean is the average of target returns, while the shaded area around the mean
represents the range of estimates from the lowest to the highest estimate. This aids visualisation of a number of important factors such as: the range
of analyst estimates; where Credit Suisse’s estimates on this stock sit relative to consensus; and where the share price is relative to consensus
mean and consensus range target.
Target return is calculated as capital gain plus forecast dividend yield (net) over the next 12 months. For “CS tgt” we have used Credit Suisse’s
target price and Credit Suisse forecast for 12-month forward dividend, grossed up for franking. For the consensus mean and range, we have used
consensus target price and consensus dividend forecasts for 12 month forward.
QBE Insurance Group
(QBE.AX / QBE AU)
31
27 October 2014
Companies Mentioned (Price as of 24-Oct-2014)
QBE Insurance Group (QBE.AX, A$11.14, NEUTRAL, TP A$12.2)
Disclosure Appendix
Important Global Disclosures
I, Andrew Adams, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and
securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in
this report.
3-Year Price and Rating History for QBE Insurance Group (QBE.AX)
QBE.AX
Date
06-Jan-12
12-Jan-12
28-Feb-12
02-Apr-12
13-Jun-12
17-Aug-12
12-Nov-12
30-Nov-12
04-Dec-12
12-Dec-12
17-May-13
06-Jun-13
02-Jul-13
15-Oct-13
09-Dec-13
25-Feb-14
29-Jul-14
01-Oct-14
Closing Price
(A$)
13.12
11.35
11.50
14.04
12.40
13.05
11.80
10.94
10.60
10.66
15.40
15.23
15.94
14.53
12.00
12.27
10.57
11.69
Target Price
(A$)
13.50
11.50
12.00
14.50
14.50
14.20
14.00
13.60
13.10
16.00
16.60
17.25
17.25
13.65
14.30
11.60
12.20
Rating
N
O
*
O
N
N EU T RA L
O U T PERFO RM
O
N
* Asterisk signifies initiation or assumption of coverage.
The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's
total revenues, a portion of which are generated by Credit Suisse's investment banking activities
As of December 10, 2012 Analysts’ stock rating are defined as follows:
Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months.
Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months.
Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months.
*Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relati ve to the analyst's coverage universe which
consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractiv e, Neutrals the less attractive, and
Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total
return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the
most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings
are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian
ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiv eness of a stock’s total return potential within
an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and
a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10 15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return
relative to the average total return of the relevant country or regional benchmark.
Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications,
including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other
circumstances.
QBE Insurance Group
(QBE.AX / QBE AU)
32
27 October 2014
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24
months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or
valuation of the sector* relative to the group’s historic fundamentals and/or valuation:
Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months.
Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.
Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months.
*An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.
Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution
Rating
Versus universe (%)
Of which banking clients (%)
Outperform/Buy*
45%
(53% banking clients)
Neutral/Hold*
39%
(50% banking clients)
Underperform/Sell*
13%
(44% banking clients)
Restricted
2%
*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely
correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to
definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.
Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the
market that may have a material impact on the research views or opinions stated herein.
Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer
to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research and
analytics/disclaimer/managing_conflicts_disclaimer.html
Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot
be used, by any taxpayer for the purposes of avoiding any penalties.
Price Target: (12 months) for QBE Insurance Group (QBE.AX)
Method: Our $12.20/share 12-month forward valuation of QBE is based on a 10% discount to our blended DCF (WACC 9.3%, terminal 2.5%,
insurance margin 12.5%) and P/E (11.5x).
Risk:
Key risks to our $12.20 valuation of QBE include: (1) a 'soft' market pricing cycle, (2) large claims events, (3) currency and yield
movements, (4) reinsurers default and (5) latent claims exposures.
Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the
target price method and risk sections.
See the Companies Mentioned section for full company names
The subject company (QBE.AX) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit
Suisse.
Credit Suisse provided non-investment banking services to the subject company (QBE.AX) within the past 12 months
Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (QBE.AX) within the next 3
months.
Credit Suisse has received compensation for products and services other than investment banking services from the subject company (QBE.AX)
within the past 12 months
As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (QBE.AX).
Important Regional Disclosures
Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.
The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (QBE.AX, QBE.AX) within
the past 12 months
Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares;
SVS--Subordinate Voting Shares.
QBE Insurance Group
(QBE.AX / QBE AU)
33
27 October 2014
Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not
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For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit
http://www.csfb.com/legal_terms/canada_research_policy.shtml.
As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.
Principal is not guaranteed in the case of equities because equity prices are variable.
Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.
To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important
disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research
analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the
NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a
research analyst account.
Credit Suisse Equities (Australia) Limited ........................................................................................................................................Andrew Adams
For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683.
QBE Insurance Group
(QBE.AX / QBE AU)
34
27 October 2014
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QBE Insurance Group
(QBE.AX / QBE AU)
QBE Insurance Group 2014 10 24 - The waiting game continues.doc
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