Insurance Australia Group: Strategy session

About the author:

Author name:

By Richard Coles

Job title:

Senior Analyst

Date posted:

08 December 2021, 9:00 AM

Sectors Covered:

Insurance, Diversified Financials

• Insurance Australia Group (ASX:IAG) has held a business update focusing on its 5 year strategy.
• Medium term targets remain unchanged, e.g. a cash ROE of 12%-13%, with the drivers of these targets being customer growth, A$250m profit improvement in IIA and other productivity improvements, e.g. A$400m of value creation in DIA.
• IAG’s overall strategy sounds logical, although history shows it is one thing improving margins in IIA and another thing being able to maintain them. We also retain some skepticism on customer growth targets given IAG has been losing personal lines market share in recent times.
• We make no changes to earnings/valuation. ADD maintained, with IAG cheap trading on 13x FY23F earnings.

Strategy Day

IAG has held a business update focusing on its 5 year strategy. Medium term targets remain unchanged, e.g. targeting a cash ROE of 12%-13%, an insurance margin of 15%-17% and a growth profile. IAG’s FY22 guidance for a 10%-12% reported insurance margin and low single-digit GWP growth was also re-affirmed.

Key takeaways

IAG pointed to three broad drivers of its expected profitability improvement medium term, namely; 1) Growing group customers numbers by 1m over 5 years; 2) an expected A$250m profit improvement in Intermediated Insurance Australia (IIA); and 3) other productivity improvements. We discuss each of these points below:

1) Customer growth – IAG wants to add 1m customers over 5 years. Of this, the bulk (750k) are expected to come from Direct insurance Australia (DIA) through a combination of; taking the NRMA brand Australia wide (400k), targeting younger customer segments (250k) through the launch of a digital business ‘Rollin’, and the digitising of IAG’s small business offering (100k).

2) A$250m profit improvement in IIA – will come primarily from; the remediation of the IAL personal lines portfolio (A$170m of premium currently but loss making), pricing improvements driving margin improvement (IIA rates were up +9% in 1Q22), improved underwriting practices and the lowering of the management expense ratio (through things like product simplification).

3) Other productivity improvements – relates primarily to claims improvements in DIA and NZ. In DIA, IAG are targeting A$400m of value improvement over 5 years through improving claims efficiency through reduced wastage and streamlining processes etc. In NZ, claims efficiency improvements are expected to come from things like supplier consolidation (20% reduction in suppliers is the target) and new claims centers (“repairhub”) looking to manage more IAG claims internally.

Other key points: 1) IAG is essentially looking to maintain a flat expense base over time (A$2.5bn – consists of underwriting expenses, claims handling costs, & fee based expenses) with planned reduction in “maintenance” expenses to offset higher costs tied to “transformation”; 2) IAG’s natural hazard allowance is expected to continue rising from here (claims have exceeded allowances by 0.8% of NEP over the last decade on average); and 3) IAG believe a capital return is likely if Business Interruption court cases go their way (maybe 50bps of CET1).

Morgans Thoughts

IAG’s overall strategy sounds logical, although history shows it is one thing improving margins in IIA and another thing being able to maintain them.

We are probably most skeptical on whether IAG can grow customer numbers by 1m over 5 years as planned, noting IAG has been losing share in personal lines in recent times. However, positively, it does appear that IAG has already made a significant start on executing its plans in FY22.

Also, in regards to the IIA productivity improvement, healthy current rate increases are already rolling through the book which will help this business (although management did point to some signs of claims inflation across the group which will offset rate increases to some degree).

Changes to forecast and investment view

We leave our earnings/valuation unchanged. IAG had a difficult FY21 and FY22 is set to be a weather affected year.

However, we believe for the patient investor the stock is cheap trading on ~13x FY23F earnings, and we expect continuing insurance price increases, combined with management’s strategy to improve performance, to drive improved profitability over time. ADD maintained.

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