Wondering why your CTP premium, if you register a car in NSW, is higher than it’s ever been and some $150 more than interstate friends and family are paying? It’s due to insurers trying to recover their costs after an alarming surge in legally represented but fraudulent CTP claims in southwestern Sydney. NSW CTP scheme reform is in the works, with the relevant minister expected to introduce legislation for implementation from as early as 1 July 2017, but until then NSW car owners could continue to suffer at the hands of the scoundrels spoiling it for the rest of us.
The other group currently suffering is shareholders of ASX general insurers, especially Insurance Australia Group (IAG) and QBE Insurance Group. Both recently reported earnings to 30 June affected by elevated CTP claims while IAG also gave up premium revenue and market share to reduce its exposure. IAG still has the largest share of NSW CTP due to its ownership of the NRMA brand and has intensified its anti-fraud surveillance.
IAG also continues to face downwards pressure on commercial insurance premium rates from strong competition as liquidity sloshing around the globe in search of a return finds its way to the Australian commercial insurance industry. IAG’s premium revenue in this category fell by seven per cent in fiscal 2016 as the insurer commendably backed away from unprofitable business. Commercial insurance underwriting earnings recovered to a small profit in 2016 but this was mainly due to lower claims last year and the release of older claims provisions.
The problems in CTP and headwinds in commercial insurance are the main reasons IAG’s share price is down from a recent peak of $6.17 on 15 August. If the shares get oversold there could be a buying opportunity in a stock with a useful dividend yield of five per cent fully franked and capital upside. Our valuation is $5.35, which with the 27-cent dividend we forecast for 2017 implies an eight per cent annual return at $5.20 and a 10 per cent return at $5.11 – before franking. Expected returns of this magnitude – CPI plus six per cent or so – are reasonable for mature, slow-growth stocks like IAG. Many investors desire adequate returns with low volatility and IAG, along with other similar mature ASX 50 businesses, fits this profile.
Our interest in IAG increased recently when we became more confident about our 27-cent dividend forecast. To ensure all shareholders benefit from IAG’s surplus franking credits we would have preferred a special dividend to the current $300 million off-market buyback but the main point is the buyback indicates not only IAG’s currently strong capital position but also its ability to replenish that pool. Directors’ confidence in IAG’s capital strength is clear from the recent increase in the dividend payout range from 50-70 per cent to 60-80 per cent of earnings. This and the cut to the dividend from 29 cents in 2015 to 26 cents in 2016 reduce risk for income-seekers entering the stock now. The Berkshire Hathaway ‘quota share’ deal reduces earnings volatility and the amount of capital required to back policies written, and further support still for the dividend should come from a major cost savings program to be presented to the market at a strategy day in December.
As the US Federal Reserve moves towards its next interest rate increase, and scepticism about extreme experimental monetary policies by other central banks mounts, the epic rally in the ‘expensive defensive’ utility and infrastructure stocks is probably over. IAG is emerging as a new opportunity for conservative and income investors.
Originally published in The Australian.
David Walker is Senior Analyst at StocksInValue.
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