QBE Insurance (ASX: QBE) is, first and foremost, an insurance company. Similar to other insurance companies like IAG (ASX: IAG) or Suncorp Group (ASX: SUN), QBE generates a substantial portion of its revenues by protecting individuals and companies against risk of loss through its various insurance products. In 2012 this risk cover brought in US$18.434 billion in gross written premiums.
However, hit by the impact of unusually high catastrophe pay-outs including US$331 million for one of the worst US droughts in decades, and a US$335 million cost from the severe impact of Superstorm Sandy, the total underwriting result in 2012 was just US$453 million.
The vast majority of QBE's profit in 2012 came instead from its significant investment portfolio made up of investors' funds and insurance policy fund which totalled US$31.5 billion. This portfolio of cash and investments generated combined earnings of US$1.216 billion. With the Australian dollar dropping by 7% against the US dollar in the last month, that portfolio has arguably increased by $2.2 billion in Australian dollar terms.
That would be an attractive proposition if the company was about to cash up and liquidate its investments, however is unlikely given the importance the portfolio has in providing a return for investors.
So how does QBE invest this stately sum? According to its 2012 annual report QBE invests conservatively following low-risk strategies to protect the capital in case it may be needed for claims payments. To this tune 42% of the portfolio is invested in corporate bonds, 25% in government bonds and 26% in short-term money. Just 0.4% of the US$31.5 billion was invested in equities in 2012, suggesting the company had only a small exposure to the global surge in equities in late 2012 and the first quarter of this year.
It also means the company has suffered from low interest rates being paid on fixed interest investments, which by the end of 2012 were yielding just 1.9%. However any increase in interest rates on fixed interest will help considerably increase portfolio earnings.
Foolish takeaway
Fortunately, QBE is at no risk of becoming an investment firm any time soon. Fewer disasters in the first half of 2013 as well as the impacts of cost cutting should see insurance profits rise considerably in 2013, a promising prospect for investors.
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Motley Fool contributor Regan Pearson owns shares in QBE Insurance.
