Insurance can be a tough industry, however when done properly it can be an exceptionally profitable one to be a part of. Investors need only look as far as the unrivalled Warren Buffett, who's vast fortune was built on the foundation of a strong insurance business, to see that this is true.
Insurance companies thrive in times of low numbers of natural disasters but financial performance can quickly veer off-track following a couple of poorly-timed bushfires or natural disasters.
With the year quickly approaching it's end, now is the ideal time to quickly review the risks and potential rewards on offer from the major ASX-listed insurance companies.
Financial Outlook
| Company | Measure | 2015 (actual) | 2016 (expected) |
| QBE Insurance Group Ltd (ASX: QBE) | Earnings per share (cents) | 68.6 | 91 |
| Dividend per share | 37 | 46 | |
| Insurance Australia Group Ltd (ASX: IAG) | Earnings per share (cents) | 42.3 | 41.5 |
| Dividend per share | 29 | 29 |
Risks
QBE Insurance Group Ltd
- QBE's insurance profit is heavily dependent on the company's risk management processes. They've disappointed in years gone by so investors will be looking for proof that they've plugged the leaky holes.
- Competition is increasing in the insurance space, leading to lower-than-expected premium growth as insurers chase market share during times of strong earnings. QBE has flagged that revenue will be lower this year, however that's a sign that their risk management processes are stopping potentially risky policies being written.
Insurance Australia Group Ltd
- The biggest risk to IAG, in my opinion, is that the group's Asian strategy falls flat on its face. IAG has been building its presence in the region over the last 11 years but it currently contributes only 6% of revenue and worryingly is forecast to grow quickly to 10% over the next year. My view is that a rapid expansion, especially at a time when global insurance companies are performing strongly, could lead to IAG overpaying for minority stakes in insurance companies that it doesn't control.
- IAG has also been a big dividend payer in recent years. There appears to be much more downside than upside risk to the payment as disasters will eventually return and the company is pursuing growth options that will require capital investment.
Opportunities
QBE Insurance Group Ltd
- Around 70% of QBE's revenue comes from overseas and the company reports in US dollars. Currency fluctuations can and will have a meaningful impact on the group's profit and investors should keep a close eye on the currency impact in the 2015 financial report.
- QBE's balance sheet has been repaired by the new management team, which should lead the way for higher dividends in coming years. Long-suffering shareholders will be hoping (note that there's very little an insurer can do to ensure ongoing profitability due to the unpredictability of the weather) that QBE continues to sail smooth seas so that those dividends can flow in 2016.
Insurance Australia Group Ltd
- IAG initiated a complex strategic relationship with US global insurer Berkshire Hathaway earlier in the year that still appears to be poorly understood. I'm not going to pretend to understand it but there could be some currently unknown strategic reasons why IAG would enter into the agreement. I'll be watching for notes in the half-year report about how the partnership is working out.
- Management is still working on integrating the insurance business purchased from Wesfarmers Ltd (ASX: WES) in 2014, which could see margins improve over time. This opportunity is also far from certain however, as analysts at the time considered IAG to have overpaid for the asset.
