Many investors are disappointed with the 19% capital gains recorded by the ASX in the last five years. However, investors in Insurance Australia Group Ltd (ASX: IAG) have seen their shares rise by 71% during the same time period. Although that's less than the 74% gains made by Suncorp Group Ltd (ASX: SUN), it is well ahead of the 33% fall in value of QBE Insurance Group Ltd (ASX: QBE) since July 2011.
Looking ahead to the next five years, IAG's shares could keep beating the ASX for the following four reasons.
Digital capabilities
Digital advancements are proving to be disruptive to the insurance industry, but IAG's investment in its Labs division means that it has increased its capabilities in this space. It is now better able to develop improved customer insights as well as customer journey maps which should aid in IAG's understanding of its customers and partners' needs.
Further, IAG Labs should aid IAG's understanding of risk patterns and help reduce its customers' cost of managing risk. This improved understanding of its customers could help IAG to better differentiate itself from peers and may help it to develop improved margins and profitability.
Balance sheet strength
IAG's balance sheet continues to offer relative stability and this could appeal to investors while the economy's outlook is uncertain. IAG is well-capitalised, with a Prescribed Capital Amount (PCA) multiple of 1.8 times. This is above the company's target range of 1.4-1.6 times. IAG's common equity tier 1 (CET1) ratio is 1.23 times, which again is above the target range of 0.9-1.1.
This strong financial position should allow IAG to deliver a rising payout ratio over the medium term. In fact, it has increased the target payout ratio to 60%-80% of cash earnings (from 50%-70%), which could increase demand among investors for its shares with the RBA set to remain dovish over the medium term.
Integration progress and reduced volatility
The integration of Wesfarmers Ltd's (ASX: WES) insurance business continues to progress in-line with expectations. Alongside a new operating model in Australia, the deal is expected to result in synergies of around $230 million in the 2016 financial year.
Further, the 20% quota share arrangement with Berkshire Hathaway has thus far met IAG's expectations. It has not only reduced regulatory capital requirements, but has also lowered IAG's earnings volatility. In my opinion, more consistent earnings could appeal to increasingly risk-off investors, with IAG's beta of 0.77 indicating that it offers a low volatility shareholder experience.
Asia expansion
IAG's gross written premiums in Asia increased by 20% in the first half of the current year, with the region being a key part of the company's growth strategy. Although many investors may see this as a risky strategy given the uncertain outlook for China and other emerging markets in the region, IAG's exposure to well-established and profitable markets such as Thailand and Malaysia improves its overall risk/reward ratio in my view. Further, with expansion into developing markets such as India and Vietnam progressing well, IAG is becoming increasingly well-placed to benefit from rising financial product penetration in the region.
