Insurance Australia Group has strengthened its earnings stability through reinsurance protection.

About IAG Australia Group Limited

Insurance Australia Group Limited (IAG, ASX: IAG) is Australia’s largest general insurer with a heritage that dates back to 1925 when the National Roads and Motorists’ Association (NRMA) began providing insurance to its members. In 2000, NRMA demutualised and separated its road services and insurance operations, and the new NRMA Insurance Group was listed on the ASX.  In 2002 NRMA Insurance Group became Insurance Australia Group Limited.

Reinsurance reduces future earnings volatility

IAG has entered agreements with global reinsurers that mitigate the risk of extreme weather events and other natural perils impacting earnings and capital for the next five years. The agreements provide greater certainty over the cost of natural perils such as cyclones, fierce storms, flooding and bushfires. This reduces the incidence of claims-related negative earnings surprises which enables IAG to issue more reliable earnings guidance and provide consistent dividends from dependable cash flows.

The lower earnings volatility provided by the reinsurance contracts reduces the amount of regulatory capital prescribed by the Prudential Regulator, the Australian Prudential Regulation Authority, to be set aside to meet future insurance claims. This releases capital to be either returned to shareholders in higher dividends or (more likely) by way of a share buy-back. Alternatively, the capital may be applied to increase the underwriting capacity of IAG, which should generate higher future earnings. The estimated capital release is around $350 million.  IAG completed a $200 million on-market share buy-back in May 2024 at an average share price of $6.38. This compares to today’s share price of $6.90. An advantage of a share buy-back is that IAG’s future earnings are shared among fewer shares. Broadly speaking, this results in future earnings per share growing at a faster rate than earnings. IAG may announce an on-market share buy-back when releasing the Group’s FY24 results on 21 August.

Long-tail adverse development protection

IAG has also taken out reinsurance cover for protection against long-tail insurance risks such as adverse judicial developments and other liabilities that build up over a long period and involve high incurred but not reported claims. Such claims, when superimposed with inflation can be significant and include Product Liability, and Professional Risks and Workers’ Compensation claims. Examples range from asbestos claims, construction defect claims and environmental claims involving pollution events that occur over many years. IAG has also taken out reinsurance cover for other long-tail claims such as molestation and silicosis up to a sub-limit of $50 million.

FY24 Results and FY25 earnings guidance

IAG will announce its full-year 2024 financial results and FY25 earnings guidance this month. The recently negotiated five-year reinsurance contracts that remove the adverse claims impact of extreme natural perils experience, should enable IAG to reaffirm the Group’s impressive 15 percent Reported Insurance Margin target for FY25. This in turn supports stable earnings and consistent shareholder dividends.

Looking ahead

IAG is the largest general insurance company in Australia with about 29 percent of the general insurance market. This high market share delivers scale benefits that include, for example, its new Enterprise Platform technology that now administers five million insurance policies online.

IAG, like all insurers, has been impacted by claims inflation, particularly regarding car insurance and building insurance repair claims. However, high inflation has been accompanied by higher interest rates that have enhanced income returns on IAG’s conservative investment portfolio that has a material exposure to fixed interest securities like government and corporate bonds. Higher interest rates also reduce the outstanding claims provision that insurers must maintain to cover future expected claims that are inherent in the insurance book but not yet identified. The present value of estimated future insurance claims is lower when the interest rate used to discount future claims liabilities is higher.

A trend to lower interest rates will not benefit insurance companies generally, as it does for most other businesses, although lower claims inflation should prove positive for IAG’s earnings outlook. However, with IAG’s reinsurance protection against extreme weather events and other perils in place for the next five years, the potential for future unanticipated negative earnings surprises is considerably reduced. This should provide for favourable shareholder outcomes at least in the medium-term.