QBE Insurance Group's Profit Margins Collapsing

Published: Mon 26 Jul 2010

Wendy Blair

It's not surprising that the share price of the QBE Insurance Group dropped sharply after CEO Frank O'Halloran issued a shocking 52-percent profit downgrade, admitting that the company's insurance margins, an all-important figure, would continue to plummet.

The profit downgrade was especially disappointing arriving almost immediately after the corporation had discussed its financial expectations with investors on June 16. At that time, QBE predicted insurance margins of 16-18 percent. Yesterday, O'Halloran dropped that number to 15.7 percent.

Although O'Halloran blames the insurance-margin crunch on the unpredictability of discount-rate movements, that explanation does not help QBE's creditability.

Insurance companies live and die by their forecasts and estimations. By making such a large miscalculation, O'Halloran hurts confidence in an insurer that has taken a beating on the sharemarket-declining 32 percent in the last six months-and sorely underperforming relative to the market as a whole and its primary competitors, such as IAG Australia, Suncorp, and AMP.

The announcement also begs the question: what took so long to issue the downgrade? According to a July 5 report from Axiome Equities, the average government three-year bond rate for the primary countries in which QBE does business had dropped by approximately 25 basis points. Axiome predicted that this would result in a $100-million drop in insurance profit, in accordance with QBE's sensitivities.

"QBE reported that its first-half insurance margin will be at the low end of its 16 per cent target when it updated the market on June 16. Had the investor update been on July 1, it may have reported the first-half insurance margin would be below this target," the report claimed.

The Worst Is Yet to Come

Things will only get more difficult for O'Halloran in the second half of 2010, with the United States on alert for a highly active hurricane season and premiums weakening in most lines of insurance because of overcapacity.

The reason is clear: additional hurricanes translate into pricier claims, and that means lower insurance profits and an insurance-margin crunch.

Two experts who predict U.S. hurricanes, Bill Gray and Phillip Klotzbach at Colorado State University's department of atmospheric science, have recently issued their most recent forecast, and they are convinced hurricane season will be substantially more active than usual.

They estimate that 2010 will see about ten hurricanes (the average is 5.9), 18 named storms (average of 9.6), 90 named storm days (average of 49.1), 40 hurricane days (average of 24.5), five major hurricanes (average of 2.3), and 13 days of major hurricanes (average of five).