Investment Matters

QBE: Righting the ship

This week we are revisiting one of our long-term holdings: QBE.

QBE is a general insurer and underwriter, with diversified global exposure (it writes policies in North America, Europe, Australia & New Zealand and the Asia Pacific).

Recently, there has been a turnaround in QBE’s business.  The company's share price has appreciated by 25% this financial year.

This reflects our view that the company is executing its strategy and is continuing to improve its underlying business.

A primer on insurers

General insurers provide all forms of insurance other than life insurance.

An insurer’s earnings are based on its competency in four key areas:

  1. Underwriting performance: Its ability to assess insurance risk and correctly price its policies.
  2. Investment performance: The returns it earns by investing premiums collected, as well as shareholder funds.
  3. Increase premiums over time: Its ability to increase premiums over time while ensuring it retains its customers.
  4. Cost control: Its ability to reduce the cost to acquire customers as well as general and administrative expenses.

In the short term, it can be difficult to assess the performance of insurance companies. This is largely because underwriting and investment performance can be volatile.

Underwriting performance can be volatile because large claims may skew results.  Furthermore, claims may occur in clusters, for example when extreme weather events occur.

Investment performance can fluctuate from year to year due to market volatility.  QBE’s net investment yield fell in FY-18, largely due to a selloff in markets late last year. 

Our investment in QBE

While these factors have caused earnings to fluctuate in the short-term, your investment team has assessed QBE based on its long-term prospects.

Our long term view is that the company will outperform because of the steps it is undertaking to improve its underlying business (particularly so in recent years).

The company has worked diligently to simplify and better integrate its business lines, while improving underwriting.

A detailed bottom-up review is being conducted of its individual portfolios.  These “cell reviews” are an ongoing process being conducted by senior management in person, across the group, to improve performance and ensure alignment with the group’s broader strategy.

The company is focused on several initiatives including:

  • Ensuring consistent pricing across the group
  • Implementing global claims standards
  • Refining underwriting standards and practices, and ensuring they are consistent across the group
  • The sale and exit of unprofitable businesses
  • Investment in data and analytics to improve the underwriting and claims process
  • Reducing its exposure to large/catastrophe risk

The result of this will be higher, less volatile earnings and improved returns for shareholders.

QBE’s recent performance

We note that clients have been patient in waiting for these improvements to be reflected in the company’s financial results. As with many of our investments, this patience is beginning to be rewarded.

We have begun to see signs of improvement in the company’s most recent results.

In relation to the four key areas highlighted earlier:

  • Increases in premiums: The company has been able to implement significant pricing increases over FY-18 (5% on average) while customer retention has remained stable.
  • Investment performance: While investment performance was lacklustre in 2018 (a net investment yield [1] of 2.2%), the company forecasts that this will improve materially (to a level of 3-3.5%), which should bolster future profitability.
  • Underwriting performance: Improved underwriting performance is reflected by its attritional claims ratio [2]. This ratio has begun to trend down across all geographies (see graph below).
  • Cost control: We can see that QBE’s expense ratio [3] has consistently declined over the last three years (see graph below).
IM QBE 1Source: QBE, First Samuel 
Source: QBE, First Samuel

Our assessment of QBE’s future

QBE’s return on equity or ROE (its net profit as a percentage of shareholders' funds) has improved over the last 5 years, from a level of 7.5% in 2015 to 8.5% in 2018.

We assess that QBE will continue to execute and improve its underlying business, which the market will recognise.

Furthermore, we assess that there is still significant scope for improvements to be made (particularly in remediating QBE Asia Pacific).  We forecast that with these continued improvements, QBE’s ROE will increase to approximately 10% within the next few years.

Thus, we believe that clients will continue to be rewarded for their patience.

[1] Net investment yield is calculated as investment income net of investment expenses as a percentage of capital invested.
[2] The Expense Ratio is calculated as underwriting and administrative expenses as a percentage of net earned premium
[3] The Attritional Claims Ratio is calculated as the total value of claims under $2.5m as a percentage of net premium earned. The exclusion of large and catastrophe claims (which can be sporadic and have a large impact on underwriting profit) gives a better reflection of underlying underwriting performance over the short-term.