Australasia Australia
General Insurance
4 February 2009
General Insurance
Yielding to the new world
James Coghill, CFA
Research Analyst
(61) 2 8258 1660
james.coghill@db.com
Scott Olsson
Research Analyst
(61) 02 8258 2764
scott.olsson@db.com
Relatively solid notwithstanding yield challenges
With premium rates turning and solid underpins for risks-in-force growth despite
slowing economies, we see numerous reasons to be upbeat about the sector’s
main revenue line. However, without corrective action, the ~400bps reduction in
bond yields since June 2008 is likely to be a significant challenge for margins over
the next couple of years. We examine this issue in detail in this review, concluding
that there are a number of levers that act as a shock absorber for this risk, but it
clearly can't be ignored. Our Buys (QBE, SUN) remain unchanged.
Deutsche Bank AG/Sydney
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
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may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at
http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Industry Update
Top picks
QBE Insurance (QBE.AX),AUD23.75 Buy
Suncorp-Metway Ltd (SUN.AX),AUD7.40 Buy
Companies featured
Insurance Australia Gp (IAG.AX),AUD3.84 Hold
2008A 2009E 2010E
P/E (x) 103.7 17.9 11.4
Div yield (%) 5.0 4.2 5.6
Price/book (x) 1.6 1.7 1.6
QBE Insurance (QBE.AX),AUD23.75 Buy
2007A 2008E 2009E
P/E (x) 14.3 13.8 10.6
Div yield (%) 3.9 5.3 5.4
Price/book (x) 3.5 2.1 1.9
Suncorp-Metway Ltd (SUN.AX),AUD7.40 Buy
2008A 2009E 2010E
P/E (x) 19.9 7.9 6.3
Div yield (%) 6.3 8.8 11.9
Price/book (x) 1.0 0.6 0.6
Global Markets Research Company
What do lower fixed interest yields mean for the GIs?
Although not a new issue, the collapse in bond yields will, in our view, be one of
the main talking points in the GI reporting season. Given our relatively positive
view of the GI investment case, we have delved into some detail around yields to
illustrate how we think the dynamics are likely to play out in coming months.
A startling collapse in a significant P&L driver
We illustrate how the impact from a yield shock on the balance sheet at year-end
and in the subsequent period is theoretically absorbed without impacting margins
on established reserves for existing business. However, as new business is
written, margins will clearly dilute if pricing is not adjusted. For the current average
duration of insurers’ claims reserves, we estimate a 2-4% reduction in yields
would require an 8-14% increase in premium rates to maintain return on capital at
15%. Such rate increases appear high, but even if these aren’t fully achieved we
believe risks for FY10F margin compression are tolerable – timing issues and likely
near-term inflation assumption adjustments should provide some offset.
Pricing cycle remains a more significant consideration
We’ve also examined how premium rates responded to yield volatility over the
past forty years, covering three distinct hardening phases of the cycle. Generally,
low yields are associated with sharply firming premium rates. We appreciate that
low points for yields would have also been accompanied by a range of mostly
negative economic and investment market factors and these would have also
played a part in driving rates up – most of these are also prevalent today.
No change to sector preferences – QBE and SUN over IAG
We see QBE and SUN as quite different investment propositions – we prefer QBE,
however acknowledge that SUN could outperform QBE should risk aversion
moderate at some point in 2009. We like domestic GI and believe SUN is a better
way to play this relative to IAG – the risk reflected in SUN’s valuation discount due
to bank credit concerns, which are likely to intensify but not cripple the group,
appears unjustified.
Valuation and risks
IAG’s 11.7x forward PE reflects a 15% premium to the market compared to SUN
at 6.4x, a 37% discount. Historically both stocks have traded at a 10-15%
discount. Despite the potential downside from SUN’s Bank exposure, one has to
be quite imaginative in assessing their relative prospects in GI to justify this
valuation gap. Price targets are generally based on DCF methodologies, sector
risks include lower yields and high cat losses - see pg 18 for stock specific details.

Table of Contents
Yielding to the new world ................................................................ 4
Executive summary...................................................................................................................4
The roller coaster that doesn’t want to go up...........................................................................6
Collapsed yields prevalent at previous turning points of the cycle ...........................................7
The relative importance of investment income for ITR margins ...............................................9
How will insurers’ margins respond to low yields?.................................................................10
The pricing lever – how much required to stand still?.............................................................12
The inflation lever can’t be ignored.........................................................................................13
Potential impact on FY10F ITR margins ..................................................................................15
Valuations and EPS trends ............................................................. 16
EPS momentum......................................................................................................................16
Long-term P/E trends..............................................................................................................16
DCF framework assumptions .................................................................................................18
Risks ......................................................................................................................................18
GI in pictures.................................................................................... 19
Price performance...................................................................................................................19
Earnings momentum...............................................................................................................20
Dividend momentum ..............................................................................................................21
Returns on equity....................................................................................................................22
Capital management ...............................................................................................................23
Premium growth outlook ........................................................................................................24
Insurance trading results.........................................................................................................26
Group underwriting results (aggregated) ................................................................................27
Running the numbers...................................................................... 28
Running the numbers - IAG.....................................................................................................28
Running the numbers – QBE...................................................................................................29
Running the numbers – SUN...................................................................................................30