IAG warns of tough conditions ahead as investment income weighs on profit

IAG has posted a slide in profit, but its Berkshire Hathaway deal is expected to support underlying insurance margins.

IAG chief executive Peter Harmer. (Picture Norm Oorloff)

Insurance Australia Group has warned of continued tough conditions in commercial insurance lines but said the quote-share deal with Warren Buffet’s Berkshire Hathaway will continue to support its underlying insurance margin.

IAG (IAG) today booked a net profit of $625 million for the year through June, a 14 per cent slide year-on-year. The slide in profitability was caused by “significantly lower” investment income, which fell by around $100m, from flat equity markets and a higher effective tax rate. Insurance companies rely on investment income to help underwrite their policies.

But IAG’s full-year insurance profit, the group’s preferred measure, increased 7 per cent over the year to $1.18bn. The group lifted its insurance margin from 10.7 to 14.3 per cent, a figure which reflects both investment returns and the performance of the insurance business.

The underlying insurance margin gained a 250 basis point benefit following the Berkshire Hathaway quote-share agreement, which was struck after Warren Buffett’s reinsurance business last July paid $500m for an equity stake in IAG and about $200m a year for a 20 per cent share of its Australian and New Zealand ­insurance business.

Revenue was up 12 per cent to $16.77bn, despite a 0.6 per cent slide in gross written premium for the year, which IAG said was due to softer commercial market conditions in Australia and New Zealand.

“We’ve seen solid growth and strong profitability in our personal insurance lines in Australia and New Zealand, primarily driven by GWP growth for home and motor,” chief executive Peter Harmer said. “Our commercial businesses in Australia and New Zealand have withstood continuing price pressure and maintained their strict underwriting discipline which has resulted in lower business volumes as we exited unprofitable business,” he said.

“The Berkshire Hathaway quota share arrangement continues to perform well for us, reducing earnings volatility and releasing capital,” Mr Harmer said.

And thanks to its solid capital position, IAG said it will embark on a $300m off-market share buyback. The Berkshire deal has lowered IAG’s regulatory capital requirement by around $400m with an estimated further $300m reduction over the next two to three years. The impact of the Berkshire Hathaway quota share is expected to be similar to fiscal 2016, IAG said.

IAG did manage to exceed its net natural peril claims allowance by $59m following unexpectedly high claims losses from the East coast low storms which ravaged the eastern Australian seaboard earlier this year.

IAG said over the coming year it expected gross written premium to be “relatively flat”, flagging another tough year in commercial insurance lines.

IAG will pay a final 13c dividend, bringing the year’s total payout to 36c per share, including a 10c special dividend. Discounting the special dividend, the group’s distribution was lower than the prior year’s 29c per share payout.