QBE Insurance’s (ASX:QBE) first-half 2024 (1H24) results offer a nuanced picture.  Depending on your interpretation of the performance of the American business, QBE Insurance is either off to a challenging start to the year, or long-term prospects remain optimistic, largely driven by ongoing restructuring efforts, particularly within the company’s North American segment. 

The result missed several analysts’ forecasts and raised some concerns about the insurance pricing cycle and particularly whether the pace of price increases is moderating amid more intense competition. 

A slow start to the year 

QBE Insurance’s 1H24 results did fall short of analyst expectations, suggesting a tough first half. The company reported a return on equity (ROE) of 16.9 per cent, which was robust but did not meet forecasts. This miss raised concerns about the pricing cycle and the progress of QBE Insurance’s North American turnaround.  

QBE Insurance’s North American operations weighed on its performance. For 1H24, the company reported a combined operating ratio (COR) of 93.8 per cent and an insurance margin of 11.6 per cent. 

Ratios explained 

The combined ratio measures the profitability and financial health of an insurance company. There is an inverse relationship between the ratio and profitability. The higher the ratio is, the lower the profitability of the insurance company and vice versa. 

The combined ratio is calculated by adding up the incurred losses and expenses and dividing them by the earned premium over the period. 

Incurred losses include claims paid, loss reserves, and loss adjustment expenses.  

Earned premium refers to the premium collected by an insurance company and already earned for the portion of a policy that has now expired. It is what the insured party has paid for the portion of time the insurance policy was in effect but has since expired. 

In essence, the combined ratio measures whether the insurance company is earning sufficient revenues from its collected premiums relative to the claims it pays out. The aim is to maintain a combined ratio below 100 per cent and remember the inverse relationship between the ratio and profitability: the further below 100 per cent, the better.  

The insurance margin comes from the concept of a “float,” which is the pool of funds that insurers collect from policyholders’ premiums. Until a policyholder makes a claim, the insurer can invest this money to earn additional profits. The insurer keeps these investment profits entirely. 

Insurance company shareholders expect these investments to generate significant returns, which can increase their annual profits and dividends. 

To calculate the insurance margin, we first need to understand the net earned premium (NEP). This starts with the gross written premium (GWP), which is simply the total of all insurance premiums collected. However, from an accounting perspective, it’s more relevant to look at the gross earned premium (GEP), which is the portion of GWP that has been earned during a specific financial year. For example, if a one-year policy worth $1,200 is written on December 1st, only $100 of it would count as GEP by December 31st, the end of the financial year. 

To calculate NEP, take the GEP and subtract the costs of reinsurance cover (insurance that the insurer buys to reduce its own risk) for the same period. 

Finally, the insurance margin is determined by dividing the profit made from investing the float (known as the insurance profit) by the NEP. 

After adjusting for QBE Insurance’s unusual items, such as favourable catastrophe (CAT) costs and market movements, the underlying COR was slightly lower at 93.7 per cent. Its insurance margin was 10.7 per cent. This represents a deterioration compared to the previous corresponding period, driven by higher-than-expected claims, increased CAT budgets, and rising operational expenses. 

North America remains a critical area for QBE Insurance, with its COR reported at 97.5 per cent. Although this is an improvement from 106.9 per cent (a loss) in the prior period, the underlying metrics tell a less favourable story. Adjusting for favourable CAT costs and reserve movements, the underlying COR actually rose to 101.8 per cent, underscoring the difficulties QBE Insurance faces in this market. The company’s focus is now on the runoff of non-core portfolios, which is expected to gradually improve the COR over the next few years, potentially delivering a 1.2 percentage point benefit to the group by FY26. 

Despite the challenges in North America, QBE Insurance’s International and Australia-Pacific divisions performed robustly, helping to offset some of the weaknesses. The International division reported an underlying COR of below 90 per cent, while the Australia-Pacific segment posted a COR of around 91 per cent. These strong performances underscore QBE Insurance’s ability to generate profitability across different regions, providing a buffer against the underperformance in North America. 

Stock valuation and outlook 

The company is trading at a forward price-to-earnings (P/E) ratio of about 10 times FY25 estimated earnings and a price-to-book (P/B) ratio of almost 1.5 times. This is cheaper than the global peer average, which some analysts estimate is 12.5 times.  

Importantly, QBE Insurance has lowered its FY24 guidance. The company now expects GWP to grow by about three per cent, which is a downgrade from the previous mid-single-digit guidance. The company’s own forecast combined operating ratio for FY24 remains at approximately 93.5 per cent.  

The company’s strategic focus has to remain on improving its North American business and optimising its portfolio. The company’s ability to navigate through these near-term challenges while laying the groundwork for future profitability is key. If QBE Insurance can successfully execute its North American turnaround and continue to capitalise on its strengths in other regions, the company’s shares could be re-rated. This is more likely if the company’s combined ratio improves to below 92.5-93 per cent by FY26. 

While QBE Insurance faces challenges, particularly in North America, the underlying trends remain positive. With a solid plan to address its current issues and an attractive valuation relative to peers, we believe QBE Insurance is well-positioned for long-term growth. 

The Montgomery Fund and the Montgomery [Private] Fund owns shares QBE Insurance. This article was prepared 11 August 2024 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to QBE Insurance, you should seek financial advice.