Jacqueline McGarry asks whether Australia's largest insurer might be about to go on another acquisition rampage.

After assessing the damage caused by its worst catastrophe year on record, QBE Insurance Group is weighing anchor and continuing its acquisition hunt.

Vince McLenaghan, QBE Australia Pacific Asia Central Europe (APACE) CEO, says QBE's sights are set firmly on Asia and other overseas markets, but Australia's largest insurer may also look closer to home.

As the second-largest underwriter in the Lloyd's market and a strong player internationally, QBE is frequently the focus of industry rumours. So while McLenaghan does not refute Australian analysts' speculation that QBE would grab the chance to consolidate Australia's market, he says there is nothing concrete on the horizon.

"There are always plans. We are always looking for opportunities. If anyone is considering a divestment we usually get a call. We have not received any calls from major (Australian) insurers. We are working on several smaller acquisitions, but nothing major."

McLenaghan says rumours QBE would pursue one of its main competitors were fuelled by market politics. He believes there could be many reasons the rumours persisted, despite QBE's consistent denials. "Everyone knows where a fire is and they start to put two and two together; they don't always come up with four. Rumours abound in this market and you really have to wonder where they are coming from."

Move should come soon

Nick Caley, an ABN Amro director, says Australia market consolidation was likely and that QBE is best placed to make a major acquisition. Insurance Australia Group, Promina and Allianz are all potential targets. "QBE, having made almost 100 acquisitions, is acquisitive, we know that. It's a matter of availability and the premium cycle."

Caley says QBE is unlikely to wait years to make a move in Australia. "If it does happen, my gut feeling would tell me 18 months when we are looking at the bottom of the cycle."

But McLenaghan says QBE wanted to write more liability, marine, corporate and industrial property, and construction and energy business in Asia to capture that growing commercial market. "In Asia we have decided we run a very good business, but it has typically been an agency set-up. We are trying to attract more commercial and industrial business."

QBE established plans to expand through acquisitions in the Asia Pacific region two years ago. Back then, CEO Frank O'Halloran said that QBE wanted to double its Asian business in three years. "We can double our income by going for organic growth or by acquisition," he said.

2005 results boost

In March, at the release of QBE's 2005 results, O'Halloran said the group's APACE operations finished the year with an "excellent" combined operating ratio of 83.3%, compared with 89% in 2004. Gross written premium (GWP) for the division was up 13% to A$3.1bn, mainly because of acquisitions in 2004. In 2006, GWP was expected to be $3.3bn.

In the year to 31 December 2005, the QBE group boosted net profit after tax by 27% to $1,091m. Pre-tax profit was up 37% to $1,523m. Insurance profit before tax increased 39% to $1,288m, GWP was up 7% to $9,408m and net earned premium (NEP) was up 9% to $7,386m.

The result came despite catastrophe losses of $515m, compared with $320m in 2004, mostly as a result of the US hurricane season. QBE has a high exposure in the US through two Lloyd's syndicates. QBE owns Syndicate 566, a specialist non-marine, aviation, personal accident and marine excess-of-loss reinsurance syndicate, and Syndicate 2000, a non-marine syndicate specialising in casualty treaty and property direct and facultative, mostly in North America.

The QBE group drew 25% of gross earned premium (GEP) in 2005 through its Lloyd's division and 16% from its American operations. QBE's 2005 American portfolio was 37.4% property and 25% casualty.

In July, QBE announced a private placement of non-cumulative perpetual preferred securities with institutional investors to raise $730m in net funds after expenses. The proceeds are to repay $400m bank debt and for "general corporate purposes", including potential acquisitions.

O'Halloran says the securities were issued to US institutional buyers and were not offered in Australia. "This issue allows us to repay short-term bank debt raised to finance acquisitions made in 2005 through cost-effective, more stable long-term funding. The securities provide QBE with further financing flexibility and balance sheet strength for future growth."

The capital raising put QBE's excess capital at nearly $1.5bn, but a catastrophic hurricane season in 2006 could force O'Halloran to tighten the acquisition purse strings. Unlike most other Australian insurers, QBE writes 70% of business offshore so has much greater exposure to global events.

Cat risk fears

McLenaghan says QBE has reorganised its portfolios to reduce exposure to hurricanes and other natural catastrophes, particularly in the US Gulf Coast. "There has been a lot of commentary about global warming (and) whether it will have the impact of changing climatic conditions. Some say yes and some say it's cyclical. QBE is not necessarily beholden to one side or the other. Certainly there is something occurring and what we have done is re-underwrite our portfolios to reflect that," he says.

Equator Re, QBE's Bermuda-based captive reinsurer, is expected to write additional GWP from proportional reinsurance for QBE divisions in 2006. Equator Re has produced an underwriting profit each year since 2002, dropping to $30m in 2005, compared to $72m in 2004, because of catastrophe losses.

O'Halloran said GWP in 2005 was up 27% to $353m and NEP increased 28% to $295m. Equator Re purchased additional excess-of-loss reinsurance protection for 2005 and industry loss warranty covers. "The risk profile of our insurance and reinsurance operations will continue to be amended to improve the reward for the significant catastrophe risks we underwrite," O'Halloran says.

Pricing is a concern for all Australian insurers. A newspaper article in July said rivals had accused QBE of undercutting rates to grow market share. McLenaghan denies the allegation and says pricing movement is driven largely by direct offshore foreign insurers (DOFIs): "We have seen a drop in liability, which is surprising because we are pricing risks that may not be settled for three to four years. A lot of discounting seems to come from new players and DOFIs. Most locally domiciled companies are responsible and pricing correctly."

Pricing pressure

He says pressure from consumer groups to drop premiums and plaintiff lawyers to wind back tort reforms, introduced after the HIH collapse, is naive and irresponsible. "There is an acute naivety about insurance and what it achieves. Not many people look beyond the policy wording to who is providing the capital. There is always a question about insurers earning too much money. If insurers and shareholders cannot make adequate returns they are not going to provide capital. If we cannot make profits and attract capital there is no industry."

McLenaghan says the Australian market is "no different to most other markets" and industry issues for Australian insurers were global threats of climate change, pandemics and pricing. Pandemics and natural catastrophes "can impact so quickly," he explains. "The risk for us, as an industry, is to recognise risks. Until we know what the risks are, we are not going to be able to price accurately."

He claims Australia's current problem is DOFIs. "The DOFIs issue is a big one. We work with disadvantages in Australia. We employ Australian citizens and they pay taxes. DOFIs can employ workers in countries with lower wages. It is not a level playing field. We do not mind competition, but the rules should be the same. On one hand the (Australian) government has a lot of larger issues to confront, like world trade and opening new borders, on the other hand they have a responsibility to Australian insurers ... not to put them at a disadvantage."

In July, Credit Suisse downgraded its outlook on Australia's general insurance industry because it claimed locally-listed stocks were trading at an unsustainable premium to overseas insurers. Analyst Arjan van Veen said general insurers, including QBE and its rivals IAG and Suncorp, could be over-priced. "While compared to the global peer group, Australian property casualty insurers enjoy relatively high and sustainable returns on equity, we nevertheless see downside risk to industry profitability. Accordingly, we have downgraded our property & casualty sub-sector view to underweight."

Van Veen said it appeared at first glance that QBE has been trading at a "considerable premium to its global peers", especially considering where it generated income. "Investors (should) consider that QBE has historically grown through acquisitions, and the greater the spread between itself and its targets, the more accretive the future acquisitions."

He said downside risk was not insubstantial, given the current premium differential to global peers. QBE was "obviously not immune to any global rate weakening, which would put into question its medium-term return on equity sustainability, although it has some gearing capacity".

- Jacqueline McGarry is a journalist with Kate Tilley Journalism.


VINCE MCLENAGHAN: Vince McLenaghan became QBE APACE CEO in 2005. He has 29 years' experience in the insurance industry, 23 of which have been with QBE. McLenaghan has held several general management roles, including managing director QBE Asia Pacific, before his current position.

FRANK O'HALLORAN: Frank O'Halloran was appointed CEO in January 1998. He joined QBE in 1976 as group financial controller and was appointed CFO in 1982. There are no indications to suggest when O'Halloran is likely to retire. He has denied rumours it will be soon. When he does step down, he is likely to be replaced by either Vince McLenaghan; Tim Kenny, CEO of QBE Europe; or Steven Burns, CEO of QBE US.

Source: QBE.