Tower seems in good state

TIM HUNTER
Last updated 05:00 13/04/2014

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OPINION: A feeling came over me as I read my new house insurance documents from State Insurance last week. It was like being burgled.

Policy changes mean State will cover our house only up to a fixed amount of $398,300, while several of the policy excesses have been increased significantly.

The premium of $840 is about the same as last year, but if we want to get as much cover as last year we will have to pay a lot more.

It's basically a price rise.

This got me thinking - if insurers are making out like bandits, maybe they would be a good investment.

As usual, New Zealand investors don't have much to choose from on the local market, with Tower the only NZX-listed insurance option.

Australian listed players active in NZ's house insurance market are IAG, through its brands State and AMI, and Suncorp, which trades through Vero and AA Insurance.

The sector also has a wild card, Lumley, whose ownership is in the balance.

Lumley is in play because IAG wants to buy it from Perth-based conglomerate Wesfarmers.

The deal has been approved by Australia's competition regulator, but its NZ component has yet to get a tick from the Commerce Commission. IAG is the dominant player on this side of the Tasman and it stretches credulity that it will be allowed to buy Lumley's New Zealand business.

Assuming the commission has its thinking cap on, Lumley NZ could be up for grabs by another insurer - perhaps even Tower.

The commission has said it will decide by April 30.

However, while the fate of Lumley could affect the competitive dynamics in the market in several ways, investors will probably be looking at other factors. For example, one of the reasons insurers are cranking up premiums is that their reinsurance costs have also risen after the Christchurch earthquakes in February 2011. Reinsurance is extra cover the insurers buy from big global institutions to reduce their exposure.

You can see the effect in the insurers' local financial statements.

For example, IAG's reinsurance costs were 11 per cent of its gross premiums in the year to June 2010, but rose to 17 per cent in 2011. Suncorp spent 10 per cent of its gross premiums on reinsurance in 2010, but 17 per cent in 2011 and 28 per cent in 2012.

This has squeezed insurers' margins, but the effect may be temporary. Matt Goodson of Salt Funds Management, which owns about 7.6 per cent of Tower, sees reinsurance premiums starting to decline.

"There's a lot of interest in writing reinsurance in New Zealand, so prices are coming down," he says.

As reinsurance premiums fall, you can bet your bottom dollar insurers will expand their margins rather than pass on the savings to customers.

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Add that to the premium inflation caused by the move to "sum insured" policies and you have a fair wind for insurers' finances.

Tower has another thing going for it, say its followers.

This relates to a regulatory requirement imposed by the Reserve Bank last August that Tower maintain an $80 million capital margin over and above the minimum solvency requirement.

The ruling was aimed at ensuring Tower had the financial strength to handle its obligations from the Christchurch quakes.

At last balance date Tower's minimum solvency capital requirement was $79m and it had solvency capital of $196m, which was $117m above the minimum requirement and therefore well above the RBNZ's stipulated margin. Tower has historically had a policy of holding a significant capital margin, but as it works through its quake payouts the Reserve Bank margin is likely to be eased.

Adrian Allbon of Goldman Sachs, one of only three analysts covering Tower, sees the upside.

"The two-year bull case is that as they complete Christchurch [insurance settlements] there is a slug of regulatory capital which should be released."

In February Tower said it had settled 80 per cent of its Christchurch claims and was happy with the amount it had set aside for the rest, which it hoped to complete by the end of 2015.

With so much money tied up, "Tower is heavily incentivised to go as fast as it can" to settle its quake claims, says Allbon.

Goldman Sachs currently has a "buy" rating on Tower and, in his research note dated November 26, Allbon put a 12-month price target on the stock of $2.15. Last week it was trading at about $1.54.

Several canny professional investors own large chunks of Tower stock, including Devon Funds, ACC and Salt, based on the view that the shares are currently undervalued.

So far the wider market has not agreed, but the fundies could just be quick off the mark.

As for the Australian options, IAG and Suncorp are much bigger and more complicated than Tower. Both are trading not far off two-year highs on a historic cash yield of about 6.7 per cent.

"They've had a good claims year," says Goodson, describing their share values as "quite full".

That doesn't mean IAG and Suncorp are a poor investment, just that they don't look a bargain. And as usual, New Zealand investors must factor in the lack of Australian tax credits on dividends, which makes Australian shares slightly more expensive for buyers on this side of the Tasman.

Investors interested in getting a piece of insurance action, whether here or in Australia, should, of course, do their homework. But it could well be worth a look to soothe some of that premium pain.

NZ gross premium revenue

IAG $1.9 billion

Suncorp $1.1 billion

Lumley $435 million

Tower $279 million

Tim Hunter is deputy editor of the Fairfax Business Bureau.

- Sunday Star Times

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