As I noted last week, insurers like QBE Insurance Group Ltd (ASX: QBE) and Insurance Australia Group Ltd (ASX: IAG) ("IAG") have had a good run recently as investors anticipate interest rate rises. If interest rates really do rise by a couple of percentage points, Insurance Australia Group would appear cheap at today's prices.
Yet I'm still not all that keen on the business. For one, its dividend is much less attractive than it was when shares were $5. Although dividends and share prices will rise if interest rates go up, it's an open question when that will happen and how much rates might rise by.
Despite Mr Trump's much-touted rapid rate rising schedule, it might still take 2-3 years for rates to rise significantly above zero in the US, and that doesn't have anything to do with Insurance Australia Group – given it's IAG's policy to invest its 'technical reserves' (~67% of total investments) in fixed interest securities that match the underlying insurance liability.
This means that, since most of IAG's policies are in the ANZ region, most of its technical reserves are invested in Australian fixed-interest investments – and thus are sensitive to Australian rates, not US ones.
On top of that, IAG is already a major player in the low-growth ANZ insurance market. There's limited room for it to grow via expansion – small ventures in south-east Asia notwithstanding – and premium growth in Australia in particular has been slow recently. Investors also need to consider that rising interest rates can put pressure on asset values, and thus insurance premiums. Thus, an already stagnant and competitive insurance market might have more pressure placed on it if interest rates do go up.
Foolish takeaway
Insurance Australia Group does have some opportunities for growth, including through aggregation of smaller or niche insurers or by increasing distribution of its policies through brokers. Its ventures in south-east Asia do have some very long term potential. Yet bearing in mind its price, the likely pace of interest rate rises, and the opportunities in its core business, I think would-be buyers are better off avoiding IAG shares at today's prices.
