A recent report by Western Australian regulator the Economic Regulation Authority (ERA) has recommended "replacing the existing home indemnity insurance model with a model that separates the insurance into construction period coverage from the warranty period coverage."
At present, QBE Insurance (ASX: QBE) and Calliden Group (ASX: CIX) are the only two remaining providers of WA home indemnity insurance, with QBE accounting for approximately 90% of policies and Calliden the remaining 10%. The 2012 review and subsequent recommendations for WA's home indemnity insurance market came in the wake of Vero Insurance, owned by Suncorp Group (ASX: SUN), walking away from providing home indemnity insurance in 2010. Vero's decision forced the WA government to step in and agree to underwrite 100% of the risks stemming from contracts written for ex-Vero customers for a period of time.
The ERA report stated that "the possibility of QBE exiting the market is a realistic one. Throughout the course of this inquiry, QBE has indicated to the Authority the difficulties that it faces in the provision of this product and provided data as to its lack of profitability." Given these insights it is not surprising that changes have been recommended.
The potential for QBE to exit the market and leave the WA building industry once again in a compromised position is quite high. Recently QBE announced its withdrawal from the South Australian home indemnity insurance market, which is the only other jurisdiction that operates under a model similar to WA.
Foolish takeaway
From a shareholder's point of view, it is pleasing to see QBE acting rationally. A criticism often levelled at both the insurance and airline industries is a focus on volumes rather than profits which inevitably push down returns to sub-par levels. That QBE is prepared to walk away from sub-optimal arrangements is commendable and hopefully the recommendations by the ERA will create a better marketplace for all parties concerned.
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Motley Fool contributor Tim McArthur owns shares in QBE Insurance and Calliden Group.
