Is IAG the insurance company for you?

Insurance Australia Group (ASX: IAG) was the market darling of yield investors during the profit reporting period in August this year.

IAG announced a huge rise in profit of 275% to $776 million on the back of low claim numbers and an extraordinary rise in insurance margin to 17.2%. The traditional range for insurance margin is between 8% and 14%. This allowed the company to declare a full year dividend of 36 cents, more than double last year’s 17 cents, which pushed the yield to above 6% fully franked. The payout equated to 65% of cash earnings, at the upper range of IAG’s policy range from 50%-70%.

At the time, IAG forecast a much lower margin of 12-14% for the next financial year, as the unusually low number of claims was not expected to continue. IAG Chief Executive Mike Wilkins this week confirmed that the company is on track to achieve an insurance margin of between 12.5% and 14.5%, and growth in gross written premiums (GWP) of 5-7% for FY14. GWP growth is a measure of the growth in revenue from the sale of insurance polices and is a key indicator of insurance company health. GWP growth in 2012-13 was also unusually high at 11.8%.

IAG is the biggest insurer of homes and cars in Australia, is a general insurer in New Zealand, and has exposure to Asia via partnerships with established insurance businesses in the region. The Australian and New Zealand general insurance business is the group’s largest contributor and consists of local names including NRMA, RACV, SGIC and SGIO.

In order to diversify earnings away from the saturated Australian market, IAG has acquired minority stakes in insurance companies in Vietnam, Indonesia, India, China, Thailand and Malaysia. IAG is aiming to generate 10% of GWP from its Asian interests by 2016 and is on the way to achieve this, with 7% accountable to Asia — up from 6% in August.

In other positive news, the New Zealand business has settled 46% of claims relating to the Christchurch earthquakes, with the plan to settle the remaining by December 2015.

Foolish takeaway

Like all insurers, IAG is largely at the mercy of mother nature.  As seen during late 2012 and early 2013, favorable weather conditions can lead to extraordinarily high profit margins and dividends, however the inverse is also true. The string of extreme natural disasters during 2011 and 2012 pushed larger insurers such QBE insurance into the difficult position where claims exceeded premium income.

Investors should also note that IAG is unlikely to pay out the same 6% dividend next year, as lower profits will push the company outside of its target 50-70% payout ratio if the payout is to be maintained. Those looking for another big dividend paying company should discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."

Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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