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Why these two insurance companies will smash the market

There is no sugar coating it. Insurance companies have been in a slump. As Suncorp (ASX: SUN) Chairman Dr. Ziggy Switkowski put it “four years of volatile economic conditions and an abnormal run of natural disasters” has played havoc with investment returns and insurance margins – the two fundamentals of insurance success. However this poor run could be coming to an end.

Suncorp and fellow insurance company QBE insurance (ASX: QBE) hold a large chunk of their insurance funds in conservative investments like bonds and cash which over the last few years have been returning lower and lower yields as governments drop interest rates. Increasingly though talk is surfacing of interest rates being raised as economies start to growth again.

The other interesting aspect of the last two years has been pricing. To keep the system working insurance pricing must reflect risk of claims being made. When risks or claims rise insurance premiums are subsequently increased. This then grows gross written premiums. The great trick here is that it is essentially a one-way valve and in years where there are fewer claims insurance premiums are very rarely lowered.

Suncorp is expected to see a significant change in fortunes as the company’s three year transformation program starts to see results. The transformation is targeting group wide growth of between 7% and 9% over the next two years and a group return on equity (ROE) of 10% for FY15.

This should see a larger dividend for shareholders with the company’s target dividend payout ratio of 60% to 80% of full year cash earnings.

Similar to Suncorp’s turnaround efforts QBE has also found itself requiring a significant over-haul of its operations after a disastrous result in FY11 dragged into FY12. In the 2011 financial year investors saw the ROE generated by the company effectively halve from 13.1% to 6.8%. However forecasts are for improving margins going forward.

Both Sunccorp and QBE used similar repair strategies to unite their sprawling brands and business off-shoots and cut costs, Suncorp using a “One company. Many Brands. One team” tag while QBE called theirs ‘One QBE’.

Foolish Takeaway

The combination of rising interest rates down the track, higher premiums revenues and lower costs will set the way for insurance companies to turn around their forutnes and smash the market over the next year or two.

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Motley Fool contributor Regan Pearson owns shares in QBE Insurance.

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