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The tale of 2 insurers

Insurance Australia Group Limited (ASX: IAG)  had an exceptional 2013 financial year – mainly due to a favourable claims experience, higher than expected reserve releases and narrowing credit spreads. As a result, the insurance margin came in at 17.2% on gross written premium growth of 5%. Net profit increased 69% over 2012.

With the acquisition of the insurance division from Wesfarmers Ltd (ASX: WES) for $1.845 billion (mostly financed by a $1.2b institutional placement and $200m share purchase plan), Insurance Australia will maintain dominance in the Australian and NZ marketplace. IAG has had a good start to the 2014 year and full-year adjusted earnings-per-share should come in around 47c. At $5.75 this places IAG on a prospective 2014 price-earnings ratio of 12.2 and a fully franked yield of 5.4%.

So far there has been little return from the $700m investment in Asia and patience will be needed here. Potential clouds on the horizon include softer equity markets, increased competition in the Australian market and widening credit spreads.

Although 2014 is unlikely to be as kind to Insurance Australia as the year just passed, it isn’t difficult to justify a share price of $6+ for this company.

In contrast QBE Insurance Group Ltd (ASX: QBE) has experienced a horror 12 months with progressive profit downgrades and major writedowns in its American division. Ironically operational performance ratios in Australia and New Zealand outpaced rival Insurance Australia. Europe did ok and the smaller Asian division improved returns.

Which begs the obvious question – is America too hard for major Australian companies to handle? Of major companies the only longer-term successes in the US so far have been Amcor Limited (ASX: AMC), Computershare Limited (ASX: CPU), James Hardie (ASX: JHX) and Macquarie Group Ltd (ASX: MQG).  In each case a clearly defined product and service segment has been identified and intensively developed.

QBE’s problems in the Americas centre on the lender placed (mortgage insurance) and crop insurance businesses – as Harry Hindsight says ‘both were a bad case of mistiming’. Other issues include the regulatory need for increased reserves in Europe and South America. After taking these factors into account, QBE still compares badly with American companies such as Ace Insurance; which is heading for a record year. QBE needs to do a lot more work in the US.

Another drag on QBE is the miserable return from invested funds – currently less than 2% pa. QBE is an extremely conservative investor maintaining minimal exposure to equity markets. This seems to be short sighted thinking by the board and hopefully will change over time.

Given all this, is QBE a buy around $11.60? In my view only if slowly building a position as there are uncertainties yet to be resolved.

Foolish takeaway

In my view, at present IAG is the golden princess and QBE the wicked witch in the ASX insurance scene. IAG cannot get much better and QBE can only get better as it reforms. There are signs QBE is revamping US operations with some success and the board has acquired more depth in industry experience. There are definite reasons for optimism that the bulk of bad news is now revealed.

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Motley Fool contributor Peter Andersen owns shares in James Hardie,  Macquarie Group and QBE Insurance

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