Better buy: Insurance Australia Group Ltd or QBE Insurance Group Ltd?

Credit: Federalreserve

As I’ve written in previous articles, insurance operations in the Asia-Pacific aren’t looking too joyful as a result of high competition and stagnating asset prices in Australia and New Zealand, as well as very low levels of personal insurance through growth markets in Southeast Asia.

This affects Insurance Australia Group Ltd (ASX: IAG) particularly, and management’s recent decision to raise that company’s dividend payout ratio could reflect an implicit acknowledgement that the company won’t be able to reinvest the funds in itself effectively. QBE Insurance Group Ltd (ASX: QBE) faces similar issues in the ANZ region, although its global diversification will mitigate the worst of any market downturns here.

One interesting investment trend set to play over the next few years is rising interest rates, so that companies with large cash balances such as Computershare Limited (ASX: CPU) are potentially big beneficiaries from rising US interest rates. With their huge cash and fixed-income portfolios, surely insurers would be another great contender?

Not necessarily. According to information provided in their most recent annual reports, both Insurance Australia Group (“IAG”) and QBE stand to lose money when interest rates go up. That’s because the price of bonds moves inversely to rates, so as rates rise, prices go down. This disadvantages buyers who held from a higher price, like QBE and IAG.

Here’s a quick look at their portfolios:

Insurance Australia Group

  • Has $14 billion in its investment portfolio
  • $9.7 billion of this is ‘technical reserves’ which are entirely in fixed interest and cash. 80% of this is held with creditors grade ‘AA’ or above
  • Remaining $4.3 billion is in a variety of investments, including equities and interest bearing
  • Total of $12.5 billion in ‘interest bearing investments’ (page 18 of recent interim report)

IAG stands to lose A$366 million for every 1% increase in interest rates, according to its annual report in August last year. The majority of notes are intended to be held until maturity however, so this pricing risk will reverse as instruments mature.

QBE Insurance Group

  • Has US$27.7 billion in its investment portfolio
  • US$12 billion in corporate bonds, total of US$25.1 billion in interest bearing investments
  • Remaining $2.5 billion in growth assets such as equities

QBE stands to lose US$142 million in profit for every 1% increase in interest rates, according to its February annual report.

Insurers like QBE and IAG use a market garden of investment and derivative types to manage their ‘cash flow’ risk (e.g. interest earned from investments) and ‘fair value’ risk (e.g. the value of bonds falling as rates rise) and the use of these will be outside the area of competence for many investors. In short, winning from rising interest rates is not as simple as buying an insurer.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia owns shares of Computershare. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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