Insurers are favourites of yield-seeking investors. When they're matched to a big name like Medibank Private Ltd (ASX: MPL) and a sexy story like an aging population, rising healthcare costs, and mandatory insurance premium increases, it can lead to big price increases.
Indeed, Medibank shares are up 50% in the past 12 months, and now yield a miniscule 2.4%. Despite all of the above-mentioned tailwinds as well as a cost cutting program, I would not consider buying shares in Medibank today. While it is a solid, well-run business with a decent long-term outlook, investors are not permitting themselves a margin of safety by buying shares at today's prices.
With recent loss of market share to competitors, as well as declining customer numbers and an incoming CEO who will likely bring new ideas about running the business, there is a significant amount of uncertainty ahead. As I wrote here, the potential for future cost cutting is also somewhat opaque.
I would call Medibank a 'Hold' only, as I believe neither its growth prospects nor its dividend adequately compensate investors for the pricing risks they take in buying it today.
One company I would consider owning as an income investor is Insurance Australia Group Ltd (ASX: IAG), which offers a more compelling 5.7%, fully franked yield, although it too carries pricing risk. Unlikely Medibank, IAG struggles to achieve premium increases in a highly competitive, low-inflation market, though it comes with the benefit of a powerful backer in the form of Warren Buffett's Berkshire Hathaway.
IAG's well being is strongly tied to both housing and car markets in the ANZ region, with the vast majority of its earnings coming from property and vehicle insurance, which is partly tied to the value of those assets. Deflation in housing prices and/or a decline in general economic conditions could put pressure on premiums and margins.
IAG does stand to benefit from rising interest rates boosting the yields of its cash and bond investment portfolio over the long term – though it will also have to wear a decline in the face value of its bonds – but with the cash rate recently hitting a new low of 1.75%, that part of the cycle may be some time off.
