Are QBE Insurance Group Ltd shares undervalued?

In case you missed it, Australia’s east coast has been battered by violent storms as a low pressure system creates torrential conditions causing flooding and wild winds in coastal towns. As conditions abate, the real damage is uncovered with early estimates revealing losses could hit $56 million as a direct result of the storms. This invariably spells disaster for listed insurers like Insurance Australia Group Ltd (ASX: IAG), QBE Insurance Group Ltd (ASX: QBE) and Suncorp Group Ltd (ASX: SUN).

Insurance losses

On Monday, the Insurance Council of Australia declared certain regions in Queensland and New South Wales an insurance catastrophe. This was extended to include parts of Victoria and Tasmania on Tuesday.

Broadly, classification as an insurance catastrophe means insurers (and policyholders) can access an industry task force set up to assist with claims and disaster management. The Turnbull government has also stepped in to pressure insurers to ensure claims are resolved in a speedy fashion.

The losers

Whilst government and industry action is a positive for victims affected by the natural disaster, key losers from this are insurance companies. IAG, QBE and Suncorp are likely to bear the brunt of losses as Australia’s three-largest insurers, meaning their profits could take a hit as a result.

The sharemarket has reacted accordingly, sending shares in IAG, QBE and Suncorp down 2% to 3% since Friday, despite the broader S&P/ASX 200 Index (ASX: XJO) posting a modest rise.

Missing link

In my view, QBE is unlikely to be as affected as IAG and Suncorp, making it a good investment at current prices.

Why QBE?

IAG owns general insurance brands such as CGU and AAMI, thus is likely to receive the highest number of claims from this storm (as most of its policyholders would be east coast based).

Suncorp is a Queensland-based insurer, with a large concentration of policyholders coming from its home state. This implies it will be affected by claims from the storm. However, Suncorp has a very strong banking arm in the region, which should absorb group losses making the impact from these storms minimal.

Finally, QBE is the most diversified of the trio. It derives 33.5% of its gross written premiums from North America, indicating it has lower exposure to the east coast of Australia. Therefore, it should not receive as many claims as the other two insurers. I believe QBE is the better buy if you add in that QBE benefits from a strengthening American economy, a rising dividend payout ratio and the prospect of future rate rises in the U.S. (leading to higher profits).

Foolish takeaway

Insurance companies are always volatile investments, given profits can be affected by unforseen natural disasters. Nevertheless, insurers can also be very profitable businesses through periods of relative calm, thus investors would be wise to purchase these companies in times of turmoil.

Whilst I believe all three insurers should not issue profit downgrades as a result of the storms, QBE remains my pick of the trio because of its breadth of diversification and prospects of a growing dividend.

If you are interested in quality dividend shares, then I would recommend this top dividend share instead. A strong yield and potential share price gains make this a great investment idea in my opinion.

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Motley Fool contributor Rachit Dudhwala owns shares of QBE Insurance Group Ltd.. The Motley Fool Australia has no position in any of the stocks mentioned. 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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