News: QBE ratings firmed by AM Best, page-11

Hi KosCyp

I'll have a go at answering your questions

QBE is an insurer. They insure people against potential risks. So they collect Premiums today and cover against risks such as cyclones or floods that may occur at some time in the future. As an insurer they have to be good at assessing risk. They are good at this in Australia and the Australian arm of the business has good metrics. Meaning they insure someone for a dollar and on average pay out 90 cents in claims. Leaving a healthy profit. Numbers change all the time but you need good underwriting skills to assess risk. Bad underwriting means you insure someone for a dollar and pay out $1.10 in claims.

Historically QBE grew by acquisition. They brought out other insurers overseas. Problem is

a) GFC in Europe and US meant some people could not afford to re insure so they lost income
b) They made a motza on housing insurance in US. Government changed the rules so they are not making the motza in this market segment anymore
c) Bad underwriting in Overseas markets made for bad numbers and loses from overseas operations
d) Low interest rates means they are not getting good returns on they money they have invested
e) High A$ means you lose money when you convert US assets to A$

So back to the premium. They have the premium but they don't know what they have to pay out by way of claims in the future. By law they have to put a certain amount of money in cash type assets Govt bonds etc so they can pay out on a claim later on.

Back in the good old days they got 55% of their profits from the interest they earned on these deposits. Back then the $A was worth 80 cents like it is now and US interest rates were higher than they are now.

The US is their largest market so they hold more $$$ in US cash type assets. So when interest rates go up they make more money on the investment = more profit. PROVIDED THEIR IS NOT AN ABNORMALLY HIGH CLAIMS HISTORY. So interest rates could go up and we could have a bad cyclone season. QBE would make more $$$ from higher interest rates but then have to pay it out on more claims.

Assuming a benign claims year and higher interest rates you make more profit. Then when you convert the profit into $A it is increased when the $A is 80 cents US and you reduce the profit in $A when it is US120 cents. So higher profits come from higher interest rates and a lower A$.

So in February we will be converting US profits on cash reserves to $A at 80 cents not 100 cents. It does not matter when the A$ dropped July - Dec but when the numbers come out in Feb 2015 we want the A$ to be low relative to US$

My conclusion is the agency has greater access to recent numbers from QBE than we do. They are basically saying the fundamentals of the core business of insurance is improving. So in February I expect to hear better insurance metrics driving better profits boosted by a lower A$. Then next year if interest rates pick up that will be a bonus. If not the improvements in the insurance business should continue to drive better returns.


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