Leading short-term insurer reports 220% earnings surprise

Gareth Stokes, FAnews Online Editor

If you had to isolate a number from Santam Limited’s (JSE: SNT) interim results for the six months to 30 June 2009 it would be the 220% increase in headline earnings (from 89c/share in the first half of 2008 to 284c). Group earnings for the half-year topped R320m! Before you get too excited we would remind you this earnings surge is due to the group’s investment performance rather than operational strength. Santam positioned its invested funds optimally to benefit from the stock market recovery that’s played out globally since 9 March 2009.

The group also boasted a significant increase in return on insurance funds and strong operating cash flows. “The group’s operating activities generated healthy cash flows of R958m during the period,” said Santam. Unfortunately the insurer’s underwriting performance was more subdued. At 30 June 2009 the group boasted a solvency ratio of 42% (nicely within its 35% to 45% long-term target) and was able to declare an interim dividend of 166c/share. Santam shares ended the day 0.26% higher at 8927c, representing a gain of 44% since its November 2008 low.

Underwriting performance scorched by large fire claims

It wasn’t plain sailing on the operational front. Business conditions remained tough in the first half of 2008. Santam says under these conditions the 7% improvement in gross written premium is a significant achievement. Although business volumes were moderately better, the group expressed some concern over the risk rating of this business. The short-term insurers appear to be walking a fine line as they attempt to balance appropriate risk rating with premiums the market can accommodate. This is a recipe for disaster in the event of unexpected insurance shocks going forward.

According to Santam “the six months under review have been challenging from an underwriting perspective.” The group net underwriting margin came in at a paltry 1.4%, prompting a slum in the net underwriting result from R326m to just R88m. This plight is similar across the country’s short-term insures. Reasons given for the decline include “negative margins in the property and motor classes.” Underwriting in Santam’s personal and non-specialist commercial business were subject to “marked increases in both claims frequency and cost!” Another major problem – mentioned by rival Mutual & Federal at its recent half-year presentation too – is the massive spike in industrial accident and fire-related claims. The shining lights in Santam’s stable include specialist insurance categories like the liability and crop businesses. Both reported solid performances in the latest half year.

Santam expects the underwriting margin to “remain under pressure during the second half of the year,” although they don’t expect the drag effect caused by large fire claims to repeat over the period. The insurance business is closely linked to economic conditions, and any recovery in the insurer’s personal lines and commercial businesses will be slow. GDP growth is expected to resume in the fourth quarter of 2009, creating a foundation for improved business conditions in FY 2010.

What the future holds

What are the major stumbling blocks going forward? We know the South African consumer is at war with debt. Household debt levels remain unacceptably high and with estimates of 425 000 job losses in the first half of 2009 the situation could deteriorate further. Rising unemployment and cautious spending activity have a knock-on effect on earnings prospects across all business sectors. Santam’s response to this joint challenge is the familiar short-term insurance refrain. They will “optimise profitability in all aspects of the business with a strong focus on risk management and improving effectiveness.” They firmly believe the group’s diversified financial services footprint will see it through.

Santam learnt a painful lesson after the shocking investment account performance in the first half of 2008. Management is painfully aware that market volatility could easily reverse the gains reported in the latest period. To this end the group has taken proactive steps to reduce the downside risk of equity exposure without sacrificing upside potential. “This was done using appropriate derivative structures,” said Santam. Another capital management challenge is that South Africa is at (or near) the bottom of its current interest rate cycle. Santam expects the prime interest rate to remain around 10.5% for some time, thereby limiting returns on cash-related investments.

Santam remains a mover and shaker in the short-term industry. In the latest half year the group confirmed the sale of its 35% stake in short-term insurer Lion of Africa Insurance Company to existing shareholders. In a separate transaction, Santam offered to purchase the entire business of Emerald Insurance Company and Emerald Underwriting Managers. Each of these transactions is subject to Regulatory approval while the Emerald transaction requires shareholder approval too.

Editor’s thoughts: Short-term insurance is often viewed by consumers as a grudge purchase. As the debt load increases it becomes increasingly difficult to ‘sell’ the product. Has Santam performed to expectation by increasing gross premium by 7% in the first half? Add your comments below, or send them to gareth@fanews.co.za