Super profit weighted by soft underwriting margin

11 March 2024 Gareth Stokes

The 2023 full-year results published by Santam Limited (JSE: SNT) on 29 February 2024 were somewhat of a Jekyll and Hyde affair, juxtaposing a healthy rise in both earnings per share (EPS) and headline earnings per share (HEPS) with a disappointing underwriting result. During the 12-month period HEPS surged by 27% while the underwriting margin came in at just 3.5%, well below the insurer’s long-term target of 5-10%. The underwriting margin in the prior year was 5.1%.

Earnings soar despite underwriting margin pressures

Despite the lower-than-desired 12-month underwriting result, the insurer was able to reward shareholders with a 64% increase in net income attributable to its equity holders and more than 24% rise in shareholder value. These results were achieved despite headwinds in the overall operating environment. “Weak economic growth in South Africa, our largest market, and elevated levels of inflation and interest rates dented any prospects of a meaningful improvement in consumer disposable income [last year],” said Santam Group CEO, Tavaziva Madzinga. 

The insurer faced adverse weather and fire-related claims; exposure to Turkey-Syria earthquake losses; and elevated claims inflation, among other challenges. But the question many readers will be asking is how the insurer was able to produce excellent EPS and HEPS over the same 12-months that its underwriting profit fell 26%. It turns out the solid profit performance had little to do with the insurance result. Over the period, Santam benefited from a triple-whammy of strong returns on local and foreign money-market and fixed-interest portfolios; foreign currency gains following a weaker rand-dollar exchange rate; and profit realised on the recent disposal of the group’s interest in SAN JV. 

The disposal of Santam’s 10% stake in SAN JV to Allianz Europe was announced back in May 2022, but it took over a year for all the suspensive conditions to be fulfilled. PS, the price tag for the transaction was then published as EUR120.5 million. According to the insurer, its resilient earnings performance was further supported by the Santam Partner Solutions’ Alternative Risk Transfer (ART) businesses, which reported strong results of R516 million thanks to a 33% growth in operating earnings to R443 million and 103% growth in investment return earned on capital to R73 million. 

Earthquake, fire, flood and hailstorm

The underwriting result was explained away by adverse weather conditions; the insurer’s exposure to the February 2023 Turkey-Syria earthquake; run-off losses from cancelled loss-making business; and large fire claims. Santam was quite open about the claims paid following recent fire, flood and storm losses. Floods in the Western Cape cost the insurer R403 million and hailstorm in Gauteng burned through another R180 million. Over the 12-months, fire claims amounted to R422 million compared to R388 million in the prior year. Strip out these catastrophes and hazards and the underwriting margin lifts to 8.4%. 

GWP and solvency on track

In a brief trading statement issued two weeks prior the final result, Santam hinted that its gross written premium (GWP) would show satisfactory growth. At the time this writer used the ‘predicting premium growth’ formula published in his book ‘Everything you need to know about non-life insurance in South Africa’ to predict around 6.5% GWP growth for 2023 made up of 5% for inflation; 0.5% for GWP growth; and 1% to 1.5% for market expectations. The forecast was almost spot on, with full-year GWP growing by 6%. The group remains well-capitalised with an economic capital coverage ratio of 155% versus 156% in December 2022. 

The latest results offer useful insights into the insurer’s longer-term approach to its conventional insurance business. One significant observation is the ongoing focus on profitability which saw around R1 billion in unprofitable GWP stripped from the books over the past year. New business initiatives yielded good outcomes too, with more than 150 000 policies sold in partnership with MTN since its launch in April 2023. And direct-insurer MiWay’s monthly growth almost doubled towards the end of 2023 compared to the first-half, delivering 5% growth over the year. 

There was not much information on the class of insurance business performances, except that the motor class recorded growth of 4% in GWP and the property class by 7%. According to Santam its engineering class achieved excellent growth of 15%, recovering well from 2022, due to solid growth at Santam Re and new business at Mirabilis from outside South Africa. Transportation also had a stellar year as GWP increased by 17% thanks to strong performances from Santam Re and the Specialist Solutions heavy haulage business. 

Rises in reinsurance premiums and reinstatement costs

“We continue to drive diversified growth,” said Madzinga, “The benefits are evident in our results, with a substantial profit contribution from the Specialist Solutions business providing welcomed relief to the adverse claims experience in the Broker Solutions, Client Solutions and Santam Re businesses”. 

He did not, however, dwell too much on the cost of reinsurance challenge facing domestic insurers. This challenge was highlighted in the half-year trading statement which noted exposure to the Turkey-Syria earthquake saw it lose up to its reinsurance retention limit of R150 million. This and other loss events contributed to large reinsurance premium hikes and heavy reinsurance reinstatement premiums in the latest period. 

This may be an appropriate time for some insurance theory, specifically to explain reinstatement. In layperson’s terms, the reinstatement premium is an amount that an insurer pays to its reinsurance partner in the event the maximum limit on its ‘excess of loss’ type reinsurance contract is breached.  In the event the maximum loss limit for a reinsured catastrophe peril is breached during the course of the year, the insurer will find itself without cover for that peril. Reinsurance companies accommodate the rising frequency and severity of natural catastrophe losses by including reinstatement conditions in the reinsurance policy, allowing an insurer that exceeds its annual cover limit to reinstate cover for the remainder of a period, subject to paying over another premium. 

The reinstatement premium can be significant, and may even exceed the original premium charged for the entire 12-months. For example, Santam suffered a net loss after reinsurance and reinstatement premiums of R570 million following the April 2022 KwaZulu Natal floods. Excluding that event, the insurer had already paid flood reinsurance reinstatement premiums of R69 million in the first half of 2023 versus R50 million in the first-half 2022. PS, you will encounter many variations of reinstatement and should pay close attention to areas such as sub-limited perils in property catastrophe reinsurance contracts. 

The slow domestic growth and unemployment drag

Santam is not optimistic about South Africa’s 2024 economic prospects. They expect structural limitations in areas such as electricity supply and transport to place severe pressure on economic activity and investor confidence. On the plus side, the insurer hopes for some relief in the personal disposable income ‘space’ as both inflation and interest rates appear to have peaked. They note that a decline in interest rates would be supportive of GWP in the short-term. “We remain confident in the group’s prospects and the potential to deliver enhanced growth and profitability through several strategic initiatives,” Madzinga concluded. 

Writer’s thoughts:

There are so many extreme weather related events in South Africa these days that we risk forgetting how much insurers chip in to assist policyholders. Are you surprised by the losses retained by Santam following flood events in KZN in April 2022 and the Western Cape, early-2023? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts

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