Investors of insurance company stocks love falling expenses as that is the only way an insurer will make quick profits given its long-term nature.
ICICI Lombard General Insurance Co. Ltd delivered just that in the third quarter (Q3) results and a 3.8% gain in the stock on Tuesday should occasion no surprise.
The company reported a modest 5% rise in its net profit to Rs231.76 crore for the quarter ended December but the key highlight was the sharp drop in expense ratios. Management expenses as a percentage of gross direct premium income fell to 23.5% from 25.9% because the insurer managed to keep a lid on its commissions to agents as well as other operating expenses. Total expenses, however, rose marginally by 7% for the nine-month period ended December 2017.
The result was an improvement in the combined ratio—a gauge of incurred losses and expenses as a percentage of premiums earned—to 96% from 106.6% a year ago. For the entire nine months ended December, the combined ratio improved to 100.4% from 106.2%.
This means that ICICI Lombard made an operating profit in Q3 through its underwriting business. The company’s loss ratio also improved to 76.3% from 79.8%.
The big question is whether this would sustain going forward. The insurer’s management is also not confident of maintaining the current ratios, although chief financial officer Gopal Balachandran did say that the endeavour would be to not let the ratios deteriorate from here.
Interestingly, brokerage firm Macquarie just a week ago had flagged concerns and rated the stock an “underperform." Macquarie is worried that there is too much lag between expenses incurred on insurance business and premiums collected, which indicates that the general insurer will struggle to keep its operating profit intact. Further, the grossly under-penetrated general insurance market is too enticing to ignore and the competition is heating up.
The brokerage firm’s concerns are certainly not misplaced. ICICI Lombard’s gross direct premium income grew 17% in the nine months ended December and this would increase if the insurer is serious about expanding its market share, currently about 8%. Growth in business will bring losses upfront to the company. That means the underwriting profit or operating profit would likely peter out.
The ICICI Lombard stock trades at a rich premium of 6.4 times its estimated book value for fiscal year 2020. Considering the headwinds of competition and possible rise in expenses, the valuation looks unsustainable.