Global insurer QBE 8217 s second strike

It’s very easy to get caught up on financial businesses that look cheap on face value. When QBE downgraded its earnings in January, we said “there won’t be too many brave investors willing to catch this falling knife”. Our grievance wasn’t necessarily that an insurance business had lost money, but rather the way it translated the loss to the market. Within only two months in late 2011 it saw a large reversal in its earnings. That’s life, insurance businesses make and lose money over the cycle. But the thing that struck us most was the big promise of a turnaround in 2012, a very emotional promise built on unrealistic assumptions and the hope that now more “one-off” catastrophes occur.

Today’s downgrade shows that bet hasn’t paid off. The impact of Superstorm Sandy has left QBE exposed and the money it set aside in 2012 when writing premiums has not been enough to cover its new exposures. This is what happens when businesses try to go too hard in too short a time. Instead of making a profit of US$1.6bn this year as market consensus estimates were pointing too, QBE now hopes for pre-amortisation earnings of around US$1bn. That’s not necessarily a bad number, it’s just that the market is now starting to completely lose trust with management and more importantly the board.

Bottom line: For us it’s not about the numbers only. Insurance companies can book the most attractive earnings but if they’re taking onboard too much risk it will eventually come back to bite. QBE has done the right thing by shareholders in the way it has conservatively invested funds during a turbulent time in equities markets. But at the end of the day this is an insurance business and the way risk is managed is now under scrutiny. The 2001-2011 decade run up in profitability was probably more good luck than good management. As QBE tries to find its way again, IAG quietly continues to push into Asia through very attractive acquisitions. Perhaps it has learnt its lessons of failure in the UK but that’s what business is all about – learning from your mistakes, admitting them and moving on. QBE is still in denial.