Why are analysts so upbeat on IAG?

That gets to a problem IAG has suffered for several years: costs of settling claims or solving stuff-ups have ballooned beyond the insurer’s initial prediction. And in this latest example, it meant last year’s profits were higher than they should have been and a key earnings target was actually missed.

Yet enthusiasm remains for the company and the sector as premiums rise; of five specialist insurance analysts, three have buy recommendations for IAG.

IAG’s latest blowout arose partly from what’s known as claims development, where claims costs inflate more than initially anticipated.

That is usually associated with what’s called “long-tail” claims. Take, for example, someone being injured – the final bodily damage may only be known months or years later. Hence, bills balloon.

Damage from “short-tail” claims, such as a house burning down, are usually more obvious early on, so predictions are more accurate.

But claims development can still strike short-tail insurance too. IAG this month said inflationary trends remained “elevated” particularly in car claims, resulting in “prior period development in our first half result as we finalise the settlement of short-tail claims for amounts more than we expected at 30 June”.

No hard number was supplied but the rising motor-claim anecdote surprised analysts. “This is a negative, noting [IAG] had previously flagged reducing motor inflation,” JPMorgan analyst Siddharth Parameswaran wrote.

Citigroup’s Nigel Pittaway said: “IAG seems to have been, once again, caught out by the month-by-month volatility in motor claims.”

More pain included an additional $47 million in claims from wild weather events that actually occurred last financial year, but IAG said the final damage bill had only now become apparent.

This $47 million was “primarily” from a hailstorm that bulleted golf-ball sized hailstones on homes and cars in NSW’s Hunter Valley-Newcastle region on May 26, it said. The Australian Financial Review has since confirmed the hailstorm represented 60 per cent of that cost.

At last financial year’s end IAG had been pressured to hit targets because analysts had earlier criticised it for downgrading guidance after costs rose faster than anticipated.

Since February, IAG had argued insurance margins would be “around 10 per cent” for the financial year. Come August, the official figure hit 9.6 per cent.

But that would have been about 9.2 per cent if that $47 million had been booked earlier. If the unspecified motor-inflation problem is included, the figure is potentially worse.

It followed earlier insider concern linking IAG missing internal warnings about failing to pass on discounts for six years – which cost more than $500 million – partly to cultural shortfalls including a reluctance to deliver bad news.

IAG defended the timing of releasing additional damage details and pointed to other factors such as the May hailstorm. “The estimated cost of any event can change over time, as we get a clearer understanding of the cost,” it told the Financial Review.

The hail had initially appeared small and damage moderate. “Over time it emerged that there were pockets where the hail was larger, and the damage was more significant,” IAG said.

Many customers also “didn’t identify damage until sometime after the event and as a result we’ve seen a large number of late property claims since [financial year end].”

Despite the downgrade, analysts such as Hunter Green’s Mark Tomlins remain positive with buy recommendations.

“IAG has many attractions including strong brands, a reasonable track record on claims management, and a positive premium rate outlook. Its strategic targets add the potential for improved future business performance and continue to encourage us retaining our positive outlook … despite the strong [environment] headwinds,” he wrote.

Citigroup’s Mr Pittaway said the comparative lack of natural disasters so far this financial year was positive. He further anticipated the benefits of premium rises to flow through later this financial year and next.

Morgan Stanley’s Mr Stadnik, while neutral on IAG, agreed: “Insurers are well-placed to over-earn,” he said of the predicted benefits of this year’s El Nino period.