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By Mark Devcich, Pie Funds
CBL is a New Zealand insurer offering a wide range of credit insurance, reinsurance and financial-surety products. The company is listed and regulated in New Zealand, but it generates most of its business from Europe, through an international distribution network that it has developed over
a number of years.
CBL has been one of the best-performing companies on the New Zealand Stock Exchange (NZX) in the past few years – its shares have risen more than 140 per cent from the Initial Public Offering (IPO) price of NZ$1.55 in October 2015.
Local investors deterred by insurance sector
Difficulties in understanding insurance have meant a lot of New Zealand investors have put CBL in the too-hard basket.
The only other listed insurer in New Zealand is Tower Insurance (TWR.NZX), which hasn’t been a great experience for investors, as the company has suffered from large claims associated with the Christchurch earthquakes.
Australia has more listed insurance companies than New Zealand, so Australian investors are more familiar with the specialist insurance sector. It’s one of the reasons why CBL has a dual listing and trades on the Australian Stock Exchange (ASX), as well as the NZX.
Insurance has historically been a tough business globally. The barriers to entry are few and capital often flows into the insurance industry when conditions are favourable. However, more capital increases competition and drives down the profitability margins that insurers can earn.
The insurance business model
Insurance companies can earn money in two ways:
• from underwriting (the difference between premiums and claims)
• from investment returns.
Insurers receive significant amounts of money as premiums in advance of the need to pay out claims. This is referred to as ‘float’, and it can be invested by the insurance company – while keeping sufficient reserves aside to pay out claims as they fall due. The benefits of investing float (essentially other people’s money) mean that insurance companies are often willing to just break even on underwriting.
The insurance industry is cyclical (see Figure 1). During periods of excess capital and low interest rates, underwriting and investment returns can be subdued. This is called a ‘soft market’ and these conditions are what we have experienced in recent times.
Yet, even in tough conditions, CBL’s strong underwriting profitability has generated a solid return on capital, despite the headwinds of low investment returns on government bonds.
CBL’s competitive advantage (its ‘secret sauce’) is down to three main factors.
CBL’s secret sauce ingredients
Disciplined and profitable underwriting
One of the company’s major strengths is the willingness to not write business just for the sake of growth. CBL will only write profitable business. Its conservative management team will walk away from underwriting volume to preserve capital and profitability if the insured risk does not meet the company’s return requirements.
A key reason for CBL’s IPO was to improve its capital base, and this has been instrumental in the insurer achieving a credit rating of A- from AM Best.
This rating allows CBL to write more business in different territories than it has in the past. For example, through its partners, CBL has started to offer financial-surety products into Asia.
Niche insurance markets
CBL has a focus on compulsory insurance coverage, with small policy limits and excellent recovery prospects. It has limited exposure to natural catastrophe risk and enjoys a wide spread of policyholders, which reduces the risk to any one group of policyholders. Most of its lines are renewable products with strong retention rates.
One such highly profitable line is builders’ warranties in France – these protect the builder and/or the homeowner. It is compulsory for the owner of a newly built property or renovation project and the builders to insure against construction defects on the property. CBL’s claims costs are often low as CBL has strong recovery prospects from the other insured party or collateral provided.
CBL can hold its position in these niche markets because it has strong relationships with local partners, who write profitable business on its behalf.
CBL recently acquired 71 per cent of its partner SFS, which is a leading Managing General Agent (MGA) that writes specialist construction-sector insurance products.
The larger insurers are often unwilling to dive down into the markets that CBL operates in – the markets are too small or the insurers don’t have the specialist expertise. The strong relationships that CBL has developed with its partners mean it’s difficult for new insurers to gain the insights to write profitable business in those segments.
Founder-led mindset CBL’s managing director is Peter Harris, who bought the business in 1996. Successful financiers Alan and Alistair Hutchison have also backed the company.
The alignment of the management and the board, and their belief in the business, was shown by the limited sell-down of holdings at the IPO by Peter Harris and Alistair Hutchinson – they relinquished only 12 per cent and 16 per cent of their holdings respectively. Their combined shareholding is worth NZ$412.5 million (based on a NZ$3.75 share price).
Many of CBL’s offshore insurance partners are also private businesses that have a similar owner-operator culture to CBL.
Investing for growth CBL has historically held its investment portfolio conservatively in short-term cash and fixed-income securities (government bonds). It has followed this investment approach because government bonds have the lowest regulatory risk weighting, so they’re the safest form of capital to hold. However, the returns are also the lowest.
With its stronger balance sheet, CBL could improve its investment returns by investing more in equities. The company would also benefit from increased investment income as a result of higher interest rates.
Well-known US insurers, such as GEICO (Berkshire Hathaway-owned) and Markel (NYSE:MKL), have had high-calibre portfolio managers – the likes of Lou Simpson and Tom Gaynor, respectively – who’ve invested a large portion of the shareholders’ equity and float, and achieved strong investment returns from that strategy.
A reassuring outlook CBL’s profitability has increased strongly over the last five years. (See Figure 2.) Its results for 2016 and 2017 are projected to see this trend continue. The 2017 year will include a full-year contribution from its acquisition of SFS, as well as benefits from cost efficiencies and contributions from new business.
On consensus forecasts, CBL is trading at a 2017 price-to-earnings multiple of 11, which is well below the average NZX market multiple of 18.5.
Runway to growth
CBL should enjoy a long period of profitable growth. Its management team has shown it can make opportunistic acquisitions, as well as execute on organic business development opportunities through effective partnerships.
An investment in CBL allows shareholders to ride on the coat-tails of the board and management, who are compounding a significant amount of their own capital alongside the company’s other shareholders.
CONSENSUS FORECAST: The combination of individual forecasts, each calculated using different methodologies, to derive one consolidated average forecast.
REGULATORY RISK: The risk of losing money due to changes in laws or regulations.
FINANCIAL SURETY: Protects a lender against financial loss in the event of a creditor defaulting on a loan or other debt.
INITIAL PUBLIC OFFERING (IPO): An IPO is the first sale of shares by a company new to the share market. Once the IPO is complete, the company is listed on the stock exchange and its shares can be freely traded between investors through the exchange. At this stage the company is referred to as a ‘public’ or ‘listed’ company.
Managing General Agent (MGA): A managing general agent is an individual or a business that can act on behalf of an insurance company. The managing general agent can do a number of different things on behalf of the insurance company, including setting up insurance agents and negotiating insurance contracts.
PRICE-TO-EARNINGS RATIO: A measure of how expensive an individual share is. It is calculated by dividing the trading price per share by earnings per share. A higher price-earnings ratio could also indicate expectations of higher future earnings.
RECOVERY: The ability of an insurance company to pursue a party at fault, typically another insurance company, for the costs it incurred in settling its own policyholder’s claim.