Different Roads To Boosting Profits
The Age
Saturday July 15, 2000
NRMA's Eric Dodd started the roadshow for the group's $4billion listing with a bang this week.
He told fund managers that results for the year just ended would be 50 per cent higher than prospectus forecasts.
Yesterday NRMA's major car insurance rival, the Royal & Sun Alliance-owned AAMI, announced a 29 per cent profit increase for the 1999 year.
At face value, the NRMA and AAMI performances suggest there is good money to be made from car insurance.
In fact, the stories of the results are different and help to understand the challenges, and perhaps opportunities, facing Dodd as he takes NRMA through to a new era as a listed, for-profit company.
The surge in NRMA's profitability came very late in the. Most of the revision from the prospectus forecast of $184million profit to the $276million now expected related to the steep rise in the Australian sharemarket in the last week-and-a-half.
This, and NRMA's performance history, says that as an insurer, NRMA is a great investor.
Over the past 15 years, NRMA has not made an underwriting profit from its insurance activities, chalking up more than $2billion underwriting losses.
According to its prospectus, it again expects to lose money on underwriting this year and next, although less than before.
AAMI's results, on the other hand, show its underwriting has been consistently profitable - it generally makes money from the insurance business.
Despite the underwriting losses - and the AAMI experience is atypical of the general insurance industry, where underwriting losses are the norm - NRMA has been consistently, occasionally heavily, profitable throughout most of its recent history.
This flows from the investment earnings on its technical reserves and its retained surpluses/shareholders' capital.
The reliance on investment earnings has, not surprisingly, injected substantial volatility into NRMA's results. AAMI has been far more consistent, largely because it hands its reserves over to its shareholder to invest.
In a sense, its results are notional because it assumes, rather than earns, a 6 per cent return on its technical reserves and a risk-free rate plus 3 per cent for its invested shareholder funds. In 1999 this meant a 9 per cent return.
Given the investor-friendly climate over the past decade, its results almost inevitably would have been substantially better had it been able to invest on its own behalf.
As it is, it has generated pre-tax returns on equity of more than 20per cent for the past five years.
The two companies make a good comparison because, while NRMA would describe itself as a financial services group, it is still largely a general insurance group that relies heavily on car insurance.
It is also probably fair to say that, in AAMI, which is essentially a monoline insurer, NRMA sees a benchmark for what it would like to become in its core general insurance operations.
AAMI's success in recent years has been driven by stringent control of its claims and expense ratios, despite a terrific reputation for customer service.
NRMA's demutualisation provides the opportunity, and the need, for NRMA to build on the improvement in the fundamentals of its business that Dodd has been achieving.
NRMA is about to be exposed to the discipline of the sharemarket and the daily judgment it provides. Both its returns and their consistency will have to improve if NRMA is to maximise shareholders' interests.
There is sufficient growth in the end of general insurance NRMA dominates to enable a well-run and focused company to make money at the operational level, particularly given the problems of the other major player, the AMP-controlled GIO.
Dodd is pursuing a strategy of diversification for NRMA to reduce its exposure to the NSW market and its concentration on car insurance.
Unlike AAMI, to this point, NRMA is trying to evolve into a broader financial services group.
This makes it even more important that the underlying performance of insurance operations continues to improve.
While NRMA has tried to ease expectations of an acquisition-spree post-listing, it does have an acquisition strategy and needs to have one to remove some volatility from its results - it needs to take surplus capital out of market exposures and invest it in operational earnings.
It will help Dodd that some of NRMA's self-imposed and expensive community service obligations will reside with the road service business and that the inhibition that mutuals feel in raising premiums will recede when the insurance business becomes a for-profit corporate.
But he faces some awkward issues in managing NRMA's evolution.
The demutualisation and the boardroom warfare it entailed has been distracting for the group. The recent controversy over Dodd's relationship with his chairman, Nick Whitlam, and the demarcations of their roles, suggests the problems will not simply end with the listing.
The market, and the reshaped NRMA board, can be expected to deal fairly brutally with any further governance issues that arise post-listing, but the potential for instability is inherent in the group.
There will need to be a big cultural change as NRMA shifts from a benevolent mutual to a performance-focused corporate, perhaps with some accompanying restructuring, and attempts to better translate its size and brand strength into scale and margin benefits.
Change is a delicate and dangerous issue for an organisation with such powerful brand and customer relationships.
Dodd would be aware that the listing will create a question mark over NRMA's historically high customer retention rates, particularly once policy holders are free to sell their NRMA shares and therefore become simply customers rather than policy holder members.
Certainly NRMA's competitors see an opportunity to win market share.
The fact that Dodd has survived, and the business has fared pretty well, despite the distractions and confrontations of the past year or so, suggests a successful transition from the old NRMA to the new is not beyond him and the organisation.
He could receive some help from an unexpected quarter.
AAMI's success has been built on its focus and the fact that for most of its history it had many insurance company shareholders. As long as it performed, its management was left alone.
The senior management, which has been remarkably stable, has made it clear for a long time that it believes a large part of AAMI's success related to its specialisation in car and home insurance and the intensity of focus this specialisation has generated.
Management has steadfastly resisted suggestions the AAMI brand could be extended further into financial services.
Last year a gradual rationalisation of its shareholder structure ended when RSA became the sole shareholder and stepped up its exposure to, and therefore interest in, Australia with the Tyndall acquisition.
RSA's Australian managing director, Mike Wilkins, is AAMI's new chairman.
In the AAMI annual report issued yesterday, there was an interesting interplay between Mr Wilkins and his chief executive, Brian Keane.
In his chairman's report, Wilkins said AAMI enjoyed such a solid marketplace presence that it had the opportunity, ``should it wish", to expand successfully its products and services.
In his report, Keane commended RSA for ``resisting any temptation to change the sensibly restrained and supportive approach it has demonstrated over the years as its relationship with AAMI has grown".
It is not quite a ``hands off" warning, but it hints at potential pressures and frictions at a point when NRMA's major competitor has an historic opportunity to profit from any NRMA distraction.
Dodd would not be displeased.
© 2000 The Age