We  came  away  from  our  recent  meeting  with  LPI  feeling  positive  on  the  group's prudent  underwriting  strategy  and  efforts  to  overcome  the  growing  industry headwinds. However, as we are less bullish on its earnings pace, we are revising lower our net  profit  forecasts  by  3.3%  and  8.4%  for  FY12  and  FY13  respectively. We  downgrade  our  call  to  NEUTRAL,  with  our  FV  tweaked  lower  to  RM14.82. Based on the current price and our dividend payout forecast, LPI's dividend yield is still an appealing 5%.

Weaning off reliance on motor segment. The high-risk nature of the motor segment is not  expected  to  significantly  concern  LPI  as:  i)  LPI's  motor  contribution  has  been declining, dipping from 30% in FY10 to 24% in 9MFY12, and may fall further to 20%, ii)
the company has recognized its share of MMIP's losses on a 'smoothed' basis, and iii) it adopts consistent strict underwriting policies.

High  reinsurance  not  a  concern. We  are  not  overly  concerned  on  the  high  usage  of reinsurance, due to the following: i) LPI has minimal exposure to foreign exchange risks, ii) it conducts business with foreign reinsurers with at least an A- rating, and reviews the reinsurers'  performance  annually,  and  iii)  leading  global  reinsurers  have  been developing more sophisticated and resilient risk and capital management products. We think LPI's reinsurance programme is adequately prepared against counterparty risk.

The challenges ahead. LPI is focused on enhancing services, claims management and cost  efficiencies  moving  towards  2016  when  detariffication  is  expected  to  commence, while  securing  customer  loyalty  and  agent  productivity  versus  the  rise  in  foreign insurance players. The management has expressed interest in venturing into the takaful industry,  but  given  the  licensing  restrictions,  it  is adopting  a  wait-and-see  approach  for potential opportunities.

Downgrade to NEUTRAL, FV revised to RM14.82. We are revising downward our net profit  forecasts  by  3.3%  and  8.4%  for  FY12  and  FY13  respectively,  due  to:  i)  lower forecasts  for  earned  premiums  growth  to  11.5%  and  13%  for  2012  and  2013 respectively, ii) a lower retention rate that is closer to ~60% and iii) a net commission ratio of 7.4% and 7.5% for 2012 and 2013 respectively.  Our revised FV is now based on a three-year PE band of 19x against FY13f EPS, which implies a 14% premium to the weighted average PBV multiple of the industry's recent M&A transactions.  

Dividend  yield  still  attractive.  Although  we  are  nudging  down  our  dividend  payout estimate to 95%, the dividend yield is still an attractive 5% at the current share price.

MOTOR 
 
Motor  segment  ratio  over  premiums  on  the  decline.  We  believe  that  the  high-risk,  lumpy  nature  of  the motor segment  is  not  expected  to  be  of significant concern to  LPI, due to  the  following: i)  LPI's  already-low reliance  on  motor  premiums  has  been  on  a  downtrend  from  30%  in  FY10  to  24%  in  1H12,  while  the management hopes to decrease its reliance further to 20%, ii) the share of MMIP losses has been recognized on  a  staggered  basis,  and  iii)  LPI's  consistent  strict  underwriting  policies  will  largely  help  to  mitigate  the upside  in  its  claims  ratio.  The  company  generally  does  not  offer  third-party  insurance  coverage,  opting  to focus  more  on  comprehensive  coverage.  Other  considerations  are  minimising  coverage  to  vehicle  brands prone to theft and commercial-type vehicles.

Staggering the absorption of share of MMIP losses. Our previous report stated that the motor segment's claims ratio in 4QFY11 spiked to as high as 99% due to a one-off occurrence in its share of Malaysian Motor Insurance  Pool  (MMIP)  losses  amounting  to  RM11.1m.  The  management  said  that  for  FY12,  the  share  of MMIP losses borne by LPI has been staggered or 'smoothed' at RM2.6m-RM3m per quarter. We believe this could be recorded at slightly >RM3m for 4Q's results but should not be a significant impact on the motor claims ratio so long as stringent underwriting is in place.

FIRE 
 
Fire insurance premiums still the prime driver. Sales of fire insurance is expected to continue riding on the property  loans  growth,  especially  those  offered  by  Public  Bank,  being  the  largest  segment  with  superior underwriting  margins  before  management  expenses  of  >70%.  According  to  the  management,  the  gross premiums  split  is  about  half  for  residential  properties  and  the  remainder  for  commercial  and  industrial buildings,  of  which  commercial  properties  have  a  slightly  higher  allocation.  Commercial  properties  are deemed the best choice due to its higher premium values with moderate risk exposures. However, as we are less bullish on the property sector moving forward, we believe growth for this segment should moderate from FY13 onwards (9MFY12: 16% y-o-y growth).

REINSURANCE 
 
High  reliance  on  reinsurers.  As  a  general  insurer,  the  company  has  traditionally  ceded  substantial premiums to reinsurers, as evidenced by the low retention ratio of 65% vs the industry average of about 81%, based  on  BNM's  statistics.  Although  it  is  a  good  thing  to  have  as  much  reinsurance  usage  as  possible  to mitigate claims risks, the company's reliance on many global reinsurers  has  exposed  it  to  international insurance  cycles.  However,  we  are  not  overly  concerned,  since:  i)  LPI  has  a  minimum  exposure  in  foreign exchange risks in USD (the main currency denominator in the global reinsurance market), ii) it is comfortable conducting business with foreign reinsurers of at least an A- rating from agencies like Standard & Poor's; the financial stability and reinsurance track records of these reinsurers are annually reviewed by the management and iii) leading global reinsurers have been revamping themselves with more sophisticated and resilient risk and capital management, after having experienced several tranches of major catastrophic losses for the past decade. We think LPI's reinsurance programme is adequate against counterparty risks.
 
INVESTMENT 
 
Good  mix  of  long-term  investments  and  liquidity  position.  LPI's  investment  objective  is  to  strike  a balance between long-term capital growth and ample liquidity in its portfolio. It has a "buy and hold" strategy where  the  company  focuses  on  investing  in  blue-chip  securities  with  high  dividend  incomes,  which  are currently at >50% of its total investment portfolio. A large portion is invested into Public Bank's shares, mainly enlarged due to revaluations in its carrying value. Short-term cash investments comprise approximately 25% of  its  portfolio,  while  the  remainder  is  largely  allocated  to  government  bonds  and  other  held-for-maturity financial assets. The management is looking at a 4%-5% in overall investment yields.


KEY CHALLENGES 
 
Preparing for detariffication. Recognising this challenge, LPI focuses on enhancing customer services with existing  and  prospective  clients,  as  well  as  claims  management  which  are  partly  attributed  to  underwriting prudence.  It  does  not  rule  out  further  enhancing  cost  efficiency,  mainly  done  by  compressing  management expense  ratios  as  it  moves  towards  2016  when  detarifficaton  is  expected  to  commence.  We  note  that  its management expense  ratio  is  at  a  healthy  level  of  ~15% and  the management  is confident  to maintain  this ratio below 20%.
 
Rise  of  the  foreign  players.  As part of the industry's' liberalization, there has been an increasing trend of major foreign insurers entering the market through M&As. These players are likely to command better capital and  global  expertise  in  the  market,  have  key  access  to  certain  customer  segments,  and  most  importantly, may  have  more  experience  in  managing  detariffication,  as  it  may  have  managed  events  that  happened overseas.  However,  LPI  believes  that  its  undiminished  track  record,  focus  on  agent  productivity  and  long-standing  relationships  with  its  clients  will  give  the  company  the  upper  hand  to  maintain  growth  moving forward. Currently, agents contribute a substantial ~45% of LPI total premiums.

Venturing  into  takaful.  Given  the  increasing  incentives  and  expectations  of  the  takaful  industry,  the management  has  expressed  interest  in  the  takaful  business.  However,  this  is  still  subject  to  BNM's restrictions on takaful licensing. As of August, there were 12 takaful players licensed by BNM.

VALUATIONS REVISION  
 
Net profit revised  lower. We are revising our net profit forecasts downwards by 3.3% and 8.4% for FY12 and  FY13  respectively.  The  downward  revision  is  mainly  due  to:  i)  the  upside  in  LPI's  investment  income being  fairly  limited  given  the  company's  conservative  investment  portfolio;  although  the  company  has substantial exposure to equity classes, we do not see realization of  a large portion of these unless dividend income is compressed, ii) lower forecasts for earned premiums growth to 11.5% and 13% for 2012 and 2013 respectively, iii) a lower retention rate closer to ~60%, iv) a higher net commission ratio of 7.4% and 7.5% for 2012 and 2013 respectively.

These are, however, offset slightly by upward revisions due to: i) a lower tax rate of 23% and ii) expectations of its claims ratios dipping marginally to below 50% from 2013 onwards in line with  LPI's efforts to enhance its underwriting policies and pricing strategy.

Downgrade to NEUTRAL, rolling over our forecast to FY13 with FV revised to RM14.82. We are rolling over our forecast to FY13 EPS, implying a FV of RM14.82, which gives a 9.8% upside from the current share price.  Hence  we  downgrade our  call  to  a  NEUTRAL.  At  the  current  price,  LPI  is  trading  at  17.5x  FY13  PE and 2.2x forward BV. Our revised FV is pegged to a 19.0x average three-year PE band, and translates into 2.45x forward BV.

Still at a premium. With our FV, the forward PBV multiple is at a 14% premium to recent M&A transactions in the industry, excluding the pending disposal of CIMB Aviva to bids from severallarge global insurers. 

However, dividend still attractive. Assuming our revised dividend payout of 95% (based on the historical 10-year dividend payout trend), the dividend yield based on the current share price is still >5% for both FY12 and FY13. Although LPI does not have an official dividend policy, management does not see any downside on  this  payout  trend.  The  high  payout  ratio  would  not  compromise  LPI's  internal  capital  adequacy  levels which are already above the minimum 130% capital adequacy ratio (CAR) requirement by the regulators.

 Source: OSK