Picking a challenger brand in the insurance sector

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Boutique investment manager Forager Funds Management remains committed to the life insurance challenger brand Freedom Insurance, despite recent volatility in its earnings and share price.

Forager had a good year last year, with its Australian Shares Fund producing a return of 24.9 per cent for the 12 months to the end of December, compared with a return of 12.5 per cent for the S&P All Ordinaries Accumulation Index over the same period.

Over the past three years the fund has returned an average of 20.3 per cent a year, compared with an index return of 9.2 per cent a year.

In its latest quarterly report, Forager says there is a good investment case for life insurance industry disruptors. The Australian life insurance industry generates around $16 billion of annual premiums.

Banks and financial advisers control 85 per cent of the market. The remaining 15 per cent belongs to the direct-to-consumer channel.

“The banks and their related parties are under significant political and regulatory pressure due to poor customer outcomes,” says Forager chief investment officer Steve Johnson.

“Commissions have been high, process poor and policies difficult to understand. As a result, nimble players like Freedom should continue to win market share.”

Of the 15 per cent market share held by the direct-to-consumer channel, Forager estimates that Freedom has an 11 per cent share – up from 6 per cent a year ago.

Freedom works in partnership with Swiss Re, which underwrites the insurance risk. Freedom’s role is to design products, distribute and market them, and administer policies.

Forager says this business model requires little capital investment, as Freedom uses Swiss Re’s balance sheet to write business.

“The overall market is expanding, thanks to a growing and ageing population. Freedom says its growth is with customers who cannot afford to buy insurance through a financial planner,” Johnson says.

Freedom’s strengths have been low cost distribution and sourcing uninsured consumer segments.

“This requires ingenuity and experience, which likely takes some time to build. So, while new firms are likely to enter that industry, it will take time and serious effort before they become a serious threat. In the meantime, Freedom has the opportunity to build scale,” Johnson says.

When Freedom sells a policy, it receives an upfront commission from Swiss Re that roughly covers its customer acquisition costs. It also collects trail commissions over the life of the policy and it’s these trail commissions that represent Freedom’s economic profit.

The upfront commissions and the present value of the entire stream of future payments are booked immediately as revenue. In the early years of its existence, the company reports revenues well in excess of cash flow. As it matures, revenue and cashflow align.

In November, Freedom announced that sales in the first half of the financial year would be in the range of $27 million to $29 million. This is down from the $33 million of sales in the previous half.

“Assuming perpetual growth is a mistake but the 50 per cent share price fall since June makes a stock look like good value,” Johnson says.

Freedom’s share price soared from 40 cents in January to 90 cents in August, only to collapse back to 90 cents in November. Forager is looking for better things from its holding.


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