Taking Stock 29 July 2021

THE release last week of the results of an investigation into 42 of New Zealand's largest insurance companies has highlighted two issues that no investor should overlook.

The Financial Markets Authority (FMA) released its findings, after surveying the insurance sector, specifically the fire and general insurance sector.

It found that in almost every case, rotten, self-serving practices have prevailed for years.  I would guess they have prevailed for decades.

Insurers did not just use rotten practices to obtain premium income for events that the sector then tried to side-step.  It also promised rebates for multi-insurance loyalty and did not apply the discounts.

It allowed the public to fill in forms, accepted the forms, accepted the premium payments, and then when a claim was made, used the fine print of the law to debate, and try to avoid, payouts.

Investors should make themselves well aware of this foulness.  The FMA believes refunds, totalling many millions, are due to investors.

Just one simple example is commonplace.

To obtain income protection or health insurance, a new client might be asked to testify that he/she has had no medical history that might suggest an existing health condition.

Someone who once fainted in church, but did not think to disclose that, might find any claim was disqualified.

It seems some insurers would seek to debate whether the full disclosure had been made if there were any possible excuse for not accepting a claim.

The second issue that all investors should record is that there is now undeniable evidence that the Financial Markets Authority has teeth and knows how to chomp.

It has attacked various KiwiSaver managers, nearly all of whom are much better at marketing than they are at adding value.  Their fee structures, especially for the index funds, are absurdly high.

The FMA has attacked various financial planners and has had them brought in front of the courts.

It has the banks on high alert that it is not just the Reserve Bank which is watching bank behaviour.

The FMA is now intervening to ensure that, in the finance sector, remuneration policies reward excellence, but do not set their rewards based on selling targets.  Quantitative assessment will gradually replace bonuses based on the volume of sales.

I expect there will be new internal criteria to ensure profit-sharing, or bonuses, are decided on excellence and value-add.

The extreme salaries and bonuses that have made multi-millionaires out of people, who in at least one case was a crass front-runner, will soon have to be justified by excellence in client outcomes.

The FMA was initially headed by a gutsy ex-banker, Sean Hughes, who fought the finance company cheats, albeit with an inadequate budget, and with government interference that placed hurdles in his tracks.

When Hughes left, a softly spoken but competent British lawyer, Rob Everett, arrived, genuinely experienced in matters of governance and institutional behaviour.

He leaves in a few weeks, at a still young age, probably seeking relief from the grind of working his way around those who resisted decent standards during his seven-year reign.

Hughes and Everett have done much to erase the memories of the Securities Commission, whose contributions in the 1980s and 90s, despite a pitifully low level of political support, far exceeded those of the Securities Commission's last leader, Jane Diplock, who oversaw the finance company sector.

Diplock was saddled with co-governors whose achievements in most cases bore no obvious pathways to the governance requirements of a regulator.

She seemed in awe of the NZX, whose record as a regulator was even worse than Diplock's, its leader Mark Weldon simply inept, talents misdirected, a brat, in my language.

To be fair to Diplock, she too had pathetic political support, leaving her with weak staff (Liam Mason, her senior counsel being one honourable exception).

The Clark government's Commerce Minister, Lianne Dalziel, would probably be the first to agree that the finance company debacle was largely attributable to her own ignorance and her inability to understand the sector, and maybe her unwillingness to apply energy to learning about the sector.  She watched, as looters ran down the streets, brandishing investor money.

She and Clark could not be convinced to apply attention to the sector, but Diplock shared the blame; a regulator with no empathy for investors or markets.

The FMA has reached far greater heights than Diplock's Securities Commission.  Everett, like Hughes, will leave knowing that he has opened doors on poor behaviour that can no longer be closed, silently.

The insurance sector, like the banking sector, has had a toxic culture for decades; generally dreadful governance, arrogance from overseas owners, poor practices known but not addressed.

Taking Stock was fairly aggressively discussing those matters a mere 35 years ago.  Nobody seemed to care.  The insurance sector's response was to ask me out for dinner, rather than to fess up and address the behaviour.

There is very little satisfaction in noting that at last the doors are being prised open, but meanwhile hundreds of millions have been captured by the people who escaped the regulators' attention.

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THOSE who pay premiums to buy insurance should be protected by a simple new practice.

When an application for insurance is made, the attached premium payment should be held in a trust account.

After a prescribed period – say, thirty days – the payment should be returned to the client if the insurer believes there are errors or omissions in the application form.  Thirty days is enough to complete due diligence.

Alternatively the payment should transfer to the insurance company, signalling that unless clear fraud has been committed by the applicant, the disclosure has been checked, validated, and the policy is thus approved.

Accepting premiums for years, and then seeking to invalidate the policy because of error or incorrect omission, should be a practice that the FMA's enquiry will abolish.

Congratulations to the FMA for its refusal to bow to this Old Boys Network.

Next up, will they please do this to liquidators and receivers, where too often equally rotten practices are left unchallenged, at the great expense of those who are not bankers, trust companies, lawyers, accountants, repossession agents, storage suppliers, financial advisers, investment banks or, in a few cases, close friends or relatives of the liquidator/receiver?

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WHEN the Ponzi scheme clown David Ross was exposed, his investors lost at least $100 million.

The ANZ had been the banker for his magic mining stock fund for many years.  The bank and a tiny number of under-powered financial advisers helped Ross build credibility.

Any inspection of his bank accounts would have made it obvious that he intermingled client money with his own business funds, and frequently used incoming client money to pay his personal and company bills.

Unsurprisingly, those who lost vast sums have posed a question; how come his banker, ANZ, took no apparent interest in what by any description was an illegal business?

Equally unsurprisingly, the investors have found a litigation funder (LPF) to bring a case to court to test the possibility that the ANZ breached its duties by taking no interest in how Ross accounted for other people's money.

It is sad to record that there is no market surprise that the ANZ has inadvertently lost a swathe of records that might have shed light on the alleged neglect of the bank.

Did anyone in the bank notice the anomalies, record them, and take no further action, or, more likely, hand them on to others who saw no fire under this smoke?

A fair alternative question is whether a bank has any obligation to oversee accounts, other than to meet money laundering laws, or the potential funding of terrorism, its only responsibility being to ensure any credit facility it offered carried minimal potential bank loss, in the future.

We will learn the High Court's opinion of what highly privileged bankers must do to earn the privileges that come with a banking licence.  The licence is a pathway to soft profits, we all would acknowledge.  Surely a bank has to earn this privilege.

That ANZ has lost important records will not mean that this case dies for lack of evidence or proof.

Indeed it is conceivable that the bank's mistakes will not help to convince a judge that the ANZ has conducted itself faultlessly.

The case will set important precedents.

Either the banks do not need to oversee accounts and take action where there is reasonable doubt that the account holder is behaving legally and fairly, or the banks are expected to blow a whistle when smoke implies underlying flames, in this case from the incineration of other people's money.

It is fair to note that if the banks do owe a duty of care to those who interact with a rotten business, a whole new raft of costs would fall on the banks.

Someone would have to pay this cost.  Might this imply a new fee - call it account supervision fee - applicable to all new account holders?

We will discover the outcome of this matter unless, of course, a confidential, out-of-court settlement is reached, the penalties paid out to Ross' investors, subject to their signing a confidentiality agreement requiring full repayment should any investor breach that agreement to remain silent.

Of course with such a settlement no liability would be conceded by the bank.

We would not want, after all, to set a precedent and create new law, would we?

There are many ways of reining in the Australian banks and forcing them to appoint appropriate directors, rather than politically-savvy hacks.  Politics, after all, is the central skill of most executives in banking.  Careers are built on office politics, sadly.

A court ruling might be a decent tug on those reins.

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THAT ANZ is accused of such poor supervision is not altogether surprising.

Other large banks offend regularly, the most recent bank to be accused being Deutsche Bank, the German giant which has now retreated from New Zealand, after ending a presence through its link with the Tauranga-based sharebroking, funds management business, Craig & Co.

Deutsche Bank is accused of allowing German Ponzi schemes to blossom, failing to observe the most obvious discrepancies.

Of course, Deutsche Bank has the undesirable sobriquet of being Europe's most delinquent bank, having paid billions in fines, some resulting from its involvement in allowing the likes of Putin and other Russian billionaires to smuggle their ill-gotten money out of Russia and into equally complicit American and British banks.

Deutsche Bank is Europe's equivalent of Goldman Sachs.

The highest profile misdeeds of American and British banks have centred on the revolting bonuses stolen from shareholders, the most obnoxious example being Merrill Lynch's misuse of government subsidies around the 2008 global crisis, when the US taxpayer poured tens of billions into a banking salvage operation.

Literally billions of this troubled asset relief programme were purloined by bank executives, billions in bonuses given to the same incompetent and greedy idiots who over a decade had caused the banks to falter, with their no-documentation, liar loans, their absurd speculation in foreign exchange, derivatives and commodity trading, and their personal greed.

I guess one day we should move on from these memories but even when that day arrives, we should still refuse to pay homage to those ex-banking millionaires who were the beneficiaries of the bonuses from that era.

They were not then, and are not now, self-made millionaires, basking in the rewards of their admirable achievements.

They are simply people who escaped banking before the balloon went up.

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Johnny Lee writes:

Z ENERGY has provided an update to market in the form of its Investor Day, giving current and prospective shareholders a glimpse into the vision and long-term plan for the company by the current management team.

Z Energy – once something of a staple of income portfolios held by retail investors – has been on a consistent downtrend over the last few years, driven by technological and societal change, an extremely competitive environment and of course the dramatic impact of Covid-induced lockdowns.

The update addressed many of these points and serves as essential reading for Z Energy shareholders.

The first and most obvious message conveyed is that, while Z Energy is aware of the headwinds facing its long-term future, it sees ''more risk to shareholder value by rushing in (to change), so we will retain optionality''.  Effectively, it sees an industry with many moving parts and rapidly evolving market forces, that would heighten the risk of an early bet on a particular horse.

The risks associated with technological change are obvious.  Z Energy's primary business is the distribution of petrol and diesel to motor vehicles.  Electric vehicles, while a tiny part of our current fleet, are unlikely to be anything but an accelerating force.  With global vehicle manufacturers ramping up their commitments around electric vehicles, it is only a matter of time before this flows through to New Zealand.

As the Climate Change Commission's report noted, our vehicle market is heavily reliant on Japanese imports, in part due to our minority position as users of right-hand drive cars.  Accordingly, our progress will be entwined with the government policies and consumer choices of the Japanese, which adds an additional degree of difficulty with forecasting.  Broadly speaking, the expectation is that electric vehicles will overtake traditional internal combustion engines in the mid-2030s.

One point made by Z Energy specifically regarding this was the likely distribution of such uptake, and indeed what an average petrol user will look like at this time.  Motor vehicle owners who live in central cities, drive infrequently and fill their tanks even more infrequently, are not generally sought-after customers.  These vehicle users are perhaps more likely to be at the forefront of electric vehicle adoption, as concerns around battery life and range anxiety are less relevant to the car owner who drives from Taranaki Street to Lyall Bay one day a week.

Conversely, the customer who drives fifty kilometres to work from Paraparaumu to Wellington - via Transmission Gully of course – will face a different set of needs.  The trucking industry, bus services, Uber drivers and airlines are all facing changes on this front, and Z Energy is actively analysing its response and trying to position itself as having the flexibility to address this new consumer.

Electric vehicle adoption is not necessarily a death knell for Z Energy.  The company instead highlights the opportunities that exist in this space – in terms of participating in the ''High Speed Charging'' space in strategic locations that users will occupy.  Geographic location may also become paramount in capturing the demand of the remaining internal combustion users, if their vehicle use is to be relegated to long-distance travel.

Z Energy also gave a formal forecast around jet fuel demand, predicting it will not fully recover until 2025.  At this point, it almost seems pointless to try to accurately forecast such a recovery.  With the globe now in the grip of a Covix resurgence, driven by the Delta variant, investors need to accept that such forecasts are going to vary wildly from company to company.

Alternative fuels including biofuel and hydrogen were also discussed.  The impact of biofuels is likely to be limited to partnerships with local producers, while hydrogen is being examined through the lens of servicing the heavily vehicle transport market.  Z is exploring what this market may look like, and whether it would consider a role in hydrogen production.  It sees itself as ''well placed to offer hydrogen refuelling'' should the trucking industry move in that direction.  The company also believes hydrogen may have a role in decarbonising the aviation and shipping industries.  Readers may recall Contact Energy and Meridian Energy's recent comments regarding hydrogen production in the South Island, as the two electricity generators sought to stimulate discussion around such an idea.

In terms of capital management, Z Energy made it clear that the company wanted to de-leverage (repay debt) and focus on producing a sustainable - in the short-term at least - dividend of no less than 19 cents per share.  That dividend does come with the increasingly common caveat ''under all plausible circumstances'', a reminder of the dark days of the national lockdown which saw Z Energy crumble in value.  Nevertheless, a 19 cent dividend will entice more than a few investors, although the rise of ESG funds globally will naturally make the share trade on higher multiples than it otherwise would.

This fall in value, and the absence of a recovery, has led some to label Z Energy as a potential acquisition target, highlighted by the sudden rationalisation within the oil and gas industry.  Time will tell if there is any truth to such commentary, but in the meantime shareholders can enjoy their 19 cent dividend, as the company aims to position itself to face the challenges ahead.

TRAVEL 

Johnny will be in Tauranga on 26 August.

David will be in New Plymouth on Thursday 19 August.

Kevin will be in Timaru on 5-6 August and Christchurch on 11 August.

Michael will be in Auckland on 18 August then Hamilton and Tauranga in September.

Chris will visit Christchurch on August 17 (afternoon) and 18 (morning) and begin again to earn his keep! Clients wishing to review their portfolios are welcome to contact him now, as he is unable to extend his stay to accommodate late requests. He will undergo his second operation on 8 September and thus will not be returning to Christchurch until October.

On Wednesday 25 August he will be in Auckland, able to meet by arrangement in Ellerslie and Albany. To date, he has six available times in Ellerslie, beginning at 10am (Ellerslie International Hotel).

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd