IAG's fracturing marriage

One of the most lasting insurance partnerships in Australia – the close link between Insurance Australia Group (IAG) and the Royal Automotive Club of Victoria (RACV) – is under pressure. IAG owns 70 per cent of the Insurance Manufacturers of Australia (IMA) operation which produces car, house and other insurance products for New South Wales and Victoria and some other markets. RACV owns the remaining 30 per cent.

The IMA joint venture was formed in 1999 and ended an insurance price war between the NRMA and RACV. The joint venture lifted margins and helped Insurance Australia Group (IAG) to be split off from the NRMA and list in August 2000.

Unfortunately for IAG shareholders the company has used many of the rewards from its 70 per cent stake in IMA to fund unprofitable ventures off shore. The RACV has used its 30 per cent share of the bounty to build the largest mutual organisation in Australia covering not just motor service but also a series of resorts and clubs and other activities. Including a value for IMA members funds are well above $2 billion and there is no debt.

IAG is looking to expand and in theory the most obvious bolt-on purchase is to buy the RACV's 30 per cent of IMA. And so recently IAG canvassed RACV suggesting an offer price of around the $1.4 billion to $1.5 billion mark. That was followed by a report by the AXIOME Equities Group suggesting that IAG might be able to buy the 30 per cent insurance stake from RACV at just $1 billion.

Both $1 billion and $1.4/1.5 billion were ludicrously low because the RACV not only has a 30 per cent stake but it has the right to buy out IAG at a "fair” price should there be a control change at IAG (IAG's takeover insurance, December 15).

It is the most potent poison pill in Australia because anyone buying IAG runs the risk of the RACV purchasing 70 per cent of the most profitable IAG asset at a price below the value that the bidder placed on the asset in the takeover.

Since QBE made an unsuccessful bid for IAG in 2008, the RACV has always been on red alert to bring in a partner and snap up the 70 per cent IAG stake should there be an IAG control change, but of course the strong preference for RACV is to leave the current arrangement as it is.

The 30 per cent joint venture stake has now been totally embedded into the RACV operation. The group recently purchased the Noosa Sanctuary assets for some $60 million compared to a building cost of $210 million and the money comes from the insurance business (Noosa's Hotel California, November 29).

The RACV network of clubs and resorts has been acquired at discount levels because RACV has had cash at the ready thanks to the insurance investment. But the assets are run on a member benefit basis and are not big profit earners.

If the insurance business was sold and the money returned to members the wider RACV operation could go into melt down. Even if IAG made a serious offer of around $2-3 billion dollars it is unlikely that the RACV would accept.

So the NSW insurance giant would need to run a two to three year campaign to virtually liquidate the RACV in Victoria. It would be no easy task. Members would have to be convinced to take their benefits in a cash sum rather than participate in the flow of low priced benefits they currently enjoy. The example of what happened to the NRMA after the IAG split off would be a big factor in any such fight.

IAG's surprise $1.4-1.5 billion approach will now set the RACV off into a second contingency plan – which might involve bringing partners in to bid for and liquidate IAG to get to their 70 per cent of the profitable insurance venture.

Both parties are now facing each other with bare teeth. The likelihood is that neither will start what will be a war to the death where the loser would be liquidated – but stranger things have happened

Note: I am a member of the RACV and the RACV city club.