IAG expects to record sharp falls in earnings for the last financial year as the business copped a huge blow from adverse natural perils, prior period reserving and credit spread factors.

The insurer made the grim predictions on Friday ahead of the release of its 2019/20 financial results on August 7.

IAG says its insurance margin will likely come in at 10%, lower than its 12.5-14.5% guidance. In the 2018/19 year the insurer recorded an insurance margin of 16.9%.

Higher than anticipated attritional perils experience in the June quarter has probably pushed up net natural peril claim costs to $904 million, IAG said. It forecast in February a figure of $850 million.

Preliminary figures show cash profit is set to drop 70% from a year earlier to $279 million, while net profit will fall to $435 million from $1.08 billion. The business expects to record an after-tax profit of $326 million from the sale of its 26% interest in SBI General Insurance in India. The sale was completed in March.

IAG did see a short-term drop in new business volumes in the March-May period when the economy was hit by nationwide lockdown measures, reducing gross written premium (GWP) by $80 million. But volumes have since returned to normal levels in most of its core portfolios.

“These are not the numbers we envisaged at the beginning of the year,” CEO Peter Harmer said in a conference call with analysts.

He says IAG will not be giving earnings projections for the current financial year because of the pandemic.

While the pandemic has had a “broadly neutral impact” on its reported insurance margin, IAG has set aside around $100 million to provide for potential claim cost impacts from business interruption (BI), landlords and other lines.

Deputy CEO Nick Hawkins says the business maintains the view “there is a specific exclusion for pandemics in our policy wordings” for BI policies.

He calls the $100 million provision a “conservative” position taken by the company to factor in possible fallout from the pandemic, which includes the estimated impact of an economic downturn on the settlement of long tail claims.

Some law firms are arguing that insurer exclusions that cite the repealed Quarantine Act would not hold up. But insurers say the intention of the exclusions is clear regardless of which act is referred to

Analysts from Credit Suisse have crunched the potential fallout on IAG should the BI exclusion not hold up in court legally, putting a likely claims exposure at $100-300 million.

“While policy wordings are clear in the intent to exclude business interruption from the current COVID-19 environment, a wording error is being legally challenged and could result in domestic insurers paying such claims, with IAG the most exposed,” Credit Suisse said.

“We don’t have insights into how the legal cases will or won’t play out. However, should IAG be found liable to pay such claims, we consider the claims cost to be in the hundreds of millions and not billions as we think the current share price implies.”