Ratings agency warns that Australian giant faces "stiff competition" in key markets.

See also: Where next for IAG UK?

Fitch has revised the outlook of Insurance Australia Group's (IAG) main underwriting subsidiaries, Insurance Australia Limited, and IAG New Zealand Limited from stable to negative.

In a statement the ratings agency said the Insurer Financial Strength (IFS) ratings of the business had been affirmed at 'AA-', reflecting a number of challenges facing the group which had "potentially adverse consequences for capital and earnings."

Fitch added that IAG was likely to encounter stiff competition in its core markets.

It said that IAG's FY2008 performance had been weaker than expected due to underperformance in the group's UK business, parts of which were put up for sale last week. Fitch added that excessive weather-related claims and depleted investment returns were the other reasons for several profit downgrades earlier this year which culminated in a revised insurance trading result ratio at the bottom of the 6 to 8 per cent range.

"While IAG is taking steps to address underperformance, it will take time to judge success in what is likely to remain a challenging external environment," Fitch commented.

"The more immediate impact is that IAG expects a decline in its regulatory capital multiple to an estimated 1.70x for FY08 from 1.87x at H108 after payment of the final dividend for FY08.

"Steps taken by IAG aimed at reinvigorating its businesses involve a refocus back on the home markets of Australia and New Zealand, scaling back of the group's UK activities, an efficiency programme IAG estimates will generate $A130m in annual savings and several changes to key senior executives (including the CFO, Chief Risk Officer and Group Actuary)."

Fitch concluded: "Although a turnaround in the businesses will take time, IAG has a strong and well-established franchise in Australia and New Zealand, underpinned by strong brands.

"Furthermore, the newly appointed CEO [Michael Wilkins] has a successful track record in profitable growth, having previously held the post of CEO at Promina, which was a large Australian non-life insurer acquired by Suncorp-Metway Ltd in 2007. From a capital perspective, IAG also has access to $A550m of contingent capital, which can be quickly converted into qualifying regulatory capital should IAG choose to bolster its capital position."

Last week, IAG announced that it would be scaling back its UK operations under the umbrella of underwriter, Equity Red Star. The group's UK retail portfolio, comprising Equity Insurance Brokers, Hastings, Open & Direct, underwriting agency Advantage as well as Lloyd's syndicate Alba, will be offloaded.

The group also announced a $A350 writedown of its UK portfolio.