MARKET COMMENT
Takeover Is Best Option For RSA

By James Carlisle
November 7, 2002

If reports of the rejection of a proposed cash call are true, the proposed slimming down announced by Royal & Sun Alliance (LSE: RSA) this morning is the only option remaining open to it.

RSA has targeted a 'cross-cycle combined ratio' of 102%, which basically means that it aims to make underwriting losses of 2p for each £1 of premium received. Underwriting losses are apparently acceptable in the insurance industry because you're able to make investment returns from the premiums that people pay to you ahead of their claims. (It sounds like asking for trouble, though, if you ask me.)

Anyway, the plan is to sell or exit businesses that aren't expected to achieve these targeted returns and/or don't have a strategic competitive advantage. The capital freed up from these businesses can then be used to fund the businesses where RSA feels it does have a sustainable competitive advantage.

One of the nice things about insurance is that it has little in the way of 'barriers to exit', allowing capital to be moved easily from business to business. Unfortunately, the flip side is that there's also very little in the way of 'barriers to entry'. So talk from RSA of focussing on areas where it has sustainable competitive advantages looks optimistic to say the least.

General insurance is a plain old commodity business. It's a matter of collecting data, doing underwriting sums, collecting premiums and processing claims cheaply and efficiently. Success relies on the ability to get the sums right and economies of scale. The market is rightly sceptical of RSA's arithmetic and has apparently refused to replace the scale that the insurer has recently lost. With the shares on a price to book ratio of 0.4, someone with a better track record and more money should buy the group and put what capital remains to more effective use.