Qualiport

Independent Are Flooded
Friday, 13 November 1998

And the Qualiport suffers

We interrupt the Qualiport's normal service for this very important announcement.

Independent Insurance (IIG), one of the portfolio's more recent purchases, today issued a trading statement. When these come through the wires at unexpected times, you invariably know they are not going to make pleasant reading.

The shares dropped 33p to 228.5p, adding to yesterday's 16p fall. (Did someone know something?) Before going into the reasons for the trading statement and the share price fall, it is worth recapping some salient points of the insurance business.

Insurance is a very competitive business, where price is usually the determining factor when choosing one policy over another. Most insurance companies struggle to make an underwriting profit. "How do they make money then?" I hear you ask. They are essentially investment vehicles. They receive their premiums well in advance of the settlement of any claims. In that period, the insurance company invests the money in various securities, whether they be high grade bonds, equities or high yielding liquid cash accounts, with the intention of maximising the investment returns. This is how most of the pure insurance companies make serious money.

If an insurance company can make an underwriting profit, then they are effectively getting their investment float at a negative cost. Only the very best companies can consistently achieve that feat. Independent Insurance has made an underwriting profit every year from 1993 to 1997, and on top of that has increased net profits (after investment gains) every year for the past 10.

Insurance claims are unpredictable in both their timing and their cost. This is especially so when we are talking about catastrophe cover. I'm sure many of you have seen and read about the shocking carnage Hurricane Georges has wreaked across Central America. Unfortunately, it is not a matter of if hurricanes hit these areas, but when, and how ferocious they are.

Insurance companies know this and take on the risk with their eyes wide open. For many years they may make above average catastrophe profits, then in one year they may be forced to pay out millions of pounds in claims. As long as they get their premiums right in the first place, over the very long term the insurance company should stay in the black. Warren Buffett's company Berkshire Hathaway covers the city of San Francisco for a large portion of its earthquake risk. It has the financial muscle to be able to take on such a big risk and, when the claim eventually comes, will be able to easily meet the expense.

At its interim results stage, Independent Insurance said that the local April floods had cost them £8m. Today, they revealed that the October floods had cost them a further £7m. On top of that, their international property account has lost about £3.5m courtesy of Hurricane Georges. Finally, Independent confirmed that they had been investigating entering the financial services sector. For a variety of reasons, most of which look to stem from the recent stock market downturn, they have decided to postpone those plans. This will entail writing off system development costs of £5m.

Adding all those numbers together, we get £23.5m. Last year's underwriting profit was £21.3m, so it appears that Independent will struggle to break even on that front this year. But remember that we need to add the investment gains to any underwriting profit or loss to determine the net profit figure.

There is some good news to come from all this. The company is seeing a hardening of insurance premiums and, as they have never chased business just for the sake of it, will be well positioned to benefit from this.

Today Independent Insurance said that their net asset value had increased to approximately £250m by the end of the third quarter. At 228.5p, they are capitalised at about £525m, leaving them trading on a price to book value of 2.1. This is an historically low level.

When we made our purchase in Independent Insurance, we perhaps prophetically said:

"A hurricane could come in and make a mess of underwriting profits in one fell swoop. The April 1998 floods in Britain hit insurers hard. There are many more natural disasters lurking out there, just waiting to happen. They will happen -- no-one knows where or when, except that sometime in the future, something will happen to wipe out an insurer's profits in any given year or years."

That year could just be 1998.

I don't see today's statement as a profit warning. The company has done nothing wrong -- it's just that the elements have conspired against them. Their business plan remains intact, and they remain confident about the future. So do we.

The Qualiport took a bit of a hammering today, and we are now back in the red. A profit warning from failed Qualiport candidate Reckitt & Colman (RCOL) saw their shares tumble 150p to 900p. They took Unilever down with them, as many analysts conveniently link the two companies because they are global consumer product groups. As we saw only a week ago, Unilever unveiled a solid set of third quarter numbers, so the connection looks a little thin. Our big winner Rentokil Initial (RTO) took a little breather today, too, for no apparent reason.

Next Week

In a Qualiport special, on Monday we will take a look at the growing Internet sector. We will be aiming to select the four "best" companies, regardless of their valuation. Could one of them be theglobe.com? That company floated on the New York Stock Exchange today at $9 and hit $97 in early trading.

Have a great weekend, Fools. As usual, all comments, ideas and suggestions are encouraged on the Qualiport message board.

Have you registered as a Fool?

Bruce Jackson (TMF Googly)

Qualiport Numbers

                           13/11/98 Close

                    Company   Change    Bid
                      EMA      0.10    11.05
                      IIG     -0.33     2.74 
                      MKS      0.00     4.46
                      PIZ      0.03     8.00 
                      RTO     -0.15     3.58
                      ULVR    -0.11     6.28 

Qualiport Stocks

Last Rec'd  Total #  Company   In At   Current  Change
 19/12/97    783       RTO      2.55     3.58    40.4%
 27/10/98    755       IIG      2.58     2.25   -12.8%
 04/11/98    245       PIZ      7.93     8.00     0.9%
 17/07/98    298       ULVR     6.72     6.28    (6.5%)
 17/04/98    169       EMA     11.85    11.05    (6.8%)
 11/05/98    368       MKS      5.54     4.46   (19.4%)


Last Rec'd  Total #  Company   In At     Value    Change
 19/12/97    783       RTO    2046.53   2803.14   756.61
 27/10/98    755       IIG    1972.64   1698.75  (273.89)
 04/11/98    245       PIZ    1966.34   1960.00    (6.34)
 17/07/98    298       ULVR   2052.54   1871.44  (181.10)
 17/04/98    169       EMA    2052.57   1867.45  (185.12)
 11/05/98    368       MKS    2054.11   1641.28  (412.83)


Cash:                                    £3,975.57
Current Total :                         £15,817.63

Total Invested:                         £16,184.62
Profit/(Loss) :                          (£ 366.99)

Value Per Share

                   Day     Month    Year    History
Qualiport         3.05%   (0.70%)  30.48%   33.41% 
FTSE 100          0.26%    0.46%    6.38%    8.82%
FTSE All Share    0.15%    0.54%    4.46%    6.65%

For an explanation of Value Per Share accounting, please click here.