When prices fall in a particular sector, it can be a great time to buy shares in the best companies. And I think that’s the case at the moment in the insurance industry with Admiral (LSE:ADM).
The stock is down around 6% since the start of the year, but the reason doesn’t have much to do with the business specifically. That’s why I think there’s a potential buying opportunity here.
Premium financing
The car insurance industry has come under pressure in the last month. The Financial Conduct Authority (FCA) is looking into what’s known as ‘premium financing’.
In ordinary terms, this involves paying an insurance premium over 12 months, rather than up front. This is useful for a lot of people, but especially companies with large fleets to insure.
It’s no secret that this involves paying more over time, but the amount has been catching the FCA’s attention. Over the cost of a year, this typically involves an APR of between 16% and 22%.
The prospect of an investigation into premium financing sent shares across the industry lower last month. As well as Admiral, Direct Line also fell significantly on the news.
I think this is an overreaction. I see the fall in Admiral’s share price as an opportunity to add a quality name to my portfolio at a bargain price and I’m looking at doing so this month.
The best in class
Insurance companies make money in two ways. One is by taking in more money in premiums than they pay out in costs and the other is investing their premiums in assets that provide returns.
In general, underwriting – the bit involving writing insurance contracts – isn’t hugely profitable. Even Warren Buffett at Berkshire Hathaway doesn’t aim to do much more than break even.
Admiral, on the other hand, has impressive results here. The company consistently posts better profitability metrics than its competitors – including Direct Line – and has done for years.
The reason’s simple. Admiral’s telematics initiatives give it a big advantage when it comes to predicting the likelihood of accidents and allowing it to price its policies more efficiently.
I don’t anticipate Admiral’s competitors catching up any time soon. But it’s worth noting there are some risks that investors should consider before taking a view on buying the stock.
An opportunity
The biggest concern, in my view, is inflation. If this proves to be persistent, then repairs are likely to be more expensive and this will cut into company profits.
At the start of the year, this would have been enough to put me off buying the stock. But after the recent declines, I think this looks like a good opportunity.
In general, I don’t think the insurance sector is a particularly attractive one for investors. Every so often though, a promising opportunity turns up in a surprising place. And that’s what I see here. I do think Admiral is worth considering.
