More Troubles Ahead For The Insurers?

I thought I’d go back to straight reporting for one day, so I asked all my sources if they had any particular views on the UK’s Prudential Regulation Authority (PRA) Annual Report published last week.


“You are kidding, right?” was the identical reaction I got from two of my contacts, who similarly pointed out that the report received the broad attention it deserves – virtually none. They probably underestimated the impact that the findings could have on capital requirements for insurers. Or did they?

(I can’t really tell you what a few others said off record!)

Exane BNP Paribas On PRA Annual Report 

I am not a big fan of the insurance sector and related combined ratios, unearned premiums and similar stuff. As it turned out, analysts at Exane BNP Paribas are — and they duly did their homework.

Enter a key part of the PRA release, which was sighted by the French broker.

The PRA said that it had “focused on ensuring that its categorisation of insurers (and hence the intensity of supervision) properly reflects the potential impact of the failure of the firm on policyholders.” In short, “certain types of insurance or policyholders require a higher degree of protection.” As such, greater focus on compulsory insurance and long-term life insurance products is strictly necessary.

Exane BNP Paribas commented: “We expect that this could see more capital required for motor insurance and annuities which cannot be transferred.” 

(“Transferred” as in reinsured.)

“Action: remain underweight annuity writers such as L&G and UK motor (Admiral).”

The analysts did not discuss the outlook for Aviva (LSE: AV) and RSA Insurance (LSE: RSA), but the former has a 10% downside, according to their estimates, while the latter carries a downside risk of 18%. It is too early to argue whether a cash call will be actually required, but how are these insurers coping these days with a difficult regulatory and political environment?

Let’s dig a bit deeper into their performances.

Legal & General (Market Cap £13.3bn), Admiral (Market Cap £4bn)

As one would expect, Legal & General (LSE: LGEN) revenue and operating profit have been volatile in the last five years. Trailing earnings per share (EPS) are broadly in line with the EPS it reported in 2009, but L&G is a more efficient and profitable business today. Growth for earnings into 2016 isn’t exactly breathtaking and will likely diminish over the period. In the last five years, its stock performance reads +301%. The stock is flat in 2014, yet it’s hovering around record highs. A correction is overdue, the bears would argue. Investors are wary of regulatory risk.

Admiral (LSE: ADM)shares halved in value in the second half of 2011 in the wake of a profit warning, but they have recovered since. In fact, they are not too far away from their five-year highs right now. Trailing EPS have almost doubled in the last five years, but they aren’t expected to grow as quickly in future. Admiral is much smaller than L&G and, by the very nature of its business, is much more profitable.

Aviva (Market Cap £15.1bn) And RSA (Market Cap £4.9bn)

Aviva has underperformed in recent years, but has bounced back in the last 12 months. The insurer is cutting costs and is doing all it can to become a truly appealing value proposition. Cash flow is on its way up, estimates for EPS are bullish, and management have shown they can grow the business while receiving the backing of the investor community. For its part, RSA is less troubled than a year ago, but is still troubled. Its margins are under strain and EPS growth is likely to remain subdued for a few years.

A Valuable Alternative

Elsewhere, there are much smaller companies that could beat the market these days. In the last five years, this stock has performed +637%, and could offer even more upside over the medium term.

In spite of an incredible rally, its trading multiples are not too demanding and more upside could also come from a takeover of this British high-tech business.

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Alessandro doesn't own shares in any of the companies mentioned.