Yesterday, the Lord Chancellor raised the discount rate for personal injury compensation claims, but not by the amount that insurance companies were hoping for.
The rate was raised from -0.75% to -0.25%, but insurance companies had hoped he would raise it to a positive figure of between 0% and 1%.
The amount paid out in personal accident claims can be significant, particularly if it is a lump sum designed to cover a long period of life. Therefore a small change in the discount percentage can make a large difference to insurers’ profits. This negative rate ensures that the injured party receives a better payout than the insurance companies would like.
Although several insurance companies saw their share prices drop in response to this news, it is expected that FTSE 100 companies Admiral Group (LSE:ADM) and Direct Line Insurance Group (LSE:DLG) will be most affected because they mainly deal in car insurance products.
But it could be up to five years before this discount rate is reviewed again, so companies will just have to deal with it.
Strong company
Admiral’s share price was down slightly after the Lord Chancellor’s news, but it finished the day at a drop of only 0.09%. It is a strong company and has increased in value by 49% over the past five years. Admiral is a household name in the UK and it also delivers car insurance products throughout Spain, Italy, France, and the US.
Insurers are under constant pressure to tweak pricing to appeal to customers and maintain control of costs and there are also regulatory pressures to stop only new customers receiving the best prices.
Nevertheless, Admiral has outperformed the FTSE 100 over the past year. The group is a regular dividend payer and I estimate its forecast dividend for 2019 to be 5.5%.
Outstanding dividends
Direct Line’s share price also fell slightly by 0.71%, on the news of the discount rate, but it has increased in value by 22% over the past five years.
The company is also a regular dividend payer, and I estimate its forecast dividend for 2019 to be a whopping 8.7%. Direct Line is famous for its generous special dividends, so hopefully, this will continue. Insurers are facing challenges as the sector is presently in a cyclical downturn and increased competition is putting pressure on pricing. This focuses Direct Line on improving its underwriting quality and reducing risk in an effort to ensure its insurance contracts remain profitable.
Profitable pair?
The debt ratios of both companies are less than 1, with Admiral at 0.89 and Direct Line at 0.69 and I think that this is acceptable.
The PEG ratio of Admiral is also less than 1 at 0.9, which can indicate an undervalued company. However Direct Line’s PEG is 1.88, which is clearly not quite so great. Both companies have dividend cover of 1.1, which is far from brilliant and makes the worry of lesser dividends in the future a real possibility.
Overall, I’m inclined to like these companies for a long-term portfolio, as I don’t think either will go bust anytime soon and their dividends are renowned for their generosity, so even if they are reduced, they are still likely to be better than many of the other FTSE 100 companies.
