Are calmer waters on horizon for insurers?

The word insurance has its roots in the Latin securus, meaning ‘free from care’. The phrase, however, does not describe the current sentiments of investors in UK insurance companies, whose share prices have been damaged by economic and other woes. 

The casualties include the £27billion giant Prudential. 

Its shares have tumbled by 24 per cent this year as a consequence of delays in appointing a chief executive and lockdowns in China – nowadays Asia and Africa are the Pru’s prime focus. 

Avast!: Shares in Admiral have been in freefall but are now well placed to stage a recovery

Shares in Aviva and Legal & General have fallen by 30 per cent and 15 per cent respectively, while Direct Line is at its lowest for a decade following a profits warning. 

Like Admiral, Sabre and other motor insurers, Direct Line has been hit by soaring used-car prices. These have sent up the cost of claims, because when customers’ cars are written off, the amount needed to replace it based on market values is higher. 

As a result, Direct Line’s combined operating ratio (COR) is set to be between 96 per cent and 98 per cent. The COR, a key metric, is a measure of an insurer’s costs as a proportion of premiums: the closer to 100 per cent, the less profitable the business. 

It seems that, in today’s climate, insurers are an unattractive proposition. Unless, that is, you are prepared to take a gamble. 

Gavin Pickett, equity analyst at Orbis Investments, argues that motor insurers’ profits should bounce back, with Admiral well placed to stage a recovery. 

The general insurers seem also worth a bet if you want to improve your income, or to give your backing to initiatives that are crucial to the levelling-up of Britain. 

Such projects are not only essential to economic recovery, they can also provide a return with an element of inflation-proofing.

Companies such as Legal & General, which is the steward of billions of pounds of savers’ cash, are big investors in property and infrastructure in the UK. 

Deutsche Bank has lowered its target price for Prudential from 1550p to 1475p, but senses that there may be some good news ahead. There is even more optimism about the prospects for those other general insurers Aviva and Legal & General. 

Peter Doherty of Sanlam Investments UK contends that these businesses are cheap at present because, for one thing, they offer ‘high and sustainable dividends’. Under chief executive Sir Nigel Wilson, Legal & General, a £15.4billion group, has been transformed from a somnolent insurer into what Alan Dobbie, co-manager of the Rathbone Income Fund describes as a ‘great British business success story and a pensions behemoth’. L&G is one of the fund’s top holdings. 

Aviva has also been revitalised, under the leadership of Amanda Blanc who took over as chief executive two years ago. 

There has also been pressure from the Anglo-Swedish activist investor Cevian Capital which has a 6 per cent stake.

Her reshaping of the business, which includes a move into wealth management, has changed the perception of Aviva.

Ian Lance, co-manager of the Temple Bar investment trust which owns shares in the group, says: ‘On a price-to-earnings ratio of nine times next year’s profits – and a dividend yield of 7.7 per cent – we believe the shares are inexpensive.’ 

How are Aviva and L&G able to be so generous to shareholders? 

The answer is their role in the radically altered company pensions sector. Increasingly, hard-pressed managers at companies wish to be relieved of responsibility for their defined benefit (DB) or final-salary pension scheme. Aviva and L&G are power players in the multi-billion ‘bulk annuities’ game, in which an insurer receives a capital sum to become custodian of a company’s DB scheme and to take on the financial and demographic risks involved.

It is forecast that many more such transfers will take place. Dobbie says: ‘With the majority of DB schemes closed to new joiners, and funding positions somewhat at the mercy of markets, there are clear incentives for companies and pension fund trustees to shift these liabilities to specialists.’ 

To match these liabilities, L&G puts money into build-to-rent housing, urban regeneration and university science parks, which Dobbie says should deliver good returns and strong cashflows for years to come. 

Such infrastructure schemes provide a measure of protection against inflation because some of the projects in which they invest have contracts with index-linking. A planned shake-up of the restrictive European Solvency II regulations should allow more funds to flow into these and similar projects. 

For me, the rewards that could be produced by such projects represent the strongest argument in favour of allocating some cash to Aviva and L&G. There is, of course, no assurance that holding these shares will be free of care – now or in the near future. 

This post first appeared on Dailymail.co.uk