Investment Column: Insurance is where the action is to be found
Thursday 19 August 2010
It has been a lively old time for Britain's insurance industry in the last few months. Prudential was forced to scrap its blockbuster deal to buy the AIA Asian business in June. Clive Cowdery's Resolution buyout vehicle then followed last year's acquisition of Friends Provident with a £2.75bn deal for Axa's UK life business.
Aviva and RSA got into a slanging match this week after the former turned down its rival's £5bn offer for its non-life businesses. And yesterday saw Legal & General's shares jump on speculation about a bid from the Swiss giant Zurich.
This wave of activity reflects three things. First, Prudential's debacle notwithstanding, deals are do-able again as the financial crisis recedes and confidence returns to markets. Second, valuations remain relatively cheap having been battered in the meltdown. And third, companies are jockeying for position in a market in which size and scale play a huge part.
Andrew Moss promised "One Aviva Twice the Value" when he took over as chief executive in 2007, but the share price has roughly halved in that time. Investors have doubted the wisdom of Mr Moss's "composite model" – keeping life and general insurance under one roof – and the growth potential of his UK and European-focused business. But first-half profit beat expectations as Mr Moss's cost cuts bore fruit and new business sales surprised on the upside.
Legal & General's UK-centric business also produced better first-half results than expected. Oriel Securities analyst Marcus Barnard reckons the market seriously underestimates the growth potential of Aviva and Legal & General. What's more, both have made chunky £1bn-plus reserves against their corporate bond portfolios that could be released in the medium term.
Despite the bungled bid for AIA, which could yet see chairman Harvey McGrath or chief executive Tidjane Thiam lose his job, Prudential's valuation has held up well. Investors place a premium on the Pru's big Asian business, which generated forecast-beating profits in the first half of the year.
Lurking in the wings is Resolution – launched in 2008 to combine life insurance businesses in a market it says is "ex-growth" and over populated. The Axa deal gets Mr Cowdery almost halfway to his target of combining a number of life companies to form a £10bn operation by 2012 that would cut costs and generate higher returns for shareholders.
Aviva's life business, the Pru's UK operations or even Legal & General could be a target for Mr Cowdery. His presence may be keeping the UK-focused insurers on their toes and driving them to produce the operational improvements coming through in their results.
Along with most sector analysts, we rate Aviva as a buy. The company's 6.5 per cent dividend yield is chunky but not scary (a yield that is too high suggests the market believes the payout is at risk) compared with 4.4 per cent for both the Pru and L&G. Retail investors can sensibly take the dividend while hoping for a break-up or further performance improvements from pressurised management.
We rate the Pru and L&G as holds because of the former's rich valuation and the lower likelihood of the latter being involved in takeover activity.
Let's not forget that one of the catalysts for all this activity is RSA (formerly Royal & Sun Alliance). It got out of life insurance years ago and now combines its More Than retail business with corporate insurance.
Andy Haste, the chief executive, has done a great job in turning round the mess left to him in 2003 and he would no doubt wring plenty of savings out of Aviva's assets. But with RSA willing to enter talks with Aviva that could lead to a higher offer, we are cautious about the shares.
There may be more corporate action in life insurance, but we think parts of the hugely varied non-life sector offer good prospects, too. Margins in the general household and motor sector have rebounded after companies increased their prices to counter greater levels of fraud and payouts heightened by ambulance-chasing lawyers. But corporate insurers are languishing at the bottom of the cycle waiting for a catalyst to spur price increases.
Along with Numis Securities, we like Hiscox, which combines catastrophe underwriting – whose margins have stayed beefy post-Hurricane Katrina – with upmarket personal insurance covering niche such as kidnap and fine art. We like this balance of businesses and their resilience against the frantic competition in other parts of the non-life sector.
Our top picks are therefore the unsteady giant Aviva and the nimble niche player Hiscox.
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