Insurance Post

Admiral battens down the hatches

Henry Engelhardt-Admiral

Admiral has been the darling of the stock market for a number of years but, despite record pre-tax profits, its share price took a tumble last week. Chinwe Akomah finds out why.

Last week, despite posting a record half-year pre-tax profit of £160.6m and a combined operating ratio of 94.2%, former stock market darling Admiral Group saw its share price take a nosedive.

In its core UK car insurance business — COR 90.4%, up from 82.9% in H1 2010 — £90.7m of the £168.2m profits came from ancillary income, including referral fees, with customers up 33% and a 59% increase in premium terms.

But although the motor insurer was pleased with its results — CEO Henry Engelhardt declaring the £1bn-plus six-month turnover an “incredible achievement” —analysts were less impressed by the trends emerging. With the half-year loss ratio in UK car rising to 76.3% from 65.9%, the spectre of bodily injury claims costs — long bemoaned by the rest of the motor insurance industry — is finally starting to bite. And prior year reserve releases could not come to the rescue to the same degree this time around: down to £4.0m from the £17.3m of H1 2010.

The result was Admiral’s share price falling by around 11.8% on the day its results were released — 12.77% wiped off by 2.30pm before rallying a little — and falling again the next day.

Not so long ago, Admiral was brushing off concerns about bodily injury claims and boasting it was not suffering anything “unusual” in related claims patterns, contrary to competitors’ commentary, which “gives the impression something has changed radically” (www.postonline.co.uk/1730644). That was during the first half-year results season of 2010.

One year on, Admiral has noticeably changed tack. Echoing his peers, director of finance Kevin Chidwick told Post that personal injury lawyer fees are the “root cause” of the bodily injury claims inflation problem (www.postonline.co.uk/2104227) and even Mr Engelhardt stressed in his opening remarks that Admiral is “not immune” from the rising tide of injury claims and their associated costs.

Caught out by claims
But Mr Chidwick claimed bodily injury claims were still not affecting Admiral as much as other insurers like Royal Bank of Scotland Insurance, which had to set aside £100m during the third quarter of 2010 on top of £320m already reserved in the second quarter for bodily injury claims (www.postonline.co.uk/1895333).

Investec securities analyst Kevin Ryan would beg to differ. He told Post Admiral had finally been caught out by claims costs and this had also taken the market by surprise. “In previous years, Admiral’s high year reserve releases bolstered underwriting profit. Last year, for example, claims reserve releases were £17.3m but, in the first half of this year, they were £4m.

“Some claims take a while to settle but once they are settled what is left should go into underwriting profit. But Admiral’s underwriting profit this year indicates claims costs are coming in and this has impacted on its combined operating ratio. It was 82.9% last year but in these half year results it has deteriorated to 90.4%. Claims costs are hitting Admiral hard.”

Mr Ryan added that insurers like Aviva are catching up. Aviva’s half-year results this year revealed a combined operating ratio of 94% for private motor. “The chasing pack is catching up and this shocked the market. It thought Admiral could carry on defying gravity forever but this was not the case and the market did not appreciate it.”

A good run
Admiral definitely had a good run of things. In 2007, its pre-tax profit was £182.1m; followed by £202.5m in 2008; £215.8m in 2009; and £265.5m in 2010. Its market share is 11% and one in 10 cars on the road is insured by Admiral but even these consistently strong performances were not enough to ease market concerns when it saw Admiral’s reserve releases dry up.

Collins Stewart analysts have given Admiral shares a ‘buy’ rating for Admiral’s share price. Analyst Ben Cohen said: “The main issue for the market was a concern around the higher claims inflation recognised for 2010. The net result of which was lower reserve releases than the market had expected.

“The market had expected Admiral to quantify how much profit came from referral fees and that was in line with what was expected. Referral fees are not as much of an issue for investors, as they were two months ago.” Mr Chidwick confirmed this to Post: referral fees make up only 8.8% of ancillary income and 5% of Admiral’s profit.

Jefferies analysts, whose Admiral share recommendation is to ‘hold’, blamed recent margin pressures on the share price drop. Equity analyst James Shuck said: “The key reason for the drop in share price is that market perception was there was no real sign of margin pressures in the areas Admiral was growing in. But we thought this was unlikely 
as the company has not been reserving as conservatively as it had done in the past. This is the first time we have seen these sorts of 
margin pressures.

“In theory, it seemed Admiral was immune to the effects of bodily injury claims,” he commented. “The market thought it would see prior year development on reserve releases but Admiral was not as flexible as it first thought. This is the first time Admiral has had disappointing new 
business profitability.”

He added: “This story is no longer about strong growth in a hard market, but guessing around the ultimate profitability of the very significant chunk of business that Admiral has recently taken on. In this respect, the market has had to reassess its view of underlying margin deterioration and future reserve releases.”

Mr Shuck explained that the earnings impact from lower than expected reserve releases was limited because Jefferies was “relative cautious”. “We are lowering our EPS by 3% to 4% but this is because we are removing referral fees from our profit forecasts as we expect these to be banned.

“Our relatively cautious stance on Admiral reflected concerns that the market was taking an overly optimistic view of the profitability of 
new businesses.”

Proving the analysts wrong
Although unwilling to comment on the drop in share price and analysts’ cynicism about Admiral’s business model, Mr Chidwick said: “Everybody is entitled to their own opinion,” adding: “We hope to prove the analysts wrong.”

Perhaps this process has already started. Admiral’s share price continues to fluctuate but closed on Tuesday at around 1345p. Mr Shuck said: “Admiral shares are bouncing back a bit because it was hit so hard. We are seeing a bit of support 
for it.”

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