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RSA - Large losses knock underlying profits

Nicholas Hyett | 28 February 2019 | A A A
RSA - Large losses knock underlying profits

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Underlying operating profits fell 19% to £517m, with negative weather effects and major losses in the group's commercial insurance business weighing on results.

CEO Stephen Hester said "We strongly believe that 2019 will show a bounce back and are taking decisive action to that end".

The board announced a 13.7p final dividend, taking the full year payment to 21p - up 7% year-on-year.

The shares fell 4.1% in early trading.

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Our view

CEO Stephen Hester's initial turnaround plan for RSA is more or less complete. The balance sheet has been painstakingly restored, £460m of cost savings have been delivered, and final tweaks to the portfolio are being made.

Unfortunately, a series of large losses and a spate of weather related claims have upset the boat this year. Most of this is down to the commercial business, particularly in the London Market where RSA writes larger, more specialist insurance contracts.

Volatility is an inherent part of insurance, but RSA has proven more volatile than management had hoped. Hester's response has been to dramatically downsize the London Market business, and up the amount of reinsurance the group does. That might mean giving up some of the premiums RSA earns, but should also make the business less lumpy.

A poor underwriting performance meant RSA opted not to pay a special dividend this year, despite the group's Solvency Ratio sitting comfortably ahead of target. Historically, even the ordinary dividend has proven about as reliable as an English summer - although it now looks more secure. The stock currnelty offers a prospective yield of 5.5%.

Unfortunately it's now that the real work begins.

The problem RSA faces is that for all its recent progress, it's still in personal insurance, and that's a tough market in which to deliver knockout performances. Product differentiation is all but impossible except on price, and that can end up destroying margins. In an increasingly transparent world of price comparison websites, that challenge is all the greater.

We're impressed with the job Hester has done since he joined in 2014. The dramatic improvements in underwriting performance, RSA's bread and butter, should make investors sit up and take notice. Unfortunately, the other strand of the strategy, cost cutting, can't continue indefinitely without damaging the business. We still struggle to get excited about RSA's long term growth prospects.

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Full Year Results

Net written premiums rose 1% in the year to £6.5bn, with increase in Scandinavia and Canada offset by a 3% decline in the UK & International.

Controllable costs were down 2% in 2018. The group has now exceeded its target of more than £450m in cost savings since 2014, a year ahead of schedule. Cost efficiency will now be moved into "business as usual mode".

RSA's combined operating ratio deteriorated by 2.2 percentage points to 96.2%. As a result, underwriting profit fell 33% to £250m. Investment income fell 3% to £322m.

The group has taken steps to improve performance, including exiting portfolios and increasing reinsurance. Excluding losses associated with these changes, underwriting profit stands at £344m, with a combined operating ratio of 94.6%.

Exits include 50% reduction in activity in the London Speciality & Wholesale market. The division saw underwriting losses of £109m in 2018 as a result of a tough market and shortcomings in RSA's own underwriting. The group is also reviewing the rest of its Commercial portfolio - re-underwriting or re-pricing where appropriate.

The group finished the year with a Solvency II ratio, a key measure of capital for insurers, of 170% (2017: 163%). That's after paying the final dividend and substantially above the group's 130--160% target range.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.