RSA may not deserve all the respect the market is showing it

21st August 2012

One way investors can gauge the success of an insurance business is to look at gross written premiums – the amount of business an insurance company actually writes. Here RSA has enjoyed some strong growth in recent years, with consensus estimates for gross premiums in 2012 up 38% from 2006 levels.

Furthermore a rising proportion of that growth is coming from the emerging markets and elsewhere overseas, which means RSA is increasingly doing business in areas of the world where the stockmarket values that business more highly.

Over the same six-year period, however, RSA's profitability has not improved – indeed operating profit is down 9% since 2006 and the business the group is writing in emerging markets is hardly generating any profits at all.

There are good reasons for this, the most obvious of which is that RSA has been growing its overseas businesses from scratch and thus has yet to enjoy much in the way of benefits of scale. Also, the sort of costs it has had to inject mean it would have been unreasonable to expect profitability from day one. Nevertheless, given the intervening period and the size of its overseas businesses now, one could reasonably expect the group to be a lot more profitable than it currently is.

A second factor contributing to RSA's lack of profitability is that insurance companies traditionally make their money in two ways. One is by writing home, car and other insurance policies and the other is by taking the premiums they are paid for those policies and investing them in low-risk assets, such as government bonds. Unfortunately such assets are returning very little in the current environment, which has clearly had a knock-on effect on insurance companies' balance sheets.

Even so, ways do exist to enhance returns in such an environment – the classic example being share buybacks. However, RSA's share count has actually been growing steadily in recent years and is now up by a fifth since 2006 as many investors have exercised scrip dividends, which allow them to take equity instead of cash. As a result, RSA's earnings per share number has fallen 27% over the last six years.

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