With Michael Faulkner

UK insurance heavyweights Aviva and RSA came under the analysts’ glare this week in notes from Citigroup. Aviva, which this week reported lower than expected general insurance results for the first half of the year, did not emerge well from the analysis.

Citigroup argued that the group’s 98% ‘meet or beat’ combined operating ratio (COR) target could not be sustained for much longer and may already have been breached. It said that Aviva was “maintaining the appearance” of meeting the target through a combination of unsustainable reserve releases, the inclusion of extraneous businesses and the exclusion of relevant costs.

Aviva’s cost base was still too high and its efforts to reduce it were being counteracted by higher commissions to brokers, inflation in the system and shrinkage of premium volume, the banking group warned. Citigroup also expressed concern about Aviva’s efforts to increase rates and said claims costs could rise if the UK economy slipped into recession.

It said: “Having been a ‘second quartile’ performer in 2004 it is now deep in ‘third quartile’ territory, suggesting this business has some serious challenges. Things should still be OK for 2008 but concerns are gathering for 2009.”

Aviva’s rating was downgraded from ‘buy’ to ‘hold’, on the back of Citigroup’s views on the fortunes of the UK general insurance market. RSA’s performance, meanwhile, was a curate’s egg, according to Citigroup. The insurer’s underlying UK accident year combined ratio was around 103% excluding the summer’s flood losses. Margins were likely to deteriorate further in 2008 and 2009, requiring substantial prior year reserve releases to achieve a UK COR of below 100%, which may not prove sustainable.

RSA will report its half year results this week and is expected to unveil operating profits of about £421m, compared with £403m last time.

Citigroup said RSA’s management was navigating through the soft market better than its peers, with UK underwriting performance “looking a lot better than for Aviva”. But the expense ratio was still high and commercial property results last year were poor, said Citigroup.

It concluded that RSA was well placed to benefit from a potential turn in the market. RSA’s rating was downgraded from ‘buy’ to ‘hold’.