Why RSA is coming into focus

Rumours surrounding a takeover of RSA continue to circulate and as the credit crunch wears on, the insurer is looking increasingly attractive.

The media has been buzzing for the past few weeks about possible bid interest,

particularly from Zurich, and the rumour was further fuelled by a jump last week in RSA shares.

With a strong position relative to its peers, coupled with the fact that the sale of Royal Bank of Scotland’s insurance arm, RBSI, is considered increasingly unlikely, RSA has become the best-looking insurance acquisition target in the UK.

The insurer has already been through its own cost-reduction process and gained kudos from analysts for its strong management team, and stability in underwriting profitability since 2005.

A senior analyst said: “People have been talking about who could buy RSA for the past four years, so there’s always speculation around it. It’s one of the few remaining national champions in the UK.”

But while RSA is appealing, it would not come cheap.

The analyst said: “Four years ago the business was broken, it was losing money and in dire straights. Someone could have bought it relatively cheaply and done a fantastic turnaround. But Andy Haste [RSA?group chief executive] and his management team have delivered that turnaround. So that is a challenge.

“If you’re looking to acquire it to turn it around and improve it, that’s already been done. To create volume, an acquirer would either need to break it up or attempt to fold their existing business into RSA, in a reverse takeover, and have RSA’s management.”

This, he said, could be an ideal type of acquisition for an overseas insurer such as AIG, which could potentially transform its UK footprint while gaining a significant improvement in other geographies.

Along with AIG and Zurich, potential suitors are believed to include companies previously linked to a bid for RBSI, such as Allianz, QBE, Travelers and Allstate. Zurich is considered a frontrunner because, like RSA, it has a strong commercial lines focus.

Impressively, RSA’s Fitch-calculated combined ratio – which includes some underwriting expenses not included in the insurer’s own calculated combined ratio – has remained below 98% since 2005.

Ratings agency Fitch also likes the fact that the group has continued to resolve the last few remaining legacy issues following its restructuring in the mid-2000s. Two years ago RSA sold off its US non-life business, which held the majority of its exposure to asbestos risks. And in July, the group settled its lawsuit with General Motors.

In the first half of this year, RSA reported a reserve release of £123m, versus £336m released in 2007. The Fitch report said: “Continuing strong earnings, together with the absence of reserve deterioration and effective management of the soft cycle over the next 12 to 18 months, could trigger an upgrade.”

Fitch added that RSA had shown good profitability in all segments for the past

“RSA has probably invested more than any other insurer in improving their underwriting and claims managment capabilities.

Equity analyst

18 months, with positive development in reserves and good progress in managing soft-cycle conditions. It also said the group had a strong market position internationally and had implemented premium rate increases in UK personal and commercial lines that should help maintain profitability.

But it said capital adequacy should be higher and that RSA was “constrained by continuing bolt-on acquisitions, high dividend pay-out and some continuing exposure to asbestos risk.”

Meanwhile, RSA has also impressed ratings agency Moody’s, which said the insurer had good core underlying profitability, as well as improved financial flexibility and capitalisation.

Moody’s added that, despite challenging operating conditions, RSA has had continued strong operating performance with a strong run-off result on prior year claims reserves. In the first half of the year, RSA posted a post-tax profit of £292m versus £237m in 2007, and a combined ratio of 93% in the first half of this year versus 93.3% for the same period last year.

Citigroup was not as optimistic, downgrading its RSA rating from “buy” to “hold”. But this rating was due to the soft market conditions affecting the UK property and casualty market as a whole.

A report by Citigroup said RSA’s underlying UK accident year combined ratio was around 103% in 2007, even discounting the flood losses. It expects margins to deteriorate further this year and in 2009, adding that the group would need to find big levels of prior year releases in order to report a UK combined ratio below 100%.

Referring to UK?property and casualty the report said: “Underlying margins are slightly above average, the company looks to be a good underwriter and the management team is clearly much more on top of key industry issues than some of its more reactive competitors.

“At the same time although it has done a good job of retaining businesses with much better rate adequacy than the industry as a whole, the company cannot defy gravity. With an underlying combined ratio of above 100% in the UK on current year business, we think the company will need to find sizeable releases in order to keep reporting decent earnings in this division.”

RSA reported a UK operating profit of £230m for the first half of the year. But although this was down £2m year-on-year, the insurer had been hit by a number of large losses. Gross written premiums rose 1% to £1.4bn, despite a tough stance on ratings.

A major saving grace would be that RSA is considered to be fairing better than its competitors in the soft market conditions.

The senior analyst said: “In the UK market, which is becoming increasingly competitive, RSA has probably invested more than any other insurer in improving their underwriting and claims management capabilities, which has been driving benefits through to the bottom line performance in terms of combined ratios, where they have been outperforming a number of their competitors.”

But he added: “Where they have got a challenge compared with some of their competitors is in the fact that they do have a relatively high expense burden.”

Having already been through its own cost reductions, it is unlikely that RSA will announce any massive job cuts like the ones planned at rivals AXA, Norwich Union and Zurich. As reported by Insurance Times last month, 6,000 jobs in the industry have been axed so far this year.

RSA shares have responded to continued takeover speculation. Last week, its shares jumped 5.69% following market speculation of bid interest from Zurich, according to Reuters. The insurer saw its price rise 8.20p to 154.10p. As Insurance Times went to press, its share price was 152.90p.

RSA?had no comment.