Analyst counsels caution on Zurich takeover of AIG auto

Analyst Collins Stewart has downgraded Zurich Financial Services Group stock to “hold” from “buy”, even after it rallied 50% following the acquisition of AIG’s US Personal Auto Group.

In a statement the analyst said: “The AIG deal does not materially change our view of Zurich as a whole.”

It said the deal was based on a 14% return on equity, in line with its forecast for the whole company, but that a 12% borrowing rate meant the deal would only be earnings per share neutral in 2010.

Zurich bought AIG’s auto business through its subsidiary, Farmers Group. Under the deal, Farmers Group is to sell immediately the regulated insurance part of the acquired business to the Farmers Exchanges, which Zurich manages but does not own.

The company said the transaction was expected to boost its earnings immediately.

Under the terms of the agreement, Zurich will acquire AIG’s auto business for $1.9bn (£1.3bn). Zurich will raise $1.1bn (CHF6.7m) through a share placing to fund part of the deal.

However, Collins Stewart warned: “The issuance of CHF6.7m shares is also likely to act as a near-term dampener on performance.”

The transaction positions Farmers Exchanges as the third largest traditional direct writer of insurance in the US and the third largest US personal lines insurer overall.

The deal includes 21st Century Insurance and AIG’s Agency Auto. Zurich stands to gain 1.5m direct auto customers.

Ben Cohen, analyst at Collins Stewart, believed that AIG’s business was a good fit.

“The direct business gives them an important channel and there should be good cost-cutting from integrating the two businesses because they are both based in Los Angeles,” he said.

“It’s a bit less clear how much underwriting profit that business will make as it’s been going backwards for the past couple of years. The nice thing for the Zurich model is that they earn a fee rather than being too dependent on the underwriting return, so their exposure to that is limited.”