Lloyd’s insurers will ‘benefit quickly’ if interest rates rise

A rise in UK interest rates would give a big boost to Lloyd’s insurers listed in the UK, according to Espirito Santo Investment Bank analyst Joy Ferneyhough.

“From an earnings perspective, these Lloyd’s vehicles would benefit relatively quickly if and when we do see any interest rate rises,” said Ferneyhough, who published an outlook for listed Lloyd’s insurers, titled ‘Under the weather’, last week.

“We talk about companies’ underwriting and quality of business,” she added, “but if we get a 50-basis-point rise in interest rates in the next six to nine months, you are going to see earnings upgrades on these stocks because they are so short in duration and conservatively weighted towards cash and government securities.”

Interest rates have been at 0.5% since March 2009. On 13 January, the Bank of England’s Monetary Policy Committee voted to maintain them at this low level. Insurers’ investment returns have been severely depressed by the low interest rates, given the heavy weighting of their portfolios towards fixed-income instruments – predominantly government bonds – and cash (see news analysis, page 14).

However, there has been some optimism since the beginning of the year that the bank will push up interest rates to counteract inflation.

Investors will favour the Lloyd’s insurers who are working to improve return on equity and value through share buy-backs or restructuring, Ferneyhough argues. One such company is Novae, which at the end of last year transferred the business from its FSA-regulated company to its Lloyd’s operation, freeing up regulatory capital for redistribution to shareholders.

Ferneyhough also believes the market will favour the larger players because of their ability to be lead underwriters on business and thus dictate prices, terms and conditions. “For the smaller guys it will be very difficult through a softer market. Also, all of them have come out and said: ‘We need to be bigger to be more relevant’. But it is difficult to see how you would get that growth organically when prices are falling away.”

Mergers and acquisitions could help smaller firms grow, but Ferneyhough believes talk about M&A in Lloyd’s has been overdone. Although the current low valuations of many listed Lloyd’s insurers make them potentially attractive targets, Ferneyhough believes buyers are in short supply. This is largely because most owners are unlikely to sell up at a discount to net asset value, meaning that would-be suitors would have to pay a large premium to the target’s current share price.

“Hardy knocking back Beazley at what did look like pretty fair value may also have put buyers off,” Ferneyhough said. “They may think that other Lloyd’s vehicles will try to ramp the price up.”