U.K. roadside assistance firm AA Plc faces a cut in premiums and, says one analyst, will have to accept lower profit margins if it is to succeed in a plan to claw back the motor and home insurance business it has lost in recent years.
This is on top of the short term financial hits it expects the insurance division to take in its current year of account to return to growth. This, along with changes the AA is planning elsewhere in its business, is thought to have contributed to a roughly 33.4% drop in its share price from the 116.30 pence close on Feb. 20, the day before it announced the plan, to its 77.40 pence March 1 close.
But the company is confident that the pain it is taking now will result in a profitable and growing insurance business.
It aims to get back up to more than 2 million motor and home policies by 2023, which will mean adding around 540,000 new policies to the current 1.46 million. The AA expects the insurance division’s trading profit to grow by between 9% and 14% a year after 2019. It is also expecting a 95% combined ratio, a measure of underwriting profitability, at its Gibraltar-based insurance underwriter.
Revealing the plans to analysts on Feb. 21, AA CFO Martin Clarke said: "In the past, this is a business that's been run tactically and for short-term profitability. If we are to capture a broader market, then that model needs to change to focus on profitable volume growth with new business commission and pricing adjusted accordingly. Profitability in the insurance business will, therefore, decline this year, but thereafter, assume a genuine and sustainable growth trajectory."
Regaining lost ground
The AA is best known for its membership-based breakdown recovery service, but it is also a major U.K. personal lines insurance broker, ranking fifth in this segment according to a 2017 study by Insurance Times and corporate advisory firm, IMAS.
It also started underwriting insurance in 2016. It converted XL's Gibraltar unit, which it bought in 2015, into AA Underwriting Insurance Company Limited, which now sits alongside the other insurers on AA's panel and underwrites just under a third of the motor and home policies the AA sells.
But the company's insurance business has been shrinking. While the new underwriting business has returned the motor policy count to growth recently, total policies of 1.85 million are down 14.7% on the 2.16 million it had at 2015 year-end.
The company admitted that it has failed to keep pace with changes in U.K. insurance buying, where the majority of motor business is bought on price comparison websites. New AA group CEO Simon Breakwell told analysts: "15 to 20 years ago, the AA was one of the largest [motor and home] insurers in the country. It's ... ground that we have ceded to new competitors and to price comparison websites."
To regain lost share, the AA is planning £15 million of operational and capital expenditure in the 2019 financial year to grow its insurance business. The costs will come from additional technology and also the increased cost of doing business on price comparison sites, which charge insurers and brokers a per-policy fee. This expenditure will cut the insurance unit's earnings before interest, tax, depreciation and amortization by £7 million for the year to Jan. 31 2019.
The insurance expenditure is part of a company-wide £45 million bill, which in part prompted the company to cut its dividend to 2 pence a year going forwards from 5 pence in 2018 and 9.3 pence in 2017.
It will also pump between £40 million and £50 million of solvency capital into AA Underwriting Insurance Company Limited, with half coming from existing group cash and the remainder from the insurer's retained profits. This is a jump from the unit's current £11 million of capital, but an AA spokesman said it allows for headroom above the 2 million policies it is targeting.
There could be more longer term costs. Berenberg analyst Calum Battersby said in a Feb. 23 research note that he was expecting "significant revenue growth" in the insurance business, although at a "significantly lower margin" than the company had achieved in the past.
The company will also have to face up to companies such as Hastings which, like the AA's insurance business, is a U.K. broker backed by a Gibraltar underwriting unit, but that has been designed from the ground up to take business from price comparison sites. In an interview, Battersby said: "I think it is possible [to take on companies such as Hastings] as long as they are prepared to lose margin and cut their own prices to compete."
The AA acknowledges it will have to price keenly to compete and believes its plan will allow this. The AA says it can offer cheaper rates to members, because it knows more about them than insurers or brokers could usually find out through standard underwriting procedures. But it currently only insures 9% of its 3.3 million members. It is also working on extrapolating what it knows about members to non-members, in theory also enabling it to offer competitive quotes to non-members.
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