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High hopes for UK insurer Sabre's IPO despite tough market

U.K. motor insurer Sabre Insurance Group Plc should be well-received when it makes its stock market debut later in December, according to equity analysts covering the U.K. nonlife insurance market.

The company, which is majority-owned by funds advised by private equity firm BC Partners, announced its IPO plans Nov. 13 and said Nov. 23 that it would price the offering of 33% to 50% of its issued share capital at between 220 pence per share and 240 pence per share. Sabre expects to raise as much as £206 million from the offering, in which BC Partners will see its stake decline to between 37.5% and 40.0% from 67.8%, assuming the full exercise of a 10% overallotment option.

Sabre will be the smallest of its peer group, with an expected market capitalization of between £550 million and £600 million, and is coming to market at a difficult time. Telecoms firm Arqiva postponed its London Stock Exchange float Nov. 3, citing "uncertain IPO market conditions." On the same day, food company Bakkavor pulled its IPO because of "the current volatility in the IPO market," although it subsequently floated Nov. 16.

There is also uncertainty in the insurance market itself. After cutting the personal injury discount rate to negative 0.75% from 2.5% in March, which hurt U.K. insurers by raising the cost of claims for long-term damages, the government has introduced draft legislation that would restore the rate to between zero percent and 1%. This would undo some of the damage, but there is much uncertainty about when the new law will materialize.

The discount rate could put a dampener on Sabre's flotation, suggested Shore Capital insurance analyst Eamonn Flanagan, who said: "The one thing the management would have had their work cut out in trying to explain in the IPO process was Ogden."

Although Sabre got off relatively lightly from the initial impact of Ogden, taking a £2.2 million one-off hit to its 2016 results, it could face further costs, in particular through its reinsurance bill. The company said its reinsurance premiums increased at renewal in July because of the discount rate cut, and there could be more increases to come in July 2018 if uncertainty remains.

Underwriting a strength

The company is also not immune from the competitive pressure in the U.K. private motor insurance market. It noted in its prospectus that it faced "significant competition" from other insurers and reinsurance brokers, some of which have "greater financial resources, better brand recognition, greater pricing flexibility or greater risk tolerance" than it does.

But Sabre, which had a 1.9% share of the U.K. motor market in 2015 and booked £196.6 million of gross premium in 2016, has several features that should set the specialist motor insurer apart from its fellow U.K. motor insurers, not the least of which is underwriting performance.

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Sabre reported a combined ratio of 69% in 2016, some 21.8 percentage points better than that of Admiral Group Plc. Accounting firm EY said the wider industry's motor combined ratio was 100.2% excluding the impact of the discount rate change, and 109% including the discount rate hit. The combined ratio is a key measure of underwriting performance for nonlife insurers and shows claims and expenses as a percentage of net earned premium. A combined ratio below 100% is an underwriting profit, while one over 100% is an underwriting loss.

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The 2016 performance was not a one-off — Sabre's average combined ratio between 2006 and 2015 was 74.2% — and Flanagan said he recalls the company's performance being impressive back when it was bought by Aviva Plc predecessor company General Accident in 1996.

"It was a fabulous underwriter then. Despite the various owners, Sabre has managed to retain that franchise," he said. "The combined ratio and the loss ratio numbers are fantastic. They are genuine, and they turn them out regularly."

Aviva sold Sabre in 2002 to privately owned motor insurance firm BDML, which sold its broking operations and renamed itself Binomial Group in 2005. BC Partners bought its controlling stake in Binomial, which by then owned only Sabre, in 2014.

Panmure Gordon analyst Barrie Cornes described Sabre's results, and the combined ratio in particular, as "fabulous," adding: "It is a very good company. Assuming the price is right, I'm sure will be well-received."

Sabre says its underwriting performance has outperformed in part because of its strict approach to pricing, which internal actuaries set to ensure the company hits its combined ratio target of 80% or better across all business. The company also credits its in-house pricing model and proprietary data.

Not reliant on add-ons

A further positive is that underwriting performance makes up a large part of Sabre's operating profit. A common criticism by equity analysts of some U.K. motor insurers is their heavy reliance on so-called ancillary income — profit derived from selling add-ons to the core motor insurance policy and fees for making changes to policies ­— and installment income, collected when an insurer allows customers to pay their premium over a year rather than a lump sum upfront.

Regulatory scrutiny of add-ons has prompted concerns that this part of the business could start to shrink. Insurers have also come under fire for the interest rates they charge when customers pay monthly.

Sabre's prospectus shows that 86% of its 2016 operating profit of £65.1 million was generated from underwriting, leaving only 14% derived from ancillary, installment and investment income. By contrast, 51.3% of Admiral's 2016 U.K. motor profit before tax was made up of ancillary and installment income, while Esure Group Plc's ancillary income, which it calls additional services revenue, represented 67% of its 2016 motor trading profit.

Flanagan said: "Sabre is a proper underwriting company. It has none of this strange reliance on what I perceive to be much lower-quality earnings — the likes of ancillary and installment income. I find that very encouraging."

Sabre also said in its prospectus that it will not be pursuing growth for growth's sake, noting that it has prioritized meeting its 80% or lower combined ratio target ahead of growth. It said it plans to pursue "high-single-digit growth" in gross written premium over the medium term and "further profitable growth" over the longer term.

Flanagan said: "There is a fundamental problem when insurance companies go out there with a growth strategy nearly regardless of what the market looks like. I think Sabre are very much in the camp that says we'll grow, but only when appropriate."

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