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John Kingham doesn’t ‘fall in love’ with individual companies. But if he had to pick a favourite, Admiral would be it. Here’s why…
As a general rule, I’m not a huge fan of ‘cheerleading’ individual companies. My preferred approach is to own a broadly diversified group of companies that I like, and not to ‘fall in love’ with any of them. The future is, after all, a very uncertain place, and no company is guaranteed a bright future.
However, at this time of year, many investors like to talk about which stock they think will perform best over the coming 12 months, so I thought I would join in and write about Admiral, the UK’s leading car insurer. I’m not ‘in love’ with Admiral, but if I had to pick a favourite, then Admiral would be it.
There are lots of reasons why, such as the fact that Admiral has produced consistent growth and average total shareholder returns of almost 16% per year since I first invested in 2013. But that’s all in the past, and when it comes to investing, it’s the future that counts. On that front, I think Admiral is probably more attractively positioned and valued today than it was when I became a shareholder.
Admiral: the UK’s largest car insurer
Most people in the UK have heard of Admiral. For those who haven’t, it’s the country’s leading car insurer with more than four million UK car-insurance policyholders. As well as UK car insurance, it has almost a million UK home-insurance policyholders and another million policyholders in its international car-insurance operations. It also owns several leading price-comparison websites, including confused.com in the UK.
Admiral has grown rapidly since it was founded in 1993 and is today a multi-billion pound FTSE 100 company. Along the way it helped to disrupt what was previously a broker-based car-insurance market, with the direct model pioneered by Direct Line and Churchill Insurance (Admiral’s first and long-time chief executive, Henry Engelhardt, was a member of Churchill’s founding team).
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Market leading underwriting ratios
Stripped down to its very essence, I would say that Admiral’s long-term strategy is to first develop market leading underwriting ratios and then to incrementally expand into adjacent markets from a position of strength. Underwriting ratios are important because they drive an insurer’s profitability, and there are three of them.
First is the loss ratio, which is the ratio of losses (claims) incurred to premiums earned during a specific period (typically a company’s financial year).
The trick with the loss ratio is to price risks (ie policies) rationally, and then to get the balance right between volume and value. For example, anyone can write a million car-insurance policies if the premium is set at £10 per year. Cash will come flooding in from premiums, but if the average loss eventually turns out to be £300 per year you’ll soon be out of business. On the other hand, you could set the premium at £900 per year, but if the expected average loss is £300 then competitors will undercut you, you won’t sell any policies and once again you’ll soon be out of business.
Admiral tries to optimise its loss ratio by focusing on the three areas of data, analysis and discipline. It gathers as much data as possible about the risk profile of different driver/car/location combinations, by leveraging coinsurance and reinsurance; invests heavily in people and technology to extract as much risk pricing information from the data as possible; and it focuses on writing rationally priced policies at all times, even if other insurers are pricing low to gain market share or pricing high to boost short-term margins.
Applying pricing discipline means Admiral may struggle to grow at times when the insurance market is very soft, ie when premiums are low following a period of low claims. However, in the long term, saying no to policies that will eventually be loss-making (even if it means foregoing premiums up front) is the rational choice.
The second underwriting ratio is the expense ratio, which is the ratio of underwriting-related expenses to premiums written during a given period. A low expense ratio comes from efficiency and keeping costs low, and there are lots of ways that Admiral does exactly that.
For example, Admiral has several offices in the UK, all of which are in Wales rather than London. As you may suspect, rent, wages and just about everything else is a lot cheaper in Wales than London. Admiral uses the direct-insurance model, which strips out the cost of insurance broker middlemen. It owns comparison websites like confused.com because it’s more efficient to profit from owning comparison websites than to pay commission to use third-party sites. It also focuses heavily on customer satisfaction, because this increases renewal rates. In addition, it focuses on keeping staff happy (Admiral won the 2018 Sunday Times Best Place to Work award), which means less staff turnover, which reduces recruitment expenses. And Admiral has a very well-known brand which helps it acquire customers at lower prices.
I could go on, but you get the point. In a nutshell, Admiral’s strategy for maintaining a low expense ratio is to attract customers cheaply through comparison websites (preferably its own), to offer them rationally priced policies, to retain them as customers by providing a good service, and to do all of this with extreme efficiency.
This focus on rational insurance pricing and super-efficient operations shows up in the third underwriting ratio, which is known as the combined ratio.
The combined ratio is the sum of the loss and expense ratios and Admiral’s is consistently far below the UK car-insurer average. A combined ratio of more than 100% means that claim losses and underwriting expenses exceeded premiums, which means the company made an underwriting loss. This is surprisingly common, and as a group, the UK’s leading car insurers typically have a combined ratio of more than 97%, which is an underwriting profit margin of less than 3%.
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Admiral’s combined ratio is typically about 90%, giving the company clear market leadership in terms of profitability. This ability to produce consistently above-average profits is Admiral’s core competency. However, now that Admiral is the UK’s leading car insurer, future growth will be driven by the second strategic pillar of incremental expansion into suitable adjacent markets.
Incremental expansion from a strong core
There are many markets which are similar to UK car insurance, where Admiral’s long-honed skills in risk pricing and efficient operations may be equally successful.
The most obvious is international car insurance, where the knowledge that comes from insuring millions of UK cars over the last 30 years should come in very handy. Admiral realised this long ago and began to launch overseas operations in 2006, first in Spain, then Germany, Italy and the US. Along with these insurance businesses, Admiral launched several international comparison websites to shake up their broker-based insurance markets and pave the way for direct insurers like Admiral.
These international businesses wrote £140 million of net premiums in 2018, compared to £450 million from the UK business. Just five years ago they produced £50 million of net premiums, so they’re growing very rapidly and as a group they’ll likely overtake the UK business within the next decade.
As for profits from these international businesses, they don’t generate any (yet), but that’s because insurance is all about scale, both in terms of data collected and operational efficiency. However, each year, each country has made strides towards positive profits, and as a group they are now very close to breakeven. If they get anywhere near the UK’s level of profitability in the next five or 10 years, then they will provide an enormous boost to the company’s overall results.
Another adjacent market is UK home insurance. This is a relatively new business, but so far, it’s gone well thanks to Admiral’s ability to a) advertise at low cost to its existing four million car-insurance customers and b) bundle insurance for a home and multiple cars into one MultiCover policy. The home insurance business now has almost one million customers after just a few years of operation.
The newest addition to Admiral’s collection of adjacent markets is Admiral Loans, which is hoping to leverage Admiral’s knowledge of risk pricing in an entirely different (but surprisingly similar) market. This is a very young business, but the market is certainly big enough to produce significant additional profits within the next decade.
Coinsurance, reinsurance and the death of private car insurance
At this point, it might seem that Admiral’s continued success is inevitable. But it isn’t, and as with any company, there are many risks.
For example, Admiral uses an unusual degree of coinsurance and reinsurance, effectively passing 75% of the risk (ie policies) it writes onto other insurance companies. This allows Admiral to write about three times more policies than it could otherwise, and that gives it access to much more accident data, which helps it to price risk more accurately. It also helps with economies of scale and building a nationally recognised brand. The result is very high returns on equity which have averaged about 40% over the last decade.
However, Admiral is dependent on these contracts staying in place on broadly similar terms. So if it was unable to renew or replace these agreements, Admiral’s ability to write insurance at its current scale would be severely impaired.
Admiral has been using this arrangement for many years and the coinsurers and reinsurers seem happy with the steady flow of profitable premiums they have received over the years. As long as Admiral continues to write profitable policies, there seems to be no obvious reason why the coinsurers or reinsurers would end this arrangement, but you never know.
Another longer-term risk could be the end of private car insurers, driven by either autonomous cars or subscription cars, or a combination of both. If we ever get autonomous cars that work reliably and safely, then it’s likely that when in autopilot mode these cars will be insured by a third party (possibly the manufacturer) rather than the driver. This means the manufacturer is likely to sign large bulk insurance contracts with a small number of insurers to cover its entire autonomous fleet. The risk from subscription cars is similar, where there is an increasing trend for people to pay for everything on a monthly subscription, including cars. Insurance could end up being bundled into a single monthly payment along with car hire, service costs and so on, and the insurer would probably be selected by the subscription service provider.
Either way, the insurance would be sold in bulk to a corporation, and that’s a very different market to insurance sold directly to consumers. This is why it’s interesting to see that Admiral recently signed a deal with Ford UK to provide the official Ford-branded insurance to Ford drivers. It’s possible that large contracts like this could make up the majority of Admiral’s business in 10 or 20 years.
An attractive yield and good prospects for further growth
Despite having grown its total assets (mostly consisting of premium reserves), net assets (the surplus of premium reserves above and beyond expected claim liabilities) and dividends by around 12% per year for the last decade, Admiral still has a very attractive dividend yield of almost 6% at a share price of 2,100p.
That’s quite a high yield, and yet Admiral doesn’t seem to have any obvious problems at the moment. So why does a company with an excellent track record of growth and a seemingly bright future have a dividend yield close to 6%? I think there are several reasons.
The first is that Admiral is unusual because it pays out almost 100% of its earnings as dividends. It can do that because, with returns on equity averaging 40% or so, it doesn’t have to retain a lot of earnings in order to grow. So even though its dividend yield is almost 6%, its price-earnings ratio is relatively high at 15.4. Investors that screen primarily on PE ratios (and there are many) will not find Admiral very interesting.
For those investors looking for high dividend yields, there’s a good chance they’ll glance at Admiral and then look elsewhere. That’s because Admiral’s dividend is split into two parts: a normal dividend and a special dividend. In 2018, Admiral announced normal dividends of 90.4p and special dividends of 35.6p. Most investment websites exclude special dividends in their yield calculations because special dividends are typically infrequent and unreliable. As a result, they show Admiral’s yield as 4.3% instead of 6%. A 4.3% yield isn’t bad, but it’s a long way short of a 6% yield.
However, Admiral has paid a consistently large special dividend every single year since it joined the stock exchange in 2004, so for me it makes sense to regard the special dividends as normal rather than special.
And if you do that, then Admiral starts to look like a market leading insurer with a long track record of double-digit growth, multiple fast-growing international businesses, an ability to successfully expand into adjacent markets and, last but not least, a dividend yield of around 6%.
As I said at the beginning, I don’t like to ‘fall in love’ with individual companies, but if I had to pick a favourite, Admiral would be it.