On Monday, RSA Insurance Group told analysts in a conference call that it was investigating incorrectly booked large losses and the potential accelerated recognition of earned premiums in its Irish business, RSA Insurance Ireland, over at least the past two years. The call followed Friday’s announcement that it had discovered issues within RSA Insurance Ireland, and as a result 2013 group operating profits would be £70 million lower than previous market expectations. RSA subsequently suspended three senior members of its Irish management team. Although Ireland contributed only 4% of RSA’s 2012 net written premiums, the lower overall profitability and uncertainties around the Irish business’ reserves are credit negative for RSA.
We consider the £70 million hit to earnings arising from the Irish claims and finance announcement an earnings issue rather than a capital issue because the hit to earnings is only 10% of 2012 group operating profits. As a consequence of its discoveries, RSA injected €100 million of capital into its Irish business, increasing its regulatory solvency position to nearly 230%. To put this in context, increased regulatory scrutiny of insurers in Ireland typically occurs when regulatory solvency is below 150%.
However, the potential for reputational damage with distributors or policyholders is possibly more credit negative than the hit to earnings. The reputational damage can sour relations with key shareholders in what has already proven to be a difficult year for RSA following a dividend cut at year-end 2012, Canadian losses in June and July, the St Jude’s day storm and a separate Irish bodily injury issue also announced last week.
RSA believes that the accounting irregularities in Ireland are an isolated event and do not reflect group-wide failures in risk management and controls. The initial problem in Ireland was identified as part of a routine internal audit investigation. However, following Friday’s announcement, RSA appointed PriceWaterhouseCoopers to conduct an internal investigation focussing on the financial and regulatory reporting processes and controls within the Irish business, the group oversight and controls of the Irish business during the relevant period and the adequacy of remedial actions being taken, including assessing whether £70 million is an appropriate valuation of the loss.
This announcement compounds a difficult week for RSA, during which it accelerated the release of its third-quarter results to disclose its estimated cost of the St Jude’s Day storm at £45-£65 million. As part of its third-quarter announcement, RSA also announced that it would likely need to strengthen its Irish motor bodily injury reserves, with the group currently holding approximately £330 million of Irish claims reserves, of which £140 million relates to personal motor and a further £45 million to commercial motor, the two lines of business most affected by bodily injury claims. Although these two developments in its Irish business are unrelated, it is likely that had accurate data been available, adverse bodily injury trends might have been detected sooner and RSA could have increased premiums sooner, lessening the financial effect on the group.
RSA has indicated that it will likely increase capital requirements on its Irish business as a result of the increased earnings volatility, which will suppress future economic returns on this business. RSA will consider future M&A opportunities more judiciously, likely leading to lower inorganic top-line growth and increased capital retention, which we would view as credit positive. Current budgeted M&A spend is typically £150-£200 million per year for RSA.
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