Rough justice for insurers as interest rate decision hammers shares and questions dividends

“A shock decision by Lord Chancellor and Justice Secretary Liz Truss to dramatically change the way in which personal injury claims are assessed is pounding the shares of leading insurers, which may now need to jack up insurance premiums if they wish to meet profit and dividend forecasts,”says AJ Bell Investment Director Russ Mould.

“Analysts had already been expecting a cut in the so-called Ogden Rate, which is used to calculate compensation payments to victims of car accidents based on the return any money paid out can earn when it is invested. The lower the Ogden rate, the bigger the lump sum the insurers must pay out.

“The consensus was looking for a drop to 1.0% from 2.5%, the figure set back in 2001. The actual reduction announced by the Government today takes the Ogden Rate down to -0.75%.

“This will be a nasty shock to most, but not all, of the big insurance firms in the FTSE 100 and FTSE 250, some of whom may now struggle to meet the profit and dividend figures expected of them by analysts for 2017 and beyond.

“This will be of particular concern to income hunters who have latched on to the yields offered by Direct Line and Admiral – both are among the three highest yielding stocks in the FTSE 100, based on 2017 forecasts:

Ten highest yielding stocks in the FTSE 100 for 2017

Source: Digital Look, analysts’ consensus forecasts.

“Direct Line has already said that a one percentage point shift in the Ogden Rate would cost it £190 million, compared to a consensus pre-tax profit forecast for 2017 of £499 million. Today it says the new discount rate will hit pre-tax profit by £215 million to £230 million after reinsurance recoveries.

“Admiral says the estimated total net financial impact of all claims settling at the new rate is £140 million to £175 million, compared to consensus pre-tax profit forecasts for 2017 of £388 million.

“Such hits do raise questions over the dividend forecasts for both firms. Admiral has today confirmed it will pay 51.5p a share as planned for the second half of 2016, adding that details on future cash returns would be made available alongside its full-year results, which have been pushed back a week to 8 March.

“This is not to say dividend cuts are certain – the firms could choose to raise prices and cut costs, although how easy it will be to increase premiums in a highly competitive market remains to be seen.

“There could also be some ripple effects for major reinsurers but there may also be some winners too. Shares in FTSE 250 firm Hastings are unchanged today, despite the wider carnage in the sector.

“Most of Hastings’ policies are new and it does not have a backlog of liabilities which would be affected by changes to the Ogden discount rate.

“The company also has low costs, a well-integrated approach to price comparison sites and a strong technology platform. It could therefore be a beneficiary if the change to the Ogden rate does force some of its rivals to increase their premiums, allowing it to capture market share more quickly.”

Source: UBS Research, company accounts, Digital Look, analysts’ consensus. *Before today’s announcement

These articles are for information purposes only and are not a personal recommendation or advice.