U.K. Personal Lines Update: Regulator Premium Financing Discussion Reveals Shares as Undervalued

With the recent announcement that the Financial Conduct Authority is investigating premium finance used to pay for insurance premiums, we believe the share price reactions of U.K. personal lines insurers in the market Jan. 10 are exaggerated and the shares of Direct Line and Admiral remain undervalued. Of the two, we prefer Admiral because we believe the company is less exposed to any future regulator action. While some news in the market has discussed double-digit premium finance rates that have fallen marginally over recent years, we think Direct Line has been charging around 4.5% last year in its motor book and 3.1% in its home insurance book, much lower than the rates being discussed in the media. In its rescue and other personal lines business and its commercial business, Direct Line has historically been charging very low-single-digit rates. If we converge these premium finance interest rates to a long-term rate of 2%, assuming the Bank of England bank rate will fall long term to this rate, we arrive at a fair value estimate for Direct Line at something in the region of GBP 1.95 per share. We believe Admiral is less exposed to any future action because across its entire U.K. business we think it has been charging premium finance rates of around 3.75%—much lower than the current base rate of the Bank of England. If we perform the same exercise on Admiral, converging these premium finance rates to 2% long term, we arrive at a fair value estimate for Admiral at something in the region of GBP 27.7 per share. We therefore believe both Admiral and Direct Line are undervalued.