Even though Storm Darwin was blamed for a large chunk of the significant losses at FBD last year, it now appears that there was another storm brewing in the background at the largest insurer in the country.

In a year when the company had projected to make €45m profit, similar to previous years, after two profit warnings and weak midterm results, it ended up making a loss of €4.5m last year. The share price has collapsed by 47% in the past 12 months, wiping over €200m off the market capitalisation of the predominantly farmer-owned (24.6%) insurance company.

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As we reported in last week’s Irish Farmers Journal, there are fundamental problems in the wider insurance market, but serious questions need to be answered about what has gone wrong at FBD.

How does a company which had delivered consistent profits in excess of €50m in the previous three years see half of its market capitalisation destroyed in one year? Were profits overstated or did it not allow for the way the claims and investment returns world has developed?

While the company blamed a number of factors, including Darwin, an increase in economic activity along with a rise in the number of claims, with interim results due out in three weeks, it now appears that the poor performance is not just related to 2014.

The bad weather and Storm Darwin cost the insurer and 9,000 affected customers €15m net of reinsurance. But the main reason given by FBD for the poor results was an increase in the frequency of motor and liability claims, as a result of economic recovery.

Another factor related to larger-than-expected numbers of prior-year medium-sized injury claims. This related to accidents that occurred in 2011 and 2012 and meant that the money that was set aside to settle these claims was not sufficient. The combined cost of these claims and maintenance of the reserve level resulted in a charge of €13m.

Farming base

FBD, which was set up by farmers in the 1970s to provide cost-effective, reliable insurance, enjoys a dominant position in the Irish farm insurance sector (with about 80% market share).

FBD’s traditional core business covered farm policies to include farm houses, their contents, outbuildings and stock, along with public, personal and employers’ liability and machinery.

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The group has maintained and developed this lucrative, low-cost recurring income stream and farming customers and related connections equate to about 48% of FBD’s total premiums.

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So, what went wrong?

Because of its rural links, FBD was always underrepresented in urban markets. For example, in 2011, its share of the Dublin market was less than 5%, even though it had a share of the national market closer to 12%. It decided that big urban areas needed to be tapped to grow its business.

FBD wanted growth and embarked upon a strategy to increase market share. It went from having 8% market share in 2002 to last year becoming the largest insurer in Ireland, with 13.7%. This is especially significant considering the market shrunk by 40% over the same period.

Unfortunately, it now seems that FBD didn’t fully consider the strategy and prioritised a growth model that sought volume growth over an appropriate risk-based growth strategy. But as cracks started to appear last year, FBD reversed this strategy and started pulling back from business. The volume of policies written for the full year decreased 1.9% but it accelerated in the second half, which was 6.3% down.

Alongside this, multi-channel distribution became a critical element of FBD’s development strategy. In particular, it built on the success of the local office network and in 2008 it launched No Nonsense, a low-cost challenger brand to fend off competition from online offerings.

It invested a lot in building this brand as it aggressively went after the motor market. In the short term, this was great business, but because motor drives personal injury claims and coupled with the overall deterioration of the claims environment, this market has been underperforming.

The initiative to develop the broker business progressed well, despite increased competition in the business insurance sector, particularly for larger risks.

With an estimated 45% of all industry-wide premiums originating via brokers, FBD focused on building relationships with brokers as a means of leveraging new business. FBD not only had to do it cheaper, but a lot of the business it booked ended up being the business insurers didn’t want.

Last year, 20% of all new business was sourced from brokers. This compared with 4% in 2008. And 59% of its new commercial premiums were sourced from brokers last year, compared to just 11% in 2008.

FBD’s strategy to move to progressive dividend policy, despite potential income volatility from earning swings, saw the insurer pay out in excess of €66m in the past five years alone. Even last year, when it lost €4.5m, the board agreed to pay a dividend to shareholders of €17.5m.

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Broken business model

As with all insurers, because of low interest rates, investment returns no longer significantly subsidise the underwriting operation. This is reflected in a combined operating ratio (COR) of 111% for the industry last year (below 100% leaves a profit).

FBD had a COR of 113% in 2014, in line with industry averages. Increased claims didn’t help last year and are an industry-wide phenomenon. FBD’s loss ratio increased from 67.9% in 2013 to 86% in 2014.

In recent years, FBD has been de-risking its balance sheet, keeping an eye on Solvency 2, which comes into effect in January 2016. It increased its exposure to bonds as just one element of a strategy that has seen it maintain a prudent reserving policy.

Even though investment returns have fallen below historic norms, total investment assets of €883m made a return of 3.1% last year, which is a satisfactory performance given the low yield environment.

Capital requirements

With new capital requirements coming down the road in January 2016, it is likely that FBD, similar to all insurers, will now need additional capital in order to secure an adequate buffer to cover risk.

The problem right now is that FBD doesn’t get any credit for having capital tied up in the 50:50 joint venture hotel and leisure property assets it has with Farmer Business Developments.

In 2011, FBD found a solution to its property dilemma as exposure to volatile property assets proved a major impediment for a number of investors. This saw it forming the JV to jointly manage and control the €161m of non-core hotel and leisure assets – which were a legacy from the Celtic Tiger era.

This move held a number of attractions for FBD, not least reducing the downside risk from any further asset valuation adjustments and hence refocusing attention on the solidly performing insurance business.

The transaction involved an exchange of €52.5m of company debt outstanding to Farmer Business Developments into convertible loan notes. In effect, it meant that 50% of the hotel and leisure assets transferred to Developments.

The issue today is that the regulator wants investments that are as close to cash as possible. This JV could offer a method of helping to raise capital by moving the remaining hotel and leisure assets over to the JV in exchange for some €50m. While there will be questions over the value of these hotel assets, it may be a side issue. The real question is how much money FBD may require to give it an adequate buffer.

If not, it may have to go back to all shareholders, including farmers, and ask for more money (a rights issue), or it could also issue a bond.

FBD share price history

The share price has struggled since 2008, but was more related to the macro environment as the world adjusted to a new economic reality post-boom. In May of that year, it was trading in the region of €27. It subsequently fell to lows of just under €6 as the financial crisis took hold in late 2008/early 2009.

It remained relatively flat until 2011 and peaked in January 2014 at €19.30. Since last Thursday, shares are down 18% and closed at €7.45 on Monday.

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Shareholders would be correct to wonder how this situation has come about. Clearly mistakes were made and the company is in a capital pinch.

Serious questions remain as to how the board, senior management and auditors have allowed a situation such as this to arise.

Did they understand the provisioning required in new markets and did the board have the adequate skills and insurance experience necessary to govern what has become the largest insurer in Ireland?

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