A good piece of advice for investors in general is to avoid the motor insurance industry. It has a terrible record when it comes to making money. Since 2008, the UK motor insurance industry has reported an average combined ratio of 104%.
A combined ratio is a key metric of profitability for the insurance sector. It tells us how much a company pays out in insurance claims compared with how much it receives from premiums. If the ratio is consistently above 100%, that’s not a good sign, as it means the company is consistently losing money on an underwriting (pure insurance) basis.
However, there are some gems in the sector – businesses that are very picky about whom they choose to insure. Admiral (LSE: ADM) is one of my favourite plays in the sector due to its diversified and international business model. Sabre Insurance (LSE: SBRE) had its issues amid a tough claims environment in 2023. A little over a year later, Sabre seems out of the woods, although the market does not seem to understand the potential opportunity.
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Sabre pushes through a tough industry
Unlike Admiral, a mass-market insurance group offering everything from car to home and travel insurance to personal loans, Sabre has a more focused business model. The company has three main business divisions: motor, motorcycle and taxi insurance. It provides insurance to drivers who may be unable to find coverage anywhere else, which means it targets a unique customer base and has much more flexibility on pricing compared with its mass-market peers.
That’s good news in a tough business that is going through a rough patch. The years 2022 and 2023 were some of the worst on record for the industry, with combined ratios of 111% and 112% respectively on average. It is still losing money, even though the average car insurance premium has risen from about £400 a year at the start of 2022 to £622 in the second quarter of 2024 – a rise of just under 60%, on average.
While premiums have risen 60% on average, the cost of repairing vehicles and personal injury claims has accelerated even faster. Analysts at Panmure Liberum have calculated that if insurance premiums accurately reflected claims inflation over the past four years, the average premium should be £849 per year, 36% above current levels.
Even then, the analysts warned, that would only take premiums back to 2012 levels in real terms (taking into account inflation in the price of car parts), and the industry didn’t make money in 2012.
This suggests the industry would have to hike average premiums to roughly £1,000 a year to be sustainably profitable. Considering how much flak the sector is already taking for pushing premiums up by nearly 60% over the past few years, further significant premium growth seems improbable.
It seems as if the industry has decided to start swallowing the losses – the data suggests that mass-market car insurance providers have started to reduce premiums. Sabre, on the other hand, hiked its prices by a double-digit percentage during the first nine months of 2024, according to its latest trading update, issued in mid-October. For the reasons outlined above, Sabre can push through growth while other companies fight for market share.
Should you invest in Sabre?
Sabre is focused on underwriting profitability and its profit-margin goals. As such, it will not write business that does not conform to its pricing model, whereas some of its peers may be willing to accept that risk. The firm knows its markets well, so it can price effectively without relying on guesswork or over-optimistic projections.
It’s this unique advantage that has enabled the company’s combined ratio to come in ahead of the rest of the UK motor insurance industry by 20 percentage points on average over the past decade, according to asset manager Berenberg’s analysis. In 2022, a historically bad year for the industry and a bad year for Sabre, the company still reported a combined ratio of 93.4%, significantly above its long-term average in the mid-70% range, but still profitable and better than the wider sector.
The company has substantial competitive advantages and unique qualities in a commoditised industry. However, Sabre’s current valuation does not seem to take these factors into account. The stock is currently trading at a price-to-earnings (p/e) multiple of 8.2, compared with its five-year historical average of 12.8 and peak of 18 times earnings, according to Panmure Liberum.
That could be something to do with the market capitalisation, which, at £350 million, is below the radar of most large fund managers. Investors have withdrawn tens of billions of pounds from UK small-cap funds over the past five years, depressing the valuation of small-caps and causing valuation distortions. Sabre seems to be a case in point.
It could be some time before these trends reverse, but it will pay investors to wait – the company has committed to returning the bulk of its earnings to shareholders via dividends. Berenberg believes that could translate into the company returning 43% of its current share price in dividends by 2027.
On an annualised basis, that suggests a dividend of 9.3% for 2024, 10.7% for 2025 and 11.4% for 2026, based on past underwriting profitability trends and the current solvency ratio, which sits at 85%, above the management target of 140% to 160%. Management has indicated it will return anything above this level to shareholders as surplus capital.
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