Should I buy shares in esure?

esure, creator of some of the insurance world’s most annoying adverts – think of the Go Compare tenor, the fluorescent pink of Sheilas’ Wheels and the patronising ‘Calm Down Dear’ from the late Michael Winner – is coming to the stock market in a flotation which could value it at up to £1.3 billion. So will its shares prove more enticing than its adverts?

The launch of the prospectus came in an awkward week for insurers with shares in Aviva and RSA Group – owner of the Moreth>n brand – dropping sharply as they cut their dividends, ostensibly to finance future growth but actually reflecting years of over-distribution. But these two have international networks and a range of businesses, which thrive and shrink according to global fortunes and management skill.

esure, by contrast, is focused on the UK market. Its business comes mainly through two areas of the personal insurance market – motor and home – sold largely online.

Its founder, Peter Wood, knows a thing or two about insurance, having created Direct Line and made his first fortune running it for Royal Bank of Scotland. esure, launched in 2000 initially in conjunction with Halifax, now has around 5 per cent of motor policies in the UK and has been growing its share of home insurance rapidly: its insurance book enjoyed compound annual growth of 24 per cent between 2008 and 2012.

The bulk of that business – 82 per cent - is generated online through comparison websites and it is developing distribution through the social media channels which are becoming increasingly popular. Its part ownership of Go Compare also allows it to keep on top of what the competition is doing in a market which is driven almost exclusively on price.

Among the strengths esure highlights in its prospectus are its prudent reserving policy, which helps guard it against unexpected events such as severe weather or a leap in personal injury claims; an efficient claims management process; an infrastructure which will allow it to accommodate future growth without significant extra cost; and a low-risk approach to new business with 97 per cent of its motor policy holders aged over 30 and virtually all its home policies in areas deemed a low flood risk.

It is selling itself on a growth strategy, saying that it thinks regulatory changes such as banning insurers discriminating on the basis of gender will benefit its Sheilas’ Wheels subsidiary, whose policyholders are overwhelmingly female, while outlawing legal referrals will reduce whiplash claims. It is also adding services such as breakdown insurance and lost key cover.

But the prospectus also underlines the challenges facing the insurance industry, changes which could put further pressure on already tight underwriting margins. The Competition Commission’s investigation into motor industry practices – such as directing where car repairs should be carried out – is due to report this autumn but the Office of Fair Trading thinks such restrictive practices are costing an extra £10 per motor insurance policy, or £225 million across the industry.

esure’s assurance that the regulatory changes will be good for profits has yet to be tested in practice. And as we know, the weather is becoming more unpredictable: the group’s Loss Ratio, which measures the impact of claims, went from a chilling 104 per cent in the freeze of 2010 to a warming 55 per cent in 2011, when the weather was calm. Then there is the risk of new entrants, particularly to the comparison market where barriers to entry are low, and of cut-throat competition from larger rivals.

Like Direct Line, which came to the market last year, esure is promising generous dividends with the pledge that it will distribute half of its profits after tax as dividends each year, with further special dividends when capital still exceeds the requirements of the business. It says that would have led to special dividends of at least 20 per cent of reported profits in 2011 and 2012 had it been listed.

Direct Line has had a reasonable debut with the shares gaining almost 20 per cent on its 175p flotation price, behind rival Admiral but ahead of the FTSE 350 index, RSA Group and Aviva. A substantial part of that came on the opening day, reflecting the fact that Direct Line’s sale was priced to succeed in what was then a very depressed market. In its maiden results announced at the end of last month, chief executive Paul Geddes warned of fierce competition and the threat of market reforms.

esure has set the price range for its offer at between 240p and 310p and is likely to sell around half of its shares. The deadline for applications through intermediaries is 19 March. Peter Wood, whose stake will fall from 49 to 35 per cent, is committed not to sell any further shares for at least another year while his private equity backers, Tosca, will see its stake fall from 39 to 16 per cent and is locked in for 180 days.

At the midpoint, and assuming similar growth to last year, the business will be valued at around 12 times earnings. That is slightly ahead of Direct Line but below Admiral. That is not especially generous for a new issue: esure would be advised to aim for the bottom end of the range to guarantee a successful debut.

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