Novae Group Plc. (LSE: NVA) Provides Re(insurance) products in the UK and Internationally. The company operates through three business segments including Property, Causality and Marine, Aviation & Political risk. The company was incorporated onto the London Stock Exchange in 2006.

1. Vigilant Leadership

Quantitively

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* Combined Ratio – The Ratios, in per cent, of the sum of net insurance claims and expenses, to net earned premiums. It is also the sum of the claims (loss) ratio and expense ratio. img_0324

Qualitatively

Annual Bonus

  •  Maximum: 300% of base salary for the top level management.
  • Measures: Profit. Before. Tax targets

Long term incentive plan

  •  Maximum: 200% of base salary for top level management.
  • Measures: Average annual Net assets value growth. And absolute Total Shareholder Return.
  • Targets: 7% minimum average annual growth in both measures.
  • Awards: Novae shares over three year periods.

2. Long term prospects

Persistent operations

There is little doubt that the current underwriting environment in the UK and internationally is challenging for insurance companies. A lack of significant market losses and an abundance of capital continue to contribute to a softening rating environment.

The two main challenges that Novae faces to its long term prospects include firstly, a slow down of growth, which effectively begun in 2008. The recent Brexit vote could further contribute to slow downs in growth. Pricing provides the latter challenge, especially as casualty insurance customers predominantly purchase premium policies based on price. Therefore, if Novae is unable to develop a pricing advantage it may see premiums fall overtime.

Nonetheless, Novae’s response to the challenges, includes increasing acquisitions, extending to emerging markets, maintaining a prudent approach to reserving, improving the investment income and building market leading capabilities in selected areas.

Technological advancements

  1. Smart Homes – Sensors and monitoring systems to give homeowners and insurers data on and control over major risks.
  2. Telematics, driverless cars and motor insurance – Telematics monitors customers driving habits for more accurate risk profiles and pricing. However, future introduction of wide scale driverless cars will redefine the kind of motor insurance required, limit accidents and reduce the overall need for insurance.

* Novae’s Causality division stopped writing direct motor business in 2015/16, which during its time contributed 0.4% of the gross written premiums.

Risks

  1.  Catastrophe Risks – The potential for aggregated losses to arise from catastrophic events.
  2. Investment Risks – The risk of economic losses arising from fluctuations in the value of Novae’s asset and liability portfolio driven by economic variables.
  3. Reserving Risks – The risk that claims reserves will be materially different from the ultimate cost of settlement.
  4. Credit Risks – The risk arising from the potential failure of business counter-parties to fulfil financial obligations to Novae Group.

Solutions to risks

  1.  Geographical diversification, monitoring and controls of aggregate exposures and disaster scenarios across multiple return periods.
  2. Strategic Asset Allocation process to optimise the risk and reward balance. Also, Investment modelling and stress testing to ensure within appetite.
  3. Use of proprietary and standard reserving models. Along with, Internal and external reserve benchmarking.
  4. Guidelines support careful selection and monitoring of counter-parties, including limits to individual exposures.

3. Stable and Understandable Business Economics

Stability

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Buffettbooks

Understandable Business Economics

Industry

General insurance providers in the UK provide insurance premiums ranging from motor insurance to health insurance. Revenue is generated by charging customers premiums for Policies and then investing the remaining in assets (Insurance float).

I.e. John Brown pays for a 1 year motor insurance policy, 7 months has cleared, therefore the insurance company can record 7 months of earned premiums. This essentially can be invested by the company elsewhere (asset allocation), until John makes a claim. The period between issuing the premium policy and a claim being made is what creates the insurance float.

It is no doubt that the property & causality underwriting industry will face some turbulence in the coming years, especially due to Brexit’s impact on insurance companies ability to generate creditable investment returns. The Industry is expected to grow at a compounded annual rate of 3.7% through the next 10 years. 

Rank in Industry

In relation to Novae’s peers, ranked 2nd based on revenue. (AIM – all share and FTSE 250)

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FinancialTimes

Competitive Advantages (MOATS)

  1.  Prudent approach to reserving (84th percentile)
  2. Talented teams with strong capabilities and backgrounds
  3. Recognised leaders in Financial institutions insurance 

Barriers to entry

* High expertise required     * Regulatory requirements     * Mature Industry     * Strong market leaders in existence     * Developed niches

Business Segments

* Property     * Causality      * Marine, Aviation & Political risks

Major Competition

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Claims (loss), expense and combined ratios

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Over the past 7 years, Novae Group has been successful in reducing their claims ratio by 16%, while this has been mitigated by an increase of 8% in expense ratio over the same period. Thus, overall Novae has increased the efficiency of underwriting by 8% over the last 7 years, which is good testament to the company’s continued investment in underwriting talent and expertise.

Furthermore, Novae’s combined ratio, although not market leading, has also seen a successful reduction of 8% over the past 7 years, which again highlights improving performance in the business.

2011 may stand out as an anomaly, which can be explained due to catastrophic events occurring during the year.

Financing and Capital structure

Capital structure img_0334

Annual Reports

Financing
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Regulatory Implications

As the nature of the insurance business changes due to technological innovation, the regulatory framework will change with it to address potential new risks and existing gaps in supervision.

Innovations will lead insurers to gain and store more information about their customers and their behaviour, resulting in increased operational risks. In response, the resilience of automated systems needs to be guaranteed as insurers become increasingly reliant on them.

Insurers will also face challenges with regard to restrictions on their ability to use new data sources. According to Helena Kingsley-Tomkins, assistant vice president, Moody’s, “While insurers will have a new trove of information on policyholders to help assess and price risk, they will also have to navigate a growing number of rules around how they use and protect the information.”

Growth Prospects

  •  Allocating capital safer and at higher returns.
  • Growing trading relationships throughout and excluding Europe.
  • Investing in more underwriting talent.
  • Launching new syndicates in the Lloyd’s of London.
  • Suitable acquisitions (made easier by Novae’s consistently strong free cash flow generation, which I have underestimated in this analysis I will admit.)

4. Valuation

From computing an earnings power model of Novae Group Plc. and discounting the earnings back to today’s present value using a 7% discount rate and a 12% perpetuity rate to be Intrinsically valued between £ 7.60 – £ 8.60 per share, equating to £ 500 Million – £ 560 Million for the entire company. 

Anything misunderstood, view the definitions here.

Thank you for reading,

Jordonlee W. Smith

2 thoughts on “Novae Group Plc.

    1. Hi Sam, great question !
      For discount rates I usually start with the risk-free rate which is the 10 year gilt rate (U.K. government bond) I then add the current yield from the FTSE 100 index. Finally I make adjustments based off of 1. Consistent/non-consistent dividends. 2. Level of debt/equity. 3. The general long term prospects. 4. Historic management record. This gives a conservative discount rate as it considers the current return from bonds, equities and it considers the quality of the specific company in question. For the perpetuity rate I use anything between 10-15% using a lower figure in good economic environments and higher figure in poor environments. For Novae the calculation was 10yr gilt return= 1.5% + total equities return = 3% (based on a 33 P/E for the FTSE 100) + 1 for the long term prospects of Novae being not as defined as other companies/industries + 1 for slight inconsistency in earnings (especially in 2011 due to catastrophes). Total is 6.5 however I rounded to 7 to add extra security. This is a very conservative way of discounting, I am aware that many investors just use the risk free yield (bond yield) however I like to consider other opportunity costs too.
      I’d like to know how you think/feel about this discounting approach.
      Thank you for your question.
      Jordonlee

      Like

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