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R&SA seals US disposal for £443mn loss

UK insurer Royal & Sun Alliance Group plc (R&SA) today (28 September) said it has at last achieved finality for its US legacy business with the £158mn ($300mn) sale of the operation to Arrowpoint Capital, a Delaware vehicle set up by the unit's management team.

The £158mn will be paid as deferred consideration, funded from the future performance of the US operation, equivalent to around £70mn in present value terms, and representing a 78 percent discount to book value at 30 June 2006.

On receipt of shareholder and regulatory approval, R&SA will plough £151mn ($287.5mn) into the new company. As a result, R&SA will take a £443mn pre-tax loss on the disposal of the business, including the capital contribution, write off of net assets and other costs.

The company will also delist from the New York Stock Exchange at the end of October, terminate its American Depositary Receipt programme, and seek to terminate its US Securities and Exchange Commission registration, saving an estimated £10mn a year in costs.

R&SA said it will maintain the Adverse Development Cover it put in place in 2003 - a reinsurance protection already at its policy limit - and a £79mn letter of credit to support the business, which will be stepped down two years from completion of the deal, subject to the financial health of the US business.

The company said neither represented new exposures or material risks, "given their nature, timing and likelihood".

R&SA group CEO Andy Haste described the announcement as a "significant step" for the insurer.

"The sale of the US operation is the right deal for our shareholders and US policyholders. The transaction will bring certainty and finality and delivers our objective of a clean exit from the US," he said.

R&SA has been looking to cut its US operations loose since putting them into run-off in September 2003 - a decision triggered by developing legacy losses and a capital crisis at the reinsurer that had led it to raise £960mn in a rights issue.

The operation had continued to haemorrhage losses as actuarial investigations identified reserving deficiencies, with a total of £800mn of funds raised ploughed into reserves and the establishment of a contingent liability fund.

In its interim results last month, the company was able to announce an improvement in its US operations as it continued to "de-risk" the run-off subsidiary.

Indeed, the division - which had been significantly scaled down - delivered an insurance result of £6mn, compared to a £24mn loss in the first half of 2005.

Analysts welcomed the deal, supporting the view that the transaction represents a "clean exit" for R&SA.

Collins Stewart analyst Tim Young said that a sale had become increasingly likely in the current climate.

"The evolving pricing environment and available capacity in reinsurance, the hedge funds' and private equity's desire for more aggressive risk-return in a low interest rate/low volatility market, as well as significant advances on R&SA's part to simplify and de-risk the US business made a sale ever more likely," he commented, suggesting Arrowpoint Capital's backers are likely to be a combination of private equity and hedge fund interests.

Noting the after-tax loss on disposal of £310mn translates to 10p off the company's net asset value, Young said the cost to shareholders is worthwhile.

"We think this is a small price to pay for an issue that has frightened investors for years and occupied an inordinate amount of management time and effort. We also think that the transaction quickly becomes value-accretive.

"Without the US handicap, it is likely that there will be various capital releases at group level that will help to counteract the depletion, not least the possibility to refinance existing debt," he predicted.

He also said the deal gives the insurer the opportunity to recapitalise, as it pursues rating upgrades, and that a likely halving of its debt costs should allow it to put in place greater leverage.

"The group has a commitment to return the group's rating with all the major agencies to A. With the disposal of the US, we think this is a floor, not a ceiling," he said.

Rating agency Standard & Poor's also welcomed news of the disposal, but said it wouldn't lead to a change in R&SA's A- with a stable outlook rating.

In a statement, the agency said: "The sale of R&SA US represents a conclusion to the last, and potentially most pernicious, of the legacy issues inherited by R&SA's incumbent management team."

"Standard & Poor's considers the disposal to be a capital, not an earnings, event. The completion of this transaction will have no material effect on the group's capital adequacy and we expect improvement in capital quality due to the attendant reduction in the potential volatility of the group's loss reserves going forward," it added.

It said that while the deal will see continued "limited" financial support for the US business, "the transaction does succeed in capping R&SA's future exposure to R&SA US at a level expected to be immaterial from the group's perspective".

Rival Moody's, however, said it would put R&SA's Baa1 financial strength rating under review for a possible upgrade on the news.

The agency said the review reflects its view that, "whilst the disposal will result in a significant loss for the group, it will also largely eliminate the group's future exposure to the US operations, which have produced significant underwriting losses in recent years and have weighed on the group's ratings".

It added that any upgrade is dependent on "a successful completion of the sale of the US operations, the expectation that the current levels of profitability at Royal & Sun Alliance's core businesses will be maintained and continued modest financial leverage".

"This would likely include the core businesses maintaining a combined ratio of around 95 percent for 2006, a core group underlying ROE of above 12 percent and group financial leverage (including pension adjustments) of around 30 percent," it concluded.

Shares in the R&SA were up 6.25p or 4.3 percent to 150.75p in trading this morning as markets digested the news.

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