Bid premium potential remains for Brit

Takeovers of Lloyd's insurers have a mixed history. There haven't been many in recent years and, when bidders have emerged, talks have often collapsed. So the approach for Brit from Apollo Global Management could easily come to nothing. Indeed, Brit's bosses have been playing a high-risk game by refusing to talk to Apollo even though the private equity fund has upped its indicative offer from 1,000p a share to 1,050p. "The lack of alternative bidders and the recent discount-to-book value at which Brit has traded suggests that the stock would fall to around the £8 level were Apollo to walk away," notes Ben Cohen, an analyst at broker Collins Stewart.

But, despite the risks, investors could do well if Apollo persists. That's because, even after the shares soared from about 700p before the approach to 903p now, they remain undemandingly rated for an insurer. They still trade below KBC Peel Hunt's 1,102p full-year estimate of net tangible assets (NTA). And rival underwriters' shares are pricier. Shares in RSA Insurance - hardly the sector's most profitable underwriter - trade at roughly 1.4 times forecast NTA, while Amlin's trade at 1.2 times. So management's view that Apollo's indicative offer undervalues Brit may be reasonable and another rise in the offer could yet materialise.

There's certainly little in Brit's performance to justify that discount. With its 2009 figures, Brit reported a combined ratio (of claims to premiums) of 94 per cent - not the sector's best underwriting performance, but solid enough nonetheless. What's more, with all of its managed capacity under its own belt, Brit doesn't share profits with Lloyd's Names. The group's trading update in May also reported that average premium rates on renewed business has risen 1.4 per cent in the first quarter. The UK business performed especially well - rates grew 3 per cent, helped by a 10 per cent rise in UK motor insurance premiums.

And the outlook for premium rates has brightened further. That reflects losses from recent catastrophes, notably the Chilean earthquake and BP's Deepwater Horizon rig disaster. True, paying claims arising from catastrophes hurts short-term profits, and Brit expects a relatively heavy £46m hit from the Chilean earthquake. But such events also leave insurers needing to hike rates in order to rebuild reserves, so the recent catastrophes could help halt the decline in premium rates that has been evident since hurricanes Gustav and Ike in 2008.

Brit's investment performance looks good, too. With 94 per cent of its funds invested in high-quality bonds and cash, Brit is taking few investment risks and the 1 per cent return in the first quarter - suggesting a 4 per cent annualised return - looks reasonable for today's low interest-rate environment. Moreover, a prospective dividend yield of over 7 per cent on the shares is amongst the tastiest in the sector.