Chesnara gains life

Chesnara has been moving along nicely, profitably managing the run down of life-insurance funds that are closed for new business. In the process, it has thrown off lots of cash as its requirements to hold capital diminish and it has rewarded shareholders with a dividend that even now generates a yield of 8.7 per cent.

But Chesnara is turning from being a manager of zombie funds into a living, breathing life assurer, following its acquisition of Stockholm-based Moderna Försäkringar. Moderna writes new business, principally in corporate and personal pensions, but also life assurance policies. It has around 9 per cent of the Swedish unit-linked market, and the acquisition, which cost £20m, was secured far below Moderna's embedded value of £74.7m.

As a result, the deal has boosted Chesnara's own embedded value - a valuation metric that takes into account future profits from business already written - from £179m in June to £259m at the end of September. Yet, even without the acquisition, Chesnara had pushed its embedded value higher, thanks mainly to a rise in share prices but also as a result of favourable persistency rates, meaning that premium income was boosted because fewer policy holders cashed in their policies.

Buying Moderna means that profits are set to fall in 2010 (see table) mainly because of the amortisation costs of the acquisition but also because Chesnara will be spending cash on integrating and expanding the Moderna operation. In fact, Moderna is not expected to be profit-making for around two years, because writing new insurance policies involves taking lots of up-front costs while profits don't come through until recurring premium income overtakes the initial costs. However, amortisation is an accounting item rather than a cash outlay, while ongoing trading losses at Moderna won't be big enough to affect the enlarged group's progressive dividend policy.

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Besides, a glance at Chesnara's solvency position provides assurance. True, the cost of acquiring Moderna has reduced its solvency ratio - the ratio of net assets to net premiums. Even so, at the end of September, group-wide Chesnara had a solvency ratio of 314 per cent, while its Swedish unit had a ratio of 298 per cent. In both cases, the regulatory target is a ratio of 150 per cent.

Even with the expansion, Chesnara is expected to continue running a tight ship. Back office operations have been outsourced, and staff numbers at the core business are less than 20. However, there will be increased costs associated with integrating the Moderna business, and there will be additional expenses associated with Moderna's recent agreement to take over the operational management of Aspsis, a Swedish insurance company whose operations were suspended because the company has insufficient funds to meet its commitments. However, the hope is that the Aspsis deal will add to profits in the medium term.

Despite these two deals at what look to be bargain-basement prices, the acquisition of closed books of life policies remains difficult. While a shift towards including a live insurance business is a positive step, Chesnara's core business will eventually wind down unless management finds some closed books. The upside is that dividend payments are likely to remain generous because, as the closed life business runs down, the amount of regulatory capital that the company is required to hold falls as well, freeing up cash.