Rising rates buoy Jardine Lloyd Thompson

With the fall-out from the financial crisis still in evidence, buying shares in an insurance broker might not appear to be the safest course of action. But that would ignore the fact that underwriters are boosting premium rates across almost all of their business lines. That’s good news for insurance broker, Jardine Lloyd Thompson (JLT) - as rates go up, so will its commission income and, therefore, group profits.

Bizarrely, the improving insurance market reflects the hefty pay-outs that insurers have been forced to make - largely as a result of last year’s hurricane season. Indeed, insurance broker RMS has estimated that the total cost to insurers from hurricanes Gustav and Ike was somewhere between $15bn (£9.7bn) and $28bn. In addition, miserable financial markets have meant hefty losses for insurers' investment portfolios. While these factors spell bad news in the short term, they also force insurers to raise premium rates in order to rebuild their capital.

There is plenty of evidence that premium rates are rising. In a trading update from JLT last month, management said that “some lines, such as aviation, financial lines and catastrophe-affected classes, are seeing rate rises". And the underwriters themselves have had plenty of good news to report. Lloyd’s insurer Novae said last month that, across all of its market segments, rate increases in the first three months of the year had averaged 5 per cent. And, earlier this month, Lloyd’s underwriter Beazley reported that premium rates had risen “significantly” in all of its short-tail catastrophe-exposed classes.

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JLT’s core operation looks well placed to take advantage of that improving market. With its full-year figures, the group reported that the core risk and insurance operation - responsible for 84 per cent of turnover - had increased underlying trading profit by 26 per cent year-on-year to £80m., while the smaller employee-benefits unit grew trading profit 10 per cent in 2008 to £15m. That decent performance has continued into 2009. “During the first quarter the group has seen good rates of business renewal and new business wins,” said chief executive Dominic Burke last month.

Still, weak investment conditions and low interest rates are proving bad news for the group’s investment book - investment income slipped 9 per cent in 2008 to £15.8m. Although, with over a quarter of the group’s turnover denominated in dollars, JLT has benefited from sterling's weakness. Yet that can't be relied upon Indeed, the group's profits are highly sensitive to movements in sterling's exchange rate. After hedging, each one cent movement in JLT's achieved exchange rate translates into a £0.75m change in pre-tax profits.

Insurance brokers continue to face the implications of a probe by Elliot Spitzer back in 2004, as well. The former attorney general of New York had found that some brokers steered clients' business towards those insurance companies that paid the highest commissions, leaving brokers’ practices under increased scrutiny. This has meant greater disclosure, which has been bad news for commission rates. Certainly, there is no suggestion that JLT behaved improperly, but the probe did persuade its management to drop all business that could be perceived as connected to such practices. And, beyond small bolt-on acquisitions - such as the £5m move to buy Harman Wicks & Swayne last June - the group hasn’t filled the gap with the kind of transformational deal that created big US rivals, such as Aon and Marsh & McLennan.