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Why I'm Bullish on RSA Insurance Group

LONDON -- After cutting its dividend, RSA Insurance  (LSE: RSA  )  still yields a generous 5.3%, and it's well set to pay a progressive dividend in the future, founded on growing international earnings.

That's scant consolation if you held shares that lost 16% of their value last week when the insurer shocked the market with a 33% cut. Existing shareholders feel bruised, and income investors are understandably wary.

But RSA's mishandled investor relations shouldn't detract from its prospects. Perversely, the dividend cut makes the shares a buy.

What went wrong?
Reducing the dividend wasn't, by itself, a bad thing. Analysts had warned that the payout was too high, and the pre-cut yield of over 7% was exceptional. But RSA made two big errors:

  • It gave no hint that a cut was possible (unlike Aviva  (LSE: AV  ) (NYSE: AV  ) ).
  • It wrong-footed the market by increasing the last interim dividend.

I think CEO Simon Lee deserves some sympathy. He's only been CEO for 16 months, and for just nine months when the interim dividend was declared last August. You'd expect the chairman and the finance director to have the ear of institutional investors. But the new chairman has only been on board for a month.

When the interim dividend was declared, the old chairman was on his way out. The new finance director was only two months into the job, in his first public company role. RSA's new investor relations director, poached from Legal & General, was only recruited later that month.

Track record
So nul points for investor relations, but Mr. Lee has an impressive track record for operational management. For eight years, he was right-hand man to Andy Haste, his predecessor as CEO who was brought in to save the failing company formed from the merger of Royal Insurance and Sun Alliance.

That was a highly successful turnaround, and a key component was the international division that Mr. Lee ran. He built a stable of profitable operations in Canada, Scandinavia, Latin America, and Western Europe, which now contribute 65% of the company's premium income.

The company's strategy is to establish itself as a significant player in profitable insurance markets. It sees future growth in emerging markets, whose contribution increased by 44% last year. Emerging markets now make up 10% of premiums and are planned to almost double by 2015.

Those overseas markets generate better underwriting profits than the U.K. Last year, 97% of RSA's total underwriting profits came from overseas.

Profits in the U.K. are dependent on investment returns from the bond portfolio held as reserves to pay out claims. The prospect of prolonged low bond yields, along with the desire to invest in new markets, were the reasons behind the dividend cut.

And there's the great irony. At the time of the so-called great rotation out of bonds into equities, equity investors are expecting insurers to pay them high yields out of income generated from bonds.

Something has to give, and Mr Lee's plan of diverting the dividend to invest in more profitable insurance markets makes sense.

Is Aviva next?
The question on many investors' lips is whether Aviva will also announce a dividend cut next month. Its situation is different, but it has a new CEO who might relish the prospect of "re-basing" his starting position.

He's also fresh from Asia and, in his recent management reshuffle, has brought in a former colleague to run Aviva's Asia business. Like Simon Lee at RSA, which last year created an Asian division, he might well envy Prudential's success in the region.

My hunch is that Aviva won't cut. The chairman made such superhuman efforts to restructure and shore up the firm's capital, I don't think he'd readily let that work be overshadowed. But it's a calculated guess, I have no illusions about that.

Reliable dividends
If you want more reliable dividends, insurance isn't the sector for you. You might be more interested in this company. It's currently yielding 5.7%, providing a better income that RSA.

It's in a sector that pays reliable and stable dividends. The company in question has been increasing its dividend well above the rate of inflation. And its shares might be worth 20% more than they are trading at. Those are just some of the reasons that it's just been named the "Motley Fool's Top Income Stock for 2013."

You can find out more in a special report prepared by the Motley Fool. Just click here to download it. It's free.

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