RSA’s Irish Probe Raises Doubt About CEO’s ControlsDonal Griffin, Joe Brennan and Sarah Jones
In September, RSA Insurance Group Plc Chief Executive Officer Simon Lee expanded the role of his top Irish lieutenant, Philip Smith, and praised his “outstanding record.” Two months later, he suspended him.
Smith, 45, and two fellow executives were placed on leave Nov. 8 pending an investigation of accounting practices at the Irish unit. Lee faced questions from investors this week about how much he knew about those accounting issues when he presided over a trading update and analysts’ call six days earlier.
“We didn’t expect these issues to be material,” Lee, 52, said on Nov. 11 as he discussed events that led to the suspensions. “During the second half of last week, as the investigation proceeded, it became clear that the financial implications were much more serious.”
The news triggered the worst sell-off of RSA shares in about a decade, erasing 417 million pounds ($664 million) of market value and prompting downgrades from firms including Credit Suisse Group AG and JPMorgan Chase & Co. Analysts asked whether the U.K.’s biggest non-life insurer can manage its risks properly after almost a decade of acquisitions and said the London-based firm may have to cut its dividend for a second time in two years.
RSA, which insured the house of British explorer Captain James Cook in 1765, operates in 32 countries across Europe, Latin America, Canada and the Middle East and has made more than 60 acquisitions in eight years, according to Gordon Aitken, an analyst with RBC Capital Markets. The investigation could signal a wider concern that the company’s management controls aren’t strong enough, he told clients in a note on Nov. 11.
“We lack confidence in the business, management and the strategy,” Aitken wrote, changing his rating on the firm to sell from hold. “We are now more concerned about the potential lack of control at the center following issues being investigated in Ireland.”
RSA fell 4.8 percent to 104.10 pence in London. The stock has slumped 17 percent so far this year, the worst performer on the 19-member FTSE 350 Insurance Index.
Smith, the CEO of the Irish unit, and the other two suspended executives -- Rory O’Connor, the local chief financial officer, and Peter Burke, the claims director -- couldn’t be reached for comment. The company said in its statement that “no findings have been made against any individuals at this time.”
A woman who answered the door at Smith’s home in Cabinteely, a suburb in south Dublin, said he didn’t have a comment. She declined to give her name. No one answered at O’Connor’s apartment in Dundrum, close to the RSA headquarters. The firm declined to provide contact details for Burke.
The RSA probe centers on two issues: the “timing of the recognition of earned premiums” and “the booking of large losses” within its claims division over the past two years, RSA CFO Richard Houghton said Nov. 11 on the call with analysts.
In other words, the insurer is investigating whether the Irish unit reported the amount of premiums paid to the company earlier than it should have, which could increase profitability. It is also studying the timing of when the unit set aside reserves for insurance claims.
RSA’s comment on Nov. 11 “was that they felt there might have been an acceleration of earned premium,” said Eamonn Flanagan, a Liverpool, England-based analyst at Shore Capital Group Ltd. with a hold rating on the stock. “The reason someone might do that, hypothetically, is to increase profitability or reduce the losses. If you bring a premium forward, you reduce those losses against the claims.”
RSA had already gotten a handle on much of the second concern, the “large loss issues” within the claims division, by the time of a Nov. 5 call, Lee told analysts on Nov. 11. The firm judged this not to be “material,” Lee said.
“I think it’s the accounting issues that have come to light more recently,” he said.
In August, supervisors from the Central Bank of Ireland visited RSA’s headquarters in Dublin and found issues with the firm’s “delays in increasing cash reserves on large claims,” the regulator said in an e-mail.
In September, soon after the regulators’ visit, Lee expanded Smith’s position to RSA’s group director of global brokers, a role beyond his local Irish duties.
“Philip has an outstanding record of delivery,” Lee said in the statement announcing the move. “Under his leadership, RSA has grown to become the number one general insurer in the Irish market.”
Jon Sellors, a RSA spokesman, said that Smith hadn’t been promoted in September. He’d received an “extension of duties,” Sellors said.
Auditors reported the results to the Irish board, which started an investigation into claims reporting and accounting issues, RSA said on Nov. 11. The central bank said it set part of the terms of the probe.
After the initial review was completed late in the afternoon of Friday, Nov. 8, “we took the need to inform the market,” Lee said. RSA issued a seven-paragraph statement at 6:25 p.m., after European markets closed, reporting the suspensions and naming three senior executives, led by Adrian Brown, CEO of its U.K. and Western European operations, to take control of the Irish business.
Before markets opened again Nov. 11, RSA directors in London hired PricewaterhouseCoopers LLC to conduct an external review into controls at the Irish unit, the firm said. The accounting firm is also advising on an internal probe, which is headed by three non-executive directors of the subsidiary, Leo Blennerhassett, Roy Keenan and Fergus Clancy, a person with knowledge of the matter said.
When markets did open, RSA’s shares fell as much as 16.4 since Friday, their biggest drop since March 2004. Almost 420 million pounds have been wiped off the firm’s market value since the accounting issues were disclosed.
Lee has grown RSA’s revenue by continuing an acquisition strategy initiated by former CEO Andy Haste, who returned the insurer to profit in 2005 after five years of losses caused by surging U.S. asbestos claims.
Haste, who became CEO in 2003, made more than 40 acquisitions before he tried to buy London-based Aviva Plc’s U.K. non-life unit in 2010 for 5 billion pounds, an offer that was rejected. Haste, now deputy chairman of Lloyd’s of London, declined to comment for this article.
Before replacing Haste in late 2011, Lee ran RSA’s international unit, helping turn it into the company’s biggest division by revenue after making strategic acquisitions in Ireland and Scandinavia.
RSA named Smith CEO of the Irish business in 2007, according to the firm’s website. A former partner with Accenture Plc, he helped the firm boost its share of the Irish market in terms of premium income to 15 percent in 2011 from 10 percent two years earlier, according to central bank data.
Among the acquisitions Smith oversaw was the purchase of the 123.ie business unit for 65 million euros ($87 million) in 2010. The brand gained recognition through radio and television advertisements using the jingle, “one, two, three, dot ie, just log on and save mon-ey.”
“We’ll be judicious in our approach to M&A going forward,” Lee said on the conference call on Nov. 11.
The company may also have gained market share in Ireland through low pricing, according to Emmet Gaffney, a Dublin-based analyst with Investec Bank Plc.
The fact the company increased motor premiums by 13 percent in September “suggests their pricing was too low for the risks they were pricing,” Gaffney said. “This is a fairly sizable increase in what is a relatively competitive market place.”
RSA said then that its full-year operating profit will be 70 million pounds lower than analysts’ estimates as a result of issues in the Irish business. This almost wipes out the local unit’s 25 million-pound average underwriting profit, or what’s left from premiums earned after claims and expenses, over the past three years, according to Eamonn Hughes, an analyst at Dublin-based Goodbody Stockbrokers. It was the second time in a week RSA said it may not meet its profit target.
Lee said Nov. 11 he’s “very confident” the issues in the Irish business are isolated. “We believe that fundamentally the control framework and the way the controls operate in the group is strong and we will learn from any lessons that come out of the reviews,” he told analysts.
RBC, Credit Suisse, Canaccord Genuity Corp. and JPMorgan downgraded their ratings on the firm. RSA, which cut its dividend in February, could reduce the payout again as a result of the fallout while the various probes in the Irish business could further punish investors, Barrie Cornes, an analyst for Panmure Gordon & Co., said in a Nov. 11 note to clients.
“The bigger concern, and the one likely to hang over the stock until the review is completed, is the potential weaknesses in group central control and oversight,” said Andy Broadfield, an analyst with Barclays Plc who has a sell rating on the shares. The news will “leave the RSA stock languishing until year-end at the earliest,” he said.