Since 2011, this Danish insurance market leader has benefitted from a highly capable management team that continually manages to improve the business – without taking unnecessary risks. Most recently, a large-scale acquisition of Alka has increased the business volume, and the company has more hands
to play. One of the winning hands is a major shareholder who is extremely generous to customers which is something that can attract even more.

When entering 2018, Tryg was already the largest property and casualty insurance company in Denmark – and when the deal to acquire Alka was approved by the competitive authorities in the fourth quarter, the company jumped a little further ahead of the rest. Tryg has a market share of 22 percent on the private insurance market in Denmark, and there is a lot of profit to be made.

Tryg’s history and experience with the insurance market date back several centuries. Kjøbenhavns Brand is the oldest part of Tryg, founded back in 1738 at the order of the Royal Family. This was in the aftermath of the Copenhagen fire in 1728 (hence the name, Københavns Brand which means “Copenhagen’s fire”). The fire burned down a quarter of Copenhagen, thus highlighting the importance of being insured. The name Tryg came into play in 1911, but for a time it was called TrygVesta after having acquired a Norwegian company called Vesta, which was a part of Nordea.

Today, being insured is the norm for most people and companies in developed countries. Insurance policies cover many different areas, such as house insurance, health insurance (either private or via the employer) or, for us Danes, the government-funded single payor health insurance.

For the customer, there is nothing complicated about being insured: the customer pays an amount today in order to cover any potential future losses from a number of events that are defined in the insurance policy.

These (typically) recurring payments represent the revenue in an insurance company, called premiums earned. In an insurance company, the insurance-related costs are divided into two groups: claims provisions and operating costs. The technical result is what remains when both costs have been paid. Operating costs, as the name suggests, are the costs of operating the company. These include costs for the sales staff, the administrative personnel or the actuaries who estimate the amount of provisions. The claims provisions represent the insurance company’s estimates of what it will require to cover the claims made by customers during the year. In some cases, these claims can be calculated within the current year, but other times it can take years or decades before the total payments of a claim are completely determined.

A global leader

One of the profitability targets in a non-life insurance company is the so-called Combined Ratio. The Combined Ratio states what proportion of the annual premiums earned is either tied to claims provisions or to operating costs. All other things being equal, the lower the Combined Ratio, the more profitable the insurance company is.

Usually there is a delay between receiving a premium and a potential future insurance claim. During this period, the insurance company can use this money as interest-free loans. These can be invested and thus generate returns; thereby comprising a secondary source of income on top of the above technical result. Previously, many insurance companies were satisfied if the technical result was “balanced”, meaning that the Combined Ratio was at 100 percent. The earnings thus only came from the investments made. Today, most insurance companies make a profit from both areas. Non-life insurance companies in the Nordic region are global profitability leaders with Combined Ratios of below 90 percent. This can, to a great extent, be attributed to the fact that it is a well-consolidated industry with a limited number of players and that managements are generally highly competent and in it for the long term.

Tryg does not only insure private, commercial and industrial customers in Denmark – it also operates in Norway and Sweden. However, it is the private
customer segment in Denmark, Norway and Sweden that generates the most stable and predictable value creation. The reason should be found in the inflationproofed insurance premiums and a very strong disciplined approach to deciding how the risk of the individual insurance products should be priced. This can include car insurance or house insurance (which combined represent around half of the insurance premiums for Tryg in Denmark) or health insurance.

For an insurance company, it is not difficult to quickly grow premiums earned or the short-term reported earnings. After all, they can just lower the prices of the individual insurance products and afterwards sign new insurance contracts with all the customers seeking to insure risks that competitors are not willing to cover. The risk of signing the wrong kinds of insurance agreements does not necessarily appear in the first, or second, or third year. The insurance agreements are typically based on large datasets and calculations of various degrees of complexity that determine the probability of future claims and their associated costs. The second or third year can thus destroy any value that was created by an aggressive pricing strategy in the first year. Insurance companies will periodically face large-scale events that can reveal the risks having been assumed but not previously noticed – this might be once-in-a-century or once-in-250-year events such as the storm that hit Denmark in 1999. Between 2012 and 2017, the annual claims dropped from being more than 72 percent of premiums to 66 percent, which reflects strong enrolment and pricing discipline at Tryg.

A generous major shareholder may attract new customers

We believe that the quality of an insurance company is best evaluated over a long period of time – through demonstrating consistently strong technical results that generate capital to the owners. The latter is an expression of the insurance company having created more earnings than the capital requirements set aside for covering the signed insurance agreements.

Tryg’s largest shareholder is the foundation TrygFonden, which owns 60 percent of the outstanding shares. TrygFonden has an indirect influence on the operations at Tryg. For the last few years it has rewarded the insurance customers an annual ‘customer bonus’, where they receive eight percent of the previously paid insurance premium, whether they have had any claims or not. This initiative has only been going on for three years. Thus, there is still unrealized potential and work to be done in spreading the message to the two thirds of the Danes who are currently unaware of this attractive bonus. This bonus helps retaining customers but is also a strong competitive advantage and selling proposition for Tryg’s sales staff in their battle to win new customers.

In 2019, Tryg is expecting premiums to grow between two to four percent in local currencies. This might not justify a label as a growth company, but these are very respectable growth rates on the mature Nordic insurance markets. The customer bonus is not only assessed to attract or retain customers, it can also make it easier for Tryg to increase the prices a bit faster than the inflation rate, as the sales staff can remind customers that Trygfonden is still repaying them eight percent of the insurance premium. In 2018, Trygfonden paid out more than 700 million Danish kroner to Tryg’s Danish customers, and out of these, more than 440 million Danish kroner went to private customers.

However, the customer bonus is not the only way in which Trygfonden can help Tryg get new customers onboard. They also help in this respect via the fund’s marketing campaigns that also is marketing for Tryg. Generally, we see it as good use of our companies’ resources when they invest in business expanding initiatives. Naturally, we like it even better when they can benefit from good – and free – marketing.

New insurance customers are generally a good thing, but it is even more important to retain existing customers. Tryg has an annual customer retention rate of 91 percent. For every percentage point that this can be increased, management expects the company’s annual costs to be reduced by 50-150 million Danish kroner. This is an amount that will improve Tryg’s Combined Ratio by 0.5 percentage points. In general, the longer a customer has been with the company, the more profitable that customer is. Thus, it is very good news that Tryg has improved its retention rates over the last few years and that one of its objectives is to continue improving customer loyalty levels.

380,000 new customers all at once

With the acquisition of the Danish insurer Alka, Tryg acquired a customer portfolio of around 380,000 customers in the attractive private customer segment and annual premiums of 2.5 billion Danish kroner. Before the acquisition of Alka, Tryg had annual premiums of 18 billion Danish kroner. Alka has been good at pricing risks and has consequently been among the best in Denmark measured by the Combined Ratio. Tryg finds opportunities to optimise the operating costs at Alka. Optimising the insurance claim processes and the economies of scale in terms of purchases should help grow the already high profits.

We expect that the names of the two companies, Tryg and Alka, will both appear as an option and as separate brands for the customers. In this way, Tryg will be able to reach a wider target group than it could reach on its own. It would also create better opportunities to price differentiate by customer segment.

Growth in premiums earned are one of the reasons for expected earnings growth. The other reason is continuing optimisation of the cost base consisting of claims and operating costs for processing claims and new sales. Insurance companies have significant opportunities for optimising their operating costs via an increasing use of IT. Before acquiring Alka, Tryg had 700 fewer full-time employees than in 2011 – a decrease of 17 percent despite higher premiums. IT can help with both the processing of customers’ claims and with customer inquiries in general. Additionally, it can help reduce the risk of fraud and false claims. Tryg has chosen to increase its investments in IT infrastructure by 500 million Danish kroner as part of its plan to optimise future earnings. This amounts to just over two percent of the annual premiums earned.

Currently, Tryg’s costs amount to 14 percent of premiums earned, and we expect that this level can be maintained up until 2020. The costs have also grown a bit with the acquisition of Alka, as previously mentioned, Alka was not operating as cost efficiently as Tryg. Tryg expects that there will be cost synergies amounting to around 300 million Danish kroner from the year 2021 – which will be in addition to Alka having achieved an underwriting profit of slightly below 350 million Danish kroner. Alka was acquired for eight billion Danish kroner.

Hübbe is managing to constantly move the company forward

Management has a number of financial targets. The first is that the technical result should amount to 3.3 billion Danish kroner in 2020, equivalent to a Combined
Ratio of 86 percent. In addition, the operating costs should amount to no more than 14 percent of the premiums earned. Finally, the return on equity should amount to at least 21 percent as it has been each year since 2012.

Morten Hübbe is the CEO of Tryg and has been running the company since 2011. Previously, he was the CFO of Tryg for nine years after joining the company in 2001. During Morten Hübbe’s time as CEO, the insurance discipline at Tryg has been constantly improving based on the company’s Combined Ratio. Barbara Plucnar Jensen is newly appointed CFO as of early 2019 and will join Morten Hübbe on the executive board.

Financial statements of insurance companies are difficult to read and comprehend, and a single year cannot be viewed in isolation. There are significant estimates involved in the calculation of future claims. In addition, some types of insurance claims have a very long processing time from the date the claim is received to when it is paid out. Therefore, year after year, management must use historical data, analyses and other decision-making tools to make a number of estimates in order to calculate the size of the reserves that need to be set aside for future payments. The differences between these estimates and what is actually paid out in the future are often significant.

Thus, it helps put our minds at ease when insurance companies, consistently and over the course of many years, demonstrate that they have been too cautious in their provisions. This decreases the risk of unpleasant surprises. However, complicated financial statements with many management estimates are a dangerous combination if management is not credible – or if it is too aggressive in striving for increased short-term reported earnings. We would therefore also be concerned if the management was not characterised by a strong degree of continuity.

Generally, Tryg has had a “safety margin” of around three percent when it calculates its provisions. Over the last five years, however, annual run-offs have exceeded six percent of the premiums earned. Thus, all those five years run-offs have exceeded management’s current expectations of three to five percent. In 2018, it was at 6.5 percent, equivalent to more than 1.2 billion Danish kroner – approximately where it has been for the last five years. We view this is an indication of a conservative approach to calculating claims.

A sensible reduction of the exposure to industrial insurance

Tryg’s non-life insurance business is assessed as being stable and attractive particularly for private customers. However, Tryg also gets 18 percent of its earned premiums from industrial insurance. Industrial insurance is a significantly more competitive market than the private insurance market. The reason is that the industrial insurance market is more transparent, focusing on prices and typically includes annual insurance policy renewals. The large industrial companies often use insurance brokers to collect, compare and negotiate the most attractive insurance terms and prices. In addition, there are higher capital requirements to be set aside for expected future claims. The expected future claims will often be larger in scale compared to the greater number of smaller claims that are made by private customers. Thus, more reserves are required to weather these fluctuations.

We do not see this part of the business as being as attractive and as steadily value-creation as the private customer business. The industrial insurance part of Tryg amounts to less than 20 percent of premiums earned, but it ties up a significantly larger part of the capital. In 2017 and 2018, the industrial insurance unit had a Combined Ratio of around 100 percent excluding run-off gains. This was despite the fact that Tryg Garantiforsikring, formerly known as Dansk Kaution A/S, has an impressive Combined Ratio of below 60 percent. We are pleased to see that Tryg is selectively narrowing its industrial insurance activities.

Insurance companies do not only make money on the annual premiums. They also make money from investing the premiums that they continually receive from their customers (termed as “floats” by Warren Buffett at Berkshire Hathaway). These investments are mainly in bonds, and while these have had positive returns as a result of falling interest rates, it has had a negative impact on the expected return on new investments. In 2018, Tryg suffered a loss on their investments of 330 million Danish kroner compared to a profit of 530 million Danish kroner in 2017 and almost 1 billion Danish kroner in 2016. Higher interest rates will reduce the market value of the current bonds, but they will have a positive impact on the expected return on investment from the allocation of new reserves.

In addition, a higher interest rate will also have a positive effect on Tryg’s provisions for future claims. These provisions will be reduced if the interest rates, and thus applied discount rates, should increase. This is due to the higher expected returns even from “risk-free” government bonds. The smaller provisions also increase the potential for paying out dividends.

In 2018, Tryg paid dividends of 6.6 Danish kroner per share, equivalent to more than the whole year’s earnings. This amounted to a dividend yield of almost 4.5 percent. Since 2012 the ordinary annual dividend has grown by more than 4 percent per year. The dividend policy at Tryg is that the annual dividend should increase and equal a payout ratio between 60 to 90 percent. Tryg did not pay out any extraordinary dividends in 2018 due to the acquisition of Alka, but in previous years it has paid out additional capital through extraordinary dividends. We expect that there will also be significant annual distributions at steady growth rates in the future, based on continuing strong earnings from a stable insurance business.

Tryg and other insurance companies are without a doubt attractively positioned by increases in interest rates. We have not invested in Tryg due to their “secondary business” as asset managers. Instead, we have invested in Tryg because they are in a great position to achieve profitable growth and gain market shares in a well-consolidated and disciplined Nordic insurance market. On paper, insurance seems simple, but succeeding in making the right insurance decisions on a continuing basis is a much more difficult feat. Tryg (in Danish “Safe”) provides safety to its customers – and to us as shareholders.