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Direct Line Group - Ogden rate hits profits

Nicholas Hyett | 7 March 2017 | A A A
Direct Line Group - Ogden rate hits profits

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Direct Line Insurance Group plc Ordinary

Sell: 220.00 | Buy: 220.10 | Change 1.30 (0.59%)
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Changes in the Ogden Rate (the rate at which personal injury compensation payments are calculated) announced last week have had a significant negative effect on full year results at Direct Line, as expected. Reported profits for the full year were £403.5m compared to £520.7m in 2015. Excluding the Ogden effect, profits would have been £578.6m.

The shares fell 0.5% following the announcement.

Our View

A change to an obscure financial ratio blew a great big hole in Direct line Group's full year results. However, the impact should be limited to 2016, and underneath those numbers the group is performing quite well in what is a tough industry.

Highly competitive with broadly generic products; few companies can maintain any semblance of pricing power in personal insurance. That tends to drive combined operating ratios (the percentage of premiums that are paid out as claims or expenses) closer to 100% as companies are forced to attract customers through cutting their prices. The advent of price comparison websites has not helped.

Fortunately for Direct Line (DLG), the strength of the Direct Line brand means that it is able to bypass price comparison sites altogether, while also supporting high levels of customer retention. That has helped support pricing, keeping margins strong.

As the market leader, DLG enjoys access to more information on claims and customer behaviour than competitors, helping the Group to price more accurately. Scale also provides opportunities for cost cutting (we're impressed that Direct Line can reduce its costs sufficiently to partially absorb the £24m Flood Re levy).

The group has said that it will be targeting a Solvency capital range of 140%-180% going forwards. Despite reporting a Solvency II ratio of 165% in 2016, the group decided not to pay a special dividend. This, together with a move to paying any special dividends on an annual basis, suggests management may be taking a more cautious approach to regulatory capital. That has the potential to negatively impact shareholder returns, although analysts are still forecasting a prospective yield of 7% for 2017 .

Overall, however, Direct Line is delivering a respectable underwriting performance in a challenging and highly competitive sector. If it can maintain its brand position, and resulting price advantage, then the group should continue to generate strong returns.

Full Year Results

The total number of in-force policies declined to 15.8m (2015: 16.1m). However, gross written premiums increased 3.9% to £3.3bn in 2016, as the group grew the number policies written by its own brand Motor and Home insurance businesses, at the expense of partnership policies.

Expenses increased in the year, reflecting higher non-cash impairments and the £24.1m Flood Re levy. Excluding these charges, expenses were broadly flat. The group aims to reduce its expense ratio going forwards.

The group's combined operating ratio (a key measure of underwriting quality at insurers) deteriorated to 97.7% (pre-Ogden: 91.8%, 2015: 94%). Pre-Ogden, and adjusting for normal weather, the group's combined operating ratio was 93.5%, towards the bottom end of the 93%-95% target range.

The group has announced a 5.4% increase in the final dividend to 9.7p per share. The group's Solvency II capital coverage ratio post dividend was 165%, in the middle of the group's 140%-180% target range.

The group does not expect Ogden to have a material impact on 2017 profits.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.