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Direct Line - On course for a strong full year

Nicholas Hyett | 9 February 2018 | A A A
Direct Line - On course for a strong full year

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Direct Line Insurance Group plc Ordinary

Sell: 216.20 | Buy: 216.60 | Change 0.00 (0.00%)
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A brief trading update ahead of full year results showed Direct Line on course for operating profits of £610m and profit before tax of £540m (2016: £403.5m and £353m respectively). The strong performance was ahead of market expectations, reflecting an increase in gross written premiums and improved underwriting performance.

The shares were up 2.6% following the announcement.

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Our View

Highly competitive with broadly generic products; few companies can maintain any 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. Price comparison websites haven't helped.

Fortunately for Direct Line (DLG), the strength of its brands mean it's able to bypass price comparison sites altogether, while also supporting high levels of customer retention. That's helped keep pricing and margins strong. As the market leader, DLG enjoys access to more information on claims and customer behaviour than competitors, helping it to price more accurately, while scale provides opportunities for cost cutting.

Recent results have benefited from bumper reserve releases, but those are unlikely to continue forever. The decision to upwardly rebase the dividend at the half year was welcome, not only for the immediate cash infusion but because of the confidence it implies in the long term future of the business. Improving operating expenses and higher in-force policies are more important to the group's long term future.

Looking ahead to full year results, investors will be eyeing Direct Line's improved Solvency II ratio (a measure of insurer capitalisation) with interest.

Before the final dividend payment it sat at 185%-190%. Management say they are looking to operate in a 140% to 180% range in the normal course of business, so there's scope for additional capital returns through special dividends or share buybacks. Analysts are forecasting a prospective yield of 7.2% for 2018 - although as ever there are no guarantees where dividends are concerned.

Direct Line is delivering a respectable performance in a sector which is currently enjoying a bit of a let up in pricing pressure. If it can maintain its brand position, and resulting price advantage, the group should continue to generate strong returns.

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Full year trading update

Group gross written premiums in the year rose 4% to £3.4bn (2016: £3.27m), with 350,000 more direct own brand in-force policies at the year-end compares to last year.

Combined operating ratio (a measure of underwriting performance, where a lower number represents a better performance) improved from 97.7% in 2016 to 92% in 2017. This reflects lower underlying expense and commissions ratios than in the previous year.

The group expects to finish the year with a Solvency ratio (a measure of insurers capitalisation) of 185%-190%, before paying the final dividend, thanks to higher profits and lower than expected capital requirements.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.