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Direct Line - Pricing pressure weighs on policy growth

Nicholas Hyett | 6 November 2018 | A A A
Direct Line - Pricing pressure weighs on policy growth

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Direct Line Insurance Group plc Ordinary

Sell: 216.50 | Buy: 216.80 | Change 0.40 (0.18%)
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Gross written premiums fell 5.8% in the second quarter to £854.5m, largely thanks to a £47.3m decline in white label policies. Gross written Premiums associated with Direct Line's own brand policies rose 0.6% to £610.4m.

The group remains on track to meet its 2018 and medium term targets.

The shares were little moved in early trading.

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Our view

Personal insurance can be a tough industry. It's highly competitive, and rivals offer broadly generic products. This means few companies can maintain any pricing power.

That tends to negatively impact combined operating ratios (the percentage of premiums that are paid out as claims or expenses) as companies are forced to cut prices to attract customers. Price comparison websites haven't helped either.

Fortunately for Direct Line (DLG), the strength of its brands means its own lines are usually able to bypass price comparison sites altogether, and also supports 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 a slackening of pricing pressure, and bumper reserve releases. But those tailwinds now look like they're unwinding. Improving operating expenses and in-force policy growth are more important to the group's long term future.

In that light, the decision to rebase the dividend upward at the full year was welcome - not only for the immediate cash infusion but for the confidence it implies in the long term future of the business. It also means the shares currently offer a prospective yield of 9% once special dividends are included - although it's expected to fade as reserve releases decline.

Direct Line is delivering a respectable performance in a tough sector. If it can maintain its brand position, and resulting price advantage, the group should continue to generate strong returns.

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Third Quarter Trading Update

Total in-force policies fell 3.8% versus the same period last year to 15.2m. That reflects the end of white label agreements with Sainsbury and Nationwide, with own brand policy numbers rising 3.5% to £7.1m.

With own brand policy numbers expanding faster than gross written premiums, that suggests competition in the sector remains tough.

On a segmental level, Motor policy numbers rose 1.9%, driven by progress in own brand, although gross premiums fell 1.2% to ££456.4m. Claims inflation was at the upper end of the Group's long term expectations of 3-5%.

Home own brand policies grew 0.3%, with premiums up 0.9% to £115.3m. Partnership premiums declined by 50% following the end of some white label agreements and now stand at £51.4m. Claims inflation is expected to be within the group's long term expectations.

Rescue and other personal lines saw 3.1% growth in gross premiums, reaching £113.4m, while Commercial fell 0.2% to £118m. Within that, Green Flag rescue and Direct Line for Business saw premiums grow 13.1% and 7.6% respectively.

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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.