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Direct Line - End of white label products dent numbers

George Salmon | 5 March 2019 | A A A
Direct Line - End of white label products dent numbers

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Direct Line Insurance Group plc Ordinary

Sell: 269.20 | Buy: 269.50 | Change 0.10 (0.04%)
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Operating profits of £601.7m were 6.4% lower in 2018, as an increase in own brand insurance policies failed to offset several large white label agreements.

The board announced a 2.9% increase in the final dividend to 14p, although the special dividend fell 44.7% to 8.3p.

The shares were broadly unmoved in early trading.

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Our view

Personal insurance can be a tough industry. It's highly competitive, and with rivals offering pretty generic products few companies can maintain any semblance of pricing power.

That tends to have negative consequences for 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.

There's a bit of a changing of the guard going on at the moment - as long serving CEO Paul Geddes passes the reins to CFO Penny James. And that means we could be in for a change of direction.

In recent times the group's been stepping back from large white label deals in order to focus on developing its own brands. That strategy has benefits - since the lack of commission payments to partners means own brand sales are potentially higher margin and direct access can also make them stickier customers. We'll have to wait and see if James sticks to that plan.

For now though the group's delivering healthy dividend growth, and a special dividend will be welcome too (even if it's lower than last year following the non-recurrence of certain reserve releases) with a prospective yield of 7.9% next year. Even after dividends the group's Solvency II ratio is towards the top of the target range, which should help sustain the ordinary payment. Bear in mind though that the special dividend will likely fade as reserve releases decline, and no dividend is guaranteed.

For now 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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Full Year Results

Direct Line saw total in-force policies fall 4.3% in 2018 to £15m. That primarily reflects the end of Home insurance agreements with Nationwide and Sainsbury, with own-brand policies up 3.2% to £7.1m.

Gross written premiums of £3.2bn were 5.3% lower than last year, with own brands up 1.8%. That follows a slight shift toward lower risk policies during the year.

Total Motor policies were up 1.9% on this time last year, with customer retention remaining strong. Lower expenses meant the divisional combined operating ratio (a key measure of underwriting performance) improved to 88.9%. Operating profits rose 4.7% to £415.2m.

The end of the Nationwide and Sainsbury partnerships meant Home policies shrunk 18.4% - although own brand policies were flat year-on-year. Higher losses and expenses saw the division's combined operating ratio deteriorate to 93.6%. Operating profits fell 35.5% to £83.1m.

Rescue and other personal lines saw in-force policies fall 2.7% to 7.5m, although the higher margin Green Flag business continued to grow. Commercial policies rose 6.6% with good progress in Van and Landlord insurance. Operating profits in the two divisions were £43.4m and £60m respectively.

Underwriting profits fell 11.5% to £255.1m, as lower earned premiums and a slight deterioration in the combined operating ratio, to 91.7%, negatively impacted performance.

Instalment and other operating income rose 7.1%, to £192m, while Investment returns shrank 11.9% to £154.6m. As a result overall operating profits shrank 6.4% to £601.7m.

The group finished the year with a Solvency II ratio (a key measure of insurers capitalisation) of 170% (2017:165%).

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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.