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Direct Line - Motor still tough, but on track for full year

Nicholas Hyett | 31 July 2019 | A A A
Direct Line - Motor still tough, but on track for full year

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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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Direct Line's (DLG) total number of in force policies declined by 3.2% in the first half to 14.8m, with gross written premiums down 2.2% to £1.6bn and operating profits falling 10.2% to £274.3m.

The group's interim dividend rose 2.9% to 7.2p per share.

The shares fell 1.2% 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 has tended 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 have only exacerbated the problem.

Nor is that the only headwind. The industry at large hasn't been helped by technical changes to the way personal injury claims are valued either - increasing the reserves insurers need to hold. The changes set DLG back around £15.9m in the first half.

Fortunately for DLG, the strength of its brands means its own lines are usually able to bypass price comparison sites, and that also supports high levels of customer retention. As one of the larger players in the market, DLG also 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. As a result pricing and margins have been comparatively strong.

New CEO Penny James has focussed attention firmly on cutting costs, and the groups making steady progress. Unfortunately that's being overshadowed at the moment by the decision to step 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. Unfortunately it also means the fixed portion of the cost base has to be spread over a smaller number of policies. We'll have to wait and see if the scales end up settling in DLG's favour.

For now the group's delivering healthy dividend growth, and potential special dividends will be welcome too with a prospective yield of 8.5% this year. The group's Solvency II ratio has been towards the top of the target range, which should help sustain the ordinary payment at least - although 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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First Half Results

The decline in policies in the first half was driven by the end of partnerships with Sainsbury and Nationwide, while own brand policies rose 2% to 7.2m. Green Flag and Direct Line for Business, showed particular strength while direct motor and home markets remain tough.

The decline in premiums was driven by lower average premiums in motor, which remains competitive, and Home. That was partially offset by growth in Rescue & Other Personal lines and Direct Line for Business.

DLG's combined operating ratio, a key measure of underwriting profitability, improved slightly in the first half to 92.5%. That was driven by lower commission and claims, although operating expenses as proportion of premiums increased.

The substantially weaker operating profit performance reflects an exceptional motor performance and property sales last year, as well as a decline in investment income (which was 20.6% lower at £75.7m).

The bank's Solvency ratio, a key measure of capitalisation, improved by 10 percentage points to 180%.

DLG continues to target a combined operating ratio of 93-95% in 2019 and over the medium term. The group aims to report operating expenses of below £700m for the full year, and achieve at least a 15% return on tangible equity.

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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.