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Direct Line - motor claims down 70% during lockdown

Nicholas Hyett, Equity Analyst | 6 May 2020 | A A A
Direct Line - motor claims down 70% during lockdown

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Direct Line Insurance Group plc Ordinary

Sell: 216.90 | Buy: 217.90 | Change -2.20 (-1.01%)
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Direct line grew gross written premiums 4.7% to £789.6m, of which £551.9m were direct own brands, an increase of 5.6%. In force policies fell 0.6% to £14.7bn.

The group estimates its solvency capital ratio at 177% after suspending the dividend, up from 174% on 31 March.

The shares rose 2.4% in early trading.

View the latest Direct Line share price and how to deal

Our view

Given the importance of the insurance industry in absorbing shocks to society and the financial system, the regulator is very keen for insurers to remain well capitalised throughout the crisis. That's prompted much of the sector to suspend dividend payments for the time being, Direct Line included.

If all goes well there's always the possibility the dividend will end up getting paid, just at a later date. However conditions could yet get substantially worse, so nothing's guaranteed.

In the longer term nothing has really changed for Direct Line. Personal insurance remains 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. Direct Line is expecting Motor claims to rise at about 3-5% each year, which is putting upwards pressure on prices as insurers raise premiums to compensate.

Against this backdrop, CEO Penny James has firmly focused on cutting costs and leveraging recent investments in technology. COVID-19 may have upset the timing slightly, but we expect the same basic ideas to stick.

Insurers must set aside a portion of the premiums they receive to meet future claims, called reserves. But, if claims turn out to be lower than expected or the rules around how much must be set aside change, the excess can be released as profit. In recent years profits have been flattered by the release of prior years' reserves.

That's unsustainable in the long run, and James wants more profit to come from current year underwriting, driven by lower costs, better underwriting and some growth. That could prove easier said than done though, as better underwriting often means higher prices, which would make growth a challenge.

Direct Line does have a few key advantages. The first is the brand, which has helped it price more aggressively than competitors. The second is scale, because the new, leaner cost base can be spread across more policies. The new technology infrastructure should also help the group compete on price comparison sites, and may improve underwriting accuracy for the direct brands.

Overall we think Direct Line's targets are ambitious but not unachievable - although a lot's riding on the new technology investments living up to their billing. Of course, this relies on James navigating the ongoing pandemic successfully. The PE ratio of 10.4 prior to the announcement is slightly below the long run average. We would caution investors that earnings may be more volatile than usual this year, so metrics like PE ratios should be handled with care and not looked at in isolation.

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First Quarter Results

Direct Line's largest division, Motor, recorded a 6.2% increase in gross written premiums to £410.9m despite a slowdown in new business as the lockdown got going. As fewer people have been driving Direct Line's seen Motor claims fall 70%, although this is expected to be offset by slightly higher costs as repairs take longer to complete. Early May has already seen an uptick in the number of miles driven.

Home premiums fell 2.4% to £137.8m, reflecting the run-off of past policies. Claims associated with storms Ciara and Dennis are expected to be £18m net of reinsurance. The division has seen reduced new business during the lockdowns as phone sales were temporarily suspended.

Rescue premiums grew 2.8% to £108.3m, reflecting a strong performance from Green Flag, where premiums grew 11.3% to £19.7m. Commercial premiums increased 10.1% to £132.6m, and Direct Line's standard business interruption policies don't provide cover for COVID-19.

The group still expects to achieve a 93-95% combined operating ratio this year, although acknowledges that the cost saving program may be held back. The group still intends to bring operating costs down to 20% of premiums and current year underwriting up to 50% of profits in the next few years, although these plans may also be delayed.

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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.

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