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Direct Line - largely as expected

Nicholas Hyett, Equity Analyst | 10 November 2020 | A A A
Direct Line - largely as expected

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Direct Line Insurance Group plc Ordinary

Sell: 216.70 | Buy: 217.00 | Change 0.30 (0.14%)
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Direct line's third quarter gross written premiums fell 0.8% to £851.5m. Of these, £617.6m were own brand policies, an increase of 0.3% on last year.

Management expects the full year combined ratio, which is the percentage of premiums paid out in claims and costs, to be below the 93% to 95% target range. The group also reiterated its expense ratio target of 20% by 2023.

The shares were unmoved in early trading.

View the latest Direct Line share price and how to deal

Our view

The impact of coronavirus has been pretty limited for Direct Line so far, as reduced motor claims have offset higher costs and claims elsewhere - such as in travel. The dividend was temporarily suspended, but is now back and the group is paying a special dividend to catch up on what was missed.

In the longer term very little 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.

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. COVID-19 may have upset the timing slightly, but we expect the same basic ideas to stick.

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.

Direct Line Group key facts

  • 12m forward Price/Earnings ratio: 11.1
  • Average 12m forward Price/Earnings ratio since listing (2012): 11.2
  • Prospective yield: 8.5%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third quarter trading details

Motor premiums fell 2.3% to £447.2m, although the number of in force policies was flat. There was less demand for more expensive insurance as people bought fewer new cars and fewer young drivers entered the market. Claims frequency fell but average claim severity was higher as Covid imposed additional repair costs, including longer repair times and additional cleaning requirements.

Own brand Home policies rose 1.0% to £112.8m, although old partnership business declined. As a result total Home policies fell 1.3% to £156.6m.

Green Flag Rescue premiums rose 9.6% to £26.2m. Other Rescue and Personal Lines fell 9.1% to £85m, primarily due to lower travel insurance demand.

Commercial premiums rose 9.9% to £136.5m, reflecting strength in own brand policies for Small to Medium Enterprises, Churchill trading on price comparison websites and Van pricing.

The group said there has been no change to its net estimate of the impact of Covid-19, and still expects business interruption claims of £10m and travel claims of £25m. The cost of extra colleague and customer support relating to coronavirus is still around £90m.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.