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Direct Line - disparate COVID impact

Nicholas Hyett, Equity Analyst | 8 March 2021 | A A A
Direct Line - disparate COVID impact

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Direct Line Insurance Group plc Ordinary

Sell: 297.60 | Buy: 297.70 | Change 2.70 (0.92%)
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Direct line's full year gross written premiums fell 0.7% to £3.2bn, of which £2.2bn were own brand policies, up 2.2% year on year. The group's combined operating ratio, which is the percentage of premiums paid out in claims and operating costs, improved from 92.2% to 91.0%.

Profit before tax fell 11.4% to £451.4m, reflecting lower investment income and increased restructuring costs.

The group declared a final dividend of 14.7p per share, up 2.1% on last year.

The shares were broadly flat in early trading.

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Our view

The impact of coronavirus has been felt unevenly across Direct Line's business, as reduced motor claims have partially offset higher costs and claims in areas like travel. The dividend was temporarily suspended, but is now back and the group has launched a share buyback to return excess capital to investors.

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.

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, so CEO Penny James has firmly focused on cutting costs, capitalising on recent investments in technology and increasing the contribution of current year underwriting. 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 and also secure a relatively high proportion of direct sales (without selling though price comparison sites). The second is scale, because the new, leaner cost base can be spread across more policies. In time the new technology infrastructure should 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: 12.0
  • Average 12m forward Price/Earnings ratio since listing (2012): 11.2
  • Prospective yield: 7.7%

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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Full year results

Motor premiums fell 2.1% to £1.6bn, but current year claims fell 19.2% to £988.7m as customers drove less during the pandemic. While claims frequency fell average claim cost rose as Covid imposed additional repair costs, including longer repair times and longer replacement car hire. Overall, the division's combined ratio improved from 94.8% to 87.7% and the division generated £363.5m in operating profit, up from £302.6m.

Home premiums fell from £577.9m to £586.6m and net claims rose from £268.4m to £309.1m. This reflects higher extreme weather costs and lower reserve releases from prior years. The divisions combined ratio rose from 80.3% to 87.1% and operating profit fell from £150.6m to £101.4m.

Green Flag Rescue and Other Personal Lines premiums fell 4.2% to £417.8m and the division's combined ratio rose from 95.4% to 102.0%, indicating unprofitable underwriting. This was mainly due to a £44.4m loss in Other Personal Lines due to a fall in demand for Travel insurance. Rescue made an operating profit of £51.2m, up from £45.2m last year.

Commercial premiums rose 7.4% to £567.8m, and the combined ratio fell 0.2 percentage points to 95.5%. This reflects lower current year claims but also lower reserve releases. Operating profit fell from £54.6m to £50.4m.

The group's Solvency II capital ratio stands at 191% after dividend payments and an upcoming £100m share buyback program. The group plans to reduce the level of capital to between 140% and 180% in the near future.

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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.