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Direct Line - gross written premiums nudge upwards

Sophie Lund-Yates, Equity Analyst | 9 November 2021 | A A A
Direct Line - gross written premiums nudge upwards

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Direct Line Insurance Group plc Ordinary

Sell: 216.40 | Buy: 216.80 | Change 0.20 (0.09%)
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Direct line had gross written premiums of £857.1m in the third quarter, up 0.7% from the same time last year. That reflects strong growth in Commercial products, while Rescue, Home and Motor all declined. Total in-force policies fell 0.4%.

The group's on track to meet its medium-term target of a combined operating ratio between 93-95%. This is still expected to be 90-92% for the current financial year.

The shares fell 1.8% following the announcement.

View the latest Direct Line share price and how to deal

Our view

Direct Line hasn't escaped from the pandemic unscathed. Lower Motor and Travel premiums continue to weigh, and the recent hikes in second-hand car prices means average pay outs are higher.

But a lot of this is outside the group's control, and in reality, the longer-term picture hasn't really changed.

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.

New rules next year also mean insurers will no longer be allowed to automatically hike home and car renewal quotes. This will be a headwind felt by the whole industry, but exactly what it will look like in the first quarter numbers of next year is unknown.

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.

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.

Direct Line's dividend yield is now at the point where we need to talk about it. In this market, an 8+% prospective dividend yield should ring alarm bells rather than get your mouth watering. We'd usually want profits to be at least 1.5 times the dividend, and Direct Line is some way off. The group needs to recover to 2019's level of profitability, and then surpass it, for the dividend to become more sustainable. That's reflected in the relatively low valuation and high dividend yield, and as always there are no guarantees.

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. If the group can't recover and return to growth quickly, the dividend could come under pressure.

Direct Line Group key facts

  • 12m forward Price/Earnings ratio: 10.4
  • Average Price/Earnings ratio since listing (2012): 11.2
  • Prospective yield (next 12 months): 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 results

Motor gross written premiums fell 1.4% to £440.9m. Direct Line own brand premiums made up 97% of the total. The group increased prices to reflect increased severity inflation, although wider market pricing didn't follow this trend.

An "increasingly competitive" market affected Home, where gross written premiums fell 1.1% to £154.9m. Direct Line own brands were flat in the period.

Despite a 9.2% increase in Green Flag premiums, Rescue and other personal lines gross written premiums fell 3% to £107.9m. The decline reflects reduced international travel.

Commercial gross written premiums rose 12.4% to £153.4m as it benefited from Direct Line's transformation programme.

The group's bought back £47.6m of shares in its £50m second and final tranche of the buyback announced earlier in the year.

Penny James, Senior Independent Director of HL is also CEO of Direct Line Group.

Find out more about Direct Line shares including how to invest

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.