First quarter total gross written premiums fell 2.4% to £734.3m, with the biggest reduction coming from Home, although all divisions apart from Commercial declined. The number of in-force policies was down 8.7%. Direct Line saw pricing pressures, and increased claim inflation in the period.
The group is still targeting a combined operating ratio of 93 - 95%.
The shares fell 6.1% following the announcement.
We should lead with Direct line's prospective yield. A prospective dividend yield above 9% should be met with alarm bells rather than applause in the current environment. A large part of why the yield's so high, is the reduction in Direct Line's share price.
It's true that on the face of it, the group's profits are now covering the dividend - an area we were concerned about previously. But only just. And there are some challenges remaining meaning we can't rule out changes to shareholder returns.
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 also mean insurers will no longer be allowed to automatically hike home and car renewal quotes. This is a headwind felt by the whole industry. However, we must admit that amongst this unhelpful development, Direct Line's ability to keep its medium-term targets intact is no mean feat.
We're also encouraged by Direct Line's strong retention rates in key areas, made more difficult by changes to automatic renewals. The money invested in launching a new integrated Motor platform should also help with this in the long run, as well as boosting efficiency (more on that later).
One of Direct Line's key advantage is its brand. This 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. New technology infrastructure helps the group compete on price comparison sites, and is improving underwriting accuracy.
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 not a long-term source of growth, so we're also heartened to see reserve releases becoming a less significant part of total profit.
CEO Penny James has instead focused on cutting costs, capitalising on recent investments in technology and increasing the contribution of underwriting.
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 has a strong offering in a difficult market. The challenges are reflected in a below-average price to earnings ratio, which could rerate should we see continued accelerated momentum. As ever, there are no guarantees.
Direct Line Group key facts
- Forward price/earnings ratio: 9.7
- Ten year average forward price/earnings ratio: 11.1
- Prospective dividend yield (next 12 months): 9.3%
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.
First Quarter Results
Motor gross written premiums fell 5.4% to £347.3m, while the number of policies was broadly flat. New business premiums across the market increased mid-single digits in January, and rose again in April. Direct Line is seeing the negative effects of increased claims severity, but this is being largely offset by a lower-than-expected number of incidents.
Pricing reforms had more of a negative effect on Home. Gross written premiums fell 9.9% to £126.4m. Claims inflation was at the top end of the 3-5% medium-term range.
Rescue and other personal lines and Commercial saw gross written premiums fall 2.2% and rise 11.6% respectively.
The group bought back £23.9m of shares as at the end of April as part of the first block of £50m, from the £100m buyback announced in March.
Direct Line CEO, Penny James, is also a Senior Independent Director of HL.
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.
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