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Direct Line Group - underwriting profitability in-line with plans

Half year underlying gross written premiums fell 2.1% to £1.5bn, with a 4.3% fall in direct own-brand policies....

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Half year underlying gross written premiums fell 2.1% to £1.5bn, with a 4.3% fall in direct own-brand policies. The decline largely reflects difficult market conditions and regulatory pricing changes. The number of in-force policies fell 9.2% to 13.2bn.

Direct line had a combined operating ratio (COR), which measures the profitability of an insurer's underwriting, of 96.5% compared to 84.2% last year. A lower ratio indicates better profitability. Operating profit fell 47.1% to £195.5m

Direct line continues to expect s full year COR of 96-98% and announced an interim dividend in-line with last year, of 7.6p.

The shares were unmoved following the announcement.

View the latest Direct Line share price and how to deal

Our view

Direct Line's prospective yield is approaching 11% and it's crucial to understand why. The yield's increased because of a reduction in Direct Line's share price, rather than an increase in the cash value of dividend payments. An abnormally high yield in this scenario can be a cause of concern and suggests markets feel shareholder returns are under pressure.

Given the challenges remaining, we're inclined to agree.

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 mean insurers can 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 in the past 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.

CEO Penny James has instead focused on cutting costs, capitalising on recent investments in technology and increasing the contribution of underwriting. That's all the right move in our view, but keeping momentum going comes at a big cost, and together with the competitive pressure elsewhere, means analysts are expecting free cash flow to fall in the coming years. That puts increasing pressure on the dividend.

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. 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, especially in the current uncertain economic climate.

Direct Line Group key facts

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.

Half Year Results

"Significant" increases in more serious, expensive, incidents impacted the UK Motor market in the period, as well as regulatory changes and supply chain disruption, meaning Direct Line's Motor division saw in-force policies fall 0.8% to 3.9m. Gross written premiums fell 6.5% to £706.8m, with both volumes and average price falling.

The FCA's changes to pricing practices impacted Home, which saw the group's retention rates improve, but new business volumes fall. In force policies for own-brand policies fell 4.7% to 1.8m. Overall gross written premiums fell 10%.

There were more supportive market conditions for Commercial, where the group saw 12.4% gross written premium growth to £377.8m, across its major businesses, including Churchill. There were 0.9m in-force policies, which was a 4% improvement.

Overall Rescue in-force policies increased by 1.3% to 3.4 million whilst gross written premium decreased by 5.1% to £77.6 million compared to last year.

The group reiterated its target of achieving at least a 15% return on tangible equity each year, with this currently standing at 17.8%.

HL's Senior Independent Director, Penny James, is CEO of Direct Line Insurance Group plc.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 2nd August 2022