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Direct Line - challenging environment sees profit tumble

Direct Line's full year underlying gross written premiums fell 3.2% to 2.97bn pounds, ...

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Direct Line's full year underlying gross written premiums fell 3.2% to £2.97bn, of which £2.09bn were own brand policies, down 5.5% year on year. The decline reflects a reduced Motor and Home policies, which more than offset growth in Commercial policies.

The group's combined operating ratio, which is the percentage of premiums paid out in claims and operating costs, worsened from 89.5% to 105.8%, which is in loss-making territory.

Operating profit fell 94.6% to £32.1m. Higher claims inflation, severe weather events and regulatory reforms were called out a substantial headwinds which significantly impacted the group's results. 2023 will continue to be affected by macroeconomic uncertainty, and claims inflation which is higher than initially thought.

The solvency ratio, a measure of balance sheet strength, decreased from 176% to 147%, driven by lower profits, and also losses on investments held. Post year end the solvency ratio had improved by 5 percentage points.

The group does not intend to pay a final dividend, and will review the dividend outlook at the half year mark.

The shares fell 4.6% following the announcement.

View the latest Direct Line share price and how to deal

Our view

Direct Line continues to struggle in the face of significant headwinds. It's a challenging situation for a new, and as yet unappointed, CEO to come in and pick up.

The final dividend was given the chop back in January, despite prior assurances that it was secure. This is a perfect reminder that returns are never guaranteed. The road to restoring the dividend looks long and uncertain, so we're very dismissive of the prospective 8.8% dividend yield.

Poor weather conditions over December meant a material increase in weather-related claims, pushing annual levels to around double more than typical numbers. Weather's also had a knock-on effect to motor claims. When we add in the rising costs of covering insurance claims, profitability comes under pressure. An insurer's combined operation ratio measures the percentage of premiums that are paid out as claims or expenses. This came in above 100% for 2022, in loss-making territory.

The Motor division accounts for nearly 50% of the group's written premiums, so improvement in this area will be key to driving a recovery in the group's financial performance. Pricing action has already been taken to try and restore margins, but this will likely put a dent in future volumes. And in short-term at least, higher than expected claim inflation on business written during 2022 will continue to affect Motor earnings during 2023.

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 as companies are forced to cut prices to attract customers. Price comparison websites have only exacerbated the problem.

One of Direct Line's key advantages 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 expected to improve underwriting accuracy.

All-in-all, the challenges outweigh progress at the moment. And even with recent efforts to bolster its position, the group's important solvency ratio is lower than we'd like to see, although there has been a slight improvement to kick off 2023.

Turning the ship around certainly won't be an easy task or a quick fix. There's also a lot's riding on the new technology investments living up to their billing. The current challenges are reflected in a below-average price to earnings ratio, which looks appropriate in our view.

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.

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
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 13th March 2023