Direct Line expects total weather claims to be in the region of £140m for 2022, well ahead of the £73m previously estimated. This comes as December saw a significant increase in claims due to prolonged and severe cold weather.
Motor trading improved in the fourth quarter compared to the third, with own brand policies broadly flat and gross written premiums down 2%. Claims inflation remains a challenge, and along with an increase in claims frequency over the fourth quarter, the motor loss ratio (claims + costs / premium income) for 2022 is expected to rise by around 6 percentage points.
The investment property portfolio saw a drop in valuation of around 15%, or £45m. Occupancy levels remain at around 95%.
All in, Direct Line expects to see its combined operating ratio (COR), normalised for weather, for 2022 at around 102% to 103%. COR is a measure of profitability, anything above 100% suggests total costs are higher than premiums. For 2023, higher claims inflation is expected to increase COR by around 2-3 percentage points from the previous target of 95%.
Fourth quarter challenges put capital coverage at the lower end of the target range. As such, the board has decided not to pay a final dividend for the 2022 financial year.
The shares were down 27.3% in early trading.
View the latest Direct Line share price and how to deal
Our view
Having spent most of the last 6 months with a forward dividend yield over 10%, Direct Line's finally succumbed to trading pressures and the final dividend's been given the chop. Markets are unsurprisingly concerned, not least because management have been reassuring investors that the final dividend was secure. This is a perfect reminder that returns are never guaranteed and we wouldn't be surprised to see the yield come under more pressure over 2023.
There are a few elements to unpick here. Poor weather conditions over December meant a material increase in weather-related claims, pushing annual levels to around double of more typical numbers. Weather's also had a knock-on effect to motor claims, which trended higher in the fourth quarter.
When we add in the ongoing struggles with inflation, which is pushing the cost of covering insurance claims higher, profitability comes under pressure.
An insurers combined operation ratio measures the percentage of premiums that are paid out as claims or expenses. Direct Lines slew of claims and higher costs means that's now expected to come in at over 100% for the current financial year, into non profit territory. 2023 looks under pressure too, expected around 97-98% - that doesn't leave much wiggle room.
More broadly, 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 area we've been encouraged by is Direct Line's strong retention rates, but it's new business that's proving tricky to come by in key areas like Home. That's putting downward pressure on the number of in-force policies.
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 improving underwriting accuracy.
CEO Penny James has 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 aren't expecting free cash flow to recover until at least the end of 2023.
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 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.
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.
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