Third quarter underlying gross written premium fell 5.8%, to £807.2m, as declines in both Motor and Home were only partially offset by an increase in Commercial. The group saw a drop in the number of in-force policies compared to the end of the second quarter, from 13,231 to 13,086.
Direct Line was forced to take pricing action over the quarter to help restore margins in Motor, leading to a drop in new business early in the quarter. In Home, the new business market conditions remain ''very challenging''.
Inflation remains a headwind, trending around 10% in Motor. Home and Commercial aren't quite as exposed for now, but the group expects inflation in these areas to continue to tick higher.
The group expects underwriting performance for the current year to be in line with expectations, along with the outlook for potential dividends. It did, however, downgrade its expected combined operating ratio (COR) forecast to 98% or higher, from 96-98%. COR measures the profitability of an insurer's underwriting, and a lower ratio shows better profitability.
The shares fell 4.7% following the announcement.
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Our view
Direct Line's prospective yield is more than 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.
We're inclined to agree, not least because of the challenges ahead but also because the group's not far off the lower end of its target solvency ratio. Further moves toward the low end would put returns under pressure.
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've been encouraged by 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 which have fallen in the recent quarter.
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.
Insurers must set aside a portion of the premiums they receive to meet future claims, called reserves. 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.
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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