Direct Line still a rank below Admiral

Fortunes varied wildly in the general insurance sector in 2020. After years defined by dogged competition, Covid-19 upended the claims environment and suddenly divided winners and losers along policy lines.

Admiral (ADM) was particularly well-placed. With its focus on motor insurance, the company saw a massive decrease in the frequency of claims as car owners drove less, resulting in a total claims reserve release of £242m, just shy of a particularly strong 2019.

Fortunately for both shareholders and customers, management recognised the unsustainability of the division’s combined ratio of 69 per cent – in effect, £69 of claims and costs for every £100 in premium income – and arrived at two canny decisions: the return of £110m to customers through a ‘Stay at Home’ rebate in May, followed by big discounts to both repeat and new policyholders.

The combined effect was muted growth in turnover from £2.46bn to £2.47bn, and a chunky 9 per cent increase in customer numbers to 4.75m. Liking what they’ve seen, investors have pushed up the shares by 34 per cent in the past 12 months, leaving the company priced at just under eight times’ consensus forecast book value for the 2021 year end.

Peel Hunt, which describes that rating as “hard to justify”, nonetheless thinks that “by treating customers well, Admiral’s [customer] retention rates are likely to remain higher than normal”. Even as the claims environment normalises as lockdowns end, future earnings are likely to be supported by prior year underwriting profits.

Direct Line (DLG), which also sells commercial, home, personal, rescue and pet insurance, didn’t reap the same benefit from its motor division. Though lower claims lifted the division’s operating profit from £303m to £364m, in-force policies went sideways from 4.04m to 4.06m, while longer repair times led to greater-than-expected claims severity.

As a result, the combined operating ratio - claims, costs and expenses to premiums - fell only modestly to 87.7 per cent. Elsewhere, weather costs ate into profits in both commercial and home lines, while travel insurance underwriting was hit by the near-collapse of a functional market in the first half of 2020.

Ongoing uncertainty means near-term forecasts are guarded, though management still thinks a combined operating ratio of 93 to 95 per cent is possible in 2021; throw in cost-cutting initiatives, and guidance for a 15 per cent annual return on tangible equity remains intact.

This leads us to conclude that, powered by £100m-worth of share buybacks, Direct Line could close some of its stark valuation gap to Admiral this year, even if the latter has played a stronger hand ahead of the Financial Conduct Authority’s motor insurance pricing review. We maintain our previous advice on both stocks - hold.

Last IC View: Hold, 2,639p, 12 Aug 2020 (ADM), Hold, 326p, 4 Aug 2020 (DLG)