Direct Line aims for profitability next year

Shares in motor insurer Direct Line (DLG) found favour with the market after rising 15 per cent on the back of the troubled insurers half-year results. It seems that all management had to do to win back everyone’s confidence was to book a £30mn provision for 'price walking' claims, cut the dividend and continue making a pre-tax loss on bad underwritten premiums.

While the 'kitchen sinking' operation may amuse the jaded, it cannot obscure the fact that there are genuine grounds for optimism if the company can discard its troubled legacy under its incoming management.

The company has struggled with maintaining a consistent underwriting policy over the past couple of years, but the current interim management has put considerable work into reorganising this through a combination of price hikes for motor premium renewals of 25 per cent, with higher premiums for new business. The better overall underwriting performance meant that profitability is now “consistent with a 10 per cent net insurance margin”.

Alongside new written business being up by 7 per cent, this should see Direct Line into profitability as older unprofitable contracts recede during the rest of this year. However, the combination of self-help measures will take time to show in the reported results, according to interim chief executive Jon Greenwood.

Meanwhile, the main reason for the pre-tax loss was the £184mn underwriting loss it had to book for motor insurance, mainly because of premiums not keeping ahead of inflationary pressures in the car supply chain.

On a reported basis, the net insurance margin in these results was 6.4 per cent. The company also announced the disposal of its brokered commercial insurance business, NIG, so that it can concentrate purely on retail lines. The sale of the commercial book will also help to maintain the company’s solvency ratio of 147 per cent as this will release about £270mn of capital over time.

The initial impression is that the company is well on the way to stabilising the troublesome parts of its business so that incoming chief executive, Adam Winslow, currently head of Aviva’s UK motor division, can enjoy the best possible start in January. Broker Peel Hunt reckons that the possibility of reserve releases is low given the company’s need to maintain its solvency position, which should see it through to the point that insurance rates start to harden. The broker forecasts a PE ratio of 12.6 and 5.6 for 2023 and 2024, respectively. A turnaround in progress. Buy.

Last IC View: Buy, 175p, 25 May 2023