Company Reports

On March 22 Ageas announced it was no longer interested in making an offer for Direct Line. This follows the announcement of Direct Lines’ results last week where a new performance plan was laid out and confidence in the future value of the business was clearly communicated. This effectively raised the hurdle over which Ageas would need to demonstrate value accretion to both its own shareholders and those of Direct Line. We maintain our fair value estimates and no-moat ratings.

It is hard to dress up what is ultimately a bad set of full-year results for Direct Line. While a change of management can lead to a depression in earnings and an elevation in one-off items, the earnings announcement on March 21 reveals all has not been well for a while. There are nascent signs of an improvement and a better outlook. However, we think it is going to take a lot to convince the investment community that that is truly a turnaround. Motor insurance continues to be a problem line and management are holding off announcing the decision to place Direct Line on price comparison websites until the capital markets day in July. The board is proposing a GBX 4.0 per-share dividend versus our full-year estimate of GBX 5.6 per share. The sale of the commercial insurance business has helped bolster the group’s solvency ratio to 201% at year-end. The dividend is sensible. We maintain our fair value estimate and no moat rating.

Direct Line announced on March 13 that it received a revised and highly conditional indicative proposal from Ageas on March 9. This second bid raised the cash component from GBP 1.0 per share to GBP 1.2 per share, but lowered the stock component by increasing the Direct Line/Ageas share conversion rate from 25.24047 to 28.41107. This means the value of the stock component has been lowered from GBP 1.760 billion to GBP 1.536 billion. The total value of the offer has been marginally raised from GBP 3.079 billion to GBP 3.118 billion, or GBP 2.36 per share, an increase of 1.3%.

Direct Line was founded in 1985 by Peter Wood and Martin Long as a personal lines insurance company that operated with a model of direct-only sales. In the early days, the business became synonymous with selling directly as the company was known for its red telephone. While the business was originally established to cut out intermediaries, Direct Line has since reverted to a model of selling through high street partners and wholesalers. As the financial crisis started to unravel in the United Kingdom, Royal Bank of Scotland was requested by the European Commission to divest Direct Line. While RBS fully exited its financial interest in 2014, there wasn’t a complete operational separation until 2017. Ever since this financial separation, we think Direct Line has begun to reorient its business away from third-party policy sales, but investors haven’t really seen an improvement in the company’s loss ratios. We believe partnerships bring less control over risk selection, and this is why Direct Line started to move away from this.

Direct Line announced it has rejected a GBP 3.1 billion takeover offer from Ageas, the Belgium insurer, at an implied share price of GBP 2.33 per share.

According to articles published by Reuters and the Financial Times, Ageas is considering a bid to buy Direct Line. The announced bid seems a little off to us, given the tone of Ageas' earnings call where capital allocation decisions seemed to reiterate a share buyback in the second half of the year. Ageas doesn’t have an enormous amount of cash, so we think any possible purchase would have to be funded by debt or a capital raise. This would be an outsize acquisition for Ageas at a reported GBP 3.1 billion, on the back of what seems to have been decent results in nonlife. We maintain our fair value estimates and no moat ratings for Ageas and Direct Line.

We believe the announcement on Feb. 9 that the U.K.'s Financial Conduct Authority has agreed with the majority of the market to halt guaranteed protection of asset policy sales is a good thing and improves the unknown conditions surrounding these companies. Guaranteed asset protection has been sold to insurer policyholders against the difference between the initial purchase price of a vehicle and the outstanding value. The FCA's complaint stems from its findings that only 6% of the amount customers pay in premiums for guaranteed asset protection policies is paid out in claims. The regulator’s bone of contention is that it does not offer value for money. This marks the third intervention by the regulator into personal insurers, following general insurance pricing reforms and an investigation into premium financing. We think these investigations are coming to an end. We maintain our fair value estimates and moat ratings for Admiral and Direct Line.

With the recent announcement that the Financial Conduct Authority is investigating premium finance used to pay for insurance premiums, we believe the share price reactions of U.K. personal lines insurers in the market Jan. 10 are exaggerated and the shares of Direct Line and Admiral remain undervalued. Of the two, we prefer Admiral because we believe the company is less exposed to any future regulator action. While some news in the market has discussed double-digit premium finance rates that have fallen marginally over recent years, we think Direct Line has been charging around 4.5% last year in its motor book and 3.1% in its home insurance book, much lower than the rates being discussed in the media. In its rescue and other personal lines business and its commercial business, Direct Line has historically been charging very low-single-digit rates. If we converge these premium finance interest rates to a long-term rate of 2%, assuming the Bank of England bank rate will fall long term to this rate, we arrive at a fair value estimate for Direct Line at something in the region of GBP 1.95 per share. We believe Admiral is less exposed to any future action because across its entire U.K. business we think it has been charging premium finance rates of around 3.75%—much lower than the current base rate of the Bank of England. If we perform the same exercise on Admiral, converging these premium finance rates to 2% long term, we arrive at a fair value estimate for Admiral at something in the region of GBP 27.7 per share. We therefore believe both Admiral and Direct Line are undervalued.

Direct Line has reported gross written premiums of GBP 2.7 billion for the first nine months, a more than 20% rise on the same period in 2022 as the business incorporates 725,000 customers from mobility. This places the business ahead of the GBP 2.9 billion in gross premiums written that we forecast for the full year. Without the mobility partnership, Direct Line's motor insurance policies declined by 8.5% year to date. That is versus the 10.1% decline that we have forecast for the full year. Active home insurance policies have declined by 2.7% year to date versus the 6.5% decline we have penciled in.

Direct Line has reported results for the first half of 2023 and there is one thing that investors are focusing on: solvency. On the evening of Sept. 6, the company announced the sale of its commercial insurance broker business called NIG. This sale sketches out Direct Line’s intention to focus on its core operations of personal-line insurance and insurance for small-size businesses. The sale of the NIG business to Royal Sun Alliance, owned by Intact Financial Corporation, is being transacted at an upfront price of GBP 520 million with an earnout of up to GBP 30 million. This sale is expected to release GBP 170 million in capital upfront, GBP 270 million in total, and that should result in a 45-percentage-point rise in solvency. The transfer of NIG is expected to take place in the second quarter of 2024. At the end of first-half 2023, Direct Line’s solvency still stood at 147%, so it remains weak and the business has decided again to not pay an interim dividend. The sale of NIG brings much-needed capitalization as Direct Line continues to struggle in U.K. motor insurance. The company has been battling the rising cost of motor insurance claims and now estimates claims inflation of 17 percentage points for underwriting in 2022. That resulted in a substantial deterioration in the company’s motor claims ratio. Price rises are still being put through with average premium renewals of 19% over this interim. As of June 2023 rate rises were more like 30%. The number of motor policies Direct Line has been writing declined as a result by 4.2%. There is continued emphasis on better underwriting standards and exiting some bank partnerships. Further action that has been taken includes more fraud prevention, better use of premium discounts, and opening the company’s 23rd accident repair center, so Direct Line has better control over the claims process.

Direct Line was founded in 1985 by Peter Wood and Martin Long as a personal lines insurance company that operated with a model of direct-only sales. In the early days the business became synonymous with selling directly as the company became known for its red telephone. While the business was originally established to cut out intermediaries, Direct Line has since reverted to a model of selling through high-street partners and wholesalers. As the financial crisis started to unravel in the United Kingdom, Royal Bank of Scotland was requested by the European Commission to divest Direct Line. While RBS fully exited its financial interest in 2014, there wasn’t a complete operational separation until between 2015 and 2017. Ever since this financial separation, we think Direct Line has begun to reorient its business away from third-party policy sales, but investors haven’t really seen an improvement in the company’s loss ratios. We believe partnerships bring less control over risk selection and this is why Direct Line started to move away from this.

After Direct Line announced the appointment of new CEO Adam Winslow a few days ago, it revealed on Sept. 1 that the Financial Conduct Authority is undertaking a review of its past business. This news is highly disappointing and highlights two things. The primary reason for the review by the authority is to investigate an error in Direct Line's implementation of the new general insurance business pricing rules, effective Jan. 1, 2022. First, this error has meant that for some customers Direct Line has not calculated equivalent new business prices in line with these rules. This could mean that either new customers have been offered and sold insurance at prices that are lower than the prices being charged to existing customers with the same risk profile or existing customers have been offered renewal prices that are higher than the prices they would be offered if the same customers were new. The FCA's review is being undertaken across home and motor insurance, Direct Line's primary lines of business. Second, we believe it highlights that under the old regulatory regime, Direct Line more than likely used the practice of price walking as we concluded in our April 30, 2022 special report "In General, Admiral Is One of Our Favourite Businesses in Insurance."

All in all Direct Line has reported quite a disappointing set of numbers for the first quarter of 2023 as the business continues to remain under pressure. While the company has reported a 19% rise in average motor insurance premiums quarter on quarter, much of that has actually been the result of increased premiums in partnerships that the business has been exiting over the long term. Within the split, motor insurance own-brand average premiums are down 7.9% and motor partnership average premiums are 19.2% higher. All in there has been an 11% quarter-on-quarter rise. There has been some small low-single-digit increases in average motor premiums since the end of 2022. Together, it was not enough to offset the 14% motor claims inflationary management that was reported with full-year numbers, higher than the peak 9.6% rise in consumer price inflation. As a result, the business has guided this year could be another difficult one in terms of earnings. Motor policies are not looking much better with a 2.3% and 10.0% decrease in own-brands and partnerships respectively, since the end of 2022.

Direct Line was founded in 1985 by Peter Wood and Martin Long as a personal lines insurance company that operated with a model of direct-only sales. In the early days the business became synonymous with selling directly as the company became known for its red telephone. While the business was originally established to cut out intermediaries, Direct Line has since reverted to a model of selling through high street partners and wholesalers. As the financial crisis started to unravel in the United Kingdom, Royal Bank of Scotland was requested by the European Commission to divest Direct Line. While RBS fully exited its financial interest in 2014, there wasn’t a complete operational separation until between 2015 and 2017. Ever since this financial separation, we think Direct Line has begun to reorient its business away from third-party policy sales, but investors haven’t really seen an improvement in the company’s loss ratios. We believe partnerships bring less control over risk selection and this is why Direct Line started to move away from this.

Direct Line was founded in 1985 by Peter Wood and Martin Long as a personal lines insurance company that operated with a model of direct-only sales. In the early days the business became synonymous with selling directly as the company became known for its red telephone. While the business was originally established to cut out intermediaries, Direct Line has since reverted to a model of selling through high street partners and wholesalers. As the financial crisis started to unravel in the United Kingdom, Royal Bank of Scotland was requested by the European Commission to divest Direct Line. While RBS fully exited its financial interest in 2014, there wasn’t a complete operational separation until between 2015 and 2017. Ever since this financial separation, we think Direct Line has begun to reorient its business away from third-party policy sales, but investors haven’t really seen an improvement in the company’s loss ratios. We believe partnerships bring less control over risk selection and this is why Direct Line started to move away from this.

When looking at the exposure of insurers to the unfolding banking crisis, we believe this is limited. The main impact of the crisis currently seems to be contagion, so investors are selling shares cheaply. However, exposure to United States bonds is either in government bond securities, or exposure to Credit Suisse, Silicon Valley Bank, and other U.S. regional banks is immaterial, which is 50 basis points or less of their investment portfolio. Some do hold larger bank debt holdings of up to 5.5% of shareholder investments, but nearly all that debt ranks as senior. AT1 debt tends to be very minimal or there is no exposure as a policy with board-level approval. The vast majority of corporate debt held is investment-grade. We maintain our fair value estimates and moat ratings across our European insurance coverage. Allianz remains our Best Idea. Admiral is one of our top picks.

Direct Line has reported full-year 2022 results today that have not been taken well. Estimates from PitchBook place consensus estimates of earnings per share at around GBP 0.02. Yet, negative GBP 0.03 is the actual. In terms of the business’s group profit, this amounted to negative GBP 39 million for the year. That is versus the negative GBP 55 million that we forecast. There is a lot to digest in the results but we reduce our fair value estimate to GBP 2.65 per share and we maintain our rating of no economic moat.

Direct Line was founded in 1985 by Peter Wood and Martin Long as a personal lines insurance company that operated with a model of direct-only sales. In the early days the business became synonymous with selling directly as the company became known for its red telephone. While the business was originally established to cut out intermediaries, Direct Line has since reverted to a model of selling through high street partners and wholesalers. As the financial crisis started to unravel in the United Kingdom, Royal Bank of Scotland was requested by the European Commission to divest Direct Line. While RBS fully exited its financial interest in 2014, there wasn’t a complete operational separation until between 2015 and 2017. Ever since this financial separation, we think Direct Line has begun to reorient its business away from third-party policy sales, but investors haven’t really seen an improvement in the company’s loss ratios. We believe partnerships bring less control over risk selection and this is why Direct Line started to move away from this.

Direct Line has announced the recruitment of Mark Lewis as an independent nonexecutive director effective March 30, 2023. Lewis spent three years as MoneySupermarket Group CEO and with the rise in the cost of living, consumers have gone back to shopping around. U.K. insurance remains one of the most active products for shopping around. We think this appointment shows that the U.K.'s insurance business model, ultimately, hasn't changed and that Direct Line has begun to recognise, more than ever, that they need to permanently look to this channel to remain competitive and grow. We maintain our GBX 285 fair value estimate and no moat rating.

After Direct Line encountered inflation, weather, and commercial property valuation elements that meant it could not pay its final dividend, it shored up its balance sheet through reinsurance, and on Jan. 27, 2023, CEO Penny James announced her resignation. The news comes after a fraught few weeks for the business—yet we’re not necessarily fans of the announcement. Jon Greenwood, currently chief commercial officer will be acting CEO until the board makes a permanent appointment.