The Hidden Nasty In Direct Line Insurance Group PLC’s Latest Results

Direct Line Insurance Group PLC (LON:DLG) issued strong-sounding 2013 results, but one Fool believes that several problems may show themselves in 2014.

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direct line

Direct Line Insurance Group (LSE: DLG) published its full-year results on Wednesday. Shareholders were kept sweet with the announcement of a second special dividend of 4p, and a 5% increase to the final dividend, taking the total payout for 2013 to 20.6p: that’s a whopping 7.8% yield at the current share price.

However, last year’s special dividends were largely funded by one-off divestments, and lurking beneath the surface were a number of potential issues which I believe may dent the firm’s profits in 2014.

Motoring slowdown

Motor insurance forms the largest part of Direct Line’s business, but the sector has seen intense competition over the last year, pushing down prices. Direct Line’s premium income from motor insurance fall by 4.1% last year, while policy numbers fell by 7.1%.

Motor profits were boosted by a 67% increase in prior-year reserve releases, but this kind of improvement isn’t sustainable, and Direct Lines says that releases are likely to be lower in 2014.

Unknown cost of weather claims

Direct Line’s initial estimate for the total cost of weather-related claims in the UK is £90m – £110m, but the firm admits that actual claim costs will only be known once the flood waters have receded. Direct Line also warns that with ground water levels so high, there is also an increased risk of further flooding.

I expect the total cost of weather-related claims to rise further, once the full extent of the damage is known, putting pressure on Direct Line’s 2014 profits.

Other headwinds

Profits from Direct Line’s run-off segment rose tenfold in 2013, from £6.1m to £63.6m. However, £52.1m of this came from reserve releases, and the contribution from the run-off segment is expected to be lower in 2014.

Similarly, although shareholders enjoyed two special dividends totalling 8p per share in 2013, these were largely funded by divestments and are unlikely to be repeated.

It’s also worth pointing out that Direct Line had to pay more for each new customer in 2013. The average commission paid rose by 2.1% to 11.2% of each premium.

Looking ahead

Although Direct Lines trades on an undemanding P/E of 10.5 times 2013 adjusted earnings, consensus forecasts for 2014 and 2015 suggest earnings per share of around 24p, indicating that the City doesn’t see Direct Line delivering much in the way of growth in the near future.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland does not own shares in Direct Line Insurance Group.

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