Direct Line Insurance Group PLC
LSE:DLG
Earnings Call Analysis
Q2-2023 Analysis
Direct Line Insurance Group PLC
The discussed earnings call transcript outlines a company in the midst of navigating significant change and implementing strategic initiatives to address various challenges. The focus was on the financial overview, showcasing a gross premium growth by 10%, with rate increases in Motor and Home offsetting reductions in in-force policies. Commercial lines also showed strong performance. However, adversity in the Motor line from the previous year had a notable impact on group results. A remediation provision for customer-related reviews also contributed to a GBP 93 million loss in insurance service results, with a net insurance margin being negative at -6.4%. Yet, excluding Motor, a positive net insurance margin of 12.2% was evident. Solvency remained stable at 147%, while investment income yield made promising gains and is expected to reach between 3.4% to 3.5% by year-end.
The transcript reveals a particular interest in the Motor line, which although currently displays a -26% net insurance margin, is expected to uplift substantially. The management conveyed confidence in their corrective measures as written premiums have increased by 7%, with a significant 19% jump in own brand average premiums. Despite a lower in-force policy volume, the intention is crystal clear: prioritizing margin over volume for sustainable profitability. With forecast improvements, an 11% higher average earned premium is anticipated in the second half of the year and a 19% increase in the first half of the next year. These predictions hold firm management's belief in transitioning to a net insurance margin consistent with 10%.
In the Residential space, the company saw a modest premium growth with proactive market navigation. Commercial lines, on the other hand, experienced remarkable premium growth of 25%. This growth is supported by market alignment and a strategic focus on strong policy growth and rate improvements. With net insurance margins holding at 13% and 9% for Residential and Commercial respectively, the underlying narrative suggests a resilient performance outside of the Motor line challenges. The strategic disposal of NIG contributes further to capital resilience, estimated to add approximately 45 points to the solvency position.
The conversation touched on the critical subject of dividends. The conditions for dividend reinstatement have been carefully outlined: restoring capital resilience -- already achieved by the proposed sale of NIG -- and demonstrating a return to organic capital generation in Motor. Investor interest is palpable for dividends to resume, yet the board's stance is cautious, opting to evaluate Motor's performance over the latter half of 2023 before making the final call. This underscores a prudent, measured approach designed to align business recovery with shareholder expectations.
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Good morning and welcome to the Direct Line Half Year Results 2023 Conference Call. My name is Carla and I will be the operator of today's call. [Operator Instructions]
I would now like to pass the conference over to our host, Jon Greenwood, Acting CEO, to begin. Jon, please go ahead when you're ready.
Good morning, everyone. Back in March, I told you that our key priorities were to restore our capital resilience, improve our performance in Motor and maintain the performance in our other businesses. Over the past 6 months, we've taken decisive action to address each of these and put the group back on a stable footing.
Firstly, we've reached agreement to sell our commercial brokered business to RSA. This transaction will strengthen the group, both strategically and financially and is forecast to improve our solvency ratio by around 45 points to above 190%.
In Motor, the first half earnings are clearly not at an acceptable level but are not representative of the profit of the business we are writing today. We've taken significant pricing actions which are starting to take effect. It has taken longer than expected for these actions to work through but we estimate that we are now underwriting profitably, consistent with a net insurance margin of 10%. Our other segments performed broadly as expected and also benefited from benign weather in the first half. I'm also delighted that Adam Winslow has agreed to take up the position of Chief Executive and is expected to join us in Q1 2024. Adam has an excellent track record and a deep understanding of the sector and we look forward to welcoming him next year.
We have announced the sale of our commercial brokered business. It has been part of the group since 2003 when it was acquired as part of the Churchill acquisition and its success has been driven by strong and extensive partnerships with brokers. Over the last 10 years, we focused on improving its operational and financial performance. Strategically, we have long thought about its fit within the group. With the turnaround now complete and the business delivering strong growth and good returns, now is the right time to crystallize the value for our shareholders. We've run a discrete process at a very attractive valuation and are delighted to announce the sale. We believe the initial goodwill consideration combined with the earnout provisions and capital release provides a strong valuation for shareholders.
We are retaining the Direct Line for business and Churchill brands, enabling us to fully focus on retail personal and commercial small business customers. So standing back, as well as being the right strategic decision, the sale will rebuild the resilience of our balance sheet and Neil will take you through the solvency detail later in the presentation.
Turning to Motor on Slide 5. We took a range of actions to mitigate the impact of claims inflation and improve margins. Pricing, of course, has been the main driver of margin improvement and that was reflected in the substantial increase in our average premiums. I will take you through our pricing actions in more detail in a moment.
Risk modeling is a key part of our pricing capability and we are continuously upgrading our models. We've also taken other underwriting and claims actions to mitigate the impact of inflation. This includes tightening underwriting for some higher-risk segments, including those with a higher propensity to fraud and we are expanding and making maximum use of our own repair network.
Looking to sustain margins in the longer term, we have launched new products such as Churchill Essentials into the PCW channel and we're very encouraged by the initial take-up. We're also planning to launch Direct Line Essentials in the very near future.
Significant additional resources were deployed into Motor earlier this year. And that investment will be maintained as we continuously upgrade our pricing capabilities with a particular focus on PCW trading.
As I said, pricing is the main lever we use to drive margins and we put through 37 points of rate during the first half and continue to apply rate in July and August in response to claims inflation. There were also substantial changes in our underwriting risk mix, reflecting targeted pricing actions to reduce our exposure to vehicle groups with higher damage costs and higher theft risk.
As you can see from the chart, premium increases were significantly higher in the second quarter. New business average premiums are now above GBP 500 and renewals are around GBP 400, resulting in a 28% increase in total average premiums. On the right, you can see that our average premium increases were ahead of the market over the last year and, in particular, across the second quarter.
Inevitably, our focus on pricing actions to improve margin led to some policy loss. And the own brand's in-force policy count fell by 4% during the course of the half year. But the rate of decline slowed over the period as rates increased across the whole market. On September 1, we will welcome 700,000 Motability customers through our new partnership which is expected to contribute around GBP 700 million of gross written premium annually.
The Motor market continued to experience significant claims inflation. Our view of severity claims inflation for 2022 increased to 17% but our outlook for 2023 is unchanged. The main driver of claims inflation in 2023 has been repair costs, with higher labor costs the single biggest factor.
As I referenced earlier, we've taken a range of actions in claims to improve costs and improve the customer experience. We recently opened our 23rd Auto Services site in Perth, enabling us to increase the proportion of repairs carried out in our garages and we are also increasing the proportion of claims coming into our wide and managed network.
Repair cycle times and total loss ratio remained high through the first quarter but these both started to decline and are closer to where we expected them to be. Improved capacity across the network is reducing the level of total losses and used car prices have been broadly stable through the first half.
On frequency, whilst there has been an increase in miles driven, the improvements we've made to our risk mix has offset this increase. So while there is still some pressure in the system, some of the key trends are stabilizing but we remain very alert to the risks and we'll closely monitor all of our cost drivers and trends and continue to feed insights back into our pricing and risk models. Our outlook for 2023 claims inflation is unchanged at high single digits.
Pricing actions and GWP growth takes time to earn through into net insurance revenue and profit. And clearly, our first half results do not reflect the impact of the major pricing actions I have just described. So although we have reported a net insurance margin in the first half of minus 26%, this primarily reflects the earning through of the unprofitable business written in 2022 and earlier this year.
Based on our expectations of full year claims inflation, we estimate that we are currently writing to a 10% net insurance margin. This chart shows how average premiums and the perceived written loss ratio have evolved, driving margins progressively higher. So while this has taken longer than expected, we can see clearly that our pricing and claims actions are taking effect quarter-by-quarter. This will start to be reflected in our 2024 results as this written business earns through.
Outside of Motor, our other products have traded broadly in line with expectations, delivering 12% growth in premiums and strong net insurance margin of 12% in the first half. In Home, the team have navigated the market well and delivered a return to modest premium growth. In the second half, Home will begin to roll out a new technology platform, providing opportunity to deliver a step change in our pricing and new product development capabilities.
Commercial continued to perform well in H1 and we are retaining the direct elements of the Commercial book as it's a valuable part of our franchise.
Rescue and other personal lines is another valuable part of our franchise. Green Flag is the third largest rescue provider in the U.K., offering great value and market-leading services to over 2 million customers. Green Flag continues to explore new revenue streams through Green Flag patrols which are expanding following a successful pilot in Scotland. Our largest product within the other personal lines is Pet which is sold under our Direct Line and Churchill brands. This product delivers strong returns but our investments have been prioritized elsewhere over recent years and Pet is not currently sold through PCWs. We plan to unlock the potential of this part of the group through investment in systems and capabilities, with new products planned for later this year.
We have retained the commercial direct portfolio as it has a natural synergy with the rest of the group. Commercial Direct includes landlord, van and the suite of bespoke micro SME products sold through Direct Line and through PCWs under the Churchill brand. As you can see, we've delivered material growth over recent years.
The sale of commercial broker enables us to become a fully focused retail personal and commercial SME insurer and provides a platform for improved performance. Through our well-known brands, we offer a wide range of general insurance products across motor, home, commercial, travel, pet and rescue. Customers can choose to come direct, via a price comparison website and can engage on the phone whenever they need us most. Our customer focus drives us to adapt and evolve to meet their changing needs, whether that's developing new products and services, building new partnerships or expanding our repair network. This is why the new consumer duty regulations are strongly aligned with our mission to be brilliant for customers every day.
I'll now hand over to Neil for the financial update.
Thanks, Jon and good morning, everyone. As you know, this is our first set of results we're reporting under IFRS 17. And by now, I'm sure you're quite familiar with the changes this brings. And we've published some extra slides on the website today to help explain some of the movements in the comparatives. But the key message from our earlier discussions on this topic is that the new standard does not change the economics of the group.
So let me start with the financial overview on Slide 14 with the key financial metrics. Gross premium grew by 10% in the first half, with premium growth in Motor, Home and Commercial. Rate increases in Motor and Home more than offset reductions in in-force policies across the first half, whilst Commercial continued its strong performance. And we spoke at year-end about how it would take some time for the adverse performance in Motor from 2022 and early 2023 to earn through the book. And you can see that this has impacted the group results. In addition, in the first half, we have provided for approximately GBP 30 million of remediation for customers affected by the 2 past business reviews that we are currently undertaking.
The insurance service result was a loss of GBP 93 million as the adverse Motor result was partially offset by resilient performance of other lines and relatively benign weather to date. The net insurance margin was minus 6.4%. However, outside of Motor, the net insurance margin was a positive 12.2%. Operating loss was GBP 78 million, with higher investment income partly offset by the unwind of the discount benefit on claims. Now on solvency, the ratio was broadly stable versus the year-end at 147%. And I'll come on to talk about the impact of the NIG sale in more detail later on.
So turning to Motor. The key point to note here is that the first half earnings are not representative of the profit of the business we are writing today. Jon has talked you through some of the trading metrics already. So to summarize, written premium was up 7% in the first half. Own brand average premium was up 19%, with in-force policies 4% lower as we focused on margin. The actions we've taken during the first half mean we believe we are now writing at loss ratios consistent with a 10% net insurance margin.
Now clearly, this is not visible in the reported earnings today which are showing a net insurance margin of minus 26%. And on the following slide, I'll take you through some of the earned premium trends looking forward. On top of the lower average premium earning though, we also saw some adverse development on damage claims, particularly in the last quarter of 2022 which we highlighted in the Q1 trading update. These trends increased our view of claims severity for 2022 to around 17% and contributed to a prior year reserve strengthening of GBP 60 million.
Now given the inflationary macro backdrop, I would expect prior year releases to be minimal in the short term. These factors resulted in a GBP 180 million operating loss. Now last week, we welcomed almost 700,000 new customers as part of the partnership with Motability and this is expected to add around GBP 700 million of gross premium annually. To remind you, this book is capital-light as it's 80% reinsured and is repriced every 6 months.
Now on Slide 16, I've tried to give you a framework for thinking about how the loss ratio will develop over the next 12 months. As you can see from the chart, average earned premium, the gray line, was flat to last year despite the increases in average written premium during the year. Now as you all know, it's earned premium that drives the P&L. And so this chart is showing you the forecast development of that measure based on the business we have written to date. You can start to see average earned premium increasing in Q2 and we expect this to continue to increase through the next 12 months, with earned catching up with written this time next year.
So putting these trends into numbers, average earned premium is forecast to be 11% higher in the second half and 19% higher in the first half of next year versus the first half of 2023. So to repeat, the key takeaway. The report earnings are not representative of the business we are writing today.
Let me move on to Home on Slide 17. As Jon said, the team have navigated the market well, utilizing our strong brand footprint, particularly in the PCW channel and prioritizing margin while delivering a return to modest premium growth. The Home market experienced a positive pricing in the first half of 2023, with new business market pricing up around 19%, a significant shift from the market environment of 2022. This led to more shopping in the market, albeit shopping levels are still lower than before the implementation of the pricing reforms.
We increased our prices during the first half to reflect our view of claims inflation and higher reinsurance costs and that resulted in a 9% increase in own brand average premiums. Retention has remained strong over the period, with in-force policies reducing by 1.5% since year-end. Overall, gross written premium grew by 1% or 4%, if I adjust for the impact of the PPR-related remediation.
Underlying claims trends for 2023 remain in line with our expectations of high single digits. However, we did experience a one-off increase in escape of water severity for claims received late in 2022 around the same time as the December freeze event. And this has reduced the opportunity for prior year reserve releases compared to an unusually high level in the first half of 2022. The net insurance margin was 13%, with an operating profit of GBP 33 million.
Now looking forward, Home will continue to trade in a similar way, prioritizing margin over volume and using its brand portfolio to achieve this. And again, as Jon mentioned, we're on target to launch our new Home platform this year which will bring longer-term trading and product development opportunities.
Let me move on to Commercial on Slide 18. During the first half 2023, Commercial continued to deliver strong policy growth and double-digit premium growth. This reflects its transformation alongside a positive commercial market backdrop. Gross written premium increased by 25% compared to last year, with rate carry of around 14%, delivering strong growth across both NIG and direct own brands. The direct own brand portfolio which will remain part of the group, delivered premium growth of 12%, with growth in both Direct Line and Churchill. The claims ratio at the Commercial level increased to 49% as lower weather-related claims were offset by a lower level of prior year reserve releases and the latter was partly due to some adverse development in Commercial -- Motor.
We also saw an improving expense picture as operational leverage improved the acquisition and expense ratios. Overall, the net insurance margin was 9% and operating profit was GBP 41 million. Looking forward, the outlook for the Commercial market remains positive.
Finally, Rescue and other personal lines and this continued to deliver a healthy diversified profit for the group at a strong net insurance margin. Gross written premium reduced by 3% as a result of lower Rescue and Pet volumes. Operating profit was GBP 28 million and the net insurance margin was 19%.
A few words on Rescue as it's the largest product in the segment. Rescue's in-force policies and gross written premium were lower but was mainly a result of lower-linked Motor policies which more than offset stable premiums in Green Flag direct. The net insurance margin was lower than last year, primarily due to some higher claims costs but remained attractive at 29%.
Let's move on to costs on Slide 20. Operating expenses within the insurance service result increased by 4% year-on-year, showing disciplined expense management in an inflationary environment and this delivered an expense ratio of 20.5%. Staff costs were stable year-on-year as reduction in headcount offset salary inflation. We continue to see an increase in amortization costs reflecting the investments we've made over recent years. Now looking forward, we are focused on driving further cost efficiency, albeit this is in the context of a general inflationary pressures in the market.
So let me move on to investments on Slide 21. Net investment income continued its upwards trajectory as the book rolls on to assets benefiting from recent increases in yields. Net investment income was GBP 80 million which represents an investment income yield of 3.2% after fees, up from 2% in the first half of last year. And currently, we're expecting a further increase in the second half so that the full year investment income yield should be between 3.4% and 3.5%.
As you know, we've elected to take most fair value movements through the P&L as part of IFRS 9 and this all comes through outside of the operating result. You can see last year, we saw a large reduction of GBP 225 million, whereas this year has been a lot more stable as spread tightening has been broadly offset by interest rate movements. Property valuations have been slightly positive in the first half.
So let me move on to capital on Slide 22. At our full year results, I set out several capital levers, some of which were mechanical tailwinds and others that were self-help management actions. In respect of organic capital generation, this has been negative in the first half as the weak Motor profitability more than offset capital generation elsewhere. Looking forward, we should see capital generation from Motor improve faster than IFRS 17 earnings given the written nature of Solvency II.
We've seen modest positive movements on some of the mechanical tailwinds over the first half and expect to see an improvement in the second half, including the proposed reforms to the risk margin under Solvency II. We expect this alone could improve capital coverage by approximately 4 percentage points. Overall, we expect mechanical tailwinds to deliver around 4 to 7 points of benefit across the second half.
Now in terms of capital, the biggest impact is the sale of NIG which is on the following slide. And here, I've set out the expected capital benefit from the proposed sale. The consideration and capital release provide a significant uplift to our solvency position, with an estimated day 1 benefit of approximately 45 points. This arises from a combination of net proceeds and capital relief on the front book as this is fully reinsured. In addition to this, we estimate further benefits of around 10 points over time from the natural paydown of existing claims reserves as well as the prospective earnout.
So bringing this all together, let's turn to the first half capital and pro forma on Slide 24. The group's capital coverage was stable at 147% at the end of June as capital generation, expenditure and market moves all offset each other. If we include the estimated 45 points from the proposed sale of NIG, that gets us on a pro forma basis to above 190%. So standing back, the proposed sale of NIG fully restores the capital resilience of the group.
Let's move to dividend outlook on Slide 25. In the announcement, you'll see, we've set 2 conditions for restarting dividends. The first is to restore capital resilience which has been met by the proposed sale of NIG. The second is a return to organic capital generation in Motor. Now we've made good progress on a written basis and the Board will review how this business develops over the second half of 2023 and early 2024 before deciding whether this condition has been met. I would like to reiterate the Board understands the importance of dividends to our shareholders which is why we are setting out these clear conditions today.
Now my last slide in the pack looks at the pro forma position of the business going forward after the sale of NIG and the addition of Motability. As you can see, looking forward, we will focus retail personal lines and small business insurer with scale, demonstrated by a policy count of close to 10 million and gross annual premium of over GBP 3 billion. For each of these areas, we have an ambition over time to generate a net insurance margin of above 10%.
With that, I'll hand back to Jon to sum up.
Thank you, Neil. Our messages today are clear and straightforward. We've taken strategic action to rebuild capital and decisive action to improve Motor profitability. The fundamental strengths of this business remain. We are a multiproduct, multichannel business with some of the most recognizable and powerful brands in the market and scale across retail personal and commercial insurance. We will maintain our focus and continue to execute to drive improved performance across the group.
Thank you and we'll now take your questions.
[Operator Instructions] Our first question comes from Will Hardcastle from UBS.
So look, on the first one, it looks like this was around 70% of the premium and also earnings in 2022 in Commercial. So that what's being disposed of. You've given the historical premium split but is that also a fair reflection to historical profitability split as well and, I guess, is what's left for the direct component? Is that a similar return on capital to the other component as well?
Secondly, just -- it certainly looks like, as you say there, Neil, solvency is fixed, I guess, barring any further shocks. Just thinking about that, is there any plans for any more, I guess, inclusive investigation review of any areas of businesses such as reserving once the new CEO comes in -- once Adam comes in? And I guess what messages can you say to help really allay any potential investor concern over the area?
So I take the return on capital for the Commercial business. And I'll pass over to Neil for the other questions. So the remaining Commercial business is a combination of a fairly sizable van book of business which performs consistently with our Motor business. It's had some inflation challenges recently but, historically, has performed very well. There's a significant landlord book of business in there as well which does perform extremely well and provides very good return on capital and then a much smaller SME business which is equally attractive. So I think what we have in the direct commercial business is a fast-growing part of the organization which is following some very strong trends in the SME market, where increasingly, people are looking to buy direct or through PCWs and can generate us some very attractive returns. Neil?
Yes. So on reserving, I think Motor is obviously the main discussion point here. The strengthening in the first half is really down to a lot of the -- some of the damage trends we saw coming through which I wouldn't expect to be repeated. They're quite specific to a situation. And we have, in the first half, strengthened some of our inflation assumptions for things like general damages, where we expect those -- there to be some increases coming in the future. So I think we've taken the right appropriate reserving picks in the first half and I think that's reflected in the numbers.
Our next question comes from Thomas Bateman from Berenberg.
Congratulations on the deal. I'd just like to go back to the implementation of the duty reforms [ph] and obviously, the FCA's review of that. Can you just explain to us what happened with the implementation of that and maybe some of the feedback that you've got from customers? I guess I'm thinking a little bit about reputation damage going forward, how you're looking to manage that. The second question is on the deal. How long would you expect the back book to run off in terms of years? And I'm thinking particularly in terms of the capital return. So when that extra GBP 100 million comes off, how would you expect -- or if you would expect that to return that to shareholders, that would be helpful.
Yes. Look, on the changes -- the pricing changes that took place last year, I think some fairly complicated rule changes, particularly into products where pricing is quite complex. Clearly, we made a mistake. We're very sorry about that. We will clearly do -- through the past business review, we will be contacting those customers that have been affected and providing them with the appropriate compensation.
Neil, should I pass to you for the other questions?
Yes. So on the back book, so you're right, we retain -- effectively, the reserves on the business has been earned already. I mean the reserves kind of have an average duration of just over a couple of years. It's not completely linear. But if you assume over 3 years, I think that will be a fair approximation, Tom.
Our next question comes from Youdish Chicooree from Autonomous Research.
I've got 2 questions, if I may, please. The first one is on the NIG deal. It sounds from your release that you are contemplating a sale of the back book as well. So I'm wondering what kind of capital that would release if you were to actually sell the back book as well? That's my first question. And then secondly, on just sort of the outlook for Motor profitability, I mean you provided us the trajectory of the earned premium going forward. So thank you for that. But my question is really on the claims inflation side. I mean your outlook for claims inflation is very similar to peers but your experience in 2022 is vastly different. And I'm wondering what gives you confidence that you're going to move from a 17% severity inflation to a high single-digit inflation work at the moment.
Shall I pick up the inflation question first and then hand over to you? Tracking inflation in 2022 was clearly very challenging because the trends were very volatile and there were many moving parts in that inflation story. I think what we've seen through 2023 is a stabilization of some of those factors, things like used car prices have started to stabilize. Clearly, our tracking of inflation is very granular now. So we are keeping a very keen eye on all of the different components that feed into inflation. So I think a combination of our confidence in our tracking and what we're actually seeing in terms of those trends stabilizing give us confidence that we can reiterate that high single-digit expectation for inflation this year.
And on the back book question, so we will discuss with RSA taking on the back book as well. The reason for that is it makes more sense to put the front book and the back book together before you do a Part VII. So it would operationally make it easier but there's no guarantee that will happen. And obviously, we'll have to look at the pricing. In terms of capital relief, it doesn't change the quantum of capital relief. But it may accelerate the timing of the capital relief if we were to do a back book deal as well.
Just a follow-up on the inflation comment. I mean has there been a step change in your capabilities to track and model for inflation in the past year? Or was it in place like since the beginning of last year?
I think it's fair to say that throughout 2023, we have been increasing both the cadence of our approach to tracking claims inflation and the granularity. So yes, there has been a step change in the way that we track and monitor claims inflation in 2023.
Our next question comes from Rhea Shah from Deutsche Bank.
Great deal. I just wanted to ask, firstly, around the 45 extra points of solvency once the deal is approved. I get that it takes you above the 190% and you have to look at what the Motor capital generation does to really assess the dividend. But what else could you do with this 45 basis points? Will you invest in the business to improve underwriting performance in Motor and other areas? Or is there anything else you could do? And then secondly, around Motor, in particular, what do you expect to be a normalized level of the current year attritional Motor to get to that 10% net invest -- insurance margin?
Shall I take investing in the business? So the group has been, over a number of years, now making very significant investments in -- particularly in technology. So as you know, we've replatformed the Motor business. You heard from the presentation that we are, in the coming months, expecting to launch our Home platform which again brings new capability. Similarly, in pricing, we have been rebuilding our pricing sophistication and modeling. So an awful lot of investment has actually already taken place. What we're doing now, of course, is leveraging that investment to make sure that we get the best from it.
So my summary would be much of the heavy lifting when it comes to investment has already taken place because typically, that is in the sort of technology space. We will, of course, continue to invest. I think in pricing, in particular, there are further opportunities for us to invest. But that's substantially about people and capability rather than big, heavy IT investments. Neil?
No. So I don't give any specific number because it depends on how you make up the margin when you get there. But I think from the 10% margin -- if you start with 10% and adjust for expense ratio and acquisition costs, you can imply a claims ratio from that calculation.
Our next question comes from Alexander Evans from Citi.
Just firstly, on the FCA's past business review, the pricing practices. I think in the release recently, you said half of that GBP 30 million was provided within the full year '22 results. And then you also mentioned the underpayment of Motor claims have been provisioned for in full year '22. So what's the additional GBP 15 million related to in 1H? And obviously, there's been a numerous sort of retrospective actions from the FCA. How well do you think Direct Line is prepared for a consumer duty and how to -- compared to peers?
And then just sort of secondly on the performance in 1H in Motor. If you do the math, I think it looks like your current year attritional loss ratio is about 5 percentage points worse half-on-half. That seems a little bit worse than we've seen from peers. What was it in the first half that's sort of surprised? Was it basically claims inflation was a bit higher than you thought and being stubborn? Or is frequency also another issue that we've seen as well?
Okay. On the past business reviews, I think the first thing I would say is, look, we're very disappointed it's happened. Those issues are quite mature now in terms of our understanding of the -- Neil will talk to the actual provisions. Consumer duty, we're taking extraordinarily seriously. We think we're very well placed. We've had a significant amount of the organization focused on ensuring that we deliver consumer duty well and we're very confident that we've done that. Neil?
So let me take the -- let me do the answer on attrition first. So including that GBP 30 million is a modest increase in the provision relating to the total loss remediation as well. So it's not particularly material but there was a modest increase in it. On the half-on-half walk, I think probably the 2 things I just pull out. First one is that, obviously, in the first half of this year, there is also the remediation cost in Motor which is -- will be part of the walk. And the second part is, if you look at the chart I produced on average earned premium, you'll see the average earned premium in the first half of this year hasn't actually moved that much. And you've still got inflation going through the book. So that explains why you haven't seen a particularly -- where you see that movement in the first half of this year versus second half of last year.
If I could just follow up on that, Neil. I guess the remediation is actually a benefit in the first half because you've taken GBP 40 million in the second half and this GBP 30 million in the first half, right?
But they're prior year movements. They're not current year movements. Because this is relating to old claims, they will be coming through the prior year reserving as opposed to the current year movement.
Our next question comes from Derald Goh from RBC.
Two questions, please. The first one is just on the deal itself. I'm just thinking out loud here. But was an asset swap with RSA's home and pet portfolio in consideration at all because it seems to me that it would be a good supplement to the lost Commercial volumes and presumably, you'll also release some capital because it'll be less capital-intensive in Commercial book? So was it a capital thing? Or is it a market share thing that's what's constraining in this factor? Or is there still a chance that this might happen?
Second one is just on the dividend. I guess how are you thinking about making any positions now before the new CEO comes in? What is dividend or not for that matter? Any sort of capital positions?
I'll take the first question. What I would say is, look, we recognize that there was an opportunity with Intact to help focus our group strategically on retail business, utilizing all the strategic strengths that we have in our strong brands and our expertise in marketing and the PCW channel. I think that was the -- that was clearly the right strategic move and, as you've seen, dealt with our first priority around solvency. An interesting thought which I'm not going to particularly explore, future decisions like that are equally -- I mean we'll always keep an eye out. But for now, I think we're just very satisfied that we've made the decision that we have and help refocus the group in the way that we have done. Neil?
And on the dividend, I think as a Board, we will discuss that at the year-end, so February, March time and to make a decision then. I don't want to pre-empt any thought process ahead of that point.
Yes. Yes, got it. And a quick clarification, if I may. Are there any residual costs from the disposals going forward, please?
Neil, do you want to cover this?
There will be -- so -- sorry, when we say [ph] it's a -- so yes, there will be an element of cost that was allocated to the NIG business. We think it's about a GBP 10 million cash cost which will be reallocated. But obviously, we'll work hard to ensure that we remove that residual cost in the business.
Our next question comes from Faizan Lakhani from HSBC.
My first question is on Motor. So you produced this -- written Motor loss ratio suggests that you're writing at your NIM margin. If I just look at Q2 2023 point, your written loss ratio is around 80%. When I load on expenses on top of that, it seems like you're operating above 100% combined ratio even on a written basis at the latest data point. Is there any sort of help in trying to understand what's going on there? The second is on your other lines of business outside of Motor. I mean you talked about a positive NIM margin of 12%. And when I look at the current year loss ratio, even when factoring in the fact that we've probably had higher yield, that's where we have discounting, all 3 lines of businesses -- see now [ph] -- sort of a 2-point deterioration there. But your commentary seems to suggest that you're pricing for claims inflation and all those lines. So can you just help try and sort of tie those 2 things together?
Do you want me to take this?
Let me try and take those. I didn't quite get the maths on your first one because I was trying to write it down as you were saying it. I think the key thing is that today, we're writing at the margins of 10%. So the walk needs to be from what we are today rather than the business earning through in the first half of the year. So that might be where the walk doesn't work. But we're obviously very happy to take it off-line and we'll walk through with you.
It was Slide 9 where you provide the written loss ratios. So that surely factors in current pricing rather than the earnings. And that at Q2 2023 is at 80%. So if you factor in a 20%-plus expense ratio, that's the 100% combined ratio.
Yes. So the 18% will reflect over Q2. There's been further improvement as we go into Q3. So there might be -- there's further upside there. That's my RAC but why don't we go through your RAC. I think it's probably best thing to do and see if we can just help you triangulate that. On the other business lines, yes, look, there's some movements here and there. I think in Home, it's worth saying that, obviously, the remediation cost that's gone into the Home P&L for the first half of this year would impact the loss ratio. So there's a couple of points in Home that explain -- is to explain fueled by those remediation costs. That's probably your walk there.
On Commercial, there's nothing particularly to call out. I think we've talked about -- I think Jon has actually referred to van business where they're seeing some similar trends but that's now fully being priced for, so improves. So they're probably the 2 biggest things versus anything in particular you want to call out. But net-net, we're satisfied -- very satisfied with the performance of the other businesses.
Our next question comes from Freya Kong from Bank of America.
I guess just a question about platform and the IT systems. You've had the total loss review. You've had PPR implementation errors and then you missed price of claims inflation in the last year and early this year and it's all happened when the new Motor platform has come online. Is there anything we should be worried about with respect to the platform? Or are these just unfortunate isolated incidents? And on the PPR implementation, over what time period was this? And when was the issue fixed?
Secondly, you mentioned it yourself on the call but given that you are now writing at 10% insurance -- net insurance margins and solvency capital generation is on a forward-looking basis rather than earned, wouldn't this mean that we should start to see positive capital generation in the second half and that would satisfy the Board requirements for switching to dividend back on?
Thanks. The issues that have led to the past business review, I can say are all fixed from a go-forward point of view. The -- they are quite different issues. So multi total loss was a process change not at all linked to IT. So I think what you did have in 2022 was a combination of many changing things. Clearly, inflation was one and it was a fairly fast-moving picture with inflation, I think, outstripping most people's expectations. So I think, yes, 2022 was a year in which there were -- there was a great deal of change from a number of different areas. It just happens that we also were implementing our new IT system.
Neil, can I pass over for the other question?
Yes. Thanks, Freya. On the dividend, your logic is correct. I think what we've clearly set out is the condition is for us to ensure that the business which is actually -- the performance of the business that we believe is we've written to 10% insurance margin is actually playing through as we go through the second half of this year and into early next year.
Okay. So just prudence.
Our next question is from Ashik Musaddi from Morgan Stanley.
Just a couple of questions. First of all, going back on the capital question, I mean so you have 190% now. There is some mechanical positives coming on the way and most likely, we'll be generating positive capital generation as well. So we won't be far away from 200%. Now I appreciate that just 1 day back, the capital situation was not that great. So it's very hard to take the call now as to what is the excess capital or not. But what needs to happen for you to have a bit of confidence that, okay, now we need to stick with 140% to 180% and anything above that is excess capital, so what would be the trigger? Is it you need -- you want to wait for a year or 2 to see what's going on there? Or it needs to be underwriting performance? Or any visibility on that would be helpful. So that's one.
And secondly, is it possible to get some color on what is the ultimate unwind of discount rate would be on the current book of business? I mean right now, I think you're running at a run rate of about GBP 100 million. So what would be, say, in 2, 3 -- in a couple of years' time, just trying to get an ultimate sense so that -- all I'm trying to get is just to get a big picture back of the envelop profitability number because I guess your accounting is now pretty simple. You have an insurance margin because all the ancillary income is now part of insurance revenue, so everything is part of insurance margin. And then you have investment income which we know is pretty straightforward. The missing link is basically knowing the ultimate unwind based on the current interest rate. So any color on that would be helpful.
So let me do the first one first. Obviously, in any unwind, there's a prediction here. So -- and it's kind of a 6-month time lag between interest rate moves and the unwind. So we would expect that unwind in the second half of the year to be modestly higher than the first half of the year. And then that unwind then should play out -- so the second half annualized should play out as the long-term unwind unless you see more moves in interest rates. But obviously, it's dependent on future moves in interest rates as well. So you take the first half, increase it a bit, times it by 2 before my guidance.
On the dividend, look, of course, as you rightly say, the number yesterday is very different to the number we're talking about today. We will take the time over the second half, ensure we're comfortable with the capital generation in Motor, look at everything else and then the Board will have a conversation at the time of the full year results.
Our next question is from Abid Hussain from Panmure Gordon.
Two questions from me. Firstly, on Motor price increases. Just to hit the 10% target and for us to actually see that in the P&L next year, how much do you need to increase Motor insurance prices from relative to where you're seeing at the moment? Do you still need to push through more price increases basically over the course of the next 6, 12 months or so? That's the first question. And then my second question is on the disposal. It feels like you've sold a -- well, a business that was growing double digit and generating decent earnings. And I wonder if you -- if the Board considered an alternative path of returning to the 180% capital coverage through perhaps underlying capital generation over time.
So I'll take the first question. And I'll pass it over to Neil for the second. So as we've said, our estimate is that we're writing to a 10% net insurance margin. We have our forecast for claims inflation which is high single digit. We would, in any year, be, on a monthly basis, applying incremental rate increases to match off that claims inflation. We have continued to see rate go through the market in July and August. So we're pretty confident that we both know how much rate we need to push through for claims inflation and the backdrop in the sense that the market continues to increase prices is supportive of that. Neil?
Yes. Look, I think Jon set out the rationale of the deal really clearly actually in the slides. And there's a very strong strategic rationale for doing this transaction and the focus it brings to the group and the kind of strategic adherence of the remaining group. So I think, first and foremost, we should see it as a strategic transaction. The fact that then also improves the capitalization quite materially means that almost the second question is a moot point because the transaction solves is what is being a very strong strategic rationale as well.
Can I just come back to that?
Yes.
So I'm sorry but you're suggesting that you would not have -- also the -- you wouldn't have done this deal had there not been a capital issue in the first place. So something doesn't -- it didn't sit right.
Let me -- so I've run that business for the last 10-plus years. And at the time of the IPO, it was a business that wasn't making money. It always has slightly outside of our kind of core competencies. A very different distribution model didn't leverage the powerful Direct Line and Churchill brands. So it has always been a quite separate business and not really benefited as much as the other businesses do from the strategic strengths of the organization. We have thought on a number of occasions about whether it was the right business to hold as part of the portfolio. So this isn't by -- this is by no means a decision that's been made just in this period. It's one that we've been revisiting from time to time. Having successfully completed that turnaround and given the very attractive valuation that we've achieved, we thought that this was the right moment and we think it's a great price for shareholders.
Our next question comes from Nick Johnson from Numis.
Three fairly quick questions, I think. Firstly, what impact will Motability have on the coverage ratio, all else equal, when the full GBP 700 million of premium has landed? Is that already in the 190%? So that's one. Secondly, the net margin of 10% in Motor currently. Just wondering what that equates to in old IFRS 4 combined ratio terms. Basically, I'm trying to get a sense of where you are versus history on that. Apologies if I've missed some sort of reconciliation somewhere. And then lastly, on consumer duty, you say you're well placed. Just want to clarify whether that means you are well placed to make some necessary changes or that you don't think significant changes will be needed.
Okay. On consumer duty, we clearly did conduct a review of the organization and look to areas where we might want to make changes in response to consumer duty. Particularly around things like the way in which we communicate products and features to customers, we have made some changes there. I think we're satisfied that the changes that we have made are well positioned relative to the expectations of consumer duty. We'll continue to review that. But yes, I'm happy that we're in a good place, re consumer duty.
Neil, can I pass to you for the Motability question?
Yes. So -- Nick, so Motability, because the capital requirement looks 12 months forward, already at the June date, 9 months of the Motability business is already in there because we have to look 12 months forward. And that's on an underwriting risk perspective. Obviously, over time, you get the reserves as well, so it will creep up a little bit. But the majority or the risk is already reflected within the June balance sheet. On the RAC back to IFRS 4 combined ratio, I'm really trying not to do that because we don't run the company on that basis any longer. But the -- it's kind of -- there's discounted benefit, the impact of other income, the impact of installment income, it kind of sums to a 7 points together, that kind of stuff. So that could give you an idea of where it might be but obviously, as we said, we are driving it as a margin rather than just an old combined ratio basis. So we don't actually look at it on that basis.
Our next question comes from Anthony Yang from Goldman Sachs.
I think just coming back to Slide 8 which is -- which talk about the claims inflation, could you give any color on the -- what's your observation on the bodily injury claim side, maybe both large BI and the smaller BI? That will be helpful. And the second point is just on the policy count outlook. So obviously, I think you have pushed the prices higher and strongly in the first half. And if they -- excluding the impact from Motability, would you consider to -- would you put policy count behind the pricing as a priority in the second half?
So I'll take the second question and pass it back to you. For the full year, we said we were prioritizing the Motor margins and would -- openly said we were doing that over volume. I think the backdrop has been very helpful. We have seen some reduction in volumes but we think the balance that we've struck between getting ourselves to a better place on Motor margins and the volume trade-off that's been required to do that has been the right balance. We continue to review that. Clearly, we are in a much better place than we were at the beginning of the year having reached the point where written business is at a 10% net insurance margin. So we would keep it under review. But I suppose I'd summarize by saying we're in a much stronger place than we were when we were absolutely having to prioritize margins over volume. I wouldn't probably go beyond that because it's difficult to predict how the second half will pan out. Neil?
Yes. So just on injury claims, actually, a couple of things worth calling out on small body injury. Obviously, there's been quite a change in the mix of that. It was a bit whiplash claims coming out of that book. The one thing we're watching very carefully is general damages and how the courts and the adjustments coming up soon will affect general damages. So that's a specific item that we reserve against that risk. It's probably one thing I call out on small body injury.
On large body injury, there's volatility in that because it's a high severity, low frequency. We have seen a few large claims coming through this year but I think that's inherent volatility as opposed to any trend. Obviously, we will be looking carefully at the ASHE index when it comes out in Q4 to see where that comes out because that impacts the PPOs but we are -- I have got a relatively high inflation assumption for ASHE within our reserving.
We have no further questions registered at this time. So with that, I'll hand back to our host, Jon Greenwood, for final remarks.
Just a thank you from me for taking the time. I know it's a very busy day. So, thank you for taking the time to join us today.