Direct Line Insurance Group PLC (LON:DLG) has been downgraded by Deutsche Bank after recent data suggested motor insurers' compensation pay-outs are climbing much faster than premiums.
UK motor insurance premiums have dropped sharply over the past year amid intense competition, but recent data has shown they are starting to pick up again, albeit quite slowly.
READ: Direct Line suffers overall decline in third-quarter premiums
According to data compiled by Deutsche, motor insurance prices rose 0.1% month-on-month in October, having edged 0.7% higher in September.
“This stabilisation in monthly pricing is consistent with our view that motor insurance prices are at an inflection point and are likely to increase gently from here,” read a note to clients.
In theory, that bodes well for the industry, but claims inflation – the amount of money insurers are having to pay out in compensation – is going up much faster.
“At the 1H18 results, motor insurance companies commented that claims inflation was returning to a more 'normalised' level of 3-5%, and subsequently at the 3Q18 stage, indicated to be at the top end of this range,” said DB analysts in a note to clients.
“This, therefore, represents a bigger gap between price increases and claims inflation, indicating a bigger compression in margins than we initially expected.”
Downgrade to ‘hold’, forecasts slashed
They added: “Reflecting this dynamic, with this note we remove Direct Line from our ‘buy’ list (to ‘hold’) – reversing the upgrade from October – and reduce our target price to 370p (from 390p).”
Deutsche also chopped its forecasts for Direct Line by 6% for this year, 5% for next year and 4% for 2020.
“We acknowledge though that Direct Line's dividend yield even on our new numbers remains very attractive (c.8.8% p.a. on average for the next three years); however, we now believe this is outweighed by the risk of consensus earnings downgrades.”
Direct Line shares were down more than 2% in early deals, although they recovered as the morning wore on, and were broadly flat in mid-morning trade at 324.4p.