Moody’s has suggested that Direct Line’s recently announced quota share reinsurance agreement will improve the firm’s Solvency II capitalisation and is likely to better its returns over the medium term.
Direct Line executed the strategic reinsurance arrangement via its principal underwriter, UK Insurance Limited on the 26th of January. Direct Line said that the arrangement comprises a 3-year structured 10% quota share treaty.
Moody’s noted that this could reduce absolute earnings, however, it added that based on other quota share agreements in the UK personal lines market, profit-sharing terms tend to be favourable for insurers, with an asymmetric skew towards participation in profits against sharing of losses.
Moody’s also said that the transaction will improve capital efficiency by reducing capital requirements under the Solvency II regime, despite the uptick in counterparty risks.
The quota share announcement follows Direct Line confirming earlier this month that it would cancel its final dividend for 2022, as total weather claims for the year were estimated at nearly twice its original expectations.
The company currently expects to pay claims worth around £90 million due to freezing temperatures in December that resulted in burst pipes and other related damage.
On this, Moody’s said, “We consider the transaction to be part of a longer-term strategic initiative to improve capital efficiency rather than a direct response to Direct Line Groups’ experience in 2022.”
Moody’s observed that the transaction will increase Direct Lines’s year-end 2022 Solvency II ratio by around 6 percentage points.
The rating agency added, “excluding the arrangement, Direct Line stated that its solvency is likely to be towards the lower end of its 140%-180% target range and was one of the drivers of our negative outlook on the group. This transaction will bring the group closer to the middle of its target operating range for solvency.
“We still see execution risk in the group organically rebuilding its Solvency II coverage toward 160% because this is partly contingent on restoring underwriting performance.”
On the 27th of January, Direct Line announced that Penny James has agreed with the Board to step down as Chief Executive Officer and Director.
The firm stated that the Board is initiating a process to appoint a successor, noting that until that process is complete, Jon Greenwood, currently Chief Commercial Officer, will serve as Acting Chief Executive Officer.
Moody’s said that it will continue to monitor Direct Lines’s progress against its business plan, though it does not anticipate any immediate change in strategy following this announcement.
The rating agency concluded, “Notwithstanding the recent weakening of the group’s earnings and solvency position, DLG’s A1 insurance financial strength rating reflects the group’s powerful brands and top tier position in the UK retail property and casualty (P&C) market, together with a growing share of the UK small and midsized enterprise commercial P&C sector; a relatively conservative investment portfolio, which has been further de-risked during 2022; and low financial leverage with good average earnings coverage of interest.
“These strengths, however, are tempered by the group’s dependence on the very competitive and highly regulated UK personal motor insurance market.”
Others are not as convinced, with analysts at Berenberg suggesting, “this deal is relatively minor and does not fix the group’s underlying issues or sufficiently address its thin capital buffer.”
