Trading Update for the first quarter of 2016

Direct Line Insurance Group plc

Trading Update for the first quarter of 2016

4 May 2016

Direct Line Group's Trading Update relates to the first quarter ended 31 March 2016, and contains information to the date of publication.

Highlights

Paul Geddes, CEO of Direct Line Group, commented:

"This was another quarter of top line growth for Direct Line Group, as customers responded favourably to the many improvements we have made to the business over the last few years. For the rest of 2016, we will aim to build on these foundations, while keeping a firm control of our costs, and we reiterate our combined operating ratio target of 93% to 95% for ongoing operations."

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Notes:

1.     Ongoing operations include Direct Line Group's ongoing divisions: Motor, Home, Rescue and other personal lines and Commercial. It excludes discontinued operations, the Run-off segment and restructuring and other one-off costs.

2.     Combined operating ratio is the sum of the loss, commission and expense ratios. The ratio measures the amount of claims costs, commission and expenses compared to net earned premium generated.

Business update

During the first quarter of 2016, Direct Line Group (the "Group") delivered further policy growth in its Motor and Home own brands and made good progress towards its strategic objectives, including continued investment to build future capability.

The Group has continued investment in brand differentiation through a succession of Direct Line proposition initiatives. Direct Line Home recently launched a new proposition to provide customers with an emergency plumber within three hours¹. With customers shopping more following insurance premium tax rises, the Group's improved capability, together with better price competitiveness, has attracted customers and driven the growth in own brands in-force policies.

Partnerships remain strategically important and the Group will look to build on its improving manufacturing capability in order to develop propositions for current partners. Recently, the Group has worked successfully with Peugeot and Citroën on a new car proposition for young drivers incorporating telematics technology. This proposition has now been extended across a greater number of car models within their ranges.

With its focus on providing insurance to small and medium-sized enterprises, Commercial has continued to enhance its offering with the launch of a further full-cycle product for NIG's customers distributed through the eTrade broker channel.

The Group also continued to focus on new car technology, centred on improving safety, and is now offering discounts for customers with vehicles that have autonomous emergency braking.

Financial update

In-force policies - ongoing operations (thousands)

Gross written premium - ongoing operations

Notes:

1.     Home Plus product for uncontrollable water leaks

2.     Rescue in-force policies have been revised to exclude partner post-accident vehicle recoveries.

Total in-force policies for ongoing operations reduced by 1.8% compared with the end of the first quarter of 2015. The fall primarily related to Rescue and Travel, within the Rescue and other personal lines division, and was mainly due to a decline in partner volumes. Growth in in-force policies continued to be experienced in Motor, Home's own brands, Green Flag direct and Commercial direct. Gross written premium of £777.8 million increased by 4.2% compared with the first quarter of 2015 (£746.5 million) primarily due to continued growth in Motor, which was partially offset by a reduction in Home partnerships.

Motor total - effect on premium income of changes in price and risk mix¹

Total Motor in-force policies increased by 1.7% compared with the end of the first quarter of 2015. The market continued to experience high levels of shopping around. Motor's own brands grew by 2.0% over the same period with customer retention remaining strong. Investment in brand differentiation through a succession of Direct Line proposition initiatives and competitive pricing contributed to the improved performance. Motor gross written premium increased by 10.5% in comparison to the first quarter of 2015 as premium inflation returned to the market, which in part reflects ongoing claims inflation. Motor's risk-adjusted prices increased by 9.4% compared with the first quarter of 2015.

The Group continued to experience positive development in large bodily injury claims from the 2014 and 2015 accident years, both of which the Group believes are prudently reserved. In damage and small bodily injury claims, the current-year trends are similar to those previously reported and overall claims inflation remained around the top end of the long-term range of 3% to 5%.

Home own brands - effect on premium income of changes in price and risk mix

In-force policies for Home's own brands increased by 1.9% compared with the end of the first quarter of 2015, while partnership volumes reduced by 5.9%. Gross written premium was 3.4% lower than for the first quarter of 2015 primarily due to partners which were 5.0% lower, while own brands experienced a smaller reduction of 1.7%. Home's own brands risk-adjusted prices decreased by 2.3% compared with the first quarter of 2015, in part supported by improved claims trends. Home's own brands maintained their competitiveness in a deflationary market supported by the investments which the Group has made; this also helped continued strong retention.

When compared with the long-term average, the weather in the first quarter was benign with approximately £5 million of claims from major weather events (first quarter 2015: £nil). Flood Re launched successfully on 1 April 2016; the Group has supported its formation and ceded chosen risks to Flood Re from its inception.

Rescue and other personal lines experienced a reduction in in-force policies of 3.7% compared with the first quarter of 2015 mainly related to partner volumes in Rescue. Gross written premium for Rescue and other personal lines experienced growth of 1.9% compared with the first quarter of 2015. Rescue gross written premium increased by 4.0% compared with the first quarter of 2015, mainly due to Green Flag direct sales.

Commercial in-force policies were 5.8% higher than the first quarter of 2015 reflecting increased sales through Direct Line for Business, while volumes sold through broker channels were stable. The increase in gross written premium of 2.1% in comparison to the first quarter of 2015 reflected growth in Commercial direct. In particular, the Group's Landlord product benefited from an increase in buy-to-let properties ahead of changes in stamp duty.

Total costs²

Notes:

1.     Risk mix reflects the expected level of claims from the portfolio. It measures the estimated movement, excluding insurance premium tax, based on risk models used in that period and is revised when risk models are updated.

2.     Operating expenses and claims handling expenses from ongoing operations. It excludes discontinued operations, the Run-off segment and restructuring and other one-off costs.

The total costs for ongoing operations of £219.4 million were slightly lower than for the first quarter of 2015 (£220.7 million).
A reduction in claims handling expenses was partly offset by an increase in operating expenses, including IT costs.

The Group aims to reduce total costs in absolute terms in 2016 compared to 2015 although the rate of reduction is expected to be lower in 2016 than in 2015, due in part to the cost of Flood Re. The Group's contribution to the annual levy, based on its market share, is expected to be in the region of £25 million and will be charged to operating expenses in the second quarter of 2016. Total costs therefore in the first half of 2016 will be higher than in the same period last year.

Investment return - ongoing operations

Against a background of volatile debt markets in the first quarter of 2016, the Group generated investment income of £41.1 million and achieved an annualised income yield for continuing operations¹ of 2.4% (first quarter 2015: 2.4%) in line with the Group's expectations of 2.5% for 2016.

During the first quarter of 2016, the Group recognised net realised and unrealised losses of £7.7 million (first quarter 2015: gains £10.5 million). These losses primarily reflected the Group's decision to sell certain high-yield securities, where credit quality was of concern, which resulted in realised losses of £4.6 million. At the year end, the available-for-sale reserve was £5.4 million and this reserve has increased to £40.8 million at 31 March 2016.

Investment holdings - total Group

At 31 March 2016, total investment holdings of £6,934.1 million were 1.7% higher than at the beginning of the year. Total debt securities were £5,172.0 million (31 December 2015: £5,194.4 million), of which 12.1% were rated as 'AAA' and a further 59.1% were rated as 'AA' or 'A'.

Outlook

For 2016, the Group reiterates its expectation to achieve a combined operating ratio in the range of 93% to 95% for ongoing operations, assuming a normal annual level of claims from major weather events.

Notes:

1.     Continuing operations include ongoing operations and the Run-off segment.

2.     Investment holdings include investment portfolio derivatives which have been netted within debt securities. This excludes non-investment derivatives used to hedge subordinated debt and operational cash flows.

Corporate information

Direct Line Insurance Group plc is a public limited company registered in England & Wales, number 02280426. The address of the registered office is Churchill Court, Westmoreland Road, Bromley BR1 1DP.

The Annual Report & Accounts 2015 is available at: www.directlinegroup.com

Forward-looking statements disclaimer

Certain information contained in this document, including any information as to the Group's strategy, plans or future financial or operating performance, constitutes "forward-looking statements". These forward-looking statements may be identified by the use of forward-looking terminology, including the terms "aims", "anticipates", "aspire", "believes", "continue", "could", "estimates", "expects", "guidance", "intends", "may", "mission", "outlook", "plans", "predicts", "projects", "seeks", "should", "strategy", "targets" or "will" or, in each case, their negative or other variations or comparable terminology, or by discussions of strategy, plans, objectives, goals, future events or intentions. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this document and include statements regarding the intentions, beliefs or current expectations of the Directors concerning, among other things: the Group's results of operations, financial condition, prospects, growth, strategies and the industry in which the Group operates. Examples of forward-looking statements include financial targets, which are contained in this document specifically with respect to return on tangible equity, the Group's combined operating ratio, cost reduction and investment income yield. By their nature, all forward-looking statements involve risk and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future or are beyond the Group's control.

Forward-looking statements are not guarantees of future performance. The Group's actual results of operations, financial condition and the development of the business sector in which the Group operates may differ materially from those suggested by the forward-looking statements contained in this document, for example directly or indirectly as a result of, but not limited to, UK domestic and global economic business conditions, market-related risks such as fluctuations in interest rates and exchange rates, the policies and actions of regulatory authorities (including changes related to capital and solvency requirements or the Ogden discount rate), the impact of competition, currency changes, inflation and deflation, the timing impact and other uncertainties of future acquisitions, disposals, joint ventures or combinations within relevant industries, as well as the impact of tax and other legislation and other regulation in the jurisdictions in which the Group and its affiliates operate. In addition, even if the Group's actual results of operations, financial condition and the development of the business sector in which the Group operates are consistent with the forward-looking statements contained in this document, those results or developments may not be indicative of results or developments in subsequent periods.

The forward-looking statements contained in this document reflect knowledge and information available as of the date of preparation of this document. The Group and the Directors expressly disclaim any obligations or undertaking to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, unless required to do so by applicable law or regulation. Nothing in this document should be construed as a profit forecast.

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