Jefferies downgrades Direct Line to ‘hold’

"In our view, the industry-wide turn to deflation means that the time to raise prices ahead of inflation without materially contracting the policy count has now passed," it said.

"As we expect Direct Line's new management to remain prudent and hit target margins (as widely expected), we see the upside opportunity as limited, while continued policy count contraction is a risk."

Jefferies noted that over the past year, its view has been that when rising prices are overtaking claims inflation, a rising tide would lift all boats - i.e. that market-wide profitability would recover.

While this remains the bank’s base case, it said that management's comment that Direct Line "experienced a higher level of large bodily injury claims" in the third quarter is a concern, even though guidance has been reiterated.

"On this, we confess to some scepticism on the targeted earn-through in 2024, because to reach the circa 72% loss ratio implied by guidance requires 66% loss ratio in 2H 2024, which is -12%pts improvement on 1H 2024 and -18%pts on 2H 2023," it said.

"As consensus already has a circa 72% loss ratio, upside appears limited, while risks are rising."

Jefferies said that looking ahead to 2025, prices across the industry are falling, even though claims inflation is only decelerating.

"We suspect that the shift in pricing reflects the pivot to growth seen at Admiral and Hastings, which was a rational decision on their behalf, as both reached their target profitability in 1H 2024.

"This presents a problem to Direct Line, because the days of being able to raise prices faster than inflation without losing too many in-force policies is now at an end. In our view, the new management are prudent, meaning that they will continue to price at a level that allows them to maintain the target profitability (13% net insurance margin), compelling Direct Line to shed policies."

On the positive side, Jefferies said that getting incrementally closer to the 13% target and maintaining guidance when prices are falling will help, but execution risk is high.