Direct Line Insurance Group PLC

LSE:DLG

Earnings Call Transcript 2022-Q2

[Penny James, CEO]

Good morning, everyone, and welcome to our 2022 Half Year Results Presentation. It's lovely to see so many of you in-person at this, frankly, extraordinary venue. Thank you Goldman's, and a warm welcome to all of you joining us online as well. I'm joined here today, as usual, by Neil Manser, our CFO and there are various members of our executive team in the audience as well. Feel free to grill them afterwards.

Before I hand over to Neil, I just want to reflect on the trading update that we issued last month, where we spoke to many of you about the complex dynamics that are operating in the market at the moment, affecting the Motor business and wider industry. And so it's ultimately about looking ahead and anticipating claims costs based on what you can see today and what you know of the past. In all honesty, this is a complex when there was a period of heightened inflation, war in Europe, supply chain dislocations, uncertain customer behavior as we exit the pandemic and pricing reform, all set across against the backdrop of low average premiums, in fact, historically low average premiums.

So it's a difficult trading environments and short term profitability has been impacted. But moments like this require a deliberate response. So we've taken actions to protect margins, we're benefiting from our diversified business model and we continue with the strategic priorities, which fuel the long term earnings power of this business. So in today's presentation, Neil is going to talk you through the financials and I'll build on this by explaining how we see the markets and what our strategic priorities are in response to that.

So turning to the key messages. The market has experienced a unique combination of factors. We've taken actions to get back on track. We are now writing at our target margins. We're pushing further on costs and restoring balance sheet resilience. And these actions are expected to return our combined operating ratio to around 95% in 2023 and between 93% and 95% in 2024. Our diversified business model remains important. Outside of Motor, other business units are performing in line with expectations, and we continue to focus on putting capital behind the opportunities with the best returns.

Market dynamics in the first half have simply reinforced the importance of our strategy. We've made good progress with our latest Motor pricing model and a digitizing customer journeys. And lastly, the long-term earnings power of the group remains strong. And the capability the business has built makes us resilience to get through the period ahead and well positioned, if and when the market turns. We declared an interim dividend of GBP7.6 per share and have confidence in the sustainability of our regular dividends for this year and beyond.

I now hand over to Neil, who will take you through the financials.

[Neil Manser, CFO]

Thanks, Penny and good morning, everyone. Penny has captured key themes in her intro. So let me go straight in with the key numbers, many of which you will recognize from the trading update on the 18th of July. We delivered operating profit of a GBP196 million and a combined operating ratio of 96.5%. Our Direct own brand in-force policies fell by 1.5% with our focus on preserving margins in Home, partially offset by strong Commercial direct growth. Costs continue to reduce year-on-year. And finally, as Penny said, we've announced an interim dividend of GBP7.6p, in line with 2021, which results in solvency ratio of 152%.

We will go to Slide 6. Here we got the headline P&L ratios. But let me start by reminding you the first half of 2021 that was, of course, a very strong result, elevated in large part by the claims frequency tailwinds in Motor during the second COVID lockdown. I'll go through the detail by business area on the following slides. But ostensibly, we delivered good results in Commercial, Home and Rescue, which helped to offset the lower Motor results.

Prior-year reserve leases were in line with expectations following conservative reserving for inflation at year-end and investment return improved. So, overall, the first half operating profit of GBP196 million, a core of 96.5% and our return on tangible equity was 17.8% still well ahead of our 15% long term target. And this demonstrates the benefits of our diversified business model.

Moving to trading on Slide 7. I'll start with in-force policies where Direct own brands reduced by 1.5% over the first half. I pulled out the Direct own brands caught in movements on slide. And as you can see, the biggest driver is Home where we focused on preserving value as the market settled down post PPR. Outside of Home, reductions in Motor and Green Flag were partially offset by Commercial.

Now, Penny will talk some market dynamics in a bit more detail later on. But at a macro level we saw lower shopping levels in Motor and Home, partially offset by higher retention. Written premiums, shown here on the waterfall, Direct own brands were 4.3% lower with the biggest fall in Motor, whereas growth in Commercial offset lower Home premium. Total group premiums were down less at 2.1% benefiting from another strong performance from NIG.

Turning to Slide 8. Before I move on to the results in more detail, let me spend some time on the Motor claims inflation trends during the first half. Now there are three key themes, I'd like to draw out. First theme, we've seen claims inflation ahead of what we assumed in our pricing, and there are few reasons for this. One, the increase in used car prices, which feeds into total loss and theft claims and influences around 30% of our Motor claims cost. You can see on the left-hand side of the slide, the impact from total loss costs over the last three years.

Two, this was exacerbated by supply chain disruption, which became increasingly acute across the half, driving the elongation of repair cycle times on average over 50% and increased the number of vehicles written off. Now, this not only increases costs through higher car hire charges, but it also delays the visibility of these inflationary trends. And three, these factors led to higher third-party claims where we can't control the claim. And the impact of this is again being more visible during the second quarter.

So one of the questions we've been asked over the last couple of weeks is, could you have seen this sooner? The answer is, that the combination of progressive ways of inflation together with settlement delays, particularly on third-party claims, has reduced visibility. We knew inflation was there, and we've been pricing for it, but the real extent has only come through in the second quarter.

The second theme is that despite the inflation, our garages continue to deliver competitive advantage. You can see on the slide that our own garage network, DLG Auto Services has outperformed. We've seen a smaller increase in repair times from a base that was already lower. And this delivers not just better customer outcomes, but lower costs.

And thirdly, underpinning our revised outturn, we have made prudent assumptions on how these trends progress throughout the rest of 2022. We expect used car prices to remain elevated throughout the second half at a similar level to Q1. Claims frequency remained broadly flat despite the potential impact of the cost of living crisis and supply chain disruptions to last well into 2023.

Now, we are seeing positive developments in small bodily injury claims, which offset some of the inflation discussed above, and overall, we expect claims inflation in 2022 of around 10%. We've covered a lot in the slide, though what I would like you to take away is the following. Inflation is market-wide, evidence has been slow to come through given settlement delays, but we still think that we are outperforming where we can control the claim.

So moving to Slide 9 and the Motor results. The claims trends I've just gone through resulted in an elevated current year loss ratio of 86.4%. The year-on-year view does look quite stark, but remember the first half of 2021 there's around 12 points benefit from COVID. During July, we've returned to writing our target margins based on our latest view of claims, following pricing action taken and through deployment of new pricing models, which again Penny will talk to a bit later.

Gross written premium was down 6.5% in the first half due to the lower risk mix and the impact of structurally lower claims frequency. Overall, we delivered profit of GBP62 million, combined ratio of 105%, and we have taken the actions required to restore margins.

Moving to Home on Slide 10. I spoke earlier about how we're approaching the first half was to preserve value as we navigated the new regulatory environment. And this has resulted in a reduction in new business, which you can see coming through in lower policy counts, and this is broadly in line with the reduction in policies in the market. We've been progressively pricing the higher claims inflation, which we estimate at around 8% in 2022.

Our current year loss ratio of 57%, combined with strong prior year, delivered a first half combined operating ratio, normalized for weather, of 87.5%. Now, we expect prior-year reserve releases to reduce in the second half and continue to expect full year combined ratio in the low 90s, good result whilst navigating a significant market reset.

In Commercial, on Slide 11, the team has managed to maintain the momentum from last year. We saw both policy count and premiums grow across energy and Direct own brands at the same time as expanding margins. And despite claims inflation around 7%, we achieved strong rate carry of around 9%. This demonstrates the benefits of our previous transformation as well as supported market conditions. Lower than normal large loss claims in the first half, we do expect the current year loss ratio to tick up a bit in the second half, but a fantastic result nonetheless. So another strong result for Commercial, 12% premium growth, improvement in the combined ratio at a higher profit.

Let's move on to Rescue and other personal lines on Slide 12. Now the majority of profit here comes from Rescue, which you can see on the right-hand side of the slide. Operating profit was GBP28 million, broadly level on 2021. This is another good result against a strong comparator. The continued low frequency offset by fuel costs and mix effects. Gross written premium remain broadly level year-on-year. We aim to return to growth towards the end of the year once our new system has fully embedded in. Penny is going to talk a bit more about how excited we are about the future of Green Flag.

Let's move to expenses on Slide 13. Again, we continue to make good progress on the controllable cost base in the first half and aim to reduce operating expenses going forward despite inflationary pressures. Operating expenses are GBP5 million lower in the first half as our cost transformation savings more than offset non-cash depreciation and amortization charges and levies were slightly down due to reduction in the Flood Re levy. Staff costs were 6% lower, demonstrating the progress we've made in our digital transformation and automation. And again, Penny will talk through how we're driving uptake through these digital channels in a minute.

We're on track to reduce our cost base in 2022, in line with our target and expected cost base between GBP690 million and GBP700 million. But we won't stop there. Having set ourselves a target of GBP670 million in 2023. We believe the actions we've taken to date have made us more competitive versus the industry, which is vital to the industry adjust to the pricing practices performance.

So let's turn to the balance sheet, starting with investments on Slide 14. Investment return increased to 2.6% in the first half with higher net investment income alongside positive revaluations on our investment property portfolio. In terms of yield, we've reiterated net investment income yield of around 1.7% for 2020, for this year with some potential upside if hedging costs come in lower than expected. Reinvestment rates increased during the first half and we've increased our yield expectations for next year to 2.2%.Credit quality in the portfolio remained strong. But as we progress through the first half, interest rates have clearly risen and credit spreads widened. And this has reduced the availability for sale reserve by GBP179 million.

Now, given the market volatility, we took the decision not to reinvest some maturities and as we said in our trading update, we are taking further action to improve our capital resilience, and that includes reducing our exposure to longer-duration U.S. dollar credit. We've begun this an expecting losses on disposal of between GBP20 million and GBP25 million during the rest of this year. But this is, of course, already reflected within our solvency position and importantly, will not affect our yield expectation for 2022.

So moving to capital on Slide 15, and this sets out the capital walk to 30th of June. Now, there are a number of larger than unusual movements in the first half, so let me talk you through those. First, we saw capital generation, excluding market movements of 12 points and this more than covered the first half dividend we've announced at GBP7.6 per share. Market movements were higher than usual and of the 10-point reduction, 7 points relates to credit spreads. Subject to the actions we are taking, we expect this pool to par over time.

Now the impact of higher interest rates appears in a few different places, but overall, the net effect is broadly neutral as a reduction in asset values are positive in the increase in the reserve discounted credit and a further positive in the reduction in the SCR offset each other. Overall, the SCR was flat with the benefits of the higher interest rates that I just talked about offset by the impact of the revised 2022 and 2023 underwriting account book. You can also see the unwind second half of GBP100 million buyback on the slide.

And lastly, the ineligible capital relates to the increase in Tier 3 deferred tax from the negative investment mark-to-market and again, this should unwind over time. And all of this leaves us with solvency ratio of 152% at June 30, well within our risk appetite range. As I mentioned earlier, the actions we've taken during the year restored our written margins during July, and this will underpin our dividends as we look ahead into 2023. Now it's important to acknowledge that the revised core expectation for this year might mean that we pay an uncovered regular dividend for 2022. And the Board is comfortable with this given the positive outlook into '23 and beyond.

For 2022, we have a number of actions in train to increase our capital resilience. I mentioned earlier that we are reducing our longer duration U.S. dollar credit portfolio and with a number of other actions being considered including the use of strategic reinsurance that I talked about at year-end. With a strong track record of returning to shareholders, we feel confident in maintaining that record as we look ahead.

So let's conclude on the combined operating ratio outlook on Slide 16. Our medium-term target of a range of 93% to 95% holds, but due to a 6 point higher current year loss ratio in Motor this year, we now expect the group combined ratio to be 3 points higher between 96% and 98%.We've taken the required actions to restore margins, and we expect this to lead to an improvement to around 95% in 2023 around the top of the medium-term target range as we are still earning through premium written in the first half of 2022. We continue to tackle costs, and we are seeing rising investment yields. We're confident that we have the actions in place to restore the earnings power of the business.

And with that, I'll pass back to Penny.

[Penny James, CEO]

Thanks, Neil. What I want to do now is give you my view of the markets, the actions we're taking and what this means for our future strategy for what has happened in the market. Well, FCA pricing reform at the start of the year has been significant. It's caused the new business market to reduce by around 15% to 20% and retention levels to increase by 5 to 8 points. Reducing switching was an aim of the regulators, but the degree of that change is so far greater than we anticipated, although it may yet moderate if and when premium inflation starts moving through the markets.

Heightened inflation, especially in used car prices has persisted, only beginning to fall a little at the end of the period. Meanwhile, supply chain dislocation deteriorated, impacting vehicle repair settlement times, where it became clear through Q2 others were suffering more. And there's been a lack of certainty around customer behavior. Having come out of a pandemic where clams frequency has been unpredictable at best, the U.K. is now facing a cost of living crisis, which may yet impact driving patterns. As it stands, frequency is some 10% to 15% below pre-pandemic levels. And this was reflected by the market in premium reductions through 2021.

Further, in practical terms, pricing reform has been a major undertaking for the industry. It's meant changing every model, every price and many data sources. It's disruptive trend analysis and limited visibility through transition. So how has the market reacted to all of this? Well, initially by making an appropriate adjustment for the pricing reform at the start of the year.

Also, we see new brands and sub brands and different product sets were firm to able to maneuver due to smaller back books just as we ourselves have used different trading strategies between our Direct Line and Darwin brands, for instance. But it's now clear the market was not pricing claims inflation. Perhaps given the complexity, it's not a surprise the market is taking time to find an equilibrium. But on the upside, we did see some limited upward price movement in the second quarter and have started to see bigger steps taken by some key players in the last two weeks.

So if that's the market, what have we done? Well, we are focused on protecting value, mitigating claims inflation and restoring margins. At the start of the year, our priority was to protect our back books because they represent both value today and potential long-term relationships with customers into the future. On PCWs, where things are most competitive, we're both optimizing across brands and building further product options. As a result, we've seen retention rise around 6 points in Motor with Darwin primarily driving the new business growth.

In Home, Direct Lines performed better than expected. And although, new business reduced, retention is stronger than anticipated and much higher than in 2021, which is ultimately the key to sustaining profitability. As Neil has laid out, we have increased prices for claims inflation and mitigated it where possible. Having reset pricing for January's price reforms, we've put through additional inflationary increases from March onwards. This was ahead of much of the market.

As the layers of inflation became clear through Q2, we have redacted by step-changing the inflation assumptions within our pricing, restoring our margins. And throughout, we've been used our new pricing capability. The main model drops went live in March and June, and I'll talk to those in a moment. We're seeing cost benefits arising from the investments we've made, but as margins are squeezed, we have pushed harder.

In summary, while contending with many complex market variables, we've continually assessed claims inflation and where it was likely to land. We've acted quickly to restore margins as soon as visibility became clear. We've done this ahead of the market, and we've delivered using our new strategic pricing capability.

Turning to Slide 20. You can see how we're improving competitiveness with this new Motor pricing capability. Even though it's early days, we've seen it deliver a material improvement in the margins that we're now writing based on the current claims estimates. The results of our most recent Motor model deployment has significantly improved our loss ratios. We've seen written loss ratios improved by between 5 percentage points and 7 percentage points. This is in line with our expectations and represents a significant step forward.

In the current environment, we've invested this into margin, but this should come through an improved competitiveness and is an important part of our future growth potential as and when the market cycle turns. The next stage of our transformation is about pace, the cadence of model updates and optimization. But equally as important is enabling customers to access digital journeys. People want the flexibility to deal with their insurer however they want, wherever they are making a purchase, tracking a claim or waiting for a settlement. Having built the infrastructure, we are now delivering greater adoption.

On the left of this slide, you can see that Churchill is ranked as the leading insurance brand for digital service and claims capability. A quarter of our claims are now notified digitally and in Motor this is up another 10% from this point last year. Motor online amendments have doubled through the first half, and for the first time in Q2 we have had more customers self-serve through their online accounts and calling us. With less switching in the market expected, competing on end-to-end digital journeys is crucial for our Net Promoter Scores, our customer retention, but also as Neil said earlier, a lower cost to serve.

Now this slide shows how our Motor pricing and digital capability fits within our overall strategy. When adding it to our customer-focused brands, claims expertise and a track record of innovation, you can see it's a powerful package for the future, and no less so for the market changes. And we know it works because of the success that we have seen elsewhere in the business, which I'll touch on now.

Turning to Slide 23, you can see how our strategy has led to results in Commercial where the right tech investments drive top line and margin growth. Our Direct Line and Churchill Direct brands have seen GWP growth of nearly 30% over four years. In the first half, we've seen growth across all products, SMEs, Landlord, small trades, farm, and we're encouraged that Churchill's business is performing very strongly on PCWs.

And it's a similar story at NIG, with 25% GWP growth since 2018. It really is making its mark and continued success has been happening with increased margins. The point here is that Commercial is furthest along its tech transformation, and it shows how targeted investments and great people can now strengthen other areas of the business, which have similar capability.

Another great example is on Slide 24, where our Green Flag brand continues to disrupt the Rescue market. We're delighted, it recently ranked as one of the top 15 brands for customer service in the U.K. That's across any sector. In the last four years, it's grown strongly at improved margins. Rescue operating profit has grown by around 40%. Both Commercial and Rescue demonstrate how our strategy and smart capital decisions leads to great innovation and brilliant customer outcomes.

We're also prioritizing high-growth, high-return opportunities as part of our ongoing work to deploy our capital as efficiently as possible. And we've started to lay some of the groundwork already. We won the Motability partnership, a capital-light structure, which has us reinsuring 80% back to Motability. We're making good progress and look forward to starting in late '23, and we expect to welcome 600,000 new customers. We've renewed our Home NatWest partnership serving 0.5 million customers, and we've taken the decision to reduce exposure to packaged bank accounts, where they don't meet our target return levels. We're progressively recycling capital from lower-return partnerships to attractive growth opportunities.

To conclude then, I recognize that the events of the first half have impacted the short-term profitability of the business. But we have already moved to restore margins and the fundamental earnings power remains. The balance sheet remains strong, and we have actions already in flight to rebuild its resilience. Combined, these give us confidence about the sustainability of our dividend into the future. This is a great business with brilliant people and fantastic brands, set to drive growth into the future. Our strategy remains the right one and despite all the turbulence, we are making real progress. As ever, there is much to do, but we step forward with confidence.

Thank you for listening. Neil and I will now take your questions. I'm going to hand over to Brecca, who's our call moderator to coordinate the Q&A. And I think the intent is to go to the phone lines first and then come into the room. Thanks. Was expecting Brecca to speak, but she maybe speaking to the phone line.

[Operator]

[Operator Instructions] We will take few questions from the phone line first. And our first question comes from Youdish Chicooree of Autonomous Research.

[Youdish Chicooree, Autonomous Research]

Good morning, everyone. Thank you for taking my question. This is Youdish from Autonomous Research. My first question is on your new pricing engine in Motor, which you say is delivering an improvement of 5 points to 7 points in your loss ratio. And first, I was wondering on why did it take so long to actually deploy this system? And then secondly, if you believe that, that level of improvement is sustainable, so does that not mean that your medium-term common ratio target is too conservative? Thank you.

[Penny James, CEO]

Thanks, Youdish. Why did it take so long to deploy? Well, the truth is, you're right. It's taken us a number of years to get to the point where we've replaced all of the Motor policy admin system, the claims -- we have upgraded the claims system. And within that, we've updated all of the models that sit around -- and infrastructure that sits around our pricing. And in addition to that, we've developed a strong data capability, both in terms of people and infrastructure that sits around that and supports that as well.

And that's enabled us to increase by around fivefold the amount of data points that we're bringing into pricing to introduce machine learning and so and so forth. So you're right that it's taken a while to get to the point that we've had the infrastructure and people capability to be able to make those moves in terms of the development. That said, we think that we've made a massive step change this year in the capability that we have, and I'm delighted to see the results are starting to flow through at this point.

In terms of what that means in terms of margins going forward. Obviously, we've put both underlying claims inflation through. We're also seeing benefits from the pricing models. How over time that we deploy that, and where we take that as growth and where we take that as margin will be a choice we'll make in the contest of the market as it develops. But clearly, having that in the armory and further improvement still to come is a big positive at this point.

[Operator]

Thank you. Our next question comes Greig Paterson of KBW. Your line is open, Greig.

[Greig Paterson, KBW]

Good morning, everybody. Can you hear me?

[Penny James, CEO]

We can and hi, Greig.

[Greig Paterson, KBW]

Just by the way, I'm not going to ask this, but risk mix impacts year-on-year Motor and Home, if I can get those off-line, please. And two questions, Willis Towers Watson put out a recent piece of work saying that there was a big backlog in mid-sized bodily injury claims that had built up last year because of inertia in the medical triage business. And I don't mean whiplash, I mean, the sort of GBP50,000 to GBP200,000,000 claims. I wonder if you can talk about that, whether that's going to produce upside risk to your 10%?

And the second question is, on the SCR what is the opportunity for further optimization there? I know you've said that the credit -- the reduction in your credit risk on our asset portfolio has reduced the SCR. But what are the optimization -- model optimization should we be factoring some of this in our forecast, is the question? Thank you.

[Neil Manser, CFO]

I can do both of those. So, yes, Greig you're right, there are some slowdowns in settlements in bodily injury claims given medical evidence has been slower post-COVID. When our claims teams look at the numbers, they factor that into the analysis and that's factored into the 10%. So let's say, I mean, it's also, as you're fully aware that sort of came through the portal, and we're paying very close attention to what's referred to as tariff plus claims. So again, and we've taken some, we think, prudent assumptions around those.

On the second, SCR optimization, so in the first half there were kind of two big movements -- the benefit from higher investment yields is a positive SCR, i.e., SCR comes down. But that was offset by the outlook for underwriting guidance, as we talked about, so they broadly offset each other. The asset derisking, I talked about has only just started, and that's not reflected within the SCR and that could be worth a few points.

Looking forward, obviously, profitability is a big driver of SCR. So to the extent we can improve margins, deploy pricing more effectively, that gives us a slight kick in to SCR over the time. And of course, we're always looking at ways we can optimize. I've talked before about strategic reinsurance, which is one of the tools available to us over time. So very focused on optimize the SCR where we can in an appropriate way.

[Penny James, CEO]

Thanks, Greig.

[Greig Paterson, KBW]

Sorry. Thank you.

[Penny James, CEO]

Thanks, Greig.

[Operator]

I'd like to hand it back to [indiscernible]

[Paul Smith, Director of IR]

So we'll take questions from the room, if you could limit yourself to two questions please. There's a button to turn on your mic to people on the phone line to her. So Rhea, we'll start just here.

[Rhea Shah, Deutsche Bank]

Thanks, Paul and thanks, Penny. The first question is, again, around results. What assumptions do you have or what did you have for inflation at the full year '21 results and have those assumptions for inflation changed since then? And the second one is around the dividend. You're talking about sustainability in the dividend, what -- but if we think about in a different way, what level of growth should we be expecting going forward? So maybe not for '22, but '23 and beyond? Thank you.

[Neil Manser, CFO]

So I’ll take the first one, first. So inflation assumptions in reserve. So I can't give you the exact numbers, but obviously, when we looked at the reserve at year-end, and we took, what we thought were appropriate assumptions for reserving. And obviously, you can see that we've seen positive prior year runoff at the start of the year -- during the first half of this year, which supports that. We have seen -- of course, as you go through the year, we have seen a tick up in the 2021 inflation as well as 2022. And that's kind of to expect to as we build that into our reserve assumptions.

Yes, I can certainly do dividends. So I think the policy is quite clear, which is the progressive dividend policy in line with business growth. And over time, that policy is unchanged. I don't get it clearly, you've seen what we've done historically around how we've grown the dividend to the extent that the business grows in a similar rate in the future, we'd look at similar set of assumptions. So the policy is still the same. At the moment, we've maintained a dividend half year. And that's going to the -- as we look this year, the same ability is around maintaining. And then in the future, as all the actions we've taken as a business come on stream, the Motability promotion comes on and we'll start to grow this in the future, we will look at whether we can then grow that dividend payout.

[Benjamin Cohen, Investec]

Ben Cohen, Investec. Just to follow-up on bodily injury inflation assumptions. I just wondered if you could talk to the risk that those would worsen in the second half of the year? And how sensitive they would be to general cost of living. And the second question was, you made reference to looking at reinsurance options for capital benefit. I just wondered if you could say more about that. Would you be looking at presuming some kind of ADC cover rather than any kind of proportion of reinsurance? Thanks.

[Penny James, CEO]

I think on inflation, more broadly and bodily injury, couple of different dynamics. I think, at the small end, obviously, you're seeing improvements from whiplash reforms. So that's kind of going in the other direction at the moment, the point that Neil said. In terms of larger bodily injury, you're right, the underlying wage inflation can affect those in terms of settlements and so on, and that's in a way why we're reflecting that within our 10% overall claims inflation number.

[Neil Manser, CFO]

Reinsurance options, so there are plenty or reinsurance options. We have a slight advantage being internal model company, so we can deploy reinsurance effectively to the risk types we understand completely. So it opens up the options for various different types. I'm not going to say exactly what it's going to be today, because I think that would prejudge what we get to. I think there are a number of options out there. Going to share could be one, reinsurance structures debt, also look at reserve risk could be other ones as well. So there's plenty of structures out there, and obviously, we'll update as we're going through the process.

[Unidentified Participant]

Two questions. The first one is just on, I guess, the -- it's kind of coming about the trading update. When we look at kind of when we have these shocks in the market, typically, they can surprise you for a number of periods to come, right? So if you look at 2009, 2010, and bodily injury and accident spiked, there were couple of years of -- for the industry are pretty painful kind of results. How comfortable are you and how can you help us kind of get comfort the actions that you've taken right now will be sufficient?

The second question is coming back to the inflation assumption that you've made for 2022. I'm not sure whether -- I've probably read the press release completely incorrectly. But you talked about a 10% inflation number across 2022. Is that an average? Is that an exit rate? Because I think Q1 was less than 10%. Q2 sounds like it was 10%. So what happens in the second half of the year and what's the assumption there? Thanks.

[Penny James, CEO]

I think in terms of what gives us comfort from where we are now, which I think is the first question. Look, we're pulling levers, to me, there are two dynamics. What are the levers that support the long-term earnings power of the business? What are the levers that kind of restore the resilience in the balance sheet, having used some of it up on the event. So we've been careful in picking those claims inflation assumptions moving forward. Everything operates in a range, but we believe we've defensible passed through those. We're taking a sensible view and we'll continue to monitor them and adjust as necessary.

I think the supply chain kind of impacts have been quite an extraordinary feature of the first half. I can't ever think of seeing a combination of factors like we've seen in the first half at the moment. So it doesn't feel like what we've witnessed is the gradual drift of an issue kind of opening up. It feels like there's been a big impact from that. So we're taking kind of actions both against that, but also on where we see long-term inflation trends as well. I think on top of that, we are starting to see the benefits coming through from the strategic investments we are making and that makes us feel very positive.

So amid all of the turbulence there are some really, really good signs as well. The exact timing and the shape of moving that to growth depends as well on what other people do in the market, we know that. But for us, focusing on the margins, continuing to deliver those strategic priorities, stressing the balance sheet where there is enough amount to give us confidence moving forward. That was the trading one. Claims inflation year-on-year?

[Neil Manser, CFO]

So I will do that too. What we try to do is be more helpful by saying, across 2022 we expect inflation of 10% versus 2021 for the year. The reason why we've done that because if you look at any half year inflation stats, they get very misleading because, for example, used car prices started to rise halfway through last year. So the pure inflation rate in the first half of this year is a bit different to inflationary rate in the second half of this year. So we tried to just cut through it all and say, for this year, we're expecting a 10% inflation for the year as a whole based on '21 base.

[Unidentified Participant]

Hi. Good morning, guys. Two questions, please. So seven months on from the FCA pricing changes, given that the impacts have been a bit more severe than expected, have these reforms changed your longer-term outlook for the market in terms of growth opportunities and structural profitability? And do you think the reduction in the new business markets for both Home and Motor are permanent features of the market? And secondly, to sustain a flat or growing dividend in 2023, what sort of growth assumptions are baked into your outlook? Thanks.

[Penny James, CEO]

So PPR, look, we have seen structural changes. So I think it is -- to your second part of your question, it was designed to, and I think is demonstrating effective at reducing the amount of switching. I think we should expect, therefore, some degree of structural reset for that. At the moment, I mean, premiums are at 2014 levels in the market. And hence, by the rebalancing moment on transition that you've not seen a huge shift in those for some time. I think as the market, assuming if and when the market starts really moving to address claims inflation, then I suspect you'll see some of that structural shift moderate. That will encourage more switching for spell. But I think we should expect a structurally lower new business market than we've had before.

Does that automatically mean there are less margins in the market? No, I don't buy that. Actually, the renewals book and the strength of customer relationships remain key, especially for us with the business that we have and the customer base that we have. So I still see lots of potential around growth, both in the new business market, albeit at a slightly different shape, but actually amongst our end customer base as well. So we remain positive on that poll.

[Neil Manser, CFO]

So in growth -- so as there's premium growth and policy growth, should be quite different. And as rate goes through the market you'd would expect premium growth to grow faster than policy growth. So there's relatively modest policy growth within the plans. But of course, we've got Motability that comes on stream in Q3 towards the end of next year, and slightly more premium growth, because obviously, we're pricing that and certainly the severity inflation will work through into average premium over time.

[Faizan Lakhani, HSBC]

Hi. Faizan Lakhani from HSBC. Thank you for taking my questions. The first, coming back to the claims inflation assumption. When I think about the shape of frequency, when the Department of Transport data, it was pretty low in January and February, given the fact that we were still in sort of pandemic-related restrictions. What gives you the comfort the frequency stays flat from here onwards? My estimate would be that probably pick up even with the cost of living.

And the second question is on your derisking -- on DM credit risk. When I look at your asset duration, it's about two years, not probably too different to what I'd expect your reserve to be as well. It doesn't feel like there's a great deal of room to mismatch in the ALM. So just trying to understand how you can shorten that duration. Thanks.

[Penny James, CEO]

Okay. Let me take the frequency one. So what have we actually seen? Frequency has been pretty flat from mid-Q1 onwards pretty consistent. So there was a small spike for the storm event, but bar that it kind of settled into a pattern. What do we think about when we think about that moving forward? I think there is a structural change in how people are living their lives. So if you look at the number of miles people are driving, they are back up at pre-pandemic levels. If you look at the frequency that has shifted, and that is about people driving different patterns and living their life in a different way than they were beforehand. Those effects feel as though they're set to stay within a range around that current assumption.

I think the thing that is less certain still than that is around the impact of cost of living on how people are operating. So there is a natural assumption if you like, that when entry prices go up, people will drive less. I think we've yet to see that in any meaningful sense coming through the frequency numbers or any identifiable sense anyway, and we are relying on that in our pricing assumptions either.

[Faizan Lakhani, HSBC]

So, just to clarify. So relative to Q2 flat, but Q1 was abnormally low still.

[Penny James, CEO]

So it's been creeping back up. I think you can see graph on those. But it's been creeping back up over the course of last year -- back end of last year and into the early point of -- bar some small smooth movements through particular lockdowns. But it stated, I want to say, February-March sort of time has been far, I should say far blip storm events where Motor sort of blip as well as, obviously, the Home spike. It's been pretty steady since then.

[Faizan Lakhani, HSBC]

Duration?

[Neil Manser, CFO]

So there's not a huge impact on duration from this. I mean it's -- the portfolio we're looking at is just over 10% of the portfolio and we'll reduce the duration in that portfolio, but they wouldn't have a huge impact on the overall duration. So the asset liability -- I mean we're talking about 0.1 and 0.2 of the year. It doesn't have a material impact on the ALM.

[Thomas Bateman, Berenberg]

All right. Good morning. Thanks for taking the questions. Thomas Bateman, Berenberg. Just discussing a little bit more about the SCR again. I think we talked about the investment portfolio being a positive, but the Motor profitability being a negative. How much is that negative on Motor profitability. And given that you're now warranting at your target loss ratio, could some of that reverse in H2 a little bit? And just on the dividend, you alluded to the discussions with the Board and the Board being comfortable with, I guess, flat dividend this year. What -- did you discuss in that what kind of the key drivers, what are the numbers that you need to hit and to be comfortable with that?

[Neil Manser, CFO]

Yes. So let me take the first one first. So on SCR, the capital I would -- looks forward, but it will capture some of the impacts of the first half of this year as well. So you haven't got all the impact flowing through capital quite yet in the -- in terms of capital requirements. So to the extent the margins improve, and that's sustainable there might be some upside towards the end of the year as that's will fully worked through and you start bringing and you look forward another 12 months. So still there is some drag in the SCR from the assets we talked about the trading update. There is some potential upside as you go further. That was the first question.

[Penny James, CEO]

So the Board -- I will answer the Board one. What's the Board conversation around dividends? Essentially, this is half Motor, half not. All the other business lines are going well to start up with. We've dealt with the margins. So they're looking at a forecast that reflects that when they're considering dividend viability. We're actually seeing some positive market signs, but I don't think we've really, as a Board banked that in our thinking, particularly. They look at the range of the risk appetite, where we sit now, the levers that we have available to us to strengthen. And it's the package of all of those things that has given the board comfort and we had exactly that conversation before the trading update.

[Thomas Bateman, Berenberg]

Thanks. Just one point of clarity, you said that there's a new Motor model coming, I think that was in July. Is that in the 152 number or is that a tailwind to come in H2?

[Neil Manser, CFO]

So some of that's in the 152 number because, obviously, we knew that model was covering when we look at doing the SCR. As that works through though, you might get some more benefit in the -- as we work through this year. And when we do this structure, to understand when we look at the capital model, the guys who run the capital model don't just don't leave everything the pricing same. They kind of say, well, we can see that, but actually, we're going to be more cautious in the capital model because the capital model is a regulatory model. And as the evidence comes through, they can recognize more of those benefits in the capital model.

[Thomas Bateman, Berenberg]

Thank you.

[Alan Devlin, Goldman]

Thanks. Alan Devlin, Goldman. A couple of questions. First of all, on investment income, you've given the guidance for this year and 2022. Given current yields, where should that portfolio kind of altered the go-to, any upside from '24 onwards? And then just on the reinsurance you've talked about, as a kind of profitability this year, is that kind of pushed that back to an FY '23 topic or is there things you could still do in the second half for the Direct solvency this year? Thanks.

[Neil Manser, CFO]

Yes. So investment income, we're obviously giving some expectations for next year. We are investing -- we can invest higher than that. And as the book matures, we should expect all other things being equal, and the investment market is pretty hard to pick at the moment, you would expect some upside going into '23 -- sorry, into '24 and '25. So bit more upside to come through, assuming current yields continue where they are.

On reinsurance, no, I don't think any deal we do, would obviously be a '23 deal, because you can't -- we will do it through this year, just probably start on the 1st of January, 2023. And that -- these deals tend to be multiyear deals. The reinsurers will look at the same facts when we look at. They'll be excited by the benefits coming through the pricing model, which will underpin the returns for the next couple of years, and that's how we've been doing the reinsurance.

[Ivan Bokhmat, Barclays]

It's Ivan Bokhmat from Barclays. The first question may be on the 5 point to 7 point improvement to the loss ratio. I was just wondering if the -- that already includes the 15 point increase in the rates that you've done or it's completely separate? And maybe on the same topic, if you could give a little more color, do you see that through any particular channels or it's across the book? Is it driven by Darwin or the traditional brands, et cetera.

The second question is on Home, your premiums have been down quite a bit, and you were saying that you were focused on maintaining -- protecting the book following the reform. I was just wondering whether now six months in, do you still feel you need to do that for the rest of the year? Is it going to last into the following year? And if I could sneak in a third question, please, on Motability for 2023. I was just wondering the reinsurance arrangements that you talk about, is this something that was set in place or it can still change after the -- this year? Because some of your peers they talked about reinsurance costs going up.

[Penny James, CEO]

Okay. Motability, the reinsurance and the structural agreement. So it's the deal allows us to reprice appropriately for the market, but its -- but that's not open to change in the same way as I've mentioned when sales might. Home -- so the priority actually on Home will remain. There is a lot of value in those Home back books. There are loyal customers, they're loyal for reason and there is lots of opportunity in those relationships as well. So we entered the year keen to protect those back books, but actually, they remain the heart of the profitability of that business moving forward.

What that means though is that as time goes on, we'll be -- and we understand the market, we'll be able to optimize that more effectively in the choices that we make. So to begin with, we kind of take no risks on that as we move on, we can explore it and understand what those optimizations are. And remember, Home has got the new system and pricing capability coming in 2023 in the same way as Motor has had it. So it's opportunity to build different products and pricing structures and so on and a great deal more flexibility opens up in 2023.

So for now, we are focused on protecting the back books. We still think there are growth opportunities within the market as it stands, and we're focused on delivering the sort of strategic deliverable that gives them much greater flexibility next year and beyond. I think a final point on growth on the Home is market still, still not really pricing claims inflation in full fiber. So there's another moment in time where we just had to see that move. So we won't run at growth until the environment is right to do so, albeit less extreme than what we've seen in Motor.

There was another question. There was a third question, which I have lost track of 15 points and the 5% to 7.6% of the model. So the claims inflation assumption or the pricing increase assumption of 15 is not inclusive of those 15 to 7 points. So we put up 9 points of inflation through plus the rebalance in PPR.

[Ivan Bokhmat, Barclays]

Hi. Thanks. First one, reserving, have the inflation assumptions changed on the large bodily injury claims on the full year or not? And if so, what was the offset because PYD was still quite high in Motor. And do indexation clause impact the reserves materially. There was a comment from another insurer that that's having an impact on theirs. And the second one, just on the packaged bank account exposure reduction. I'm trying to understand is this what's already happened or this is still more to go in the future. And I guess if that's the case, what's the sort of quantum probably not unprofitable, but on premium and then maybe sort of solvency implications with that going forward? Thanks.

[Neil Manser, CFO]

So I'll do reserving. So large bodily injury reserving, look, we look at this all the time very detailed. And we look at all the trends going through. We've historically seen positive runoff from large bodily injury claims. We have seen that continue. We're challenging ourselves on wage inflation assumptions, carry inflation assumptions because they are the key things that drive bodily injury and we're comfortable with where we're reserving -- where the reserves are. That's the first question.

[Penny James, CEO]

Packaged bank accounts, we are starting to see the move. It's a bit of a reduction in coverage this year. It's actually driven by partner, but actually is consistent with the direction of travel. They come in big blocks so there are significant in premium terms, much less significant in margin terms altogether. And they carry the same, depending on what territory is the same -- carry the same capital loads at the other end of the business. So depending on what you free up, you can free up capital underneath it. So the way we're thinking about that is recycling that capital into Motability effect. So is what we think about it at the moment.

[Ivan Bokhmat, Barclays]

Thanks. Just a quick question on policy counts. So you're down 20 bps from March and you're saying sort of new business pricing is up 15%. I just wondered if you could give a little bit color on renewal pricing and how you've seen that relative to where people are in the market? And then just on Home on the second half, obviously, it's been one of the dry summers. What's the allowance at the moment? And when you said the market is not pricing for claims inflation for higher substance claims and losses there?

[Penny James, CEO]

I missed the first one. So can you...

[Ivan Bokhmat, Barclays]

Yes.

[Penny James, CEO]

Is that a Motor question. Sorry, there's -- the sound is...

[Ivan Bokhmat, Barclays]

Motor renewal pricing.

[Penny James, CEO]

Motor renewal pricing, okay. Let me start there. I mean I think the key on Motor renewal pricing is it follows those claims inflation assumptions overall. So the rebalance at the beginning of the year between PPR -- under PPR between the front and back books. But broadly, through the year, what's happening is that we're putting those claims inflation assumptions through, and that's what you're starting to see through the renewal book. If we weren't seeing that, then we wouldn't be able to say that we were confident on the margins.

[Ivan Bokhmat, Barclays]

So would you say that, that 15% in new business price increase is reflected but from a lower starting point in renewal?

[Penny James, CEO]

So the 9 points that we've talked about in relation to inflation, you'll see in renewal, we haven't disclosed a number of how much those renewal premiums went down at the start of PPR, it's pretty sensitive. But yes, you see an offset from that. So I think that's renewal pricing. What's the second one was?

[Ivan Bokhmat, Barclays]

Home?

[Penny James, CEO]

Home, and overall reserving and what we're seeing. I think at the moment, we are not seeing anything of any note. We're obviously monitoring the weather and so on so forth around subsidence. We are reasonably strongly provided for that territory and we'll continue to monitor it.

[Ivan Bokhmat, Barclays]

Yes. Perfect. Thanks.

[James Pearse, Jefferies]

Hi, everyone. James Pearse from Jefferies. So the first one is just on Darwin. So you've mentioned you've had good new business growth from Darwin. Just wondering if we can maybe get some numbers in terms of level of growth and policy count. And then maybe just a point of clarification. The new risk pricing model that you've spoken about this morning, has that been implemented across all of your Motor brands? And the second one is on Ogden. So just interested to get your take in terms of the outlook on the Ogden rate, just giving where inflation is right now?

[Penny James, CEO]

You do Ogden or Darwin?

[Neil Manser, CFO]

I'll do Ogden first. So if you recut the Ogden rates today, it will be unchanged. So you recast in the first half of the year, it would have been more negative. If you recut it today based on the counter price, we've drawn the unchanged and where it's today and it's we're pointing.

[James Pearse, Jefferies]

And is there a general expectation in the industry right now do you think that that could go down or going forward.

[Neil Manser, CFO]

I think it's really hard to tell. It's pretty much a formula. And the outcome of the formula has changed by 100 basis points over the course of the first half of the year. So it's -- we can model out what we think is going to be at the right point in time. Obviously, review is a couple of years like still. And I think there's really some talk about, do they change the method well to dual rates, so there's still some discussion in industry about it.

[Penny James, CEO]

In terms of the pricing models, all brands Motor except Darwin is the answer. Darwin runs its own pricing model has been used in machine learning for some time. But yes, no, it's operating across all of the other brands and Darwin.

[Neil Manser, CFO]

So it's a policy count at half year about 180,000 policies, and that's up from 140,000 at year-end, so decent growth through the first half of year, which is what we expect.

[Derald Goh, RBC]

Good morning, everyone. Derald Goh of RBC. Couple of questions, please. I guess the first one is just on the topic because of living prices. So you alluded to changes in customer behavior, but I'm just keen to get your thoughts around how you're thinking around fraud, whether it's in Motor, Home or in other lines of businesses? And is that already being contemplated within your claims inflation assumption in that outlook? And the second one is just on the credit derisking. How much will your solvency sensitivity be lowered by -- based on the expected actions to date? Thank you.

[Penny James, CEO]

Yes, the cost of living first, and then I'll hand over to credit. So what are we seeing? We're seeing pockets. So you've seen a few high worth vehicles disappearing off the streets and so on and forth, but it's really pockets rather than anything sustained at this stage. We have some of the most advanced fraud models in the industry. We have an excellent fraud team, and so they are tuned in to look for -- and look at their algorithms to identify those things both the premium stage and at the claims stage.

What are we seeing in customer behavior more broadly? It's certainly a topic on customers' minds and anecdotally as you talked to people in the contact center, it's high in people's mindsets. And so the ability to offer different product arrangements, so reduced cover or reduced X rates to cover may become kind of more appropriate over time. It's kind of still moderate at the moment as people have always been price conscious. They're price-conscious now. I don't think we're seeing a dramatic shift in actually what people are doing.

On the other side, we're also mindful about claims that are driving behavior and whether there are pluses and minuses there. So we haven't taken a dramatic stance in any direction on cost of living and our core assumptions, but we continue to monitor it. And from a customer perspective, we are -- as we have done through and since the pandemic supporting people of any help with payment terms and so on and so forth.

[Neil Manser, CFO]

Second question. So the impact of derisking is about a 25% reduction in credit exposure, so that's sensitivity.

[Paul Smith, Director of IR]

So in the interest of time, we'll take the last question from Oliver (ph), and then we'll hand back to Penny.

[Unidentified Participant]

Thank you very much. Two questions on the solvency roll forward. One is we've had a lot of questions on the sort of individual moving parts around the SCR. But can you just say whether you expect the SCR to be lower by the end of the year, perhaps with and without reinsurance. And then the second question is on the deferred tax credit or deferred tax asset, so it's about 15 points of the solvency ratio at the moment. What's the driver of that going forward as -- you can't increase any further quite clearly, but can it reduce?

[Neil Manser, CFO]

Okay. So the deferred tax actually there is two drivers of it. First one is the tax effect of the intangible assets, which will -- which unwinds over time as you amortize these assets. The second impact which have been more half year impact has been the increase in the AFS negative, because obviously that has a tax effect against it as well, and that will unwind as you have portfolio effect. Obviously, the tax assumption with the DTA is the current tax rate for next year. Obviously, there's some debate around what that corporation tax rate will be next year as well anyway. That's first question. In terms of predicting the SCR, quite hard to predict the SCR precisely, but definitely the impact of the credit derisking will reduce the SCR.

[Unidentified Participant]

Can I come back on that? I mean you've got rising prices, which presumably is negative CRS which increases yes, presumably. You've got Motability and is often confused to that. But I mean, if premiums go up because of rising prices, does that raise the SCR. So that's sort of questionnaire is it. You've got Motability increasing the SCR. You've got the effect of reducing the packaged bank accounts, reducing the SCR and then you got reinsurance in credit and/or whatever happens to future expectations about the loss ratio. It's just the direction that we know which one drives what, but it's just very difficult trying to sort of pull them all together. You presumably can and know the answer. But it's very difficult for us to second guess that. But it's incredibly important for the share price.

[Neil Manser, CFO]

Let me try and help you then. So Motability only comes onstream at the back end of 2023. So it will have minimal impact on the year-end SCR. To the extent we reduce exposure to package bank accounts, that's positive to the SCR. But again -- but it takes a while for that all to unwind. So you kind of see those two things almost as offsetting each other at a macro level. But in terms of -- so then on the other movements, you've got, clearly, the asset derisking reduces it by few -- which would reduce SCR, and it's kind of like GBP30 million, GBP40 million, something of that range.

And then you've got the progression, I think it's was from earlier around -- to the extent the price -- the capital model over time can bake in the evidence of the new pricing models more fully over time, that will have a positive impact. The way that comes of capital model is really looking at the next 12 months of profit. To the extent the next -- the profit outlook for the next 12 months changes, that is a one-for-one into capital model. So -- I mean, premiums going up in isolation does not particularly drive the capital model, assuming they're just going up because inflation is going up. So it's not that you don't take a potential premiums. And we want to look at the risk that attached to it and then the profit signature of it.

[Paul Smith, Director of IR]

Great. Thanks, everyone, for the questions. I'll hand back to Penny.

[Penny James, CEO]

Look, firstly, thank you, I think, for the quality and the range of the questions, which I think demonstrates the complexity of the environment that we've seen and are seeing. What I'd really like you to take away is that we've taken actions to restore the margins and we are on that. That to remember that this is a diversified business model, so actually, Motor has had its challenges in the first half, but actually, the other businesses are performing well. And fundamentally, the earnings power of the business remains, having taken those actions, which is why we are confident in the sustainability of the dividend. But thank you for talking to us several weeks ago. Thank you for talking to us again today. And we look forward to chatting to a few of you afterwards. Thanks.