Direct Line Insurance Group PLC

LSE:DLG

Earnings Call Transcript 2022-Q4

[Jonathan Greenwood, Acting CEO]

Good morning, and thank you, everyone, for joining us this morning. I think many of you know me already, but for those of you that don't, I'm Jon Greenwood, I'm the acting CEO. By way of background, I spent my career in U.K. General Insurance working for a number of firms. But for the last 22 years, I've been at Direct Line. Until late last year, I was the Managing Director of our Commercial Insurance division. And prior to that, I held a number of positions including Managing Director of Home, Pet and Travel, and prior to that, Director of Products and Pricing.

Turning first slide. The group did not perform well in 2022. Market conditions were challenging with high claims inflation and significant FCA pricing reforms, but we did not do a good enough job of navigating those challenges. Exceptional weather and challenging investment markets also created headwinds. Motor, in particular, was affected by high claims inflation, which remained ahead of our expectations throughout the year. In combination with other factors, including the impact of the FCA pricing reforms this gave rise to our poor Motor result.

In a moment, I will detail the actions that we are taking to restore our Motor performance to an acceptable level. I would, however, highlight that outside of Motor, normalizing for the impact of elevated weather claims, all our other businesses performed well and in line with our expectations. Home navigated well through the implementation of the FCA reforms and elevated inflation, and Commercial delivered double-digit premium growth. The weak financial performance in Motor impacted capital generation and our solvency ratio and we decided not to recommend a final dividend in 2022.

In a moment, Neil will take you through our business performance and balance sheet in more detail. However, we have already taken action to begin restoring our capital strength, including the reinsurance program announced in January. In addition, we have further self-help options that Neil will describe later.

2022 was a tough year. And clearly, our performance in Motor was disappointing. However, I do believe that the group remains fundamentally strong, we have a diversified business, strong brands and millions of loyal customers. I -- currently is to execute well to leverage these strengths and to generate the cash flow that enables us to deliver attractive returns for shareholders.

Turning to Slide 4. At our January update, we estimated a normalized 2022 group COR of around 102% to 103%. We have come in at 103.3%. As we can see here, our 2022 weather-adjusted performance was ahead of our target COR in all business lines except Motor, which reported a COR of 114.7% due to the combination of factors, which I will talk about in a moment. Excluding Motor, ongoing normalized COR of 92.2% was better than our medium-term target of 93% to 95%. Commercial COR improved by 3.5 percentage points with our new platform, enabling us to take further advantage of our pricing capabilities and strong client focus.

As this slide shows, outside of Motor, where there were significant challenges, the rest of the group delivered a solid underlying performance. Weather was a big factor in 2022 with total weather claims of GBP 149 million, more than double our weather budget. We experienced our highest level of weather-related claims for over a decade, including our highest individual event from the December freeze. Our 2022 weather claims were made up of three events: The storms in February; the extremely dry weather over the summer, which resulted in subsidence claims; and the freeze event in December, which drove significant claims volumes in Scotland and the Northwest and cost us GBP 95 million.

We have a relatively large market share in Scotland in part because of our RBS partnership and the heritage of Direct Line. Generally, we like Scottish properties given the build quality and the relatively low catastrophe exposure to wind storm and flood events. This event was unusual because of the duration of the subzero temperatures and then the speed of the fall. We had over 500 large claims, which averaged over GBP 100,000 each. And many of these involved cold water tanks bursting in lofts, creating a huge amount of damage. Of course, weather events are part of our business and during the year, we supported over 15,000 customers with weather-related claims.

Turning to Motor on Slide 6. You can see the deterioration in the COR was largely due to the higher current year loss ratio, which increased by 18 points to 91%. The first thing to note is that the -- is that 2021 benefited from the lower claims frequency that we saw during the COVID lockdowns. This accounted for around 5 points of the loss ratio deterioration. The remaining 13-point increase was principally due to two main factors.

The first of these was severity inflation, which throughout 2022, was tracking substantially above the levels assumed in our pricing. Our long-term average expectation for severity inflation was 3% to 5%. Actual severity inflation was around 14%. At the interims, we described the impact of used car prices at longer repair times on inflation. Our response was to put through 10 points of rate to restore written margins. However, claims inflation deteriorated further in the second half, driven in particular by third-party claims and a rising claims frequency. Again, we responded by taking our rate increases across the year to 29 points in total, but our pricing and margins lagged the inflationary curve.

The second factor pushing the loss ratio higher was the impact of the FCA pricing reforms. This reduced the margin on our renewal business, and the impact of this was not offset by the volume of new business that we'd expected. In addition, we did not get the balance right between retention and renewal discounts, which eroded some of the rate increases.

Let me take you through the claims inflation trends we saw in 2022 on Slide 7. There were four main drivers. Two impacted us predominantly in the first half and two towards the end of the year. First, you will be aware that higher used car prices were a major inflationary factor in 2022. Secondly, average repair times also increased substantially. In our externally managed network average key to key times in 2022 increased by 25% and the average total repair cycle time, which includes the period between the booking being made and the vehicle arriving at the garage increased by 60% year-on-year. For our own garage network, the figures are lower. However, still show a year-on-year increase.

Our settlement costs reflects the combination of both these factors. The impact of higher used car prices can be mitigated to some extent when we repair vehicles rather than write them off. And having our own garage network helps us to control these costs. But the fact remains that our average total settlement costs were substantially higher in 2022.

Used car price inflation appears to be stabilizing and we are seeing signs of capacity constraints easing in our own network. Based on what we see today, we estimate claims inflation will be a high single-digit number in 2023.

Two further inflationary factors principally explain the deterioration we saw in the loss ratio in the fourth quarter. Firstly, we saw further inflation in third-party damage costs. These are claims where our customer is at fault and the repair is handled by another insurer. And they account for around 30% of our total claims. Third-party severity innovation in the year were significantly ahead of overall severity inflation due to longer repair times leading to longer higher periods and higher labor rates.

The next chart demonstrates how third-party claims costs developed. In every quarter, paid claims at the same stage of development were higher than in the previous quarter and above the range we saw previously. This caused us to increase our estimate of third-party claims inflation. Lastly, we saw claims frequency increase by around 12 percentage points in December. We believe much of this increase was driven by the freeze and claims frequency has appeared to normalize during Q1. However, the spike in Q4 added around 1 point to our 2022 loss ratio.

Turning to pricing on Slide 8. The first thing to note is that we put through 29 points of rate on new business in 2022. This comprised 7 points at the start of the year in response to the FCA pricing reforms and 22 points across the rest of the year in response to claims inflation. Combined with the changes in risk mix, this led to an increase of 10% in average new business premiums compared to 2021. The story was different for renewal business where we reduced our premiums by around 8% for the implementation of the FCA pricing reforms. We also put through 22 points of rate in response to claims inflation, but some of this was traded away to optimize retention, which increased to 82%. The net result of all these actions was a 6% fall in average renewal premiums. Much of our rate increase in both new business and renewals was put through in the middle of the year, and consequently, we lost policy count in the second half.

So to summarize, 2022 saw a combination of managing FCA pricing reforms, the changing balance between new business volume and renewal volume, mix risk changes and the rate increases weighted towards the second half. This was reflected in the 3% fall in our average premiums and meant that our pricing failed to catch up with claims inflation.

So having set out our challenges in 2022, I'll now talk about the actions that we are taking on Slide 9. My top priority for 2023 is getting the Motor COR back on track. We're pushing ahead as rapidly as possible in a number of areas.

Firstly, we've already taken pricing action to restore written margins based on our latest inflation assumptions. Motors deployed around 11 points of additional rate in Q1. And we will prioritize margins over volume and have a more disciplined approach to retention.

Secondly, we're focusing on using our new pricing tools to their full potential, ensuring that we apply the sophistication in our risk pricing models. This includes deployment of substantial additional resources. And we will make sure that Motor has both the capacity and the capability it needs to price with greater accuracy.

Thirdly, I will accelerate the alignment of our model more closely to the PCW channel, which accounts for around 90% of new business sales in the market. We've been shifting our business focus to align with these structural market changes for several years, and this is supported by the rapid investment we are making in pricing. The group has also three distinctive brands focused on the PCW channel, and our pricing and product mix will continue to evolve. Churchill Essentials is an example of a new product, which has already expanded our footprint in the PCW channel. I should stress that this will in no way dilute our continued focus on the direct market where we have clear advantages.

Restoring the profitability of the Motor business, along with the continued good performance across our other businesses will generate capital and help restore the strength of our balance sheet.

2022 was a tough year when the combination of market factors and inflation pushed our Motor business into loss. We've already taken concrete actions to get the Motor business back on the path to profitability and restore capital strength.

Thank you. And I will now hand over to Neil to take you through the financial update.

[Neil Manser, CFO & Director]

Thanks, Jon, and good morning, everyone. Now as Jon has already said, this is clearly not the set of results that we wanted to be presenting today. But let me start on Slide 11. Overall, ongoing operating profit was GBP 32 million, a significant reduction on the performance in 2021. Whilst the normalized combined ratio of 103.3% is in line with the January trading statement, it's well below our original target for the year. As Jon has already covered, the majority of this is Motor related, and this was compounded by the higher weather-related claims taking the headline combined ratio to 105.8%.

Outside of Motor, our other businesses performed well with a combined ratio of 92% when normalized for weather, better than our for the year. In-force policies across our portfolio were 3% lower than prior year, with growth in Commercial, more than offset by reductions across other segments. And adjusted gross written premium fell by a similar amount.

Now we also saw pressure on investments, both in the P&L and through the unrealized position on the balance sheet. And the combination of these factors impacted the capital position with the solvency capital ratio falling to 147% at the end of 2022. Allowing for credit spread movements in 2023 to date, and reduced ineligible capital following the adoption of IFRS 17, this increases the solvency ratio to 152%.

Let's turn to the segmental results starting with Motor on Slide 12. Now Jon has already talked you through the main moving parts, which resulted in a Motor combined ratio significantly worse than expectations at 115% and an operating loss of GBP 77 million, clearly a poor result. The significant premium increases we've put through in 2022 and to date in 2023, will take time to earn through. But in the first half of 2023, the premium to be earned where in the main relate to business written during 2022, which, due to claims inflation revisions, we now expect to have a higher-than-target loss ratio. We, therefore, expect 2023 earnings to be depressed before recovering into 2024.

On a more positive note, we look forward to welcoming Motability customers in the second half of this year, affected to contribute around GBP 500 million of additional gross premium annually and to remind you, about 80% of that is reinsured.

Let's move on to Home on Slide 13. The Home did a good job of navigating the FCA pricing reform and elevated claims inflation by focusing on maintaining margins while deploying its brands thoughtfully. And this strategy enabled it to deliver a combined ratio normalized for weather below 95%. In-force policies fell by 6% in a market where there were fewer new business sales, whilst retention remained strong. Claims inflation was elevated as an estimated 7.5%, which was reflected in our pricing. However, the current year attritional loss ratio increased by 5 points following renewal price reductions and the nonrepeat of positive claims experience in 2021. The contribution from prior years was also lower due to a high 2021 comparator and some adverse development late in the year on old subsidence claims. Now as Jon said, Home also saw several weather events during the year totaling GBP 119 million, well above our expectation, and this led to a small operating loss.

Looking ahead, whilst the Home market remains very competitive, we have seen market premiums increase in Q1 with rates up around 7 percentage points. We think this may be partly due to increases in catastrophe reinsurance pricing but is nonetheless a positive sign. Outside of trading, the Home team also did a good job driving the strategy forward. They successfully renewed the partnership with NatWest and are also on track to start rolling out our new Home platform this year.

Let's move on to Slide 14 and another standout year for Commercial. And this demonstrates the combination of previous technology and pricing investments, good trading and a positive market backdrop. In 2022, Commercial delivered double-digit premium growth alongside an improved current year attritional loss ratio. The premium story reflects successful trading in both NIG and Commercial Direct. NIG grew 14%, Direct was up 17% and included within this was 52% growth in Churchill. On claims inflation, our estimate was around 7% for 2022, with our premium inflation a couple of points above this.

Now alongside underwriting actions of [indiscernible], this enable Commercial to improve its attritional loss ratio by a further 2 points, resulting in a normalized combined ratio below 93%. These results demonstrate what we can achieve when we combine great brands and customer experience with expanded propositions and improved pricing sophistication. And 2023 has started well with strong premium growth in January and February.

Let's turn to Slide 15 for Rescue and other personal lines. The first thing to note is that the results in both years exclude three runoff partnerships, which we now report separately. These partnerships were all low margin insurance for packaged bank accounts. Overall, operating profit was GBP 60 million with a strong Pet result supplementing the Rescue result of GBP 53 million. The Rescue is a larger business -- segment and saw lower sales due to reduced Motor volumes where Green Flag is sold alongside a Motor policy as well as the impact of transitioning to its new policy platform. Claims frequency remained broadly stable in 2022 and remained below pre-pandemic levels whereas claims inflation was higher, and this was mainly due to elevated fuel costs and resource constraints across our network of suppliers.

Earlier this year, we launched our first Green Flag branded patrol vehicles with repairs completed by our own fleet of mechanics. This is an important step forward and should help to mitigate some of the impact of heightened inflation as well as offering new revenue opportunities, such as selling batteries at the roadside. We'll continue to roll this out over the next 18 months.

So let's turn to operating expenses on Slide 16. Operating expenses in 2022 were in line with our target of around GBP 700 million and GBP 6 million lower than 2021, and this reflects the progress we've made on improving efficiency and cost control. Despite macro inflation pressures, controllable costs reduced by 6% to GBP 491 million more than offsetting the increase in amortization, depreciation and levies. Now these savings were delivered through a reduced office footprint, lower technology run costs and increased customer adoption of digital and self-serve channels. We also recognized GBP 45 million of restructuring and one-off costs, principally due to a technology impairment following the exit of two travel partnerships I've just talked about, plus the write-off of office fixtures and fittings.

Now the majority of these restructuring costs are noncash and therefore have no impact on solvency. Looking ahead, we remain focused on driving cost efficiency, but we won't be immune from inflationary pressures in the market.

Let's move toward the investment portfolio on Slide 17. Now it's a tough year for the investment market with all major asset classes seeing reductions in valuation and some extreme volatility. Against this backdrop, investment income was up with income rising -- income yield rising to 2.2%. Realized and unrealized losses totaled GBP 67 million and resulted from two areas. First, realized losses from disposals of our debt securities, mainly relating to the actions taken in the second half of the year to reduce our longer-duration U.S. dollar credit holdings. And secondly, the negative fair value adjustments on commercial property we saw in the fourth quarter. In total, this delivered investment return of GBP 51 million.

Now looking ahead to 2023, the outlook for yield is more positive, and we expect the investment income yield to increase to 3.2% as maturing assets are reinvested at higher yields, together with higher yields on floating rate assets. The total return yield for 2023 is modeled at around 4% once pull to par effects are included. Now given this measure includes unrealized movements as well, the outcome will clearly depend on market movements during the year. As a reminder, from 2023, total investment return will now be recognized in the P&L rather than being split between P&L and balance sheet. So taking all that together, a more positive outlook for investment return after a very tough 2022.

Let's move on to capital on Slide 18. So here, you can see the various moving parts in our solvency ratio. If I start on the left-hand side, the half year solvency ratio was 152%. The weak financial performance has impacted capital generation, which was negative 19 points in the second half before capital expenditure of a further 5 points. We took significant management action, which improved the ratio by around 14 points, including asset derisking and the new 10% whole account quota share reinsurance. These moves resulted in a solvency capital ratio of 147% at year-end.

Now since year-end, we've seen two positive moves, which have improved the ratio by around 5 points. First, credit spreads have narrowed. And secondly, the transition to IFRS 17 has reduced the amount of ineligible capital as some of our Tier 3 capital has been reallocated to Tier 1. So we're now sitting around 152%. And as Jon mentioned earlier, restoring capital strength is a key priority for 2023.

And so I'll now move on to the actions we have in train and available, and this is on Slide 19. So the first thing to highlight is our actions are underpinned by organic capital generation across all our business areas in 2023 but with a weighting towards the non-Motor areas. As you can see here, we have a range of further self-help actions as well as mechanical tailwinds that we believe will help to restore capital strength.

Of the mechanical items we set out, the pull-to-par effect on our bonds is likely to be the most material and has already delivered a positive contribution to capital in early 2023. Added to that, we would expect to restore the loss carryback allowance within the SCR on returning to profitability. I've added the PRA's upcoming changes to the risk margin within Solvency II to the list, but timing on this is uncertain. Altogether, we estimate these tailwinds could deliver between 7 and 15 points of solvency.

In terms of actions we are planning to take, shown here on the right, our main focus is on improving margins in Motor, as this supports both capital generation and underpins our solvency capital requirement. Alongside this, and following on from the whole account quota share, we can expand our use of reinsurance further. The quota share reduces our underwriting risk, and we think there's an opportunity to reduce our reserve risk as well. We are also reviewing our asset allocation to ensure we have the right risk/reward trade-off. So overall, we estimate the self-help actions could generate up to an additional 15 points of solvency.

We'll continue to work through these actions over the coming months. I will provide an update to the half year results. However, if I stand back, we know the importance of dividends to our shareholders. We're fundamentally a cash-generative business, and we're focusing on the capital actions to restore dividend capacity.

Now let me move on to Slide 20. As you know, IFRS 17 is effective from the 1st of January. And as I set out in December, it would improve alignment between IFRS earnings and capital generation under Solvency II. We also believe the new standard should improve comparability between companies. Now we're changing our headline key performance measure from combined ratio to net insurance margin, which we believe is a better measure of how we run the business.

Moving to our net insurance margin should improve our reported ratios at group level by around 6 percentage points, reflecting the inclusion of installment and other income within revenue alongside additional claims discounting. So for example, a 96% combined ratio under the old accounting standard would translate into around a 10% net insurance margin under IFRS 17.

So let me finish off with outlook on Slide 21. We expect our 2023 earnings to be impacted by the elevated Motor claims inflation we saw during 2022 and alongside continuing uncertain macroeconomic outlook. The actions we have taken to restore our Motor written margins based on our latest claims projections should support earnings into 2024. At a group level, our ambition is to reach earnings consistent with a 10% net insurance margin, but this will clearly take time given -- to achieve given the headwinds in Motor.

On capital, as I've set out today, we have a range of actions designed to rebuild our solvency position, including positive organic capital generation during 2023. Now again, the Board understands the importance of dividends to shareholders and we'll update the dividend outlook at the half year results, taking into account performance in the first half, progress on capital actions and the outlook for the remainder of 2023.

And with that, I'll hand back to Jon.

[Jonathan Greenwood, Acting CEO]

Thank you, Neil. Whilst Motor had a very disappointing year in 2022, I set out earlier the steps that we are taking that are focused on getting that business back to an acceptable level of profitability. All of our other businesses are in good health and performed well. Home navigated well through inflation and the FCA pricing reforms. Commercial delivered double-digit growth and improved its current year loss ratio. Green Flag is expanding its range of products and services.

Direct Line is a business with many fundamental strengths and these remain intact. We're a multiproduct, multichannel business with some of the most recognizable and powerful brands in the market. We have top three positions in Motor, Home and Rescue. Our customer focus is recognized in high retention scores. We have strong claims expertise, including the U.K.'s largest insurer-owned repair network and advanced fraud management and indemnity control capabilities. Our clear opportunity now is to leverage these strengths to return to delivering acceptable levels of performance and profitability.

So let me summarize on Slide 24. Our #1 priority will be to improve Motor performance by getting Motor pricing right. That is how we can restore profitability. We've made a good start, increasing rates by around 11 points year-to-date. On the balance sheet, we've taken steps to restore capital strength and have further options available that are in addition to rebuilding Motor profitability, which will further enhance our capital strength. Across the whole group, we will maintain our strategic focus with customers central to our thinking and resources directed to the most valuable products and channels.

In summary, the fundamental strengths of the group remain and I know we can leverage these again to deliver attractive returns for our shareholders.

Thank you, and we will now take your questions. If I can hand to Paul, please.

[Paul Smith, IR Director]

Thanks, Jon. We'll start with questions in the room before going to the phone line. [Operator Instructions]. We'll start with Alan.

[Alan Devlin, Goldman Sachs Group]

Alan Devlin from Goldman Sachs. I had two questions, please. The first one is on your comments on the -- looking at the COR into 2023. I mean, busy, do you expect that to improve, '23 versus '22? And your comments on how it earns through. Surely, the business in 2023, particularly in the latter half of the year should have an increasing impact on the -- as I kind of work through. So how do you think it -- kind of the year kind of progresses? Is that -- how does that earn through the price increases written both last year and this year kind of earned through this year?

And then secondly, just on the capital on the capital leverage on Page 19. I mean, how much of them do you think will likely come through? I mean the AFS pull the par, presumably a current interest rate does quite mechanical how much of that comes through this year and next year? And on the self-help actions, particularly the asset derisking. I presume you can do that gradually as well if you invest in higher-quality bonds. How much of that you could come through this year and anything on the potential reinsurance transactions? Don't know if that's two or not.

[Jonathan Greenwood, Acting CEO]

I mean, that's three, definitely.

[Neil Manser, CFO & Director]

Okay, four, but yes. Right. Let me try, Alan. So on outlook for the year, I'd expect we can make progress in 2023 versus 2022, definitely. Motor is the most uncertain part because clearly, we are earning in 2023, the business that a lot of it was written 2022. And even on the -- putting price changes through in early in this year, it takes 6 weeks to push it through the renewal book because you sent out renewal in like 6 weeks ahead. So there's a slight time lag. So you would expect to see the move during the 2023 being tough in the first half, certainly improvements in the second half as that starts to earn through, assuming that we don't see any other changes in claims inflation. I think that was the first one.

Second one on capital. So the pull-to-par effect, on the left-hand side, we've got the mechanical in we talked about . The 7 is kind of made up of pull-to-par effect and the IFRS 17 change. So they've change ineligible, which is the 7 points. There should be further pull-to-par effect in future years because not all our bonds are maturing next year. So that continues over the next few years.

On the capital actions. I'm not going to break down the capital actions between where the 6 and 0 to 15 range. We'll work through them on -- through them all. But clearly, there are -- in this interest rate environment, there are -- when we look at the asset portfolio and how it's positioned in credit versus risk-free versus government bonds, there are opportunities to get a good year without taking too much asset risk.

[William Hardcastle, UBS]

Will Hardcastle, UBS. On reserve releases, can you talk through, I guess, why it was a bit lighter than normal? You mentioned subsidence in home, for example. I understand that on current uplift, I'm just trying to understand that on the prior year. And then if there was anything in Motor that we need to think about on those as well?

Second one, it's a tricky one. I guess back to the question, why has it taken so long to push through these price increases in this inflationary environment? Was it a change in view of the persistency of inflation going forward? Or was the data being collected, was there a lag effect?

[Jonathan Greenwood, Acting CEO]

So I'll take the second of those questions, and I'll let you...

[Neil Manser, CFO & Director]

Do the first -- so just first --. So prior year, actually more moves than normal in the second half of this year. So on Motor, we said at the Q3 that we were seeing a delay in settlement of a large volumes of claims, which have pushed reserve releases to the right. So we haven't seen any large injury reserve releases come through in the second half of the year. However, we are actually seeing settlements still come through positively versus case reserves, but we're being cautious on the outlook there because clearly, there is some inflation in the system. We do expect it to come through it at some time, and we are holding some specific reserves against inflation risk.

On -- so the movement actually you've seen in the second half is more to do with third-party property damage where some of the movements we saw were even on the back -- even go back to the '21 year because you're seeing some very late settlements in third-party property damage at the moment.

On Home, the second half impact is subsidence on old years rather than the current year. So subsidence in the current year sits within the effective within the weather number is actually going back to 2018, which was quite a big subs year. So we're just seeing some movements on some of the old -- some of those claims, mainly due to actual inflation in the marketplace, so building inflation.

[Jonathan Greenwood, Acting CEO]

On the first question, I think there are kind of two factors to consider. The first is a lot of the premium that we were earning in 2022 would have been written in 2021. So inevitably, we were pricing that business ahead of some of the factors, which really only emerged in 2021. So clearly, lots of the inflationary factors, shortage of parts, the rapid increase in the value of secondhand vehicles, the labor rate inflation, many, many things that fed into that 2022 inflation story were not visible in 2021 when we were pricing business that was ultimately earned in 2022. So that's a key component.

As we saw inflation through the course of 2022, we clearly did react to that but I think it's fair to say that we were perhaps optimistic about where it was going to settle. And ultimately, the inflation, particularly in the second half, continue to deteriorate beyond the judgments that we've made when we responded to those inflationary pressures as we saw them.

[Thomas Bateman, Berenberg]

Thomas Bateman from Berenberg. Just on your IFRS 17 guidance. You're saying 10% is an ambition. I don't think you've set that ambition for 2023. It's kind of a 2024 onwards. Is that correct? And how quickly should we expect you to meet that 10% NIM guidance?

On capital and the dividend, it looks today that you're kind of rolling out a capital raise. Is that correct in the sense that you've put on kind of mechanical and self-help stuff rather than a big capital raise? And similarly, I assume that's because you're looking to retain the earnings that you generate in 2023 and hence, unlikely to pay a dividend at half year? But for what would determine the kind of full year dividend outlook?

[Jonathan Greenwood, Acting CEO]

Okay. Do you want to take those?

[Neil Manser, CFO & Director]

So second one first, we'll update at half year on dividend outlook. I'm not going to speculate ahead at the half year on dividend outlook. And we'll look at the performance in the first half of the year, outlook for the rest of the year and any capital actions we've done. So let's hold that conversation to the half year.

On IFRS 17 and the margin, we said its ambition. We have not put a time horizon around it given the headwinds in Motor coming through. Clearly, we will not meet that in 2023 because the Motor earnings lagged. And we are working hard to restore the margins that we need to hit that ambition. But I'm not going to give you an exact timeframe on it. I mean, I think making earnings out for 2024 sitting here today is quite early things to do.

[Nicholas Johnson, Numis Securities]

It's Nick Johnson from Numis. Just one question, please. So just back on the 10% NIM target. So that equates to 96% COR under IFRS 4, which is obviously worse than the 93%, 95% target you had beforehand. Just wondering if you could explain why you're now targeting a lower combined ratio than previously?

[Neil Manser, CFO & Director]

Yes. So it's a bit more conservative than under the old IFRS 4 measure. So agree with that, Nick. Our aim is to, over time, beat that target but certainly over the next couple of years, given the headwinds in Motor that we're facing as we just earned through the premium, I think it's a central place to start.

[Rhea Shah, Deutsche Bank]

Rhea Shah, Deutsche Bank. You mentioned 90% of new business market sales are done through PCWs. Where is Direct Line now? And where do you expect that to go? And could that have an impact on average premiums going forwards?

And then on the restructuring cost, you mentioned that they were mostly noncash, but how should we expect those to develop over the next few years?

[Jonathan Greenwood, Acting CEO]

I'll take the first of those questions. I'll let Neil take the second one. So yes, clearly, there's been a long-term trend towards PCWs. I suppose I'd probably start by just giving my perspective on the group and its position within PCWs, which is when you think about what it requires to be successful in that channel, it's about brand, it's about pricing, it's about trading.

Starting with brands, we deploy three brands into the PCW channel: Churchill, Privilege and Darwin. So we are fortunate in having an excellent, stable of extremely strong brands. Churchill brand, in particular, is an extremely successful brand in the PCW channel. We know that customers will select that brand even against more competitive prices. So from that perspective, I think we've got a particularly strong position.

We've been operating in the PCW channel for a very long time. So already, we've got good experience of operating in that channel. We have recently enhanced our pricing tools. And I think that only underpins our position in the PCW channel. And we've also recruited additional people in, especially with experience of that PCW channel, both in the trading teams and in the pricing functions.

So I start from a position of thinking we've got a really strong proposition in the PCW channel. In terms of average premiums, it's just very much about risk selection as it would be in the direct channel. Neil?

[Neil Manser, CFO & Director]

On restructuring costs. So a lot of restructuring costs we've had have later been property related and a lot of the ones in 2022 are -- we're actually moving our head office. We're selling Bromley and moving out Bromley and moving to a much smaller head office. So they're property related. There may be some more property related factors over the course of the next couple of years. But if I were to say a number low double-digit million, something like that, we're not expecting significant restructuring costs.

[Freya Kong, Bank of America Merrill Lynch]

Freya Kong from Bank of America. Just a follow-up on Alan's question and the management actions that you're taking. In terms of restoring margin in Motor, is that on a written or earned basis? And in your report, you talk about moderate and severe stress tests in solvency. Could you give us some color on what those scenarios might look like and where your solvency ratios would land?

And sorry, second question. Thinking about the second year impacts of PPR on Home and Motor, it's clear that renewal margins have come down across both books of business and not been offset by new business growth. How do you expect this to evolve over 2023? Or are we looking at structurally lower margins across the group?

[Neil Manser, CFO & Director]

The first of those -- I think I'll do the first one. So I forgot the first part of the first question because there's a second part that we do...

[Freya Kong, Bank of America Merrill Lynch]

So first part of the first question was Motor margins being -- written or earned?

[Jonathan Greenwood, Acting CEO]

Do you want me to do that? And...

[Neil Manser, CFO & Director]

Well, let me do the capital and then you do the product. So from a capital perspective, there we're looking at written margins because it's written margins are relevant for the capital model as opposed to earned margins. So getting those written margins in the right place.

In terms of the severe and plausible stresses. We haven't disclosed exactly what those are, but you can kind of work out what the kind of things that will be in there, inflation spike, credit spread spike, those sorts of things. The severe stress is pretty severe. It's taking the Bank of England and kind of some of the Bank of England base cases. And so we would expect to use, in those situations, as you would expect, management actions to restore solvency.

[Jonathan Greenwood, Acting CEO]

So on the margins, yes, we're clearly looking to restore margins on a written basis going forward. I think as Neil said in his presentation, some of the premiums written in the very early part of this year, we will still have a greater headwind as they flow through 2023.

On the impact of PPR, I think the major impact of PPR has already been felt. We did expect slightly higher new business volumes to offset the renewal -- sorry, the reductions that we made in average premium on the renewal book that didn't quite come to pass as we'd expected. New business volumes may well pick up as we go through the second year, so that might reverse. And generally, I think there are things that we can do to increase and improve margins in any event.

[Faizan Lakhani, HSBC]

Faizan Lakhani from HSBC. Just two questions for now. First one, since January, it seems like the tone around what you can achieve in 2023 has changed. Before, you sort of guidance 2 to 3 points above your 93 to 95, so that was just 97 to 98 this year. It doesn't feel like you're suggesting that you can get there and that you have been pricing claims inflation at the start of the year. So I just don't quite fully understand that messaging around that.

The second is, you seem to have loaded your reserves for higher bodily injury inflation. Have you done the same for your solvency model? Or is that a risk for this year?

[Jonathan Greenwood, Acting CEO]

I'll take the first one, Neil. You'll take the second one. On the first one, there's simply a lag that affects us. So whilst we have been increasing prices, if you think about renewals, there's always a 6-week lag, which means that whilst we increase prices, we have to wait until those renewals feed through. So that's why there's still a headwind coming from the business that we wrote in the first quarter of this year. Neil?

[Neil Manser, CFO & Director]

So on reserving, we do hold some inflation, some reserves specifically for heightened inflation risk in the reserves, that's right. And in the capital model, we have strengthened the inflation basis within capital model as well at the year-end.

[Teik Goh, RBC Capital Markets]

It's Derald Goh from RBC. Two questions, please. The first one, I appreciate it's difficult to give any steer on Motor COR at this stage. But could you maybe talk about the outlook for Home and Commercial COR for '23 and beyond?

And secondly, how much scope do you have to accelerate that growth in Commercial? It looks pretty profitable, but at the same time, I imagine it's more capital consumptive than the other lines.

[Jonathan Greenwood, Acting CEO]

I'll take the second one. Look, the commercial business is performing well. Early part of this year is also looking quite positive on growth but it is more capital consumptive. But we're very pleased with the returns that we're achieving now on that particular business. Do you want the...

[Neil Manser, CFO & Director]

Yes. I wouldn't add too much on the other businesses. I think the other businesses, as we said in the presentation, performed well during 2022, actually slightly better than target margins. I assume that those businesses are achieving the hurdles we need.

[Ashik Musaddi, Morgan Stanley]

Ashik Musaddi from Morgan Stanley. Just one question. I saw a remark that you're trying to improve retention even from 82%. I mean is that my understanding right that you are trying to improve retention than -- better than 82%? Or that's the level of retention you're looking for?

And other than price, what is that, that will drive retention higher? Because I mean, I guess others would try to do the same, given the backdrop is very tough at the moment on the new business and competition is a bit more on the side. So what could you do to improve retention on that?

[Jonathan Greenwood, Acting CEO]

I think you may have picked up on the specific comment we made about the balance between rate and retention that we struck in 2022 where, if anything, we probably have the balance slightly too skewed towards retention rather than rate. So first of all, we don't set an absolute target for retention. We guided much more by the margins that we're pursuing. And this year, what we're saying is, if anything, we would strike a slightly different balance than the one we did in 2022.

[Abid Hussain, Panmure Gordon]

It's Abid Hussain from Panmure Gordon. Three questions, if I can, please. The first one on pricing. So the first one on pricing versus inflation. I'm just wondering, where is your current pricing tracking particularly across the Motor book, but any color on the Home book would be useful? And where do you think inflation is going to settle across 2023, please? That's the first question.

And the second one is on pricing versus your peers. Are you willing to push through prices ahead over and above your peers? I know you say value over volume, are you willing to push through prices ahead of your peers to restore your margins? And if so, can you give us some sense of price elasticity across our Motor book in particular? Post the pricing practice reforms, has that sort of changed the elasticity of the Motor book? So that's the second question.

The third question, a bit of a difficult question. It's around the decision-making. I just wanted to understand, is the current Board fully empowered to make all and any strategic decisions given the recent management changes?

[Jonathan Greenwood, Acting CEO]

Let me take the first question. So we are expecting claims inflation in 2023 to be high single digit. We're clearly pricing to that level. So that's the answer there.

In terms of pricing versus volume, we're very much guided this year by restoring margins over maintaining volumes. So whilst we can't predict what peers will do, our philosophy through 2023 will be very much centered around pricing for the margin.

[Abid Hussain, Panmure Gordon]

Just a follow-up on that. Are you seeing evidence of inflation tracking down to 9%, 8%?

[Jonathan Greenwood, Acting CEO]

So yes, we -- I think as we said in the presentation, in our own network, in particular, we've seen evidence of capacity returning. So the challenge last year was the constraint on capacity in repair centers. We're seeing some early signs of that easing, hence, we've said that we expect inflation to move down from last year's 14% to a high single-digit number this year.

On the second question, which I think you said question around...

[Abid Hussain, Panmure Gordon]

It's essentially around are you fully empowered to make all decisions?

[Jonathan Greenwood, Acting CEO]

Yes. So the Board have actively asked me to take any decisions that are necessary to make sure that the business returns to the kind of performance levels that we'd all expected to.

[Paul Smith, IR Director]

I think that's covered the questions in the room. So I'll just pass -- sorry, Darius, did you want to -- sorry, last one.

[Darius Satkauskas, KBW]

Darius, KBW. Just one question. Is there anything unusual about the ongoing audit and what's been signed off at this point? The reason I'm asking is you make a point that the audit is still ongoing whereas I think in the past, you'd make a point that the sort of is based on the audited numbers. Can you just sort of give us some color on that?

[Neil Manser, CFO & Director]

Yes, it's not -- we don't know we do it. It's not uncommon to have it unaudited. There's nothing to read into that.

[Paul Smith, IR Director]

I'll pass to Adam to coordinate the questions on the phone. Over to you, Adam.

[Operator]

[Operator Instructions]. And our first question today comes from James Shuck from Citi.

[James Shuck, Citigroup]

So my two questions, I just wanted to push more on the 2 to 3 points of margin improvement that you expected in 2023 because -- well, sorry, margin -- yes, 2 to 3 points over your 95, expecting 97, 98. Can you just confirm that you have actually stepped away from that today? It's not clear to me whether you have or not? And if you have, what has changed in the space of 2 months or so? Is it the market getting more competitive? The pricing not held as much as you believe? What are the drivers of that, please?

Secondly, on the solvency level, so I think you got about 152% at the end of February because you gave a market update in the release as well. Does that include the pull to par? Or is there still more to come from the pull to par through the remainder of the year? And how are you thinking about where that target needs to be? Obviously, with the operating earnings outlook being somewhat cloudy, do you need to be closer to 170? And how fixated are you on your credit rating? If you were to get downgraded, what impact would that have on your business, please?

[Neil Manser, CFO & Director]

There are about 3 or 4 in there. I think I counted. Let me try and do them. So credit rating, we've got a flat rate at the moment with Moody's. It is important for some parts of the business, but not most of our business, I would say. But I think we're confident that the level of capitalization we have at the moment are consistent with that.

Second one, trying to work backwards here. We're in the range I'm not getting we're in -- we're on . We're in that range today. Clearly, when -- we would always look at the operating environment we're in, the outlook for the business, all the other external factors out the wings certain where to be in the range. But clearly, we want to, at least, get back up to the 160 level.

Then on the first one, which was the COR. Obviously, there won't be a COR this year because obviously, we all know we're moving accounting standard.

In terms of where we thought we might be, I think we're not going to give a specific guidance for 2023 because of the uncertainty out there. And I think I'd be -- so we're probably being slightly more conservative than we were back in January for how I articulate it.

[James Shuck, Citigroup]

Sorry, Neil, I can't quite follow. Does that mean the 2 to 3 points above your 95, I know we're a different accounting standard. But you gave us only a couple of months ago. Are you saying you'll be [indiscernible] that in '23, if we were to be on the same accounting expanded now?

[Neil Manser, CFO & Director]

So we're not going to give a specific number for what that will be. But I think there are clearly as we -- that was done in early January. We have been putting rate through the book. It does take a life that rate to earn through because of the renewal lag. So I would say we say we're being pay a bit more conservative than that, how I'd phrase it.

[Operator]

The next question comes [indiscernible] from Barclays.

[Unidentified Analyst]

I've got a few questions as well. So first one, just when I think about this combined ratio of 96%, which is equivalent to 10% of net insurance margin, you're suggesting that business outside of Motor is actually doing materially better than that at 92% at the moment, adjusted for weather. And you're going to aim to achieve 96%? What does it mean for the implied Motor combined ratio that you think is sustainable over the medium-term?

Second question, I just want to maybe understand, it's a bit technical, but on Home, you've only increased your weather budget by 3% for 2023. Why is that? Because way below inflation? Is there some changes in exposure? Maybe related to that, you can talk about the changes to your reinsurance coverage that you have purchased.

And the third question, if I may, just to follow up on what James just asked before. Your solvency ratio last year before final dividend and buyback was just a little bit shy of 198. And this came down towards the very bottom of the range if you take out the quota share, which was implemented very late in the year. So it's almost a 60-point move within the year. What makes you comfortable that 140 to 180 is an adequate range and that 160 is the right point within the range? Because I think there's a lot more volatility in the solvency ratio that we have anticipated for a business of your risk profile.

[Neil Manser, CFO & Director]

Do you want to do those? Right. So just three is hard to remember. So the 198 was not the adjusted number. The 198 included is from Tier 2 debt that we were going to retire. So that I don't think that the appropriate number to take as a starting point. We said the adjusted number was 160 at year-end. So I think that's the right starting point for that calculation, not 198. On Home -- I've written Home, I have forgotten the question.

[Jonathan Greenwood, Acting CEO]

There was -- the weather budget does...

[Neil Manser, CFO & Director]

The weather budget, okay. So the weather budget reflects inflation in -- underlying inflation, less lower policy count this year versus last year. So that's the on the weather budget.

On the COR. The 6-point transition is not equal by each segment. So waiting because obviously some segments or some parts of our business have greater other income or installment income. So that 96 is -- it will be different -- the rec between the 10% margin and the COR different for each business line, what I tried to give you is an overall average is 6 points. So hopefully that just helps when you're thinking through that triangulation. And then lastly, on the net insurance margin, I've written down, which was -- what was the net insurance margin once? Oh, that was it.

[Unidentified Analyst]

The final one, small numbers, just from the reinsurance program for 2023 [indiscernible].

[Neil Manser, CFO & Director]

So reinsurance, and I think basically that was for Home, Ivan. So on Home, we renew our reinsurance on the 1st of July, not the 1st of January. So we haven't gone to that process for this year yet. Look, I think from all the feedback I got from the market in January, we would expect reinsurance pricing to be up. We already retained quite a decent amount actually. We're about 150 retention. We haven't had a loss into that reinsurance program for a long time.

[Unidentified Analyst]

Okay. And on Motor, it's still GBP 5 million, right, per risk?

[Neil Manser, CFO & Director]

On Motor, per risk, we've given you that, GBP 5 million. It's in the back of the presentation, actually. So GBP 5 million unchanged. We did see some price rise on that program, but it's fully placed on the same terms as last year.

[Operator]

We have no further questions on the phone line. So I'll now hand back to Jon.

[Jonathan Greenwood, Acting CEO]

Thank you very much. I think with that, then I'd just like to say thank you for taking the time to join us this morning. And I think we're closed. Thank you.