Direct Line Insurance Group plc (DLG) Earnings Call Transcript & Summary

Hello, everyone, and welcome to the Direct Line Group IFRS 17 Teaching Call. My name is Daisy, and I'll be coordinating your call today. [Operator Instructions] I'd like to hand the call over to your host, Neil Manser, the Chief Financial Officer at Direct Line Group to begin. So Neil, please go ahead.

Thanks, Daisy, and good morning, everyone, and thank you for joining us for our IFRS 17 briefing this morning. Now I know you've sat through many of these presentations over the past few weeks. So I'm going to keep the comments upfront brief, only referencing a few pages in the pack we sent out, and then we can get into any questions you have. The key messages we want you to take away from today are set out on Slide 2. First and most importantly, these accounting changes do not impact the economics of our business or our dividend paying capacity. Secondly, the standards will drive several presentational changes in the income statement and balance sheet, which we think improves comparability between companies and should be beneficial for investors. Thirdly, the accounting choices we've made will improve alignment between reported earnings and capital generation under Solvency II. Fourthly, we expect there to be a modest reduction in equity on transition, largely due to the treatment of acquisition expenses. We expect similar reserve strength with reserves set at around the 75% confidence level. And finally, we plan to use net insurance margin as our key performance measure and will set out our targets on this basis alongside our full year 2022 results. So let's take each of these points in a bit more detail. I'm going to start on Slide 5 to orientate you around the high-level income statements before I go into our policy choices. Now it's important to state here that this is the management view of the income statement and the statutory view will be a slightly different presentation. We have a new headline revenue measure that replaces net earned premium called net insurance contract revenue and this will now include elements of other income as well as premium. After deducting net claims and expenses, we arrived at the insurance service results and this replaces the underwriting results and again includes elements of other income reported -- currently reported separately, for example, installment income. On a management view, we intend to report operating profits as the insurance service result plus investment income and noninsurance activities. And below operating profit, we will capture the changes in fair value of assets and the movement of discounting liabilities in 1 place. There are a number of more detailed changes to where elements of income and costs will be reported, and these are set out on Slides 8 and 9. Let's turn to the accounting policy choices on Slide 6. The accounting choices we've made are designed to improve alignment between earnings and capital generation. Our contracts qualify for the premium allocation approach or PAA, as virtually all of our insurance and reinsurance contracts are for 1 year, so we'll continue to earn on a straight-line basis. From next year, premiums will include installment income and other similar income, which will also be earned on a straight-line basis. Moving down to acquisition costs, where today we defer these the balance sheet and next year we'll expense all our costs as incurred, which again brings it into line with the treatment under Solvency II. Now the mention of claims is the biggest change under IFRS 17. Today, we discount only our PPO liabilities, but under IFRS 17, we will discount all of our claims liabilities. This means there will be much closer alignment between IFRS and Solvency II with small differences only arising from the illiquidity premium used under IFRS versus the volatility adjustments used under Solvency II. Lastly, the debt securities, we've chosen to recognize unrealized gains and losses in the income statement to match our liabilities rather than an equity, as they are today. On Slide 7, you can see that in addition to the measurement changes, the standard introduces new terms and acronyms for the components of claiming reserves. The chart shows the current IFRS 4 management margin is removed under IFRS 17 and events not in the data or ENIDs are added. A risk adjustment is then applied around the 75% confidence level before the total is discounted. Now there are 2 new acronyms that I suspect by now you're familiar with, the BEL or best estimate liability; and the LIC or liability for incurred claims. So in summary, we will hold a similar level of reserve strength and the changes bring us much closer in alignment with Solvency II. Now I'm going to move to Slide 10 and the opening balance sheet. The headline is that there is a modest reduction in equity and the waterfall shows the main movements. Basically, the removal of deferred acquisition costs is largely offset by a reduction in claims liabilities, including discounting. As you can see, the changes are straightforward. And finally, a few words on KPIs on Slide 11. As I mentioned upfront, we've opted to change our headline metric from combined ratio to net insurance margin. There are a few reasons for this. The main reason is that we believe it's a better measure of how we run our business as it includes income that currently sits outside of the combined ratio. And we also think it's easier to compare insurers on this basis. And lastly, it can measure there is more in line with other retail industries. We will set out our targets on this basis alongside our full year 2022 results. That's all I want to cover today, you can see that the changes for us are relatively straightforward, and we believe the way we present the P&L going forward will be helpful. I'll now hand back to Daisy to open the line for your questions.

[Operator Instructions] Our first question today comes from Freya Kong from Bank of America.

Just checking on the breakdown of the insurance contract revenues, are you going to give us a split of the NEP and the other income or installment income? Are we going to get that sort of granular detail? And then secondly, am I right in thinking that you're going to put the discounting of liabilities, their insurance finance expenses below the operating profit?

Thanks, Freya. Yes, so on the first one, we should get all the detail in the notes of the accounts. So we'll split out the movement -- the premium line and then the contribution from other income into the insurance contract revenue. So you should be able to see all that quite clearly in coming through. And then on the discounting, what we've done is we're going to put all that through 1 line that fits in which -- it's in the net finance expense number that captures all of the discounting impacts on the market movements. So it's all in 1 place.

Okay. That's below the operating profit because this is your management view, right?

Yes. Exactly. Exactly.

Okay. Okay. Cool. All right. So it's more comparable to what we have now, I guess?

Yes, we're trying to create a line that is a clear line for you to judge our performance against.

Our next question is from Thomas Bateman from Berenberg.

Just the first on the discount rate. Can you just give us a bit of a guidance, maybe the level of discount rates that we're using and i.e., what the liquidity premium might be? And the second question is just on the DAC. Could you just give us an idea in terms of -- because I assume we have a slightly higher cost next year and slightly lower costs moving forward? And could you just give us some kind of order of magnitude of it?

So on the first question, illiquidity premium, it depends where you are on the curve. So for a short duration, it's pretty minimal actually. And then as you go further out, it becomes greater. So it's, I would say, fairly you go out, it's somewhere between 100 and 200 basis points, but it would depend a lot on where markets are and obviously, it's changed quite a lot over the course of this year. So it's quite minimal short-term, gets increasing greater as you go up the curve. I think quite -- I'm saying the second question can you say it again, Tom?

Yes. So because we're changing from deferring acquisition costs, I guess we have slightly higher costs in year 1 as you write off, is that fair? And maybe what's the impact of deferring the costs next year?

Yes. Got you, sorry. So it depends very much on the growth rate. So in a normal year, you would -- in a year where you're fairly flat in terms of your new business flows, you wouldn't actually expect to see any difference because you unwind the DAC is equivalent to your new acquisition cost going in. Clearly in a year if you have very strong growth, you will see some new business strain coming through. But it will very much depend on the new business growth year-on-year just estimate whether that's a drag or a positive.

[Operator Instructions] Our next question today is from Faizan Lakhani from HSBC.

I just had a question on Solvency II in terms of the flow from IFRS 17 earnings into capital generation. Currently, you have sort of CapEx strain in there, will that still be there going forward? I just wanted to understand that really.

Yes. So thanks, Faizan. So what we try to do is align as much as we can. Clearly, there are somethings that will not align between IFRS earnings and Solvency II and a CapEx is 1 of them. So we'll continue to amortize through the IFRS 17 P&L. And then in the Solvency II, the steady Capgem -- the intangibles are written off, and then you'll see the Capgem -- sorry, the CapEx going through the sort to it will be the same as today. We can't align that because the accounting treatment is just different.