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Earnings season: why the Direct Line share price just crashed

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The Direct Line Insurance Group (LSE: DLG) share price crashed when markets opened this morning after the FTSE 250 insurer scrapped its dividend.

The firm said it had faced a surge of claims after December’s cold snap and no longer had enough spare cash to support the payout. This is bad news for shareholders — including me — so here I’ll explain exactly what’s happened and how I plan to handle this situation.

Key facts: the big freeze

Direct Line says that December’s “prolonged period of sub-zero temperatures” across the UK caused a spike in claims for damage due to burst pipes, water tanks, and related damage.

So far, 3,000 customers have made claims. Some further costs could still arise, but the company estimates that total costs relating to “the freeze event” will be around £90m. That’s around £30,000 per claim, including some business customers whose costs may be higher.

Weather-related claims for this year are now expected to total £140m, including subsidence claims from the summer drought.

Claims costs are still rising

Unfortunately, the big freeze wasn’t the only problem highlighted in today’s update. Last year, Direct Line (and most other motor insurers) saw a big increase in claims inflation. Repairs were taking longer, due to parts shortages. They were also costing more to settle, due to high used car prices.

This problem hit the whole industry, so I wasn’t too concerned. By November, the situation seemed to be under control. The company said motor insurance prices had been increased and claims costs were “tracking closely to our expectations”.

Unfortunately, it looks like costs are actually still rising. In today’s update, the firm said that while its in-house repair costs are under control, claims made by other insurers are still rising.

The icy weather in December resulted in extra claims too, as drivers crashed on slippery roads.

Direct Line shares: buy, sell, or hold?

Insurance companies need to keep a certain amount of surplus capital to ensure they can payout on claims. Normally, the amount required is fairly predictable. But sometimes bad weather or other problems arise, causing a sudden spike in claims costs.

That seems to be what has happened here. As a result, the final dividend has been scrapped to save cash. As a shareholder, I’m disappointed, but I also understand that these things can happen.

However, I’m starting to wonder if Direct Line’s claims assumptions have simply been unrealistically low. The stock’s 10% dividend yield — before today — was perhaps a warning I should have heeded.

I’m not sure, but the damage has been done. For this reason, I’m not planning to sell my shares at the moment. Direct Line remains one of the UK’s largest motor insurers and I don’t see any fundamental risk to the business.

My plan now is to wait for the company’s 2022 accounts to be published on 7 March. These should provide a clearer picture of the company’s financial situation. Hopefully, they will also include updated dividend guidance for 2023 and beyond.

The post Earnings season: why the Direct Line share price just crashed appeared first on The Motley Fool UK.

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Roland Head has positions in Direct Line Insurance Group Plc. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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