General insurance stocks like Direct Line Insurance Group (LSE:DLG) have traditionally been excellent sources of passive income. The steady flow of cash they make from premium collections have for the most part made them rock-solid stocks to buy for dividends.
Their reputation as dependable income shares have suffered more recently, though, as cost pressures have mounted. This particular FTSE 250 operator slashed the annual dividend by two-thirds in 2022, to 7.6p per share.
But with premiums rising strongly and costs moderating, City analysts expect dividends from Direct Line shares to explode from last year’s levels, as the table below shows.
Should you invest £1,000 in Direct Line right now?
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| Year | Dividend per share (f) | Dividend yield | Dividend growth |
|---|---|---|---|
| 2023 | 9.5p | 4.1% | 25% |
| 2024 | 14.3p | 7.8% | 51% |
| 2025 | 18.1p | 9.9% | 26.6% |
These dividend forecasts suggest the insurer could be a great source of passive income. But how robust are current estimates? And should I buy the business for my portfolio in the new year?
Good and bad
First it’s worth taking a look at Direct Line’s dividend cover. For 2024 and 2025 predicted dividends are covered 1.2 times and 1.4 times respectively by anticipated earnings. These readings fall well below the widely regarded security watermark of 2 times and above.
Weak cover hasn’t stopped the company from paying huge dividends in the past however. And the upcoming sale of its NIG brokered commercial insurance business will give the firm improved financial strength to meet current dividend forecasts.
Direct Line estimates that the NIG deal will boost its Solvency II capital ratio from an unimpressive 147% in June to above 190%.
Alarm bells
The NIG transaction is critical in terms of future dividends. The business says that its Solvency II ratio must return to the higher end of its 140-180% target range before cash payouts resume (it paid no dividend for the first half of 2023).
While the deal hasn’t been completed it looks likely to go through without a hitch. However, this is only part of the dividend recovery process. Direct Line has also said that organic capital generation needs to return at its Motor division for payouts to be resurrected.
This won’t become clear until full-year results (likely some time in March). Until then a large question mark hangs over the insurer’s dividend policy.
Worth the risk?
On the plus side, higher premiums will start to boost the company’s bottom line from this year. But there are still huge obstacles Direct Line must overcome to pay the sort of massive dividends it has in years gone by.
A backdrop of intense market competition across its Motor and Home divisions poses a risk to earnings (and dividend) growth from 2024 onwards along with efforts to keep its balance sheet on a strong footing.
The insurer’s ability to keep hiking premiums could also falter as accusations of industry overcharging grow. The company will be keen to avoid further action from the Financial Conduct Authority after the regulator ordered it to repay £30m in September to existing policyholders who it overcharged.
On top of this, profits at Direct Line are in constant jeopardy from higher-than-expected claims costs.
It’s worth noting that City brokers have reduced their dividend estimates for Direct Line shares in recent months. And given the possibility of further reductions in the months ahead, I think there are better stocks to consider buying for passive income.
