Is Direct Line Group right to float so soon?

If the talk about Direct Line Group’s (DLG) initial public offering (IPO) launch tomorrow is true, it is good news for the insurer and could help warm up the cold feet of other insurance sector companies waiting in the wings for better flotation conditions.

There is much discussion about whether now is a good time to float given stock market volatility amid the continuing economic turmoil.

Several companies, such as Hastings and Cooper Gay Swett & Crawford, are holding fire on their IPO plans. Also, under the conditions of its 2008 bail-out, DLG parent RBS does not need to sell any of its stake until 2013.

RBS has to shed the majority of its stake in DLG by the end of 2013 and the entire holding by the end of 2014.

But that does not mean DLG and RBS are wrong to push ahead now.

Challenging the status quo

For a start, the sentiment about the state of the IPO markets is improving. German insurance holding company Talanx - the parent of reinsurer Hannover Re and industrial mutual insurer HDI-Gerling - has announced its intention to float this autumn, despite previous reluctance.

Some may point to social networking site Facebook’s poor share price performance since its stock market debut as a sign that investors are not receptive to IPOs. But Facebook’s problems are likely down to uncertainty about how it can make enough money to justify its float valuation. DLG certainly does not have this problem.

It is one of the biggest, if not the biggest, personal lines insurer in the UK and has a good portfolio of household-name insurance brands.

Also, thanks to the efforts of chief executive Paul Geddes and his team, the company is now comfortably profitable. Yes, the first-half 2012 combined ratio was heavily bolstered by reserve releases, but at least the company now has reserves to release rather than having to add to them.

Leap of faith

There are some uncertainties about how the Office of Fair Trading’s motor insurance probe and the Jackson reforms will impact ancillary income.

It is also not clear, in the current difficult trading environment, when and whether DLG will hit its target of a 15% return on capital employed. The company’s combined ratio is still running above 100% and the low interest rate environment is making it difficult for all firms to counteract underwriting losses with investment returns.

Still, the company has shown its determination to cut costs. Its recent announcement of 891 job cuts, while bad news for employees, shows prospective investors that the company is not afraid to make big changes to ensure profitability.

In short, DLG has a good, strong story to tell would-be investors. And with a dearth of other opportunities for investors to get their teeth into, DLG’s flotation could be very welcome.