Higher costs for used cars, more expensive parts and longer repair times have hit profits at Direct Line, the UK’s second-largest motor insurer.

The group’s shares were among the poorest performers yesterday in London following a trading update in which it warned that overall claims costs are rising at about 10 per cent. Direct Line has started increasing prices for motor insurance in a bid to restore profit margins, but analysts at Jeffries cast doubt on how effective that might prove.

Direct Line, which also owns the Churchill and Green Flag brands, is the second UK motor insurer to warn on profits in the space of a week after Sabre Insurance Group said its claims inflation is running at about 12% versus roughly 8% in 2021. The entire sector is struggling with higher claims costs, with shares in market leader Admiral down nearly 8% yesterday on the back of the news from Direct Line.

"Following Sabre's profit warning, it is clear that claims inflation is accelerating at a pace that UK motor insurers cannot keep up with,” Jeffries said in a note to investors yesterday. “Even with prices rising, we expect margins to deteriorate significantly.”

Direct Line said its combined operating ratio – a measure of costs as a proportion of premiums charged – will be between 96% and 98% this year. The closer that figure is to 100%, the less profitable the business.

READ MORE: New car shortages set to continue in 2022

In May, Direct Line said it expected to be between 93% and 95% this year, compared to 90.1% last year.

“We have already taken actions including increasing prices and deploying new pricing capability to restore margins, which mean we expect our 2023 combined operating ratio will improve to around 95% and we reiterate our medium-term target range of 93% to 95%,” chief executive Penny James said.

Motor insurers performed well during the early part of the pandemic as lockdowns led to fewer cars on the roads and fewer claims. As a result, insurance premiums fell during the year to last autumn.

However, global shortages of semiconductors and other materials have cut availability of new cars and driven up second-hand prices. According to Auto Trader, the average price of a used car in May was £3,400 more than it was a year earlier.

Direct Line said it was “confident” on maintaining its regular dividend payments but will now hold back on a second £50 million share buyback announced earlier this year.

READ MORE: Calnex weathers semiconductor storms to generate record profits

“The group is confident in the sustainability of its regular dividends and is continuing to take action to both improve returns and further increase resilience given macro-economic uncertainty, including reducing credit exposure and, as previously disclosed, is considering the use of strategic reinsurance,” Direct Line said.

“In the light of the current market environment, the board has decided not to launch the second £50m tranche of the £100 million share buyback programme announced earlier in the year.”

Direct Line said its other business units – which span home, travel, pet, and life insurance along with the Green Flag roadside recovery service – were performing largely in line with expectations “demonstrating the benefit of the group’s diversified business model”.

The group posted an 11% increase in operating profits for 2021, though pre-tax profits dipped by £5.4m to £446m after accounting for restructuring costs. Shares in Direct Line closed yesterday’s trading down 22.75p at 193.65p.