sold his 25 per cent shareholding to the bank in return for an earnings
formula based on the performance of Direct Line. In return, Mr Wood was
given a free hand to develop the business without central interference. In
1992, Mr Wood was appointed to the board of the Royal Bank of Scotland
Group.
This early period was spent in frantic development of the sophisticated
communication and information systems behind Mr Wood’s idea. It was
intended from the beginning to develop a direct telephone and mail distri-
bution channel, bypassing the brokerage route and thus saving the com-
mission charged.
After the sale of the first policy there followed a period of test marketing
prior to a national launch in September 1985. The business grew rapidly,
driven by carefully monitored tactical press advertising and marketing to
the customers of the Royal Bank. By 1992 Direct Line had grown dramati-
cally and was the market leader in Direct Insurance, with some
670 000 policy holders of its motor policies. This represented an increase of
89.9 per cent in premium income over 1991, while at the same time the
company’s expense ratio had reduced from 19.6 per cent to an industry low
of 14.5 per cent. In a traditional broker-based insurance company around
38 per cent of overall expenses were commission and a further
17 per cent related to claims handling. In Direct Line some 12 per cent of
expenses were variable. The remainder of the expense base was more or
less fixed. Substantial scale economies would thus occur if volumes were
increased up to the point where capacity constraints occurred.
Nevertheless, since much of Direct Line’s fixed costs were based on com-
puting and communication while labour costs were limited, substantial
experience effects were possible.
In addition to its expense ratio advantage, Direct Line had been highly
successful in driving down its claims ratio to less than 70 per cent com-
pared with an industry average of over 80 per cent. This reflected the supe-
rior risk profile of Direct Line’s motor portfolio. In motor insurance Direct
Line had become one of the leading participants, with a national market
share of 4.5 per cent, and many analysts believed that the company would
shortly become the leading motor insurer in the UK. Further, Direct Line
enjoyed a customer retention rate of 85 per cent compared with the indus-
try average of around 50 per cent.
In October 1988, adopting similar tactics to those used to develop the
motor market, Direct Line launched its Home Insurance product and by
1992 had over 206 000 policies in place. Like the motor industry, the split
between structure and contents was some 60/40. Moreover, around 30 per
cent of those with a household policy also had a motor policy with the
group. Direct Line were also extremely careful in insuring properties with
contents value at over £40 000. Such properties were physically inspected
and strict security requirements laid down before policies were put in force.
114 Relationship Marketing