Direct Line 42 Regulatory News (12QN)

Interim results for Direct Line Insurance Group plc

For the six months ended 30 June 2012

Financial highlights

·; Operating profit from ongoing operations1 of £224.2 million up 7% compared with the first half of 2011 (1H 2011: £209.5 million) with adverse weather in 1H 2012 offset by higher releases from prior year claims reserves

·; In-force policies of 20.1 million, up 4% during 1H 2012 (FY 2011: 19.4 million) with Motor and Home stable and growth in Commercial and Rescue and other personal lines

·; Combined operating ratio2 for ongoing operations of 101.1%, an improvement against 1H 2011 (102.5%) driven by a significant improvement in the loss ratio

·; Profit before tax of £106.5 million (1H 2011: £187.5 million) reflects restructuring and other one-off costs relating to the separation from RBS Group

·; Earnings per share (basic) of 5.5 pence (1H 2011: 9.5 pence, FY 2011: 16.6 pence) with adjusted earnings per share3 of 10.8 pence (1H 2011: 10.2 pence, FY 2011: 20.5 pence)

·; Annualised return on tangible equity4 ("RoTE") from ongoing operations of 10.2% compared with 10.0% in 2011. Had the capital actions taken by the Company in 1H 2012 (£800 million dividends and £500 million subordinated debt issuance) occurred on 1 January 2012, annualised RoTE from ongoing operations for 1H 2012 would have been 12.1%5

·; Total dividends of £800m paid to RBS Group during 1H 2012 with an additional £200 million approved and paid on 3 September 2012

·; Net asset value of £2.9 billion (FY 2011: £3.6 billion) and tangible net asset value of £2.5 billion (FY 2011: £3.2 billion) equal to 194 pence and 168 pence per share respectively

Strategic highlights

·; Renewed or extended long-term distribution deals with key partners in 1H 2012 - Nationwide Building Society, and Sainsbury's Bank - and expected to reach agreement with RBS Group for RBS and NatWest in September. In addition, Churchill and Privilege launched on comparethemarket.com in July 2012

·; Further progress in rebuilding competitive advantage in pricing and claims management with benefits starting to be realised

·; Initiatives launched to target £100 million of gross annual cost savings6 by the end of 2014

·; Successful inaugural capital markets transaction with £500 million of Tier 2 subordinated debt issued in April 2012

·; Separation from RBS Group substantially complete with independent corporate functions and governance from 1 July 2012

·; Direct Line Group continues to deliver its transformation plan and has set a target of a 15% RoTE

Paul Geddes, CEO of Direct Line Group, commented

"This has been an important period for Direct Line Group. We are now beginning to see the benefits of our transformation plan in pricing, risk, claims as well as capital management actions and operational efficiency. Other than some transitional services provided by RBS Group, we have essentially achieved the goal of operating as a standalone insurance company. This means we have full ownership of our cost base and have launched initiatives to target £100 million of gross annual cost savings across the business. Real progress has been made during the first half of the year towards achieving our target of a 15% RoTE."

See page 2 for notes

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Notes:

(1) Ongoing operations

Ongoing operations include the Group's ongoing segments: Motor, Home, Rescue and other personal lines, Commercial and International. It excludes Run-off and Restructuring and other one-off costs.

(2) Combined operating ratio

Combined operating ratio is the sum of loss, commission and expense ratios (all expressed as a percentage of net earned premium). The ratio excludes instalment income and other operating income (as well as investment income).

(3) Adjusted earnings per share

Adjusted to exclude Run-off operations and Restructuring and other one-off costs and based on weighted average number of ordinary shares in issue during the period (using UK standard tax rate).

(4) Return on tangible equity (RoTE)

Adjusted to exclude Run-off operations and Restructuring and other one-off costs and based on average tangible invested equity (adjusted for the weighted average value of dividend paid in the period) (using UK standard tax rate).

(5) No adjustment for the weighted average value of dividend paid in the period as assumes all dividends paid on 1 January 2012.

(6) £100 million gross cost savings

Cost savings expected to be recognised in operating costs for ongoing operations and claims handling expenses by the end of 2014.

 Forward-looking statements

Certain information contained in this announcement including any information as to the Group's strategy, plans or future financial or operating performance constitute "forward-looking statements". These forward-looking statements may be identified by the use of forward-looking terminology, including the terms "believes", "estimates", "anticipates", "projects", "expects", "intends", "aims", "plans", "predicts", "may", "will", "seeks" or "should" or, in each case, their negative or other variations or comparable terminology, or by discussions of strategy, plans, objectives, goals, future events or intentions. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this announcement and include statements regarding the intentions, beliefs or current expectations of the Directors concerning, amongst other things: the Group's results of operations, financial condition, prospects, growth, strategies and the industry in which the Group operates.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future or are beyond the Group's control. Forward-looking statements are not guarantees of future performance. The Group's actual results of operations, financial condition and the development of the business sector in which the Group operates may differ materially from those suggested by the forward-looking statements contained in this announcement. In addition, even if the Group's actual results of operations, financial condition, and the development of the business sector in which the Group operates are consistent with the forward-looking statements contained in this document, those results or developments may not be indicative of results or developments in subsequent periods.

The forward-looking statements contained in this announcement speak only as of the date of this announcement. The Group expressly disclaims any obligations or undertaking to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, unless required to do so by applicable law, regulation or accounting standard, or the Listing Rules or the Disclosure and Transparency Rules of the FSA.

Overview

Direct Line Group made further progress in the first half of 2012 in relation to both its strategic plan and financial performance.

Business development

In the first half of 2012, Direct Line Group (the "Group") continued to make significant progress in delivering its strategic aim to be Britain's best retail general insurer by rebuilding competitive advantage in the areas of distribution, pricing, claims management and operational efficiency.

The Group has renewed or expanded partnership agreements that represent a substantial portion of its portfolio, especially in its home segment. The existing contract with Nationwide Building Society has been extended to 2015, and building on this relationship, the Group began to handle all of the post sales service and claims management for Nationwide's home insurance customers. The agreement with Sainsbury's Bank to provide motor insurance to its customers is now in its second year and was extended to provide home insurance.

Furthermore, Direct Line Group expects to reach agreement with RBS Group in September for an arm's length, five year distribution agreement for the continued provision of general insurance products post divestment.

Following the launch on comparethemarket.com, Churchill and Privilege motor insurance products are now available on all four major price comparison websites in the UK. This move reinforces Direct Line Group's multi-channel distribution strategy. Home products are expected to follow later in the year.

Execution of the Group's pricing and claims transformation plans continues with further developments in its pricing capability, embedding peril level technical pricing models for Home and developing price optimisation for Motor. Within claims management, and following pilot testing, a number of claims initiatives were implemented and the benefits are beginning to emerge. Claims inflation in small bodily injury claims has abated and together with lower litigation rates has contributed to higher reserve releases from estimates for prior year claims.

In line with the strategic business transformation plan, the Group has launched further initiatives to target £100 million of gross annual cost by the end of 2014, with one-off restructuring costs expected to be c. £100 million. The initiatives include reducing administration costs in central functions and improving marketing efficiency.

The Group also made further progress in optimising its capital structure during the first six months of 2012. On 27 April 2012, £500 million of Tier 2 subordinated debt was raised following publication of inaugural credit ratings from both Standard and Poor's and Moody's Investor Services. Direct Line Group's principal underwriter, U K Insurance Limited, is rated A by Standard and Poor's and A2 by Moody's Investor Services; both ratings carry a stable outlook.

Since 1 July 2012, the Group has been operating on a substantially standalone basis from RBS Group with independent corporate functions and governance following the completion of a number of separation initiatives. During 2012 to date, these included: launching a new corporate identity, confirming further senior management appointments, appointing a new independent Chairman , agreeing and issuing new terms and conditions for staff, implementing independent HR systems and making progress on an arm's length transitional services agreement with RBS Group for residual services.

Over the last 18 months a number of regulatory reviews and initiatives have been announced by the UK Government, the Ministry of Justice, the Office of Fair Trading and others in relation to the motor insurance industry. Direct Line Group is actively engaged with the major stakeholders, and supports the introduction of a coherent set of reforms.

Overall, Direct Line Group continues to deliver on its transformation plan and remains focussed on delivering its target of a 15% RoTE.

Financial summary

In-force policies and gross written premium

In-force policies (IFPs) for ongoing operations increased 4% during the first half of 2012 to 20.1 million and were broadly stable compared to a year ago (FY 2011: 19.4 million and 1H 2011 20.0 million). The increase related mainly to Rescue and other personal lines and arose from an increase in travel policies from packaged bank accounts. Motor and Home IFPs were stable during the period across both own brands and partnerships.

The Commercial business continued to grow IFPs through Direct Line for Business which focuses on micro and small businesses. After a period of strong growth in 2011, International consolidated its position at 1.4 million IFPs.

1 Adjusted to exclude Run-off operations and Restructuring and other one-off costs (using UK standard tax rate)

Gross written premiums (GWP) of £2,058 million were broadly stable with 1H 2011 (£2,093 million) reflecting the trends in IFPs. Motor market rates were broadly stable in 1H 2012.

Underwriting results

The combined operating ratio from ongoing operations of 101.1% improved over both 1H 2011 and full year 2011. This was attributable to a significant improvement in the loss ratio which more than offset an increase in the expense ratio.

The improvement in the loss ratio was despite approximately £90 million of weather related claims in the Home segment following the wettest April to June period since meteorological records began. Home weather related claims were approximately £50 million more in the UK than expected for the first half of 2012 (1H 2011: approximately £20 million better than expected).

Releases from prior year claims reserves contributed £228 million and represented 12.3 percentage points (pts) of net earned premium (1H 2011: £70 million and 3.6pts; FY 2011: £189 million and 4.9pts). Reserve releases in 1H 2012 arose from all segments particularly from Motor and Commercial. Releases from Motor were partly attributable to benefits that are starting to arise from the Group's claims transformation programme. Prior year reserve increases in Home in 2011 primarily reflected late reported claims on the 2010 weather events, some of which were released in 1H 2012.

The higher expense ratio in 1H 2012 reflected a temporary increase in central overhead charges relating to building separate corporate functions, higher management recharges from RBS Group of £16 million and accelerated spend in relation to marketing activities. The effect of lower net earned premium added around 1 percentage point to the ratio for ongoing operations. The Group expects to make progress in reducing its expense ratio in the second half of 2012.

On a segmental basis the combined operating ratio improved in Motor, Rescue and other personal lines and International compared with the first six months of 2011 and full year 2011. In Motor the improvement reflects management actions taken to improve the risk profile of the book as well as benefits flowing from the Group's claims transformation programme. Given the stage of this programme, these benefits are primarily achieved through releases from prior year claims reserves.

The Home combined operating ratio was adversely affected by the increase in weather related claims as noted above. Commercial benefited from significant reserve releases but was affected by a number of one-off large claims in its property book. The International combined operating ratio benefited from significant reserve releases in 1H 2012. Rescue and other personal lines demonstrated an underlying improvement in the 1H 2012 loss ratio compared with 1H 2011.

Operating result

The operating result for ongoing operations of £224.2 million was a 7.0% increase on 1H 2011 (£209.5 million). The underwriting result and investment return both improved but this was partially offset by a lower contribution from other income.

Other income of £98.8 million fell 26% due to the cessation of fee income relating to managing certain elements of the run-off of the Tesco Personal Finance (TPF) business and lower instalment income reflecting lower IFPs in Motor period on period and promotional campaigns.

Investment return of £145.4 million was £19.9 million (16%) higher than 1H 2011 and reflects higher realised gains arising primarily from portfolio restructuring. The income yield on the total portfolio (including run-off) was 2.1% in 1H 2012 (FY 2011: 2.3%) reflecting a higher proportion of short term deposits. The investment assets supporting the TPF liabilities are predominantly held in cash.

At 30 June 2012, exposure to peripheral Eurozone bonds was £51 million, less than 1% of the portfolio, comprising non-sovereign debt issued in Ireland, Italy and Spain. During the first half of 2012 the Group increased its investment in corporate bonds by investing approximately £400 million in US dollar corporate credit, bringing the portfolio closer to its maximum allocation of 60% toward corporate bonds. This is managed through leading global third party asset managers and is hedged back to Sterling. The Group believes that accessing the US markets should significantly increase the breadth of its investible corporate bond market and reduce its concentration risk.

Run-off and Restructuring and other one-off costs

The Run-off segment, which includes the exited personal lines broker and TPF businesses, made a profit of £1.2 million compared with a loss of £12.4 million in 1H 2011. Currently the majority of the results of operations from the TPF business are attributable to TPF through commission payments, and favourable run-off has resulted in a higher commission ratio in the period.

Restructuring and other one-off costs of £109 million primarily relate to activities associated with separation and divestment from RBS Group. It is currently expected that for the whole of 2012 costs will be approximately £170 million before any charges associated with the recently announced cost saving initiatives.

Finance and other costs

Finance costs increased to £10.2 million primarily reflecting interest associated with the £500 million Tier 2 subordinated debt issued in April 2012.

1 Investment income excludes net gains and is shown on an annualised basis.

2  Investment return includes net gains and is shown on an annualised basis.

Profit, and return on equity

Overall pre-tax profit for 1H 2012 was £106.5 million with profit after tax of £82.8 million (1H 2011: £187.5 million, £142.2 million; FY 2011: £342.9 million, £249.0 million respectively).

Annualised return on tangible equity for the period for ongoing operations was 10.2% (FY 2011: 10.0%). Had the capital actions taken by the Company in 1H 2012 (£800 million dividends and £500 million subordinated debt issuance) occurred on 1 January 2012, annualised RoTE from ongoing operations for 1H 2012 would have been 12.1%.

Earnings per share

Earnings per share were 5.5 pence (1H 2011: 9.5 pence; FY 2011: 16.6 pence). Adjusted earnings per share3 for 1H 2012 were 10.8 pence, an increase of 5.9% on 1H 2011 ((1H 2011: 10.2 pence; FY 2011: 20.5 pence).

Dividends

Total dividends of £800 million were paid to RBS Group during 1H 2012 with an additional £200 million approved and paid by the Board on 3 September 2012.

Net asset value

The net asset value at 30 June 2012 was £2,905.7 million (31 December 2011: £3,612.8 million) with tangible net asset value of £2,514.8 million (31 December 2011: £3,247.0 million). This equates to 193.7 pence and 167.7 pence per share respectively.

Capital position

Direct Line Group continues to be well capitalised, with an estimated Insurance Groups Directive (IGD) coverage ratio of 306% at 30 June 2012 (31 December 2011: 319%).

3Adjusted to exclude Run-off operations and Restructuring and other one-off costs, and based on weighted average number of ordinary shares in issue during the period (using UK standard tax rate).

DIRECT LINE INSURANCE GROUP PLC

COMBINED INCOME STATEMENT

DIRECT LINE INSURANCE GROUP PLC

COMBINED STATEMENT OF COMPREHENSIVE INCOME

DIRECT LINE INSURANCE GROUP PLC

COMBINED BALANCE SHEET

DIRECT LINE INSURANCE GROUP PLC

COMBINED STATEMENT OF CHANGES IN EQUITY

For the year ended 31 December 2011 and the six months ended 30 June 2012

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION

1. ACCOUNTING POLICIES

Basis of preparation

The condensed combined interim financial information presented has been prepared for Direct Line Insurance Group plc ("the Company") and its subsidiaries (together the "Group"). The financial information has been prepared on a historical cost basis except for investment properties and those financial instruments that have been measured at fair value. This condensed combined interim financial information has been prepared in accordance with IAS 34 Interim Financial Reporting, with the exception of the requirement to include a combined Cash Flow Statement.

International Financial Reporting Standards ("IFRS") as adopted by the European Union ("EU") does not provide for the preparation of condensed combined interim financial information and accordingly, certain accounting conventions commonly used in the preparation of combined financial information issued by the UK Auditing Practices Board have been applied. The application of these conventions results in material departure from IFRS as adopted by the EU with respect to the following item:

• the preparation of the combined financial information has required the allocation of certain RBS Group costs to the Group. While such costs have been allocated on the basis intended to reflect their nature, the financial information has not necessarily reflected the results of the Group had it been a standalone group during this time. As these cost allocations did not result in a corresponding cash payment, they are offset by an entry in equity, described as 'demerger reserves'.

The Group was formed on 2 April 2012 when the Company acquired Direct Line Versicherung AG. Prior to this date, the Group was not held by a single legal entity and, accordingly, consolidated financial statements do not exist. The combined financial information has been prepared using merger accounting principles, as if the transaction that gave rise to the formation of the Group had taken place at the beginning of the comparative period. Under these principles, the condensed combined interim financial information has been prepared as if the Company were the holding company of Direct Line Versicherung AG from 1 January 2011, the date of the beginning of the comparative period. The assets, liabilities and the profit or loss of the Company and its subsidiaries, and of Direct Line Versicherung AG have been combined. All transactions and balances between the entities included within the Group have been eliminated. The condensed combined interim financial information reflects a liability payable to RBS Group, at each period end prior to acquisition for the Direct Line Versicherung AG consideration. As the basis of preparation represents a reorganisation of entities under common control, it is therefore outside the scope of IFRS 3, Business Combinations. Accordingly, as permitted by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, it has been accounted for as a group reorganisation.

Adoption of new and revised standards

There have been no new or revised standards adopted during the period.

Principal accounting policies

There have been no significant changes to the Group's principal accounting policies as set out on pages F-11 to F-22 of the Historical Financial Information, included in the Group's prospectus dated 25 April 2012. The policies have been applied consistently throughout all the periods presented to items considered material to the condensed combined interim financial information.

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

2. SEGMENTAL ANALYSIS

There have been no significant changes to the Group's reportable segments as set out on pages F-50 to F-51 of the Historical Financial Information, included in the Group's prospectus dated 25 April 2012. The following is an analysis of the Group's revenue and results by reportable segment for the six months ended 30 June 2012 (reviewed):

All operations are in the UK except for International which operates in Germany and Italy.

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

2. SEGMENTAL ANALYSIS (Continued)

The following is an analysis of the Group's revenue and results by reportable segment for the six months ended 30 June 2011 (unaudited):

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

2. SEGMENTAL ANALYSIS (Continued)

The following is an analysis of the Group's revenue and results by reportable segment for the year ended 31 December 2011 (audited):

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

3. INVESTMENT RETURN

Impairments on available‑for‑sale financial assets during 2011 relate to debt securities. There were no impairments in 2012.

*Other net realised gains are in relation to the sale of other investment funds in June 2012.

4. OTHER OPERATING INCOME

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

5. EARNINGS AND NET ASSETS PER SHARE, RETURN ON EQUITY

Basic earnings per share are as follows:

Basic earnings per share are calculated by dividing the profit attributable to owners of the Company by the weighted average number of ordinary shares in issue during the period.

Net asset and net tangible asset value per share are as follows:

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

5. EARNINGS AND NET ASSETS PER SHARE, RETURN ON EQUITY (Continued)

Net asset value per share is calculated as total invested equity (excluding non-controlling interest) divided by the average number of shares in issue during the period.

Net tangible asset value per share is calculated as total invested equity (excluding non-controlling interest) less goodwill and other intangible assets divided by the average number of shares in issue during the period.

Return on equity is as follows:

Return on equity is calculated as profit after tax for the period divided by average invested equity, expressed as a percentage.

*Annualised.

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

Included within the debt securities balance above is £233.7 million (31 December 2011: £304.6 million) relating to securities issued by members of RBS Group.

Other investment funds comprised an investment fund which included Euro and US Dollar denominated bonds, hedged back to Sterling.

DIRECT LINE INSURANCE GROUP PLC

NOTES TO THE FINANCIAL INFORMATION (Continued)

* included in the above are investments held by the Group in Global Treasury Funds PLC, (an open ended umbrella investment company with variable capital incorporated with limited liability in Ireland) as at 30 June 2012 of £838.6 million (31 December 2011: £612.0 million). RBS Asset Management (Dublin) Limited is the appointed manager to the fund.

8. INSURANCE LIABILITIES, UNEARNED PREMIUM RESERVE AND REINSURANCE ASSETS