The telephone insurance company owned by Royal Bank of Scotland made a negligible pounds 5m before tax in the first six months of the year compared with pounds 45m a year earlier, because of falling motor insurance premiums and higher household claims as a result of the weather.
The bad weather knocked a pounds 22m hole in Direct Line profits and the motor price war cost another pounds 25m.
However, Royal turned in a strong banking performance that more than compensated for its insurance subsidiary's difficulties, so group profits were 11 per cent higher at a record pounds 301m for the six months.
Direct Line has shaken up the industry and is widely credited with creating the intense competitive pressures in motor and household insurance that led to last week's proposed pounds 6bn merger between Sun Alliance and Royal Insurance.
Peter Wood, founder and chairman of Direct Line, said: "The past six months have been the most difficult trading environment we have ever faced."
He said the price war was unsustainable. "We have no doubt that the cycle will turn soon. When it does we are best placed of any insurer to benefit." Motor insurance rates - down 20 per cent over two years - were going up, so the second half would be better than the first, he added.
"We are sneezing and the rest have a high fever," Mr Wood said. Direct Line might raise premiums 2 to 3 per cent, but competitors would need 10 per cent a year two years running to break even, he claimed.
On household insurance, Mr Wood said: "Competitors will have to come down to compete with us." Direct Line's rates were static, it had good reserves and had provided well for subsidence claims caused by last year's drought.
Dr George Mathewson, chief executive of the parent bank, said the Royal and Sun Alliance merger marked "the beginning of a process of strategic consolidation in the UK general insurance market which will cut capacity and ensure the survival of only the most efficient players".
Direct Line has increased its market share and raised its efficiency during the price war, so the operating cost per policy fell pounds 6 to pounds 45, Mr Wood said. But falling rates cut premium income pounds 2m to pounds 306m.
The most dramatic effect of the price war was a fall of more than a quarter in new household and motor policies taken on compared with a year earlier, as Direct Line restrained itself from chasing unprofitable business.
Royal Bank of Scotland's interim dividend rose 17 per cent to 5.4p and bad debts and other provisions fell from pounds 71m to pounds 45m. Profit before provisions rose pounds 5m to pounds 346m.
Lord Younger, the chairman, refused to give any clues about whether the bank would buy a building society such as the Woolwich.Reuse content