Conduit Holdings Limited (CRE) Earnings Call Transcript & Summary

Hi, everyone, and thanks for joining us today. I have Alex Bateman, our technical accounting specialist and Andrew Couper, our Chief Actuary with me today. We have a slide deck to walk through for 20, 25 minutes or so, and then we'll take any questions. I'll start with the usual disclaimers, but do want to emphasize that the numbers we have included are indicative, unaudited and subject to change. We did want to put some meat on the bones, though, to help you understand the implementation impact on us, and we do hope that things won't move too much from here as we're pretty well advanced in processes and audit now. So on to the contents, this is what we're covering today, some background in our policy decisions, the impacts of those and then where we go from here. As we and many others have been saying, the implementation of IFRS 17 is an accounting and reporting change. There's no impact on how we view the business, the economics of that, and there's no impact on our strategy. Our reserving approach is unchanged, but IFRS 17 brings additional disclosures, which you'll see in the notes to our financial statements. As we were already recording our investments at fair value through P&L, IFRS 9 doesn't have any financial impact and only minor tweaks to our investment disclosure. We have intentionally set up our investment accounting inception to minimize any transitional impacts from IFRS 9, so that's all as expected. On transition to IFRS 17, we expect an increase to shareholders' equity of $7 million, driven primarily by discounting and to a lesser degree, a net deferral of acquisition-related operating expenses. In our year-end financial statements, we estimated an increase on opening shareholders' equity at 01/01/'22 of between $6 million and $9 million that were well within our range of expectations. Small numbers in the overall scheme of things, and as noted here, nothing that has any impact on our solvency position, cash generation or dividend paying ability. We do expect a bigger impact from discounting on the 2022 financial year, and we'll come on to that later but again, a positive impact. So to reiterate, IFRS 17 is a timing impact, not a profitability impact. We'll have the initial benefit from applying discounting to our losses as they're incurred, and we'll then see that discount unwind over time. The future impact of discounting in our P&L will vary depending on what happens with interest rates and also the growth rate of our reserves. Despite the noise that IFRS 17 brings, while we will get used to the representation of the numbers, it boils down to discounting of losses for us and that reduces volatility in our income statement as we have better asset liability margin. Both sides of the balance sheet are now fair valued. From the presentation side, presentation and disclosure will change significantly. The income statement will now show the reinsurance service results versus the IFRS 4 presentation of revenues and expenses separately. The changes in the income statement, though, are largely a marking exercise. The balance sheet will be more condensed with asset and liability positions driven by cash flows. Arguably harder to follow, but there are more on disclosures required that should provide greater insight into the components of reinsurers asset and liability movements. Policy decisions laid out here. These would all have been included in our year-end financial statements, so you can also refer to those for more information. Key things to note is that we're PAA and we're following the same approach to reserving as we did under IFRS 4, with a confidence interval following out of that. With the better view in the next few slides, the application of those policy decisions and the directional impacts of those. As a reinsurer and a quota share writer, the move from gross premium written to reinsurance revenue means there is a significant netting down of our top line, albeit that is purely presentational. Let me walk through the chart to explain that. Starting on the left-hand side of the chart with IFRS 4 gross premiums written, the first adjustment is to remove reinstatement premiums. They are now included in reinsurance service expenses along with losses as they are contingent on losses. That gets us to our new APM. We said last quarter, we'll continue to provide gross premiums written, excluding our [ RIPS ] as a KPI. We add, as we do currently, no change there, and then we deduct ceding commissions. These are no longer shown separately as expensed, but netted off against income. Bringing revenue to an earned basis and deducting ceding commissions are the main reasons for the significant reduction in the presentation of our top line. Lastly, we have non-distinct investment components, which broadly speaking, is an adjustment for profit commission success within the contract and represents the amount that's guaranteed to be paid back to the policyholder. There is an equal and opposite adjustment on the expense side. so no net impact of that adjustment. No surprise in the loss reserves but the main impact is from discounting. And as we discussed on the top line, [ RIPS ] now offset here. Impacts from movements due to changes in discount rates go to finance income or expense. This slide is a bit busy, but we're trying to show the impact of some of our policy choices here and the better matching of the mark-to-market on investments versus the fair value of our liability for incurred claims. Basically, any changes that are due to unwinding discount rates or updating discount rates will go to finance income or expense. The reinsurance service expense will recognize the discounting on incurred losses using either the opening discount curve or date of loss curve for specific events. The unwind of previously recognized discount will also be based on the opening of date of loss curve. Finally, the change in liabilities due to updating to current discount rates is based on the closing curve for the period. We have some further mapping slides coming up that will hopefully make that clearer. As a relatively new company, we thought it would be useful to highlight one impact of discounting that's due to that under growth strategy. This graph is illustrative only and based on a constant rate environment which shows the likely relationship between the initial discount benefit versus the unwind as reserves grow. Once the pace of growth slows, the expectation is that the unwind of discount will provide a greater offset to the initial discount benefit. Another consideration is the future actual rate environment, which can have similar relationships between the initial discount benefit and the unwind depending on whether the rates are rising or falling within the reporting period. Another key aspect of the loss reserves under IFRS 17 is the explicit adjustment for nonfinancial risk, which is called the risk adjustment. As at the 2022 year-end, the risk adjustment was roughly 8% of the net liability for current claims and within our expectation to be between the 75th and 85th percentile. One potential enhancement in the disclosure on the face of the income statement is we now present a reinsurance service result. So you can see underwriting performance separately from everything else. We've summarized here the main impacts of the transition on that. For us, a positive impact on discounting, offset in part by the allocation of expenses previously included within our operating expenses that we now attribute to underwriting activities. The treatment of expenses under IFRS 17 is a little messy, and I think we'll take a bit of getting used to. As a significant quota share underwriter, ceding and overhead commissions are now deducted from reinsurance revenue. For the most part, other items previously classified as acquisition costs under IFRS 4 are now reported as reinsurance operating expenses, along with an allocation of what we would have previously classified as other operating expenses. Within that, acquisition-related operating expenses are deferred and earned with other attributable expenses before, but now in that new expense line. Nonattributable expenses are expenses before and remain in other operating expenses. Any financial impacts are minimal and due to the deferral of acquisition-related operating expenses. The key thing to note is that all of our expenses, however, they are labeled be included in our combined ratio as they were under IFRS 4. I'm going to take a break from talking now and hand over to Alex to go into detail on the 2022 restatements.

Thank you, Elaine. I'll now take you through the numerical impacts of IFRS 17 on transition and to our 2022 restated comparatives. On transition, we expect a 7 million increase to equity, which represents 0.7% of our previously disclosed shareholders' equity under IFRS 4 as at the 31st of December 2021. As Elaine previously mentioned, the key measurement differences here are related to discounting and the deferral of acquisition-related operating expenses. Our IFRS 17 reinsurance service result for financial year 2022 is $10.4 million compared to our IFRS 4 underwriting profit of $0.3 million. Our total comprehensive loss for the period is $43.9 million which is an improvement of $45.8 million from our IFRS 4 total comprehensive loss of $89.7 million. Discounting was a significant driver of the improvement, which included a $26.8 million reduction in the net reinsurance liabilities due to increasing interest rates over 2022. This favorable impact of discounting partially offset our unrealized loss on investments of $67.8 million. Looking at the income statement in more detail, there are a number of significant presentation changes, which I will walk through now. Commissions are represented with gross premiums earned into reinsurance revenue. Within the other measurement changes column, you can see the impact of non-distinct investment components that Elaine mentioned earlier. There is an equal and opposite adjustment of $13.7 million between reinsurance revenue and reinsurance service expenses with a net nil impact on the reinsurance service results. Ceded premiums earned are presented as ceded reinsurance expense. Net insurance loss separated into gross and ceded and presented within reinsurance service expenses and ceded reinsurance recoveries. Acquisition expenses under IFRS 17, such as brokerage, are presented within reinsurance service expenses. Finally, other operating expenses are classified as either attributable to underwriting activities and presented within reinsurance service expenses or nonattributable and shown within other operating expenses. Looking at some of the measurement changes under IFRS 17, you can see that discounting impacts in a few places. The benefit on initial recognition is presented in the reinsurance service results separately for gross and ceded and the net impact of the unwind and updating to current rates, showing within the net reinsurance finance income. The impact of discounting due to the interest rate rises in 2022 has further increased our equity under IFRS 17 as compared with IFRS 4, as shown here on the slide. The total increase to shareholders' equity for year-end 2022 as compared with IFRS 4 is $52.8 million. The impact to equity of the expense deferral increased from the 2021 year-end as a greater proportion of our expenses were being attributable. Sticking with attributable expenses for a moment, we wanted to illustrate how we see the split of attributable versus nonattributable expenses changing over time. As a relatively new reinsurer, we do expect to see an increasing trend in the amount of expenses deemed attributable as our cost base continues to mature and we reach a more stable run rate. Now for the year-end 2022 balance sheet. As Elaine previously mentioned, the IFRS 17 balance sheet is now quite condensed, so it will take some time to go through each of the presentations. Premium receivables, deferred acquisition costs and unearned premiums are now effectively netted into 1 line, which forms the liability of remaining coverage. Ceded reinsurance assets and amounts payable to reinsurers under IFRS 4 are grouped into a ceded asset for incurred recoveries and a ceded liability for remaining coverage. Losses and loss adjustment expenses are the reinsurance payables and reinstatement premiums are presented in the liability of incurred claims. Measurement changes exist for discounting, expenses and other valuation changes such as FX as IFRS 17 now states that all reinsurance assets and liabilities are monetary items and will be revalued. The last change is the one that takes away even more of the detail. IFRS 17 requires that we group portfolios of contracts into assets or liabilities combining the liability for remaining coverage and the liability to incurred claims into one net asset or liability per portfolio. Currently, this leaves us with one line on the balance sheet for ceded reinsurance assets and 1 line or gross reinsurance liabilities. This can change depending on the timing of cash flows for each portfolio, but you can see that we lose quite a bit of detail from the balance sheet as compared to IFRS 4. But we do now have disclosures that will break down the different reinsurance assets and liabilities into their component parts. Now on to how we will evaluate performance under IFRS 17. IFRS 17 will change the way we calculate our key performance ratios. We have chosen the net-net methodology as we felt this best reflects the way we manage and evaluate the business internally. I'll now go through how this methodology impacts our different ratios. Our loss ratio will include discounted losses and loss related amounts. Loss related amounts include reinstatement premiums and commissions that are contingent on claims such as profit commissions. This is all over net reinsurance revenue, which is calculated as reinsurance revenue less the ceded reinsurance expense. Our reinsurance expense ratio will include our acquisition expenses and attributable operating expenses, again, all over net reinsurance revenue. The other operating expense ratio will be all nonattributable expenses over net reinsurance revenue. As a reminder, other operating expenses will not be presented in the reinsurance service results nor allocated to our reportable segments, but we do intend to include all operating expenses within our combined ratio in line with our previous methodology under IFRS 4. The 3 ratios added together will equal the combined ratio, which can also be calculated from the income statement by taking the net reinsurance service expenses, which is reinsurance service expenses plus ceded reinsurance recoveries plus other operating expenses, all over net reinsurance revenue. We understand there are a lot of moving parts with the key ratios under IFRS 17. To help you understand how these compare to IFRS 4, we have presented both sets of ratios by division for financial year 2022 on this slide. Discounting is clearly a big part of the impact on the combined ratio, but there are also impacts due to the representation of items from the numerator to the denominator. Due to this representation alone, the combined ratio under IFRS 17 would be higher or lower than the equivalent under IFRS 4, depending on whether the combined ratio is above or below 100%, but both will trend towards each other as the combined ratio gets closer to 100% as illustrated on the graph. Discounting will then be a net benefit to the undiscounted combined ratio for the extent that this benefit could be volatile from period to period due to the movements in discount rates. Lastly, our divisional combined ratio is under IFRS 17 and now include an allocation of attributable operating expenses within the reinsurance expense ratio. This was previously all shown in the other operating expense ratio under IFRS 4. I will now hand back to Elaine to talk through our financial year 2022 KPIs and closing comments.

Thanks, Alex. So what does this mean for our 2022 KPIs Gross premiums written has a minor reduction from the removal of reinstatement premiums. ROE has increased primarily from the impact of discounting. Our combined ratio has reduced primarily due to discounting. There is no impact on net investment income n0or total shareholder return. And book value per share increases, again, largely due to the impact of discounting. Nothing new to report here. Just a reminder, when we're reporting, we will provide more guidance to help you with your modeling at the interims. And no doubt beyond that as we continue to evolve our own reporting and analysis under the new standard. In summary then, as we said at year-end, nothing about applying a new accounting standard changes the underlying economics of the business or how we view our portfolio or how we approach our reserving. For us, it's largely a marking exercise and timing impacts with the main financial impacts being from discounting reserves and the deferral of acquisition-related operating expenses, which will amount to timing differences. Discounting also means we'll see better margin between our assets and liabilities, the balance in the one-sided volatility that we've seen of late from the impact of interest rate movements on our investment portfolio. There will be presentation and disclosure changes, of course, but as a relatively new business without legacy systems or reserves, this transition is perhaps more straightforward than for some other larger, more complex companies. We have some definitions in the appendices, so read those at your leisure. Well, that concludes our presentation for today. So we'll pause there and open up for Q&A.

[Operator Instructions] The first question comes from Abid Hussain of Panmure Gordon.

I've got 3 questions, if I can, please. The first is on management information. I just wanted to ask if it's the new granular level of MI that you will receive under the IFRS 17 measures, if that's going to change the way that you run the business at all. So that's the first question. The second one is on KPIs. Can you just sort of go over which KPIs you will be focusing on going forward? Is it the same that is going to be combined ratio, but on the new measure ROE, et cetera, et cetera? And then my final question is on the reserves and risk adjustment. Are you happy with the way that the reserve levels are translating to a 75th to 85th percentile range for the confidence interval level.

Thanks for the questions. In terms of MI, a lot of the way that we look at the business internally isn't going to change. I think it's very much a reporting standard change as opposed to any kind of impact on the business and how we view that. So no real impact there. There is an extra level of reporting that's now required, extra level of effort around IFRS 17 [ to stimulate ] discounting. But the majority of that sits with actuarial and finance as opposed to anybody else in the business. And so it's an extra level as opposed to a change in anything else underlying that. One KPIs, we run through some of the changes, the impact on KPIs in the presentation, combined ratio, we will keep it in a new format as we've laid out, ROE, TSR, investment return, all those other ones they stay. The new we're adding in there is, as we've talked about previously is, I'll call it a modified gross premium written number, which takes the reinstatement premiums out of that. And the intention to include that is to, I guess, assist the transition from IFRS 4 to IFRS 17 and allow comparability to U.S. GAAP reporters and others who might also be carrying on with that measure as an APM although there's likely to be nuances between how different people define that. On the reserving side, I'll get Andrew to comment further on that. But the way that we view the standard is more as a reporting routine as opposed to changing the underlying business in terms of either how we underwrite, how we invest or how we reserve. So where we come out in terms of risk adjustment is mathematical to a degree. Andrew, do you want to comment further on that?

Yes. Within our existing reserving process, and it hasn't changed as far as introducing IFRS 17. So the underlying process, we have a series of -- we look at the reserves broken down by division. And we have a methodology to come up with our best estimate. And then we -- equally, we have some methodology to add some uplift to the undiscounted reserves to broadly get us to the 75th to the 85th percentile. There's no change. We're not changing anything as a result of IFRS 17. And then the main introduction that we are introducing, as previously, the impact of discounting. But the underlying process is unchanged. So the 8% factor is really driven by the underlying mix of business more than anything else.

[Operator Instructions] The next question comes from Derald Goh of RBC Capital Markets.

A couple of quick ones. Firstly, I'm just looking at the FY '22 comparatives on Slide 23. And why is it that the discounting impact in specialty is bigger than it is for casualty? That's question one. Second one, just on your mid-80s combined ratio guidance under IFRS 4. I don't know whether you can give us an update of what you think it might be today in IFRS 17. And within that, what is the discount rate assumption?

I'll start with the combined ratio guidance. I mean what we provided today is as much as we want to give in terms of translating the numbers and how we're thinking about things. We do anticipate giving more guidance as we move through our transition alongside you guys. We haven't updated that mid-80s combined ratio guidance yet on an IFRS 17 basis. we do anticipate providing further guidance on that June 4, but not at this stage. We'll talk a bit more about that at the interims. The discounting on the specialty side, Alex, do you want to take that one? .

Yes, sure. So when you're looking at the loss ratio, the reason why the discounted appears higher on specialty is because of the higher loss ratio. So it has a greater percentage point impact on the combined ratio. But actually, if we looked at the absolute discount on the absolute losses, casualty would be higher, as you expect, because the duration on the casualty liabilities is longer. And then specialty, it's just a function of that loss ratio being 128% on an undiscounted basis.

And just to add Derald, I mean that's been distorted by the impact of the Ukraine war during 2022. So that's why the loss ratio on specialty is a little bit elevated.

The next question comes from Barrie Cornes of Panmure Gordon.

Just a couple actually. It's a fairly basic one, actually, Elaine, but in terms of -- you talked about it being a timing issue, given that 2022 is an improvement over IFRS 4, should we think logically that there'll be a slight reduction in profitability further out as a result of it being boosted in 2022. That was the first question. The second one was just in terms of the net reinsurance revenue includes, I think, you said profit commission. I just wondered if this is new, and if it is, how easy is it to calculate profit commission going forward for the year?

The problem, I guess in terms of timing, the discounting impact is noncash impact on our financial reporting, and we do expect that discount to unwind over time. As rates increase, we get a benefit from the discounting and the opposite is true there as well. But we're also in a growth mode at the moment. So as we expect -- and we have had a slide in the pack there on that as our reserve grow, then we expect there to be bigger benefit. I think what we were trying to show in that particular slide is that as rates normalize and as we reach a point where we're in a kind of a more stable state, then there's more of an offset between those 2, but the net impact is less material. In terms of forecasting our profit commissions, I think that you need to make your own assumptions around that. And as you do know, we booked profit commissions at the moment in our numbers, it's a smaller component of our book. It's not material part.

Yes. And I think with respect to it being included in the net reinsurance revenue, it's not quite the profit commission calculation that's taken out of revenue, but it's a new sort of IFRS technical term, called non-distinct investment component, and it's slightly related to contracts where there is a profit commission. But as Elaine said, it's an equal and opposite adjustment that comes out of revenue and also service expenses. So it has a net 0 impact on the service result. And within our interim and annual financial statements, you'll see in the disclosure the amount of NDIC that's recognized in a period. So you can then work out what's been sort of stripped out of revenue and service expenses that way.

Thank you. Ladies and gentlemen, we have no further questions on the conference line. I will now hand over to Elaine for closing remarks.

Thanks very much. I'm sure that we'll get plenty more questions over the coming weeks and months on the IFRS 17 transition. But thanks for joining us today, and we look forward to continuing that dialogue with you, and we'll see you at the interims next month. Thanks, all.