iA Financial Corporation Inc. (IAG) Earnings Call Transcript & Summary

Good morning or afternoon to the folks that will be listening to this. Welcome to TD's Speaker Series. My name is Mario Mendonca. I'm the Managing Director of TD Securities Research. I cover the banks and the insurance companies. Today, I'm pleased to have Denis Ricard, the President and CEO of Industrial Alliance. We're going to go through a number of interesting questions. These are, Denis, very interesting times, and I appreciate you taking the time to do this with me today.

It's a pleasure, Mario.

Let me get started. First question I got is just how should we think about this whole issue we're dealing with the COVID-19 virus and how it impacts your business? If you could, for a moment, Denis, just stay away from the macro issues. We'll get to that in a moment. Just more generally, how this impacts your business?

Well, first of all, thanks for having me here. Obviously, we are living through events, Mario, that I'm sure you qualify as unprecedented. I think in my lifetime, we're living through a health crisis that now is becoming an economic crisis, and to some extent, a crisis of confidence. I keep saying internally that we're basically having a war effort by now against an invisible enemy. But the good news, I think, is that our government in Canada, at least, seems to have made the right decision right now to what we call to flatten the curve, as you know. And so to me -- well, by the way, in 2008, remember that I was the Chief Actuary and CFO of iA Financial Group at that time. And I must admit, it was a quite stressful time back then. The banking sector was crumbling. But not everybody was affected so directly as it is right now with the pandemic. A month ago, at the executive committee of our company, we were discussing the shortage of manpower in the market. Can you believe that? That problem has completely vanished. It's been replaced obviously by something much more important. I keep saying internally that we are writing a book as we read it, basically. And if I go back, especially to iA, in a lot of instances, we were even ahead of government decisions. And I'll use the example of employees working from home. We did that a couple of days before the government requested that because -- well, it was the right thing to do at that time. In fact, what happened is that when this crisis started, I basically set 2 priorities. The first one was to really protect the health and safety of our employees and distributors. That was the first. And the second, obviously, to continue doing business. And to be honest with you, I think we should -- we deserve a, I would call it, A+ for that. Very, very quickly, almost all of our employees were able to work from home. 18 months ago, we had prepared not for a pandemic, I must admit, but we already started -- changed our processes to become paperless and equipped our employees with much more sophisticated tools and being able to work from home from anywhere, to some extent. It made the transition much easier in this situation. We were able to maintain sustainable operations with our clients. We have very strong business continuity plan. We have started this BCP or business continuity plan review in January. When we sell things, we're not going that bad -- that good, sorry. In China, we have started our crisis working -- I mean, we had a working group crisis that have started at that time. And basically, we updated our business continuity plan. We were prepared for that. I mean I must admit, we were prepared for that. So I'm very proud of the engagement of our employees, the engagement also of our distributors. And so right now, we are able to provide what we call the peace of mind to our clients because we were able to pursue our operations. The last thing I'm going to mention is, as much as we talk about the fact that companies need to be responsible and about all their stakeholders, like shareholders, clients, employees, but also communities is important. So we've increased significantly our contribution to organizations that help the poor, providing basic necessities. And we've also increased significantly some of automation to university research and also to hospital because of obviously the link with the current crisis.

Yes. That's very helpful. Let's actually drill down now on the individual business lines in Canada and the U.S. Can you offer some thoughts how -- more specifically, say, individual insurance or wealth or the group businesses or the business in the U.S. How the crisis has impacted the functioning of those businesses?

Yes. Sure, Mario. Obviously, all businesses are being impacted by this crisis. In fact, I mean, all industries are. To some extent, we're not in such a bad situation because, first of all, the nature of our businesses is such that we still continue to have revenues. We are well diversified also in terms of our operations. So if I go line by line, if I start with the Individual Insurance, which is our biggest line of business. But let's say, both in Canada and the U.S., the same comments would apply. You all know that Individual Insurance is a long-term business where premiums are typically paid on a regular basis over a long period of time. So that's really significant and steady cash flow for our company. Well, as far as new sales, they did soften in the coming weeks, but we do expect that they will hold up reasonably well with some of the tools that we have provided the distributors. I mean on that -- from the very beginning, our priority was people's health and safety, as I mentioned, and the same applies to our distributors. And so very quickly, the decision was made to suspend all the face-to-face sales. In the U.S., by the way -- I mean [ reasonably ] a large proportion of our business was already performed over the phone from call centers. So basically, when we look in Canada or in the U.S. for the face-to-face, now it's not face-to-face, we are providing our distributors tools and solutions, but let's -- what we call in the past was the EVO platform for the approval of insurance at point of sale. And we are confident that our distribution networks will continue to generate new sales based on all of these tools we provided to them. Although we acknowledge that in the short term, it is -- sales did soften a bit. We also made sure in our insurance business that our underwriting guidelines, processes and requirements were appropriately based on the current environment. We work with our reinsurers on that to make sure that we permit [ anti-selection ], but also at the same time, that we can maximize the number of cases that can be approved without the support of external or medical test providers. Finally, for life insurance, in terms of the experience, it is too early to tell when it's going to go. We are working with the Canadian Institute of Actuaries to determine really what the impact of -- on mortality could be. The only thing today that I can provide is to say that, from the information we have today, we believe that the mortality on the insurance population should be better than on the general population. Now if I move to wealth management. In the wealth management, iA is very strong, first of all, on the seg fund side. In terms of the seg fund side, we believe that sales and retention is going to be helped by the fact that we provide some good value with the guarantees to our clients. The other thing on seg fund is about our Dynamic's risk management program. You know that we have introduced that years ago, and we started that in 2010. Basically, it's a program that dynamically buy and sell futures and forwards to protect the company on the downside of the market. Please note that since the introduction in 2010, that hedging program has generated positive experiencing over the years. But the cost of the program is directly correlated with the volatility of the market. In other words, the higher the volatility, the larger the experience loss versus our long-term expected cost. And if you look at, for example, Q4 2018, it can give you an idea of that reality because that quarter was quite volatile, and we had experienced a $0.09 experience loss at that time. Now the volatility that we are experiencing right now is much larger and will trigger proportionally higher losses, you should expect. With that said, we are in a much better situation with the program than if we have not, the downside protection for seg fund guarantee through that program. Now that's for seg. For mutual funds and the distribution on the wealth side, we expect things to slow down until the market returns. It's too bad though because we have just turned the corner in terms of net positive sales with our Clarington funds just before the crisis hit. That's too bad. If I turn to the dealer services business in Canada and the U.S., which are historically be the bigger business for us, well, the dealerships are good. So you should expect sales obviously to be negatively impacted by that. Now if we go back to the 2008 financial crisis, we saw sales of warranties, ancillary products and car loans remained at the reasonably satisfactory level at that time because, you know what, car dealers -- for car dealers, the sale of those products was a way to maintain their revenues. And we can expect a recovery when dealerships will reopen. For car loan, even if we anticipate an increase in default from that -- from those, we believe it's not time for us to, let's say, stop or quit origination because what we've seen over the years is that the most adaptable cohort on that business are the ones that's been generated during the crisis, basically, because of some of the credit underwriting is tightening up. Once we are through that crisis for dealer services, in general, we believe it will be a much stronger recovery. In fact, we see opportunities because we know that the U.S. market is a fragmented market. And as such, there are a lot of small players that, in fact, may be out of business, and we will be able to take advantage of that. Now to finish on dealer services, let me just also mention the iA Auto and Home business. In fact, the iA Auto and Home business is, I think, a very, very positive experience because people don't really use their cars, as a matter of fact. And the same good claim experience, we see it also for dealer services, in general, except for the car loan that I was talking about. Let me just move very quickly on the Group. The Group business, it's not a big business for us. Basically, sales are pretty much at the standstill right now. But retention is good because obviously employees are not looking for a change of provider right now. So we probably see an uptick in disability claims, however. But as I said, it's not a big business for us. So to summarize, we see short-term impacts on our revenues and earnings mainly due to the market downturn, as I mentioned. But we are very stronger now and robust, and we believe that it's going to rebound quickly after the crisis is over.

Okay. So if I could then -- I believe that when stocks -- insurance companies, in particular, banks start to trade below book value as we saw for a few names including Industrial briefly or maybe even [ some out. ] When we see that the market, of course, cares about earnings. But really, what ends up happening is the concern becomes about capital. People start to ask questions about capital. And I think that's what sometimes causes book value multiples to drop below book, as we saw for some names here. So what I'd like to do is, if you could help us contrast Industrial Alliance today versus Industrial Alliance during the global financial crisis 2008, 2009. And really, what I'm getting at is using the disclosures you've offered, I'm not seeing a very sharp effect on the company's LICAT ratio from some of the things we're seeing, like the decline in equity markets or the decline in interest rates. So the sensitivity just seems so much lower for me right now. Could you comment on this? And spend -- if you would, spend some time on the IRR as well because that's one of the more important assumptions I'm focused on right now.

Yes, yes. No problem. Well, Mario, you're completely right. The -- I mean when I look at the capital position of our organization, it has nothing to do with, let's say, 12 years ago, let's say, in 2008 before the crisis. Our -- actually, our sensitivity measures, as we have published them, show that our ratios should go up basically, which we are much more resilient and less sensitive to macroeconomic variation than we were. And this is based on 2 things. The first one is the fact that we've implemented over the years some, let's say, financial strategies or investment strategies that help us remove and/or hedge some of those macroeconomic risks. The second one is the fact that starting in 2018, there's been a new capital regime in Canada that is much more robust and based on risk compared to the MCCSR. So the LICAT solvency formula has been a great, great achievement for the industry. The regulator has done relatively a very good job there because it rewards good risk management. And it's been very beneficial to us because our sound risk management practice has been recognized finally. So that has been very, very, very good for us. And we have implemented different, like I said, investment strategies that have sales -- let me give you one example. Last year, we replaced common stocks with options, for example. So by doing that, only the first 10% market downturn affected us basically. So consequently, today, our solvency ratio is much more stable than under the previous regime. Now with our 2019 year-end results, we provided some sensitivity metrics that we have posted back in March 13. And basically, according to those sensitivities that we disclosed, we have some positive impact here. Like, for example, since then, we have introduced a $400 million debenture in February. We've issued that. That is adding 5 to 6 percentage points on solvency ratio. I can say today that pro forma solvency ratio as of today would be above the 110%, 115% target range, which we believe is appropriate for our risk profile. And that includes the impact from IAS acquisition that is to be concluded in the first half of the year. Now let me turn to the IRR, as you mentioned. This is a very good example, I mean, besides the other examples that I gave. This is a great example of investment strategies that hedge some of the risks that we have over time. In 2008, our exposure to IRR was huge. It was very, very significant. And as you know, the IRR is the initial grade at which we invest money today. It's mark-to-market. It's based on the spot rates. And at our last Investor Day in 2018, we announced that our objective was to eliminate completely earnings sensitivity to IRR. Now funny enough, it was not well received. As you remember, some investors were convinced that long-term interest rates were to increase. But -- I mean we did not want to bet on that. So we wanted to reach that goal, as we said, before the implementation of IFRS 17, which was supposed to be effective in 2022. As we mentioned at our last conference call, we basically achieved that objective at the end of 2019, much earlier than we thought. So today, we have no or very little earnings sensitivity to the IRR. Timing was perfect. When we look at the interest rate variations year-to-date, we are quite pleased that we were able to meet our goal ahead of schedule. And so we were very happy that we're able to execute the strategy to reduce the IRR sensitivity when conditions were favorable to us. So we did it at the right time for us. So my conclusion is capital sensitivity and IRR sensitivity are 2 telling examples of how our company has successfully worked on its sensitivity to macroeconomic factors since the last financial crisis. We have learned from the last crisis. And iA balance sheet and capital position today are very strong and much more resilient to macro variation -- macroeconomic variations.

Okay. And so just as a reminder for people listening in, the IAS deal -- I believe the impact of the IAS deal was 17 points to LICAT, at least that was the disclosed amount from last quarter. Does that ring a bell for you, Denis?

Yes, it's the same. Yes, still same impact.

Okay. And then just a quick follow-up then on the URR. You talked about the IRR, but the URR sensitivity is still meaningful. I know you updated your URR, I believe it was Q4 '18. You did it a year ahead of time. Do you have any sort of insight you can give us on when the URR might be updated again?

Well, I mean, this is a rate that comes from the Canadian Institute of Actuaries. As you know, it's really to reflect the long-term nature of our business. We used to take like a year or 2 in advance when -- for that rate. But the fact is that the CIA, the Canadian Institute of Actuaries, said that they were not going to update it before the next IFRS. But now IFRS 17 is being delayed 1 year. I don't have more information as to whether or not the CIA will move ahead with the change or not. But guess what, in the past, we've seen a lot of changes in the URR coming down, and we've been able to adjust over time with all our investment strategies. So -- I mean we are prepared to face that. If for any reason, the CIA is going to decrease URR, well, at this point, the only thing I can say is that the impact has been quantified in our sensitivity testing. So a 10 bps decrease would mean a $61 million hit on our net income which, when we look at it in the overall scheme, it's not that huge.

That's helpful. Can we then just -- in another insurance company's disclosure, we did see that if rates fell below a certain threshold, it would cause a sort of onetime move to a different scenario, which would cause the LICAT to drop. Is there any mechanism that you see playing out that way for you?

No, no, no. Any drop in interest rates, small or big, should increase our solvency ratio. So as you said, it depends on the unique situation of each of the company. But for us, no.

That's helpful. Can we now then -- notwithstanding the lower sensitivity, it does show that a meaningful drop in rates in markets could have an effect on the reserve strengthening or the reserve review that the company would do, I guess, every quarter and then certainly in Q4. Could you speak to timing of any sort of reserve reviews? And so -- might be more importantly, is there stuff you can do to mitigate the effects? Because you've shown a capacity over the last few years to mitigate the effects of declining rates. So I imagine there might still be some things in place, like portfolio yield optimization that could bear -- play out now.

Yes, sure. I mean you refer to the proxy that we provide, which is that -- according to that proxy, that's the effect of all at [ risk ] and the 13,000, what we need to strengthen reserve now. As you say, it's only a proxy. In fact, we have different categories of equity securities, not only the TSX. We've got like 44% of our stock, which are in private equity as opposed to public equity. Also, we have some international public equity, which then does not move the same way as the TSX. So it's really a proxy. And it's -- so we have protection. As you know, we have additional protection in our reserve, and this is the way iA differentiates itself by incorporating some additional protection in its reserving process. So far, this protection has absorbed all the recent macroeconomic movement. But it does not also consider some of the other moves that could be done from the end of the last year versus where we are today. So therefore, we will disclose where we stand at the end of Q1. We would provide updated and additional information on this macroeconomic variation impact on our reserve. But let me say this, with what we know today, there would be no need to make changes or assumptions for the time being. And we will have more clarity at year-end about the impact of the COVID-19 crisis on the assumptions underlying the reserve. So for reserve and equity, we have always covered a vision and strategy that's based on the long-term perspective, and we intend to continue to do so.

That's helpful. Okay. So you mean, like we've gone through the capital effect, we've gone through the earnings effect of some of these issues. But there's no denying that very, very low interest rates for a very long time is not beneficial for life insurance companies. I appreciate that the LICAT is properly calibrated now to give you the results we've discussed. But just more conceptually, if interest rates remain this low for how long, how do you figure that could impact the business model, the insurance business model?

Well, as I've already mentioned, in terms of the short term, how it will impact, so I will not repeat that. In terms of where the interest rates would go in the long term, we've got the in-force -- I'll go to the in-force management first, and then I come back to the -- maybe more short term. For the in-force management, I say we have time. And we've done that in the past. I mean the fact that rates decrease -- during the days when I was the Chief Actuary, rates were much higher than they are today. And we've been able to go through that period in -- I mean we outperformed basically the industry even though the rates went down. So we've adjusted some of our investment strategies over time, increasing duration, for example, and taking advantage of the positive yield curve. And so that's one way that, obviously, we will continue to do. Obviously, we -- I mean I'm sure -- as you know, that we made a decision recently or in recent years to diversify a bit more our in-force or our products or -- of the business. So -- I mean moving away from long-term guarantees as much as possible. So we've been guilty. The insurance business, for example, we've increased more the sales on the less long-term guarantee products. And also, we've diversified by entering new markets that were more short term. Like -- that is one of the reasons why we entered the vehicle warranty business in the U.S. such that it was a short-term basis business, less long term, more diversified in terms of the whole scheme of our product. So it has already changed the way that we have -- we are looking at our business. Because in 2008, I mean, this is where -- we were in a more precarious situation when you look at it, when we look at the impact of the decrease in long-term interest rate. Today, yes, it will have an impact over the long term. We have time to manage it, like we did in the past. But at the same time, we've diversified some of our operations to face that.

Now you're -- were you going to talk about the new business as well? Or did you cover that?

Well, for the new business, well, the only thing I could add on the new business is that we are repricing the new business, obviously. And this is one way, obviously, that we do that. But nothing more than that, Mario. I mean we've done that over the past year. If you look, for example, at the long-term guarantee products, so it's -- over the last 5 to 6 years, the prices for those products have increased by more than 50% -- I mean much more than 50%. So if rates -- if we believe that rates is going to stay where they are, I mean, we will just continue repricing that. And the clients and advisers will move away from those products more and more, and they will sell more like term product, adjustable products and those type of products that we have.

That's helpful. So let's now think about -- and this is really one of the toughest ones for me as I think about all the banks and life insurance companies, is you do have a large general account of assets and the credit risk has changed. Now hopefully, it's all just a very short-term spike in credit risk that will normalize when the world gets there or gets our act together. But are there any asset classes within Industrial Alliance today that you might highlight for us that we have to be more sensitive to in this period of heightened credit risk?

Yes. Good question, Mario. Listen, when we entered the 2008 crisis, we benefited from the fact that our company's investment portfolio was very high quality. In fact, it was -- I think we did. In fact, one could say that it was maybe a bit too conservative at that time, but it helped us a lot because we have started at the time to benefit from those of the credit spread widening that happened during those days. We are still less exposed to credit than our peers and our target. In fact, we have -- we still are below our target in terms of exposure to credit. So we are in a very good situation right now for that. Let me just go through some of the points here. We have about 72% of our assets that are invested in fixed income product, and those are much more stable in that context. We are more conservative in terms of the credit rating. We are more conservative in terms of some of the exposure to industries that are being affected right now. We don't expect default in this portfolio at this point. Our exposure to, like I said, transportation, tourism, basic materials and consumer cyclical sectors, for example, is low and very high quality. Our exposure to energy sector is also -- is less than our peers, and that we are indirectly exposed to those. Outside of the fixed income, we are mainly invested in 2 major asset classes: equity and real estate. For our equity, as I said, we have derivatives that limit the downside to 10%. Our private exposure is mainly in the stable infrastructure with fixed long-term contracts. In terms of real estate, a significant part of our rents are leased to governments. And we have very, very low exposure to, for example, Alberta. So all in all, when we look at our asset side, I mean, we feel very, very comfortable with what we have. Maybe the last point I will make is on car loans, sometimes people are concerned about that. We have over $700 million of car loans. We believe that the default will increase to some extent. But our expected default rate is about 5%. I mean at the extreme, if we believe this is going to double, we're talking about something like $35 million before tax. So it's nothing big in the whole scheme of iA. Our expectation is, because we follow this very carefully, it's not that it's going to double, but I was just saying if it was to double.

All right. And on...

That's it. Yes, go ahead.

Yes. Well, sorry, do you want to add anything more on the credit side before I carry on?

No, no.

Okay. Let me just drill down then, and again, this is a broad question. I'm thinking about your capital deployment priorities and strategy. In periods like this when there's so much changing so quickly, I mean, have you had time to take a deep breath and ask yourself whether you need to make adjustments to your capital deployment priorities or strategy?

Well, it's an interesting question. Funny enough, I mean, we -- capital was already deployed. To some extent, when you look at it, we have invested in several businesses recently, and we are closing one pretty soon. We are selling one of our business right now that was not strategically important for us. Basically, as I mentioned at the call for Q4, we are moving from, let's say, deployment to integration and execution of those investments. So -- and you know that we've also issued a sub debt recently in terms of getting even more robust in terms of our capital. But the idea right now, at this point, is not to deploy it, let's say, with big acquisitions. We are pretty much in the process of executing and integrating those acquisitions. This is the focus of 2020. So you should not expect to have, let's say, acquisition or something significant over the next months. The NCIB also -- for the time being, we don't intend to do anything in terms of that. So we are still -- I think the long-term perspective, the business is going to slow down a bit. Capital is strong. So for us, it's like we continue doing our business.

That's helpful. All right. And let's conclude it here with just a broad question. Is there anything -- any comments you'd like to make for investors in light of what we've seen so far this year? Any broad thematic comments you'd want to offer us?

Yes. In fact, our financial condition right now, very, very robust. I think we are very much more positioned to face the situation versus, let's say, 2008, like the solvency ratio, low sensitivity, stable, above the target range. Not -- I mean it's not pro-cyclical as it's used to be. Still have room for the leverage, we're about 26%. Still have some flexibility there if, for any reason, we need something in the near future. Investment portfolio remains of very high quality. Conservatism in the reserve, we have protection there. The protections did their job so far. So I mean, when I look at it, I mean, obviously, we said at the last quarters and the last Investor Day that we are aiming for an EPS growth of 10%-plus a year. Well, this crisis is putting that on hold for the time being. But we believe that we will rebound at the end of this crisis, such that we will be able to meet that objective. Let's go through this event right now. Let's have the society back on track first. Let's do our work of participating of -- the collective effort to prevent the spread of this contagion. And I was watching a Bill Gates interview recently, he was talking about the pandemic. It was quite interesting by the way. And we will be better prepared. This -- the whole idea was let's be better prepared. In fact, we were prepared for something right now. When I looked at where we were in 2008 versus today, we were better prepared, and we are better prepared. So I am an optimistic. I believe that -- the fact that, let's say, for example, the G20 countries are adopting quick measures to manage the economic crisis will lead to a quicker recovery than otherwise we would have had, I mean, especially compared with 2008 where it took, let's say, weeks and months to have a one single measure. Here, it took few days and all countries were investing significantly to make sure that the crisis will not hit too much the economy. So I'm quite optimistic. And one thing for sure, you know what, the sun will continue to rise from the East.

Denis, I share your optimistic -- or somewhat optimistic outlook. I agree I have faith that society as a whole will find a way to cope with this. And in prior periods when markets have fallen aggressively and credit spreads have blown up or any indication, investors are very forward-looking. And at some point, I think in 2020, they'll start looking to the valley, and the market will price it in well ahead of any major economic recovery. That's just been my experience. But Denis, I sincerely appreciate you taking the time to do this. I think it's very helpful for your investors when they listen to this. Thank you again.

Okay. See you. Thanks.