Intact Financial Corporation (IFC) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome to one of our afternoon presentations here, a fireside chat with the UBS Virtual Financial Services conference. I'm Brian Meredith. I am the insurance analyst here at UBS. And it is my great pleasure to have Charles Brindamour who is the CEO of Intact Financial for our next fireside chat here. So I'm going to get right into it with several questions. If you've got questions, you can chat them to me, and I'm happy to ask Charles as well.

So first question for you, Charles. So as I think about the COVID-19 situation, if we think 12 months from now, what do you think the kind of longer-term implications are for the Canadian property casualty insurance industry? And then how is Intact positioned to take advantage of that?

Brian, thanks for hosting me. I was looking forward to catch up with you again, and I'm glad that so many people joined us today. COVID-19, obviously, when we think about our strategy, and we spent a fair bit of time on that, Brian, in April once we've put the bulk of managing the crisis behind us, our strategic framework is one that starts from the outside and then builds on our strength to develop the business. And so the question is, from a strategic point of view, what are the mid- to long-term implications of COVID-19? At the consumer level, our perspective is that consumer savings rate will go up. And we think, as a result, value for money will become a more important element of the value proposition. Obviously, we've been a meaningful uptick on digital engagement. And that's a heavy trend that was there before. In commercial lines, Brian, we're -- we protect 1 in 4 SMEs here in Canada and small- to mid-sized businesses across North America. What's clear to us is that it's really hard for SMEs at the moment, and we might lose 3% to 5% as a country of SMEs. And our perspective is that the middle will consolidate, the small will be smaller, and there'll be more of those, and the mid will be bigger. And so from a strategic point of view, the question we ask ourselves is how do we win at the smaller end and how do we differentiate ourselves at the mid-end where, in the past, I mean, we sort of tackled that business really in one blood. And then at the societal level, it's clear to us that income disparity, skill gap in society will be exacerbated as a result of COVID-19 and the expectations of companies like ours will go up. And so being a force of good, putting our strengths to work will be key not only with our employees but with communities at large. And so how are we positioned in that context? Well, if you look at the consumer trends, Brian, we doubled down on digital engagement and digital tools over the past few years, and that came in really handy in that environment. In terms of value for money, as I was talking about, our multichannel distribution platform, ranging from belairdirect, which is our low-cost, simple insurance operator, is extremely well positioned and picking up very nicely now in steam. Our broad distribution platform, our online access to Intact Insurance position us really quite well to adapt where consumers are going. Then in relationship with the trends we're seeing at the business level, clearly, our specialty lines platform is differentiated for what the new midsized businesses will look like. And we have a very good value proposition for the small business as well. More needs to be done from our perspective on that front, but we've got a lot of optionality in the model, Brian.

Got you. I'm just curious, can I have a follow-up on that? On the SME part of it, is the product -- does it need to be changed as a result of what's happened here with COVID-19? Is there something that you're thinking about that now small businesses are going to be much more concerned about, business interruption coverage and those types of things since, obviously, a lot of them didn't have it?

Yes. Business interruption in the context of pandemic is not something that insurers can actually cover. And I don't see the product evolving to cover more of that. I think the product is working very well. I don't see a change happening at that stage. Now what I'm more focused on, Brian, with the team here at Intact is how do we provide more value for money at the small end of commercial lines, how do we leverage our distribution, our digital expertise to a greater extent to make it easier for small entrepreneurs to do business with us. I think there's an opportunity there. We're deeply penetrated in that space. And I think this is an area for us to win in the midterm.

Makes sense. Kind of extending on that, I'm curious, are you seeing any increased number of UBI type of customers as a result of what's going on right now with the pandemic and where we're dropping miles driven? And are people more focused on that? And maybe with your -- with respect to your -- you have an investment, I believe, in Metromile as well and maybe what they're seeing.

Yes. I think the April was a slow month. And what happened in April was rather odd, it was more [ paralysis ] in the system than anything else. But when I look at UBI take-up these days on new business, I'd say in the direct channel, Brian, we're in the 65-ish percent zone, which is a high rate of take-up. And in the broker channel, we're in the 45-ish range. And these are numbers that are a few days' old. So a nice pickup from the early part of the crisis but not materially higher than before the crisis. It is surprising to us. We're clearly putting more emphasis on that now, and I do expect that to migrate upward in the coming months.

Got you. And have you seen any impact with your ride-share business as a result of what's going on?

Yes. I think that there's been a meaningful reduction in kilometers driven on the sharing front as well.

Got you. Terrific. And then the other one, I'm just curious, so Intact has been very successful with respect to M&A and acquisitions and building out its platform and franchise. Has this crisis that's going on right now created any additional opportunities there? Has it slowed it down? Kind of what is your perspective on things?

So we have created Intact in its current form in a crisis. And clearly, we're running the business with that history in line where, from a capital point of view, we can play offense and defense, meaning that we can absorb blood, bad news here, should there be at the macro level, to be able to play offense if opportunities present themselves. Our thesis is very much intact. From the perspective that we said in the Canadian marketplace at the manufacturing level, 15 to 20 points shouldn't change hands. We used to say 20 to 30 points. Half of it got done. And the ingredients that are at play now are very favorable to our thesis. We entered the crisis at the industry level with an ROE of about 5%. And so you move into COVID-19, and I'm talking about the industry here, with headwind on the investment front, with a fair bit of pressure because of COVID-19. The reinsurance market is putting pressure on primary carriers as well. And then a big portion of our industry is actually in foreign hands, and there's a lot of pressure globally taking place at the moment, which leads me to say this is a very good environment to be in a position of strength because there will be a reassessment of strategies, I think, in the Canadian marketplace, and we stand ready to take advantage of that. We're well on our way with the integration of the Guarantee Company of North America, which we've closed in December, making good progress on that front. And as we've mentioned before, we intend to consolidate our position here in Canada, and this is a good time to do it.

Good time. Great. And then I'm just curious, let's take candidate and let's look at the U.S. So how has your experience with the OneBeacon acquisition kind of been different than Canada? Are you still looking in the U.S. to continue to kind of grow your platform?

So first of all, I'm thrilled with the acquisition of OneBeacon, which we've done in 2017. I'm thrilled with the team, Mike Miller's leadership, and people running our business units in the U.S. have been excellent guys to work with. And as a result, we've made a lot of progress. I mean I've made it very clear from the moment we've made the acquisition that our license to operate in the U.S. was to run the business in the low 90s, to have a top-quartile underwriting performance. We've taken actions on that front. And what I made clear is that before we actually see real traction there and sustainability, we're not going to deploy much more capital in the U.S. Well, sitting here 3 years later, we have shut down lines of business that we felt only hope could lead you to stay in. We have really broad governance and a bit of pricing sophistication. We have embedded a number of claims practices as well, which we brought in from Canada, including in-sourcing some of the legal work and have taken costs out of the system, very much in line with the synergies we've lined up or laid out at the start, which means that sitting here today, the business is running in the 92%, 93-ish percent range. And the market momentum is obviously better than what we had anticipated when we made the acquisition. So overall thrilled and, as a result, ready to deploy capital in the U.S. should we find opportunities that are good and that would meet our economic objectives. Now the lens we're taking to look at these opportunities, Brian, though, is how does it reinforce the footprint we have right now and so as opposed to take us in vastly new exotic direction, so to speak. I really want us to bulk up our strengths and get bigger and better at what we're doing already. And what it means in practice is that we're keen on insurance company opportunities. There are not that many, frankly, it's my assessment at the moment, at least in a reasonable size. And we're also interested in distribution acquisitions. And those are more plenty-fold, smaller, yet very strategic in that you can expand your footprint in the areas of strength and make money being a distributor. And so we're really focused on that part in the U.S. at the moment but open and capable to deploy capital at a different level than we would, say, 6 to 12 months ago.

And when you say open to distribution, are you referring more to an MGA-type situation or actually buying brokers?

Well, both. But the reality in specialty lines, Brian, is MGAs lend themselves more to the platform that we have. So I would say the bulk of our attention on distribution in the U.S. at the moment is on MGAs.

Got you. Makes sense. So next question here, do you believe that the personal auto hard market is going to continue to have momentum over the next 12 to 24 months?

Well, I think that the industry in aggregate in automobile insurance, in particular here in Canada only, Brian, because we don't do personal auto deal in the U.S., not a place we want to compete. We entered this market in a hard pricing environment in automobile insurance. You've seen our top line pick up meaningfully after a number of years of heavy lifting. The industry is probably a couple of years behind on that front, which is great from a margin and top line point of view for us. And so all else being equal, I doubt that the industry will have digested its issues coming out of COVID-19. And the question then is, well, how about frequency and what does it mean to the market? And as far as I'm concerned, if frequencies drop, the rate of rate increases will change as well. There's no doubt about that. But the industry, given it started from a weak profitability position, will need, I suspect, to convince itself that those frequency drops are structural in nature. It's unclear to me that they necessarily are. We are within 10 to 15 points of the driving volume that existed a year ago. We're above the driving volume coming in the crisis. But if you take seasonality into account, we're low teens below where we were a year ago, and that's inching upward every week. And so -- and as you know, when you price, you price 12 months out. And so it is a bet to say, look, this will be structurally lower for the next year or 2. It's not clear to me that a loss-making industry in automobile insurance will make that bet necessarily. My perspective is that if the trajectory of rates drops, it's because the frequency will have dropped as well. And I'm not worried about margins for us in that regard.

Got you. So you're not seeing a lot of competitors dropping rates at this point. They're still kind of pushing for them. It's just more of a credit situation.

Yes.

And then how do you think your rate is right now compare to the rest of the industry?

Yes. I think in relative terms, Brian, we were more expensive than the industry right until about a year ago by a big margin. That margin is now narrowing. I think the industry is probably catching up a little bit. And if you look at our growth starting in mid '19, you've seen we've gone from shrinking, which was deliberate, to a certain extent, to single-digit growth. I think that -- I suspect that we'll move in a more positive zone in the coming 12 months because the industry has not cut up to our rate levels yet.

Yes. And I guess that's my next question. I mean your margins in your personal auto business now are kind of where you've targeted or pretty close to it, right?

Yes.

So what are you doing right now to drive unit growth, right? Is there any additional things, additional measures to take advantage of this opportunity right now?

Yes. So we haven't slowed down any brand investments in any meaningful way or a response duration strategy. So we are running the business to grow at this stage. We were careful in the early parts of the crisis not to bother consumers in a period of pain but certainly are back at trying to generate response. We've doubled down on our investments in the digital interaction, and we'll continue to do so during the coming 12 months. And we're pushing our distribution initiatives, Brian, whether it is belairdirect, front and center, we're investing in promoting Intact Insurance and the online offer of Intact Insurance. And BrokerLink through our distribution, own distribution channel, is also gaining a fair bit of traction now. So we're really using brand, customer experience as well as distribution horsepower to grow in the automobile insurance segment.

Great. So let's pivot a little bit over to commercial lines. Maybe you can talk a little bit about your COVID-19 exposure. You didn't have an increase in your provision in the second quarter of '20, and you seem pretty darn confident that that's not going up, right? So what gives you that confidence that you've got it contained already, particularly when I'm reading in media all the time that these lawsuits are going on and all sorts of stuff going on. What are your defenses there? Why are you so confident?

Yes. I think, Brian, I came out early when we reported Q1 and we said, look, the direct losses related to COVID, we've done a ground-up policy by policy assessment of everywhere we felt we could be hit. We have provisioned $83 million in the first quarter, but this was really ground up assessment. The incurred to date is about $30 million, and we've closed 80% of the files for which we've received a claim. So sitting here today, if we -- if there's a meaningful wave, too, that exercise will start again with a major lockdown. So this is where I think we have to remain sober to a certain extent. But it is a ground-up assessment. And with 80% of claims closed on what's been reported to date, we feel pretty good. There are a number of lawsuits that will take many years. Some of them are groundless in relationship with business interruption. And you're seeing a number of our E&O or D&O lawsuits for long-term care homes and things of that nature. We provisioned for that. That's part of the $83 million. We basically did an overall review of where there was a potential for negligence because keep in mind that you need to prove negligence here and did, again, a ground-up analysis provision for it. And we still were in decent shape at this stage. The indirect consequences of vacancy, of meaningful economic slowdown, that's not part of our direct exposure because it's really hard to know what happens on that front. There's no clear signs today then there'll be a massive headwind coming from that. But that's the place where I think we need to remain vigilant. And then the last thing is there's been a number of lawsuits on business interruption. You need direct physical damage. The recent case law all goes in the same direction, it's pretty clear. The historical case law or common law in Canada is also very clear from that point of view. So we're prepared for a multiyear fight on that front but not one we're concerned about, quite frankly.

Great. And you kind of mentioned the secondary impacts of a potential economic downturn. I mean one that I think about right now for some of the U.S. companies is surety exposure. And you obviously just made an acquisition that increased your surety kind of type business fairly meaningfully. What are your thoughts on that?

Yes. Well, I think it's -- that's the one to watch. I would say, high level, Brian, we've got a little more than $500 million of surety, half of which is commercial surety, half of which is contract surety. I think the point you're making, it might be more directed towards contract surety, which is construction-driven and quite sensitive to the economic cycle. We've done an in-depth review of that portfolio. It's -- as I said, it's about half of our exposure. It's been fairly resilient over time. Now the contract surety operation of the GCNA, we're less familiar with because we've owned it now for 9 months. But if you go back to 2008 and '09, for instance, that business ran in the '90s, which was not great for surety. But -- in the big scheme of things, I don't take a 90% combined ratio in a bad time. And I'm not saying this is where this is headed, but I'm saying, first of all, it is half of the $0.5 billion that is contract. Second of all, I think it has shown some resilience. Then if you step back and you look at the construction industry, the private demand has been, at the industrial level, fairly resilient. And I would say even in April, like, my colleagues in the construction business said that the private demand was very strong. And a case can be made that the public demand, which didn't come as fast as what people thought, is building up and likely to build up as well. And so at the end of the day, I think the thing to watch in surety, I'm not sure it's demand so much as the extra cost of getting the job done, so to speak, because of the environment in which we operate.

Got it. Makes sense. Let's talk a little bit about the commercial lines marketplace in Canada. It's a hard market. It's been a hard market. I guess my question -- the question I get from a lot of investors is how sustainable do you think is this pricing environment we're in right now. Are we going to get peaked out here soon? Will it continue? What are your kind of views on that? And then in that context, are you positioned to kind of continue to kind of take some share here in that marketplace?

Yes. I think between our position in Intact Insurance, our Main Street commercial lines operation and our specialty lines operation and the fact that, that business is running in the low 90s, it was 95 in Q2, but I think this is a low 90s business, I think we're in excellent shape to take advantage of the hard market while expanding our margin. We don't have capacity issues. We don't have rate adequacy issues. Brian, we've been increasing rates in commercial lines here at Intact for the last 6 years. We've been working on the unprofitable parts of our portfolio for many years. And so we're sort of enjoying this environment. We're open for business. And you can see it in the top line. Growth is in the teens in commercial lines. Rates are in the upper single-digit range. While inflation is in low single-digit range, at least that's my read right now. And so it is a very good place to be for Intact at the moment. The bigger question is how long are we in this environment for? And there's a lot of anecdotes. But if we take a macro assessment of this, the industry's ROE coming into this crisis was 5.5% in Canada. Again, I repeat, that was the industry's ROE, important not to mix up the numbers here. It's ran historically at 9% to 10%. So our perspective is for the industry to get back to its historical performance, you've got 2 years of correction needed, 18 to 24 months. Then you throw the current context in. And what do you have in the current context? Well, you've got 3 main things: one, a lower interest rate environment; two, pressure coming from COVID-19; three, pressure coming from the reinsurance market, which is also very hard and restrictive at the moment. So you layer it down on top of an industry that was generating 5% ROE, our perspective is that we still have got 18, 24 months of momentum in the market here.

Got you. And then I just want to remind our audience members that if you got any questions, feel free to go ahead and chat on, I'm happy to ask them to Charles, I've got a lot of questions here. One of the questions actually that came in, and it kind of falls on that subject, is given the current interest rate environment, do you need to reset your target combined ratios right now, particularly, like, you always talk commercial of low 90s, right, mid-90s in auto, and I think particularly for commercial lines, do you have to reset it lower to get an acceptable return on capital?

Yes. Brian, we've been pricing for decades using an ROE target. And I'll tell you the ROE target hasn't come down because the risk-free rate has come down, okay? So that's the first point. And as a result, you need to reset from a combined ratio point of view given that. I mean it's just part of the math. And so it is fair to assume that the guidance we've given is one that takes into account a low interest rate environment. And it's fair to assume that those numbers are not going up anytime soon, at least with what we're in control of. And that's why low 90s might have been 92%, it's now probably much closer to 90%, if you know what I'm saying. I've been careful with the guidance we've given over time, Brian, but clearly, a lower interest rate environment implies, from a pricing point of view, lower combined ratios, given the ROE target hasn't changed.

Got you. And then you briefly talked about this, your kind of satisfaction on what's going on with OneBeacon. I'm just curious, if I look at OneBeacon's premium growth, 7% organic. But we're in this really hard pricing environment in the U.S. now. And some of, I would say, OneBeacon's peer companies are probably growing at even a faster rate, kind of strike while the iron's hot here. Have you been satisfied with the growth that they're putting on at this point? And what could be done?

Yes. Well, the marching orders were, first and foremost, low 90s combined ratio performance. I don't know if you've heard me say that before. But certainly, the team at OneBeacon did. And I think that when you study what's happening at OneBeacon, our improvement plan involved shutting a number of business units down, such as architects and engineers and programs, we've done that early on. Then we have a number of units that are under performance improvement. And then the remaining units are doing superbly well with combined ratios in the 80s and growth in the low teens. The business units where we don't have the performance we're looking for just yet, we're working with the leaders who are doing an incredible job to take advantage of this market to make sure that their business units perform in the low 90s. Now those units are shrinking in Q2 by about 20%. And so the 7% you're talking about, first of all, has a COVID impact in it because there was a bit of a slowdown in April; second of all, as a combination of very healthy business unit growing double digit and where we feel some hard lifting is left to be done, shrinking by about 20%. You put all that together, you get 7%. And you put the GCNA acquisition on top, and that's how you get to the low-teen growth that we've shown.

Makes sense. Great. Got one, just came in from an investor, asked, do you foresee any changes in the homeowners insurance product or property insurance product?

Not in the near term. We have -- nothing substantial. We have, about 7 years ago, Brian, transformed that product. We have unbundled the product and built a peril by peril-type program with a pricing that was peril by peril-based, with conditions that took into account the fact that the burden of natural disasters increased by a factor of 5 over 30 years. That was a massive change to the product. We've broadened water coverage in the exercise and have been growing this business ever since, I would say, fairly successfully. If you look at our combined ratio in good and in bad times, 5 years in a row, including Q2, and you're looking at operating performance despite a fair bit of natural disasters, Q2 no exception of that. So I think we're in a really good position there. Clearly, on the fringe, work from home, broadening of coverage, those sorts of things take into account what's going on in the world right now. It's an area where we have expanded to a certain extent, at least temporarily. Can more be done? Maybe. That would be tactical short term, nothing structural in the mid- to long term at this stage.

Got you. Terrific. And then another one that came in, it kind of aligns with the question I was going to get to ask you. And the question, I guess, they start off, any thoughts on some of these insurtechs that we're seeing pop up that are trying to disrupt the industry like Lemonade or Hippo. And I guess on that topic, I mean, you're obviously a leader when it comes to major digital and AI initiatives, what are you doing to make sure that they don't grab some of your market share?

Yes. Well, first of all, we invest in some of them. But I think my own view is that for a real disruption to take place. There's 2 things you need: much better design and much better value for money. And if you don't have the combination of both, it's really hard to this large existing players. And then the third element in the insurtech space is that if you try to build the balance sheet by being a risk taker, that is incredibly difficult to do. So we certainly have the balance sheet. And therefore, as a firm, we've been modeling disruption in our marketplace since 2013. We -- our first disruption simulation started back then. And this notion of design and value for money being key ingredients of disruptions have been at the forefront of our thought process to prevent against that. And so what are we doing? So first of all, maintaining a very deep and close relationship with customers is critical here. And as such, we have built the 2 strongest brands in the Canadian marketplace. We're talking retail, not so much commercial lines here, Brian. So we built the 2 strongest brands to make sure that if we chose not to be on a disruptive platform, customers won't question the credibility of that platform, I would say. That's a little bit defensive. It helps on the offense, but there's a defensive play there. The second key point has been to have a broad distribution platform and try to control our distribution as much as we can. And that's why you see belairdirect, BrokerLink, Intact Insurance online, and Intact Insurance being forces in the Canadian marketplace, it is to get closer to customers. The third element has been a big portion of the digital front. I think that our tools on digital interaction are best-in-class not just in Canada but stacked very well against a number of the disruptors and, certainly, some of the top players in the U.S. The other element which is important is what you do in claims. We've chosen on one hand to go deep in the digital world, but we want to own the physical world. The reason why that's important for us is because this is really hard to disrupt. And if you build an edge in the physical world, you've got one more weapon to fight disruption and potentially make the most out of it. So you look at our investments in claims, our in-sourcing strategy, our investment in on-site, our home restoration business, is all meant to have an edge in the physical world. The last point I'll make is a massive turn on AI. And I don't know how many new start-ups of 200 AI specialists right now with the data set we've accumulated over the years. So look, we don't assume there will not be a disruption. We don't assume we will win in disruption, but we've been preparing aggressively for that for 7, 8 years now.

Great. That makes sense. And on the distribution front, I'm just curious, what do you see as your pipeline and kind of organic growth prospects right now in your brokerage business?

Well, the brokerage business is also a consolidator. So the reason why we have grown our distribution profit, which is well north of CAD 200 million now, at double-digit, is because we've consolidated. The mandate of the team in our distribution platform is to have an organic growth profile that rivals the best direct writers in Canada. So you can think of north of mid-single-digit to upper single-digit organic growth through the platform.

Got you. And then another question I sometimes get from investors is you've got this good distribution system. It's something that's somewhat less familiar to us in the U.S. as far as owning independent agents and brokers. What kind of regulatory pushback is there potentially in Canada to this whole distribution strategy that you have? And then I guess you kind of alluded to it, I guess, you believe you can transport this to the U.S.

Yes, in a different way. I think that in Canada, our strategy in distribution is to build scale in particular, in personal lines, that would not be our strategy in the U.S. because that's not complementary to what we're doing. That's why the way we think about distribution in the U.S. is how do we bulk up our U.S. specialty lines business by making strategic investments in distribution. In Canada, we're building a massive distribution engine, primarily in personal lines where, when you combine scale and options, you have a machine that, in our mind, beats pretty much any model. And so I think that, that is a different strategy than what we're thinking about in the U.S.

Right. But I guess going back to the whole regulatory part of it. Just -- how do people think of it because, obviously, your competitors can't be all that happy if they all of a sudden say Intact by one of the brokers that they're using?

Yes. So there's what are competitors, what other brokers think, and then there's what consumers think. And the 3 are different, I would say. So first of all, other than in one of the provinces, there's no ownership restriction. In the province of Québec, there's a maximum ownership you can add. Therefore, we have partners there. And we play more the role of a highly supportive private equity investor, but there's great strategic alignment. In the rest of Canada, there are no constraints. There's no pressure there because disclosure is very good. But our strategy is not to get the brokerage business to be an extension of the insurance company. Our strategy is to be the very best broker in the marketplace. And that's why you see distribution profit. If we'd be focused on just feeding the beast, you would see the distribution profit erode over time. So we're really focused on how we close, how do we retain and the margins that we're building in that platform. And as a result, it is growing. As a result, I think consumers get a very good experience there. And the competitors who are not so dogmatic and accepted our offer to be on our platform, you know what, we're now a big -- one of their biggest distributors. And it's been good for them. And one of our commitments is that if you put your product on our platform, there will not be a competitive disadvantage to you to be on our platform any more than in any other brokerage in the Canadian marketplace. By that, I mean we're not saying everybody will have the same results because we outperformed in independent brokerages, but we're saying information will not be used against you, you will not be adversely selected against. And as a result, many of our competitors have built great businesses with BrokerLink, which is run separately from the insurance operation but certainly run the Intact way.

Great. Well, we're at the closing time here, Charles. Listen, really, really insightful, a great, great discussion here. I really appreciate your time. And thank you, everybody, for joining us.

Thanks, Brian. I really appreciate.

Thank you.

Bye-bye. We will see you in person.