Trisura Group Ltd. (TSU) Earnings Call Transcript & Summary

Good morning. Welcome to Trisura Group's Second Quarter 2022 Earnings Conference Call. On the call today are David Clare, Chief Executive Officer; and David Scotland, Chief Financial Officer. David Clare will begin by providing a business and strategic update, followed by David Scotland, who will discuss financial results for the quarter. [Operator Instructions] I'd like to remind participants that in today's comments, including in responding to questions and in discussing new initiatives related to financial and operating performance. Forward-looking statements may be made, including forward-looking statements within the meaning of applicable Canadian and U.S. security laws. These statements reflect predictions of future events and trends and do not relate to historical events. They are subject to known and unknown risks, and future events and results may differ materially from such statements. For further information on these risks and their potential impacts, please see Trisura's filings with securities regulators. [Operator Instructions] I'll now turn the call over to David Clare.

Thank you. Good morning, everyone, and welcome. Our business continued to perform well in the second quarter, growing premium 77% compared to Q2 2021 and supporting a 19% return on equity through continued investment in infrastructure. Momentum is sustained as we scale an increasingly diversified specialty insurance platform. Results again were particularly strong in Canada, with 36% premium growth in the quarter supported by profitable underwriting. U.S. premiums stepped up significantly and reached a new record, increasing 103% over the second quarter of 2021. In Canada, disciplined underwriting produced strong profitability, while fronting drove increasingly diverse earnings. We have observed standout growth in earnings from Risk Solutions, the largest contributor to Canadian underwriting income in the quarter. The favorable market in corporate lines in Canada and E&S lines in the U.S. continued in the quarter, although we see a reduced pace of rate increases versus last year. The majority of our growth has been achieved through enhanced distribution relationships and new volumes. And as such, we expect to navigate eventual rate normalization smoothly. 68% growth in top line and corporate insurance was driven by expansion of programs and sustained momentum with distribution partners as well as the healthy but mitigating rate environment discussed. Surety growth of 17% was strong as the business benefits from tailwinds in established lines and expansion of our U.S. practice. Importantly, loss ratio of 14% in Canada improved sequentially, driven by profitable underwriting across all groups. Combined ratio in the quarter was 81% compared to 83% in Q2 2021, a very strong result. The Canadian platform posted a striking 32% return on equity and grew net income 70% over the prior year. With the extension of our U.S. Fronting expertise in Canada, our Canadian entity now generates attractive fee-based earnings to complement a heritage of profitable underwriting. U.S. Fronting more than doubled premium over Q2 2021, maturation of existing programs drove top line, supplemented by onboarding of new programs. U.S. Fronting generated $448 million in gross premiums written and $15 million in crunching fees. We recorded $35 million of deferred fee income at the end of the quarter, indicative of future fees to be earned. Loss ratio in the quarter increased slightly due to an evolving business mix while fronting operational ratio increased to 82% as a result of higher retention and significant investments in staffing and infrastructure. We also noted an increase in certain reinsurance costs, which have impacted the front-end operational ratio. It is important to note that our U.S. earnings will lag premium production as fees are earned, the corollary being that near-term results will be comparable to this quarter. We expect to experience the benefit of this premium growth in earnings in 2023 and beyond. On the last 12-month basis, the U.S. produced a 14% ROE in line with the prior year as a result of corresponding growth in infrastructure over the period and 2 significant capital injections. Given the rapid growth in the U.S. and the amount of capital recently downstream, we're encouraged to see the quarterly annualized ROE at 16%. Although we wrote $44 million in admitted premiums in the quarter, the market continued to drive opportunities to exit the surplus lines. The strength of our growth catalyzed our recent capital raise, which will support the expansion of our platform. I would like to thank our partners for the continued confidence. We do not take the prospect of raising equity lightly and look forward to deploying our new capital efficiently on your behalf. Interest and dividend income increased 38% over Q2 2021, the result of a larger portfolio as we grow our platform. The continued increase in interest rates drove unrealized losses in our fixed income portfolios, though the impact was mitigated through our short-duration posture. As a growing company, supported by our recent capital raise, we are in a unique position to deploy investment funds at yields not seen since 2018. We are fortunate to have a significant and consistent flow of capital to invest, enhanced by the maturation of our existing short-duration portfolio investments. Prevailing bond yields are accretive to portfolio yield, meaning that we are improving our base of interest and dividend income on a risk-adjusted basis for years to come. Our platforms have become complementary sources of opportunities for one another. As we gain market share in one geography, our presence and capabilities of companion offices provide opportunities to generate new business and service our partners in both Canada and the U.S. In the quarter, we observed this on both the distribution and capacity side as opportunities to collaborate with distribution agents and reinsurers were shared between Canada and the U.S. We remain an insurance company in growth mode and must focus on the skills and discipline that brought us to this point. Concentration in business lines we know, conservative underwriting, and detailed structuring, we are navigating a volatile environment, now armed with a larger capital base and renewed debt capacity. We are in a better position than ever before to support our partners and grow our business. In the context of strong results, it is always worth acknowledging that our business can experience volatility and severity, and claims. As we continue to grow, we strive to increase the proportion of our business is derived from recurring or fee-based earnings sources. With that, I'd like to turn it over to David Scotland for a detailed review of financial results.

Thanks, David. I'll now provide a brief walk-through of some financial results for the quarter. Gross written premium was $642 million for the quarter, which reflects growth of 77% over Q2 2021. Net claims expense for the quarter was greater than the prior year, primarily as a result of growth in the business. We also experienced a claims recovery in 2021 associated with our light annuity reserves, which has since been novated and which reduced claims expense in that quarter. Net commission expense increased by 68% in the quarter, reflecting growth in the business in both the Canadian and U.S. operations as well as a shift in business mix towards certain lines with higher commissions. Operating expense in the quarter grew by 22% over Q2 2021, reflecting growth in both the Canadian and the U.S. operations. Net underwriting income in Canada for Q2 was greater than the prior year as a result of growth in the business and a lower loss ratio. Net underwriting income for the U.S. for Q2 2022 was lower than Q2 2021 as a result of a higher loss ratio and additional catastrophe reinsurance payment made in the quarter. In Q2, the combined ratio in Canada was 81% and the front-end operational ratio in the U.S. was 82%. With the innovation of our life annuity reserves in Q4 2021, we are now able to calculate a meaningful combined ratio on a consolidated basis. In Q2, that combined ratio for the company was 79%. Net investment income was greater in Q2 2022 than 2021 as a result of an increase in interest and dividend income. The increase was primarily related to an increase in the size of the investment portfolio. Net investment income in 2021 was also negatively impacted as a result of movement in the investments supporting the life annuity reserves, which was offset by the corresponding movement in claims expense in that quarter. Net gains were $1.4 million in the quarter as a result of realized gains on investments disposed of during the period. This was less than the net gains of Q2 2021, largely as a result of movement in derivatives you just used to hedge share-based compensation, which were greater in that quarter. Income tax expense increased in Q2 2022 compared to 2021, reflecting higher net income before tax in the quarter and the impact of a tax recovery in 2021, which reduced income tax expense in that quarter. Net income for the group was $20 million in the quarter, which was greater than 2021 as a result of growth in the business. Diluted EPS was $0.48 a share in Q2 2022, which was greater than 2021. Consolidated ROE on a rolling 12-month basis was 19% at the end of Q2 2022, which was greater than the rolling 12-month ROE at the end of Q2 2021. Assets year-to-date grew by $489 million. Cash in the period increased as a result of the drawing of $30 million from our revolving credit facility. Investments have decreased, reflecting the transfer of assets from the novation in 2021 as well as unrealized losses incurred in the period. Premiums and accounts receivable and other assets has grown as a result of growth in GPW particularly in the U.S. over this most recent quarter. Recoverables from reinsurers have increased primarily as a result of growth in the U.S. fronting business as well as certain fronting programs in Canada, where claims liabilities are largely offset by expected recoveries from the reinsurers to when we see the business. Liabilities in the year-to-date period grew by $491 million, primarily as a result of growth in under premiums and unpaid claims and loss adjustment expenses, which have grown as a result of growth in both Canada and the U.S. As discussed, growth in these balances is largely offset by growth in reinsurance recoverables. Accounts payable, accrued and other liabilities has decreased in the period as a result of the settlement of assets from the novation in 2021 as well as a number of large payments in the period. Equity is approximately the same as year-end, reflecting growth in net income, offset by a reduction in other comprehensive income. Other comprehensive income decreased in 2022, primarily as a result of unrealized losses on the bond portfolio due to rising interest rates. Book value per share was $8.62 at June 30th, 2022, which is greater than June 30, 2021, as a result of profit generated year-to-date and mitigated by unrealized losses in the investment portfolio over the quarter -- over the -- yes, over the quarter. As at June 30, 2022, the debt-to-capital ratio was 22.7% as a result of a drop in the company's revolving credit facilities. However, following the equity raise in July of $144 million of net proceeds, the company's debt-to-capital ratio was below our 20% target. The company remains well capitalized, and we expect to have sufficient capital to meet our regulatory capital requirements. David, I'll turn things back over to you.

Thank you. Operator, if you could remind analysts on the line how to queue up for questions? We'll take questions at this time.

[Operator Instructions] Our first question comes from the line of Nik Priebe of CIBC.

So my general read on the pricing environment in U.S. commercial lines is that rate increases have continued on renewal, but at a more moderate pace from 1 year ago. So higher rates are supportive of top-line growth in the U.S., but how much of the momentum that you're experiencing would be attributed to the flow of business from standard to E&S markets? Has that remained an important tailwind? Or do you see that tapering along with the rate environment?

It's an interesting question, Nik, and it's difficult to pinpoint exactly how much of the momentum in the E&S space right now is attributable to that phenomenon. I would say, certainly, we would agree with your observation that rate increases are still positive, although not the magnitude that we've seen in years past. That narrative, I would say, is still present in the market in the preference or momentum we're seeing in the E&S space. We haven't yet been able to exactly measure how much is shifting out of the admitted markets into the E&S. But I would say in hard market environment, generally, that is the term or generally, that is the trend that you experienced. So difficult to give you a precise answer on that. But I would say that we continue to see faster growth in the E&S market than the admitted market overall, which should suggest that, that market continues to benefit from substitution into the space.

Yes. Okay. Fair enough. When you think about the evolution of the U.S. platform, if you are able to achieve a mid-to-high 60% loss ratio over time, is there a target fronting operational ratio that you feel is optimal for that platform or realistic that you would plan to manage to?

Yes. This is going to depend somewhat on structure and mature retention levels because that informs somewhat where your front-end operational ratio resides. At this stage, certainly in the longer term, I would expect to be targeting something in the mid-70s. But in the near term, as we talked about in our comments, the next couple of quarters will be higher than that as we invest in the platform and as we navigate through Q3 and Q4. So I would say if you're thinking about this business over the longer term, through 2023, 2024, I would expect and hope that this ratio gets back down into the mid-70s. But in the near term, as we grow and as we step up the infrastructure in this platform, you're going to see that slightly higher.

Yes. Okay. That's helpful. And then one last one for me before I pass the line. the equity raise, does that -- will that push you into a higher size category for A.M. Best? And would that -- if so, would that have an impact on your competitive positioning? I'm just wondering if it enables you to pursue larger policies that might be supportive for the ramp of admitted lines.

It's a good question, Nik. It doesn't push us into that higher-sized category yet. The next size category, I believe, is in U.S. $500 million. So on a consolidated equity basis, we're still below that in U.S. dollars, but it's something that's on our radar.

Our next question comes from the line of Jeff Fenwick of Cormark.

So David, maybe one thing we could talk about is Surety and the outlook there. I get a lot of investor questions around the risks, around a recessionary environment and the construction market alongside of that. And maybe just give us a bit of color about how you're approaching the business there, what the mix looks like and your comfort level going forward.

Yes. I would say surety as an industry and certainly a practice within our company that obviously watch closely all the time, but especially in times where people are thinking about recession. I would say from our perspective, we're usually very interested in understanding the credit quality of our surety partners that are bonding partners. That's the crux of our underwriting philosophy. That's how we've been successful over the past 16 years in the surety practice. As you go into a more uncertain economic environment, certainly, there's a lot of headlines around this now. You're obviously making sure that you're watching the credit quality of your partners. Really importantly, for the most part, our Surety partners have been an 18-month backlog of work. So what that means is as you're entering some economic slowdown or some change in economic environment, you'd start to find some change in your partners' health in the event that economic slowdown lasted for longer than their backlog of work. The other thing that this environment introduces is changes on inflation and an inflationary environment does have impact on the Surety space. Now, really importantly, what a lot of people don't recognize is it actually changes bond prices. So some of the growth that you're seeing in the Surety landscape is reflective of higher project costs and input costs for Surety have moved up. So that inflationary environment does move up your bond premiums as you navigate through this change in space.

Okay. That's helpful. And then maybe one other thing we could talk about is technology. And some of your competitors highlight that as a differentiator for them and how they target different lines. Maybe you could just speak to where Trisura has been investing there and how that's utilized in your approach to the market?

I would say technology in the insurance space is really a standard bar that everyone needs to meet. I wouldn't qualify our competitive advantage as technology-based. And frankly, I think if we had any temporary or short-term technological advantage, that would in time be arbitraged away by investments by other players. I think where you're seeing us benefit and invest is really in areas to make collaboration with our partners, be they distribution partners or reinsurers more efficient. That's where we like to improve the entity, improve the experience of our partners in working with Trisura. But I wouldn't qualify by the vehicle as tech-enabled or differentiating specifically on technology. This is really a group that benefits from the expertise of underwriters and people who have been in the business for a long time, and that's enhanced by proper investment in technology and systems.

Our next question comes from the line of Tom MacKinnon of BMO.

My question is with respect to net expenses in the U.S. and some of the spends you're doing in terms of infrastructure there. Maybe you can elaborate a little bit on those. And when I look at the -- those net expenses as a percentage of earned premium, they seem to be running higher so far in 2022 than they were in 2021. Perhaps you can shed some light on that and how that should trend going forward.

Thanks, Tom. So net expenses have moved up in the U.S., and there's a couple of things driving that this quarter. As you've seen, our premium growth has really significantly had substantially stepped up. So this new premium base requires a pull forward of some of the longer-term investments that we've contemplated. So that includes people that includes regulatory and filing investments, some legal costs as we build out this platform to support a larger infrastructure. The other thing you're seeing as we've grown the platform is investments in or changing nuances with our retention models. And those retention models can change the calculus or the proportion of the expenses and the calculation of net premiums earned. So there is some impact, as you've seen our retention step up closer to that 10% level. The other item that you're seeing specifically in the quarter and that I would expect to see in Q3, there's a little bit higher reinsurance cost as we enter into the more storm-exposed season in Q3. So all of those factors have driven this up. I would say we're likely seeing at a little higher rate as we go through Q3 and Q4, but that should mitigate into 2023 as we see these higher premiums, this higher fee income starts to get earned through that longer period.

How many points on -- do you think that would translate into if you looked at those net expenses as a percentage of the earned premium, if we were looking to 2023 and in 2024, would it be a couple of points improvement? There's got to be some operational leverage in this platform.

Yes. At this stage, we haven't targeted that level of granularity, but I think we can probably get a little bit more specific as we enter into Q3 and Q4 with you.

Our next question comes from the line of Marcel Mclean of TD Securities.

Okay. So just following on that point, with your retention being towards the top end of that 5% to 10% range that you referenced. Just given the larger capital base and the maturation of the business, is that a range that you're thinking of maybe moving up over time? Or is the 5% to 10% the long-term play for this U.S. business?

At this stage, for our quota share structure transactions is really that 5% to 10% on average across the portfolio is where we'll likely stay. You are seeing right now some nuance or some impact from structured programs that are a bit different than quota shares, which drives that reported retention ratio a little bit higher. So from a modeling perspective, Marcel, certainly, I think if you anchor yourself at that 10%, it should be a fair place to start for the business. But operationally, from a quota share perspective, the transactions we structured in that way still remain in that 5% to 10% range.

Okay. And then on a particularly a bit of a related note another ratio in the U.S., the fronting fees to seeded premiums I think you've referenced 5% to 6% is what to think about there? But in the past, you've been right near the top end of that. But for the past few quarters, it trended down to the bottom half. I think there's a little bit of that is related to the purchase of cat coverage. Is that going to be something that's ongoing that's going to keep this ratio lower? And are there any other factors at play like increased competition where you may be able to price more aggressively on your commissions?

Yes. I would say, certainly, we would expect that now to be in the 5% to 5.5% range as we see a stronger evolution or more diversified evolution of our book. Part of that is related to reinsurance costs as we navigate a more diverse book. Part of it, I wouldn't say is related directly to competition, but part of it is simply changing structures. So some transactions are structured in a way that on an accounting basis, really adopt more excess of loss structures rather than quota share structures. Those carry different styles of fronting fees or reinsurance seating commissions. So as the book has evolved as you've gotten a broader, more diversified mix of business, you see that ratio moving down, but certainly, our target for front-end operational ratio, our target for fronting fees. Those are consistent with the messages we've given previously.