Good morning. Welcome to the conference call of Porto Seguro S.A. to report the results of the second quarter of 2016. Today here with us, we have Mr. Fabio Luchetti, CEO. Marcelo Picanço, CFO and IRO. Mr. Celso Damadi, CFO and Controller. Ricardo Fuzaro, Manager of Investor Relations. This presentation is being recorded and simultaneously translated into English. All participants will be connected in listen-only mode during the company's presentation. Then we are going to start a questions and answer session, when further instructions will be provided. Should any of you need any assistance during this conference call, please request the help of an operator by pressing star zero. An audio and a slide deck of this conference call are being simultaneously webcast at the internet at the address www.portoseguro.com.br/ri.
At this address, you will find a banner called Webcast 2Q16, and this will lead you to a platform of the presentation. You may also ask questions on the webcast platform by clicking on the icon, "Ask a speaker." These questions may be sent at any time, and they will be answered live during this conference call. Before proceeding, we would like to clarify that statements made during this conference call relative to Porto Seguro's business prospects, operational and financial projections and targets are beliefs and assumptions of the company's management and are based on information currently available. Forward-looking statements are not guarantee of performance because they involve risks, uncertainties, and assumptions, because they refer to future events. Therefore, they depend on circumstances that may or may not happen.
Investors should understand that general economic conditions, industry conditions, and other operational factors may affect the future performance of Porto Seguro and may lead to results that will be materially different from those expressed in such forward-looking statements. Now, I would like to turn the conference over to the company. Please, you may start.
Hello, good morning to everyone. This is Fabio Luchetti speaking. I thank you for your participation in this conference call to report the earnings release of the second quarter of 2016. Starting on slide three, you're going to see the main accomplishments and highlights. On the second quarter, we have had a growth in our main business lines, mostly associated by our geographic expansion strategy and also our focus on product diversification, which has contributed to enhance our client base. We have implemented many actions to improve. We also took advantage of cross-selling opportunities.
We have added a considerable number of brokers, such as the case of life insurance, pension, and also property insurance. We have had a growth in the premiums around two-figure numbers. In auto insurance, the market has decreased by 4%, and our three brands increased by 6% in the quarter, thereby strengthening our market share leadership in the country, except for the South and Center West regions of Brazil, where we are second. The insurance fleet has grown by 7%, reaching 5.5 million vehicles, and we added 600,000 lives in-person insurance, thereby reaching 7.5 million lives insurance. Additionally, we have also grown 14% in the number of our lives in dental insurance, getting to almost 500,000 lives insured in this quarter.
On the other hand, the company's operational results has decreased compared to the same quarter last year because of a higher loss ratio, which has also had an impact in our bottom line, especially in auto insurance. The loss ratio of our motor insurance has increased about 2 percentage points until May, in line with the market. Also, in the second quarter last year, we had a lower loss ratio than our historical average, thereby affecting our comparison basis strongly. In terms of structure, our productivity gains have provided good results, and admin expenses remained almost flat during the quarter. In terms of financial results, we outperformed the benchmark, partially offsetting the lower operational results. We are working to improve our profitability during the year, and we believe that some of the events that had an impact in this quarter's results were quite atypical.
Now I'm going to turn the conference over to Marcelo to continue the presentation to give details about each business line.
Good morning, everyone. Thank you for your interest in our conference call. I'm going to briefly go through the main highlights of our financial performance. Initially, revenues in Q2 have grown 7% combining all our business lines, insurance, financial services, general services, and the growth in the quarter has reached 6%. In many lines, this is the growth above the rest of the market, especially in motor insurance, even though it is below our historical level of growth over the past few years, and mostly due to the macroeconomic situation in the country. Especially, we have managed to grow in some products more than 20% related to people, but in many other lines, in fact, the economic slowdown has affected our two-digit growth.
In terms of premiums, we have managed to remain stability in terms of the share in the total revenue, with a small highlight to the increase of the share of services and a reduction of our financial businesses because of the reduction of our revenues from credit cards. On slide number five, with regards to our operational results, focusing on insurance specifically, the combined ratio this quarter is well above our history and what we've delivered over the past few years, and this is related basically to an increase in loss ratio in some business lines, but especially because of automobiles that have grown significantly this quarter, partly due to climate events that we believe are not recurring, but we cannot say that they are 100% atypical for the time of the year, but they rarely happen, and this year, really, they were quite more intense, especially in June.
In May and June, we have also had some increase in crime rates, but we cannot yet say whether this is a consolidated trend, and we still need a few more weeks or maybe some months in order to be able to tell that. The combined ratio, based on the strong growth in loss ratio of almost 6 percentage points, and even with the offset of the financial results, has reached 92.6%, slightly more than 4 percentage points above the second quarter of 2015. In terms of financial results and services, we have had an increase. Sorry, not an increase, but revenues are flat, 3% in the year, 5% in the quarter. There is a reduction in the revenues from rotation credit and installment for the credit card and this was a decision that we made to reduce our risk exposure and to manage the threat risk of this portfolio.
We have taken a few credit restrictive measures because of the profile of the customers who decided to pay their invoices in installments and our risk is very much measured by our bad debt. We believe it is stable and depending on how the crisis evolves, it is important to say that it may reduce risk in the future. But in the short term, it affects the following months, and this year we are using different risk measures than we were using in the first half of last year.
On slide seven, with regards to financial results yield and income, the yield for the second quarter was quite significant at 3.6%, and in fact, it was the highest nominal yield on the largest reported yield for the second quarter, and this is especially because of our reference index, CDI is high, and also because the performance of the investments have beaten the benchmark. Our benchmark is CDI and Bovespa because we also have investments in the stock market and they have also had a good performance at this time of the year. But especially, the main driver that added value here were the funds associated to interest rates and inflation which have had a quite significant dynamic in the first half of the year, especially in Q2. This is not a new allocation. We have been doing it for a while.
As you can see on slide eight, our allocation historically is from 22%-28% indexed by the inflation. We have prefixed an allocation that is much more dependent on prices, but we had a relevant exposure here. In terms of the financial result in the first half of the year, was very positive because of that. In terms of risk exposure of these investments, it did not increase much to the opposite. We are having a reduction in our risk as compared to the same period last year. Our allocation back then was stronger in prefixed bonds. Also volatility has behaved better than it had been in the past three quarters. So in terms of risk exposure, there was not a significant change.
Last, on slide nine, considering our operational performance and the relevant reduction in our operational results, our total net income was BRL 175 million corresponding to a ROAE of almost 12%, 11.9% to be more accurate. In the first half of the year, it went from 19% to 14% this year and the total year-to-date net income was 18%, especially because of the results of the second quarter. Now, after this very brief presentation of our financial highlights, I would like to open for questions and answers. Thank you very much.
Thank you. We are now going to start our Q&A session. If you have any questions, please press star one or alternatively, you can ask your questions in our webcast platform in the icon, "Ask the Speakers." Thank you. Our first question comes from Mr. Thiago Kapulskis from BTG Pactual. Please, Mr. Kapulskis, you may ask your question.
Good morning, everyone. Thank you for the opportunity of asking a question. I have two questions. The first regards loss ratio. Now we've been able to see, considering the events, that pricing was not ideal. Obviously, it's easy to look at things ex-post, but there was a significant increase. What I would like to understand is more or less. Obviously, you've given the explanation of what is one-off. Could you give us a slight more color of what is one-off and what is more or less recurring in terms of loss ratio and what we can expect in the future in terms of loss ratio? I will ask my second question. Thank you.
Hello, Thiago. This is Fabio speaking. Thank you for your question. As we are talking about overall loss ratio, I think we should break down motor and health. In motor, it was well above what we had expected, especially considering the economic scenario, even advancing some elective events. Now, in motor, it's about 0.6 percentage points above the curve that we were expecting. It's very much adjusted over the next few months. They are different from what we had in the past. Automobile loss ratios in our portfolio, and also the comparison basis was not really very favorable because last year we had a performance that was much better than we had forecast.
The positioning of Azul in other regions of the country, we had also planned that Azul was in fact going to change prices. It was going to be slightly more competitive, it was going to gain market. When comparing the two quarters in terms of automobile loss ratio, there is this effect that we are slightly more competitive in Azul. We have about 0.6 percentage points in automobile.
Thank you. This is clear. I have a second question regarding competition. How do you see the competitive environment? Do you see any possibility of a price increase in the next few months for motor insurance?
Well, Thiago, in fact, I think that the market has witnessed this movement of slowdown and some prices going down. But what we've been seeing on the whole, that in spite of the step back, if we analyze combined ratios, especially isolated loss ratios, you see that on the whole, when an insurance company decelerates, the loss ratio should go down. This is what we would expect. But what we are seeing is that there is a drop in premiums, but we are not being able to hold loss ratio.
This will not create fierce competition because people will need to somehow balance their results. With these prices, I can't think that there is a downward trend. I think that there's an upward trend because parts are getting more expensive, and the recovery of the economy will not take place this second half of the year yet. There's violence, unemployment, theft, crime rates. Also with older vehicles. The whole basket of items that we need to balance are not really very favorable. We think that the scenario will be difficult to manage in terms of competitiveness. We adjusted prices two or three months ago, and that had an impact on our sales more recently. We think that after August, we will recover our budget.
Thank you very much. It makes sense. It's very clear. Thank you for your answers.
Our next question comes from Mr. Francisco Kops from Safra Bank.
Hello, Luchetti, Picanço, and congratulations on four of our initiatives that we find very interesting. The result in much more in terms of talking about prospects. I think that the scenario for automobile is quite challenging. Both the fleet will get older because of the reduction in the sale of new cars and also increase in robbery and theft. I think that the scenario will be deteriorated over the next few months and years. My question is, do you think there will be a certain business mortality and some companies that operate in auto insurance will go down, go out of business?
Hello, Francisco. You ask difficult questions. We need to have a meeting to discuss our answer before here. I am going to try to answer in parts. In terms of business mortality, I think that in terms of new cars, all that desire of the middle class in terms of buying new cars is going down. But new cars represent just 10% of the insurance market. 90% is of old cars. Of course, it is necessary to have more creative models. We launched Auto Roubo Itaú, and people will hire insurance that is 80% of the price schedule. It is a simpler type of insurance. We have just launched Azul Light, and they can have lower rates than the official car price table. But 80% of the sales in Azul Light, it is all new, people who have never had insurance before. It called for creativity.
We have a huge fleet in Brazil today that is uninsured, and we need to find a way to reach the mindset, and the wallet of that population. In terms of companies going out of businesses, fewer players, I would not be able to tell. It is very much related to strategy, operating overseas to understand better the Brazilian market. Recently, we had an agreement for the Chubb that decided to give up the automobile market. They are still in Brazil, but they are no longer operating in auto insurance. The market is still concentrated in the segment, and we are paying attention. Of course, there is a good position in the market. Very many insurance companies, sometimes they want to stop, and they worry about preserving their small portfolios in order not to affect their brands. Today, it is time for us to value that.
This is our position that we have in the context that you have mentioned.
Thank you, Fabio. Thank you very much. Your answer is very clear. Just one second question, much more specific. I would like to ask about CapEx. Your CapEx has been quite significant, and I see that most of the CapEx over the next few quarters is related to the development of systems. Could you give us a little bit more information about which type of systems those are, and if major investment, do you have a date for it to end? Is it ongoing continuous investment? Do you think this will ever become part of your assets rather than a new investment?
Well, Francisco, it is true. You are right. There was a period when we invested a lot in infrastructure, hardware, furniture, and a data center. Now we are going up the hill, and we are in a software phase. We are finishing our SAP implementation, and we are also developing a system for life. Then there's another system that we call boarding, that we are merging the automobile system with all back office functionalities and operations of Itaú automobile that we are bringing customers of the bank to our structure, integrating with Porto Seguro automobile system. This will be quite helpful in terms of reducing admin expenses. We also have property and casualty system, one of the oldest ones we have. It has some problems in terms of scale. So it's been investing in terms of property and life for the future. But as a whole, about 80% of our investment in development will end in 2017, and this will be very favorable for future CapEx.
Well, yeah. Thank you. That's what I wanted to hear from you.
Our next question comes from Mr. Marcelo Cintra from Goldman Sachs. Please, Mr. Cintra, you may ask your question. Good morning.
Thank you for the opportunity. I have two questions. One is a follow-up on the previous comment of Fabio related to projects, new projects, especially for automobile. Older automobiles. I would like to understand how the implementation is going and pricing and the so-called low-income insurance. The use of new parts, is this already out in the market or is this product on the shelves? Then I'll ask my second question.
Hello, Marcelo. Thank you for your question. Obviously, we've been trying to offer new products with lower average tickets, but much more in terms of expanding our coverage and benefits, and also looking at segmentation. Of course, young entrants who had never had insurance before, they are much more worried about protecting their property rather than adding other benefits. As they mature, they might add other things.
So we are investing, and we are quite happy with what we've been seeing. But we need to be careful in order to avoid cannibalism in products. We will move forward with that. In terms of low-income insurance, even though it's ruled by SUSEP, it needs to be revised when they saw that the market was kind of frustrated in the way they published their rules because they should allow using alternative parts or recycled or renovated parts is not enough to cater to all crash markets. So the thing about the low-income market is because you're not going to use new parts in a 10-year-old car. So this is relevant and should attract a new audience. SUSEP, there was a change in the superintendent, so we're expecting SUSEP to go back to their agenda so that this issue may go back to their agenda, and they might issue a new decision.
Just a follow-up. Do you have any expectations in terms of whether we should have this review this year by SUSEP insurance superintendent? Have you been talking to them about this?
Marcelo, well, it's difficult. We were expecting to see it in the second quarter, and they didn't publish it. It's difficult. I can't make any commitments. I can't tell about a date. If anything is to be published, I think that it will be in the fourth quarter.
Great. Thank you. My second question, going back to repricing, as you said, and the fleet increase, and I understand that Azul may have had some price realignment. But in terms of Itaú, the new originations of the last few months, have prices gone down in Porto too? And Chubb portfolio, is it already having any impact in terms of your fleet?
Hi, Marcelo. Well, as for Itaú, there are two effects to analyze. Number one, last year, as we have had many price adjustments. As we had many price adjustments, we are comparing an Itaú base of last year that was smaller. So there is a growth that is a little bit organic. In Itaú, exposure to fleet insurance of companies is slightly bigger, or it's much bigger than Porto and Azul that doesn't even have that. For this segment especially, there was a deterioration in loss ratio. Prices have all been realigned, and we are going to recover it in the second half of the year.
So this explains a little bit the loss ratio of Itaú that is a little bit off. But this is also slightly related to the fit with the banking channel, internal adjustments of products, and especially the previous base was slightly lower because of fine adjustments. And Porto is slightly more premium product in the automobile insurance market. And it's the one that is the most difficult to position. As economy improve, certainly auto will reposition itself.
As to Chubb, has it already had an impact in your numbers, their portfolio?
Not yet. We are waiting for the SUSEP's final position with regards to that operation, and then these numbers will start to show.
Thank you very much for your answer.
Our next question comes from Mr. Rafael Frade from Bradesco. Mr. Frade, you may ask your question.
Good morning, everyone. Going back to the loss ratio, and you said in the beginning that your loss ratio was 0.6 percentage points above your forecast. And when we look, there was a worsening of almost 500 basis points year-on-year. So, I would like to understand how much is it just due to the great impact of June or should we expect a good recovery in Q3 or a not so bad worsening?
Marcelo, just a minute. We are trying to explain this to you in the best way possible. Just a second. Okay, Rafael, we came to an agreement between Q2 first half, second half. Actually, as we had an adjustment expecting that there would be an increase, especially in Azul because of its repositioning, we are in a dilemma between what happened last year in contrast to what is happening now in terms of actual versus budgeted. So in fact, in the second quarter, there was a more significant increase, and we were off in terms of our forecast because of hailstorm, flood, and we're seeing something similar to the World Cup now.
And with regards to the first six months, there was an increase greater than expected if we look at last year, but not so relevant in terms of what we expected. The second half of the year is historically better than the first one. So we try to recover apart from price realignment that we have already done, and they are fitting into our businesses. And everything will head towards what we have expected, and we are estimating something more or less 3 percentage point increase in the automobile portfolio looking at the year as a whole.
Thank you.
As a reminder, if you want to ask a question, please press star one. Our next question comes from Mr. Gustavo Schroden from the Bank of America. Please, Mr. Schroden.
Thank you. Good morning. I have two questions to ask. The first is the automobile loss ratio. I remember that last year there was a quite positive effect in the work with junkyards here in São Paulo, the chop shop. There was an increase in robbery and theft now in the second quarter. I thought it was just in São Paulo. I know that the Lei do Desmanche is not being all that effective. It has been enacted in São Paulo, but I would like to hear if it will be implemented or enacted in other states too.
In fact, there was a great impact of the Lei do Desmanche in the state of São Paulo, especially last year. Unfortunately, we are not being so fortunate in other states. Things are quite low, and the market has been doing things also because of the Federação Nacional de Seguros Gerais. We have gone to the public security department and the transit traffic departments, and we want those issues to go into the agenda of other states too. We are expecting to have some positive effects next year. In fact, there was an increase in robbery and theft, especially higher this year in some states really going through a really critical scenario of violence, such as the case of Rio de Janeiro. The numbers have gone way up recently there. Rio Grande do Sul also.
So we have been witnessing some violence in some states that also have an impact on motor insurance. We also had an increase in crime rates in São Paulo, especially towards the end of the second quarter. This is something very one-off, very similar to the World Cup. In one month, there was a sharp increase, and then it went back down. We do not really know what lies behind that in terms of the universe of crime. We cannot indulge into a crime conspiracy. Well, there are many theories about that too. Also in terms of the stock of drugs that they wanted to sell everything. This is all beyond our control.
Okay. This is very good. Thank you. The second question regards your financial results. You said that towards the end of this year and earlier next year, that should go down. Is there a consensus? What is the company thinking about that? Do you have any allocation strategies? What should we expect for the company in terms of a more challenging financial scenario? Thank you.
Hi, Gustavo. This is Marcelo. I think there is a consensus in the market about the drop in interest rates, the Selic interest rate. The only discussion is when and how much. We know that it will come. So a normal country cannot have a 14.5% basic interest rate for a very long time, and we are all longing for normality. So there are two aspects. It is quite simple, but there are two things. One is the operational aspect, and the answer is we price according to our expectations, our future curve. So if the interest rate curve is going down, we try to increase prices because the operational financial equation needs to be integrated. As we are going to have a smaller yield in the midterm, then we start to put that into prices of whatever is sold today that will go through, and in 12 months, there will be a drop in interest rates.
First aspect is pricing, and prices need to go up because we are expecting a smaller yield from the money. Secondly, in terms of asset management, we already have an allocation that is kind of traditional, that we call structural, that is very much associated to inflation bonds and prefixed bonds. We are trying to take advantage of the time when interest rates are high, are still high. They were high and remain high. So there are some bonds that we have had for quite some time, and they have higher yields. We are not operating in post-fixed in most of our portfolio. We operate in pre-fixed and in inflation. This is not a coincidence. It is related to the protection against default. We want to have stability in face value gains, and so that we are not so exposed to post-fixed interest rates.
We have been doing it for many years, and we keep that strategy. The difference is that recently we have in Brazil a detachment between pre-fixed interest rates and inflation, many bonds still paying 6.3%, 6.4%, 6.2% plus inflation. And with a real yield that is really amazing in many geographies. And we are also allocating and trying to take advantage of that pricing levels because they seem quite interesting for us, for anyone that has the discipline of carrying this to the long term, which is what we do.
Just complementing, these pre-fixed bonds that you have you contracted them recently? Can you somehow offset the impact of the basic interest rate next year with these bonds? Can you kind of protect your financial results, shield it with your prefix bonds?
Well, actually, in the market, it is longer than 12 months. So there are some bonds with the three years. Duration is longer. It is long-term, because reserves will not disappear in 12 months. So the model of a bank in current account and treasury, they know that the money will stay there and will renew, so durations are longer than that. So it is close to three years. Yes, we can go through falling interest rates, keeping yield in a structural part. Of course, we also have treasury that is more tactic, where we win and lose depending on management. And we have bonds that we bought some time ago, a year ago, and more recently, too, even less than one month ago. So I think we are capturing a quite interesting yield. If you look at the average level of the curve, if we look at the Selic and CDI levels, there are some bonds that are below that.
As the safe yields keep, the relationship with the CDI is more positive and more interesting. I think that we are relatively hedged against a drop, but we can partially offset a relevant drop in the interest rate.
Thank you very much for your answers.
Our next question comes from [Mr. Philip].
Good morning. What is your technical vision in terms of your current volume for the next few years that you imagine that it might be necessary to increase provisions? Thank you.
Hi, [Philip]. This is Damadi speaking. So we are really compliant with SUSEP standards in terms of pension, health, automobile, and other portfolios, our reserves are all very appropriate, very compliant, and I do not see any novelty coming up in the future apart from the normal business increase.
Thank you very much.
Our next question comes from Mr. Domingos Falavina from JP Morgan. Mr. Falavina, please.
Good morning, everyone, and thank you for the opportunity. This is more related to credit cards. There was an increase in provisions in spite of the slight drop in coverage. An increase in provision to BRL 80 million from BRL 40 million something in last half of the year and BRL 70 million in the Q2 2015. Do you think it will be around BRL 80 million in terms of your provisions? How should we think about this number? Is it going to go up, down, or flat?
Hello, Falavina. This is Marcelo Picanço answering your question. Actually, our expectation is stability to drop in terms of performance. Actually, we have in the portfolio part of the credits that were given still due to a more aggressive policy, as an example, with a slightly smaller score. As these bonds are redeemed, or if they are headed towards the final loss and are taken out from the portfolio, the newer part of the portfolio, those acquired more recently, they will have a better bad debt performance and we think that those provisions may go down because of operational performance, not because of accounting adjustments. Of course, there are some adjustment in provision models that are related to evolution of the models and recognition of some variable that changes.
But I think we have already reached a high maturity level with that regard, and we are not expecting any development ex operation in terms of what is happening in terms of bookings.
Thank you. I am taking the opportunity, our TJLP is higher, that is leading all financial companies that is with a reduction. What do you think is more reasonable in terms of the interest on equity rates?
Domingos, this is Celso. JCP is higher this year, but as a reminder, there was an increase of social contribution on income from 15% to 20%. I think that effective tax rate of interest on equity will sort of compensate the tax increase. It will almost amortize the 5% tax increase that we have just had. On one hand, the tax rate went from 15% to 20%, but then on the other hand, we have a compensation of the increase of TJLP, both in terms of our equity and our long-term rates.
Working with a flat year-on-year would be reasonable?
Yes, it would.
We have a question being asked through the webcast by Mr. Eduardo Nishida from Brasil Plural. Looking on future quarters and next year, how do you think the market will behave? We have a scenario of dropping interest rates, higher unemployment, higher robbery and theft of cars. Do you think that price increases will be able to offset the drop in interest rates?
Hi, Nishida. Thank you for your participation. Well, yes, on the whole. We have been dealing with these drivers in our price composition for a long time. All these variables like inflation, falling interest rates, higher loss ratio, all these drivers automatically go into our calculation. Whenever there is any change, they will be transferred into prices. What might hold more or less is the economic scenario. Somehow we are seeing that everyone is looking at a scenario where price increases are unavoidable considering many different aspects.
In health, what happened in the quarter for the significant increase? What are the measures that you have taken? Why is there such a marked difference in results between different players in the market?
Hello, Nishida. In terms of health, what happened is that there was a considerable increase in expenses related to elective surgeries that can be scheduled. Someone was delaying a knee surgery, bariatric surgery, and there was a significant increase in the second quarter, which has driven these results to be very poor. It is hard to make comparisons with other players because the product mix is completely different. We have no individual health insurance in our portfolio. We operate in SME only above 20 lives. This was understanding the risk scenario when we are reviewing. This is where we operate. Some people will accept two lives on, and that might be profitable in the long term, but if you look in the medium long term. It is very difficult to compare.
We know that our loss ratio has always been well below any other player in the market. We are taking some actions. In answering your second question, this is what we are doing. We are reassessing all processes, how these questions come, repositioning with the network. We are repaginating all our hospital audits. We are implementing more strictly second medical opinion to avoid avoidable surgeries where the outcome in years will be similar to if you operate or if you go to physical therapy and the insurance company wins and also the patient. We want to drive loss ratio back to its historical levels.
As a reminder, if you want to ask a question, please press star one. If there are no more questions, I would like to turn the conference over to the company for your closing remarks.
Well, I thank you all for your questions and contributions, for your interest in our company. If you have any additional questions, please feel free to get in touch with our investor relations department or to go to our investor relations in our website, www.portoseguro.com.br. Thank you very much.
The conference call of Porto Seguro has now ended. We thank you all for your participation, and we wish you all a good afternoon. Thank you.