All right. Morning, everyone. My name is, Paul Holden, Senior Financials Analyst at, CIBC. My pleasure to be hosting, Rowan Saunders, President and CEO of Definity Financial this morning. Rowan, welcome, and thanks for spending the time with us.
Absolutely, great to be here.
So it was nearly three years ago when you IPO'd, and I think you successfully hit on and perhaps exceeded pretty much all of your financial objectives you laid out at the IPO. Of course, the stock has done exceptionally well also, so you've got recognition for hitting those financial objectives. I think, at least based on yesterday's closing share price, something like an 18% CAGR for the share price over the last three years, so a job well done. And that kind of led you to do your first Investor Day last week, where you had to roll out some new objectives, since most of those have-
Yeah
... again, from the IPO have been accomplished. I think probably the one that's the most important is the ROE, and that's probably a good starting point for us to discuss. I'm sure most people in the room and on the webcast maybe listened in or hopefully participated in Investor Day, but I think it's kind of worth reviewing the ROE objectives you laid out.
I also have a question in terms of how you're calibrating those ROE objectives, 'cause as someone that's followed P&C insurance for quite a period of time, I know it can be a cyclical business, so there's years where it's gonna be better than others. There's gonna be quarters where it's better than others.
Maybe talk about, you know, the ROE objectives, how you derive at them, and how you think about them through the cycle.
Sure. I'm happy to do that, and I think that there's a bit of context for us, you know, there. As we entered life as a public company, obviously coming out of a mutual, there's a couple of things. One, the company is still improving its operations, its sophistication. You have a certainly unoptimized, you know, balance sheet.
And so what we said is, "Look, those are the things that we're gonna work on over the next couple of years," and we're very pleased with the progress that we've made. And there were some big strategic things we need to do as well, which has involved not just with modernizing the technology, but reshaping the portfolio construction. And all of those things have, I think, been achieved, and that's, you know, certainly helped us on the journey.
I mean, your question about, you know, where do we go next on the operating ROE, the way I think we look at that is, the first thing is that there's just normal business practices that are improving our returns, you know? So the first thing is we continue to grow certain parts of the portfolio at a rate faster than the others.
So if you think about the automobile segment, our three main lines of business are automobile, personal property, and commercial. Automobile is the only one that's regulated, and so we've been growing that at a rate slower than, for example, commercial. Commercial is higher margin, more profit, so the mix is shifting it. I think the other part that I wanted to mention is that, you know, we've made investments in vertical integration into broker distribution channel.
You know, that is very strategic, but also very complementary and high margin returns. So that, as it continues to grow, it becomes a bigger feature of the earnings, and that helps the returns. So that's just, I would say, almost in the business as usual strategy. But the three specific levers that we called out were, the first one is getting our digital direct insurance company, Sonnet, to break even.
The second one was reducing the expense ratio of the company, and then the third one was advantages that improve the loss ratio following our claims transition. And I think when you just go back to Sonnet, you know, this is a very strategic, market-leading digital direct insurance company, but it takes time to scale up.
It takes time to, you know, get to break even, and it's been a couple of points of drag on the ROE, and, we're guiding the market to this will get to break even at the end of the year. And whilst break even doesn't sound, you know, that exciting, at least it prevents the drag that we've been having, and we think over time, the next few years, that'll start being more accretive.
The second one is the, you know, expenses, and, you know, we built a lot of digital tools, and these tools are really helping the productivity. So we're at a stage now where we're starting to get operational leverage, and we don't need to grow our expenses at the same rate of our revenues. You can see that already has started to trend down, and that's gonna continue.
And then the third one is the claims transformation. And when we thought about transforming, you know, Economical, the mutual, to Definity, the public company, we really started at the front end. We saw ourselves as a growth story. So we built new business units, we built the digital tools to grow the business, and now we're transforming the claims.
So those are the kind of levers that give us confidence we're on the path to improving the ROE. And your question is a very insightful one, which is about, you know, there is some volatility in our segment, and how do you think about that? And so firstly, you know, we do recognize that it's impossible to call the weather in the nat cat events, so you're gonna have some quarters that are, you know, more lumpy than others.
But when we think about through the cycle over, let's say, a five-year period, we're comfortable that we will be able to achieve those returns on average through the cycle. And the only point I would add to that would be that when you think about what's the baseline from which we're moving off, it's twenty twenty-three, and twenty twenty-three was actually a very high cat year. So the starting point of which we improved the operating ROE really had a fairly unusual level of nat cat events in it, and so all things being considered, that gives us the confidence through the cycle.
Okay, good. Well, it gives us a number of things to drill down on, and I guess I want to start with personal auto. Now, you know, you acknowledge you're growing a little bit slower than the unregulated pieces of the business, but still a very important part of the book... and it feels like we've hit a point in the cycle for auto, where it's just as good as it can get.
Like, you're seeing strong premium growth, flowing through very strong margins, and the question I hear from investors is: how long can this last, right? What is the competitive reaction? How is Definity, how long can the rate increases continue in personal auto, and where do you see margins sort of in the longer term?
Can you maintain these kind of strong margins you're seeing, year to date in auto?
Yeah, and I think the way we typically answer that question is, again, taking the view through the cycle. And, you know, when you think about auto as the regulated line, you know, you could back into what an acceptable return for the regulatory environment is, and it varies a little bit by province, but roughly it's 95%. And so I think we feel comfortable saying that we're confident that we can get to a 95%. Now, there are gonna be some periods where we're a little higher, there's some periods where we're gonna be a little lower, but that's a fairly, let's say, prudent guidance point for us.
Your point about where you are currently, and what we have had is, you know, we've seen this very unusual phase, where a few years ago, where the lockdowns from COVID, people weren't driving, you know, claims was down, then we were followed by this massive inflationary period, and in the regulated line, you tend to be chasing a few of those curves.
We were early and ahead of most of the market in terms of rate increases, so that also slowed our growth, so the last couple of years, it was effectively all rate and really no unit count growth, and that was by design. That's kind of cycle management for us. More recently, the market has caught up with price increases. I think, you know, if you take the biggest market, Ontario, there's an average of, you know, 10-ish% of rate flowing through the portfolio.
So now we're much more competitive again, and we're now getting a combination of rate and unit count. So that helps, certainly, you know, helps the growth. In our numbers, don't forget, still is the drag of Sonnet, and I think that as that improves, it goes down. So there's a good example where if you look at, you know, the kind of mid-nineties guidance, in our mature business, we've been able to outperform that, and in the immature business, you know, it's a little bit higher than that.
But there are still levers that we could pull to, you know, continue that. I think that's gonna be maybe not in the high, as high a rate, in 2025 and 2026, but I still think that we're constantly gonna see upper single digit price changes in personal auto.
Maybe we can address the unit count for a minute, 'cause it's, it's a question I frequently hear, particularly out of the U.S., on sort of-
Yeah
... the PIF growth as we refer to it. How do you think about that? 'Cause I think the benchmark is, you know, people in the US tend to gravitate towards Progressive and see the big double-digit unit count in PIF and wonder if the Canadian P&C company somehow can replicate that. I think that's probably too high of a benchmark, but what do you think is a realistic goal in terms of unit count growth?
Look, I think quite frankly, our unit count growth could be higher than it is. And so this goes back to when I my opening comment, which is by design. So particularly with our intermediated offering, the Vyne platform, fully integrated with broker management systems, we could grow that faster, and by design, we've chosen not to.
So we've said, look, in aggregate, we started off a few years ago with 55% of the business in personal automobile. We've now got that to 42%, and I see that going, you know, into the high thirties in the next several years as we continue to shift the business. That's the way you optimize the return. And just mathematically, if half your business is regulated to a 10% return, it's very difficult to get to the mid-teens.
So it's almost by design, but that doesn't mean we're actually contracting. We're not. We're still growing, we're just not growing as fast as the other parts, you know, of the business. I think the other element for us is that we do see that there has been a shift in the distribution. So if you look at the last, let's say, 10 to 20 years, there's about a point of market share that leaves the intermediated channel to the direct channel, and that's been fairly consistent, you know, over the years.
Our thesis is that more and more Canadians are gonna want to buy their insurance digitally, and so we've, you know, I think, built a bit of a moat around that model, but that's the Sonnet digital model, and I mean, in full transparency, it's been very difficult to do.
I think when you think about how you do that, there's the technology you've got to build, there's the brand you've got to build, but then there's the underwriting, you know, avoiding anti-selection, managing, you know, a tool that could be more fraudulently, you know, used. We're now at the position where actually the loss ratio is around where we would like it to be, but we're still subscale.
That expense ratio, which is such a scalable platform, that just mathematically will come down with growth, you know, we think is a bit of a differentiator. That's the area that if we do in the next few years, want to kind of step on the gas a bit, that will be the logical area to do it.
Okay. That's kind of my next line of question, right? You've talked a lot about optimization of returns, and how are you thinking about optimization specifically for Sonnet? I think at the investor day, you talked about running it with still high growth, as you just referred to, but with sort of a high nineties combined versus that ninety-five you're thinking about for the overall personal auto book.
So maybe you can walk us through how you're thinking about, you know, that going from that high nineties to the mid-nineties, how long does that take? And it sounds like it's all about sort of scale and optimizing the expense ratio, if I'm reading you correctly?
Yeah, I think it is mostly about that, because I think that while there is still some improvement that will naturally come with the aging and the maturity of the portfolio on the loss ratio, it's more the bigger driver is now more on the expense side of things. And what we find is that when you write new business, the profit margins are not as good as you find in year three, year four, year five. So as the portfolio matures, you get more margin out of the portfolio. And for some, that's a startup that has a high component of new business relative to its existing back book. That's a bit of a drag.
I also think that when you think about the digital model, most of your costs are upfront, so your cost of acquisition is really in year one, and if you keep that customer for the next four years, you're not paying a commission on that customer. From the accounting perspective, your cost of acquisition is incurred in year one, but then you, you know, can renew it efficiently going forward.
The sweet spot for us, and that's why I think, you know, we've indicated that it'll be accretive to underwriting profit, but just under a hundred. That reflects the fact that new business will be less profitable than the existing business. If we wanted to grow it faster, it would just be slightly higher combined ratio. If we wanted to build it slower, we would bring it down.
Getting back to your question, is at what size and scale? It's about, you know, once we go past 500, so between CAD 500 million and CAD 1 billion, I think we'll be in the sweet spot. Already, I mean, the business is we've only got 170,000, you know, customers, and the expense component is about the same or slightly better than the intermediated arm. So from here on in, it just, you know, starts to create an advantage.
Okay. Let's talk about personal property a bit. You know, a lot of focus on climate change, what it means for multiple industries-
Yeah.
-and particularly it impacts P&C coverage, directly. I mean, Q3 is probably... Q3 this year has been like, I think, any other period we've ever seen before, at least the magnitude of losses and the number of large events is quite extraordinary.
Yeah.
So how are you thinking about that? I mean, it's actually amazing to me, the stocks have barely blinked, right? Both your Definity and Intact have barely reacted. But I'm just wondering how are you thinking about responding to this? Does it change your appetite at all? Obviously, there's gonna be a price reaction, but do you think about reinsurance differently, or?
Look, I think that we like the personal property business, and I think even if you go back and look at the industry over the last, you know, decade, there's been an increasing number of events. We've had more three billion-dollar-plus events, and while you have the, you know, odd bad quarter, it's still profitable.
I think that if I looked at our portfolio last year, including some of the drag like Sonnet in the portfolio, even with a very active 2023, we still had a profit, an underwriting profit on the business. You know, we'll see the year is not done yet, but this year has been active for us. We announced a CAD 150 million net impact in the Q3, but it still will be a profitable contribution to underwriting profits.
I think we just think, look, you have to get used to the fact that this is a trend that's gonna continue, and there's a number of themes. Firstly, there's densification. So you've got more buildings in a tighter area. If you look at the big urban areas, there's nowhere for the water to go. The aging infrastructure of the system of the cities is problematic.
So I think you're gonna have that. Then you've got inflation and asset value. So we will naturally get bigger insurance pools, but also, you know, bigger losses. What we've done is we've, you know, done our modeling, and we've just moved up the probability curve. So whereas traditionally you would have your modeling and you would pick a fiftieth percentile probability, we're now at the seventy-five percentile.
So that's kind of where we're pricing to, and we keep, you know, moving it up. I do think that the ability to gain, to outperform is important. So when I look at are we comfortable in the market, even this year, from what we could see on industry events, we're once again under our natural market share. And some of that is, you know, based on the strategy, just where you happen to have big portfolios and where you don't.
Other parts of it is by design, and so I'll give you an example. You know, in Calgary, that's a very big hail loss for the industry. You know, it's really not that big for us, and that's by design, because over the last, you know, five plus years, we've consciously decided not to put capital in that area. We sell our product with an endorsement.
We put different deductibles and terms on. So we've anticipated that southern Alberta is a problem, and we don't think you can, in that particular market, get paid for the risk. So that's an example. In other areas, it could just be lucky. I think you take Quebec, for example. We just have a low share in Quebec. It's not by design. It's just we have lower exposures. But I look at it that really you have to price for the cats, and you've got to price for the attritional. And if you look at our trend over the last few years, we're doing really well on pricing for the attritional loss ratio.
So all of the aggregation, product segmentation, quality of business is working, which then allows you an increasing amount of the premium to fund for these nat cats. I also think that there's gonna be a supply im balance from reinsurers. So you asked about reinsurance. You know, the smaller companies need a weaker balance sheet, smaller balance sheets need more reinsurance, and I think that's gonna become much more difficult to attain at the right attachment points and at the price points.
So I think it favors, you know, scale players, you know, as well. So the net of it is, you know, we this year, if you looked at our personal property over the last twelve months, in certain areas, you know, we've actually been pruning.
We've got more sophisticated with geographical mapping systems, probability and predictive tools, which you might even consider which side of the lake you're on, what's the slope, what's the prevailing wind conditions, and where we're over market share, we thinned out. The combination of underwriting and pricing, I think we're comfortable. You're gonna have in our business some quarters that are you know significant and other quarters that are more benign, but again, through the cycle, we're pretty comfortable we can make the returns we're targeting in personal property.
Okay. Let's talk about the commercial business as well. I mean, that's one area where you've done extremely well. Better, better than even I would have expected. You've put on consistent double-digit premium growth, but have got low nineties combined ratio, in some cases, maybe even high eighties-
High eighties, yeah.
-combined ratio, so getting the volume and the margins, which has been a fantastic story, and you still have pretty ambitious growth plans there. So talk about how you've been able to execute on that success, getting new business at high, wide margins, and how that can continue, where you're looking to continue to grow.
Sure. And I think the way we approach the commercial business is we think about it in three main segments. There's the SME segment, there's verticals and mid-market that we like, and we play in, and then there's the large, complex, and specialty, you know, business. And the propositions we've developed vary a little based on each of those segments. I think when we go back about five years, Definity and previously Economical really was an SME-type player. We didn't have the capability and capacity. So what we've done is we've built out that, and that's a lot by, you know, teams and talent.
And that's opened up the total addressable market, and so, you know, when we thought about what was the size of CAD 35 billion dollar market, we now feel we've got the capabilities and capacity product to play at about CAD 27 billion of that. That was significantly enhanced. We then say we're only a 5-6% market share, so there's lots of opportunity to grow.
I think, you know, where we've got significant growth in is one, in the SMEs, the small and medium enterprise. Like our personal lines platform, we call it Vyne, we've built a very user-friendly ability for brokers to literally almost instantaneously quote and bind themselves. That ease of business is very good. In fact, in the small commercial business, it's a fairly concentrated market as it is.
We find that quite a nice market. It's quite a disciplined market, and brokers really don't want to spend a lot of time and effort going shopping the market, taking days to come back. So if it's not done in literally a few minutes, you don't. So that's a service proposition that I think works really well. As we get into middle market and specialty lines, it's more about the service. It's about the expertise. It's about the trading relationships. And one of the advantages that I think we have, and we may not be the only company in Canada to have this advantage, but many don't, is almost this one-stop shop.
So, you know, whether if you're a broker, we can do your specialty for you, we can do large corporate for you, we can do your fleets, we can do your personal lines and small commercial, and that's strategic relationships. So when we look at our top 50 and 25 brokers, who, by the way, are acquiring others, getting bigger and bigger, our share of wallets growing the most, you know, with them. So that's what's really helped.
And then the final point I'd make on that one is, you know, we've built this portfolio through pretty attractive market conditions, and when we've been into a fairly long, firm or hard commercial marketplace, and so roughly about half of the growth has come from rate, and the other half has come from unit count.
Okay, and maybe you just address it quickly. I have a feeling we're going to run out of time, because I have a lot of more questions for you, but address it quickly in terms of where you think we're at in terms of the cycle, the rate cycle in commercial.
Yeah. So we've definitely seen more competition, but it's on the larger kind of accounts area. 80% of our business has premiums of CAD 100,000 and less. As I mentioned, in that small commercial business, it's pretty automatic. We're still getting rate. But I think the other part to keep in mind is that the industry is at a good technical rate perspective now.
So we're still able to get rate at or above the loss cost trend, and inflation is coming down. So for the industry that said, "Look, last year, maybe I need up a single-digit rate," well, if inflation is rolled over by a few points, you no longer need that particular rate. I think our view would be that, you know, that the industry is still gonna run with rate in the mid-single digit.
There'll be some segments that are more competitive. There are some that are very competitive, but they're not big segments, you know, from our perspective. And then I go back to, you know, our proposition. There'll be some areas where we'll have to slow the growth a little bit. And that's why I think we've guided that whilst we've been growing at about 16% in commercial lines, you know, it won't be that it'll be kind of in the lower part of the teens.
Okay. Very important part of the planning. You mentioned at the beginning in terms of the ROE expansion, is dialing in really on the expense management, the efficiency-
Yes
... as well as the claims costs as well. So maybe again, you can get hit on some of the key points there in terms of how you're looking to achieve that.
So if I just start quickly with the expenses, you know, what we think about the expenses for us is a combination of the commissions we pay on the, to the brokers on the products. There's some premium taxes, and then there's the underwriting or the operation expenses. We're now at the stage where about 13% of our revenue is in operating expenses. We think we can glide over the next couple of years to 11%, so that's about two points.
A point of combined ratio is about a point of ROE, you know, for us. How we're doing that is mostly able to grow the revenue faster than grow the expenses, and that's the digital platforms. So all of the, you know, areas are focused on expenses, but we've made the big investments. I mean, the really big-ticket items have been done over...
Up to, leading up to the IPO and maybe the first couple of years, and now we feel that there's a fair bit of opportunity from operational leverage that are gonna go in. As you've seen, even looking at this year and even last year, that expense ratio has started to come down, so we're pretty comfortable that it's, you know, we can get another, you know, point or two out of that. On the claims side of things, really for us, you know, we're one of the last big companies that is on a legacy claims system, and we did that by design, modernizing the front and kind of working backwards....
And if you look at someone like Guidewire, whose base system we're using, they've done, you know, however many dozens or hundreds of deployments around the world, and they normally get about two points of loss ratio improvement. Part of that is the technology, it's the efficiency, it's institutionalizing best practices. So we're in flight.
We've just launched in the second quarter the Claim Center. We're now working on property that'll come in the back half of twenty twenty-five. So that's an area where we've already got about a point of ROE benefit, and we think there's at least another point, if not more, to come over the next couple of years as we modernize those technologies and change the practices.
Not only I think is that important for reducing the loss adjustment expenses and, managing indemnity, we call it leakage, but on the other hand, it also shortens cycle times. It gives better customer service, it drives your NPS scores up, and we haven't counted that in our forecast, but that should also, you know, be accretive to the company.
Okay, good. We only have a few minutes left. So, opportunity probably for one question, if there's any questions from the audience? Any major projects, are there any plans, or specifically you want to share, or any specifically you'd like to share?
Did you start that with M&A? Is that what you're referring to? Yeah. Look, I think that what we've said is we went through the demutualization to modernize the company and to build a leadership position in Canada, and you can do that organically, but we also have a thesis the market's going to continue consolidating, and so we've got ourselves kind of ready for that.
S o a lot of what we've been doing is getting this organic engine ready, but as you build that, you build a good platform so that you can be a better owner of somebody else's business. Our thesis is consolidation is going to continue to happen. One to two points of market share over the last 20 years have traded hands.
It's taken a bit of a hiatus because we've been in fairly unusual times, and I think that's, you know, likely going to, you know, pick up. In personal lines, you need size, you need scale, you need data. Brokers are really demanding on interactivity with them. In commercial lines, there are a number of foreign players in Canada, and really, until in just a few years ago, the specialty area was really the domain of international players.
There wasn't a lot of strong Canadian expertise. There clearly is now. The market leader is very strong at that. We built a really strong kind of business, and I think that as you have more domestic champions that can play in that space, the future looks less promising for some of these international players. So our thesis is that there's more activity coming.
Clearly, we're working, you know, on this. It's a priority of mine. We've got, you know, sophisticated corp development team, you know, in place. But these are opportunistic, and, you know, I think our story has really been to investors that, you know, we're able to march ourselves up into about 13% organically, and then really to get to the mid-teens, we need to optimize our balance sheet.
And optimizing our balance sheet ideally is through an M&A, because we're sitting with excess capital that's sitting in a bond portfolio and not returning, you know, as much as we could. We haven't effectively got any leverage on the balance sheet, and that easily adds another couple of points, you know, to the operating ROE, but that's timing, you know, timing, timing dependent.
Great. So that effectively takes us to time. So again, Rowan, fantastic job, honestly, since the IPO three years ago.
Thank you.
Look forward to achieving all your financial objectives you've laid out and helped explain today, so thanks for the time, and thanks, everyone, for listening.
Thank you very much. Thanks, Paul. Thank you.