Good morning, ladies and gentlemen, welcome to the Definity Financial Corporation First Quarter 2023 Financial Results Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you need assistance, please press star zero for the operator. This call is being recorded on Friday, May 12, 2023. I would now like to turn the conference over to Dennis Westfall. Please go ahead.
Thanks, Joanna. Good morning, everyone. Thank you for joining us on the call today. A link to our live webcast and background information for the call is posted on our website at definityfinancial.com under the Investors tab. As a reminder, the slide presentation contains a disclaimer on forward-looking statements, which also applies to our discussion on the conference call. Joining me on the call today are Rowan Saunders, President and CEO, Philip Mather, EVP and CFO, Paul MacDonald, EVP of Personal Insurance and Digital Channels, and Fabian Richenberger, EVP of Commercial Insurance and Insurance Operations. We'll start with formal remarks from Rowan and Phil, followed by a Q&A session where Paul and Fabian will also be available to answer your questions. With that, I will hand it over to Rowan to begin his remarks.
Thanks, Dennis, and good morning. Last night we reported results for the first quarter of 2023 that represent a solid start to the year. Operating Net Income of CAD 63.4 million or CAD 0.54 per share benefited from solid overall underwriting results, robust net investment income, and an increasing contribution from our recently built broker distribution platform. Our 95.3% combined ratio was in line with our financial target. It reflects the benefits of diversification in our business as strong performances in our personal property and auto and commercial lines largely offset personal auto results. Seasonal declines in auto underwriting income were also impacted by persistent inflationary pressures and a heightened incidence of theft. As expected, personal auto normalized from last year's performance as claims frequency moved off pandemic-related lows and inflation continued to impact claims severity.
We maintain our view that we can deliver an upper 90s core in this line in 2023 as our rate actions begin to be reflected in results later in the year. As previously indicated, we are committed to taking additional rates if inflationary trends warrant and have recently approved approvals in Ontario, our largest portfolio, for rate increases of close to 10% in Vine, our broker business, and 7% in Sonnet. These are in addition to rate increases we obtained earlier this year of 3.5% in Vine and 15% in Sonnet. Our actions demonstrate our top priority is defending our profitability in personal auto during this challenging period for the industry. Turning to the top line, we reported a robust 11.4% increase in premiums in the quarter.
We continue to expect top line to increase at an upper single digit to approximately 10% pace for 2023 as we manage growth in auto with an eye to protecting our margins. On a per share basis, book value was 12.2% higher than a year ago when including the estimated impact of the conversion to IFRS 17. While our operating ROE at the end of the first quarter was 9.3% over the past 12 months. We continue to hold a significant amount of excess capital, which, when combined with untapped leverage capacity, puts us in a strong position to fund our strategic growth initiatives for the coming years. Turning to the industry outlook on slide six.
We expect firm market conditions in personal property and commercial lines to persist over the next 12 months, particularly given the dynamics of the reinsurance market, while conditions in auto lines will continue to firm as insurers aim to keep pace with the combined impact of normalizing claims frequency and lingering inflationary cost pressures. As anticipated, industry results began to normalize in 2022 following very strong results in 2021, which had benefited from unusually low claims frequency in auto portfolios. Overall, we expect the industry's return on equity to trend closer to its long-run average of 10% over time. Slide seven illustrates our key financial metrics. Growth, combined ratio, and operating ROE were in line with or better than our targets, which are unchanged from the prior quarter.
As we stated before, we believe we have the growth platforms to outpace the market, but we'll continue to defend company profitability along the way. We continue to diversify the earnings profile of the business. Recall that we acquired a controlling interest in McDougall in October, thereby launching our efforts to build a leading broker distribution platform. Our partnership is off to a very successful start and positions us to benefit from a complementary source of income, one which is more repeatable by its nature. Earlier this week, we welcomed McFarlan Rowlands to the Definity family and believe their partnership with McDougall not only establishes a leading broker platform in Ontario but also provides a solid foundation for geographic expansion. We believe we have now built another platform that before too long, can reach an annual premium base of CAD 1 billion.
With that, I'll turn the call over to our CFO, Phil Mather.
Thanks, Rowan. I'll begin on slide 10 with personal auto.
Premiums were up 5.3% in the first quarter of 2023, driven by an increase in average written premiums. This is particularly evident in Ontario, where we have been successful in obtaining rate increases in both our broker business and in Summit. In the province of Alberta, we are proactively managing the business, which could include redeploying efforts and capital elsewhere. Our reported combined ratio of 100.9% in the first quarter was 4.7 points higher than the result from a year ago and largely in line with our expectations. I'll categorize the primary drivers of the change from a year ago into three themes: frequency, inflation, and theft. As anticipated, we experienced an increase in claims frequencies as driving patterns continued to normalize to pre-pandemic levels.
For reference, Q1, 2022 was still experiencing pandemic related lockdowns, which drove a strong comparative combined ratio. Severity is also up from a year ago, driven primarily by total losses as inflationary cost pressures have proven to be persistent, but were relatively unchanged compared to the fourth quarter. Finally, a factor that accounted for about a third of the combined ratio increase from a year ago is the growing impact from theft. Although it's not a new occurrence, the increased frequency of it has been quite severe, we applaud the Ontario government's recent announcements on its commitment to invest in new measures to combat auto vehicle theft related to organized crime. Continue to expect this line of business to operate in the upper 90s for the calendar year.
We have taken meaningful rate actions across much of our auto book, which we expect will result in overall written rates reaching approximately 12% by year-end, close to double the current levels. Turning to personal property on slide 11, we reported top-line growth of 12.4% for the quarter, inclusive of our ongoing efforts to improve underwriting results. We expect a continuation of the firm pricing conditions prevalent in the industry in recent years and strong broker relationships to help maintain our growth above that of the industry. Focusing on the bottom line, we reported a strong combined ratio of 91.1% compared to 92.6% in the same quarter a year ago. Actions to improve results are paying off as core accident year results improved two points from the first quarter of 2022.
We continue to target a mid-90s combined ratio for the personal property line of business on an annual basis. Moving on to slide 12, you will see that strong growth momentum in commercial lines continued in the first quarter as we benefited from broad support from our broker partners across Canada. Gross written premiums increased 20% in the first quarter of 2023, driven by strong retention and rate achievement in a firm market environment and further scaling of our specialty capabilities. We expect current growth levels to moderate somewhat in the coming quarters. The commercial lines combined ratio was also strong at 90.9% in the first quarter compared to 85.9% in the same quarter a year ago, which benefited from an unusually low level of cat losses and lower auto claims frequency related to pandemic lockdowns.
Cat losses normalized this quarter, driven by two individually large commercial property losses. We continue to expect the commercial insurance business to sustainably deliver annual combined ratios in the low nineties. Putting this all together on slide 13, consolidated premium growth was a strong 11.4% in the quarter, while profitability at a consolidated level remained solid at 95.3%, bolstered by the improved performance in personal property and strong contributions from commercial lines. Slide 14 shows our investment portfolio in greater detail. Our net investment income again increased significantly in the quarter, up nearly 60% from Q1 of 2022. This was driven by higher interest income from the combination of our proactive actions to capture yield in an increasing rate environment together with higher reinvestment rates.
We expect double-digit growth to continue in 2023, resulting in expected full-year net investment income of CAD 160 million, recognizing the solid start to the year, while also taking into account the impact of cash outflows for our investment in McFarlan Rowlands. As you can see on slide 15, our financial position remains strong. We are well capitalized with almost CAD 850 million in financial capacity under our current legal structure and subject to the continuance of Definity under the CBCA, we could add close to another CAD 600 million in leverage capacity. These figures are prior to our most recent broker investment, which had a total impact on financial capacity of approximately CAD 190 million. The estimated impact of IFRS 17 did not change our view of the business.
This includes our underwriting performance, how we operate the business, and our allocation of capital. You'll notice that we now measure excess capital above 190% as compared to 200% previously. The change recalibrates our target operating range to the new capital guidelines that were implemented in conjunction with IFRS 17. While IFRS 17 did not materially impact our results, its implementation was felt throughout our business. I want to thank the teams involved for their tremendous efforts in this regard. Slide 16 shows recent capital management actions and longer-term priorities.
While our capital management priorities remain unchanged, you will see we continue to make strong progress in our execution. As we continue on our journey to the optimization of our capital structure, the acquisition of McFarlan Rowlands represents another concrete example of our ability to deploy our financial capacity in a strategic and accretive manner. Transaction will utilize approximately CAD 190 million of our financial capacity, of our which CAD 75 million relates to debt financing, the balance being the deployment of excess capital. As we prepare for our transition to a CBCA, which we continue to target for the summer, you will note that we have successfully renewed our debt facility and upsized its capacity to CAD 700 million immediately upon conversion. Yesterday, our board approved the renewal of our expiring NCIB of up to 3% of shares outstanding, subject to regulatory and TSX approval.
I'll remind you that we see buybacks at the bottom of our priority list for capital deployment actions, hence the relatively modest size of the structure. With that, I'll turn the call back over to Rowan for some final thoughts.
Thank you, Phil. We've been clear that we believe we can build the company into a top five player in the industry. This requires continued inorganic growth, which will include both insurance carriers and distributors. Following McDougall's announced partnership with McFarlan Rowlands, we have meaningfully accelerated our path to CAD 1 billion in premiums in our broker distribution platform. In aggregate, our broker operation in the province is approaching CAD 750 million in premiums, which should generate approximately CAD 60 million in annual operating income before finance costs, taxes, and minority interests. This level of earnings contribution is possible as McDougall runs with excellent operating margins while benefiting from access to more than 50 insurance markets. Both McDougall and McFarlan Rowlands will continue pursuing organic growth in addition to their track record of bolt-on acquisitions.
Beyond Ontario, we believe there are further opportunities, and we feel McDougall now has a solid regional platform from which to execute their expansion strategy. While we've been successful building our distribution platform, we remain focused on our top five objective. Carrier acquisitions remain very much part of the strategy, and our team continues working to identify actionable opportunities. In terms of focus areas, we're interested in continually expanding our commercial insurance expertise and capabilities, particularly as it relates to specialty. That said, given our investments in technology, our platform is well positioned to take advantage of any scale opportunities in personal insurance. In closing, I'm pleased with our solid performance in the quarter. There is excellent momentum in the business, and our strong balance sheet will enable us to continue executing on our strategic vision. With that, I'll ask Dennis to start the Q&A.
Thanks, Rowan. Joanna, we are now ready to take questions.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch tone phone. You will hear a three-tone prompt acknowledging your request. If you are using a speakerphone, please lift the handset before pressing any keys. One moment please for your first question. First question comes from Doug Young at Desjardins. Please go ahead.
Hi, good morning. Thanks for the detail on personal autos. You talked about written rate getting about 12% or up to 12% by year-end at close to double the current levels. What about earned? Can you talk about the evolution of the earned rate? Can you kind of weave in a discussion about loss cost trends and inflationary pressures and where you think that will be relative to that 12% and the earned premium growth?
Yeah. Thanks for that, Doug. A couple points I would make around there. Firstly, on the severity side or the inflation side, you know, it still is an elevated level from where we've been. When we look at this on a year-on-year basis, it is up. We've also seen kind of flattening and a positive trend on the last, you know, few quarters. We feel that that inflationary period has really peaked in Q4 and now flattened. If you go back and look at the big driver of that, which is the APD or the auto physical damage several quarters ago, that was running in the high teens or around 20%.
When we get to the first quarter of this year, it's running at about 8% year-on-year, albeit, you know, flat quarter-on-quarter. That's kind of what we're seeing on the loss cost side. You know, you heard about the very strong pricing action that we've had in our major markets. The earned lag does take some time, but we are seeing that now starting to pick up. If you recall, at the end of last analyst call Q4, Paul had mentioned that our written rate was about 7%. What that's translated in your questions about earned rate is we had 4.5 points of earned rate in the first quarter, and that keeps steadily building through the year.
By the time we get to the fourth quarter of this year, our earned rate is gonna be 8.5%. As we then roll forward into 2024, we're actually into the double digits from an earned rate perspective. You know, really pleased with the powerful rate filings that we've been able to get through, and we're starting to see that earned come through. Of course, as we've guided, it really is gonna feature more strongly in the results in the second half of this year as it builds each and every quarter.
That wasn't my question. I guess it was going, where do you see that kind of to the earned increase and the inflation? Like, I guess the earned increase surpassing inflationary pressures. Is that more of a third quarter, fourth quarter type of event? Is that how to think about it?
Yeah, go ahead, Paul.
Thank you. Yeah. Just to give a bit of further detail to that. As Rowan mentioned, in the quarter, it has reduced year-over-year down to about 8%, as a year-over-year number. It's still elevated relative to pre-pandemic. What gives us a bit of confidence, to answer your question, is that it appears to be reducing quarter-over-quarter, and at this trend, we expect that to continue on through the remainder of the year. Makes us look at that earned and written rate as we've just discussed, and say, when do we expect the earned rate to essentially cover that inflationary trend? From our projection, currently we are thinking toward the end of the year.
Of course, that is highly dependent on market conditions, up to and including what's happening with the Alberta rate pause. That's our current view of the situation, and as Rowan indicated, we have very, very strong, even stronger, written and earned performance into 2024.
Okay. Just second, Sonnet wasn't really talked about in your discussions. I guess two questions around Sonnet. Can you talk a bit about your expectation on break even in terms of top line growth? When you talk about pressure on personal auto from theft, is there more pressure related to your Sonnet business? Is that theft pressure coming from all your businesses or is it more kind of lean into the Sonnet business? Just hoping to get some color on that.
I think, Zach, the first point I would say on that one is, Sonnet continues to grow at about 6.3%. That's our direct business, you know, growth rate. That, you know, has been slowing for a while and we expect that given this autumn of the environment and our focus on the path to profit, we're definitely prioritizing rate adequacy over unit count growth. A bit of a unique part of Sonnet's portfolio is the business that we have in Alberta that Paul just, you know, commented on. Whilst it's not material at a Definity level, it's only about 2% of our total portfolio. It is, you know, about CAD 80 million or just under CAD 80 million, quite important part of Sonnet's business.
In that area, we really are slowing new business growth. We know that there's about a 70% retention rate, that's gonna be a fairly big headwind to Sonnet's growth. Something we're very committed to, you know, not deploying capital into a line of business where there is a rate freeze and we're not rate adequate. I think that's the point that we have there. I'll let Paul talk about theft in just a moment. Your final question was, I think you led with it, which is, you know, any updates on, you know, the break-even guidance. Really, there's no change there. There's nothing more to report than what we've kinda said.
I think if we look at it, you get a couple headwinds in places like Alberta, where we know we're rate adequate, and that's why we are slowing. On the other hand, we've got a couple tailwinds. We're taking more rate than we had thought we'd be able to take, and we're having great traction in the Definity book. You know, that's well over, you know, that's our focus area. It's over 25% of the policies and new business, and we're getting super traction there. Nothing really to update on that story other than I think, you know, consistent with what we said before, we really are focusing on rates over unit count in the, in the near term. Paul, do you have any comments you wanna add to that and touch on theft?
Just a couple of points on Definity in terms of supporting why we believe this is a focus area for us. Our Definity portfolio has grown 37% year-over-year, and as Rowan says, it represents now a full quarter of our entire PIF count. Just from a quality perspective, we've got about a 14 point better multi-line penetration rate relative to retail. Retention is higher, credit score is better, driving record is better, payment rate is better. This is why we wanna continue focusing on that area. It does come with a slightly lower AWP because of the inherent quality of that business, but we believe it provides a better long-term return on our investment. In terms of your question related to theft, not a material difference between the two portfolios, but there are...
There is a slight difference in the fact that Sonnet has a more urban population than our overall broker portfolio. As a result, we kind of have a slightly higher frequency of theft in the urban centers, but curiously, a slightly lower severity. That's likely reflected with the value of the cars in that portfolio.
Appreciate the color. Thank you.
Thank you. The next question comes from Geoff Kwan at RBC Capital Markets. Please go ahead.
Hi. Good morning. Just wanted to ask on the impact from the wildfires in Alberta and the storms in Quebec, how that's your sense of that impact and how that compares to what you would expect for a normal Q2, given it tends to be a high seasonally quarter for cat losses.
Yeah. Thanks, Jeff. It's Phil here. I think it's pretty early to say. Obviously those events, if they transpire into being loss events are pretty early in the genesis. Q2 and Q3 are normally where we'd see a higher level of cat events. The biggest one we've seen so far in the quarter was an ice storm in Eastern Ontario and Quebec, but nothing unduly unexpected there. I think at this moment in time, we're still pretty comfortable with how things are transpiring, but we're watching those events pretty closely.
Okay. Just my other question was, going back on, I apologize if you may have answered this already, but, like how much would that in a normal quarter be, in terms of the impact of theft on the loss ratio and basis points or however you want to do that? Is it something that at some point that may change how you think about underwriting, whether or not it's incentives or how you price the product?
Yes, absolutely. I'll start with the latter question first. It is absolutely something that has already impacted our underwriting and pricing. Much of the filed rate that Rowan mentioned is targeted at the comprehensive component of it to address theft specifically. We've taken repeated and continue to take additional actions in underwriting, particularly with high-theft vehicles. There are certain types in certain provinces that are worse than others, so we'll surcharge those. Of course, we continue to take additional actions working with our brokers and our customers with anti-theft tracking devices, et cetera. I'll again repeat what Phil mentioned earlier, delighted to see the Ontario government's commitment to investing CAD 51 million in combating theft in the marketplace.
We have confidence that theft overall will continue to improve over the next few quarters. In terms of how much it represents, theft is approximately 7% of the loss of our auto portfolio. Although it's elevated, the quarter-over-quarter has actually improved. The year-over-year is still quite elevated relative to pre-pandemic levels, and we've seen a lot of that in the press. We'll continue to focus on this as a matter of priority. We have some confidence that we, together with the governments and the regulators, will be able to address this in the near term.
Really it's about, you know, if you think about the composition there, it moved the loss ratio about two points in the quarter from the prior comparison period. That's why, as Paul said, there's a lot of activity underway to address that.
Okay, great. Thank you.
Thank you. The next question comes from Paul Holden at CIBC. Please go ahead.
Thank you. Good morning. Lots of useful information and discussion on personal auto, but I just want to bring it back to a high level and ask the question: Has your outlook for the year changed at all versus when you talked about the outlook on the last conference call? Have things gotten, i.e., worse or is it kind of shaping up as expected?
Paul, thanks for the question. You know, look, this is not a surprise to us. These results are kind of falling into place largely as we've expected, you know, given the auto environment that we've had. If you kind of just step back, look at the big pictures here. We know that driving mobility has largely returned to pre-pandemic level. There is a bit of frequency that are still lower because of the driving patterns, but year-on-year it's up pretty significantly. When we look at the comparison period of this quarter versus Q1 2022, remember we were still in lockdown period in that particular quarter with the resurgence of the Omicron. That was one of the drivers that went up. We, we talked a bit at length already around the severity, which is now starting to flatten.
We can't forget that our Q1 is seasonally affected. It's the Canadian winter, that actually drives a couple points of higher loss ratio just in because of the seasonality. You, you know, you may also note that there's less PYD than we had a little bit less than the last year. We're limited, I should say. That really is kind of normal for us. If you go back and look at our trends for Q1, we like to be very prudent early in the year. You know, I think Phil has guided in the past that our overall company, you know, favorable development is one to two points a year, but it's much higher than that in automobile. We certainly, you know, expect to see some of that, you know, later.
Stepping back, you look at that, our full year guidance is not changed at all. It's unchanged. You know, we said it would be upper nineties. We still believe it's going to be upper nineties. We did say that 2023 would be the trough year of earnings, you know, for the personal auto portfolio. You know, we expect that 2024 will have better earnings than 2023, and 2023 was obviously less than last year because of those issues. We're confident to that because there's increasing evidence that inflation has peaked last year. We've seen that now kind of flattened. It's really been the APD story that we've watched come down quite, you know, quite favorably. No change or anything to comment on for ABPI. That's very consistent.
We think most of the frequency is really up, and that should kind of normalize, you know, going forward. Then you just do the math of the rates that Paul talked about. Those are really significant rates and, you know, apply to the vast majority, you know, of our portfolio. Stepping back, you know, we're comfortable, you know, with the auto guidance we've given.
Okay. Okay, that's great. I also did want to ask a specific question on PYD. Just prior to the IPO, around the time of the IPO, you added some additional reserves for this type of environment, specifically for higher severity. How much of those additional reserves are left? Assuming there is still some left, like why didn't you use more in this past quarter?
Yeah. Thanks, Paul. I think, you know, we don't specifically look at individual components like that. We look at the overall kind of strength of the balance sheet position. It's obviously been a decent amount of time since we've established those. I think what I'd say just
A big picture comment on prior year developments. you know, we're still continuing to see favorable developments run off from prior years, from last year and the year before. We're not seeing anything in the underlying numbers at this point that gives us undue concern. you know, we do tend to start the year a little conservatively out of the gates as we look at that. We continue to have, you know, good confidence in the overall balance sheet position that we have across all our lines of business, including auto. I think historically, you know, we've had about one to two points at a company level of prior year development. Under IFRS, we're still reporting on a consistent basis as we did before.
That one to two point historic level, you know, reflective of the approach that we take from reserving, we think is still a good proxy for expectations going forward. We're still very comfortable that we have a robust and solid balance sheet.
Okay. Last one for me, just in terms of thinking about acquisition potential, and I guess particularly in commercial and specialty as you highlighted, Rowan. Like, when I think about the current environment, it's obviously very good, right? It's very good for you in terms of your margins and the growth, and that's obvious in the results, and I think that's probably broadly true for the industry. Does that make it a tougher environment to find a willing seller because they're earning great ROEs on that business? Or maybe does it make it easier because, you know, they're more happy to extract the acquisition multiple that might come at a favorable time?
I think there are a couple of things that are happening in the market. You know, one is overall, you know, there are a couple of drivers in commercial lines that are relevant for companies. Some companies are more dependent on reinsurance capacity than others, and that sometimes has to do with the size and scale of your business and balance sheet. We know that the reinsurance market was really firm and has a substantial change from, you know, previous years. We saw that one on one, and we expect that to be a firm market, you know, going forward. That certainly puts, you know, some pressure on some commercial/specialty companies. Then the other thing is that brokers are really raising their expectations. We're seeing consolidation of brokers. Brokers are getting bigger.
They're looking to consolidate their business. They have higher expectations in term of interactivity service levels with their various markets. There's a big investment required to step up and do this. In a time like this where I think there is some pressure, whether it's reinsurance, inflation, Nat Cat kind of losses, not everybody is willing to make big investments, you know, in their business. I think that may bring some more opportunities to the marketplace. That's certainly part of the thesis that we have. I think when we sit back, you know, we look at our platform, which is built out.
We look at the fantastic, you know, broker support that we're getting, and, you know, a very strong balance sheet that looks to, you know, participate in any of these, you know, opportunities. I'm gonna just ask if Fabi's got anything, you know, to build on that, because I think one of the points that we're also seeing is not just hopefully more M&A opportunity, but very strong, support through our channel.
Yeah, certainly. As you know from, prior conversations, we are focusing our growth plans, in commercial insurance on three main segments. It's, small business, middle market, and specialties. We have now built a value proposition for each of those three segments that is market leading in terms of product range, service standards, and, underwriting capabilities as well. In small business, for instance, we launched a digital capability a couple of years ago that allows our broker partners to quote and bind, more than half of their small business opportunities in an automated manner. That results in us writing more than twice the amount of new business than we did a couple of years ago.
In middle market, which we are executing through our regional operations, we are benefiting from very strong relationships that we've built with our broker partners locally. Then in specialties, we are now the market leader in Canada in the sharing economy segment, which includes accounts like Uber and Turo. We have also built a very strong offering in the D&O, E&O, surety, and large property segments. Overall, I would say that we are now able to provide an insurance solution to more than 90% of Canadian businesses. That has resulted in, as Rowan Saunders mentioned, tremendous support from our broker partners. Very much in line with our strategic aspirations that we conveyed to you earlier on. We have now been growing our small business and specialty segments above market growth rates.
In Q1, those two segments grew by more than 30%. I think what is also important to consider when you look at our growth rates is about 40% of our growth is coming from rates and inflation indexation adjustments. That gives us the confidence that we'll be able to sustain our profitability in that low 90s combined ratio range. In terms of our growth outlook for the rest of the year, very much in line with what Phil mentioned, we do expect that our growth rate will sustain itself in the mid-teen range as a result of firm market conditions, our strong value proposition, and the tremendous support that we're getting from our broker partners.
To kind of, you know, put a pin on that, I think that we're having great organic growth opportunities. Some of the strong.
Insurers are now encroaching on space that was typically done by foreign insurance companies. We think that's going to potentially, you know, create some more opportunities in the marketplace because a lot of these brokers are saying, "If I have an option of placing my business with someone like Definity and other leading Canadian insurers who can do all the specialty, but also do my mid-market, also do my auto, also do my personal insurance, that's a more strategic relationship to me." I think some of that will be a headwind to their growth. That combined with my earlier comment, we think may be a thesis for some more opportunities ahead.
Understood. That's helpful. Thank you very much.
Thank you. The next question comes from Mario Mendonca from TD Securities. Please go ahead.
Good morning. This might be best suited for Paul. In the personal auto business, you talk about the move in earned rate and getting approvals in Ontario and throughout Canada. I wanna look at the question from a different perspective. Do you think that insurers see things the same way you do? I guess what I'm getting at is I often hear people compare the Canadian market to the US market, and I think there are some different dynamics from a pricing discipline perspective. I want your perspective on how you view your competitors from a pricing discipline perspective in personal auto.
Yeah, thank you. Difficult for us to comment on our competitors, but I can certainly comment on our strategy and philosophy. The idea for us is, you know, we are in a highly regulated environment. Many of our provinces are regulated and so there's always a focus on ensuring that we're well aligned with the regulator and the jurisdiction to ensure that we get broad support for recognizing the trends in the marketplace. We're delighted by the support that we've been given, particularly in Ontario. As Rowan called out, we've been getting lots of support from the Ontario regulator in terms of recognizing the inflationary trends, particularly the theft trends. This is an important health metric to ensure that we can cover the escalating trends.
Of course, even with that strong support, there's still a delay. There's a lag in between you seeing the inflationary trends and the and the rate earning through the portfolio. From a pricing perspective, our philosophy is absolutely to cover the trend, make sure we stay ahead of that trend in the long run, and ensure that we focus on the profitability of the underlying portfolio. We also look at this in the context of our entire portfolio and diversification strategy. It's not just regional diversification, it's also diversification into personal property. I mentioned previously that we would focus on extracting a bit more profits from property to offset this, and we've been successful in getting at least two points of improvement.
Fabi and his team have done an incredible job in getting profitability and growth on the commercial side. When we net it all out, we believe that we're well priced for the future to meet our guidance.
Mario, just.
Yeah.
Sorry, Mario. I was gonna just add one add to that is I think that, just 'cause your line broke up a little bit for us, I think you were asking a bit about regulators and peers or competitors. I think that, you know, what we are seeing on the competitor side of things is, you know, consistent pricing increases as well. If you look at Ontario, which is the main market where we've got 70% of our total portfolio, we're now seeing the market at about a 10% written rate. I think that gives you good e-evidence that everyone's seeing the same story. Everyone's leaning into it. The regulators are recognizing and approving that.
We feel very good about the price changes that we're putting through our portfolio and fully expect solid retention to continue given the whole market's moving at about, you know, 10% price increase. More recently, another part of evidence of that is we are starting to see some more shopping activity coming up, and that's normal as customers start seeing bigger price increases. When we put that together, you know, we do see some discipline in the marketplace, and we do know it's starting to flow through because customers are starting to once again, do a bit more shopping.
A sort of related question. In response to Paul's question, Rowan, you said that you weren't really surprised by the results in personal auto. I'll ask it this way. You know, Definity became a public company at a very odd time, you know, the pandemic and the results in personal auto during that period are not in any way indicative of what we can expect from this company going forward. Maybe let me ask this: Is it reasonable for this company in more normal environments, if there is such a thing, to generate underwriting losses in Q1? Is that a normal occurrence for a company like Definity, an underwriting loss in personal auto in any given Q1? Is that normal?
I don't think so. I think, you know, when you, when you step back, you know, we've got a couple parts to our portfolio, right? One part is the Sonnet business, which is, as you know and would expect, generating underwriting losses. You've got the broker business, which is generating underwriting profits. We put it together in this particular quarter, you know, we're right on that 100%, you know, area. Whilst we don't get into the details of each of those segments, that's generally the view, 'cause Sonnet still isn't break even. It's on the path to break even.
You know, that part of our business, which is steadily improving on the path to where we think it would be, you know, on a normalized basis, that wouldn't get you to an underwriting loss in any particular quarter for the personal auto business. I think the other thing is that inflation is not normal. I mean, this is a complete mismatch in timing between rapid elevated inflation and then the lag of rates. In a more normal environment, you don't get inflation this high, and it doesn't take so long to get your rates to catch up. That would not be an expectation of ours.
I think, you know, longer term, as we've guided and we're asked, you know, about this on the roadshow, I think that, you know, we think this is more like a mid-90s, you know, line of business and not the elevated, high 90s we're talking to now. That's a point in time for us, and we're confident, you know, we'll get over that.
sorry, just one final thing. When this company became public, when you demutualized, one of the big storylines behind it was just how the top line is growing a lot faster than the industry. And that's still true today. Do you envision a time in the near future, as in possibly next year, where Definity's top line just sort of looks like the industry? Or do you really see this persistent?
We definitely see it persistent, Mario. I think we're very comfortable with the growth engines we bought, you know, with the opportunities we see in the marketplace, that we will continue to grow roughly twice the pace of the industry. We do not see in the next several years that we will normalize to industry growth. We continually see we'll be able to outperform that.
Okay. Thank you.
Thank you. The next question comes from Brian Meredith at UBS. Please go ahead.
Hi. This is Weston Bloomer on for Brian Meredith. My first question, you highlighted some non-rate actions within personal auto that you're taking on the theft side. Are there other non-rate actions that you're currently taking across your book, you know, to improve the profitability of the business? Or is it more just rate exceeding trend at this point away from the theft?
Absolutely, we continue to take significant non-rate actions to improve the profitability of the portfolio. First and foremost, remembering that Sonnet is on a path to profitability. Year-over-year, we've had significant improvements in the mix, in the underlying mix. As I mentioned earlier in the call, one of those main focus areas is pushing more onto the Definity space, which has a better quality profile. For the overall portfolio, I mentioned already significant underwriting actions related to theft and some of the inflationary trends, we continue to refine our segmentation and use advanced analytics to identify and remediate any fraud potential.
Beyond all of that, we continue to focus heavily on the claims, improving cycle times, improving pending levels, improving amount of our claims that get sent to our preferred vendors. This is an all-hands-on-deck set of activities around continuing to improve the underlying performance of the portfolio.
Great. Thanks. A follow-up on the frequency discussion. Sorry if I missed this, did you quantify how much on a basis point perspective frequency was up on the loss ratio? I mean, it sounds like you're expecting it to normalize closer to year-end, should we expect a similar impact in the 2Q to 4Q normalizing for maybe winter weather?
Yes. I think that's an appropriate view. We're expecting it to be relatively stable now from a frequency perspective. Of course, seasonally adjusted, as you mentioned. It's the severity component that we're seeing reductions in certain input costs, and we're hoping to see those reflected in the overall trends as we roll forward through the end of the year.
Great. Thank you. Then my last one is just on the expense ratio. On the year-over-year improvement, it was mostly through claims, or commissions ratio where, you know, other operating expenses generally trended higher. Is that more just inflationary pressures or are there other investments in the business that you're making? Just curious on, you know, overall expense ratio trends as you try to hit your target combined ratios.
There's a couple of moving parts in the first quarter. On the commission ratio, we probably normally see that in the kind of mid-15 range. There was some favorable outcome of the CPC accruals we put in for 2022 from an expense basis. They're not setting that on the operating expense side. You'll see that ticked up a little bit compared to this time last year. That's really timing of some talent acquisition and investments in technology we made in 2022. You're seeing that bulge a little bit more from a comparative basis compared to Q1 last year due to the timing of when we were hiring some of that talent. That's more stable from a hiring activity this year.
What you'll probably see is that ticks down a little bit in the second half of the year as you get more to a like-for-like comparison. If I step back, you know, around a 33%, which we're very close to in the first quarter, is a good indication overall, you know, from our expectations on the expense ratio.
Great. Thanks for taking my questions.
Um.
Thank you. The next question comes from Tom McKinnon at BMO Capital. Please go ahead.
Thanks, and good morning. A question about I just want to compare the regulatory environment in Ontario to Alberta. I mean, you're jamming all this rate increase here in Ontario, but and both Ontario and Alberta are having inflation issues, but one regulator says stop, and the other one says, you know, keep it coming. Like, you've been in the business for a long time. How at what point is a breaking point? I mean, there is. How and is it the last man standing that can't get the rates through? If you could put some context on that and also compare why Alberta would say no and Ontario would say yes, and what's the issue? What would drive Ontario to eventually say enough's enough?
Yeah, good question. you know, rate pauses or rate freezes are nothing new in the Canadian context and in other contexts and typically are a political reaction to economic conditions faced by consumers. Fortunately in Ontario, you know, there was a period of rate release that had flowed through and then the inflationary trends are being recognized by the government and also by the regulator. We've got good support for that as mentioned. You're absolutely right. The trends are similar. These are macroeconomic trends. These are not trends that are materially different in the different provinces. Alberta is absolutely seeing the same inflationary trends as Ontario and indeed the other jurisdictions. What then is leading to the Alberta situation?
It is completely related to the political context and the election that's coming up at the end of this month. I won't speak too much to the political party's platforms on this, but certainly this is why it's been communicated to the industry as a pause and hopefully once the election has resolved, we can resume more normal operations. It is a challenging context obviously for the industry and ultimately we believe it's gonna be difficult for the consumer as the insurance industry has to react to these conditions. If there's no rate flowing through that portfolio and you're seeing a very significant inflationary increases, the net result is profitability is gonna suffer. Likewise, you would expect to see capital being redeployed out of that province into other provinces.
I think for your question relating to, you know, Ontario, which has been very positive, that we continue as an industry to talk with the government on solutions which really are around product reform. At some stage, and we have a history of this, when you do see significant loss cost trends that are followed by price changes or rate increases, at some point, you know, you do need to then move into some product reform to address those costs. You know, I think there's been some good examples of that happening in the past. That's something that the industry at large through the IBC continue to engage with the Ontario government with.
My sense is what we're gonna see here is some, you know, price movement in the short term, and then that'll be followed with some reform to provide, you know, some relief on the prices to consumers.
Okay. Just a less rich of a product and that would then alleviate some of the inflationary pressures.
That's correct. We've had to do that a few times, you know, through the, through the decades. I think the other issue is that, you know, fraud, and you know, you heard about, you know, earlier things like, you know, theft, but particularly the fraud there is a lot of activity and there's some regulation changes that'll help address that as well. Not everything has to be completely done through just price alone, but there are other tools available to the product. That discussion, you know, continues to occur, you know, with the province.
Yeah. Presumably that would mean less profitability levels would be on a combined ratio basis, would be around the same or maybe a little bit better, but the premiums written would be less. The scale of the business would be less. Would that be safe to say if it was, if you took away some of the richer benefits in the product?
Yeah. It's Paul here. As Rowan said, typically the reform occurs on the casualty side of the equation, you're absolutely right that we'd start to see a reduction in AWP for that component. Offsetting that potentially are the rising costs of automobiles. Just technology, even pre-pandemic, technology was getting more expensive, cars getting more complicated. As we introduce electric vehicles, into the system, we're gonna see a slight increase on that. We do expect to see sort of a net flattening of that. Of course, regulators adding more choice to the consumers. They can evaluate how they can deploy their premiums.
Okay. That's great. Thank you.
Thank you. The next question comes from Lemar Persaud from Cormark Securities. Please go ahead.
Thanks. This one's probably most appropriate for Rowan. Is the bottom line on carrier acquisitions in some way linked to the CBCA conversion? That once you have that additional financial capacity, then we can expect a bigger carrier deal. Is that fair?
Well, I mean, I think I would start by saying, you know, if you look at the current financial capacity, it's pretty significant. As we've guided before, we're very confident that the CBCA process will unfold and we're, you know, we're expecting that to be in the summer. That's well advanced. There don't seem to be any hurdles. We're assuming that happens. That just gives us, you know, more financial capacity to look at that. Really it depends on the type of, or sorry, the size of an entity. I think as we said today, we don't feel limited in terms of our ability to find opportunities in the marketplace, but it is scale dependent.
You know, if we wanted to pursue a larger, you know, target, being a CBCA company is definitely, you know, helpful for us. You know, but that's pretty imminent. I think we look to be in a pretty good shape there.
Okay, just kind of linking that to the one of your previous answers on outgrowing the industry over the next, I guess, couple of years. Do you need a deal to... Are you building any expectations of a carrier deal to outpace the market on the top line? Or if we go through the next couple of years without a deal, could you still see yourself kind of doubling the industry on a top-line growth perspective?
Yeah. The comments we make and the targets we give, you know, which is upper single digits to around 10%, that is all organic. You know, we really are pretty confident in organic abilities to build out the product lines, you know, keep retention, keep putting prices through. It's the organic story. Therefore, we don't need an acquisition to deliver that organic target of, you know, close to 10%. An acquisition would help us exceed that. What we've talked about in the past is our objective to be a top five player. If you think about the path we're on, we're doing really well on an organic perspective. There's a pretty significant gap between ourselves and getting into that top five at roughly CAD 1 billion.
We therefore say, in addition to strong organic growth, we would need an acquisition of approximately, you know, CAD 1 billion of revenue that would put us into that top five position.
Okay. Okay. kind of like trying this a little different way, what makes Definity special to, you know. I'm talking about a couple of years down the road, absent an acquisition. What makes Definity special so such that, you know, you could continue to double the industry growth without, you know, say being more aggressive on price and rates?
I mean, I think that if you just step back and I look at this and I say, look, you know, we've got solid growth, and it's happening, you know, across our portfolios. We're shifting the mix of business. Our personal automobile, you know, is a smaller percentage of our total now than it was a couple of years ago and even more than that before. We've got really strong growth in commercial lines around, you know, 20% in all of those segments. There's capacity we're putting into, you know, specialty commercial with talent pools that we've brought into the business, and our natural market share is still low there. That's how we could, you know, move up. In personal insurance, we really think that the technology advantage that we've got is what's going to help.
Brokers are consolidating the number of insurers they deal with. They, of course, need good claims and good pricing, but technology interface is a bit of a game changer, a really big driver of differentiator for them, and that's where we stand out, which is why we're getting, you know, an excellent, you know, growth from that perspective. I think those are the points that, you know, that give us, you know, good capacity. If I just step back and take a macro view, you know, we've got very strong organic growth. We've got a solid combined ratio. We're targeting to be in the mid-nineties. We've been consistently that or a little bit, you know, better than that. That's gonna keep generating, you know, solid earnings, you know, for us. We're now adding distribution income to that. Phil talked about higher investment income.
We've got a bit of a higher book value, some benefit there. We've got a lot of financial capacity as well as the organic growth story. I think there's something, you know, unique about the broker support for our business model and the fact that, quite frankly, even after being a public company, you know, our brand has gone up. We're able to retain and attract more talent than we were when we were a mutual company, and brokers are more comfortable concentrating more of their volume with us than they did, you know, before. That's really what's kind of... You know, there's a number of elements in that I realize in my answer, but that's really what's fueling, you know, our confidence in the strong growth ahead.
Okay. That's it for me. Thanks.
Thank you. There are no further questions. I will now turn the call back over for closing comments.
Thank you everyone for participating today. The webcast will be archived on our website for 1 year. Telephone replay will be available at 2:00 PM today till May 19th. A transcript will be made available on our website. Please note that our annual meeting of shareholders will be held on May 19th. Our second quarter results for 2023 will be released on August 3rd. That concludes our conference call for today. Thank you and have a great one.
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