Good morning, ladies and gentlemen, and welcome to the Intact Financial Corporation Q4 2022 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 require immediate assistance, please press star zero for the operator. This call is being recorded on February 8, 2023. I would like to turn the conference over to Shubha Khan, Vice President, Investor Relations. Please go ahead.
Thank you, Sylvie. Good morning, everyone, and thank you for joining the call today. A link to our live webcast and published information for this call is posted on our website at intactfc.com under the investors tab. As usual, before we start, please refer to slide two for cautionary language regarding the use of forward-looking statements, which form part of this morning's remarks, and slide three for a note on the use of non-GAAP financial measures and important notes on adjustments, terms, and definitions used in this presentation. With me today, we have our CEO, Charles Brindamour; our CFO, Louis Marcotte; Patrick Barbeau, Executive Vice President and Chief Operating Officer; Darren Godfrey, Executive Vice President, Global Specialty Lines; and Ken Anderson, Executive Vice President and CFO, U.K. and I. We will begin with prepared remarks followed by Q&A. With that, I will turn the call to Charles.
Thanks, Shubha. Good morning, everyone, and thank you for joining us today. 2022 was an important year in Intact's journey. This was the first full year following completion of the landmark RSA acquisition, and we made big strides towards fully integrating the acquired business. At the same time, we maintained our focus on performance with solid results despite elevated catastrophe losses and inflation pressures. We delivered net operating income per share of CAD 3.34 for the fourth quarter and CAD 11.88 for the full year. Excluding strategic exits, premium growth was 5% in the quarter, a point higher than in Q3, a sign of momentum building as markets are firm or firming across most lines of business. For the full year, premiums increased 23%, primarily on the back of the RSA acquisition.
The overall combined ratio for both the quarter and the full year was solid at 91.5%. This reflected strong performance across commercial and specialty lines in all regions and personal lines in Canada. Together with robust investment and distribution income, this drove mid-teens operating return on equity and ROE in 2022. I expect the full year outperformance to be well in excess of our objective to outperform by 500 basis points of ROE. Our results are a testament to the resilience of our business. We move into 2023 with positive top and bottom-line momentum and a strong balance sheet. This enables us, again, to raise our quarterly dividend by CAD 0.10, the 18th consecutive annual increase. Let me now provide a bit of color on the results and outlook by line of business, starting right here in Canada.
In personal property, this business continues to demonstrate great resilience in the face of increasingly frequent and severe weather events. The combined ratio was 76.9% in the quarter, 90.1% for the full year, and has averaged sub-90 over the last five, and now 10 years. Weather and sharply higher reinsurance costs are driving hard market conditions. We expect rate increases to remain in the high single-digit range and keep pace with loss cost trends. In personal auto, premiums grew 2% year-over-year, a three-point improvement compared with the third quarter. The top-line momentum was a function of both our early rate actions as well as firming market conditions. Retention levels were strong and the pressure on new business volume moderated. We expect that our competitive position will further improve as the market continues to reflect inflation in its pricing.
Our underwriting discipline resulted in a combined ratio of 95.8% in the quarter. This included nearly 1.5 points of adverse seasonal weather as well as one point of non-recurring loss adjustment expenses. The favorable impact from prior years was solid at seven points, slightly above what we expected. As I've mentioned before, prudence from the past is paying off, but the current accident year is also prudent. We continue to look at both current and prior years combined when we assess the performance of this segment. There are a number of reasons why we're comfortable with our sub-95 guidance. From a cost perspective, inflation pressures are easing. The increase in claim severity was 11%, two points lower than in Q3. We expect the deceleration to continue in the coming months.
On the frequency front, the number of accidents continues to be benign relative to pre-pandemic levels, even though it was up from the prior year. Our run rate assumes frequency will gradually increase in the coming months. Finally, written rates and insured values increased by close to nine points in aggregate by December, while only five points has been earned in Q4. When I look at our starting point and integrate these observations, I feel strongly about our sub 95 trajectory. Obviously, we're comfortable growing in this environment. In commercial lines, premiums increased 7% in 2022, excluding the impact of the RSA acquisition. Growth continues to be supported by our rate actions in hard market conditions. The combined ratio was solid at 87.9%, reflecting our profitability actions over time.
Looking at the industry, we see hard market conditions continuing given rising reinsurance costs, elevated cat level losses, and inflation pressures. Our business remains well-positioned to deliver a sustainable low 90s or better performance. Moving now to our U.K. and I business, the combined ratio was 104 in the quarter, and 97 for the full year. In personal lines, premium decreased by a modest 3% in Q4 after adjusting for the sale of our Middle Eastern business. The decrease primarily reflects our continued pricing discipline in a competitive market. The full year combined ratio of 106.2% included six points of cats more than anticipated, as well as increased subsidence claims following a very dry summer. Adjusted for elevated weather-related losses, the run rate performance of this business remains in the high 90s despite inflation pressures. Market conditions have started to firm.
We expect this to continue in 2023, supporting further rate increases. In commercial lines in that region, underlying premium growth was 9% in the quarter after adjusting for business exits. We continue to benefit from hard market conditions, which are supporting high single-digit rate increases. The full year combined ratio of 90.4% reflected the underlying strength of the platform and prevailing market conditions. We expect to operate this business in the low nineties over the next 12 months. Despite challenges in the fourth quarter, our UK&I business remains on solid footing overall. At closing, we indicated that it would take approximately two years to fully evaluate our propositions across the UK&I portfolio and take the action necessary to drive out performance.
While that timeline remains, we've already taken significant steps by exiting over $500 million of business with a combined ratio above 110%. The earnings power of that business is clearly improving. Our U.S. commercial business delivered premium growth of 18% in 2022, excluding the impact of exited lines. This was driven by the Highland acquisition, strong growth in high-performing businesses, and rate increases in hard market conditions across most lines. The full year combined ratio was strong at 88.2%, reflecting our continued profitability actions. The business continues to perform very well with rates tracking ahead of loss cost trends. We're well-positioned to deliver sustainable low 90s performance or better in the U.S. Turning to our strategic initiatives, the RSA integration remains very much on track.
In Canada, policy conversion is progressing well, and retention is tracking in line with RSA's historical experience. On the digital front, our mobile app saw over 4.5 million visits by customers in the fourth quarter. More than half of all online transactions are now completed via our mobile app, which is driving greater UBI uptake and digital engagement. Finally, we continued to enhance our AI capabilities during the year. The Intact Data Lab team has grown to over 500 professionals, underscoring our ambition to be the leading AI shop in the insurance world. To date, the lab has delivered nearly 300 models that have, in aggregate, yielded almost CAD 100 million of run rate underwriting benefits. As I said at the outset, 2022 was an important year for Intact.
We made excellent progress in integrating RSA and advancing our strategy. The performance was strong despite heavy headwinds. This is thanks to the strength and dedication of our people. At Intact, we're very focused on making sure we have the very best people. We're working hard to ensure they're proud of what they do and feel like they're part of the winning team. Again, this year, our efforts are recognized as we were named a best employer in Canada for the seventh consecutive year and in the U.S. now for the fourth year running. Our sites are now firmly on 2023 and beyond.
The business overall is operating at a low 90s combined ratio, and the outlook for investment and distribution income is strong. We're well-positioned to deliver again this year on our objectives to grow net operating income per share by 10% annually over time and to outperform the industry ROE by 500 basis points every year. With that, I'll turn the call over to our CFO, Louis Marcotte.
Thanks, Charles. Good morning, everyone. While 2022 was the first full year in a largely post-COVID world, our industry has nevertheless been faced with a number of other challenges. Inflation and severe weather chief amongst them, but there was also tight labor markets and capital markets volatility. In that context, I'm pleased to report solid results for both the quarter and the full year. The overall combined ratio for Q4 was 91.5%, despite inflationary pressures and challenging weather conditions in Canada and the U.K. Our Canadian and U.S. businesses delivered sub-90 combined ratios and investment and distribution earnings were strong. On a full year basis, the combined ratio was solid at 91.6%, further underscoring the strength and resilience of our platform.
Cat losses in the quarter were CAD 167 million, driven largely by windstorms in Canada and severe winter weather in the U.K. This figure is higher than the CAD 143 million estimate we announced in early January, reflecting a number of late claims notifications and higher costs per claim than expected in respect of the U.K. freeze event. This takes total cat losses for the year to CAD 826 million above our CAD 600 million expectation. These results in mind, we are increasing our annual cat guidance to CAD 700 million. We expect approximately 70% of losses to occur in Canada and approximately 25% in the UK& I. Within Canada, approximately 2/3 of losses are expected in personal lines.
The increase to our guidance is driven by a combination of growth and inflation, higher cat losses, and the impact of reinsurance renewals. We expect the overall earnings impact to be offset by rate actions, much of which we have put through last year in anticipation of higher reinsurance costs. Favorable prior year development was healthy at 3.8% for both the quarter and the full year, largely in line with expectations. Net investment income increased by 27% in the quarter, reflecting higher yields and higher turnover. For 2023, we expect investment income to be approximately CAD 1.1 billion as we continue to take advantage of current market rates. Distribution income was CAD 93 million in the quarter, taking annual earnings to CAD 437 million.
This is a 21 increase over last year, reflecting accretive acquisitions, organic growth, and a solid contribution from On Side. Looking ahead to 2023, we expect to grow distribution earnings by at least 10%. Let's turn to our underwriting results, starting with Canada. In personal auto, the combined ratio increased by 8.3 points compared to a low 87.5% last year. Severity increased as expected, given inflationary pressures, these pressures have eased a bit compared to Q3. Frequency increased year-over-year by almost five points. This was due to more driving compared to a partially locked down quarter last year, as well as worse than normal weather. Prior year development was strong in the quarter at around seven points, reflecting our reserving prudence over the years.
While this is slightly higher than expected, we expect prior year development to remain strong as we continue to reserve cautiously. We are seeing the positive impact of our written rates as they are starting to earn through. The impact will increase further in 2023, with earned rates accelerating from mid to high single digits as they catch up to current written rate levels. With inflation decelerating, we expect a positive impact on results going forward. Our guidance remains sub-95% for this business. Keeping in mind there will be normal seasonality in the results, particularly in Q1. Personal property, another solid quarter with a 76.9% combined ratio, 2.6 points better than last year due to lower cat losses.
The underlying loss ratio increased in the quarter by 3.9 points compared to a benign Q4 2021, primarily driven by higher large losses. In commercial lines, the combined ratio was solid at 89%, despite six points of cat s in the quarter, which mainly reflected further development of losses from Hurricane Fiona. Both specialty lines and regular commercial lines contributed to a strong underlying result. Favorable prior year development was healthy at 3.4%, though three points lower than last year, reflecting the lumpy nature of large claims development. The overall expense ratio in Canada was 29.7%, around one point lower than last year due to lower variable commissions. General expenses were up in the quarter, largely due to timing of expenses between quarters and higher variable compensation tied to outperformance. Turning it now to the UK&I.
In personal lines, the results include over 20 points of cat losses, which is 19 points more than expected. Almost all of these losses related to prolonged subzero temperatures in December, which resulted in burst pipes in thousands of homes across the U.K. In addition, there were a number of non-cat large losses and inflationary pressures continued to weigh on both motor and home. In commercial lines, the combined ratio was a solid 92.8%, driven by the continued strong performance of our regions and specialty businesses. At 90.4% for the full year and with market conditions remaining favorable, this business is well positioned for profitable growth. In our U.S. segment, the combined ratio was strong at 85.1%, with the underlying loss ratio improved by 7.2 points, thanks to our profitability actions and favorable market conditions.
Growth in this business is skewed towards our highest performing lines, which tells me that we have been successful at managing the business mix. I'm encouraged by what this means for this business going forward and our ability to deliver a sustainable low 90s or better combined ratio. Looking at our Global Specialty Lines business in aggregate, premiums grew by 12% over the year to CAD 5.5 billion, while delivering a combined ratio of 86.2%. Our U.S. business is not the only one to perform well. Specialty lines in Canada and the U.K. delivered combined ratios in the 80s in 2022, all driven by our continuous effort on profitable growth and outperformance, supported by good market conditions.
With regards to the RSA integration, we estimate annual synergies to have hit a run rate of GBP 260 million. We remain well on track to achieve our revised target of at least GBP 350 million by mid-2024. We also recorded an additional GBP 58 million of tax recoveries this quarter in the U.K., which drove a reduction in the effective tax rate. The gain is driven by a more positive outlook on profitability in the U.K. from both underwriting and investment income. This outlook allows us to recognize more tax loss recoveries from the pool of unrecognized losses which have been accumulated over time by RSA. There are north of GBP 3 billion of such losses off balance sheet in the U.K. and Ireland as of December 31st.
We have not reported these recoveries as run rate synergies given their lumpy nature, but they are part of the value created by the acquisition. We are certainly aiming to capture more of these losses in the future. With regards to value creation over the full year, RSA contributed 16% accretion to NOIPS, and we're confident of this rising to 20% by 2024. Overall, the IRR for the transaction remains over 20%. Moving now to the balance sheet, where our financial position continues to be strong despite the macroeconomic environment. We close the quarter with total capital margin of CAD 2.4 billion and a debt to total capital ratio of 21%. Book value per share grew 2% quarter-over-quarter as solid earnings and gains in our investment portfolio more than offset large mark-to-market losses in our U.K. pension plans.
Given our outlook on earnings growth and the strength of our balance sheet, we once again raised our dividends, this time 10%, which represents a 10-year CAGR of 10%. We are also renewing our share buyback program in February on the same terms as the existing program. While this extends our flexibility to purchase additional shares, we will continue to be disciplined in this regard. As we wrap up another successful year in a challenging environment, we are already laser focused on making 2023 even better, including a smooth transition to IFRS 17. While this will bring a number of changes to our key reporting metrics, these are mostly geography changes within our results, and as such will have no significant impact on our net operating earnings over time. I encourage you to refer to our MD&A, which hopefully provides a helpful summary.
Overall, as we look forward to 2023, there is much to be positive about. We start the year in a strong position despite recent headwinds. Our earnings resilience is evident and our balance sheet is strong. With the platform we have in place, a clear roadmap and an opportunistic mindset, I'm confident we will continue to outperform over the next year and beyond. With that, I'll give it back to Shubha.
Thank you, Louis. In order to give everyone a chance to participate in the Q&A, we would ask you to kindly limit yourselves to two questions per person. Of course, if there's time at the end, you can certainly queue for follow-ups. Sylvie, we're ready to take questions now.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touchtone phone. You will then hear a three-tone prompt acknowledging your request. If you would like to withdraw from the question queue, please press star followed by two. If using a speakerphone, you will need to lift the handset before pressing any keys. Please go ahead and press star one now if you have any questions. Your first question will be from Paul Holden at CIBC. Please go ahead.
Thank you. Just want to make sure I hear you correctly on personal auto, I don't think your message has changed that much. The way I'm sort of thinking about 2023 is, you know, slowing claims inflation, as you've talked about, then accelerating premiums earned and maybe sort of a net benefit of something like two to four points. Then with higher than normal PYD, or at least higher than your forward guidance on PYD, maybe being a drag of two to three points next year.
If I think about that as very simple math, that basically gets me to a 2023 combined ratio that's roughly flat versus 2022. Like, am I missing anything there? Is that kind of what your guidance is pointing to broadly?
I think your read is good, Paul, and I think that's a good way to unpack, you know, the trajectory of personal automobile. Our guidance has not changed. It is sub 95%. I'll ask Patrick to give you some color maybe on some of the elements that you have laid out. I think directionally, I would agree with how you analyze that. Go ahead, Patrick.
Yeah, I agree, totally. The, you know, if I look at the 95.8, see a combined ratio of Q4, there was, as we said, about 2.5 points between weather seasonality and the one-time adjustment on expenses. The PYD was slightly higher than expected, but that's an area, as we said earlier, that we don't look in isolation. We had a prudence reserving approach since the beginning of the pandemic because of uncertainty, and we continue to do so because there is still uncertainty around where the inflation will go exactly. We've seen very good signs of reduction in inflation, you know, from the 13% in Q3 to 11% in Q4. The drivers of that reduction are as we expected.
On car parts, on market values, we see these, and this is slowing down. Overall, I think the your analysis is very much aligned. Two maybe nuances I would bring is, if you look at the full year, I'm not sure that we expect the PYD to go down by two, three points next year necessarily, given we continue to reserve prudently in the current. On the other end, though, our pricing assumptions assumes that there would also be a bit of an increase in frequency year-over-year. Not given there was a ramp up in the earlier part of the year. Our pricing assumes that it will continue to migrate towards normal, even if over the past three quarters it was very flat.
Overall, these two are the slight nuances, but overall very much aligned with our calculations.
Yeah. Yeah, yeah. I think PYD not too far off, I guess, from what we're seeing year to date, in my mind, you know, provided frequency in the past does not start, the territory rating, obviously, but, directionally, right, Paul. Thanks for the question. Good read.
Okay. Thank you for that. Second question is related to the UK&I business, and I guess the personal lines in particular, you know, 121% combined ratio for the quarter, 106% for the year. I think even it's in your commentary of exclude cat losses is still kind of generating a below target combined ratio. Is there anything structurally related to the regulatory pricing reforms or otherwise that would prevent you from rectifying that situation, bring it down more into the target zone? If no, maybe you can give us some more specifics on what exactly the action plan is to produce a better combined ratio in U.K. personal lines. I'm talking, I guess I'm talking mostly, I just want to be specific on the property side more than more than auto.
Okay. Good question, Paul. I think if you strip excessive cat, you're in the upper 90s in first lines. You know, if I put all first lines together, that's not good enough. Obviously our work is not done. You know, I'd point to three areas of improvement. One is rates. Rates are going through the system. Two, very important, pricing and risk selection sophistication. Three, making sure we're playing in the right part of the market. There, our work is certainly not done on these elements. As I've mentioned, within 24 months of closing, we'll finalize where the footprint is, but we're not done. Ken, who is in the U.K., can give you additional perspective.
Yeah, no, very much aligned with that. You know, the 2023 overall combined at 106, as you say, you know, there's about six points of elevated cat in there. There's also about two points of subsidence claims in the home market. Just for those two, you are indeed in that upper nineties zone. We continue to hold the line on rates to deal with the inflation. The market in the early part of 2022 was slow to move. We started to see some signs in the fourth quarter of rates ticking up, but we think there's more rates needed in the market in 2023. That's clear. We're certainly pushing that. That may bring pressure on units, and with the cost base that we have.
All in that upper 90s zone is kind of the zone of performance that we see in the, in the near term. The actions that Charles mentioned are indeed the ones that are being pushed, you know, tilting that portfolio towards the direct and away from the partnerships where the economics don't stack up. The pricing sophistication, bringing some of the Intact capabilities, and deploying them in the U.K. market. Also in terms of, you know, technology footprint on the home and pet business, in particular, in the latter part of 2023.
Thanks again. I think, an element of your question, Paul, was are there regulatory constraints to bring improvement in the portfolio? I would say U.K. market is really tough, but one thing that is good in my mind is you can turn on a dime when it comes to pricing, either in the amount of price you're taking or in terms of risk selection. The U.K. trusts competitive behavior, in fact, more so than the Canadian regulatory system. When it comes to pricing and risk selection, no barriers to improvement.
That's helpful. Thank you for your time.
Welcome.
Next question will be from Geoff Kwan at RBC Capital Markets. Please go ahead.
Hi. Good morning. I just wanted to clarify, I think it was Ken's comment, because my question was gonna be like in the U.K. personal line space, like, what to you would be a success or would be good results in terms of combined ratio for 2023? If I heard it right, from Ken's comments, it sounded like upper 90s in the near term is kind of the goal. Is that correct, or did I get that incorrect?
Well, upper nineties is not the goal. I think upper 90s is what you can expect to see in 2023, because pricing risk selection takes some time. Some of the work we're doing in claims will take some time. you know, we're not going to run upper nineties business in U.K. personal lines. absolutely not. in 2023, you know, we're in the second year of the integration. That's maybe what one can expect given inflation, given the state of the market.
Absolutely, the commitment to mid-90s performance in the mid to longer term is very much the aim, but the 2023 that will.
Yeah.
Right. Okay. That's what I was talking about, the 2023, not your actual more medium-term goal. My second question was just going back on auto in terms of the claims inflation from Louis' comments. The improvement Q4 versus Q3, was that the rate of inflation was coming down, or are we actually seeing some of the actual claims costs actually net-net reducing? Also is there any comments on are those same trends playing out so far in Q1?
Q3 year-over-year was 13%. Q4 year-over-year is 11%. I'll let Patrick provide some color.
Yeah. Jeff, as we mentioned, you know, in prior quarters, if I break it down, there's 40% of the cost that's coming from liability and injuries, 30% on car repairs, and 30% on total losses, including death. On injuries and liability, no change from prior quarters. We see no inflation year-over-year on that. That's no change between Q3 and Q4. On repairable losses, the car parts themselves have been flat between Q3 and Q4, but they've been more available, so we've seen a little bit of easing on the pressure on rental costs for repairable. No, no increase between Q3 and Q4 on parts, which is an improvement from the trends we were saying before. On the total losses, the market value has flattened as well.
You know, the curve, the indices or the index of market value, which is the main driver of the cost in total losses, is also flat between Q3 and Q4, with slight reduction in the last two months. That's very aligned with what we've seen in the U.S. Because the denominator now is higher when we compare the year on year, that has created about five points reduction in the inflation rate in Q4 versus Q3, and that's the main cause of the reduction. These two items, when you look at availability of parts, the car parts prices themselves being flat and the index of market value starting to slow down, are good signs that this will continue in the same direction coming quarters.
I think, Patrick, you know, Geoff was trying to figure out what happened in Q1. We've had a chance to take a look
Yeah.
-at, January, even though it's a few days fresh.
Yeah. It is in the same direction, a slight reduction again.
Yeah.
Qver what we've done December.
Slight deceleration from Q4.
Yeah.
Okay, great. Thank you.
Thank you. Next question will be from Doug Young at Desjardins Capital Markets. Please go ahead.
Hey, Doug.
Good morning. Sorry about this, but I'm gonna stick with personal auto for my first question. I guess, you know, loss cost trends is outpacing earned rate, and you saw that last year. Is this something that's gonna reverse in Q1? Is that the message that I heard, or is this something that's more back half of 2023? Just to clarify, when I think of a sub 95% combined ratio, you talk about seasonally adjusted. I get Q1 is gonna be higher and Q2 is gonna be lower, but there's no other adjustments when we think of sub 95%. When I think of like the 95.8% that you've recorded this quarter, like that's the number we should be looking to be sub 95%. That includes probably your reserve developments and whatnot.
Just get some clarity on that as well.
This quarter, Q4, is a higher seasonality quarter. I think we've, you know, pointed out that A, there's seasonality, and B, there was even more winter than what the seasonality we would have expected, assumed. You are right there appointing us there. Q1 is a high seasonal quarter. We need to keep that in mind. Our guidance is indeed a run rate ex-seasonality type guidance. I'll let Patrick comment on last cost, because there's an element in your question though that is what you assume when you price as well.
Yeah.
Go ahead, Patrick.
Yeah. Last cost and premium, maybe I could cover the two because that's what we see crossing paths a little bit right now when we look at the coming quarters. On the last cost side, the frequency was flat for three quarters in a row. Compared to prior year, because Q4 in 2021, as we pointed out, was still a bit of lockdown. There is a year-on-year increase of about five points, but it hasn't moved for three quarters. We expect in our pricing that that might continue to or start to migrate closer to pre-pandemic. That's one of the thing in last cost. On the other end, though, the inflation from 13- 11, we expect that will continue to go down at about that pace for a few quarters.
On the premium side, return rates were in, around 5% at the middle of the year. It peaked at 9% in December. Only five of it is earned, and if you look at the next two quarters, it will be earned at the 7% rate level in Q1 and get to the high teens by the summer. You see these last cost trends crossing with the rates starting to be higher in the coming quarters than the actual last cost trend.
It seems like that cross is gonna happen about mid-year. This is like the back half of the year is when we should see earned premium outpacing last cost trends. Is that right? Am I reading that rightly?
Yes. The expectation if you strip seasonality is that this business is running now sub-95%, to be clear.
Yeah.
Okay? There will be gradual improvement as you describe as those two lines cross, but keep in mind that from a pricing adequacy point of view and from a pricing point of view, the frequency we're seeing is actually lower than what we're pricing for.
Yeah.
Lower than what we're reserving for. You put all that together.
Okay
A nd you get to our guidance. Sub-95 throughout, ex-seasonality.
Yeah.
Okay? Clearly a different combined ratio pattern in the second half than in the first half because those two lines will cross sometime in this.
Yeah. Okay. Just listening to discussion on the U.K. personal property market, if I go back many, many years and I don't know the dates, but I mean, Canadian personal property was an issue back in the day, and it took you, I forget, let's say it took you five years to go through the, you know, the pricing segmentation to really kind of fix that business. Is that like, is that what we should be expecting for the U.K. personal line business? Is this like a five-year fix, or is this something that I know 2023 can't, you know, doesn't sound like we're gonna see drastic improvement, but is this something in 2024, 2025, where you do expect that to hit the midpoint of that, or is it a longer tail fix?
Yeah. I think Doug, if I think about personal property because it's a very good example, in my mind, this was a major revamp of what we did. You know, I'll take you back 10 years ago, where we changed the product, we changed the pricing algorithm, we changed the claim supply chain management and how we manage claims, invested in prevention, and that took a few years, indeed. You know, when I look at it in retrospective, I look at the last 10 years combined ratio in personal prop 89.9. If I exclude 2022, 11 years, 90% combined. You know, five years, 87% combined, you know, with volatility with cats. When you do a major overall, it takes some time, but it pays off.
Like it's not just superficial fixing here and there. In the U.K., because I think there's heavy lifting we're doing at the moment, the piece that is quite different from when we improved home insurance is we didn't change the footprint of home insurance. We changed what we did, you know, pretty much for all Canadians, at all levels of the value prop. In the U.K., we have not concluded that we wanna play in all the segments where we are today. That's the bit that can move the needle a bit faster than changing rate algorithm technology, et cetera. That being said, you know, it'll take some time, and that's why to the earlier question, the guidance is upper nineties for 2023. That's not how we measure success. Ken.
Well, no, I think you covered everything.
Anything you wanna add?
I think the point around the distribution channel and, you know...
Good point.
... going into direct business, you're much more in control of your overall combined ratio outcome versus in the partnership side of the business, which is the majority currently of the PL business that we have. You're less in control of the combined ratio. That tilt will take a bit of time.
That's true.
That is-
Yeah.
That is the root to, one of the important roots to better performance.
Good point. We have a number of partnerships. Some of them we've exited, others we're in the process of negotiations where we're not happy with the economics. That can take some time to run. Otherwise, I think our perspective is upper 90s% this year, sub-95% over time. Lots of work left to be done in the coming months.
Appreciate the color. Thank you.
Thank you. Next question will be from John Aiken at Barclays. Please go ahead.
John.
Good morning. Sticking with the U.K. and IE just for a moment, a lot of discussion around the combined ratios, but was looking at even when you strip out the Middle East divestiture, you know, volumes are down on the U.K. and IE personal side of the equation. I get, you know, that you're trying to right-size the business going through. With all of the factors that you're putting into play for the combined ratio, should we expect volumes to continue to trend down in 2023, particularly if you're renegotiating some of these partnerships?
Yeah.
Should we actually see an inflection point at some point in 2022, or is that 2024 or later?
I'll ask Ken to provide his perspective.
Yeah. Well, indeed, you know, the pressure on top line in 2022, you know, has been, you know, driven by, yes, the exits, but also, the rate that we have been pushing ahead of the market. The market has been slow to respond on rates and therefore, the top line pressure has been there. We move into 2023, I would say overall, mid-single digit growth is the zone for personal lines. But again, we will maintain the discipline, and a lot of the outcome will be determined by how the market responds and what the market pushes in terms of rate.
Yeah. I think, you know, it's a good thing that it is a small portion of the IFC business because in the context of the work we're doing to improve PL now, we're not really looking at the top line. I'll be very clear. It's all about improving the bottom line. You know, the market does whatever it wants. We have some work to do there and could be mid-single digit, but if the market doesn't move, it'll be less than that because we'll lose some more units, and that's just the way it'll be.
Understood. Thank you. My follow-on, if I may, Louis, in terms of distribution income guidance, 10% that you expect to do better than. When we take a look at the growth that we've seen over the last little while, it's been hovering 20% or above. The drop-down in the guidance, I know, 2022 benefited from acquisitions, but should we infer from this that capital deployment opportunities in distribution are starting to slow? Or are you just being overly cautious, and we could see, well above 10% if you're actually able to execute on some opportunities?
No, I wouldn't say there's a slowdown here. The way we drive our guidance is really built on what's, I will say, in bank at the time we give the guidance. If there is additional M&A that comes out during the year, and we were certainly willing to deploy capital for that, it would be additional. We may end up higher because, you know, the market is still very good, and we think there's gonna be more opportunities coming. The guidance doesn't go for potential transactions in the future. It really is based on what we have already signed. The rest is upside to the guidance.
Just to be clear, the market is still, very good and, we're certainly, willing to deploy more capital in that space, no doubt.
Great. Thanks, Louis. I'll requeue.
Thank you. Next question will be from Tom MacKinnon at BMO Capital Markets. Please go ahead.
Thanks very much and good morning. Question with respect to the increase in the cat guide. Does it reflect? You don't necessarily cede a lot of business. I think you retain like, you know, in the high 90s in some of the lines and mid to high 90s in others. Is this increase in cat guide just a reflection of, hey, we got 2022 wrong. You know, we guided at CAD 600 and it was over CAD 800, we're just gonna change the guidance now just 'cause of, you know, the way weather is for 2023? Have you actually changed your approach to reinsurance? Are you retaining any more, is that driving this change in the cat guide?
Go ahead. Yeah. A few items here on this front. On the 1/1 renewals, which are part of the explanation why we increased our cat guidance, we were successful at retaining or securing the cat capacity we needed. The costs are higher. We had anticipated that and started pricing for it last year. The impact, as I mentioned earlier, is fairly neutral on the earnings. The cost of it and the fact that we increased retention in the three countries we operate in has actually will drive a bit more cat losses that drive part of that CAD 100 million. There's three elements, as I said in the earlier, the fact that we've grown more premiums and there's inflation, that's about a third of it.
A third is the renewals, the impact of the renewals. The last part is the increased cat losses we've seen historically. Those are the three buckets that drove the CAD 100 million increase. Our view here is this was largely anticipated and has been priced in already. Therefore, the impact on earnings is de minimis. You are right to say that we don't see it very much. The overall cat program is a small single digit, low single digit portion of net earned premium, and the impact here is I would count it in basis points overall. I hope that's helpful.
Yeah. I mean, you haven't really changed your guidance for top line growth in commercial lines quarter-over-quarter, yet there is an increase in the cats, and you're saying you're pricing for it. I would have expected your top line for expectation for commercial to have changed now that you're trying to price in these higher reinsurance costs, at least on a quarter-over-quarter basis. Am I just being too cute here?
No, no. You're not being too cute, but I'll tell you what the story is. First, it's a good opportunity, I think, to recognize the foresight of the reinsurance team, who after the July renewal said, "Okay, guys, we need to get ready for a step up in cost and an increase in retention." We said, "Let's do it." This notion that we would face a hard reinsurance renewal on 1/1 was identified months ago by Benoît and Stephen Etheridge, who runs reinsurance. That was very much baked in our thought process as we built our action plans for 2023 and our pricing plans. As a result, the guidance we've given in the past couple of quarters anticipated a hard reinsurance renewal cycle. It was a bit more expensive than what we anticipated, but nothing meaningful.
In the CAD 100 million per se, the increase in retention, which is primarily at the bottom of the Canadian program, is worth about CAD 35 million. A third of the CAD 100 million is increase in retention.
Okay, thanks. Just a quick one with respect to the deferred tax asset move. It seems to reflect your outlook for improving performance in U.K. and International. I'm assuming that this change in the DTA would have looked past two years. Now you talk about having two years to fully evaluate your business in U.K. and I. What does the move in the deferred tax assets say with respect to your two-year time frame to fully evaluate this business?
Go ahead, Louis.
Very good question. The outlook is more positive, and you'll understand we were comparing to a year ago, essentially, when we made our first, well, of course, our U.S. RSA business was already doing a DTA. This is really the first year afterwards where we have our own outlook, and we have a bit more credibility in terms of the results, and that allowed us to recognize more tax loss recoveries. The estimate is based on a five-year projection. With the fact that our underwriting is improving, the investment income is improving, and we have more credibility, we were able to increase the DTA asset. If there were changes to the structure going forward, we would have to adjust.
It gets a bit tricky as to what the impact of those changes would be on the taxable income. But we would reflect them as soon as they are known and we'd adjust accordingly. At this point, it's sort of a, I'll call it a going concern plan, five years out with what our best expectations of earnings, both on underwriting and investment income, driving it.
I think, you know, if I boil it down to two things, really. One is the guidance from a combined ratio point of view hasn't changed much, but I think when people look at our ability to generate that in earnings, it's gone up. Therefore, the DTA recognition takes that into account. Second one, which is not related to the guidance we've given, which is combined ratio-driven in nature, is the investment income potential. Put those two things together, that's how you arrive there, at time.
Okay. The two-year time frame sounds like you're a little more optimistic now.
Well, the two-year time frame is the strategic discussion Charles talked about earlier. On the tax front, it's really a five-year out. Again, I said it doesn't take into account, I will say, potential changes to the structure. It's really as we are today, looking forward with the improvements we expect to make.
Yeah.
Okay, thanks.
Thank you. Next question will be from Mario Mendonca at TD Securities. Please go ahead.
Good morning. Louis, if we could stick with you on your investment income guidance. The CAD 1.1 billion is actually a little less than what the Q4 annualized would be. I know it's marginally less. Given the new money yield, I think you said a 4.5% is a fair bit higher than your book yield. Why are you not building in some improvement in the overall realized yield over the next 12 months? It would appear that you're not in your CAD 1.1 billion guidance.
The first, if you try to use a run rate, you're right. It's a bit shy because the CAD 279 of Q4 probably has CAD 10 million-CAD 15 million of, I would call, lumpy non-It might recur, but it's more lumpy and therefore difficult to put in a fixed run rate. Otherwise that's about the only amount. That's why it's a bit shy of it. Our estimate for next year is based on current rates, where the book stands today, the turnover with a normal turnover next year. If the turnover accelerates, we could generate more. If yields go up more, we can generate more. We're on a book yield as we are today, plus ex-normal turnover, going into the future.
Just so we're clear, the CAD 1.1 billion does include normal turnover?
Yes.
Wouldn't the normal turnover in and of itself increase your realized yield?
You would. We've put some of that in the estimate, but it's not a huge. At that pace, it's not a very big. Keep in mind, we've traded quite a bit in Q4 already. The amount we can turn over next year on a normal basis has a more limited impact.
Okay, that's helpful. Charles, maybe we could go back to the U.K. for a moment. You and Ken have made the comment that it kinda depends on what the market will give you, that competitors were slow to react to rate. When you look at the competitive landscape, you look at the individual competitors that you face in the U.K. personal lines, could we make an argument that some of those competitors or maybe a majority of those competitors have lower return expectations than Intact does, and as a consequence, you're always gonna compete against firms that really don't need the same or have the same required hurdles that Intact does. Is there some truth to that statement?
There is some truth to that statement, Mario. It's important to understand that we're not all operating the same way. You can make that argument in Canada. There are people, many people in the market that have lower expectations than we do. You know, we beat them from both the top and bottom line point of view. Why? We price and select differently, and we have a better supply chain. We're not in that position in the U.K., and therefore I don't have the same confidence we can do that in the U.K. That's why we're still trying to figure out where we have a real shot at winning.
Certainly, when I say, A, you need to figure out if you can outperform, and B, you need to figure out if outperforming generates enough return to justify leaving capital there. To that question, and maybe that's where you're headed, it's not clear to me that the answer to that second question, even with outperformance, you can make enough money in all parts of the market. That's why we're not done, finalizing the footprint.
Yeah, that's kinda where I was going. If you've got competitors that have lower return expectations and Intact is not the 800 lbs gorilla there, then it almost seems like you're pushing against the string. It's not an area where you can deliver the outperformance you need to be there. That's essentially where I was going with that. Isn't that the more logical conclusion?
I think, you know, it's not that straightforward, but logically speaking, I think it's fair. I'd say, Mario, that in commercial lines, we're in very strong position. We have to keep in mind that in home we're number three, and so are we in pet. It's either number two or number three. Definitely not the 800 lbs gorilla, and I'm not sure we're actually insuring gorillas in pet, but we some degree of scale. I think our question mark on those two segments is what Ken referred to. It's how they're being distributed. That's the piece where we hesitate the most at this stage. Ken, why don't you provide color?
In addition, I guess then what that leaves, I guess then is the motor business. That's where clearly the scale.
Yeah
... is more challenging, and given the cost base and, you know, we're remaining disciplined on pricing. I think the bigger question mark is on the motor.
Definitely.
I think the scale, yes, number three position in home and pet is not, it's not number one, it's not the same as Canada, but it is a reasonably scaled position if you can tilt to a more direct offering.
Yeah
I n terms of distribution.
Exactly.
That's very helpful. Thank you.
Thank you. Next question will be from Lemar Persaud at Cormark Securities. Please go ahead.
Thanks. I apologize for going back to personal auto here, but I'm wondering if you could provide an update on the ability to push through rates in personal auto, just in light of the Alberta government freezing rates at the end of 2023. Is that something other provinces are looking at, or do you think you can continue to push through higher rates if, say, inflation comes in higher than expected or frequency rises more than expected?
Well, thanks for the question. I'm glad you bring up personal auto again because we love that business, and we have a very strong track record there, so we don't mind talking about it. In general, regulators have been quite rational. I mean, if you have a good case for why there's cost pressure, you can price for it. In fact, there are some markets, our biggest market, in fact, you don't even have to ask for permission price for inflation. It hasn't been an issue. It has not had a negative impact of any substance on performance over time. Frankly, because the cost pressure now is on short tail lines and not on long tail lines, it's much easier to demonstrate why rate needs to move.
In aggregate, you know, we think that the regulators get that, and it's easy to demonstrate. That's why in 2022 we were able to pretty much bake in nine points to cover inflation. Patrick, maybe you wanna give a bit of color on Alberta and so on.
Well, similar to the rest of the country, we're very proactive early on in 2022 in taking rates. We're starting the year in 2023 in good positions, including in Alberta. The new policy of the rate freeze is ill-advised in our view, and will do nothing really to address the core issues that are putting pressure on rates for Albertans. If anything, you know, it may cause significant harm as the industry will be temporarily left behind on reflecting inflation in the rates. While the freeze is meaningful for the Alberta market, in the context of Intact, the situation is slightly different. First, we need to be clear.
You know, we'll take the necessary actions to protect the profitability position in the province. That might include the appetite regarding new business and our renewals, and as a minimum, the amount of future marketing investment. Second, you know, we've taken rates in advance of the, of the market. We have good rate momentum in there. That's only 17% of our Canadian PA portfolio or 5% overall of IFC. It doesn't have an impact on our outlook for the next 12 months in sub 95 combined ratio guidance. That being said, you know, we reiterate the fact that while it might be attractive politically, this is not very good for Albertans.
For sure our team stands ready to engage with the government on better ways to improve in the long term, the availability and affordability for insurance in Alberta.
Bottom line, I think regulators are rational. The need for rates at the industry level is clear and easy to prove. Not concerned by regulators', you know, ability to deal with that. Alberta, it's political. It's a real bad call. I think within six months you'll have capacity issues in that market. I think other provinces understand that when you artificially try to do stuff like that, there's a blowback that comes back and, you know, that might very well be the case in Alberta. We're, I think, in good position in relative terms and feel good about our ability to price for inflation. The nine points we've talked about is baked in already.
Okay, that's helpful. My second question, I wanna come back to Mario's line of questioning on the investment income. Are you guys building in expectations for rate cuts later in 2023, which could limit market-based yields? I think, Louis, if I heard you correctly, there's CAD 10 million-CAD 15 million in lumpy revenues. Even excluding that, with normal asset growth, that could still easily get over CAD 1.1 billion. Any thoughts there would be helpful.
We have not booked any rate cuts, clearly. I think it's a prudent guidance, but not based on rate cuts plan or expected rate cuts next year at all.
Okay, thank you.
Thank you. Next question will be from Nigel D'Souza at Veritas Investment Research. Please go ahead.
Thank you. Good afternoon. Just a quick clarification on the call you made earlier. For personal auto, including the seasonal impact, do you expect that combined ratio to be above 95? Am I understanding that correctly?
No. I think we're saying sub 95 is what we would expect, you know, quarter after quarter- after- quarter, except that you need to take into account seasonality. Q1, for instance, there's a few points of seasonality normally. If you go back in time, you see that. It's a very clear pattern. That needs to be taken into account. What we're saying is that the run rate per quarter, as we sit here today, is sub 95 and, you know, should improve over time.
Got it. That's helpful. My first question was on favorable PYD. When I look at your guidance, it looks like you're expecting a favorable impact on the IFRS 17 on the PYD metric, and you're also guiding for PYD to be in the 2%-4% range over the medium term. If I take the midpoint of that guidance, 3%, that's actually, you know, lower than the favorable PYD of 3.8% in 2022. Would it be fair to expect favorable PYD to decline in subsequent quarters and trend lower? Is that the way we should think about it?
Louis, why don't you share your perspective?
I think, I'll try to bucket in two here, the IFRS impact second. First, our expectations. Historically the guideline has been between one and three, but we did expect it to be stronger in the short term given the prudence we had baked in throughout the kind of the COVID period.
I think that's still true, and you're seeing it in the actual results with the strength of PYD. That on an even basis, I think will extend, you know, at least in the next 12 months. Because of IFRS 17, I will summarize the impact to, that we can see today is roughly between one or two points of favorable impact to the PYD. I would sort of take them apart stronger than, or in the short term, higher than expected, or higher end of the range. I would add between one and two points for the IFRS 17 conversion.
Got it. That's helpful. The second question was on, again, circling back to market-based yield. you know, when I look at the increase quarter-over-quarter, 50 basis points increase, even if you strip out the $15 million or so and the lumpy items, you know, based on a reinvestment yield that you know at a 4.5%, about 4% of your portfolio turns over a quarter, you know, that would imply that your market-based yield should have been only maybe 10 basis points higher for the last quarter. Are there any other items that are driving that variance? Is it trading related or something else that enhanced your market-based yield this quarter?
Market-based yield has a denominator that moves with market volatility, and therefore it's a harder one to pin down, frankly. The yields, the book yields have gone up because we trade and we secure a higher yield. You've got the offset in the bond themselves, the bond value themselves. That's why we don't use that yield for guidance. We give the hard number to take away sort of the market volatility impact on the book and the market-based yield that comes out of it. We view the market-based yield as the result of two things: increasing the interest on the assets we own and then the volatility of the assets values themselves. The outcome is what we report on.
From a guidance point of view, we prefer to give the hard number. It's our best estimate of where investment income will land next year as we stand today. We try to not to reinvent. People are challenging on the run rate given the Q4 numbers, that's why we're saying there's probably 10, 15 of lumpiness in there, I wouldn't extrapolate strictly on the actual number. You know, that's our best guess at today where we stand based on current yields and where our book has been converted to current rates.
Okay. That's it for me. Thank you.
Thank you. Next question will be from Jaeme Gloyn at National Bank Financial. Please go ahead.
Jaeme.
Hey, guys. I guess same kind of question, you know, just in terms of the trading impact on the investment income. You know, looks like there was quite a bit of trading in Q4. What capacity do you have left to continue to execute trades? What kind of trades are these that are helping to really juice the interest revenue specifically?
You know, we're careful here with the impact of the trading, what you're seeing on the realized gains and losses in the non-operating section. We have to be a bit careful here. Our expectation right now is to go somewhat back to normal trading next year. If there are opportunities where there's a trade that makes sense and doesn't get wiped out by the realization of their loss on the non-operating earnings, we would do those trades. You're right, we took the opportunity. As markets move and rates move quite frantically, I think the investment team sees more opportunities and therefore are much more active to trade.
This is what has happened, I will say, second half of this year, very, very active, and you've seen it in Q4. You know, today I sit here, what we look at in 2023 as normal turnover. Maybe there will be opportunities and that will be a positive tailwind to the current guidance, but not more than that.
Got it. The second one, just in terms of the Highland Insurance acquisition, in specialty lines, just wondering if you can comment on the success of that acquisition, how much it's contributing to U.S. commercial, but also, how is it contributing to the distribution income as well? I guess it hits both sides.
Darren, why don't you talk about the strategic merits and what it, what it's doing for us?
Yeah, absolutely. Obviously, it's a transaction, as you know, that we made last year. We came online in terms of underwriting capacity in Q4. It is a very highly specialized niche appetite that they have at Highlands, and that's very much part of the recipe when we look at from an MGA and from an acquisition strategy standpoint. Just a reminder, though, that we did not purchase any reserves or any unearned premiums, so this obviously is earning out from dollar one. Obviously, as you can see in the MD&A, there was an impact, a favorable impact obviously, in the growth in the U.S. in Q4. That will very much obviously continue out into 2023.
Performance to date, obviously it's still very, very early, but it's very much in line with expectations and will have a positive impact on the overall performance in the U.S..
Darren, we're keeping how much of that?
We're keeping around roughly 21% of the capacity out of that operation, obviously supported by both some other direct insurers, but also some reinsurers as well.
Roughly 21%.
Okay. Can you talk about distribution income?
Absolutely. In the quarter, Highland was actually of the 22% rise was about 2%, 3% of the 22 was driven by Highland. It's a, it's a pretty significant portion of the growth in the earnings. It's 2% year to date, which is half a year for Highland. It has a meaningful impact on the distribution income for the distribution earnings.
Thank you.
Okay.
Great to hear. Thank you.
Okay.
Thank you. At this time, we have no further questions. Please proceed with closing remarks.
Thanks, everyone, for joining us today. Following the call, a telephone replay will be available for one week. The webcast will be archived on our website for one year. A transcript will also be available on our website in the financial reports and filing section. Our 2023 first quarter and full year results are scheduled to be released after market close on Wednesday, May 10th, with the earnings call starting at 11:00 A.M. Eastern time on Thursday, May 11th. Thank you again. This concludes our call for today.
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines.