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Q3 2006 ING Canada Earnings Conference Call - Final
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| Copyright: | CCBN, Inc. and FDCH e-Media, Inc. | | Source: | FD (FAIR DISCLOSURE) WIRE | | Wordcount: | 8908 |
OPERATOR: Good day, ladies and gentlemen, and welcome to the
third-quarter 2006 ING Canada earnings conference call. My name is
Michelle, and I will be your audio coordinator for today. (Operator
Instructions).
I would now like to turn the presentation over to your host for
today's call, Mr. Brian Lynch, Director of Investor Relations. Please
proceed, sir.
BRIAN LYNCH, DIRECTOR, IR, ING CANADA: Thanks, Michelle. Good
morning, everyone. Background information for today's call can be
found at INGCanada.com. Please note in particular the forward-looking
statement disclaimer in the slide presentation, cautioning you to
refrain from placing undue reliance on any forward-looking statements
we may make for the various reasons detailed on the slide.
As usual, Claude Dussault, CEO, will comment broadly on the quarter's
results. And Mark Tullis, CFO, will remark briefly on specific
aspects of our performance. We will proceed to take questions in
French or English from financial analysts and investors. Charles
Brindamour, EVP, is also with us and available to take your
questions. With that, I will ask Claude to comment.
CLAUDE DUSSAULT, CEO, ING CANADA: Thank you, Brian. Good morning,
everyone. I'm pleased to report on the third quarter, which we
consider has been another strong performance in continuity of
previous quarters. Our earnings per share for the quarter were $1.17
compared to $1.52 for the same quarter in 2005. And our net income
for the quarter was $156.8 million, a decrease of 22.7% over the
third quarter of last year.
The decrease in earnings is not reflective of the fundamentals of our
business. When you look at the two main drivers of the change, they
were the decline in the level of the realized investment gains and
the lower levels of favorable prior-year claims development. We
expect variance in these numbers from quarter-to-quarter. And even
though realized gains in prior years' reserve favorable development
were lower than last year, they were still contributing positively to
the results.
Our combined ratio of 89.9% was quite healthy with all segments of
business being in the 84% to 88% range except for personal property.
Personal property combined ratio of 107.3% was mainly driven by heavy
storms activity in the third quarter that represented approximately
10 points on the loss ratio.
The current accident year loss ratio in personal lines, auto and
property, excluding catastrophes, is 0.5 percentage points higher
year-to-date than last year and that in spite of rate decreases. For
us, this is a very significant indicator.
In commercial lines, the accident year loss ratio is 2.8 percentage
points better than last year in a highly-competitive market. These
loss ratios reflect the effectiveness of our disciplined underwriting
and pricing capabilities in a softening market.
We were pleased with the growth in our direct written premiums. It
increased by 4.9% in Q3 when we exclude AGR transfer and industry
poolls. Our number of risks insured grew by 4%. Our organic growth
continues to trend upward and is the result of a number of
customer-centric initiatives introduced in the past 12 to 18 months.
In the third quarter, we launched a loyalty initiative in partnership
with Aeroplan. And the early customer response has been quite
positive. In the third quarter, we also repaid the remaining debt of
$127 million that we had on our balance sheet.
Now for the outlook at the industry level, we expect the top-line
growth to remain in the low single-digit level and the underwriting
results to remain better than historical average and that for the
near term. So I would now invite our CFO, Mark Tullis, to tell you
more specifics on some of the issues we would like to focus on.
MARK TULLIS, CFO, ING CANADA: Thank you, Claude. Underwriting results
for the quarter were strong across all business lines except for
personal property, which as Claude mentioned, was hit by $19 million
of storm claims. Our claims frequency decreased slightly, remaining
favorable across all lines of business.
Prior-year development of $69.9 million was higher than historical
averages, although $24.4 -- $24.5 million below last year's
extraordinary level. Significantly, our income from current-year loss
experience, not counting catastrophes and Facility Association
business, remained the same as last year despite absorbing rate
decreases averaging 2.7% of earned premium.
Investment results continued to be favorable. Our book yield of 4.9%
was slightly down from Q3 '05. Realized gains were $35.8 million for
the quarter, including $3.9 million of fixed-income gains and equity
gains of $43.8 million.
We experienced other losses of $11.9 million, primarily due to losses
in the derivative portfolio backing our DROP Alpha portfolio. These
derivatives have associated equity investments that had unrealized
gains of $10.4 million in the quarter. But under current Canadian
accounting standards, we do not recognize these unrealized gains. In
total, our net unrealized gain position strengthened over $100
million in the quarter.
All-in-all, this was another solid quarter for both net income and
underwriting income.
BRIAN LYNCH: Okay, Michelle, if you could remind listeners how to
pose a question.
OPERATOR: (Operator Instructions). Jamie Keating, RBC Capital
Markets.
JAMIE KEATING, ANALYST, RBC CAPITAL MARKETS: I'm struck by the
derivatives gains/losses so to speak. I wonder if I could just follow
the money a bit. Unrealized securities gains went up $100 million.
Would that include naked the equity gains that were perhaps offset by
the hedge loss?
MARK TULLIS: Yes, of the $101.9 million, $10.4 million of them
represent the unrealized gains on the DROP Alpha portfolio.
JAMIE KEATING: That's in the delta. Is there also a number we should
be aware of that gives you an idea what the net unrealized gains
balance might be, if there is such an adjustment necessary?
MARK TULLIS: Yes, that's actually in the financial statements. It's
$130-some million. The DROP Alpha portfolio -- the amount of the
unrealized gain is in the financial statements. I'm trying to --
JAMIE KEATING: That's okay. Don't --
MARK TULLIS: -- and the net amount of the DROP Alpha portfolio is in
the MD&A. Actually, I have a tab on that. The DROP Alpha
portfolio net as of September 30 was an unrealized loss of $1.5
million. So we had a gain in the portfolio. And again, you have to
match up the derivatives in the investments.
But if you just look at the underlying equities, there was a net
unrealized loss of $1.5 million at the end of the third quarter. The
net gain in the portfolio is $136 million. So if you look at the
portfolio less the DROP Alpha portfolio, it would be $137.5 million.
JAMIE KEATING: Brilliant! Okay, that's very helpful. One other just
point of clarification. I think Brian may have helped me on this. The
commissions in aggregate expense was down quite a bit. It seems to be
the influence of I believe it's Grey Power. I just wondered if true
-- and that is the offset -- what are the other influences on the
income statement, perhaps at the premium line and so on?
I guess maybe what I'm getting at is, is there a positive influence
related to the acquisition on the other lines? And if we could just
see some of that detail, that would be helpful.
MARK TULLIS: Let me spend a minute on the commission and the -- you
know - - and explain that. If you look on the income statement,
there's sort of three things going on with the commissions. One is,
the big thing if you look at year-over-year, the commission expense
has dropped from $488 million to $457 million. The big reason for
that swing is basically as we buy brokerages and we go from paying
money to a third party, which is unaffiliated, to paying money to an
affiliated company, we eliminate the expense down below because we
are effectively paying the money to ourselves. If you look at that
swing from '05 to '06, that's what's causing the swing.
In the quarter, we had a $5 million reclass. So basically, if you
look at just the third-quarter results, the $139 million if it were
not for the reclass would have been $144. But similarly, the
commission revenue line instead of $3 million would have been $8
million. So it didn't affect the bottom line, and it doesn't affect
year-to-date.
The third thing going on with commissions, particularly as you look
at the revenue item, is the drop from 39 to 27. This represents
commissions we're paid from unaffiliated third parties. And primarily
the reason for the drop is as we have sort of eased out of the mutual
fund business, we get less revenue from third-party mutual fund
companies.
As far as how other than commissions we would be impacted by
brokerage operations, the other thing is we have expenses coming
through. So the general expense line would be impacted by the
brokerage acquisitions. I can't think of anything else that would be
significant. Because we booked --
JAMIE KEATING: Any idea what the isolated impact on the expenses is
roughly -- order of magnitude?
MARK TULLIS: Yes, it's kind of -- on the MD&A on page 19, it's
included in the expense line. So it would be -- the only thing is
it's hard to see the trend because we've got the mutual fund tucked
in in '05.
JAMIE KEATING: I will come offline.
MARK TULLIS: Yes.
OPERATOR: Andre Hardy, Merrill Lynch.
ANDRE HARDY, ANALYST, MERRILL LYNCH: Mark, can you let us know please
how much excess cash do you think you have and debt capacity right
now? And Claude, are you willing to be more precise as to the timing
of either an acquisition or if that fails your return of capital to
shareholders?
CLAUDE DUSSAULT: I'll start while Mark gets the number. No, I don't
think I can be more precise than what I've said in the past, which
it's part of our strategy. It's something that we are pursuing and
would like to see. And in the medium long-term, we're confident that
it will happen. But in the short-term, I can't comment on how close
or far we are to achieving any transaction.
ANDRE HARDY: Given that you have so much excess capital right now,
barring deployment or a return, do you think you can maintain your
historical ROE gap?
CLAUDE DUSSAULT: I think the ROE gap is something that we keep
working at expanding. We're also working at managing capital
effectively. So this is an issue that we want to manage effectively.
If the strategy was to keep all the capital and not use it, obviously
it would put pressure on our ROE. Our strategy is to try to find the
right way to get to the proper ROE gap.
MARK TULLIS: Yes, and I think as far as the excess, we have about
$650 million at the holding company. Looking at sort of the 170, 175
ratio for MCT, you would pick up another $400 million; we'd end up
around $1.1 billion. And we believe our debt capacity, consistent
with our targeted rating level was about $1 billion. So that puts us
at about $2.1 billion.
OPERATOR: John Reucassel, BMO.
JOHN REUCASSEL, ANALYST, BMO: Just a question on the personal lines.
It looks like your insured risks were up 5% in personal auto. Could
you talk about where that growth is coming from? Is that all
belairdirect or where the growth in the insured risks is coming from?
CHARLES BRINDAMOUR, EVP, ING CANADA: The growth -- belairdirect is
clearly a contributor to the growth. However, in general across the
country with a few exceptions, growth is fairly good as well in the
brokerage environment.
Quebec is a more difficult environment from a competitive point of
view in personal lines. But the other regions offer good growth
opportunities. But belairdirect, clearly as you can see in the stat
supplement, is having a very healthy low double-digit growth in
units.
JOHN REUCASSEL: So what is giving you the -- can you give us a sense
of what you are doing differently in the rest of the group to -- you
know I think if the market is flat to growing a little bit, you are
taking substantial market share. Is there something you are doing
differently?
CLAUDE DUSSAULT: I think what we would like to mention is the fact
that we have been in the past 12, 18 months doing a number of things
increasingly to improve our value proposition, including new
initiative at the customer level, the Responsible Driver Guarantee,
the zero deductible policy, Aeroplan points which I guess hasn't been
reflected yet in the growth because it's very -- it was at the end of
the third quarter.
So we have been very active. And you know those initiatives don't
generally show significant increases right away. They need to flow
through the system. And I think we're getting the benefit of a number
of initiatives that we put in place 12 months ago and 9 months ago.
We think that we will continue with the current initiatives to
develop that.
Our team is also very active at the broker level to work on the value
proposition for brokers in terms of making it more efficient for them
to do business with ING through improvements on the technology,
improvement in the services that we provide faster service. We've put
a lot of emphasis on providing best service in small commercial lines
area. So there is a series of activities.
We've been saying that organic growth is a competency that we need to
strengthen as an organization. So we been hitting both on the
distribution improvement as well as the customer value proposition. I
think we're seeing the benefit of it. I don't think we're where we
want to be yet, but the trend is encouraging.
JOHN REUCASSEL: Great. Just a last question, Claude, why do you think
-- it's surprising me consolidation hasn't happened in Canada. Can
you explain to me why the consolidation has taken longer than -- the
impatient markets want -- does it happen? Why is it so slow? Can you
help us understand that?
CLAUDE DUSSAULT: Yes, I think the overall environment is such that if
you look at the past two years, the capital position of many of the
owners of Canadian companies have strengthened significantly. And in
a way, a number of players are looking at deploying capital versus
looking at repatriating some of the capital that would be required if
there was expansion elsewhere. So we think that fundamentally, that
tends to slow down.
I think what we have been saying before is that we expect that
foreign companies as they develop into other segment of business or
other parts of the world will want to support that growth to look at
whether their Canadian operations fit well for the future. So the
fact that there is not as much of a need for capital than there was
three or four years ago for many of the parent companies as well as
having the return being positive the way they are, I think there is
on the seller side less urgency to do something than we might have
seen at other periods of time.
But I think the whole issue on acquisition is being patient, being
persistent and making sure that you find the right fit at the right
valuation. So the fact that there hasn't been anything done so far
this year is not a reflection of our lack of desire or activity to
try to find opportunities. Those opportunities have to fit at both
sides, and I think it hasn't happened yet.
Have to remind you that we have talked about 11 acquisitions since
'88, but the pace of our acquisition has been on average every two or
three years. So it's not something that we have never been in a
position of doing multiple acquisition in the same year. So we are
confident that it will happen, but the timing of it when you want to
make sure that you do it at the proper valuation is hard to predict.
OPERATOR: Doug Young, TD Newcrest.
DOUG YOUNG, ANALYST, TD NEWCREST: I just want to start maybe with a
few number questions. First of all, I guess the corporate and other
-- and I know it's fairly small but it did -- on the revenue side, it
did drop off significantly year-over-year and sequentially. And I
guess I was expecting it to kind of trend more along the lines of
last quarter. I am just wondering what happened there.
MARK TULLIS: You are looking in the MD&A in particular on page
19?
DOUG YOUNG: I believe that's the page. I don't have it in front of
me.
MARK TULLIS: You are just looking at the quarter or are you looking
at the year-to-date numbers?
DOUG YOUNG: Looking at the quarter.
MARK TULLIS: If you look at the quarter, again I think to look at
this quarter and the comparison basis, you should add $5 million to
the commission and advisory fees revenue for the quarter and add $5
million to the commission expense for the quarter. There was
basically a reclass that went through. It didn't affect the total.
You still come to $13 million income before tax. But the revenue and
expense were both low by $5 million because of a reclass.
DOUG YOUNG: Even if I guess if I add back $5 million to the revenue,
it was still down significantly. Is there -- is this just the
brokerage operations that is flowing through here or is there
other--?
MARK TULLIS: The commission and advisory fee represents our
commissions that we've received from unaffiliated third parties. So
there's two dynamics changing it from year to year. One is, as we've
exited the mutual fund business, we get fewer fee income from the
mutual fund companies.
The other is the extent to which we buy. We bought brokerages through
the years. And as we pay ourselves commissions, that goes through on
the expense line instead of the revenue line. So if there is a change
in mix of the business where maybe they go sell a little bit more ING
business and a little less of some other people's business, that
would move the commissions from being a positive revenue to a
negative expense. So it wouldn't affect the total, but it would
affect where it comes through on the income statements.
DOUG YOUNG: Mark, can you give me the absolute impact from the
Facility Association and the pools in this quarter?
MARK TULLIS: Yes. Let's see, do you want them in total or the
Facility Association separate? What are you looking for? You looking
for income effect or premium or--?
DOUG YOUNG: Underwriting income impact.
MARK TULLIS: Basically, I'll give you the Facility Association first.
In the quarter -- and we look separately at current year and prior
year and then we look in total. In total for the quarter, the effect
was virtually zero. It was $300,000 of gain. On the current year in
the quarter, there was a loss of $8.5 million. So basically on the
prior-year claims, we made $8.8 million. That's on an income side.
The pools in total -- and this includes the Facility Association, so
the numbers I read to you before would be included in this -- the
current-year results are 0.5 negative. So other than the Facility
Association, it was basically positive 8. And if you look at the
prior-year results, 6.4, 6.5 positive. So there was a negative that
offset the 8.8 from the Facility Association. That's the current
quarter results only that I read to you.
DOUG YOUNG: That's fine. That's fine. Mark, in terms of the
investment yields being down, any specific reason for that?
MARK TULLIS: Yes, there actually is. We had a one time event. Last
year in the quarter, we had -- in the third quarter '05, we've
received a special dividend -- you know in our DROP portfolio, we
invest the rollover and get dividends and occasionally we get special
dividends. We had a special dividend from one issuance of $4.5
million in Q3 '05, so it was kind of a one time deal.
We didn't have anything of that magnitude this quarter. If you adjust
that out, it would have been 4.8 last time instead of the 5.1. So
basically, we had this one special dividend that bumped our yield up
in Q3 last year by 30 basis points.
DOUG YOUNG: So the yield that you are showing now is more indicative
of what we should be really expecting?
MARK TULLIS: I think it's less -- last year the third quarter was --
I would consider a little higher than a normal run rate for the time.
And if you look at the fourth-quarter one for last year, it kind of
went down a little bit. And that's kind of why the decrease.
DOUG YOUNG: Maybe this is for Claude or for Charles. We're seeing in
Ontario obviously the latest rate reductions were essentially zero.
And we're seeing that you are growing your insured risk and direct
written premiums on the personal auto side. Is this the turnaround in
terms of we should start to see potentially some growth in these
lines?
CHARLES BRINDAMOUR: Well, we are seeing growth in these lines as I
mentioned in the earlier questions. And our level of comfort with the
rates is as good as it's been for a long time. Therefore, we're
comfortable growing and capitalizing on the customer-centric
initiatives that we have put in place in the last 18 months as Claude
referred to. I don't know, Claude, if you want to add anything there?
CLAUDE DUSSAULT: I think we have expressed that our goal is to grow
at 3 percentage points more than the average market and that we can
accomplish by growing our number of risks. So for us, it remains the
target. And as we get industry results, we will be able to see how
close we are to that achievement. But that's what we're pushing for.
DOUG YOUNG: What would -- I mean I don't know if you have -- what
would be your market share in the personal auto market at this point
and maybe if you can just stick with Ontario and Alberta. And if you
don't have it, we can go offline; that's fine.
CLAUDE DUSSAULT: Yes, I think we will go offline. Overall auto market
is higher than our market position overall -- slightly higher. And it
is slightly lower in Ontario and higher in Alberta. But I think we
would give you -- we wouldn't give you an exact percentage.
CHARLES BRINDAMOUR: Yes and the issue is that you don't have personal
auto separated when it comes to industry data. So that's why it is
difficult to give an answer.
OPERATOR: Mario Mendonca, Genuity Capital Markets.
MARIO MENDONCA, ANALYST, GENUITY CAPITAL MARKETS: Notwithstanding
what is happening to the stock this morning, you didn't make any
reference to deteriorating fundamentals or deteriorating claims
environment. But last quarter, you referred to increasing severity in
the personal auto. You made no reference to that this quarter. Should
we take that to mean that the entire increase in the claims ratio in
personal auto, excluding cats or development, really is a function of
a lower premium?
CHARLES BRINDAMOUR: The bulk of it, yes. We refer to the MD&A
under personal lines to severity in automobile. But it is not a
material factor that has an impact on the deterioration this quarter.
MARIO MENDONCA: So the trend observed last quarter, actually you were
careful. You didn't call it a trend. You said what we observed last
quarter couldn't call it a trend simply because we didn't have enough
data. How do you feel about that now?
CHARLES BRINDAMOUR: I feel the same at this point in time.
MARIO MENDONCA: Was severity similar this quarter to what it was last
quarter?
CHARLES BRINDAMOUR: Slightly better this quarter.
MARIO MENDONCA: But still not sufficient to call it as a trend.
CHARLES BRINDAMOUR: No.
MARIO MENDONCA: More of a detailed question then -- let me stick with
this for a moment. In prior quarters, you have given us a sense for
what you thought the pricing reductions would do to net earned
premium in personal auto. You've often given maybe one or two
quarters ahead. Is there anything you can offer us in this respect?
CHARLES BRINDAMOUR: Sure. You are looking at personal automobile in
particular?
MARIO MENDONCA: Yes.
CHARLES BRINDAMOUR: If we look at -- and you are looking at earned
impact?
MARIO MENDONCA: Earned, yes. You've talked a little bit about what
pricing in the past might do to earned.
CHARLES BRINDAMOUR: Right. If we look at the price changes that were
put in the system if you wanted the last year, we expect that the
whole year earned premium '06 in automobile will be impacted by about
5%. This is what have been put in the system if you wanted the last
12 months approximately.
And then, going forward, this is a matter of where frequency will be
going in terms of giving a sense, our impression is that flat-to-low
single-digit decreases is the sort of thing we will see
prospectively. But the actual impact in '06 of rates that are in the
system is about 5% on the earned and 4% on the written.
MARIO MENDONCA: When you say the impact on net earned premiums, is
that on the presupposition that the number of insured risks is
constant one quarter or one year versus the next? Or do you -- pardon
me?
CHARLES BRINDAMOUR: Yes, this is just the element associated with
rate levels. So if one is trying to understand what happens to the
top line in general, then this is -- a few elements need to be taken
into account. You need to take into account your expectation for unit
growth. You need to take into account the rate number that I just
referred to. You need to take into account the insured -- the
increase in the insured value of the carpool that we insure, which is
in the 3 to 4% range as well.
MARIO MENDONCA: Right. All of that plays in.
CHARLES BRINDAMOUR: That's right.
MARIO MENDONCA: Any comments you can make on the other segments that
are similar to this? I understand if you can't simply because they
are not regulated. But is there anything along the same lines you can
offer?
CHARLES BRINDAMOUR: Yes, I guess as you are saying these and the
other lines of business, it's not regulated nor public. But I can
give you a sense of where rates have been and are going as well as
insured value changes. And then you can deduce the units for
yourself.
MARIO MENDONCA: Sure.
CHARLES BRINDAMOUR: So if we look for instance at personal property,
the key influencing factors there would be, for instance, insured
amount. You can expect mid-single-digit-type increases for insured
amount, primarily driven by reconstruction costs. That's why the
insured amounts are going up. And rates, you can expect single-digit
rate increases there, in part driven by the impact of rain and flood
activity that we've seen in the past.
If we look at commercial non-auto, what one can expect is insured
amounts in the single digit -- low single-digit insured amount and
rates flat-to-low single-digit decreases -- is the sort of things
we're seeing and we expect to see in commercial lines in the near
term.
MARIO MENDONCA: I suppose that leaves commercial auto.
CHARLES BRINDAMOUR: Pardon?
MARIO MENDONCA: I suppose that leaves commercial auto or was that
last comment for--?
CHARLES BRINDAMOUR: Yes, that's right. That leaves commercial auto in
the picture, and commercial auto is not too dissimilar from what
we're seeing in personal auto. The difference in profile between
commercial auto and personal auto would be on the units. This is
where I would ask you to be careful there because the growth profile
that we've had in personal auto has been stronger as it was pointed
out earlier in the call than in commercial auto.
MARIO MENDONCA: So if you're giving us the amount that the -- if you
give us a rate indication and the insured amount indication, really
all we need to do then is slap on our estimate of what units are and
we can make a pretty good guess here. Would those be the three parts?
We combine those three parts. And clearly, we can be wrong on how we
do it.
CHARLES BRINDAMOUR: Yes, there is one part that is tougher to
predict, and that is relevant in commercial non-auto in my view and
it's the mix. That is the profile of your book of business. So while
in general, I've talked about the competitive environment in
commercial lines and mentioned that we were growing faster in small
accounts than in large accounts, this means that the profile of your
book of business is shifting downward a little bit. And we referred
to that in the past and that would be the missing element in the
pieces that I have identified earlier.
CLAUDE DUSSAULT: There's probably another small one, which would be
our provincial mix in automobile insurance where you have different
regime by province. And depending on where the growth happens, there
are some variations that would come from that.
As an example, as Charles mentioned, we are having a more competitive
challenge in Quebec where average premium are lower because the
bodily injury portion is covered by government, while we have some
faster growth in other provinces. That would be a gradual, not
necessarily major one, but it would be another factor.
MARIO MENDONCA: A detailed question here. The $27.2 million in cash,
you said $19 million or so was in -- how much was that in personal
insurance?
MARK TULLIS: Yes, I give you the --
CHARLES BRINDAMOUR: 19.
MARK TULLIS: -- the breakdown here.
CLAUDE DUSSAULT: $19 million.
MARIO MENDONCA: It was $19 million in personal --
MARK TULLIS: $19 million was personal property. Yes, there's actually
a Q&A that lists this out that is attached to the press pack.
It's $19 million personal property, $3.5 million personal auto, $4.6
million commercial other and $0.3 million commercial auto.
MARIO MENDONCA: Just in case I get those down wrong, it's at the end
of the presentation. Is that right?
MARK TULLIS: Right. It's at the end of the investor presentation.
MARIO MENDONCA: Sorry I missed that.
OPERATOR: Brian Lim, Scotia Capital.
BRIAN LIM, ANALYST, SCOTIA CAPITAL: I was wondering if you're seeing
any implications of a trend in reserve releasing.
CLAUDE DUSSAULT: Yes, let me comment on that specific item. Just to
give you the broad perspective of the prior-year loss reserve. We've
commented before that the long-term average has been in the 3.5% to
4% of our total reserve portfolio. So the outstanding reserve -- and
this is the percentage of outstanding reserve -- that percentage in
'05 was very strong -- was at 8.3%. And so far this year after three
quarters is 4.2%.
So historically around 4%. And this year if you annualize the 4.2%,
it would be 5.6%, so somewhat higher than historical but lower than
last year.
One thing I would like to point out on that -- and it's on page 21 of
the MD&A and there is a second paragraph from the bottom -- is
that when we're looking at the development of reserves, currently
there are two factors that are adjusting the reserve. One is the
discounting of the reserve, which lowers the amount of the reserve.
And the second element is a provision for adverse deviation, which is
the potential volatility. There is in the formula that is being used
by the actuaries an approach of measuring that risk.
The difference between the positive decrease that would come from
provision for adverse deviation minus the negative from discounting
does systematically generate, if everything is right, 2%. So there is
in the system a 2% reduction or a prior-year positive development
that is assumed in the assumption. And the remainder is a reflection
of methodology and how over time your methodology produce exact
number or positive or negative number.
The methodology that has been used by our actuaries remain
consistent. So that is why we are saying that the 3.5% to 4% is an
indication of how that methodology has performed in the past.
Now on this issue of reserve -- the other comment I would like to
make is because it tends sometimes to be confused with the life
insurance industry where you have very long duration on reserve, our
average duration on reserve or on the loss reserve is just over two
years. So basically what happened is that there is a provision that
happens -- is made when the event occurs. And as we pay or as we
reassess that provision every year, there is change in the level of
those reserves.
So when you see positive development, it means that we have paid less
ultimately than what we had as a provision initially. And we're not
talking here about long duration; it's just over two years. So it's
not change in assumption, change in methodology that produces those
developments of reserve. It is how the reality developed versus how
the assumptions were made.
We mentioned that last year was the more challenging exercise to
predict when our actuaries put reserve for 2003 and 2004, especially
in automobile insurance because of the reforms that were put in place
by government. When those reforms were put in place, there were
assumptions that were made on how they would improve or deteriorate
in some case losses in the future.
But until those reforms are fully in place and the system is
stabilized, it is more challenging when those things come into place
to have an accurate view on that. And what we have said is that the
positive development was reflective of the positive effect of those
reforms.
So I think that has been creating the 2005 higher levels. So I
wouldn't see a trend between '05 and '06. I would look at '05 more as
a result of the uncertainty that was in '03 and '04 when we were
establishing initial reserves.
OPERATOR: Stephen Boland, CIBC World Markets.
STEPHEN BOLAND, ANALYST, CIBC WORLD MARKETS: Just a quick question in
terms of the -- what's the tone at the regulator -- on the regulator
side in terms of pricing? We've seen moderate-to-stable declines
coming out of the auto in terms of Ontario, obviously a little more
challenging than Alberta. Do you see that trend continuing?
CLAUDE DUSSAULT: Well, I think it varies by province. I would say
that the province that is probably the most active right now is New
Brunswick, where there is a -- as a result of the new government,
there is a new review of rates within the province. I think that is
probably the one that generates the most activity right now.
For us, it's less than 1% of our overall portfolio. But we think that
the tone there is important because we need to make sure that the
right attitude is in place when we look at the long-term.
Alberta basically has been following the path that they have put in
place. And basically the loss or the premium decrease that took place
this fall was a reflection of the improvement in the overall
experience of the portfolio.
So had it not been for the rating board, we would have been filing
rates that would've reflected that experience. So we don't think that
it has in itself changed our position. If you ask me, I would say
this is probably not the best way for it to have that approach of
overall industry review of rates. But I think in practice, it hasn't
changed the final result that we would have likely had otherwise.
Longer-term, we are doing a lot of effort to try to bring a more open
market across the country and make sure that we convince regulators
that they will achieve better solution for the consumer by having a
less stringent regulation. And the competition will do the work as it
does in other lines of business.
So, I would say if you were putting it on the scale, I think it's --
certainly, the heat is much lower on the scale than it was two years
ago. But my personal view is that it should be much lower than it is,
but that's the environment in which we've been working for the past
number of years.
STEPHEN BOLAND: Just a quick follow-up in terms -- do you expect any
changes in your reinsurance program coming up to year-end in terms of
retention limits or just overall pricing that you are seeing in the
market?
CLAUDE DUSSAULT: Pricing, we will have a better sense of it as we
move closer to the renewal. The sense we're getting at this stage is
that we're not expecting a significant change this year. And in terms
of general program, we don't expect to make significant changes
either.
STEPHEN BOLAND: Cause it's great.
OPERATOR: (Operator Instructions). Mario Mendonca, Genuity Capital
Markets.
MARIO MENDONCA: I don't think the Company has ever really talked
about a dividend payout target or anything like that. Can you offer
anything today?
CLAUDE DUSSAULT: No, not really. We have not established a policy in
terms of percentage of profit. Our goal is to make sure that we are
providing an attractive dividend and continue to have a growing
dividend in the future. And last year, we had a significant increase,
which reflected our confidence in where our earnings were heading.
But we have not established a specific percentage policy towards
that.
MARIO MENDONCA: Now you said you wanted to offer something attractive
and growing. Are there any other criteria that would help define
attractive? Is there maybe something you can compare to either the
life insurers, the banks on a yield basis perhaps just to put some
texture around the word "attractive."
CLAUDE DUSSAULT: Yes, I know what you're asking. But we haven't done
it in any specific terms.
MARIO MENDONCA: Perhaps maybe a broad question. The P&C industry
is obviously very different from the life industry, not only in terms
of the longevity of the business but also the volatility. I think we
can all appreciate that. Does that say anything about how high the
payout ratio can be for a P&C company relative to a life
insurance company or a bank for that matter? Does the nature of the
business say anything about relative payout ratios in your mind?
CLAUDE DUSSAULT: I think you are right. The volatility certainly
creates a different dynamic. And there has been some if you look at
some of experiences that have been happening in the industry.
Progressive has established a process where they would pay a
percentage of their earnings on an annual basis and will vary from
year-to-year. We haven't gone that route.
But clearly, this is not as you can see in your expectation a
straight line trend in this industry. I think as an organization, we
have put a lot of initiatives to create a gap in ROE that will
facilitate for us or help us to minimize fluctuation over time. But
fundamentally, the industry has been having a varying ROE that is
more significant than the life insurance industry.
MARIO MENDONCA: Would you agree with the notion that because of the
greater volatility if an insurance company -- P&C insurance
company didn't want to follow the Progressive route really didn't
want the dividend to move up and down that way that it would
necessarily have to be lower than your peers in the life insurance
industry -- the payout ratio that is? Is that a reasonable conclusion
from an outsider's perspective?
CLAUDE DUSSAULT: I think it would depend where you are in the cycle.
It could be higher or lower depending on where you are in the cycle.
MARIO MENDONCA: But if we're talking very long-term and cycles sort
of average themselves out and the P&C insurance company in
question didn't want that kind of volatility in their payout ratio or
their dividend period, the cycle doesn't really matter if you're
thinking about this from a very long-term perspective.
CLAUDE DUSSAULT: Yes, I think you are right from that perspective.
Other things would affect it obviously, depending on how much weight
you put on growth through acquisition and use of capital. I think
those would influence also the percentage and how much that's part of
the strategy. And in our case, it is part of the strategy. But,
purely theoretically, if you look on the long-term, then you're
right. It would -- to maintain a level that would always be below a
certain percentage of your net earnings in a more volatile
environment would tend to have a lower yield. Yes.
MARIO MENDONCA: That was helpful. I guess that we will probably just
have to wait and see to -- over the next few quarters see what your
real call is on this. I appreciate your time.
OPERATOR: Tom Kennedy, Sprott Securities.
TOM KENNEDY, ANALYST, SPROTT SECURITIES: Congratulations on another
great quarter. Just on the detail side I guess, what was your
exposure to, if any, to the income trust sector in terms of your
investment portfolio?
MARK TULLIS: Right, we -- the income trusts are not a significant
part of our portfolio, measuring only about 4% of our invested
assets. And as you know, during the past few weeks, some asset
classes have gone up as trusts have declined. I think if you look at
total in our portfolio, there really hasn't been a significant effect
on the investment portfolio.
TOM KENNEDY: I guess to take a step back for a second, so on the
acquisition side, would you describe this -- maybe this is for Claude
-- would you describe this as more of a -- as a more attractive or a
less attractive environment than in recent past quarters?
CLAUDE DUSSAULT: It's hard to describe in those terms. I think it's
-- for us, the valuation, whether we are in a profitable, less
profitable, down or up in the cycle, remain pretty much the same
because we are looking at reflecting the positive short-term if it is
above historical and trying to reflect the longer-term pretty much
the same way depending on where we are in the cycle.
I think it affects the psychology of the seller. I think in that
sense in a deteriorating result environment, there might be a
different attitude. But as I said earlier, it's probably more driven
by the need for capital unless the return becomes significantly below
the rest of the performance of the organization or below cost of
capital. So when it is higher than cost of capital and that there is
no opportunity to redeploy, I think it tends to not generate the
activity from the seller's point of view.
TOM KENNEDY: I guess to phrase it differently, would it be safe to
say you are seeing I guess gradually fewer opportunities or fewer
sellers? Would that be a safe assessment?
CLAUDE DUSSAULT: Well, I think depending on the different period that
you look at and I think if I compare with the early 2001 when there
was a real crunch on capital, obviously there were more opportunities
in the market than there are now. But in the short-term, I would say
it's -- it has been pretty stable. And as you can see, there hasn't
been any specific thing that have happened in the last year.
TOM KENNEDY: And then I guess along those lines, is there a
particular point at which you would start pursuing other avenues? For
example, ramping up your dividend or starting to buy back stock?
CLAUDE DUSSAULT: That's part of what we are reviewing as we are
looking at those opportunities. I think for us, we need -- we would
not come to a position where we would say instead of, but we might
get to a position where we have more than what is required to achieve
the acquisition that we think are possible in the short-term. And
then, we would review those what we do with the excess capital.
TOM KENNEDY: That's very helpful.
OPERATOR: Jamie Keating, RBC Capital Markets.
JAMIE KEATING: I got the sense this Belair jewel is starting to get
some real traction. I'm just wondering perhaps along the lines of the
earlier discussion you had with Mario on sources of growth, could you
just help us out with some granularity as to what percentage of your
growth in insureds and/or in premiums is being driven by the Belair
offering?
CHARLES BRINDAMOUR: I think if you look at the stat supplement, we
break down direct versus broker. And if you look in the third
quarter, the premium growth in Belair was around 15 and year-to-date
11.5.
JAMIE KEATING: Thank you, Charles. I didn't catch that; thank you for
that. Just in terms of in that channel or perhaps in any channels on
auto, could you just describe what your hit ratio is on your new
products here on the new insureds? Or maybe actually on new and
existing insureds, how many are you offering or how many are taking
up on the new deductible or on the Responsible Driver offerings,
which seem to be going well?
CLAUDE DUSSAULT: Yes, I think in terms of hit ratio, the metrics are
very difficult to compare because what comes through a quote through
the Internet is very different than what comes through a call center
call or what is done through the broker channel where we're being
quoted with other insurers. So it's -- even though we follow those
metrics, there is a lot of caveat around how those metrics are
performing.
JAMIE KEATING: Maybe what I mean is in aggregate how much of your
business that you are renewing and/or writing new business include
one or both of those offers?
CHARLES BRINDAMOUR: The offers you're talking about are the
Responsible Driver Guarantee and the Zero Deductible, is that--?
JAMIE KEATING: That's right, Charles.
CHARLES BRINDAMOUR: Yes, the Zero Deductible is a far more recent
offer to have adequate data there. When we look at the Responsible
Driver Guarantee and we look in our direct operation, the new
business penetration is in the 35% - 40% range about.
JAMIE KEATING: Very popular then.
CLAUDE DUSSAULT: Yes.
CHARLES BRINDAMOUR: Quite popular, yes.
JAMIE KEATING: And do you get the sense the $0 deductible is going to
be potentially that -- have that good penetration?
CHARLES BRINDAMOUR: Yes, the early signs at least on the direct side
of the operation -- and this is where you always get a faster
reaction in a direct environment. The early sign is that it is indeed
popular in similar ranges in the provinces where it is offered.
CLAUDE DUSSAULT: The Responsible Driver Guarantee has been -- has had
a very strong pickup within the broker community as well. So it has
-- on the renewal, I think it is about 50% now.
JAMIE KEATING: That's very helpful. Just in terms of getting the word
out, have you done most of your marketing or is there more marketing
to do? What's the trend on that side? Can you do more and even
accelerate things? You're very active out in the market on the
marketing side.
CLAUDE DUSSAULT: We don't have a plan to accelerate. But we believe
that we need to keep a good pace.
JAMIE KEATING: One other more technical question on the 3.5% to 4%
range on your development favorable prior year. What time frame are
your numbers developed from? I'm wondering if we might -- maybe we
can see them in the numbers. I didn't think I had enough detail to
get back far enough to get that. But what time frame is that roughly?
CLAUDE DUSSAULT: This percentage is looking at all prior years
combined developments. So it goes all the way back to all of our
portfolio, and it compares year-over-year how much positive from the
prior years versus the total reserve base. So you have -- the last
column is 90-some in prior so that would include all those years.
JAMIE KEATING: One last question -- reinsurance. I guess Steve asked
about changes in pricing. Is there any change in capacity in your
markets do you know, coming on-stream or up/down or sideways on
capacity?
CLAUDE DUSSAULT: Yes, we're pretty comfortable that we will be able
to retain the same level of capacity that we have now, which is above
what is required for the most extreme one every 500 years exposure on
that.
JAMIE KEATING: I'm sort of thinking in terms of competition as well.
I would regard it if there was too much capacity that might even
disadvantage you because you are one of the best capitalized. Just
want to get a sense as to whether everyone is going to have
availability if you had a window on that?
CHARLES BRINDAMOUR: Our early indications when it comes to
industry-wide reinsurance in terms of capacity in the Canadian
marketplace is that capacity is pretty good right now.
CLAUDE DUSSAULT: Beyond reinsurance, I think if you look at the
overall capital position of the market, it's up.
CHARLES BRINDAMOUR: Yes, but specifically in reinsurance as well, the
early signs there is that there is capacity and appetite, quite a bit
of appetite for renewals.
JAMIE KEATING: Straight to one last quick quickie. The banks often
talk about their unrealized gains post quarter if there's been a big
event. So since the income trust thing happened post quarter, I just
want to get a sense if you could give us some reassurance that your
unrealized gains stayed intact through that period. It sounds like
they did.
MARK TULLIS: Yes, I think I would report what I said previously,
which is there's not a -- when you take everything into account,
including movement in other asset classes and some of the run-up
prior to the change in the tax in total for the quarter, there's not
been a significant effect.
JAMIE KEATING: Very helpful, Mark.
OPERATOR: Ladies and gentlemen, this does conclude the
question-and-answer portion of today's conference call. I would like
to turn the presentation back over to Mr. Lynch for any closing
remarks.
BRIAN LYNCH: I simply want to say thank you all for joining us and
remind you that our next earnings call will take place on February
15. And that concludes today's call. Thank you.
OPERATOR: Ladies and gentlemen, thank you for your participation in
today's conference call. This does conclude your presentation, and
you may now disconnect. Have a great day.
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