DBRS Confirms Intact Ratings with Stable Trends

DBRS Limited (DBRS) has today confirmed Intact Financial Corporation’s (Intact or the Company) Issuer Rating at A (low), its Senior Unsecured Debt at A (low) and its Non-Cumulative Preferred Shares at Pfd-2 (low). The trends are Stable. The Company’s operating subsidiaries continue to be among the strongest performers in the Canadian property and casualty (P&C) insurance industry in terms of underwriting profit and overall profitability.

The Company’s strong underwriting performance hinges on its scale, which allows it to identify and price risks by mining its extensive data base. Scale also enhances the ability of the Company to keep claims costs lower than those of its peer group and to more efficiently service its multichannel distribution networks. An efficient capital structure keeps the Company’s overall financial leverage within bounds, while providing close to $600 million in excess regulatory capital. As a long-time active consolidator in the Canadian property and casualty insurance industry, Intact has an excellent track record of leveraging its existing disciplines to extract expense and revenue synergies, most recently from the $2.6 billion acquisition of AXA Insurance in 2011 and the $530 million acquisition of Jevco Insurance in 2012.

Intact continues to be positioned to outperform its Canadian peer group by at least five percentage points measured by return on equity (ROE). This has been accomplished through superior underwriting and investment performance, while growing the Company’s earnings platform to achieve scale economies. In personal lines, the Company’s recent results reflect a mix of factors, not the least of which is the better underwriting performance in the Ontario auto insurance market and the favourable impact of an especially benign winter of 2011–2012. Offsetting some of this improvement was an increase in claims related to catastrophic events during the summers of 2011 and 2012, notably the Slave Lake fire and storms in Calgary and Ottawa. The Company has undertaken an initiative to return to consistent underwriting profitability in its personal property lines through better risk segmentation, higher pricing for identifiable perils and higher deductibles. The Company expects property insurance premium rates to increase at close to double digits in the coming year in order to help the Company achieve its target of a 95% combined ratio in the personal property segment. In commercial lines, which account for about 30% of the Company’s written premium, underwriting results have been consistently profitable as the Company improves its risk selection and pricing models, which allows the Company to retain the better and more profitable risks.

After adjusting for favourable reserve development and offsetting catastrophic claims, the overall current accident year combined ratio seems to be settling in at around 95%, which is higher than it has been for several years and is superior in the industry. Over the past ten years Intact has outperformed the industry by four percentage points in terms of its combined ratio. Nevertheless, the impact of increased catastrophic events on the Company’s results demonstrates that Intact remains vulnerable to the unpredictable, cyclical and reactive nature of the P&C insurance industry.

Because of its increasing scale, the Company continues to have an advantage in being able to add substantial value to its acquired operations, which makes them almost immediately accretive. Moreover, acquisitions enhance the Company’s business risk profile by adding diversification by product and geography. For example, AXA had lower exposure to Ontario auto, but good presence in medium-sized commercial accounts. Jevco adds several new personal product lines, enhancing the Company’s reputation with its broker distribution channel. Additionally, it adds some attractive commercial specialty lines.

While part of the Company’s excess regulatory capital has been used to pay for the recent acquisitions, the consolidated MCT ratio at 201% (September 30, 2012) continues to be well above the Company’s internal 170% target. Combined with $44 million in free cash at the holding company, there is close to $600 million in excess capital. With the acquisition of AXA and Jevco, the Company has increased its financial leverage ratio to 27.8%, which is above the top end of our comfort zone for this particular rating category. (While the Company restricts its leverage target to a debt ratio of 20%, the DBRS methodology uses a total debt ratio that includes both debt and preferred shares with a 15% to 25% range for the “A” category). However, the successful integration of the acquired operations, the full realization of synergies and the Company’s ability to pay down debt according to its longer-term funding plan provides continuing confidence in the Company’s financial management. Fixed charge coverage ratios at just below ten times in the most recent nine month period are well above the threshold for the rating category, reflecting the Company’s strong profitability. The Company has indicated that it will retain more of this internally generated capital and use some of it to pay down some of the acquisition debt to help reduce financial leverage. Should Intact not succeed in reducing its financial leverage over the next few years to levels acceptable for an “A”-rated company in this industry, there would be downward pressure on the Company’s ratings.

The Company manages its own investments, generating a premium return to its pricing benchmark of which accounts for an estimated two points of the Company’s targeted five percentage point ROE premium. Self-managed funds give the Company latitude to maximize income using trading strategies and preferred share investments that are taxed at a favourable rate. Investments are managed on a total return basis with little consideration for a strict asset liability match – bond duration is 4.3 years and liability duration is 2.3 years. The Company has hedged some of its long equity positions with offsetting shorts as part of its active risk management strategies. DBRS regards in-house management of insurance company portfolios as an incremental source of added value, provided that risks are well contained. The Company’s portfolio is conservative and liquid with over 98% of bonds rated A (low) or higher.

The DBRS rating on the Company reflects its holding company status. While Intact has very strong operating entities, their regulated nature and the structural subordination of holding company obligations result in a rating assignment for the parent that is at least one notch below where the operating subsidiaries might be rated in their own right.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Canadian Property and Casualty Insurance Companies (March 2011) and Rating Holding Companies and Their Subsidiaries (September 2012), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.