DBRS Morningstar Upgrades Ratings on Definity Financial Corporation to BBB (high) and Definity Insurance Company to 'A'; Changes Trends to Stable

DBRS Limited (DBRS Morningstar) upgraded Definity Financial Corporation’s (Definity or the Company) Issuer Rating to BBB (high) from BBB. DBRS Morningstar also upgraded the Issuer Rating and the Financial Strength Rating (FSR) of Definity Insurance Company, the insurance operating subsidiary of Definity, to “A” from A (low). The trend is now Stable for all ratings.

KEY RATING CONSIDERATIONS
The ratings upgrade reflects Definity’s consistent premiums growth in recent years and the progress made in diversifying the business to be less reliant on auto policies, both of which have contributed to a steady improvement in the Company's overall performance. Indeed, the combined ratio, and ultimately net earnings, have steadily improved over the past five years, and DBRS Morningstar expects the improved financial performance to continue.

The ratings and Stable trend consider Definity’s appropriate risk profile, which includes a conservative investment portfolio with a moderate exposure to equity risk. The Company maintains good liquidity in the form of highly marketable investment assets, recurring premium inflows, and available contingent liquidity sources. Definity’s resilient capitalization reflects its zero long-term leverage, capital flexibility, and appropriate regulatory solvency ratio.

RATING DRIVERS
Given the recent upgrade, Definity is well placed within its current rating category. Over the longer term, the ratings would be upgraded if the Company were to show sustainable growth in its franchise and earnings ability while maintaining an appropriate level of capitalization and liquidity.

Conversely, the ratings would be downgraded if there were a material deterioration in the Company’s earnings ability or capitalization levels.

RATING RATIONALE
The Company has good franchise strength and is well established in the Canadian property and casualty insurance market. Definity is the sixth largest P&C insurance company in Canada and has a 4.8% market share (as calculated by DBRS Morningstar) in the country's fragmented P&C insurance market, where only one insurer has a market share greater than 10.0%. The Company operates primarily in Ontario, which accounted for 58% of its Q1 2023 gross written premiums. Other geographic areas include British Columbia (12%), Québec (8%), the Atlantic provinces (8%), and Alberta and the Prairies (14%). Definity's product mix is diversified, with personal auto representing 42% of Q1 2023 gross written premiums, personal property representing 27%, and the remaining 31% consisting of various commercial lines products (Auto, Property, and Liability). The Company has invested heavily to position its business for future growth with a focus on opening additional distribution channels, broadening its product range, and implementing scalable systems.

Definity has a good risk profile. Much of the risk relates to the planning and execution of its strategic goals. These plans, while beneficial in the long term, carry some execution risk because of their size and complexity. Definity has prudently managed its investment portfolio mix, avoiding nonliquid assets such as real estate or other alternative assets. The Company has appropriate reinsurance to allow it to mitigate the impact of large claims losses caused by occasional extreme catastrophic weather events. Definity has taken measures to reduce any channel conflict that may arise from having both direct and broker channels, primarily by launching its Sonnet platform under a separate, independent operating brand.

DBRS Morningstar views the Company’s earnings ability as good/moderate. Definity’s revenue stream comprises a diversified, balanced, and stable group of products and business lines and has demonstrated prudent growth characteristics over the past five years. The Company’s underwriting profitability profile is aligned with its peer group. This is expected to continue due to the ongoing favourable pricing environment for most P&C insurance lines of business. Definity's premium growth trend is positive and is likely to continue as a result of the Company's ongoing business growth initiatives. The Company's various actions to improve profitability and reduce earnings volatility have paid off. Definity's net earnings results improved significantly in 2020, 2021, and 2022 and are trending well so far in 2023 based on the results of the first quarter.

DBRS Morningstar considers Definity's liquidity position to be strong/good. The invested assets portfolio comprises primarily cash and equivalents, equities, and high-quality fixed income investments. The Company’s liquid assets are more than enough to cover all policyholder liabilities, ensuring adequate policyholder protection. Most products are short term in nature, so Definity can reprice its insurance policies annually on renewal if premiums prove inadequate compared with claims experience. The Company has an unsecured credit facility for $150 million, which provides additional financial flexibility during periods of significant uncertainty. Definity reported that there was a $35.7 million balance outstanding on the credit facility as at May 11, 2023, based on the Company's Q1 2023 Management's Discussion and Analysis.

The Company has strong/good capitalization. The Minimum Capital Test ratio for Definity Insurance Company was 218.9% as at Q1 2023 (204.0% as at YE2022), which is comfortably above the supervisory target ratio of 150.0% set by the regulators. Definity still does not have any long-term debt in its capital structure, resulting in zero long-term leverage. Since its demutualization, the Company's capital flexibility has improved because publicly traded companies can raise additional capital from the stock markets when needed.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
Environmental concerns regarding climate and weather risks are relevant to the ratings of Definity and its affiliate as a P&C insurer but do not affect the assigned ratings or trends. As part of its P&C product offering, Definity is exposed to weather-related losses from natural catastrophic events such as wind, wildfire, hail, flooding, and other extreme weather events. These events can lead to earnings volatility and increased reinsurance cost. DBRS Morningstar considered this E factor as part of product risk when assessing the Company’s risk profile. The Company has adopted the processes of the Task Force on Climate-Related Financial Disclosures. Definity is committed to achieving a net-zero operational footprint and investment portfolio mix by 2040 or earlier.

There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

The Grid Summary Grades for Definity Financial Corporation are as follows: Franchise Strength—Good; Risk Profile—Good; Earnings Ability—Good/Moderate; Liquidity—Strong/Good; Capitalization—Strong/Good.

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

The principal methodology applicable to the rating is the Global Methodology for Rating Insurance Companies and Insurance Organizations (August 31, 2022; https://www.dbrsmorningstar.com/research/402220/). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929/) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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