Morningstar DBRS Confirms Co-operators Financial Services Limited Issuer Rating at BBB (high) and Affiliated Operating Companies Financial Strength Rating at "A", Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the credit ratings of Co-operators Financial Services Limited (CFSL or the Company), including the Company's Issuer Rating, at BBB (high). The credit ratings of CFSL's main operating subsidiaries were also confirmed, including their Financial Strength Rating, at "A". All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings and Stable trends reflect CFSL's established financial services franchise, including its top-five position in the Canadian property and casualty (P&C) insurance market. In recent years, the Company's growth and good financial position has allowed it to invest in developing new products, new distribution relationships, and operational improvements. Since 2023, CFSL has been reporting weaker P&C underwriting results because of the impact of natural catastrophes and other claims pressures factors on home and auto insurance business. These weaker results were partially offset by strong performance in the life insurance business, highlighting some of the potential benefits of CFSL's strategy to grow into a diversified financial services company. CFSL's investment portfolio is mainly composed of high-quality fixed income assets but also includes a moderate exposure to common and preferred equities. The Company has prudent liquidity, leverage, and capital positions, which allow it to fund its strategic initiatives and take an opportunistic approach to innovation.

CREDIT RATING DRIVERS
Over the longer term, an improvement in CFSL's franchise strength through revenue growth and additional diversification that results in more consistent and sustainable profitability would result in a credit ratings upgrade. Conversely, a sustained deterioration in profitability combined with lower capital levels would result in a credit ratings downgrade.

CREDIT RATING RATIONALE

Franchise Building Block Assessment: Good
CFSL is one of the leading Canadian P&C insurers with a growing presence in the life insurance and wealth and asset management markets with a long-term vision to become a leading, diversified financial services provider with the scale to achieve strong financial performance while remaining committed to its cooperative roots and to the financial security of Canadians. The Company has access to multiple distribution channels including a dedicated advisor network, a direct-to-customer digital platform, and access to brokerage networks, as well as unique partnerships with Canadian credit unions. In recent years, the Company has been facing some headwinds in its core Auto and Home insurance business, including claim inflation, a surge in auto theft, and elevated weather-related losses. The Company reacted with some price actions, but the challenges persist in 2024. While the Company's strategy remains sound and Morningstar DBRS expects this underperformance to be temporary, structural conditions in certain segments of the auto insurance market in particular may require the Company to rethink its risk portfolio. The Company has recognized the need to grow profitably to maintain its financial strength, but this objective is to be achieved within the broader mission of enhancing the financial resiliency and sustainability of Canadians and their communities.

Earnings Building Block Assessment: Good/Moderate
CFSL has consistently grown revenue over the past five years through both premium and unit growth, increasing its earnings potential. However, 2023 earnings of $256 million were affected by poor P&C underwriting results, particularly in the auto insurance line amid industry-wide challenges with claims inflation. The Company reported a P&C combined ratio of 104.4% in 2023 with the challenging environment continuing into 2024 resulting in a 99.8% combined ratio as at Q2 2024. In addition, significant weather events in Q3 2024 are expected to add more pressure on 2024 earnings, potentially offsetting the sustained good performance in life insurance as well as good investment returns. Going forward, Morningstar DBRS expects CFSL to continue to seek rate increases on its P&C products to revert the trend towards a mid-90s combined ratio, although it is unlikely to be achieved in the short term. Overall, the Company reported a ROE of 5.9% for 2023.

Risk Building Block Assessment: Good/Moderate
CFSL is exposed to a diversified portfolio of insurance risks, with individual P&C insurance being its largest exposure. While this exposure is diversified across Canada, the auto and home insurance markets in Ontario and Alberta are particularly significant to the Company. CFSL also has a relatively uncommon exposure to farm insurance as well as flood insurance where its risk profile is differentiated from its competitors. As exemplified through recent hailstorm, wildfire, and flooding events, the Company is significantly exposed to severe weather events, which could be further affected by climate change. In recent years, CFSL's life insurance business has provided diversification benefits to the Company by delivering steady profits, uncorrelated to P&C results. CFSL's investment portfolio is mainly composed of high-quality, fixed-income assets but also includes sizable allocations to equities, preferred shares, and mortgages. CFSL has a comprehensive risk management and stress testing framework that it uses to set adequate risk limits consistent with its risk appetite. CFSL's insurance operating subsidiaries maintain prudent reinsurance coverage, which mitigates large losses caused by catastrophes.

Funding and Liquidity Building Block Assessment: Good
CFSL has a healthy liquidity position with a large quantity of high-quality liquid assets available to meet liquidity needs, including almost $600 million in cash and over $2.1 billion in bonds rated AA and above. Additionally, CFSL has access to a $94 million credit facility, which was undrawn as at year-end 2023, and has surplus capital held at the holding company level, which is invested in liquid assets and is sufficient to cover the principal of its senior debentures. The Company has a limited amount of collateral posting requirements through its hedging program and its claims profile is relatively stable, although it is exposed to catastrophe risk.

Capitalization Building Block Assessment: Strong/Good
CFSL maintained adequate capital buffers in its insurance subsidiaries as of Q2 2024, with the Minimum Capital Test ratio of its P&C subsidiary at 223%, and the life insurance capital adequacy test ratio of its life subsidiary at 168%; both are well above regulatory targets of 150% and 100%, respectively. CFSL's financial leverage ratio was 11% as of Q2 2024, which is conservative and provides room for additional debt financing should it be required. The Company's earnings remain sufficient to comfortably cover interest payments on its debt and to generate excess capital, especially considering the lack of a consistent dividend payout under the cooperative ownership model.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
Environmental concerns regarding climate and weather risks are relevant to the credit rating of CFSL because of its large P&C operations but did not affect the assigned credit rating or trend. As part of its P&C product offering, CFSL 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 costs. Morningstar DBRS considered this ESG factor as part of product risk when assessing the Company's risk profile and earnings stability.

There were no Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024; https://dbrs.morningstar.com/research/437781).

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (September 10, 2024) https://dbrs.morningstar.com/research/439195. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

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

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

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

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit 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. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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