Intact Financial's (IFCZF) CEO Charles Brindamour on Q4 2015 Results - Earnings Call Transcript

| About: Intact Financial (IFCZF)

Intact Financial Corp. (OTCPK:IFCZF) Q4 2015 Earnings Conference Call February 10, 2016 11:00 AM ET

Executives

Samantha Cheung - Vice President of Investor Relations

Charles Brindamour - Chief Executive Officer

Louis Marcotte - Chief Financial Officer

Patrick Barbeau - SVP, Personal Lines

Alain Lessard - SVP, Commercial Lines

Mathieu Lamy - SVP, Claims

Analysts

Geoff Kwan - RBC Capital Markets

Kai Pan - Morgan Stanley

Meny Grauman - Cormark Securities

Brian Meredith - UBS

John Aiken - Barclays

Tom MacKinnon - BMO Capital

Paul Holden - CIBC

Doug Young - Desjardins Capital Market

Mario Mendonca - TD Securities

Operator

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Intact Financial Corp Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions]

Samantha Cheung, Vice President of Investor Relations, you may begin your conference.

Samantha Cheung

Thank you, Sharon, and good morning, everyone. Thank you for joining the call today. A link to our live webcast and background information for the call is posted on our website at www.intactfc.com under the Investor Relations tab.

As a reminder, the slide presentation contains a disclaimer on forward-looking statements, which also apply to our discussion on this conference call.

Joining me today are Charles Brindamour, CEO; Louis Marcotte, CFO; Patrick Barbeau, SVP of Personal Lines; Alain Lessard, SVP of Commercial Lines; and Mathieu Lamy, SVP of Claims.

We will begin with our prepared remarks, followed by a Q&A session. With that, I would like to turn the call to Charles to begin his remarks.

Charles Brindamour

Well, good morning everyone, and thank you for taking the time to join us today. Earlier this morning, we announced fourth quarter net operating income of $265 million or $1.97 per share that is 7% better than last year’s fourth quarter.

While weather was on our side the strong performance in the quarter is a good reflection of our customer driven strategy and our resolve to address performance issues. Not only was growth strong at 7% but our underwriting performance with a combined ratio of 88.6% was excellent. Our growing distribution operations also contributed to this quarter’s performance adding $22 million to our earnings.

Looking at our performance for the full year, we grew our net operating income per share by 13% to $6.38, driven by strong organic growth, better underwriting performance, and higher distribution profit. Our operating ROE of 16.6%, 30 basis points above last year is a testament to the strength of our franchise. We were pleased with the 5% growth in our book value per share over Q3 and our $625 million in excess capital.

I believe we are entering 2016 on a strong footing. Our performance in 2015 exceeds again our objective of growing our net operating income per share by 10% in average over time. We expect our ROE to outperform the industry again this year by more than 500 basis points, given we outperformed by more than 600 basis points at the end of Q3. We believe the strength of our platform allows us to do well throughout cycles as well as volatile environments.

So let us look at these results by line of business. During the quarter personal auto grew 9% driven by a number of customer experience improvements, better competitive dynamics, as well as three points from the integration of CDI. The combined ratio rose 3.2 points to 96.9% on less favorable prior year developments, and slightly higher expenses. Liability inflation in Alberta has been tough in the recent past or few years and has impacted our results in the quarter. We have a strong action plan in this province, including price increases around 8% starting in the coming months, and a continued focus on optimizing our claim strategy. We expect improvements in this segment starting this year.

With regards to the personal auto industry outlook, we anticipate low single-digit growth in the coming 12 months as mild rate reductions in Ontario will be offset by increases in other regions. Our view in Ontario has not changed. We expect three to five points in net cost reductions to be implemented in 2016 at the industry level.

From our perspective we proactively recognized a portion of that in our rate actions to date. We believe rate reductions will be in line with government cost-reduction measures and the operating environment will continue to be rational.

The personal property market remains hard allowing us to grow premiums by 11%, including 3 points from CDI. With new products on the shelves, including both our lifestyle advantage and extended water protection we are very well positioned to capture further growth opportunities in this market.

With regards to profitability, our combined ratio of 72.7% during the quarter reflects a strong performance even with benign weather, suggesting that our improvement plan is very effective. Furthermore on a full year basis, our combined ratio of 85.9% improved by 3.1 points. Overall our view on the industry for personal property has not changed and we see continued hard market conditions, leading to upper single-digit growth over 12 months.

When it comes to commercial P&C we like what we see. This line of business grew 3% year-over-year while taking robust actions to improve profitability in some segments and facing headwinds from a slowing Alberta economy. This line of business again delivered strong results with a combined ratio of 80.1% for the quarter, which is 7 points better than last year. Not only did we see lower CAT losses and favorable prior year development, but more importantly the underlying current year loss ratio improved by 3.2 points. On a full year basis, our combined ratio of 86.8% is in line with our low 90s target on a sustainable basis. Competitive dynamics should support mid single-digit growth in the coming year.

Commercial auto grew 3% in the quarter, below our run rate this year as we have begun to deploy our profitability improvement measures. Our combined ratio of 107.9% was primarily impacted by adverse prior year development. As mentioned last quarter, we are implementing robust corrective actions including rate increases and segmentation, as well as loss prevention measures. We are shooting for a sustainable combined ratio in the low 90s. While the market remains competitive, we believe the market is firmer, which should help the execution of our plan in 2016.

With regards to opportunities, the M&A landscape in Canada and around the world is moving as we expected. We continue to believe 15 points of market share will change hands in Canada and the mid-term. While Canada remains our priority, consolidation is also happening outside our boundaries, with potential impacts here in Canada. We remain patient and disciplined in this environment, but fully intend to continue to be a leader in consolidation.

Overall 2015 has been a busy and successful year for the company. We were active on the M&A front with the acquisition and integration of CDI, expanding our direct platform from coast to coast. We expanded and streamlined our distribution channels. We invested heavily in our brands and in technology all that while launching new products. Our success though is driven by our people who work day in and day out at improving our customers’ experience. They make a big difference and I thank them for their hard work.

Even though we were named one of Canada's top employers in 2015, we remain focused on creating an environment they can be proud to be associated with.

So in conclusion, we ended the year with strong momentum in both top and bottom line, while strengthening our financial position. We are in an excellent position to capture opportunities in 2016. And with that in mind we also increased our quarterly dividends by 9.4% to $0.58 per share, which is the 11th consecutive increase since our IPO.

We are confident that our strategy will continue to help us outperform the industry’s ROE by 500 basis points every year and grow net operating income per share by 10% at least per year over time. We believe our platform can deliver superior results both in good and in bad times and with that, I'll turn the call over to our CFO, Louis Marcotte.

Louis Marcotte

Thanks Charles, good morning everyone. This morning we reported strong operating results as our underwriting income grew 21% from last year thanks to a 91.7% combined ratio and higher net earned premiums. Our net operating earnings per share increased 13% year-over-year on the back of improved underwriting and distribution results.

Our book value per share was up 6% from last year at $39.83. Charles already covered most of the underwriting story, but I will add a bit of color on expenses. Overall for the year, our expense ratio was 0.2 points higher than last year as lower commissions were offset by higher general expenses mostly related to growth initiatives.

The net impact is marginal for the year and the Q4 increase is due to timing between quarters, not a general trend. We expect our 2016 expense ratio to be comparable to 2015 with quarterly fluctuations.

We reported investment income of $110 million in the quarter and $424 million for the year, both basically unchanged from last year. We expect a mild erosion of our investment income as the [environment] continues to be challenging.

Distribution earnings of $104 million in 2015 exceeded our $100 million expectation. These earnings should grow north of 10% on an organic basis in 2016.

Moving on to non-operating items, our non-operating losses of $99 million for the quarter include common share impairments of $44 million, mainly driven by weakness in the energy and material sectors. Non-operating losses led to earnings per share of $1.46 in Q4 and $5.20 for the year, both lower than last year. Overall we delivered solid operating performance with operating earnings per share growing 7% in the quarter and 13% for the year.

A few comments on our financial position. Our balance sheet strengthened significantly in the quarter on the back of strong earnings and a recovery in asset values, resulting in a 5% increase in book value per share to $39.83. At year-end, our investment portfolio had recovered most of its value as the unrealized loss position improved by $119 million from the end of the third quarter to near zero.

During Q4, we refined our impairment approach for preferred shares as they tend to behave more like debt instruments than equity instruments. We therefore determined that the debt impairment model was more appropriate. Under this model, preferred shares are impaired when credit issues arise with the issuers and cash flows may not be realized as expected. We applied this model perspectively as of Q4 2015 and concluded that no impairments were required at the end of the quarter.

Although the value of our portfolio is impacted by the volatility of capital markets and economic uncertainty, it is composed of high quality securities and delivers stable and reliable cash flows. The sensitivity of our balance sheet to equity markets and interest rates is fairly limited particularly in light of our stronger capital position.

Our exposure to energy common shares is in line with the [CSX], but focused on higher quality names with an overall exposure of 5%focused on across all asset classes. Our excess capital rose to $625 million nearly as high as where we were a year ago before the acquisition of CDI, and our leverage stands at 16.6% well below our 20% targets.

Our MCT rose from 195% in Q3 to 203% at year-end, mainly driven by operating results. We are in good position to enter 2016. Since the beginning of the year, 2016 that is, capital markets have seen further volatility with an estimated impact of 5 points on our MCT as of yesterday. The recent changes to the MCT guidelines, which better reflect a risk-based capital framework will further strengthen our capital position in 2016 and mitigate some of the capital market headwinds we are currently facing.

Our capital management framework remains unchanged. We use excess capital to maintain and grow dividends, to invest in organic or inorganic growth opportunities and ultimately to buy back shares. In 2015, we deployed capital on dividends, on organic growth, on the acquisition of CDI, and we invested some $77 million in distribution assets.

Today we announced the 11th consecutive increase in our dividends on the basis of our confidence in the quality of earnings and our strong financial position. We firmly believe consolidation in the domestic P&C industry will continue and we prefer to keep our excess capital to deploy on these opportunities.

However, there are times when the market price of our shares may be undervalued and we believe that buying back shares in those circumstances is [responsible] use of funds to increase shareholder value. We think a buyback program adds flexibility to our capital management toolbox if used with discipline. Accordingly we announced today our intention to reopen a normal course issuer bid for up to 5% of the outstanding float. Again this decision in no way signals a change in our view of opportunities for market consolidation.

In conclusion, I am pleased with our strong performance in the quarter on multiple fronts, on growth, operations and capital. We strive to continuously deliver strong returns to shareholders while being a company that our employees are proud to work for.

With that, I'll return the call back to Samantha.

Samantha Cheung

Thank you, Louis. Sharon, we are now ready to take questions. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Geoff Kwan from RBC Capital Markets. Your line is open.

Charles Brindamour

Good morning Geoff.

Geoff Kwan

Just had a couple of questions, first off just the comments you had with respect to the Alberta auto situation, just wanted to get some color I guess in terms of how much of a potential drag or impact that we might see in the upcoming quarters and how quickly you think you can improve that situation?

Charles Brindamour

Yes, I think the – we have talked about Alberta from time to time in the past two years. There has been a number of common law decisions that have created a bit of inflation and in the past few months really strengthens our position there, not only in terms of reserves, but more importantly in terms of action plan. I think action plan being pricing related, underwriting related, and claims related. One of the big things that's happened in Alberta inside as a result of our claims action plan is that our folks in the West are changing the way or have changed the way in which they handle claims, as a result of inflation, and we put also more people on the front line. So, I would say that in pretty good shape there and I do expect concrete improvements in 2016 as opposed to dragged at this point. I think I read as the worse is behind, given everything that's in the pipeline.

And I'll let Patrick add a bit of color on what we're doing there.

Patrick Barbeau

Yes, I fully agree. One of the key elements we have done in Q4 in light of this emerging trends or at this acceleration in this trend was to quickly file for additional rates. So, we just got an approval for a plus 8% in the personal auto environment that's being implemented as we speak and to be effective towards the end of Q1. And there is additional action items on the underwriting side and segmentation coming in very soon in 2016. So, we think that that will offset the trends that we have observed so far.

Geoff Kwan

Okay. And then last September you guys announced that partnership with Uber about the right sharing, and then we saw recently a competitor had come out with the product addressing that part of the market. Just only thing kind of clarify what that does in terms of how you guys are looking to capitalize on that part of the market.

Charles Brindamour

Yes. The partnership we've announced with Uber is subject to regulatory approval. But the product that we have in mind would cover all customers of Uber, from wall to wall. The alternatives that are on the market, have to be selected self-selected by the drivers and from our perspective, the solution that's in front of regulators at the moment which of course is a little bit more complex for regulators because it involves personal and commercial lines, is definitely by far the best solutions for [indiscernible]. I think the alternatives require the driver to insure first, and the driver has to be insured by one of the few insurers who actually offer that solution. So, we think that the better solution is definitely an agreement with Uber to cover customers, all customers to one policy.

Geoff Kwan

Okay, great. And then just one final question, just on the main environment. You talked about things are playing out as he expected. Was just curious at the margin with what's going on in terms of the markets kind of the macro uncertainty. Is that having an impact kind of either way in terms of what might be happening from an M&A perspective?

Charles Brindamour

I think those sorts of environment are positive for M&A, as far as I'm concerned. I think it can accelerate people reconsidering their use of capital. Then I don’t know how significant that is but I don’t see this as negative. And I think our history on that front has been one where we capitalized on periods of volatility like the one we're going to at the moment.

Geoff Kwan

Okay, great. Thank you.

Operator

Your next question comes from Kai Pan with Morgan Stanley. Your line is open.

Kai Pan

Good morning and thank you.

Charles Brindamour

Good morning.

Kai Pan

The first question on the commercial auto, you made some improvement on underlying current year last ratio. But still it's at loss at more than a 100% combined ratio. I just wonder what more could be done and how soon can we get to the talky level you're aiming?

Charles Brindamour

Yes. I think I'll let Alain talk about the action plan. But let me put things in perspective here. Commercial auto started to have results who were not as good as history last year. And you'll recall that for a couple of quarters we said "Hey, we're seeing large losses, they are happening sort of across the land" and then in third quarter we sort of became a little bit fed up with the large losses and tell you guys that we actually would roll up an action plan.

I think are appointed actuary throughout the year, also saw a bit of unfavorable development. And I think in the fourth quarter, wanted to make sure you wouldn’t see those sorts of trends in 2016. I think that's what you have to keep in mind. I'll let Alain talk about the action plan, which I would qualify as robust, that is rolling out as we speak.

Alain Lessard

Okay. So, maybe just to add a color also on the result like we said last year, we tend to look at the result of that line of business because of the size more on a yearly basis than quarterly basis. But even at 99% for the year, this is unsatisfactory, not the level we want to. We know like Charles mentioned that during the year there has been some element which are not necessarily recurrent. We believe that those elements between adjusting the reserve for certain trends, fully separating the IBNR between personal lines and commercial lines, a bit more large losses and some impact coming from the exchange rate in the U.S.

We believe those non-recurring event are probably in the range to four to six points. But that still leave a combined ratio in excess of the 90 where we want to operate. So, we've already started rolling out some corrective measure. The corrective measure, I would say are in [indiscernible] in three heads. The first one, regarding the rates. Basically, we started implementing rate increase in the fourth quarter and continue to implement more rate increase starting in the first quarter this year. Those rates are going to be mid-single digit overall and they're going to be segmented towards the part of the business or the book that is required more rate increase.

We're into this thing, also more GLM pricing, more precise algorithm to improve the segmentation. And I think it's important to understand that our commercial lines book is about 2/3rds non-price regulated. So, there is about 2/3rds of the book where we can go very rapidly and implement a great measures and implementing new GLM. This is an important, we are starting the implementation of the GLM by the end of the first quarter. And we'll think we'll have completed the review by the end of the year for every segment of the portfolio. And on top of that we've already adjusted our U.S. exposure, U.S. rates for -- U.S. exposure for trucking to the more recent exchange rate level. That started at the end of the fourth quarter.

So, we have strong action coming up on the rates. We also have some action coming up on the underwriting side, where we are basically reviewed our session to risk sharing pool to be more efficient. We are reviewing our eligibility rule for as auto transportation, driver turn around in anti-theft device. And we're putting more eyes on the larger account to make sure we're not leaving anything not understood.

And finally, we're putting more visit on the loss prevention side. We've hired more loss prevention people. We're seeing more account. And we're going to be using my fleet solution, which is the way to equip the fleet manager with a better understanding of what's going on at the driver level, be able to identify pattern, and then train more the behavior of the driver there to improve the loss prevention. So, we're quite confident that with this action plan, we're going to be bringing the combined ratio back to 90.

The full earning of the action plan will take about 12 month to get to the full impact of the earning. But we have in our mind everything that is needed to bring it back to the 90% level.

Charles Brindamour

I think that's a very good summary, Alain. I think if you go back this year, I mean, the commercial auto combine ratio was 96 in Q1, 94 in Q2, 97 in Q3. That's not good. But that's not a reason to panic. I think after the third quarter, we said we need to improve the performance of that line of business. And if you look in Q4, per se, the underlying current year last ratio improved by a few points. But the prior year development was 10 points worse than last year. And this is I think where I'm saying are appointed. Actually he wants to make sure that we're not in a non-favorable development position starting in 2016. So, I think you have that coming and then you have what I think is a robust action plan rolling at the same time.

Kai Pan

Well, thank you so much for the detail. And so, my second question regarding on the capital management side, looks like initiate a buyback program that could worse up to maybe more than $500 million. How do you decide it sort of like what valuation you buyback your stock and the

size of that versus your excess capital currently run at $600 million and then on the other side of the capital management on the acquisition front recently one of your competitors like have a sizeable acquisitions, I just wonder you guys have been always looking for opportunity like that I just wonder what’s the reason behind it and does it changed anything in terms of valuation change your appetite going forward? Thanks.

Charles Brindamour

Excellent. I’ll let Louis comment on the capital framework and then I’ll share with you my perspective on the buyback because we talked about that last quarter during the earnings call and then we’ll talk about M&A. Go ahead Louis.

Louis Marcotte

Thanks Charles. So firstly, just a reminder here, we’ve a buy towards keeping for M&A opportunities as you know. So, we took a decision with keeping that in mind and it’s important. The way we execute and we don’t get into the details, but the more we get away from what believe is intrinsic value of our stock the more we’ll buy. So the pace of buyback is accelerating as much as the price is discounted to the internal value that we’ve calculated and the concept behind it or the reasoning is that we’re in strong capital position, we’ve a good capital outlook for next year and therefore we can deploy some of the capital when we believe the discount intrinsic value is quite high. So that’s a bit how we’re going to execute the buyback.

Charles Brindamour

We intend to be opportunistic with the buyback here I don’t think the intention is really to buy $500 million worth of shares. I think we’ll find a good opportunity and in the hierarchy of capital management that’s what we intend to do. That being said, if you look at what happened in the past three weeks to a month shares have been beaten up and for me it’s a clear reason to be out there and operate the buyback and be opportunistic. I think that this is no justification for what we’ve seen and therefore we’ll be on that in the near term. So, it’s not because we don’t see opportunities in the market, we just think that the fall is certainly hard to justify and the distance with our perception of intrinsic value is such that we want to be out there with the buyback.

On the M&A I think this really just proves our thesis that there will be consolidation in the marketplace. It also underlines a view we’ve had that P&C is very different from banking and our acquisition of CDI earlier this year was a proof point of that. I think the transaction you’re referring to is another proof point of that and therefore for us sort of the canvas that we think we’re operating in is consistent with the view we had few years back, it’s happening.

Kai Pan

And what prevent you from pursuing that deal, is it on the valuation side?

Charles Brindamour

Yes, I’m not going to comment on specific deals.

Kai Pan

Yes, that’s fair. Thank you so much for all the answers.

Charles Brindamour

Okay, no problem.

Operator

Your next question comes from Meny Grauman from Cormark Securities. Your line is open.

Meny Grauman

Good afternoon. From the – better than seasonal weather was an impact in the quarter, I’m just wondering, you referenced it but I’m wondering if you could give us little bit more granularity on the impact specifically in personal property and commercial P&C?

Charles Brindamour

Of the good weather?

Meny Grauman

Yes.

Louis Marcotte

If I look at Q4 for personal property, it was yes, good weather generally normal levels of PYD and so no impact and that’s why we reported a healthy underlying less ratio of 41.6 that’s slightly above prior year, there was the few things that maybe affected the results, but overall 72.7 combined is where we’re at within – it’s tough to say when there is no weather how much it

improved your results, but compared overall for the year, the weather mostly in Atlantic, the non cat weather events that we referred to affected our results for the full year by 1.5 point so that's more on the other side. But, in Q4 I think the action plan that we have implemented was fully reflected in our earnings and that's more in our view what has created the good results.

Charles Brindamour

I think in aggregate it's hard to put a number on that in terms of cat and weather patterns broadly, our take is that in aggregate for the quarter you probably have $0.10 after tax of upside because of the good weather plus or minus a few cents there. But there is a bit of speculation so to speak with regards to what that number is. It's very clear to us that what you are seeing this quarter is action plans taking affect in commercial P&C and on the other end bit of strengthening our position in the automobile lines of business as we introduce action plans in auto.

Meny Grauman

Thanks that's very helpful and if I could ask another question on, you talk about expected improvement on the [indiscernible] in 2016 and looks like improvement in commercial auto in 2016. I am wondering when you look into 2016 what's the most – what worries you most it seems like a lot of the issues that we have seen kind of develop over the last year seems to be being dealt with quite effectively with actions plans it seemed to be working out, but when you look ahead what gives you the biggest headaches going forward?

Charles Brindamour

Headaches, we don't headaches I would say that I am hoping that, not counting on that but I am hoping that the government and the regulatory authorities in Alberta work alongside the industry to tame inflation in the system. I think we are taking actions or claims we mature and I was in Alberta last week to meet lots of claims adjusters to make sure that we were on top of things and I do think we are and I am hoping that the government to tame inflation for Albertans because that's the last thing we need right now is inflation in automobile and trans in Alberta. I am hoping that the government works on finding ways in the product to tame chronic pain inflation as well as minor injuries being treated as non-minor.

But overall, every time an issue emerges we direct the organization's energy towards the problem, try to understand the problem when we don't fully understand it and it persists we put an action plan in place and that seems to work for us. And quite frankly, I think the operating environment is such that the action plans that we put in place and that we are putting in place shouldn't, aren't too much are top-line. And fourth quarter purely shows that it's the case. I think Alberta in general not just in automobile insurance but in commercial lines as well is an area where we will spend more time in this year to make sure that we win as an insure in that marketplace in a period of slower economic environment and a bit of inflation in our mobile insurance.

But I don't have short term worries, I think as I have mentioned at the Investors Day, we are totally focused on transforming the organization to make sure that we provide our client an experience that second to none so that if and when disruption takes place in the marketplace and particularly in personal lines we are positioned to come out on top. That I would say is the organization's, I don't know if worry is the right thing, but this certainly is where we are investing our energy.

Meny Grauman

Thank you and just to clarify that issue of inflation in Alberta, is it, do you see it being impacted by the worsening economy there, is there –?

Charles Brindamour

It's not clear. I think anecdotally you hear of pressure, but I think the pressure was building up before the economy slowed down. We are certainly on high alert on that front but it's not clear to me, I don't know much. Louis, if you want to add to the perspective there.

Louis Marcotte

No this is exactly, we are watching for depth frequency to see if we see an increase we see a bit of it at this point but at the end depth represents 5% of our losses, but it's something we watch carefully in those downturns.

Charles Brindamour

I think, they are on high alert just what I’ll say and so we will report on that if there is anything else substance to report on in the coming quarters.

Meny Grauman

Thank you.

Operator

Your next question comes from Brian Meredith from UBS. Your line is open.

Brian Meredith

Thanks. Couple of question for you. Quickly on the M&A front, does the weak Canadian dollar at all kind of make you think twice about looking into the U.S. market or outside of Canada at this point?

Charles Brindamour

It doesn't, it puts pressure on the model there is no doubt. But it doesn't make us reconsider it to look outside.

Brian Meredith

It's going to make you more challenging to get your price?

Charles Brindamour

Yes, that's it. I think that the combination of shooting for IRRs and then the devaluation of the dollar depending on the country you are looking at certainly is the source of pressure but it doesn't change the strategy as far as I am concerned. The other thing is it also depends on your perspective on what the long term exchange rate should be depending on the currency you are looking at. And I think, if you think you are not too far from the equilibrium level then that's also reflected in your model. If you are far for what you think the equilibrium model is, the wrong way that puts a fair bit of pressure on your model and your ability to act outside the country.

Brian Meredith

Got you and then just quickly what’s the outlook for 2016 for distribution acquisitions?

Charles Brindamour

I think the outlook is pretty good for 2016 for distribution acquisition actually. I think that what I would call super fragmentation of distribution in Canada offers lot of opportunities we’re partnering with about 50 entrepreneurs where we have equity stakes to consolidate, BrokerLink is a consolidator. So in terms of footprint to find the opportunities it's as I think as good as it gets the fragmentation is really significant. The returns on these trades have been really good for us and therefore we will put as much capital as we can find good opportunities there. I think it's actually pretty good. I will ask Louis to give additional color.

Louis Marcotte

I think you are right. I think it's good. We are active out there brokers are moving, some are retiring whenever they are transacting and so it’s still we think a good environment to operate in. It's hard to predict specifically, but I think the environment is positive for consolidation.

Charles Brindamour

I think people increasingly understand that scale is key in personal lines distribution and that's what we are after in that exercise.

Brian Meredith

Okay. So the rate of growth you had in 2015 would it be unreasonable to expect that in 2016 as far as distribution revenues?

Louis Marcotte

So we are suggesting north of ten organically. So I would stay there. It's just hard to predict Brian, so what we have in the book right now should drive that and that hopefully we’ll be able to get more.

Brian Meredith

Great and then just last quick question. On Ontario auto, I noticed that first quarter 2016 you are going to put through the remaining great reduction, just curious Charles, how much of the acceleration in growth of personal lines you think is attributable to the fact that you have been cutting rates faster than the industry and could the fact that the industry is going to have to catch up to you guys at some point maybe offset some of that growth?

Charles Brindamour

I’ll let Patrick give his perspective, it's important to bear in mind that we were shrinking in Ontario at the same time last year. So why don't you share your perspective.

Patrick Barbeau

Yes. So Brian our last rate decrease was implemented in Ontario in last April or May, well this is not recent action and we have seen continuous acceleration throughout the year 2015. I think one of the key reasons for our success there is on the distribution side but more importantly our UBI offers which is very competitive in the market and we have seen the take up there increase significantly in the later part of the year and I think that will continue to be an advantage for us. Even if we forecast that we might have slightly lower rate reduction coming in 2016 than the average of the industry, I don't think it will affect significantly our ability to grow.

Charles Brindamour

Yes, I think that's right. You talk about UBI which is a big driver of growth I think the digital experience quick quote and so on has also driven a fair bit of traffic and we have increased response advertising meaningfully this year by close to 50% across business units. And as you know we think it's really important to build household names, we’ve shrunk our expense base to allow us to spend more in marketing we’ll keep doing that this year. So, I think there will be a few points that we will lose I think in relative terms, rate wise what this will translate into from a top line point of view I am not sure nor overly concerned. I think we will have to watch our top line in Alberta because an 8% rate increase I think will be ahead of the market there and that might be a bit of a source of pressure. But I am not concerned in aggregate with our rate actions and what it can do in our top line.

Brian Meredith

Great, thanks for your answer.

Operator

Your next question comes from John Aiken from Barclays. Your line is open.

John Aiken

To the prior development that we have seen in 2014 accident year, now obviously the commercial auto side has definitely seen some improvements but we did see a tick up on the personal auto. Is there any parallel between the two that we can read into and are we facing additional stress in 2016 on prior development on personal auto?

Louis Marcotte

Well as we – I think this slight decrease in prior year development or favorable prior year development in Q4 as we mentioned earlier result due to situation in the Alberta I think we are comfortable with what we have done on the reserve side as of the end of 2015. So I think we can expect the PYD for that line to go back to probably the higher range of what we have discussed, higher parts of the range of what we have talked about in prior part or so. I don't think there is a pressure on this PYD for this year that was mostly one time reflection of the trends in the Alberta.

Charles Brindamour

Yes, I think that's our first statement. I think some of the pressure we have seen in Alberta in personal, we also have seen in commercial auto and that's part of the action plan but otherwise I am not really concerned about prior year development in 2016 because I think the action plans in pricing some of the moves we are making in claims, management and then the appointed actuary sort of reacting to a bit of adverse development and some of these lines earlier this year by being corrective so to speak in Q4 gives me a fair bit of confident what I am thinking about this year.

John Aiken

Great, thanks. And Louis just for clarification you mentioned that there was actually five point impact on the regulatory capital ratio because of the capital markets action to date, did I hear that correctly?

Louis Marcotte

That's right. So the year from January 1st till yesterday is roughly equivalent to five points.

John Aiken

Yes and obviously as you mentioned offset by changes of the regulatory regimes so not completely deterioration, but when we look at your investment portfolio, the investment in equity is really is to get the tax advantages, nature of the dividends, is there any thoughts or discussion to altering your energy portfolio given the fact that we have actually have seen some dividend reductions coming out of that space?

Charles Brindamour

So globally I would say we are quite comfortable with the mix whether there is some decisions at the individual levels perhaps but globally the mix I’d think will be stable.

Patrick Barbeau

I think this is up to our PMs at this stage to go in and out depending on their perspective. I think the other thing that's important to bear in mind in the past 24 months if you look at our common share portfolio which is about 13% of our investment base, 5 points out of the 13 is in the U.S. And if you go back 24 months this was very close to 0, so this sort of macro perspective on Canada's concentration for certain sectors namely energy and financial has been in part addressed by a meaningful reallocation of our portfolio in the past 24 months towards the U.S. So that's the macro piece that's sort of where Louis and I are involved with the investment team than at the common stock level or securities by securities level it's the PM’s job to make sure that they are focused on the strategy and the objective of total after tax return, I don’t know Louis if there is anything that can be added there.

Louis Marcotte

Okay, I think you have covered it.

John Aiken

No, it was great guys. Thank you very much.

Operator

Your next question comes from Tom MacKinnon from BMO Capital. Your line is open.

Tom MacKinnon

Thanks very much. Just with respect to commercial P&C what’s the average rate increase you are seeing right now and what are you seeing in terms of the commercial market in Alberta and I have got follow-up?

Charles Brindamour

Thanks Tom, I’ll ask Alain, his perspective on that front.

Alain Lessard

Okay. So on the commercial lines rate increase it's been for us the eighth quarter in a row and the fourth quarter of 2015 that we have seen rate increase in the 4% - 5%, so mid single digit. So, we don't see any momentum currently to go further than that but that's about where we are right now so it's very – it's still in our mind a firm market okay. We are anecdotally also hearing from the market, from our different region action taken by our competitors either on rates or non-renewal that are basically indicating the same thing. So we see currently still a firming market and on a non-level basis we will see our earn rate level continue to increase at least for the next 12 to 18 months.

Tom MacKinnon

And with respect to Alberta, yes?

Alain Lessard

On the Alberta, this one is a tough question. We are trying to see the perspective of the impact on the Alberta market. Right now, I can tell you that we estimate the impact of the reduction in the economy in the Alberta to be about a reduction of growth of [asset] point in commercial P&C. And just let me explain what we have seen so far in Alberta on the oil and gas segment is basically a reduction in premium in the 10% to 15% and that's being fairly stable throughout the year in 2015. So, since the oil and gas is about 20% of our portfolio in Alberta that means the reduction in Alberta of roughly 3% and Alberta being 17% of our commercial portfolio we see an impact of about [asset] point and that I would say that phenomenon is being contained solely to Alberta.

Where it becomes more difficult is when we look at emerging trend and trying to foresee it again in the future what we saw in the last fourth quarter of 2015 is also a reduction in Alberta in the contractors segment of our portfolio which represents about 10% and we saw reduction again in the range of about 10%. So if the – there is a negative trend possibly on the Alberta that it could reduce or improve, not improve but grow the impact of the negative economic to a reduction from let’s say 3% to 6%. But on the other hand there are positive signs on the export side lately Statistics Canada published that the export are picking up in the last month that would affect our manufacturing sector. It will affect our service sector which represents 15% of our book. A low Canadian dollar also will affect the replacement cost of the stock of our clients for retailer and wholesaler conducive of higher premium and this represents about 15% of our portfolio. So overall we have going forward positive vectors and negative vectors so the end result is very difficult to forecast and in our mind could be relatively minimal.

Charles Brindamour

I think Tom, just so we’re clear, we’ve seen in the past four months in commercial P&C a deterioration in the top line. At general days I think Alain is talking about the oil and gas practice surety now and the past few months we were seeing some pressure at the contractor level. So clearly, it's a source of pressure and it's changed a fair bit in the past four, five months. I would say in June it was almost a non-issue limited to surety in oil and gas and I think in the fourth quarter right up to January actually we are seeing a bit of pressure there. I think Alain is absolutely right. This is a small portion of our commercialized portfolio and there is all sorts of moving pieces so the overall outlook from a pure top line point of view is not a concern but Alberta has changed that's for sure. And we will keep our eyes on what’s happening there.

Tom MacKinnon

Okay, thanks for that. And just on the positive impact of the MCT expect over the next two years, the final guidelines were put out in November 30, maybe you could just refresh our minds as to what the positive impact on the MCT would be?

Louis Marcotte

Sure. So, you remember the guidelines give more credit in fact to the hedging positions that we have and -- is working towards a better risk based framework so that provides a bit of additional points. We estimate about 1.5 to 2 points per quarter of additional MCT from the 2016 guidelines rolling out over two years starting in Q1 this year.

Tom MacKinnon

Thank you very much.

Operator

Your next question comes from Paul Holden from CIBC. Your line is open.

Paul Holden

Good morning.

Charles Brindamour

Good morning Paul.

Paul Holden

So 2015 overall obviously was very good year for the company particularly in commercial P&C and personal property and then when we look at the result for personal auto in terms of combined ratio at 95.4 like how do you view that result? Is that kind of, is it a mediocre result, is it good result, is there room for improvement there?

Charles Brindamour

Yes. I think 95.4 we don't view as good, I think we are in that sort of interest rate environment if you want to be in the, we price from using ROE targets and 95.4 doesn't cut it as far as we are concerned. The pressure point this year we have had fair bit of weather in Q1 where we have seen frequencies go up. You will recall the narrow time story in Quebec and then Alberta and I think if it wouldn't be for those two issues the results would be meaningfully better, but 95.4 is not something we consider really good.

Paul Holden

Okay. And then second question is going back to the discussion on the MCT and the estimated 5 point impact post Q4, based on the sensitivities you provided in your MD&A it was suggested that the vast bulk of that impact is from the prep share market and then if that's the case implication will be that that's all mark-to-market impact with very little probability of impairments so just looking to clarify that I’m working on the right lines?

Charles Brindamour

You are absolutely so the Q1 is driven by prep shares. They are mark-to-market but in OCI so it would hit – it hits the capital but not the P&L.

Paul Holden

Okay. Thank you very much.

Operator

Your next question comes from Doug Young from Desjardins Capital Market. Your line is open.

Doug Young

Hi, I guess, I want to cut a bit, but good morning. Just can you remind me, no worries I have been called with lots of different names.

Charles Brindamour

I think I have called Tom Doug before also so.

Doug Young

It’s okay I don't take offense. The personal auto side Alberta can you remind me that what size that is of your total portfolio and where I’m going, and I also want to kind of dig into, just the Alberta auto a little bit more in terms of I think in the mid 2000 there was some issues around the minor injury around trial lawyers and some inflation pressure. And it sounded like a description of what's going on now in terms of the inflation pressure is similar. But maybe it's different. And so, I'm just trying to get a sense of that. And then when is the last time in Alberta, there was actually reform put through on the personal auto side?

Charles Brindamour

So, ballpark, Alberta automobile portfolio in relationship with the overall portfolio is less than 20% in auto. It's definitely less than 20%. The reforms took place in '03 or '04, at the time that’s just so clear, that's a 12, 13, years ago. The issue was that minor injury has led to a lot of inflation. And what the government did like other governments from coast to coast at that time was to introduce a cap for pain and suffering awards on minor injury. This cap was introduced back then, it choked inflation in the system, completely.

There have been a couple of court decisions in 2012 and in last year, that have weakened a bit, the impact of the cap. And that has been a source of inflation in the system. But there has been very little inflation until 2011 or '12. We'll ask Patrick to give his perspective and also to talk about other reforms that have taken place, which I don’t think there was, but.

Patrick Barbeau

No. In fact that there was no other reforms. In through our discussions would I be seeing and the government of Alberta, there are some opportunities to adjust the product that we're seeing. And hopefully that will eventually help containing that inflation. But no other reforms in the recent past. As you see, on the how big it is, for our portfolio, if I combine both personal auto and commercial auto in Alberta, it's overall its 12% of the IFC book at this moment. And about a 3rd of that is represented VIP's of it, probably that there's obviously a physical damage.

So, we're talking about a 4% of our overall book that's exposed to be --.

Alain Lessard

Overall automobile portfolio.

Charles Brindamour

Yes. As I've had discussions with the government --.

Alain Lessard

Or [indiscernible].

Patrick Barbeau

Sorry. It's out to make sure 4% of the overall IFC is total or to be Alberta.

Doug Young

Okay. I guess that. Then is there discussion with the government right now about implementing performs. Typically you get a lot of inflation built in, and people kind of learned to work the system a little bit. And sounds like maybe some of that's coming through but is there conversations with the government around like price increases are great, but is there reformed discussions with the government ongoing right now?

Charles Brindamour

Yes. I mean, a number of us, myself and two other have been engaged since 2013 basically, with the superintendent and the government in Alberta to highlight where we saw pressure points and how they could fix it. And that's why when somebody asked earlier, what are you wishing for, so to speak, to hear is I'm wishing for the government to take action on what are I think very concrete proposals that would help alleviate the pressure.

Just to work here, Doug, we're not losing sleep over this. I think we've got a pretty good action plan, I think it's well contained. But I think it is in Alberta's interest and the governments own self-interest, I think you take a few of the concrete measures we've laid out for them.

Doug Young

And then just secondly, I mean, Ontario auto, I think you mentioned that you expect about three to five points of further cost reduction for Ontario Personal auto to come through. Can you remind me where that's coming from, because I think most of the catastrophic, dealer is actually the new catastrophic definition, correct me if I'm wrong. But maybe I'm wrong, where is the additional three to five points coming from?

Patrick Barbeau

We'll ask Mathieu to give you his perspective on.

Mathieu Lamy

The bulk of the reduction will come on the accident benefit side. There is three type of claims, we considering in accident benefit. I said there is the marks claim or what we call the minor injury claim there is the basic claims that are in the middle of the road and there is the CAT claim the more severe claims that on the basic and the CAT at the middle of the range and the higher portion of the range there is a reduction of coverage with an offer to buy back for insurer so that's where the reduction and benefit will be. And on the minor injury claims like it's just a different approach to treat these claims that the government will introduce this year. And most of it will be effective in 2016.

Doug Young

And sorry, so I guess the benefit from the CAT claim definition is not in the results yet so that's coming through in 2016.

Charles Brindamour

That's right.

Doug Young

Okay.

Charles Brindamour

I think there is meaningful stock coming in June and in aggregate when I look at where we were three years back when the 15% number was thrown on the table where we are today, I mean, the government work really hard to find as much as they could out of the current system to get a better deal so to speak for Ontarians and better allocate coverage so to speak or the need really isn't try to get flood out of the system so it's been a pretty healthy process as far as we are concerned and we are happy to growing that product.

Doug Young

And then to last, Louis I guess 625 million of excess capital is the number you put out there, what's the MCT you are assuming with this 625 million of excess capital?

Louis Marcotte

It's 203.

Charles Brindamour

No this is 170.

Louis Marcotte

Well I am sorry, it's measured from 170, yes.

Doug Young

That’s 170. So, I guess where I am going is that something, will you be comfortable running that 170 or what's the more normal MCT that you are comfortable running that I am just trying to wrap my mind around what excess capital in my view would be?

Charles Brindamour

I think Doug we would not run on the line. We would run in the upper 80s and the 90s but bear in mind that we have a number of things in our toolbox that are not reflected in excess capital position we have today. So, there is meaningful capital that could be I won’t say release, but capital required that could be reduced if we unlock a number of those elements in the toolbox.

Doug Young

What would those be Charles?

Louis Marcotte

You want to comment on that high level?

Louis Marcotte

Yes. So as you know we carry some long positions on stock with hedge on the other side or with shorts on the other side. On the capital front where we pay the capital on the long end we don't get the credit on the short end so those are typical buffers. So we could online those fairly quickly if we needed to generate additional capital so when we say we run we are comfortable running in the upper 80s or lower 90s it's because we know we can absorb volatility because we own those buffers and could eventually deploy them to absorb some stocks. So those are that's where we say we are in a strong position because we are, we do have excess capital, we are well above the minimum limits. But if we had to absorb some stocks or use capital on or deploy capital we always have those buffers to sort of absorb some of the volatility or the capital needs.

Doug Young

Yes, perfect. Okay that was what I was looking for. Thank you very much.

Charles Brindamour

Thanks.

Operator

[Operator Instructions] Your next question comes from Mario Mendonca from TD Securities. Your line is open.

Mario Mendonca

Good afternoon. One quick question. Louis when you refer to the 5% reduction in MCT if you could apply those assumptions to arrive at that 5% reduction apply those to your book value per share what sort of percentage hit would you expect?

Louis Marcotte

Between two and three I would say.

Mario Mendonca

Thanks very much.

Operator

[Operator Instructions] we do not have any questions at this time. I would turn the call over to the presenters.

Samantha Cheung

Thank you all for your participation today. Following this call the telephone replay will be available for a period of one week while the webcast will be archived in our website for a period of one year. A transcript will also be available in the quarterly financial archive. Our first quarter 2016 results will be released on May 4 of this year and our AGM will follow thereafter.

With that I would like to conclude the call. Thank you for your participation today. Thank you.

Operator

This concludes today’s conference call, you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!