Industrial Alliance's (IDLLF) CEO Yvon Charest on Q2 2016 Results - Earnings Call Transcript

| About: Industrial Alliance (IDLLF)

Industrial Alliance Insurance and Financial Services Inc. (OTC:IDLLF) Q2 2016 Earnings Conference Call August 4, 2016 5:00 PM ET

Executives

Grace Pollock - Director & IR

Yvon Charest - President & CEO

René Chabot - EVP & CFO

Michel Tremblay - EVP

Carl Mustos - President, Clarington Investments

Pierre Brodeur - President

Analysts

Meny Grauman - Cormark Securities

Robert Sedran - CIBC Capital Markets

Thomas MacKinnon - BMO Capital Markets

Gabriel Dechaine - Canaccord Genuity

Peter Routledge - National Bank Financial

Sumit Malhotra - Scotiabank

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Industrial Alliance Second Quarter Earnings Results. [Operator Instructions] As a reminder this conference is being recorded on Thursday, August 5, 2016. And it is now my great pleasure to turn the conference over to Grace Pollock. Please go ahead ma'am.

Grace Pollock

Thank you, and good afternoon, welcome to our second quarter conference call.

All documents related to our results, including the press release, the slides, MD&A, and the supplementary information package are posted in the Investor Relations section of our website at ia.ca. This conference call is open to the financial community, the media and the general public. The question period is reserved for financial analysts. A recording of this call will be available for one week starting this evening. The archived webcast will be available for 90 days, and a transcript will be available on our website in the next week. I draw your attention to the forward-looking statements at the end of the slide package. A more detailed discussion of the Company's risks is provided in our 2015 MD&A that is available on SEDAR or the IA website.

I will now turn the call over to Yvon Charest, President and CEO.

Yvon Charest

Good afternoon, everyone and thank you for joining us. We are reporting from Vancouver this quarter which explains the late hour for the call. With me today are Nomate Taite [ph], Assisstant to the President, Michel Tremblay, Chief Investment Officer; René Chabot, CFO and Chief Actuary, Mike Stiknip [ph], President of our U.S. operation and Carl Mustos, President of IA Clarington.

So far this year our results are simply outstanding with an excellent performance from our retail insurance and annuity business. For the seventh quarter in a row, our retail insurance in Canada and in the U.S. have good momentum with an overall increase in sales of 18%. We had strong contribution from the U.S., up 35% and our adjustable disability product up by 37%. Our IA, auto and home had a good quarter with the return premiums up by 12%. This reflects organic growth and a contribution from new agreements signed last year.

Under wealth management side, our seg fund business delivered its 10th straight quarter in positive net franchise while the industry is in net redemption. We still hold the number one position in Canada for the net fees and is third for assets. Our Mutual Fund business is not yet out of the woods but there are some bright spots. Net outflows have begun to slow down and fund performance has improved over the last 12 months. Our assets under management and administration were up 4% this quarter because of market growth, and the integration of new advisors as part of recent acquisitions by our distribution affiliates. In the group sectors, growth was little slower in both insurance and savings, with the exception of deter services that pair from well across our products.

So overall, one of our best quarters on record; book value per share was up 3% over last quarter, mainly because of the strong profit and we declare a dividend of $0.32 per share to all common shareholders. René will now comment on our first quarter profitability.

René Chabot

So second quarter profitability; so good afternoon ladies and gentlemen, we are extremely pleased with the strength and the quality of our net earnings in the second quarter. In addition to lower strain on new sales, we reported favorable policy from all line of business which supports our 2016 plan. Earnings at $1.35 per share was 17% above the top of guidance for the quarter. After adjusting for exceptional items, our estimate of core EPS was $1.26 which is a 10.5% increase over the same quarter of last year. With these outstanding results, we are above our guidance for the first half of 2016.

Experience gained for the quarter are detailed on Slides 5 and 6. Q2 was a second outstanding quarter this year for policyholder experience with gains of $0.10 EPS. In our insurance operation, individual insurance report again $0.04, mainly for morbidity. This is the fifth consecutive quarter, our favorable policyholder experience or retail insurance. On the group side, employee plan shows continuous improvement with again a $0.02 from long-term disability. Overall, group insurance added a net gain of $0.01 reflecting a small loss at SMS and in line results at the other services. In our wealth operation, individual wealth gained $0.03, mainly from longevity, as well as lower expenses.

Group savings report investment and experience gains representing $0.02 per share. For the year-to-date, the gain from policyholder experience totaled $0.19 per a share with a good improvement from employee plan, a key element of our 2016 plan. Strain improvement is another important part of this plan, and did not disappoint again this quarter. Strain was 13% in Q2, below our guidance of 15% for the year. The lower Strain which added $0.01 to our EPS this quarter was mainly due to the higher sales volume in both, Canada and United States. We also have a few other items that contribute favorably to our results this quarter. We had again a $0.10 from our hedging program and $0.01 from higher MEA as a result of favorable equity markets. We had tax gain of $0.03, mainly for true-ups related to 2015. Finally, income on capital generated a net gain of $0.01 from higher investment income, partially offset by lower result IA, auto [ph].

My last comment is on the recent movement that we have seen in the long-term interest rates. First, I want to remind you that prior year rates don't matter. At the same time, given the drop in rates since the beginning of the year, we feel it's important to give you an update on where we stand at June 30 taking into account investments again done in the first half of the year.

On Slide 11, you can see that the protection that we have in Reserve at the end of Q2. In other words, rates can drop 29 bips or as low as 1.44%. We are monitoring the situation very carefully and we continue to actively manage our asset portfolio to improve that position. The movement in rate also had an impact on our capital position. At quarter end, our solvency reissue was 199% versus 2.05 at the end of Q1, reflecting mostly the drop in a long-term rate during the second quarter. At this level, our ratio remains well within our guidance.

Those are my comments. Operators, we will now take the questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first questions come from Meny Grauman from Cormark Securities. Please proceed with your question.

Meny Grauman

Good afternoon. I know you talked about it at your Investor Day which wasn't so long ago, but just wondering if you have any more to say on a potential for URR cut in terms of just the timing and the quantum that you forsee?

Yvon Charest

Meny, I don't have no additional information to provide on URR. At the end of today, we disclosed what was ahead of us, as we also mentioned that we were waiting from one critical information which is basically what the CIA is going to do on that metrics. So we are almost sure that nothing's going to happen in 2016 and we know that probably some things will be disclosed in 2017 on that metrics. So that's a key information for us and we are waiting for it.

Meny Grauman

Okay. I guess, another competitor that reported today and sort of -- took a sort of seemingly a proactive stance when it comes to that -- I guess, do you foresee doing anything this year in anticipation of something that will likely come 2017?

Yvon Charest

We mentioned that we would like to be ahead of the curve, we mentioned that at the Investor Day, It's still an option. We also mentioned that we want to hide in 2016 or 2017. So the reality is that I would like to have hold the cards in my hands and basically we give you some information when we disclose into third quarter about what's going to happen at year-end. When we have finalized all our experience study and I do have all that information. So at the moment, it's a bit premature for me to give you indication of what we're going to do. We have to wait and see what's going to be, hold the cards in our hand basically.

Meny Grauman

Okay. And then if I could just change tracks a little bit and just ask on the Auto Finance business, the chrome [ph] business; I don't see any disclosure but just in terms of an update on loan originations and anything that you can mention in terms of credit experience during the quarter?

Yvon Charest

Well, first of all on the loan origination, what I can tell you is that it's going -- I would say better than what we had expected so far, so things are on plan. In terms of credit losses, it's -- there has been absolutely no impact in the quarter. I mean when I see an impact, I mean a negative impact on the credit losses.

René Chabot

And with respect to disclosure Meny, we are working on it and we expect to add something in Q3.

Meny Grauman

Great. Thank you very much.

Operator

And our next question comes from line of Robert Sedran from CIBC Capital Markets. Please proceed with your question.

Robert Sedran

Hi, good afternoon. René the press release suggested that the weakness in IA, auto and home related to seasonal factors. And I guess I'm not quite sure why Q2 would have been seasonally weak. Can you add some color to that?

René Chabot

Yes Robert, we just had more fire than usual, basically, that statistical situation.

Robert Sedran

So it's not from a seasonal, it's just kind of bad luck?

René Chabot

Is just bad luck.

Robert Sedran

Okay. And when I look at the performance over the last couple years, there has been a little bit of bad luck in this business, and I know -- like in the employee plans when you get on a run of some negative performance -- you were able to turn it around and are now on the other side of that. Is there something you can do in this business to sort of restore the profitability on an annual basis because it hasn't been -- it's been a bit of a drain for the last couple of years?

René Chabot

For sure, Robert, and we're going to tackle that issue. But you have to keep in mind, if you remain our disclosure with the Q4, we told you that we have entering to two special partnership; one with CAA Quebec, and that partnership is creating a kind of extent drag on us right now because we didn't have the business and we invest to get basically the business. And we fully disclosed that element last year when we gave you the run rate on that high yield to home situation for the year. And right now we are basically working with that run rate, and the only deviation we got was the one I just told you, which is the fire situation. So we know that there is going to be some -- it's going to take some years to get back to what we expect but we know that there is going to be good improvement over the next two.

Yvon Charest

It's Yvon Charest. When Rene mentioned some years, it's for the joint venture in which we have initially some cost. As for the claim experience, the guy have done quite of an analysis; our assessment is just of bad luck. So it should not be recurring because otherwise we would have to fix something.

Robert Sedran

Okay, thank you.

Operator

And your next question is coming from the line of Thomas MacKinnon from BMO Capital. Please proceed with your question.

Thomas MacKinnon

Thanks very much and thanks for taking my question here. If I was to look at the interest rate story here, we've got significant decline in the Canadian 30-year, but you seem to suggest it start at 216 and you project it all the way down to 144. So that, just given the way your sensitivity is, in terms of earnings, that would be a little over seven times $31 million, because each 10 bps on the IRR is $31 million. So it seems -- are you saying that you've got $223 million in sort of management actions you would have potentially to offset if the rates did get down to 144? Is that what you're trying to suggest? You've already got those things at hand to be able to offset that?

Pierre Brodeur

Not exactly, Tom. The decrease in rate was 45 basis points, basically. So that was the decrease that happened in rates and if you apply that 45 basis points, it's one four-time 30 million and you see that I haven't offset totally debt decrease because my margins moved to 29. So you have to factor in all these other [indiscernible 16;22] calculations. And if you do it, you will get a good idea of what happened.

Thomas McKinnen

At the end of 2015, you don't really recalibrate the -- so on annual basis, 30 year has dropped more than -- if it went down to 144, it would drop significantly more than 40 basis points. It would drop like another -- so if we went from 216 to 144, would you have enough management action and stuff on your balance sheet to be able to handle that? Because that's what you seem to suggest: that you've got these buffers to take you all the way down to 144. Am I reading that correctly?

Pierre Brodeur

You're reading it correctly. It is an update of what we are at June 30 with the rates at June 30 and with the level of protection that we had at June 30. And it's only investment gains driven and interest rate driven. And I say it just for one purpose, you all know that we retain more mortality risk than the rest of the industry and you all know that usually in every year, I'm making some mortality gains. I haven't factored any of these elements in that presentation.

Yvon Charest

Tom, it's Yvon Charest. The way I see it, you know I'm no expert, but our protection went down 14 bps whereas rates went down 44 bps. So it means that somehow we have been able to find ways to pay for the 30 bps decrease. And if we say that the IRR volatility is $31 million per 10 bps it means simply that we have management action of about $100 million so far this year.

Thomas McKinnen

And if it went down to 144, you still would have additional management actions at your disposal to offset that? Is that -- I'm just trying to understand that charge there; sorry.

Pierre Brodeur

The investor show talks about all the tools added in toolbox to do some transactions on his portfolio to create these investment gains and to face this situation. So that's basically what we said when we mentioned that we are carefully following the situation and we continue to actively manage our portfolio, we continue to do some investing and gains and we continue to be in a situation that we could improve that positioning.

Thomas McKinnen

Okay, and a question about the URR and the [indiscernible 19;17] rate. In your investor data, I think you talked about a 20 basis points potential reduction and that promulgated rate, and that maybe to stay ahead of the curve but now I get the impression that you're sort of going to wait and see what that promulgated rate is and then really act when the standards Board put that in place, that would be 2017 year end situation. So if it was 20 basis points, I mean that's a $130 million potential hit as it stands right now to your earnings and that would probably be, I guess, about a 6-point hit to your capital, too. So do you have at your disposal potential investment gains and other management actions to be able to withstand that and why not attempt to take that now or -- and why wait till 2017 on that?

Yvon Charest

At the Investor Day I provide the information in the context of this interest rate being low for long. So I just provide information to the community of what was in front of us and I split it in two parts; to shot off 20 basis points, one in 2016, one in 2017, and one later on. So that was the first of them I shared with everybody. I also mentioned that we want to be ahead of the curve, I mentioned that; we have done that in the past and want to continue to do that. So the key point here will be what's going to happen in the next part of the year, we are not there yet, we -- do you have assumption. As you know in Q3, in November we give you a flavor -- a collar on it when we're going to be there would give you to color. So many things could happen in the meantime, we continue to work actively or partner [ph], we don't know where to risk is going to be, we don't know what the mortality gain we're going to have, we don't know many other assumption. So we'll make up our homework's and would give you further light in Q3, in November, when we're going to disclose our results. Right now we still have all the option on our table, we haven't closed any option.

Thomas McKinnen

Okay, thank you.

Operator

[Operator Instructions] And our next question comes from the line of Gabriel Dechaine from Canaccord Genuity. Please proceed with your question.

Gabriel Dechaine

Good afternoon. Just on the MCC side of that, maybe I just miscalculated the sensitive but the decline in -- from rates this quarter was negative by six percentage points. Was there anything unusual in there that caused it to be a bit more acute or am I just doing the math wrong?

Yvon Charest

I think Gabriel, you've done the math wrong.

Gabriel Dechaine

I was hoping for a different answer but anyway...

Yvon Charest

Because it's totally aligned with what we publish in our capital metrics; so the thing that could have been different here is we have some seg fund, I would say noise; and we didn't any in the quarter. So if you pick the capital metrics we disclosed at year end and you apply to -- we have seeing rates, you'd be pretty close to what we disclose.

Gabriel Dechaine

Then the group insurance business; it looks like we're running consistent experience gains now for a few quarters, group LTD was good again this quarter. What's the outlook for 2017? Are we going to see -- is it too soon to expect that you're going to have higher expected profits in 2017 because they think you've fixed the business completely and so now you can kind of rate your profit expectations?

Yvon Charest

Definitely too soon Gabriel, this is something we're going to share with you in January when we publish the fourth quarter. That been said, we are very pleased with the result because the second quarter in a row with very good result, very strong result. We are well ahead of that. Well, ahead of our plan this year with respect to that, and we finally start to seeing the traction of all the effort that we have done in that segment. So we are very pleased with it, we're still working on it, and we would like to continue to pile additional quarter like that before declaring that we are half the bushes.

Gabriel Dechaine

Okay. And then just my last one; a follow-up on Tom's -- I'm hoping to clear up -- who can simplify this a little bit. What was the long-term interest rate or the IRR rate I guess at year-end. Where is it today? And what is -- and from today's you saying you can you have some tools to get you from that rate to 144 basis points. Is that -- can walk we through that which is very high level.

Yvon Charest

At year-end, the IRR was 2.17, that where mid-year end [ph], we closed the quarter-end at $172 million, $173 or $172 so it's basically 45 basis point decline. And this is what [ph] gas evolved used to mention that you see that my protection has basically reduced by 14 basis point, then you get to the math that he has done saying that we had headwinds because of 30 basis point so that we have management. And we continue to work our portfolio to improve our position with respect to that.

I'm was just going to throw it out there but if we go below one 144 basis points, what is the long term yield a high percentage point, I to hate to think of it but who knows – can you absorb that? You get back to present that Michelle has done at the Investor Day where we explained to you how the elements that we have in our tool blocks to face say the situation.. I feel extremely pleased to be in that position. June 30, very poise about that. I feel ahead of the curve and we continue to take position with respect to that. And I think I think it's a very good outcome.

Gabriel Dechaine

Well, thank you and good quarter.

Operator

[Operator Instructions] And our next question comes from Peter Routledge from National Bank Financial. Please proceed with your question.

Peter Routledge

Kind of a theoretical question about how you'll manage your capital? Your MCCA or solvency pardon me, is down to 1.99 nine but you also have lower leverage ratio as I can remember you having so there is plenty of have capacity for sub debt and pressure issuances to boost solvency ratio. And I'll turn it in a way would be to create a holding company structure -- it appears to issue senior debt and downstream equity into an operating company. Have you thought of that and will you?

Yvon Charest

Peter, this is Yvon Charest, we have looked at this legally possible to do that. What we have to consider is the following; our S&P rating at the ordering companies is single plus. And I told you in the past that none of the big holding company has a better rating than us. So if we were to have a structure similar than them, the key question for us is that what would be the rating at the operating company level and would that rating be good enough at the end of the day to have a better cost versus reward? So we concluded after looking at it that we better have to continue with the current structure for the foreseeable future.

Peter Routledge

Okay, that's really helpful. And then on the maybe -- just on the hedging experience; I guess I'm having difficulty forecasting hedging gains and losses over the last four or five quarters just given the volatility. Could you guys provide any guidance as to what might cause sizable hedging experience loss versus sizable gain, like what should I be looking for?

Michel Tremblay

It's Michel Tremblay. It would be uneasy to come with the very specific guidance we gave in the past some qualitative guidance. The first one is on the volatility. If the volatility of the market, both on the stock market interest rates lower than what we expect or the long-term average, we're going to produce again. If it's higher, we're going to produce a lot. It's is built in the process. The second one is the business risk the risk of the edge. And we said that generally speaking when a market this up we're going to gain when it is down. We're going to do so this is the quality of the gadgets we've given and it would be I think I'm safe at this moment to be given more price precise guidance than this one.

Peter Routledge

So it's a lower volume and so steadily increasing markets produce hedging?

Michel Tremblay

Yes, two parts, if development of their stock markets and interest rate is lower than the long-term average which is our expectation, we're going to win. And secondly, on the risk of the as the basis risk if the markets are going up we're going to win if they're going down, we're going to that's a quote that they've got as we've given the past is still more of the same that despite. It and Peter on the what if that's the only thing we have done is to give you cites sixteen that give you an idea of what we. That's an experience awaited thing, it's almost impossible to bet what's going to be

Peter Routledge

Okay, fair enough. Thank you.

Operator

[Operator Instructions] And the following question comes from Sumit Malhotra from Scotiabank. Please proceed with your question.

Sumit Malhotra

Thanks, good afternoon. I apologize if this was already because I was a bit late getting on the call them like my question starts with the strain. Just looking at the quarter-over-quarter change, I think you're down from 17 in 13 in Strain and the only comment I saw in the documents was higher sales in Canada and the US. Just -- maybe looking for some more color there; was there a business -- I'm guessing a business mix -- what exactly was the key change quarter-over-quarter that helped drive that increase?

René Chabot

Sumit, that's the seasonality factors because our guidance in the market is 15% plus minus 5% and in the first quarter it's plus 5% and last quarter it's minus 5%. So the reality is this train guidance is 20% in the first quarter, 15% in the second, 15% in the third, and 10% in the fourth. So this is the this is the reason why you see the quarter-to-quarter difference because the seasonality of our expenses, because of all of RSP season that we have, we sell less life insurance in the first quarter and we sell more in other quarters.

Yvon Charest

This being said when the money mentioned is his note that the main reason is volume, it's just because that we sold so much into Q2 versus expectation, that we were able to absolve our fixed with much more policies. And that is an impact and this is why we like the idea that these are going up in the old country because just the volumes were out automatically the strain percentage of premium.

Sumit Malhotra

Just to keep it simple, I've always you know kept in mind a rule of thumb when you have a situation where rates are falling your strain is going to go higher unless you take pricing actions or change the mix of business. You guys said now it's simplistic but I only bring it up because you guys have been immune to that certainly over the last year. So with this renewed drop that we've had in yields, is there anything that makes you somewhat concerned that the trend you've had in strain improvement is somewhat at risk?

Yvon Charest

The answer is no. We watch very carefully that situation Sumit, and as you know, we froze our interest rate scale at year end for the reserving process and it has an impact on both, all our quarter, as well as the strain valuation. So what's going to happen is that when we're going to be at year end 2016, we're going to reset the clock and then we will put everything into the equation; the new interest rate environment, the new mortality environment, the new assets that we're going to have, and then we'll provide a guidance to the marketplace with respect to what's going to be the strain in 2017. We mentioned to you at the Investor Day that the next target for us is 10% and even if these rates have been lower this year, we keep track with that target for the next future years.

Sumit Malhotra

Thank you for that. Last one is for Carl, if he's in the room. Carl, you gave us the helpful hint that you're looking to have mutual fund net sales positive on a full year basis in 2017, so clearly want to pay attention to the trend in that regard. I was happy to see that at least on a gross basis the mutual fund sales were stronger this quarter, I know markets were better but historically with our a species in Q1 has been your strongest period, so to see Q2 look better was positive. Is there any specifics you can provide me with -- was this just market driven or are you starting to see some of the distribution, investments, improved performance start to come through?

Carl Mustos

Thanks for the question, this is Carl here. We were pleased too with our improved gross sales in Q2 over Q1 against what would be our key trend. I think the big driver though was really a performance improvement. Across our lineup we had a significant relative performance improvement that was recognized in the marketplace and some of the new products that we launched speak to the income scene that we talked about [ph], as well as our managed solution that we launched for our affiliates. So we're quite encouraged -- it's early days and it was a modest increase. I think what we're most excited is the decline in redemptions that we've experienced over this timeframe which we think is a really good indicator and bodes well going forward.

Sumit Malhotra

Thanks for time.

Operator

And there is no further question at this time. I would now turn the call back to you.

Grace Pollock

Thank you. So this concludes our conference call today. If you further questions on today's results, you can reach us at 418-780-5945. And we thank you for joining us today.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for participation, and ask that you please disconnect your lines.

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