Intact Financial Corporation (IFCZF) Q4 2022 Earnings Call Transcript

Intact Financial Corporation (OTCPK:IFCZF) Q4 2022 Earnings Conference Call February 8, 2023 11:00 AM ET

Company Participants

Shubha Khan – Vice President-Investor Relations

Charles Brindamour – Chief Executive Officer

Louis Marcotte – Chief Financial Officer

Patrick Barbeau – Executive Vice President and Chief Operating Officer

Darren Godfrey – Executive Vice President-Global Specialty Lines

Ken Anderson – Executive Vice President and Chief Financial Officer-UK & International

Conference Call Participants

Paul Holden – CIBC

Geoff Kwan – RBC Capital Markets

Doug Young – Desjardins Capital Markets

John Aiken – Barclays

Tom MacKinnon – BMO Capital Markets

Mario Mendonca – TD Securities

Lemar Persaud – Cormark Securities

Nigel D’Souza – Veritas Investment Research

Jaeme Gloyn – National Bank Financial

Operator

Good morning, ladies and gentlemen, and welcome to the Intact Financial Corporation Q4 2022 Results Conference Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on February 08, 2023.

And I would like to turn the conference over to Shubha Khan, Vice President, Investor Relations. Please go ahead.

Shubha Khan

Thank you, Surbhi. Good morning, everyone, and thank you for joining the call today. A link to our live webcast and published information for this call is posted on our website at intactfc.com under the Investors tab. As usual, before we start, please refer to Slide 2 for cautionary language regarding the use of forward-looking statements, which form part of this morning’s remarks, and Slide 3 for a note on the use of non-GAAP financial measures and important notes on adjustments, terms and definitions used in this presentation.

With me today, we have our CEO, Charles Brindamour; our CFO, Louis Marcotte; Patrick Barbeau, Executive Vice President and Chief Operating Officer; Darren Godfrey, Executive Vice President, Global Specialty Lines; and Ken Anderson, Executive Vice President and CFO, UK&I. We will begin with prepared remarks followed by Q&A.

With that, I will turn the call to Charles.

Charles Brindamour

Thanks, Shubha. Good morning everyone, and thank you for joining us today. 2022 was an important year in Intact’s journey. This was the first full year following completion of the landmark RSA acquisition and we made big strides towards fully integrating the acquired business. At the same time, we maintain our focus on performance with solid results despite elevated catastrophe losses and inflation pressures. We delivered net operating income per share of $3.34 for the fourth quarter and $11.88 for the full year. Excluding strategic exits, premium growth was 5% in the quarter, a point higher than in Q3, a sign of momentum building as markets are firm or firming across most lines of business.

For the full year, premiums increased 23%, primarily on the back of the RSA acquisition. The overall combined ratio for both the quarter and the full year was solid at 91.5%. This reflected strong performance across commercial and specialty lines in all regions and first lines in Canada. Together with robust investment and distribution income, this drove mid-teens operating return on equity and ROE in 2022. And I expect the full year outperformance to be well in excess of our objective to outperform by 500 basis points of ROE. Our results are a testament to the resilience of our business. We move into 2023 with positive top and bottom line momentum and a strong balance sheet. This enables us again to raise our quarterly dividend by $0.10, the 18th consecutive annual increase.

Let me now provide a bit of color on the results and outlook by line of business starting right here in Canada. In personal property, this business continues to demonstrate great resilience in the phase of increasingly frequent and severe weather events. The combined ratio was 76.9% in the quarter, 90.1% for the full year, and as averaged sub-90 over the last five and now 10 years. Weather and sharply higher reinsurance costs are driving hard market conditions. We expect rate increases to remain in the high single digit range and keep pace with loss cost trends. In personal auto, premiums grew 2% year-over-year, a 3 point improvement compared with the third quarter. The top line momentum was a function of both our early rate actions as well as firming market conditions. Retention levels were strong and the pressure on new business volume moderated. We expect that our competitive position will further improve as the market continues to reflect inflation in its pricing.

Our underwriting discipline resulted in a combined ratio of 95.8% in the quarter. This included nearly 1.5 points of adverse seasonal weather as well as one point of non-recurring loss adjustment expenses. The favorable impact from prior years was solid at 7 point, slightly above what we expected, but as I’ve mentioned before, prudence from the past is paying off, but the current accident year is also prudent. So we continue to look at both current and prior years combined when we assess the performance of this segment. There are a number of reasons why we’re comfortable with our sub-95 guidance. From a cost perspective, inflation pressures are easing. The increase in claim severity was 11%, 2 points lower than in Q3. We expect that deceleration to continue in the coming months. Then on the frequency front, the number of accident continues to be benign relative to pre-pandemic levels, even though it was up from the prior year.

Our run rate assumes frequency will gradually increase in the coming months, and finally, written rates and insured values increased by close to 9 points in aggregate by December, while only 5 points has been earned in Q4. So when I look at our starting point and integrate these observations, I feel strongly about our sub-95 trajectory and obviously we’re comfortable growing in this environment. In commercial lines, premiums increased 7% in 2022, excluding the impact of the RSA acquisition. Growth continues to be supported by our rate actions in hard market conditions. The combined ratio is solid at 87.9%, reflecting our profitability actions over time. Looking at the industry, we see hard market conditions continuing given rising reinsurance costs, elevated CAT losses and inflation pressures. Our business remains well positioned to deliver a sustainable low-90s or better performance.

Moving now to our UK&I business, the combined ratio was 104 in the quarter and 97 for the full year. In personal lines, premium decreased by a modest 3% in Q4 after adjusting for the sale of our Middle Eastern business. The decrease primarily reflects our continued pricing discipline in a competitive market. The full year combined ratio of 106.2% included 6 points of CATs more than anticipated, as well as increased subsidence claims following a very dry summer. Adjusted for elevated weather related losses, the run rate performance of this business remains in the high 90s despite inflation pressures.

Market conditions have started to firm. We expect this to continue in 2023 supporting further rate increases. In commercial lines in that region, underlying premium growth was 9% in the quarter after adjusting for business exits. We continue to benefit from hard market conditions, which are supporting high single-digit rate increases. The full year combined ratio of 90.4% reflected the underlying strength of the platform and prevailing market conditions. We expect to operate this business in the low 90s over the next 12 months. Despite challenges in the fourth quarter, our UK&I business remains on solid footing overall.

At closing, we indicated that it would take approximately two years to fully evaluate our propositions across the UK&I portfolio and take the action necessary to drive outperformance. And while that timeline remains, we’ve already taken significant steps by exiting over $500 million of business with a combined ratio above 110%. The earnings power of that business is clearly improving. Our U.S. commercial business delivered premium growth of 18% in 2022, excluding the impact of exhibit lines. This was driven by the Highland acquisition, strong growth and high performing businesses and rate increases in hard market conditions across most lines. The full year combined ratio was strong at 88.2% reflecting our continued profitability actions. The business continues to perform very well with rates tracking ahead of loss cost trends. We’re well positioned to deliver sustainable low-90s performance or better in the U.S.

Turning to our strategic initiatives, the RSA integration remains very much on track. In Canada, policy conversion is progressing well and retention is tracking in light with RSA’s historical experience. On the digital front, our mobile app saw over 4.5 million visits by customers in the fourth quarter. More than half of all online transactions are now completed via our mobile app, which is driving greater UBI uptake and digital engagement. And finally, we continued to enhance our AI capabilities during the year. The Intact Data Lab team has grown to over 500 professionals, underscoring our ambition to be the leading AI shop in the insurance world. To date, the lab has delivered nearly 300 models that have in aggregate yielded almost 100 million of run rate underwriting benefits.

As I said at the outset, 2022 was an important year for Intact. We made excellent progress in integrating RSA in advancing our strategy and the performance was strong despite heavy headwinds. This is thanks to the strength and dedication of our people. At Intact, we’re very focused on making sure we have the very best people. We’re working hard to ensure they’re proud of what they do and feel like they’re part of the winning team. And again, this year our efforts are recognized as were named a best employer in Canada for the seventh consecutive year, and in the U.S. now for the fourth year running. Our sites are now furling on 2023 and beyond. The business overall is operating at a low 90s combined ratio and the outlook for investment and distribution income is strong. We’re well positioned to deliver again this year on our objectives to grow net operating income per share by 10% annually over time and to outperform the industry ROE by 500 basis points every year.

With that, I’ll turn the call over to our CFO, Louis.

Louis Marcotte

Thanks, Charles, and good morning everyone. While 2022 was the first full year in a largely post-COVID world, our industry has nevertheless been faced with a number of other challenges. Inflation and severe weather chief amongst them, but there was also tight labor markets and capital markets volatility. In that context, I’m pleased to report solid results for both the quarter and the full year. The overall combined ratio for Q4 was 91.5% despite inflationary pressures and challenging weather conditions in Canada and the UK. Our Canadian and U.S. businesses delivered sub-90 combined ratios and investment and distribution earnings were strong. On a full year basis, the combined ratio was solid at 91.6% further underscoring the strength and resilience of our platform. CAT losses in the quarter were $167 million driven largely by windstorms in Canada and severe winter weather in the UK.

This figure is higher than the $143 million estimate we announced in early January, reflecting a number of late claims notifications and higher costs per claim than expected in respect of the UK freeze event. This takes total CAT losses for the year to $826 million, above our $600 million expectation. With these results in mind, we are increasing our annual CAT guidance to $700 million. We expect approximately 70% of losses to occur in Canada and approximately 25% in the UK&I. Within Canada, approximately two thirds of losses are expected in personal lines. The increase to our guidance is driven by a combination of growth in inflation, higher CAT losses and the impact of reinsurance renewals. We expect the overall earnings impact to be offset by rate actions, much of which we have put through last year in anticipation of higher reinsurance costs. Favorable prior year development was healthy at 3.8% for both the quarter and the full year, largely in line with expectations.

Net investment income increased by 27% in the quarter, reflecting higher yields and higher turnover. For 2023, we expect investment income to be approximately $1.1 billion as we continue to take advantage of current market rates. Distribution income was $93 million in the quarter, taking annual earnings to $437 million. This is a 21% increase over last year reflecting accretive acquisitions, organic growth and a solid contribution from OnSide. Looking ahead to 2023, we expect to grow distribution earnings by at least 10%.

Now let’s turn to our underwriting results starting with Canada. In personal auto, the combined ratio increased by 8.3 points compared to a low 87.5% last year. Severity increased as expected given inflationary pressures, but these pressures have eased a bit compared to Q3. Frequency increased year-over-year by almost 5 points. This was due to more driving compared to a partially locked down quarter last year, as well as worse and normal weather. Prior year development was strong in the quarter at around 7 points, reflecting our reserving prudence over the years. While this is slightly higher than expected, we expect prior year development to remain strong as we continue to reserve cautiously.

Finally, we are seeing the positive impact of our written rates as they are starting to earn through. The impact will increase further in 2023 with earned rates accelerating from mid to high single digits as they catch up to current written rate levels. With inflation decelerating, we expect that positive impact on results going forward. Our guidance remains sub-95 for this business keeping in mind there will be normal seasonality in the results, particularly in Q1. In Personal Property, another solid quarter with a 76.9% combined ratio, 2.6 points better than last year due to lower CAT losses. The underlying loss ratio increased in the quarter by 3.9 points compared to a benign Q4 2021, primarily driven by higher large losses.

In commercial lines, the combined ratio was solid at 89% despite 6 points of CATs in the quarter, which mainly reflected further development of losses from Hurricane Fiona. Both specialty lines and regular commercial lines contributed to a strong underlying result. Favorable prior year development was healthy at 3.4%, though 3 points lower than last year, reflecting the lumpy nature of large claims development. The overall expense ratio in Canada was 29.7%, around a point lower than last year due to lower variable commissions. General expenses were up in the quarter largely due to timing of expenses between quarters and higher variable compensation tied to outperformance.

Turning now to the UK&I. In Personal Lines, the results include over 20 points of CAT losses, which is 19 points more than expected. Almost all of these losses related to prolonged sub-zero temperatures in December, which resulted in burst pipes in thousands of homes across the UK. In addition, there were a number of non-CAT large losses and inflationary pressures continued to weigh on both motor and home. In commercial lines, the combined ratio was a solid 92.8% driven by the continued strong performance of our regions and specialty businesses. At 90.4 for the full year and with market conditions remaining favorable, this business is well positioned for profitable growth.

In our U.S. segment, the combined ratio was strong at 85.1% with the underlying loss ratio improved by 7.2 points. Thanks to our profitability actions and favorable market conditions. Growth in this business is skewed towards our highest performance – performing lines, which tells me that we have been successful at managing the business mix. I’m encouraged by what this means for this business going forward and our ability to deliver a sustainable low-90s or better combined ratio.

Looking at our Global Specialty Lines, business in aggregate, premiums grew by 12% over the year to $5.5 billion, while delivering a combined ratio of 86.2%. Our U.S. business is not the only one to perform well. Specialty lines in Canada and UK delivered combined ratios in the 80s. In 2022, all driven by our continuous effort on profitable growth and outperformance supported by good market conditions.

With regards to the RSA integration, we estimate annual synergies to have hit a run rate of $260 million and we remain well on track to achieve our revised target of at least $350 million by mid-2024. We also recorded an additional $58 million of tax recoveries this quarter in the UK, which drove a reduction in the effective tax rate. The gain is driven by a more positive outlook on profitability in the UK from both underwriting and investment income. This outlook allows us to recognize more tax loss recoveries from the pool of unrecognized losses, which have been accumulated over time by RSA. There are north of $3 billion of such losses in the off balance sheet in the UK and Ireland as at December 31.

We have not reported these recoveries as run rate synergies given their lumpy nature, but they are part of the value created by the acquisition. We are certainly aiming to capture more of these losses in the future. With regards to value creation over the full year, RSA contributed 16% accretion to NOIPS and we’re confident of this rising to 20% by 2024. Overall, the IRR for the transaction remains over 20%.

Moving now to the balance sheet where our financial position continues to be strong, despite the macroeconomic environment. We closed a quarter with total capital margin of $2.4 billion and a debt-to-total capital ratio of 21%. Book value per share grew 2% quarter-over-quarter as solid earnings and gains in our investment portfolio more than offset large mark-to-market losses in our UK pension plans.

Given our outlook on earnings growth and the strength of our balance sheet, we once again raised our dividends this time 10%, which represents a 10-year CAGR of 10%. We are also renewing our share buyback program in February on the same terms as the existing program. While this extends our flexibility to purchase additional shares, we will continue to be disciplined in this regard.

As we wrap up another successful year in a challenging environment, we are already laser focused on making 2023 even better, including a smooth transition to IFRS 17. While this will bring a number of changes to our key reporting metrics, these are mostly geography changes within our results, and as such will have no significant impact – no significant impact on our net operating earnings over time. I encourage you to refer to our MD&A, which hopefully provides a helpful summary.

Overall, as we look forward to 2023, there is much to be positive about. We start the year in a strong position despite recent headwinds. Our earnings resilience is evident and our balance sheet is strong. With the platform we have in place a clear roadmap and an opportunistic mindset. I’m confident we will continue to outperform over the next year and beyond.

With that, I’ll give it back to Shubha.

Shubha Khan

Thank you, Louis. In order to give everyone a chance to participate in the Q&A, we would ask you to kindly limit yourselves to two questions per person, and of course if there’s time at the end, you can certainly re-queue for follow-ups. So Surbhi, we are ready to take questions now.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And your first question will be from Paul Holden at CIBC. Please go ahead.

Paul Holden

Thank you. So just want to make sure I hear you correctly on personal auto, and I don’t think your message has changed that much. But the way I’m sort of thinking about 2023 is, slowing claims inflation as you’ve talked about, and then accelerating premiums earned and maybe sort of a net benefit of something like two points to four points, and then with higher than normal PYD release higher than your forward guidance on PYD, maybe being a drag of two points to three points next year.

So if I think about that as very simple math, that basically gets me to a 2023 combined ratio that’s roughly flat versus 2022. Like am I missing anything there? Is that kind of what your guidance is pointing to broadly?

Charles Brindamour

I think your read is good. Paul, and I think that’s a good way to unpack, the trajectory of personal automobile or guidance has not changed. It is sub-95. I’ll ask Patrick to give you some color maybe on some of the elements that that you have laid out. But I think directionally I would agree with how you analyze that. Go ahead, Patrick.

Patrick Barbeau

Yes, I agree totally. The – if I look at the 95.8% combined ratio of Q4, there was, as we said about two and a half points between weather seasonality, and the one-time adjustment on expenses. The PYD was slightly higher than expected, but that’s and yes, as we said earlier, that we don’t look in isolation. We had a prudent reserving approach since the beginning of the pandemic because of uncertainty and we continue to do so, because there is still uncertainty around where the inflation will go exactly.

We’ve seen very good signs of reduction in inflation from the 13% in Q3 to 11% in Q4, and the drivers of that reduction are as we expected. So on car parts, on market values, we see these and this is slowing down. So overall, I think the your analysis is very much aligned. Two, maybe nuances I would bring is, if you look at the full year, I don’t – I’m not sure that we expect the PYD to go down by two points to three points next year necessarily even continue to reserve prudently in the correct.

On the other end though, our pricing assumptions assumes that there would also be a bit of an increase in frequency year-over-year given there was a ramp up in the earlier part of the year and our pricing assumes that it will continue to migrate towards normal even if over the past three quarters it was very flat. Overall these two are the slight nuances, but overall very much aligned with on [indiscernible].

Louis Marcotte

Yes, yes, I think PYD not too far off. I guess from what we’re seeing here to date in my mind, provided frequency in the past does not start the deteriorating obviously, but they’re actually right Paul, thanks for the question. Good read.

Paul Holden

Okay, thank you for that. And then second question is related to the UK&I business, and I guess the Personal Lines, in particular, 121 combined ratio for the quarter 106 for the year, I think even it’s in your commentary of exclude CAT losses is still kind of generating a below target combined ratio. Is there anything structurally related to the regulatory pricing reforms or otherwise that would prevent you from rectifying that situation? Bring it down more into the target zone, and if no, maybe you can give us some more specifics on what exactly the action plan is to produce a better combined ratio in UK personal lines. And I’m talking, I guess I’m talking mostly, I just want to be specific on the property side more than more than auto.

Charles Brindamour

Okay. Good question, Paul. I think if you strip excessive CAT, you’re in the upper 90s and personal lines, if I put all personal lines together, that’s not good enough. Obviously our work is not done. And I’d point to three areas of improvement. One is rates, so rates are going through the system. Two, very important pricing and risk selection sophistication, and three, making sure we’re playing in the right part of the market. And there our work is certainly not done on these elements. And as I’ve mentioned, within 24 months of closing, we’ll finalize where the footprint is, but we’re not done. Ken, who is in the UK can give you additional perspective.

Ken Anderson

Yes, no very much aligned with that, the 2023 overall combined at 106% as you say, there’s about six points of elevated CATs in there. There’s also about two points of subsidence planes in the home market. So just for those two, you are indeed in that upper-90s zone. And we continue to hold the line on rates to deal with the inflation. The market in the early part of 2022 was slow to move. We’ve started to see some signs in the fourth quarter of rates ticking up, but we think there’s more rates needed in the market in 2023, that’s clear. We’re put – we’re certainly pushing that that may bring pressure on units and with the cost base that we have.

So all in that upper-90s zone is kind of the zone of performance that we see in the near term. And then the actions that Charles mentioned are indeed the ones that are being pushed, put tilting that portfolio towards the direct and away from the partnerships where the economic zone stack up the pricing sophistication bringing some of the Intact capabilities and deploying them in the UK market. And then also, in terms of technology and increasing the digital and technology footprints on the home and pet business in particular in the latter part of 2023.

Charles Brindamour

Thanks Ken. And I think an element of your question, Paul was are there regulatory constraints to bring improvement in the portfolio? And I would say UK market is really tough, but one thing that is good in my mind is, you can turn on a dime when it comes to pricing either in the amount of price you’re taking or in terms of risk selection. The UK trust, competitive behavior, in fact, more so than the Canadian regulatory system. So when it comes to pricing risk selection, no barriers to improvement.

Paul Holden

That’s helpful. Thank you for your time.

Charles Brindamour

Welcome.

Operator

Next question will be from Geoff Kwan at RBC Capital Markets. Please go ahead.

Geoff Kwan

Hi, good morning. I just wanted to clarify, I think it was Ken’s comment, because my question was going to be like in the UK personal line space, like what would be a success or what would be good results in terms of combined ratio for 2023? And if I heard it right from Ken’s comment, it sounded like upper-90s in the near term is kind of the goal. Is that correct or did I get that incorrect?

Charles Brindamour

Well, upper-90s is not the goal. I think upper-90s is what you can expect to see in 2023, because pricing risk selection takes some time. Some of the work we’re doing in claims will take some time and we’re not going to run upper-90s business in the UK personal lines absolutely not. But in 2023, we’re in the second year of the integration. That’s maybe what one can expect given inflation, given the state of the market.

Louis Marcotte

And absolutely the commitment to mid-90s performance in the mid to longer term is very much the aim. But the 2023 at that loop I was speaking.

Geoff Kwan

Right, okay. Now that’s what I was talking was the 2023, not your actual more medium term goal. And my second question was just going back on auto in terms of the claims inflation from Louis comments, the improvement Q4 versus Q3 was that the rate of inflation was coming down or are you actually seeing some of the actual claims costs actually net-net reducing? And then also is there any comment on are those same trends playing out so far in Q1?

Charles Brindamour

So Q3 year-on-year was 13, Q4 year-on-year is 11. I’ll let Patrick provide some color.

Patrick Barbeau

Yes, Geoff, as we mentioned, in prior quarters, if I break it down, there’s 40% of the cost that’s coming from liability and injuries, 30% on car repairs, and 30% on total losses including debt on injuries and liability no change from prior quarters. We see no inflation year-on-year on that. So that’s no change between Q3 and Q4. On a repairable losses the car parts themselves have been flat between Q3 and Q4, but they’ve been more available. So, we’ve seen a little bit of easing on the pressure on rental costs or repairable. But no increase between Q3 and Q4 parts, which is an improvement from the trends we were saying before.

On the total losses, the market value has flattened as well. The curve, the indices or the index of market value, which is the main driver of the cost in total losses is also flat between Q3 and Q4 with slight reduction in the last two months. So that’s very aligned with what we’ve seen in the U.S. and because the domain [ph] in turn now is higher when we compare the year-on-year, that has created about five points reduction in the inflation rate in Q4 versus Q3. And that’s the main cause of the reduction. These two items, when you look at availability of parts, the car parts, prices themselves being flat and the index of market value starting to slow down are good signs that this will continue in the same direction coming quarters.

Charles Brindamour

And I think Patrick, Geoff was trying to figure out what happened in Q1 without a chance to take a look at January, even though it’s a few days fresh.

Patrick Barbeau

Yes, it is in the same direction. So a slight reduction again over what we’ve done in December.

Charles Brindamour

Slight deceleration from Q4. Yes.

Geoff Kwan

Okay, great. Thank you.

Operator

Thank you. Next question will be from Doug Young at Desjardins Capital Markets. Please go ahead.

Charles Brindamour

Hey, Doug.

Doug Young

Good morning. Sorry about this, but I’m going to stick with personal auto for my first question, and I guess, loss cost trends is outpacing earned rate and you saw that last year. Is this something that’s going to reverse in Q1? Is that the message that I heard or is this something that’s more back half of 2023? And then just to clarify what I think of a sub-95% combined ratio, you talk about seasonally adjusted and I get Q1 is going to be higher and Q2 is going to be lower, but there’s no other adjustments when we think of sub-95%. So when I think of like the 95.8% that you’ve recorded this quarter, like that’s the number we should be looking to be sub-95% and that includes probably your reserve developments and whatnot? Just get some clarity on that as well.

Charles Brindamour

So this quarter, so Q4 is a higher seasonality quarter. I think we’ve pointed out that A, there seasonality and B, there was even more winter than what the seasonality we would’ve expected. Assume so you have right there point and half, there Q1 is a high seasonal quarter, so we need to keep that in mind. Our guidance is indeed a run rate x seasonality type guidance. I’ll let Patrick comment on loss cost, because there’s an element in your question though that is what you assume when you price as well. But go ahead Patrick.

Patrick Barbeau

Yes, so loss cost and premium, maybe I could cover the two, because that’s what we see crossing past a little bit right now when we look at the coming quarter. So on the loss cost side the frequency was flat for three quarters in a row compared to prior year because Q4 in 2021, as we pointed out was still a bit lockdown. There is a year-on-year increase of about five points, but it hasn’t moved for three quarters. We expect in our pricing that that might continue to or start to migrate closer to pre-pandemic. That’s one of the thing in loss cost. So on the other end though, the inflation from 13 to 11, we expect that will continue to go down at about that pace for a few quarters.

On the premium side, return rates were in around 5% of the middle of the year. It peaked at 9% in December, only five of it is earned. And if you look at the next two quarters, it’ll be earned at the 7% rate level in Q1 and get to the high teens by the summer. So you see these loss cost trends crossing with the rates starting to be higher in the coming quarters than the actual loss cost trends.

Doug Young

So it seems like that cross is going to happen about mid-year. So this is like the back half of the year is when we should see earned premium outpacing loss cost trends. Is that, am I reading that rightly?

Charles Brindamour

Yes, but the expectation if you strip seasonality is that this business is running now sub 95 to mid-year, okay? There will be gradual improvement as you describe, as those two lines crossed. But keep in mind that from a pricing adequacy point of view and from a pricing point of view, the frequency we’re seeing is actually lower than what we’re pricing for and lower than what we’re reserving for. You put all that together and you get to our guidance. So sub 95 throughout [indiscernible]. But clearly a different combined ratio pattern in the second half than in the first half, because those two lines will cross sometimes.

Doug Young

Okay. And then just listening to discussion on the UK personal property market, if I go back many, many years, and I don’t know the dates. But I mean, Canadian personal property was an issue back in the day and it took you, I forget, let’s say it took you five years to go through the pricing segmentation to really kind of fix that business. Is that like – is that what we should be expecting for the UK personal line business? Is this like a five-year fix? Or is this something that I know 2023 can’t, it doesn’t sound like we’re going to see drastic improvement. But is this something in 2024, 2025 where you do expect that to hit the midpoint of that? Or is it a longer tail…

Charles Brindamour

Yes, I think, so, Doug, if I think about personal property, because it’s a very good example in my mind. This was a major revamp of what we did. I’ll take you back 10 years ago where we changed the product. We changed the pricing algorithm. We changed the claims supply chain management and how we manage claims invested in prevention. And that took a few years indeed. But when I look at it in retrospective, I look at the last 10 years combined ratio in personal prop 89.9. If I exclude 2022, 11 years, 90% combined, five years 87% combined with volatility with CATs.

So when you do a major overall, it takes some time, but it pays off like it’s not just superficial fixing here and there in the UK, because I think there’s heavy lifting we’re doing at the moment. The piece that is quite different from when we improved home insurance is we didn’t change the footprint of home insurance. We changed what we did pretty much for all Canadians at all levels of the value prop.

In the UK, we have not concluded that we want to play in all the segments where we are today. And that’s the bit that can move the needle a bit faster than changing rates, algorithm, technology, et cetera. That being said, it’ll take some time and that’s why to the earlier question, the guidance is upper 90s for 2023, but that’s not how we measure success. Ken, anything you want to add.

Ken Anderson

I think the point around the distribution channel, and the – going in the direct business, you’re much more in control of your overall combined ratio outcome versus in the partnership side of the business, which is the majority currently of the PL business that we have. You’re less in control of the combined ratio. That tilt will take a bit of time.

Charles Brindamour

That’s true

Ken Anderson

But that is…

Charles Brindamour

Yes.

Ken Anderson

That is the route to or one of the important route to better perform.

Charles Brindamour

Good point. We have a number of partnerships some of them we’ve exited. Others were in the process of negotiations where we’re not happy with the economics that can take some time to run. But otherwise I think our perspective is upper 90s this year, sub 95 over time. Lots of work left to be done in the coming months.

Doug Young

Appreciate the color. Thank you.

Operator

Thank you. Next question will be from John Aiken at Barclays. Please go ahead.

Charles Brindamour

Hey, John.

John Aiken

Good morning. Sticking with the UK and I just for a moment, a lot of discussion around the combined ratios. But was looking at even when you strip out the Middle East divestiture, volumes are down on the UK and personal side of the equation and I get that you’re trying to right size the business that going through. But with all of the factors that you’re putting into play for the combined ratio, should we expect volumes to continue to trend down in 2023, particularly if you’re renegotiating some of these partnerships? Or should we actually see an inflection point at some point in 2023 or 2024 or later?

Charles Brindamour

I’ll ask Ken to provide his perspective.

Ken Anderson

Yes, well indeed, the pressure on top line in 2022, has been driven by yes, the exit, but also the rate that we have been pushing ahead of the market. The market has been slow to respond on rates and therefore as a top line pressure has been there. As we move into 2023, I would say overall mid-single digit growth is the zone for personal lines. But again, we will maintain the discipline and a lot of the outcome will be determined by how the market and what the market pushes in terms of rate.

Charles Brindamour

Yes, I think, it’s a good thing that it is a small portion of the IFC business because in the context of the work we’re doing to improve PL now we’re not really looking at the top line. I’ll be very clear, it’s all about improving the bottom line and the market does whatever it wants, we have some work to do there and could be mid-single digit. But if the market doesn’t move, it’ll be less than that because we’ll lose some more units. And that’s just the way it’ll be.

John Aiken

Understood. Thank you. And my follow on if I may, Louis, in terms of distribution income guidance 10% that you expect to do better then, but when we take a look at the growth that we’ve seen over last a little while, it’s been hovering 20% or above this. The dropdown in the guidance, I know 2022 benefited from acquisitions, but should we infer from this that capital deployment opportunities and distribution are starting to slow? Or are you just being overly cautious and we could see well above 10% if you’re actually able to execute on some opportunities?

Louis Marcotte

So, no, I wouldn’t say there’s a slowdown here. The way we drive our guidance is really built on what’s – I will say in bank at the time we give the guidance. So if there is additional M&A that comes out during the year, and we were certainly willing to deploy capital for that it would be additional. So we end up higher, because the market is still very good and we think there’s going to be more opportunities coming, but the guidance doesn’t take – doesn’t go for potential transactions in the future. It really is based on what we have already signed. And then the rest is upside to the guidance. But just to be clear, the market is still very good and we’re certainly willing to deploy more capital in that space, no doubt.

John Aiken

Great. Thanks, Louis. I’ll requeue.

Operator

Thank you. Next question will be from Tom MacKinnon at BMO Capital Markets. Please go ahead.

Tom MacKinnon

Yes, thanks very much and good morning. Question with respect to the increase in the CAT guide. Does it reflect in – you don’t necessarily cede a lot of business? I think you retained like in the high 90s and some of the lines in mid to high 90s and others. So is this increase in CAT guide, just say a reflection of, hey, we got 2022 wrong, we guided a 600 and it was over 800, so we’re just going to change the guidance now just because of the way weather is for 2023? Or have you actually changed your approach to reinsurance? Are you retaining anymore? And is that driving this change in the CAT guide?

Charles Brindamour

Go ahead Louis.

Louis Marcotte

Yes, so a few items here on this front. So on the January 1 renewals, which are part of the explanation why we increased our CAT guidance. The – we were successful at retaining or securing the CAT capacity we needed. The costs are higher. We had anticipated that and started pricing for it last year. So the impact as I mentioned earlier is fairly neutral on the earnings. But the cost of it and the fact that we increased retention in the three countries we operate in is actually will drive a bit more CAT losses that drive part of that 100 million. So there’s three elements, as I said in earlier, the fact that we’ve grown more premiums and there’s inflation. That’s about a third of it. A third is the renewals, the impact of the renewals.

And the last part is the increased CAT losses we’ve seen historically. So those are the three buckets that drove the 100 million increase. And then our view here is this was largely anticipated and has been priced in already, therefore, the impact on earnings is the minimus. You are right to say that we don’t cede very much. The overall CAT program is a small single digit, low-single digit portion [ph] of net earned premium. And the impact here is I would count it in basis points overall. So I hope that’s helpful.

Tom MacKinnon

Yes. I mean, you haven’t really changed your guidance for top line growth in commercial lines quarter-over-quarter yet there is an increase in the CATs and you’re saying you’re pricing for it. So I would’ve expected your top line for expectation for commercial to have changed now that you’re trying to price in these higher reinsurance costs, at least on a quarter-over-quarter basis. Or is it just, or am I just being too cute here?

Charles Brindamour

No, no, no. You’re not being too cute, but I’ll tell you what the story is. So first it’s a good opportunity I think to recognize the foresight of the reinsurance team, whom after the July renewal said, okay guys, we need to get ready for a step up in cost and an increase in retention. And we said, let’s do it. So this notion that we would face a hard reinsurance renewal on January 1 was identified months ago by [indiscernible] who runs reinsurance. And that was very much baked in our thought process as we built our action plans for 2023 and our pricing plans.

And as a result, the guidance we’ve given in the past couple of quarters anticipated a hard reinsurance renewal cycle was a bit more expensive than what we anticipated, but nothing meaningful. And then in the 100 million, per se, the increase in retention, which is primarily at the bottom of the Canadian program, is worth about 35 million. So a third of the 100 million is increase in retention.

Tom MacKinnon

Okay, thanks. And just a quick one with respect to the deferred tax asset move, it seems to reflect your outlook for improving performance in UK and international. And I’m assuming that this change in the DTA would’ve looked past two years. Now you talk about having two years to fully evaluate your business in the UK&I, so what does the move in the deferred tax assets say with respect to your two-year timeframe to fully evaluate this business?

Charles Brindamour

Go ahead Louis.

Louis Marcotte

Very good question. So the outlook is more positive and you’ll understand, we were comparing to a year ago, essentially when we made our first well, of course our RSA business was already doing a DTA, but this is really the first year afterwards where we have our own outlook and we have a bit more credibility in terms of the results, and that allowed us to recognize more tax loss recoveries. The estimate is based on a five-year projection, and with the fact that our underwriting is improving, the investment income is improving and we have more credibility.

We were able to increase the DTA asset. If there were changes to the structure going forward, we would have to adjust. So it gets a bit tricky as to what the impact of those changes would be on the taxable income. But we would reflect them as soon as they are known and we’d adjust accordingly. But at this point, it’s sort of a, I’ll call it a going concern plan five years out with what our best expectations of earnings both on underwriting and investment income driving it.

Charles Brindamour

So I think, if I boil it down to two things really, one is the guidance from a combined ratio point of view hasn’t changed much, but I think when people look at our ability to generate that in earnings, it’s gone up. Therefore, the DTA recognition takes that into account. Second one, which is not related to the guidance we’ve given, which is combined ratio driven in nature as the investment income potential, put those two things together and that’s how you are right there, Tom.

Tom MacKinnon

Okay. And the two-year timeframe, sounds like you’re a little more optimistic now.

Louis Marcotte

Well, the two-year timeframe is the strategic discussion Charles talked about earlier. On the tax front, it’s really a five-year out. And again, I said it doesn’t take into account, I will say potential changes to the structure. It would be – it’s a really, as we are today, looking forward with the improvements we expect to make.

Charles Brindamour

Yes.

Tom MacKinnon

Okay. Thanks.

Operator

Thank you. Next question will be from Mario Mendonca at TD Securities. Please go ahead.

Mario Mendonca

Good morning. Louis, if we could stick with you on your investment income guidance, the $1.1 billion is actually a little less than what the Q4 annualized would be. I know it’s marginally less. But given the new money yield, I think you said a 4.5% is a fair bit higher than your book yield. Why are you not building in some improvement in the overall realized yield over the next 12 months because it would appear that you’re not in your $1.1 billion guidance?

Louis Marcotte

So the first, if you try to run to use a run rate, you’re right, it’s a bit shy because 279 of Q4 probably has 10 million to 15 million of I would call lumpy might recur, but it’s more lumpy and therefore difficult to put in a fixed run rate. But otherwise that’s about the only amount, and that’s why it’s a bit shy of it. Then our estimate for next year is based on current rates where the book stands today, and then the turnover with a normal turnover next year. If the turnover accelerates, we could generate more. If yields go up more, we can generate more, but we’re on a book yield as we are today, plus normal turnover going into the future.

Mario Mendonca

Just so we’re clear, the 1.1 billion does include normal turnover?

Louis Marcotte

Yes.

Mario Mendonca

And wouldn’t the normal turnover in and of itself increase your realized yield?

Louis Marcotte

You would and we’ve put some of that in the estimate, but it’s not a huge at that base, it’s not a very big. Keep in mind, we’ve traded quite a bit in Q4 already, and so the amount we can turn over next year on a normal basis has a more limited impact.

Mario Mendonca

Okay. That’s helpful. Charles, maybe we could go back to the UK for a moment. You made – you and Ken make the comment that it kind of depends on what the market will give you that competitors were slow to react to rate. When you look at the competitive landscape, you look at the individual competitors that you face in the UK personal lines, is there could we make an argument that some of those competitors, or maybe a majority of those competitors have lower return expectations than Intact does? And as a consequence, you’re always going to compete against firms that really don’t need the same or have the same required hurdles that Intact does. Is that statement; is there some truth to that statement?

Charles Brindamour

There is some truth to that statement, Mario. However it’s important to understand that we’re not all operating the same way. You could make that argument in Canada. There are people, many people in the market that have lower expectations than we do yet, we beat them from both the top and bottom line point of view. Why? Because we price and select differently and we have a better supply chain. We’re not in that position in the UK. And therefore I don’t have the same confidence we can do that in the UK. That’s why we’re still trying to figure out where we have a real shot at winning.

But certainly, when I say a, you need to figure out if you can outperform, and b, you need to figure out if outperforming generates enough return to justify leaving capital there. And to that question, and maybe that’s where you’re headed. It’s not clear to me that the answer to that second question, even with outperformance, you can make enough money in all parts of the market, and that’s why we’re not done finalizing the footprint.

Mario Mendonca

Yes, that’s kind of where I was going. If you’ve got competitors that have lower return expectations and Intact is not the 800-pound gorilla there, then it almost seems like you’re pushing against the string. It’s not an area where you can deliver the outperformance. You need to be there. That’s essentially where I was going with that. It isn’t that the more logical conclusion?

Charles Brindamour

I think, it’s not that straightforward, but logically speaking I think it’s fair. I’d say, Mario, that in commercial lines, we’re in very strong position and we have to keep in mind that in home we’re number three. And so are we in pet, it’s either number two or number three. So definitely not the 800-pound gorilla. And I’m not sure we’re actually ensuring gorillas in pet, but we some degree of scale. I think our question mark on those two segments is what Ken refer to it’s how they’re being distributed. That’s the piece where we hesitate the most at this stage. Ken, why don’t you provide color?

Ken Anderson

Well, in addition, I guess then what that leaves; I guess then is the motor business. That’s where clearly the scale is more challenging. And given the cost base and, we’re remaining disciplined on pricing. And I think the bigger – the bigger question mark on the motor, definitely I think the scale, yes. Number three position in home and pest is, it’s not number one, it’s not the same as Canada, but it is a reasonably scaled position if you can tilt to a more direct offering in terms of distribution.

Charles Brindamour

Exactly.

Mario Mendonca

That’s very helpful. Thank you.

Operator

Thank you. Next question will be from Lemar Persaud at Cormark Securities. Please go ahead.

Lemar Persaud

Thanks. I apologize for going back to personal auto here, but I’m wondering if you could provide an update on the ability to push through rates and personal auto, just in light of the Alberta government freezing rates at the end of 2023. Is that something other provinces are looking at? Or do you think you can continue to push through higher rates if say inflation comes in higher-than-expected or frequency rises more than expected?

Charles Brindamour

Well, thanks for the question. I’m glad you bring up personal auto again, because we love that business and we have a very strong track record there, so we don’t mind talking about it. In general, regulators have been quite rational. I mean, if you have a good case for why there’s cost pressure you can price for it. And in fact, there are some markets our biggest market, in fact, you don’t even have to ask for permission actually to price for inflation.

So it hasn’t been an issue. It has not had a negative impact of any substance on performance over time. And frankly, because the cost pressure now is on short tail lines and not on long tail lines, it’s much easier to demonstrate why rate needs to move, and in aggregate, we think that regulators get that and it’s easy to demonstrate. And that’s why in 2022, we were able to pretty much bake in nine points to cover inflation. Patrick, maybe you want to give a bit of color on Alberta and so on.

Patrick Barbeau

Well, similar to the rest of the country, were very proactive early on in 2022 in taking rates. So, we’re starting the year of, in 2023 in good positions, including in Alberta. The new policy of a rate freeze is ill-advised in our view and will do nothing really to address the core issues that are putting pressure on rates for Albertans. If anything, it may make us significant harm as the industry will be temporarily left behind on reflecting inflation in the right. So while the freeze is meaningful for the Alberta market in the context of Intact, the solution is slightly different, because first we need to be clear, we’ll take the necessary actions to protect the profitability position in the province, and that might include the appetite regarding new business and our renewals, and at a minimum the amount of future marketing investments.

But second, we’ve taken rates in advance of the market. We have good rate momentum in there that that’s only 17% of our Canadian PA portfolio, or 5% overall of IFC. So it doesn’t have an impact on our outlook for the next 12 months and sub-95 combined ratio guidance. That being said, we reiterate the fact that while it might be attractive politically, this is not very good for Albertans and for sure, our team stands ready to engage with the government on better ways to improve in the long-term the availability and affordability for insurance in Alberta.

Charles Brindamour

Bottom line, I think regulators are rational. The need for rates at the industry level is clear and easy to prove, and so not concerned by regulators’ ability to deal with that. Alberta, it’s political, it’s a real bad call. I think within six months you’ll have capacity issues in that market, and I think other provinces understand that when you artificially try to do stuff like that, there’s a blowback that comes back and, that might very well be the case in Alberta. So, we’re, I think, in good position in relative terms and feel good, about our ability to price for inflation. And the nine points we’ve talked about is baked in already.

Lemar Persaud

Okay, that’s helpful. And then my second question, I want to come back to Mario’s line of questioning on the investment income. Are you guys building in expectations for rate cuts later in 2023, which could limit market based yields? Because I think Louis, if I heard you correctly, there’s $10 million to $15 million in lumpy revenues, but even excluding that with normal asset growth, I could still easily get over $1.1 billion. So any thoughts there would be helpful?

Louis Marcotte

So, we have not booked any rate cuts clearly. So yes, there are, I think we’re, it’s a prudent guidance, but not based on rate cuts plan or expected rate cuts next year at all.

Lemar Persaud

Okay. Thank you.

Operator

Thank you. Next question will be from Nigel D’Souza at Veritas Investment Research. Please go ahead.

Nigel D’Souza

Thank you. Good afternoon. Just a quick clarification on the call made earlier for personal auto, including the seasonal impact, do you expect that combined ratio to be sub-95? I understand that correctly?

Charles Brindamour

Nope. I think we’re saying sub-95 is what we would expect, quarter after quarter after a quarter, except that you need to take into account seasonality. So Q1 for instance, there’s a few points of seasonality. Normally if you go back in time, you see that it’s a very clear pattern that is, that needs to be taken into account. What we’re saying is that the run rate per quarter as we sit here today is sub-95 and should improve over time.

Nigel D’Souza

Okay, got it. That’s helpful. So my first question was on favorable PYD, when I look at your guidance it looks like you’re expecting a favorable impact on the IFRS 17 on the PYD metric, and you’re also guiding for PYD to be in the 2% to 4% range over the medium term. So, I think the midpoint of that guidance 3%, that’s actually, lower than your favorable PYD of 3.8% in 2022. So would it be fair to expect favorable PYD to decline in subsequent quarters and trend lower? Is that the way to think about it?

Charles Brindamour

We, why don’t you share your perspective. So, I think I’ll try to bucket in two here. The IFRS impact second, first, our expectations. So historically the guideline has been between one and three but we did expect it to be stronger in the short-term given the prudence we had baked in throughout the currently COVID periods. So, I think that’s still true, and it’s, you’re seeing it in the actual results with the strength of PYD, so that on an even basis, I think will extend at least in the next 12 months. Then because of IFRS 17, I will summarize the impact to that we can see today is roughly between one points or two points of favorable impact to the PYD. So I would sort of take them apart stronger than or in the short term, higher than expected or higher end of the range. And then I would add between one points and two points for the IFRS 17 conversion.

Nigel D’Souza

Okay, got it. That’s helpful. And the second question was on, again, circling back to market based yield. When I look at the increase quarter-over-quarter of 50 basis points increase, even if you strip out the $15 million or so and the lumpy items, based on a reinvestment yield that you know at 4.5%, about 4% of your portfolio turns over a quarter, that would imply that your market base yield should have been only maybe 10 basis points higher relative to the last quarter. So are there any other items that are driving that variance as it trading related or something else that enhanced your market based yield this quarter?

Charles Brindamour

So market based yield has a denominator that moves with market volatility, and therefore it’s a harder one to pin down, frankly. The yields, the book yields have gone up, because we trade and we secure a higher yield, but then you’ve got the offset and the bond themselves, the bond value themselves. That’s why we don’t use the that yield for guidance. We give the hard number to take away sort of the market volatility impact on the book and the market based yield that comes out of it. So, we view the market based yield as the result of two things increasing the interest on the assets we own, and then the volatility of the assets values themselves and the outcome is what we report on.

But from a guidance point of view, we prefer to give the hard number it’s our best estimate of where investment income will end next year as we stand today. And we try to not to reinvent. People are challenging on the run rate given the Q4 numbers, and that’s why we’re saying there’s probably 10, 15 of lumpiness in there. So, I wouldn’t extrapolate strictly on the actual number. That’s our best guess at today, where we stand based on current yields and where our book has been converted to two current rates.

Nigel D’Souza

Okay. That’s it for me. Thank you.

Operator

Thank you. Next question will be from Jaeme Gloyn at National Bank Financial. Please go ahead.

Charles Brindamour

Hey, Jaeme.

Jaeme Gloyn

Hey guys. I guess same kind of question. Just in terms of the trading impact on the investment income, looks like there was quite a bit of trading in Q4. What capacity do you have left to continue to execute trades? What kind of trades are these that are helping to really reduce the interest revenue specifically?

Charles Brindamour

So, we’re careful here with the impact of the trading. What you’re seeing on the realized gains and losses in the non-operating section. So, we have to be a bit careful here. Our expectation right now is to go somewhat back to normal trading next year. And if there are opportunities where there’s a trade that makes sense and doesn’t get wiped out by the realization of their loss on the non-operating earnings, we would do those trades, but you’re right, we took the opportunity as markets move and rates move, quite frankly. I think the investment team sees more opportunities and therefore are much more active to trade. And this is what has happened. I will say second half of this year very, very active and you’ve seen it in Q4. So, today I sit here, what we look at in 2023 as normal turnover. Maybe there will be opportunities and that will be positive tailwind to the current guidance. But not more than that.

Jaeme Gloyn

Okay. Got it. And the second one, just in terms of the Highland Insurance acquisition in specialty lines, just wondering if you can comment on the success of that acquisition, how much it’s contributing to U.S. commercial, but also how is it contributing to the distribution income as well? I guess it hits both sides.

Charles Brindamour

Darren, why don’t you talk about the strategic merits and what it’s doing for us?

Darren Godfrey

Yes, absolutely. Obviously, it’s a transaction as, that we made last year, we came online in terms of underwriting capacity in Q4. These are very highly specialized niche appetite that they have at Highlands, and that’s very much part of the recipe when we look at from an MD&A [ph] and from an acquisition strategy standpoint. Just a reminder though that we did not purchase any reserves or any unknown premiums. So this obviously is earning out from dollar one. Obviously, as you can see in the MD&A, there was an impact in a favorable impact, obviously in the growth in the U.S. in Q4 that will very much obviously continue out into 2023. Performance to date, obviously it’s still very, very early, but it’s very much in line with expectations and we’ll have a positive impact on the overall performance in the U.S.

Jaeme Gloyn

And Darren, we’re keeping, how much of that?

Darren Godfrey

We’re keeping roughly 21% of the capacity out of that operation. Obviously supported by both some other direct insurers, but also some reinsurers as well.

Charles Brindamour

Roughly 21%.

Jaeme Gloyn

Louis, can you talk about distribution income?

Louis Marcotte

Absolutely. So in the quarter, Highland was actually of the 22% rise was about 2%, 3% of the 2022 was driven by Highland. So it’s a pretty significant portion of the growth in the earnings. It’s 2% year-to-date, which is half a year for Highland. So it has a meaningful impact on the distribution income from, for the distribution earnings.

Jaeme Gloyn

Thank you.

Charles Brindamour

Okay. Great to hear. Thank you.

Darren Godfrey

Great.

Operator

Thank you. At this time, we have no further questions. Please proceed with closing remarks.

Shubha Khan

Thanks everyone for joining us today. Following the call, a telephone replay will be available for one week, and the webcast will be archived on our website for one year. A transcript will also be available on our website in the financial reports and filing section. Our 2023 first quarter and full year results are scheduled to be re released after market closed on Wednesday, May 10th with the earnings call starting at 11:00 a.m. Eastern time on Thursday, May 11th. Thank you again, and this concludes our call for today.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that to please disconnect your lines.