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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. Welcome to Trisura Group Limited First Quarter 2023 Earnings Conference Call.
On the call today are David Clare, Chief Executive Officer; and David Scotland, Chief Financial Officer. David Clare will begin by providing a business and strategic update followed by David Scotland, who will discuss financial results for the quarter. Following formal comments, lines will be opened for analyst questions.
I would like to remind participants that in today’s comments, including in responding to questions and in discussing new initiatives related to financial and operating performance, forward-looking statements may be made, including forward-looking statements within the meaning of applicable Canadian and U.S. securities law.
These statements reflect predictions of future events and trends and do not relate to historical events. They are subject to known and unknown risks and future events and results may differ materially from such statements. For further information on these risks and their potential impacts, please see Trisura’s filings with securities regulators. [Operator instructions] Thank you.
I will now turn the call over to David Clare.
Thank you. Good morning, everyone and welcome. Our business reported strong operating performance in the first quarter, growing insurance revenue 58% compared to Q1 2022, and supporting a 21% operating return on equity. Momentum has sustained as we scale an increasingly diversified specialty insurance platform.
Results, again, were particularly strong in Canada, with 33% growth in insurance revenue supported by profitable underwriting. Our U.S. fronting business produced $459 million of insurance revenue, an increase of 71% over the prior year.
In Canada, top-line growth was demonstrated across all business lines. Canadian fronting and surety led the way, fronting driven by a more mature platform and surety by market share gains, as well as contribution from both our sovereign acquisition and US expansion.
Corporate insurance continued to benefit from expansion of distribution partnerships and stable pricing. We saw our warranty practices grow as auto inventory issues began to rationalize. Importantly, disciplined underwriting drove a 15% loss ratio, an improvement over strong comparative year, supported by our particularly impressive result in surety.
We are proud of our 81% combined ratio in the quarter, but did not beat a strong comparative period set in Q1 2021 of 77% due to a higher expense ratio as a result of a shift in mix. I apologize, that reference was to Q1 2022.
The Canadian business generated a 28% return on equity. With the expansion of our U.S. fronting expertise, our Canadian entity now generates attractive fee-based earnings to complement a heritage of profitable underwriting income.
U.S. fronting generated $459 million in insurance revenue in the quarter. Maturation of existing programs drove the top line. Although we generated $53 million in admitted revenue in the quarter, the market continues to drive opportunities to excess and surplus lines.
U.S. fronting generated $18 million in fees, a 30% increase, and recorded $36 million of deferred fee income, indicative of future fronting fees to be earned. Loss ratio in the quarter, adjusted for the impact of runoff, increased due to certain reinsurance costs incurred in the quarter, as well as a decrease in yield due to discount claims reserves.
Fronting operational ratio, adjusted for the impact of runoff, increased as a result of similar factors. The impact of IFRS 17 added approximately five points to both loss ratio and fronting operational ratio, which otherwise are within expected ranges. On a last 12-month basis and adjusting for the runoff program, the U.S. produced a 13% operating ROE.
A historic rise in interest rates coincided with an increase in capital managed at Trisura. A combination of growth and profitability and a recent capital raise has resulted in increased contributions to the investment portfolio. The combination of higher rates and a larger portfolio has been very positive for the contributions in the investment portfolio.
We began realizing these benefits through Q4 and observed continued momentum in Q1, with net investment income increasing 150% over the prior year. We are excited about the enhanced risk-adjusted yields we are capturing for years to come.
As we progress our strategic priorities, environmental, social, and governance considerations are front of mind and an important part of Trisura's maturation. We are focused on better communicating existing initiatives and believe we have taken steps in the right direction with enhanced ESG-related disclosure in our management information circular.
We also continue to progress in enhancing our ESG commitments, and I am excited to introduce Anik Lanthier, our newest Director, to our shareholders at our upcoming AGM. She is an important and skilled addition to our team.
We observed continued healthy pricing trends across most lines in the quarter, although expect hardening trends in insurance pricing to balance, although not reverse later this year. This will be informed by the state of the reinsurance market, as well as economic and interest rate trends, and we feel well-equipped to navigate the environment. I should acknowledge our fourth quarter experience and note we expect to see impacts from the runoff through 2023. We will endeavor to share guidance on the expected future impacts as they become available.
In response to investor and analyst feedback, we are introducing an Investor Day on June 01, immediately following our Annual General Meeting. We will be introducing the management teams of our Canadian and U.S. entities in a fireside chat format, providing the opportunity for investors to meet a broader group of Trisura members. The event will be in person, as well as streamed online.
We remain committed to disciplined underwriting and structuring standards, as well as conservative reserving. Although we have not seen signs of recession in our results to date, we acknowledge economic risks are skewed to the downside. It is our hope that volatility will provide opportunities for us to win business and strengthen our reputation, and we feel confident that we can navigate any potential changes in economic outlook.
We are planning for growth, and with a strong capital base and comparatively greater scale, feel cautiously optimistic for the years ahead. Our equity base has grown to $513 million, a healthy increase from year-end and almost reaching levels achieved in Q3.
With that, I'd like to turn it over to David Scotland for a more detailed review of financial results.
Thanks, David. I'll now provide a brief walkthrough of some financial results for the quarter. The Q1 results reflect the first quarter of the implementation of IFRS 17, [audio gap] changes particularly with respect to presentation of both the income statement and the balance sheet.
Insurance revenue, which replaces gross premiums written as the new top-line revenue balance, was $639 million for the quarter, reflecting growth of 58% over Q1 2022. Insurance service expense, which consists of amortization of insurance acquisition cash flows such as commissions, claims expense, and other operating costs, increased in the quarter primarily as a result of growth in the business, which has led to an increase in claims and commissions expense.
Net expense and reinsurance contracts, which includes both premium paid to reinsurers, as well as recoveries from reinsurers, increased as a result of growth in the business, which has led to more reinsurance ceded, particularly from Canadian and U.S. renting lines. The increase in this balance was lower than that of insurance service expense, as this balance includes recoveries from claims ceded to the reinsurers.
Net service result in Canada for the quarter was greater than the prior year as a result of growth in the business and consistently strong underwriting. Net service result in the U.S. for the quarter was lower than the prior year as a result of losses generated from a program in runoff. Without the impact of the runoff business, insurance service result was greater than the prior year as a result of growth in the business.
In Q1 2023, the combined ratio in Canada was 80.7%. In Q1 2023, the fronting operational ratio in the U.S. was over 100% as a result of the runoff program. Without the impact of that runoff program, it was 86% for the quarter and was impacted by a decline in the yield curve used to discount reserves.
Net investment income was greater in Q1 2023 than 2022 as a result of an increase in interest and dividend income. The increase is primarily related to an increase in the size of the investment portfolio, but also benefited from higher yields.
Net loss for investments was $2.2 million in the quarter, primarily as a result of movement on swap agreements used to hedge share-based compensation. Excluding the impact of derivatives used to hedge share-based compensation, there were gains in the period of $1.6 million.
Net finance expense from insurance and reinsurance contracts, which reflects the time value of money and changes the time value of money, was a loss of $4.7 million in Q1 2023 rather than the gain of $700,000 in Q1 2022, which was the result of a decrease in the yield curve used to discount claims reserves in Q1 2023.
In Q1 2022, there was an increase in the yield curve used to discount claims reserves, and as a result, the impact to net income was positive in that quarter. Other income, which represents fees for surety services, grew by 19% in the quarter, reflecting growth in the number of surety accounts.
Other operating expense grew by 25% in the quarter, reflecting growth in both the Canadian and U.S. operations. Excluding the impact of share-based compensation, which was mitigated through a hedging program, the increase was 17% for the quarter. Income tax expense was lower than the prior year as a result of lower net income before tax.
Net income for the group was $14 million for the quarter, operating net income, which adjusts for certain items to reflect income from core operations and excludes the impact of the runoff business, was $28 million, which is greater than the adjusted net income from Q1 2022 as a result of strong underwriting and growth in the business.
Diluted earnings per share was $0.30 a share in Q1 2023, which was lower than the prior year as a result of the runoff program. Operating EPS, which reflects core operations and excludes the impact of the runoff portfolio, was $0.61 a share, reflecting a 24% increase over the prior quarter.
Consolidated ROE on a rolling 12-month basis was 4.1% at Q1 2023. However, operating ROE was 20.6%, which was a slight increase over the prior year. The balance sheet has also changed as a result of the implementation of IFRS 17, with premiums receivable, deferred acquisition costs, unpaid claims, and unearned premiums presented together now as a single line item referred to as insurance contract liabilities. In addition to this, reinsurance assets, reinsurance premiums payable, and unearned reinsurance seating commission are now presented as a single line item referred to as reinsurance contract assets.
Cash in the period decreased as a result of additional purchases of investments in the period. Investments have increased as a result of more cash having been deployed into the portfolio, as well as unrealized gains on the portfolio. Reinsurance contract assets have increased as a result of growth in the business in both Canada and the U.S. Insurance contract liabilities have increased also as a result of growth in the insurance revenue in both Canada and the United States. Growth in these balances on the liability side is largely offset by growth in the reinsurance contract asset balance.
Equity is greater than the prior year end as a result of positive net income in the period, as well as unrealized gains on the investment portfolio. In addition to this, implementation of the new standards has led to a one-time increase in equity of $10.3 million as a result of the conversion to IFRS 17, primarily driven by an increase in deferred acquisition costs in Trisura Canada.
Book value per share was $11.15 at March 31, 2023, and is greater than December 31, 2022, as a result of profit generated from insurance and investment income in the period, as well as unrealized gains and the opening equity adjustment. As at March 31, 2023, debt-to-capital was 12.8%, which was lower than December 31, 2022, as a result of the increase in equity during the period. The company remains well capitalized and we expect to have sufficient capital to meet our regulatory capital requirements.
David, I'll now turn things back over to you.
Thank you, David. Operator, we take questions now.
[Operator instructions] Our first question comes from the line of Nick Priebe - CIBC Capital Markets.
I just wanted to start with a question on the program in runoff. Is it fair to assume that the earnings impact in the second half of the year should be relatively more muted than the first half, just given that the program there is expected to roll off by year-end? Or is there anything else that we should be aware of that could create a little bit of additional noise in H2?
Hi, Nick. Thanks for the question. In the second half of the year, the impact of that runoff program will mostly be informed by reinsurance that we purchase to protect ourselves through storm season. So we would expect there to be an impact, but the ultimate size will really be determined by the amount of program left in force and the price of protection that we're purchasing. So we'll provide some updates on that through the latter half of the year, probably closer to our Q2 reporting date. I don't know yet that it's appropriate for me to give magnitude of size, but we can provide some of those updates in short order.
Understood. Okay. And then, are you able to expand a bit on the composition of growth that you're expecting within the U.S. entity this year? I think you had previously signaled that property programs wouldn't be a large contributor because of some of the challenges in the reinsurance market. Are you expecting other lines without property catastrophe exposure to make up for that? How do you see the split between admitted and non-admitted market premium evolving? Just any additional color there would be helpful.
At this stage, I think most of the growth in the business is still going to be coming from excess and surplus lines or non-admitted lines. We do see some expansion of our admitted practice, but it has been slower given the tone in the market and given the disproportionate share of new business being accounted for by E&S.
I would say although our property exposure, so our ultimate PML or TIB, is not growing or attempting not to grow in the property space. Prices in that property space have been significantly increased this year. So, rates in the property space, especially in E&S, are increasing. So, that can be a contributor to growth, although I would say generally the E&S market has been a relatively healthy place.
That differs by line. There are some lines where those trends are more pronounced than others, but the space in the U.S., the excess and surplus lines market, continues to see decent momentum. And so, that growth from our book, as it focuses on E&S, is likely more so on older, mature programs than it is on new programs. I would say that that's been the contributor of our growth in 2022, and we'd expect that growth driver for 2023 to continue.
Yeah. Okay. That makes sense. All right. Thanks very much. I'll pass the line.
Our next question comes from the line of Stephen Boland with Raymond James.
Good morning, everyone. The first question is on corporate insurance in Canada. The language in the MD&A mentions moderate increases, stable pricing. It seems a little bit more conservative than what we've seen across the industry in terms of words like firm and hard markets. I'm just wondering if that is just -- is it unique to that business line?
I think generally, Stephen, we have seen healthy markets, healthy rate in the broader commercial insurance space, and I think those comments reflect that. I would note our lines of business tend to be a little bit more specialized than the broader market. We generally have higher profitability than the broader market does.
So, we've seen very, very healthy rate environments, healthy rate increases for the past few years, and I think those are appropriate in the context of the uncertainty in the market. But I do note that the rate increases we're seeing in Q1 are not as substantial as what we've seen in 2021 or 2022. So, that language attempts to reflect that. I don't mean to imply that the environment isn't healthy or isn't attractive. We've had a few years now of rate increases that we think are appropriate for our business, but it's not the magnitude that it used to be.
Okay. And then the second question is if you can just remind us about what your growth expectations are for the U.S. business again, and is it all impacted by the amount of capital that you have available?
Yes. So, our growth expectations this year for the US business again are on a top line basis and I would apply this to insurance revenue as well as the old metric which is gross written premiums. Think about that in a high team and that would include we believe the impact of this runoff program.
We don't think that that is limited in any way by the capital in the business. We've got on an adjusted basis I know our supplement reports about a seven times premiums capital surplus. We've got some surplus notes in the vehicle that drops that ratio down to closer to six times.
So we think there's healthy runway internally with the capital available in the business as well as quite a bit of surplus capital at the holding company and debt capacity. So that growth rate is not limited at all by the amount of capital we have in the business and is informed more by an acknowledgment of the maturity of the platform the size and scale that we've achieved today as well as some of the notes we've already talked about around the property space.
[Operator instructions] Our next question comes from the line of Marcel McLean with TD Securities.
So a couple of quick ones for me. Just on the runoff program, so substantially all this is going to be complete by Q4 '23 I just want to confirm that there's nothing longer tail in there that could creep into the early part of next year later.
No. The vast majority of these policies substantially all will be run off by December 31, 2021. There's about a six month period where you can make claim on these policies following those the last date that the runoff date. And so you can see claims experience for about six months after that.
The biggest exposure for this line of business is through storm season. So if you think about the runoff exposure post December 31, 2021 or December 31, 2023 really it's through a relatively benign period of the year. So we would expect our usual reserving to reflect any claims experience. So we are thinking about this program very much as being sort of runoff by the end of this year.
There can be reinsurance costs the amortized slightly past the year end, but substantially the exposure in the program should be out of our system by the end of the year.
Okay. Got it. Then the remainder of my questions are more on the underlying business here. So you call the strong growth from the U.S. surety platform. I know what's coming up probably off a pretty small base but just wondering if you can provide maybe the level of premiums or how that's tracking versus your expectations in these early days?
I think the progress platform has demonstrated in the surety space. It is a slow -- it is a slower build that's a practice and a platform that takes some time to build up. But we are happy with the expansion there with the level of premium that we're seeing.
It's I think in the quarter just under $5 million, which is -- sorry, Canadian $5 million in the quarter, which is alongside our expectations.
Okay. Perfect. And then a final one for me, just sort of looking at the overall business, we've seen strong momentum in the Canadian funding platform really since it's been launched and that continues and same with the opportunities in the U.S. space. So how do you view the evolution of the company's earnings over the next say longer term like five years. Like what would the split of fee income versus the more traditional underwriting look like?
It's a great question Marcel and this is something we've seen internally changing pretty substantively over the past five years. The contribution that we have to earnings from what we qualify as more fee based earnings has substantially stepped up. So I think about fee-based, I think about our earnings in three categories. Really there's the underwriting based earnings from the primary lines of business that we have. So surety corporate insurance some of the warranty products there's a fee-based business that we have from fronting products which are more recurring and predictable and then there's investment income, which generally is fairly predictable in how you earn it.
A greater proportion of our earnings going forward are expected to be coming from those recurring sources of business, so the fee income and the investment income. I will admit I had anticipated a larger proportion to be represented by fee income than the underwriting income sooner, but our Canadian and primary lines practice has grown quickly.
If I combine fee income and investment income, looking forward over the next few years, it's probably approaching 50% of our earnings on a composition basis as you get out in these next couple years. But that will be informed by the relative growth of each platform. All that to say the composition and diversification of our earnings today versus three years ago or especially five years ago, it is very, very different. And I think it's a positive move for the company to generate both more diversified earnings and more stable and predictable earnings.
Okay, that's helpful. Thanks. That's all for me.
[Operator instructions] I'm showing no further questions in queue. I'd like to turn the call back to David Clare for closing remarks.
Thanks very much, operator. And thank you for everyone who's joined. I do acknowledge this quarter with the adoption of IFRS 17, there's a different framework, different paradigm for investors to read and interpret our results. We have attempted to provide these in as much a clear way and rational way as we can. But to the extent you have questions for us on how to read these, how to interpret them, don't hesitate to reach out. We are here to help. With that, operator, I'd like to close the call.
This concludes today's conference call. Thank you for participating. You may now disconnect.