Definity Financial Corporation (DFY) Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to the Definity Financial Corporation Second Quarter of 2025 Financial Results Conference Call and Webcast. [Operator Instructions] Also note that this call is being recorded on Friday, August 1, 2025. And I would like to turn the conference over to Dennis Westfall, Vice President of Investor Relations. Please go ahead, sir.

Thank you. Good morning, everyone. Thank you for joining us on the call today. A link to our live webcast and background information for the call is posted on our website at definity.com, under the Investors tab. As a reminder, the slide presentation contains a disclaimer on forward-looking statements, which also applies to our discussion on the conference call. Joining me on the call today are Rowan Saunders, President and CEO; Philip Mather, EVP and CFO; and Paul MacDonald, EVP of Personal Insurance and Digital Channels; and Fabian Richenberger, EVP of Commercial Insurance and Insurance Operations. We'll start with formal remarks from Rowan and Phil, followed by a Q&A session. during which Paul and Fabi will also be available to answer your questions. With that, I will ask Rowan to please begin his remarks.

Thanks, Dennis, and good morning. The second quarter of 2025 was an exciting one for Definity as we announced an agreement to acquire Travelers Canada, a true milestone for our company and our next step in building a Canadian champion. The addition of Travelers Canada will allow us to surpass our strategic goal of becoming a top 5 P&C insurer in Canada, and we believe it will generate significant shareholder value through scale benefits and enterprise synergies, leading to an enhanced return profile for the combined business. I will provide an update this acquisition later in the call. In the meantime, we remain focused on delivering the targeted performance of our existing business and clear progress was made during Q2 on all 3 of our organic operating ROE levers, as you can see on Slide 5. We have achieved a breakeven level of performance from Sonnets and are well on track to deliver the targeted improvements from expenses by the end of 2026. In addition, we are well positioned to achieve the targeted claims improvements by the end of 2027 and expect to implement Guidewire for property and casualty claims on time and on budget in the fourth quarter. Beyond this, we've said we'd require inorganic growth, which would allow us to deploy our excess capital and introduce leverage into the balance sheet. That is exactly what the Travelers transaction will enable us to do. We can now optimize our previously unlevered balance sheet through the strategic deployment of excess capital and utilization of financial leverage capacity, which we expect will enhance our run rate operating ROE by over 200 basis points. So if I put that all together, I'm confident Definity is well on the pathway to a target of sustainable mid-teen operating ROE post integration. Now turning to the results from the second quarter on Slide 6. We again delivered on our objectives with gross written premiums up 9.1% from a year ago, adjusted for our exited line and a better-than-target combined ratio of 92.9%, a healthy level of underwriting income, more than $50 million in net investment income and a seasonally strong contribution from our insurance broker platform resulted in operating net income of $98.9 million or $0.84 per share. We ended the second quarter with book value per share of $31.39, up 19.9% from a year ago, inclusive of our private placements of common shares to fund part of the travelers transaction as well as continued solid financial results. We generated an operating return on equity of 9.6% over the past 12 months despite the active catastrophe experience from Q3 2024 which continues to weigh on operating ROE. Turning to the industry outlook on Slide 7. We expect conditions in auto lines to remain firm as insurers aim to keep pace with the combined impact of loss cost trends, ongoing regulatory constraints in Alberta and uncertainty related to the extent and impact of potential U.S. tariffs and retaliatory actions. We expect market conditions in personal property to also remain firm over the next 12 months, particularly following last year's record level of industry catastrophe losses and the move to higher reinsurance attachment points. In Commercial Insurance, while we expect overall market conditions to remain attractive, we are continuing to see that some commercial segments have become more competitive. We expect overall pricing in commercial insurance to keep pace with loss cost trends, which have normalized since their post pandemic peak to low to mid-single digits. Slide 8 shows our key financial targets for 2025. As you can see, both top line growth and underwriting profitability are at or better than target midway through the year. While I have already expressed the confidence we have in the pathway to improved operating ROE in the coming years. Despite the drag from higher equity levels, we continue to expect to deliver an operating ROE of 10% plus in 2025. Slide 9 illustrates the composition of our national broker platform. Deal activity continued in the quarter, including a strategic acquisition in Nova Scotia, marking our first location in Atlantic Canada. Our progress with M&A activity and solid organic growth has enabled us to close in on our target for at least $1.5 billion of managed premiums by the end of next year. We continue to view our national broker platform as a vehicle to diversify and strengthen the earnings profile of the business. And with that, I'll turn the call over to our CFO, Philip Mather.

Thanks, Rowan. I'll begin on Slide 11 with personal auto. Gross written premiums were up 9.6% in the second quarter of 2025, excluding the premiums of our exit lines from both periods, driven by an upper-single-digit increase in written rates and unit count growth. To maintain target profitability, an additional 5 points of rate for both Sonnet and line in Ontario was implemented effective in late May for new business. While these actions may temporarily affect competitiveness, they strengthen our positioning as market dynamics evolve. For the remainder of 2025, growth is expected to moderate to mid-single digits, reflecting the outsized impact of the portfolio transfers in mid-2024, our proactive rate actions and ongoing underwriting discipline. Personal auto produced a combined ratio of 94.2% in the quarter, 1 point better than a year ago. The performance reflects enhanced profitability in Sonnet and an improvement in the core accident year claims ratio, which continues to benefit from higher earned rates. We expect personal auto to generate a mid-90s combined ratio in 2025. While we continue to believe the potential impact from tariffs will be manageable, we are continuously monitoring the situation and are ready to take additional actions as necessary to protect our profitability. Turning to Personal Property on Slide 12. Growth of 7.1% in Q2 benefited from continued firm market conditions, driving increases in average written premiums. This was partially offset by ongoing active management of our portfolio to address volatility and risk concentration in regions with a higher propensity for climate-related parallel events. We expect this line to grow at the mid- to upper-single-digit pace for the full year given the conditions prevalent in the industry. We reported a combined ratio of 94.3% in Q2, up from the very benign second quarter of 2024, which saw only minimal cat losses. The increase in catastrophe losses was partially offset by a decrease in the expense ratio and the core accident year claims ratio. We continue to target the sub-95% combined ratio for the personal property line of business. in 2025. Slide 13 outlines the highlights in the quarter for our commercial business. Our strong execution delivered 10% growth in gross written premiums versus the prior year despite industry growth moderating from recent quarters. Our results was driven by targeted growth across strategic segments, with strong retention and rate achievements in our core segments and further expansion of our small business and specialty capabilities. Industry loss trends have normalized since their post-pandemic peak to low to mid-single digits, which has been reflected in growth at the industry level. We expect that we can continue to deliver growth at roughly twice the pace of the industry, which should translate into high-single-digit growth in 2025. Commercial lines continue to benefit from our focus on underwriting execution and rate adequacy with a strong combined ratio of 89.6% in the second quarter of 2025. The combined ratio was higher than last year's very strong 86.6%, driven by a return to more normalized loss frequency and weather, partially offset by a decrease in the expense ratio. The decrease in catastrophe losses and the corresponding increase in the core accident year claims ratio was primarily impacted by the change in definition for a single claim loss in 2025. We continue to operate our commercial insurance business with the intent to sustainably deliver an annual combined ratio in the low 90s. Turning to Slide 14. Consolidated premiums increased 9.1%, adjusting for exited lines. The disciplined nature of our growth through our underwriting expertise, pricing strategies and product expansion, along with the continued focus on expense management resulted in the second quarter combined ratio of 92.9%, up from last year, largely due to high catastrophe losses and a benign non-cat weather from the second quarter of 2024. Our expense ratio of 29.7% was nearly 0.5 point better than the prior year, benefiting from the investments we've made to improve productivity, along with our disciplined expense management. As Rowan mentioned, our second quarter operating expense ratio of 11.5% is already at the level where we expect to end the year. As you can see on Slide 15, our net investment income increased marginally in the second quarter due to an increase in interest income driven by higher holdings of bonds, partially offset by lower dividend income as we reduced our common equity holdings in the first quarter of 2025. Given the anticipated contribution of proceeds from our private placement of common shares, we now expect net investment income of approximately $205 million in 2025. Focusing on distribution income, the seasonally strong second quarter contribution of $21.9 million reflects both the ongoing inorganic expansion of the platform and continued strong organic commission growth across the business. As we mentioned on past calls, the full impact from our national broker platform also includes a benefit to consolidated expenses in the form of a commission offset. In aggregate, we've raised our expectations for 2025 growth to 20% over last year's $76 million before finance costs, taxes and minority interests. We continue to expect it to have a roughly 70-30 split between distribution income and commission offset. As you can see on Slide 16, our robust financial position was further strengthened by the net proceeds from our concurrent private placements of common shares as we raised funds in advance of the deal close. The increase in financial capacity was due primarily to our private placements, a change in our leverage capacity calculations of 30% to better reflect anticipated leverage levels to the Travelers transaction and capital generated from operating net income. These were partially offset by ongoing deployment of capital for broker acquisitions and disciplined deployment of capital to support our organic growth and dividend priorities. Slide 17 shows recent capital management actions, primarily related to the financing of the Travelers transaction. With the private placements complete, we will next turn our attention to bond issuances this fall. We also continue to finance our broker acquisitions, which remains a key area for capital deployment in the quarters ahead, and we were pleased to receive a DBRS upgrade on our trends from stable to positive. With that, I will turn the call back over to Rowan.

Thanks, Phil. Let me end with a few more thoughts on the Travelers Canada acquisition on Slide 18. We believe this is a concrete demonstration of our commitment to build a Canadian champion in the still fragmented P&C insurance industry. We've been preparing for a transaction like this for years. I'm confident we have the resources, expertise and talent to execute successfully. Definity's senior leadership team brings a wealth of experience and has deep knowledge and a proven track record in delivering successful integrations. Integration planning is well underway as we have already put in place a robust transition planning and governance structure. Since the announcement of the transaction, members of the senior leadership team and I have held nearly 2 dozen townhalls with our employees and brokers and the sentiment has been overwhelmingly positive. Our employees are excited at the prospect of our scaled capabilities and the expanded opportunities that they will bring. Our brokers are enthusiastic and are showing a clear interest in our enhanced product offering post close. We expect the transaction to close in Q1 2026 following a receipt of customary regulatory approvals. And I'm very pleased to say that we have already received unconditional clearance from the Competition Bureau. On the insurance side, we continue to be actively engaged with OSFI providing them with the information they need to fully assess the transaction. In conclusion, the acquisition of Travelers Canada will enhance and strengthen our mix of business, increase the breadth of our product offering and provide access to hard-to-source high-performing talent. The deal is financially compelling with attractive economics and will allow for the achievement of an optimized capital structure that we expect will sustainably support enhanced returns for shareholders in the years to come. And with that, I'll turn the call back over to Dennis to begin the Q&A.

Thanks, Rowan. With that, we are now ready to take questions.

[Operator Instructions] And your first question will be from Paul Holden at CIBC.

First question I'm going to ask is just sort of on the updated expectations for commercial lines and the industry growth down shifting a bit. Is that intensified competition? Like is it broadening out to more lines of business? Or is it simply just more intense competition within sort of those large accounts you've referred to previously?

Thanks for the question. I'll have Fabi give us some more insight into that. But I think the macro view we'd like to share in commercial lines is it's really a continuation of what we've been seeing. And if you look back over the last couple of years coming out of COVID, there was a lot of inflation and loss cost trends, which is really the primary driver. That is now normalizing and slowing. And therefore, when you're rate adequate and the industry has been in a firm market for a number of years, the required rate changes really reflect the ongoing loss cost. So I think that is the main kind of message. But clearly, it varies by segment, and there's a lot more nuance to that. So Fabi, would you like to just add a bit of color to that?

Yes, thank you, Rowan. Maybe kind of adding 3 or 4 additional insights to your question, Paul, and thank you for that. I think the first 1 is that indeed, we have seen more competition in the large account space. But I would say that overall, the commercial insurance segment overall is still very attractive for us. We are very pleased with the results that we have achieved in that segment in Q2. You've seen that we have a rate of 10% that is market leading. And obviously, we are very pleased with the combined ratio of 89.6% that we posted in Q2. Our frontline teams are doing a really good job in executing our business plans. And as a result of that, the underlying profitability that we have in our commercial portfolio remains very sound. I think what I'd like to point out to you as well, and I mentioned that in earlier calls as well, is that if you look at our growth rate of 10%, what is important to note is that about half of the growth rate is being generated with rate and inflation adjustments. And that gives us a great deal of confidence but we continue to cover the loss trends that we have in our portfolio. And with that, we are very confident that we'll be able to sustain the combined ratio in that 90% range. The other point I want to draw out as well, as I mentioned before as well is that we continue to benefit from our commercial portfolio being heavily skewed to the lower end of the commercial marketplace in terms of account size and limits, and that gives us just a very good opportunity to mitigate the impact of pricing, leveraging the strong digital capabilities that we built in that segment. And then maybe one of the last points I want to share with you coming back to your question in terms of industry dynamics in commercial insurance, we have more competition in the large account space for sure. But the amount of business that you're writing in large accounts a very small portion of our overall commercial portfolio. And our frontline underwriters are very disciplined. And if the margin equation doesn't make sense for us in all of those large account renewals, you're guiding them to letting those accounts go and again, because the makeup of those large accounts in our portfolio, is so small, we don't really see the impact of that increased competition in our portfolio. So overall, I would say that we view the commercial segment very attractive. We are confident that we can grow our commercial portfolio at twice that industry growth rate without compromising our profitability goals as a result of the strong underwriting and capabilities that we built in small business, middle market and specialties and with a strong support from our brokers, again, we are confident that we'll be generating growth rates in the higher-single-digit range and sustain profitability in that 90% combined ratio range.

Okay. That's a very helpful answer. I think that's really the key issue. Can you continue to gain market share but by, at the same time, maintaining your target margin. So clearly, your answer says yes. So that's very good. Second question, we have a really good slide on the broker platform. I think it's Slide 10, highlighting that you're now the 10th largest P&C insurance broker in Canada. I guess kind of 2 questions related to that. One is like as you get bigger, does it help with the acquisition accretion in any way, i.e., is there more opportunity for synergies? And then two, are there other kind of scale benefits associated with the broker business sort of more on an operational basis?

Well, I would say the answer is yes. I mean, I think that if you just reflect back on the journey we've been on, right? This is only a few years ago that we've done this. We've now deployed a little under $1 billion into the channel. As you've noted, we're a top 10 player. We're growing quite quickly. We've done about 20 transactions, another 6 this year. And what we're now seeing is that there is benefits of scale. And I think as the business grows and it standardizes its technologies and some of the back office functions, there absolutely is upside in terms of the margin. The margins, the EBITDAs that come out of a distribution channel are very attractive and very stable. It's why we like it. They are attractive and they're very, as I said, predictable. I think that whole segment has gone through quite a lot of change in the last couple of years, but it is attractive. And I think that there are a couple of different models out there for roll-ups or for consolidations. The model that we have under the McDougall's Group is a little unique. If you remember, it's unique in terms of we keep the entrepreneurs engaged. They keep equity in the business. And as they do roll-ups, they have a lot of value they can bring to the acquired companies such as more market access, more specialization and capabilities. And so we've kind of seen revenue synergies as companies we acquire increase the organic growth rate and of course, we've seen kind of cost synergies. So I think that scale play that you referred to will continue. And I think just a kind of final comment for me is like where -- we like this. It's been a very good investment for us and deployment of capital. As you can see, Phil made the comment that we've increased our guidance this year, we've done more acquisitions. The organic growth rate is strong. So we've increased guidance from 15% growth to 20% growth. And I can tell you the pipeline's still pretty full for us. So that should play out well for the next several years.

Next question will be from Mario Mendonca at TD Securities.

The comments around personal auto and sort of downshifting a little bit the growth outlook, you're obviously referring to direct written premium. But the growth in net earned premium has obviously been a lot stronger for the last 3 quarters. So what I'm trying to get at is what -- how much longer would you expect the growth in net written -- net earned premium to really outpace direct written premium? Presumably at some point, those 2 converge, and I'm just trying to figure out when that might be.

Thanks, Mario, it's Paul. Yes, you're right. And then this is really a reflection of the lag in the industry between the trend that we are seeing and the written rate that we're taking. As the rate starts to catch the trend and we're essentially near that point now, you would expect to see those elements converge as you've rightly pointed out. That, of course, assumes a fairly stable environment moving forward, while the inflationary trend has normalized or moved toward normal in that mid-single-digit range, we're still seeing some uncertainty. One element, for example, is theft. Theft has improved to your question, but still a little bit elevated relative to prepandemic levels. And then, of course, as Rowan said in his opening remarks, there's still the uncertainty around the tariff environment moving forward. So I think what you would expect to see in a stable environment is that convergence. But as you will see, markets take rate at different times, we don't all take rate on the same day. So there's always a bit of volatility quarter-to-quarter as 1 market may take a rate and another then responds a little bit later. In our particular case, we have taken 5 points of freight in our largest portfolio in Ontario, as Phil has indicated. And as we've shown in previous years when we move ahead of the market like that, we tend to see a bit of a moderation in that -- in our pattern as the rest of the market then catches up and then we gain that competitiveness thereafter.

Next question will be from Bart Dziarski at RBC Capital Markets.

Just wanted to follow up on the distribution income. So noted on the raised guidance, but when I look at the growth rates, like you're tracking at the guide is 20% already. You had 27% strong growth in Q2. You're continuing the acquisition. So is there something in the guidance that you're seeing on more cautious that keeps you at the 20%? Or is there upside to that going forward?

Yes. No, I think we're very -- obviously very pleased with the first quarter that's come through. And if you look at the underlying factors that are driving that outperformance in the first half of the year, it's the strong acquisition activity, and it's the very positive underlying growth that's come through. We have a bit of a true-up that always happens in the first half around CPCs as you make the estimates on what comes through there, and we have a contribution that came through in the first half. But generally speaking, as I know, we're very positive that 20% is the bottom end of our view. We're pretty comfortable that's going to go forward. And in particular, if you look at the acquisition activity that's happened in the second quarter, that's obviously only just occurred and therefore, we'll see some pickup going forward. So no, I think -- if you look at the underlying themes that continuous, it's good contribution from that acquisition activity, and it's the good positive underlying growth on an organic basis that we're seeing in the operations. So a continuation of the same teams, I think, is what we're predicting for the rest of the year.

Okay. Great. And then just on the -- 1 question on Travelers acquisition. So is there an opportunity for you to port Guidewire into Travelers and get claims transformation benefits there? Like I know organically, you're expecting 1 to 2 points, but is that a possibility in terms of using Guidewire with Travelers business?

So on our side, this is Fabi answering your question. So as you know from our disclosures, we're in the middle of a major claims transformation to kind of contribute that 1% to 2% ROE expansion range. Last year, we put our own auto claims on to Guidewire and that's complete and our auto line of business has about half of our claims count. And this year, we're in the middle of completing our claims confirmation to Guidewire by kind of transforming our P&C business. And we do expect that P&C transformation will be done by the end of the year. And with that, we can in-source kind of the travel claims onto a fully end-to-end installed claims Guidewire platform on our side, and that will allow us to drive additional benefits and the main benefits from a Guidewire transformation is a better customer experience, better indemnity control, better fraud prevention, better opportunity to leverage AI capabilities going forward as well. So we feel that the platform that we've built on our side will help us extracting the benefits that we put into the business case when we made the Travelers acquisition.

And Bart, the only thing I would add to that when we announced the $100 million of synergies that we expect to come out of the Travelers integration, I mean we really there were referring to the cost synergies. And so as Fabi talks about when we move the business onto our platforms, and that would be the Guidewire platform buying and personal lines, for example, and for small commercial, but also the claims what that doesn't capture is any potential indemnity improvements, which we think will likely occur in certain product lines as well. So the bottom line is that's all tracking well. We thought about that in our due diligence, in our valuation and then picking the synergies, but the synergy targets we shared in the market are really the kind of cost efficiency targets, and that would occur partly by better technology, moving them onto our digital platforms, but what it doesn't address is the potential benefit of further indemnity savings. So the big point there is that it is important for us to convert onto our platforms and Guidewire claims you pointed out, but the other benefits apply to other product lines as well.

Next question will be from Lemar Persaud at Cormark.

I just want to come back to distribution, specifically your Slide 9 there. I'm wondering if you could talk about the pace of broker M&A now that you're absorbing the travelers. You're showing here that you're at $1.3 billion in premiums. You've added $160 million in the first half of 2025. I think in the context of that $1.5 billion target by the end of 2026, it would suggest a slowdown in broker consolidation. Is that what's in the plan here? Is that because of the Travelers deal? Maybe you could provide some color on that.

Yes. Thank you for that. Look, and I think the 2 points I would make. Firstly, the Travelers acquisition would not have an impact on building out our broker platform. This really is part of the business that is stand-alone and not impacted by the Travelers acquisition. So we have the funds to keep investing in our broker platform and we have the management capability to keep that platform building and integrating as they go. So Travelers won't impact that. I think the other point I would make there is that we haven't yet updated the guidance that you talk about $1.5 billion at the end of 2026. But given the success we've had year-to-date, that certainly is looking like a very conservative estimate to us. And I think all we would say is that we really are very comfortable in tracking towards that target. But that don't read into the fact that we're slowing down our activities. I mean, I think that the broker platform continues to grow very well organically. And as I mentioned in my comments, there are significant opportunities in the pipeline. So that should continue.

Next question will be from Brian Meredith at UBS.

Just a follow-on with the Travelers acquisition and distribution. I'm just curious, Travelers is very committed to the broker independent agency distribution system in the U.S. As we look at this acquisition and your conversations with distribution, have any of the agents that Travelers did business with their brokers expressed any concern on channel conflict or something, maybe they like being with Travelers because they didn't have the broker presence.

Thanks for that question, Brian. And the answer -- the quick answer to that one is no, there is no concern. I mean I think that what we have been able to do in the last couple of months is we've engaged, obviously, with channels, with our employees, with Travelers' employees and with brokers and I'd remind you that the vast majority of Travelers brokers also represent Definity. So there is a natural overlap and in the discussions that we've had, whether they're in townhalls or the one-on-ones with the largest brokers, they are quite frankly delighted about this acquisition, and they are really pleased that Definity is the acquirer. They see that this will add capabilities to us and some further product lines. But we've got a high degree of confidence that the channel conflict is not an issue. They're pretty used to it in the marketplace. This is something that made a unique vertical integration into the broker channel in Canada, but it's not so -- it's unique to the Canadian business, and they seem pretty comfortable. So we're not really worried about that at all, Brian. It's in fact been the opposite. I think the feedback we've got from brokers that represent both organizations has actually been extremely positive.

Great. That's really helpful. And then second question, I'm just curious, down here in the U.S., auto claims frequency continues to be quite favorable. Are you seeing anything similar in Canada?

Go ahead, Paul.

Thanks, Brian. We are seeing sort of normal frequency trends seasonally adjusted. So Q2 tends to be usually a bit of a better quarter for auto claims. And so we're seeing that across the board. The 1 area in frequency that we're seeing a marked improvement year-over-year is in the theft space, as I mentioned earlier, while theft is still elevated relative to prepandemic that's really more on the severity side of the equation whereas the actual set percentages are -- have seen a pretty significant slowdown due to the actions of the government and the industry combined. Now I don't want to give you the impression that it's not an issue anymore. It continues to be an issue, but we price for that throughout. But yes, normal levels of frequency throughout, no issues to speak of.