iA Financial Corporation Inc. (OTCPK:IAFNF) Q3 2020 Earnings Conference Call November 4, 2020 2:00 PM ET

Company Participants

Marie-Annick Bonneau – Head of Investor Relations

Denis Ricard – President and Chief Executive Officer

Michael Stickney – Executive Vice President and Chief Growth Officer

Jacques Potvin – Executive Vice President, Chief Actuary and Chief Financial Officer

Alain Bergeron – Executive Vice President and Chief Investment Officer

Renée Laflamme – Executive Vice President of Individual Insurance, Savings and Retirement

Sean O’Brien – Executive Vice President of Wealth Management

Conference Call Participants

Tom MacKinnon – BMO Capital Markets

Scott Chan – Canaccord Genuity Corp.

Meny Grauman – Scotiabank Global Banking and Markets

Gabriel Dechaine – National Bank Financial, Inc.

Doug Young – Desjardins Securities Inc.

Darko Mihelic – RBC Capital Markets LLC

Paul Holden – CIBC Capital Markets

Mario Mendonca – TD Securities Inc.

Operator

Greetings, and welcome to the Industrial Alliance Third Quarter Earnings Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded on Wednesday, November 4, 2020.

I would now like to turn the conference over to Marie-Annick Bonneau, Head of Investor Relations. Please go ahead.

Marie-Annick Bonneau

Good afternoon, and welcome to our third quarter conference call. All our Q3 documents, including press release, slides for this conference call, MD&A and supplementary information package are posted in the Investor Relations section of our website at ia.ca. This conference call is open to the financial community, the media and the public. I remind you that the question period is reserved for financial analysts. A recording of this call will be available for one week starting this evening. The archived webcast will be available for 90 days, and a transcript will be available on our website in the next week. I draw your attention to the forward-looking statements at the end of the slide package. A detailed discussion of the Company’s risk is provided in our 2019 MD&A available on SEDAR and on our website with an update in our Q1 2020 MD&A.

I will now turn the call over to Denis Ricard, President and CEO.

Denis Ricard

Good afternoon, everyone, and thank you for joining us on the call today. I will first introduce everyone attending the call on behalf of iA. First is Jacques Potvin, Chief Actuary and CFO; Mike Stickney, Chief Growth Officer and responsible of our U.S. Operations; Alain Bergeron, Chief Investment Officer; Renée Laflamme, in charge of Individual Insurance and Annuities; Sean O’Brien, responsible of our Mutual Fund Business and Wealth Management Distribution Affiliates; François Blais, in charge of our Dealer Services, Special Market Solutions and iA Auto and Home; and Eric Jobin, responsible for Group Businesses.

We are quite pleased with our third quarter results, which are very strong for a second straight quarter. As shown on Slide 3, profitability was particularly good with reported EPS up 18% year-over-year. For the first time since iA became a public issuer 20 years ago, our quarterly reported EPS is above $2. Core EPS is also up at $1.83, a 5% year-over-year increase. Several factors support these solid results, including favorable policyholder experience such as the excellent performance at iA Auto and Home. Indeed, the performance of this subsidiary continues to be outstanding.

Our sales results are also noteworthy as they were strong in almost all business units, including in more mature markets such as Individual Insurances, Canada, where we continue to see growth potential for iA. Our Q3 results with 14% growth in Individual Insurance together with 11% year-over-year growth clearly demonstrate that the disciplined execution of our strategy focused on consumer and distributor experience, enables us to continue to grow in this market.

I also want to comment briefly on our Dealer Services businesses. In Q3, following the reopening of car dealerships, there was an upturn in car sales, which positively impacted our Canadian and U.S. Dealer Services sales. This shows that the challenges that may arise from the pandemic in this sector are only momentary and the potential for growth in this capitalized business remains just as interesting.

As far our financial strength and capital position, it remains sturdy with the sound leverage ratio and a 125% solvency ratio up 1% from the previous quarter with low sensitivity to macroeconomic variations and ongoing capacity to generate organic capital.

To conclude my comments on our Q3 results, I would like to say a few words on our vision and strategy. We manage iA with the long-term vision of sustainable growth and financial strength that aims to provide peace of minds to our clients. The strong results that we reported today, show that prioritizing the wellbeing of our clients allows us to best grow our business and create value for our shareholders.

These good results are also the outcome of our smart choices in technology. For instance, part of our success in Individual Insurance and seg fund sales is due to EVO, our high-performance platform, which is used by 100% of our carrier network and close to 90% on the MGA channel.

In Canada, about 93% of individual life insurance applications have been submitted through EVO since the beginning of the year. As for the United States, for the last six months, about 88% of new life insurance applications have been done electronically. These and other decisions that we have made when investing in technology has served us well since the beginning of the pandemic.

Over the next month, we will continue to focus on the wellbeing of our clients as well as our employees and distributors and facilitating their work. This will enable us to continue to deliver high-quality service to our clients and create value for our shareholders. We will also continue to support our communities affected by the pandemic as the second wave is on the way. In addition, we will, of course, keep up working on our positioning in the new normal that will follow the pandemic as well as on the integration of IAS.

I will now let Mike comment on business growth. Following Mike’s remarks, Jacques would provide more information on our earnings and financial strength. On that note, I’ll pass it over to Mike.

Michael Stickney

Thank you, Denis, and good afternoon, everyone. And continuing with the very good sales results since the beginning of the year, business growth during Q3 was robust in almost all business units. Please refer to Slide 4, as I will comment on sales results by line of business. In Individual Insurance, sales totaled more than $53 million during the third quarter, which constitutes a significant 14% year-over-year increase.

Many factors explain these good results, including the strength of our diversified distribution networks, our digital tools and attraction of new products, namely a new YRT Universal Life product, and a participating Whole Life insurance product. Now looking at Group Insurance businesses, employee plans recorded sales of more than doubled those from the same period last year, standing at $26 million. The addition of a large number of new groups during the quarter contributed to this good result.

In Dealer Services, rapid growth recovery following the reopening of car dealerships led to total sales of more than $309 million up 3% from 2019. As for our sales in Special Market Solutions at $40.3 million, they were lower than last year, mainly due to the decline in travel insurance sales. In our U.S. Operations, sales momentum remain strong in Individual Insurance with a 30% increase year-over-year.

In the Dealer Service division of our U.S. Operations, sales totaled US$249.1 million, a significant increase over the sales for the corresponding quarter in 2019. This is mainly due to the addition of the IAS sale since May 22, 2020. In Q3 sales results in this division was supported by the recovery of car sales, following the reopening of dealerships. Conversely, automobile inventories in the U.S. reached their lowest levels in seven years, which may have tempered growth during the third quarter.

The integration of IAS led by [Christine Krueger], the Head of U.S. Dealer Services division is progressing well as planned. The ongoing integration has a wide scope in order to maximize efficiencies and synergies between IAS, DAC and iA’s corporate services.

Now turning to Slide 5 for Individual Wealth Management. Let’s start with the guaranteed products, which sales continue to be excellent, totaling more than $208 million. Segregated fund sales were also very strong with gross sales of almost $725 million up 26% year-over-year. iA remains number one in the Canadian industry for net sales with nearly $376 million for the quarter more than double year-over-year. In addition, the company currently ranked second in the industry for segregated fund sales close behind the number one position.

Moving to mutual funds, gross sales were up 17% year-over-year to nearly $545 million. Net sales recorded inflows of nearly $48 million and therefore positive for the second quarter in a row. This performance was supported by the contribution of our affiliate networks.

Now turning to Group Savings and Retirement sector where sales were significantly higher than a year earlier, totaling $1.2 billion. The signing of groups with substantial assets, both accumulation products and insured annuities explains this good result. Finally, direct written premiums in our P&C affiliate, iA Auto and Home, continued their steady growth and increased 14% year-over-year. Overall, these sales pushed premium and deposits to a quarterly record of over $3.9 billion for the third quarter and increased with 43% year-over-year.

Assets under management and administration, while they slightly decreased over the last 12 months mainly due to market downturn. They increased 3% during the quarter, driven by net cash flows and growth in financial markets.

In summary, again, this quarter, our distribution networks supported by high performance digital tools in our comprehensive range of products and services have proved to be a key success factors of our growth story. Our efforts are now focused on maintaining the strong momentum.

I’ll now turn it over to Jack to comment on Q3 earnings.

Jacques Potvin

Thank you, Mike, and good afternoon, everyone. We are very happy to report to the excellent Q3 results. Starting on Slide 6, reported EPS was $2.03, which is 18% higher than a year ago. On a core basis, EPS was also very solid at $1.83 for Q3 and also for the first nine months of 2020. Core EPS is higher than last year. Core ROE for the last 12 months is 12.3%.

Now digging into results. Please move to Slide 7. Policyholder experience was again favorable in most business units including the Individual Insurance and Group Sector. It was even more positive at iA Auto and Home, our P&C subsidiary, which continues to have results above expectations. Macroeconomic variations also had a positive net impact of $0.12 EPS on the results. Strain was in line with expectation as increased premium in individual insurance offset the negative impact of the first quarter drop in interest rates.

Income on capital generated a $0.04 EPS loss, mainly due to lower investment income. On the tax side, the company’s status as a multinational insurer was the main factor supporting the gain of $0.12 EPS. Finally, two other specific items of networks. First, we incur a loss of $0.11 EPS mainly due to a software write-down. On the other hand, the sale of our residential mortgage portfolio generated a gain of $0.06 EPS.

Please refer to Slide 8 as I will now comment more specifically on policyholder experience, which totaled a gain of $0.15 EPS in Q3. Starting with Individual Insurance, a gain of $0.04 EPS was recorded mainly due to favorable morbidity experience and lower expenses, partly offset by negative mortality. Individual Wealth Management reported a result close to expectation as commissions paid on mutual fund sales were higher than expected.

Our Group Insurance sector recorded a gain of $0.03 EPS, which can mainly be explained by lower expenses in the Dealer Service division and favorable experience in the Employee Plans division. The overall positive experience in Employee Plans is mostly due to positive long-term disability experience, which was partly offset by health and dental experience and mortality. As for Special Market Solution experience was in line with expectation.

Group Savings and Retirement reported a gain of $0.02 EPS due to favorable longevity and lower expenses. U.S. operations reported experience below expectation with a $0.04 EPS loss. This is explained by adverse mortality in the Individual Insurance division, nearly half of which can be attribute directly to COVID-19.

As for the U.S. Dealer Services division, favorable experience result in a small gain. Please note that the operating profit from the IAS acquisition for the period from May 22 to September 30, 2020, is included in our U.S. operation Q3 results. IAS profit during this period was in line with management expectation as specified during the second quarter conference call.

Finally, as already mentioned, experience at iA Auto and Home was once again much better than expected with a gain of $0.11 EPS. This very good experience can be explained by lower claims, particularly in auto insurance, as well as lower expenses.

Please refer to Slide 10 for our capital position. During the quarter, our solvency ratio increased by 1 percentage point due to organic capital generation. Indeed, we generated about $70 million in organic capital during Q3 and $175 million during the first nine months of 2020. We are quite pleased with our continued capacity to generate capital organically as we consider organic capital generation to be the best source of capital.

Our solvency ratio as at September 30, 2020 is very strong at 125%, well above our target range of 110% to 116%. This target range is more than adequate for iA due to the low sensitivity of our solvency ratio to macroeconomic variations.

The market protection that is described on Slide 11 provides a better understanding of some of the reasons for this low sensitivity. Indeed, iA has a distinctive market protection in the form of a margin embedded in our reserving process that protects against the recreation of public and private equities matching long-term liabilities.

More specifically, this margin increases or decreases based on market filtration. In practice, as this margin can sustain significant market drops, we normally don’t need to adjust reserve in prior year. Most recently, the ethics of this protection was proven in the first quarter of this year. In addition to decreasing the net income volatility, this market protection also decreases our solvency ratio volatility, which supports our lower solvency ratio target.

This protection has a great value and is well aligned with our prudent and long-term approach. The current work of this prediction, which is not recognized in the solvency ratio calculation, is equal to more than 7 solvency ratio percentage points. Altogether, with a solid solvency ratio at 125%, the market protection equal to more than 7 percentage points leverage ratio of 25.1% and high quality investment portfolio, the company continues to be in a very strong financial position.

READ ALSO  President Trump Pardons Michael Flynn

I will conclude my remarks by commenting on our auctorial review and year-end risk management strategy. Please move to Slide 13. First, we expect that our regular annual review actuarial assumption will have a near mutual impact on fourth quarter earnings. Most specifically, annual assumption strengthening, including for the URR should be offset by investment gains and strategies to manage macroeconomic risk, most of which have already been completed to-date.

In parallel, since the beginning of the fourth quarter, we have concluded new reinsurance agreements as a matter of practice with [indiscernible] reinsurance market. And this year, we decided to take advantage of the favorable reinsurance market. And this reinsurance strategies are always accretive and will create value. At this time, we plan to use the gains from disagreements to take on additional protections again uncertainty arising from the COVID pandemic. Overall, we are well positioned as we expect our year-end risk management strategy to have neutral to positive impact on Q4 2020 results.

In conclusion, I will say that with our strong earning power and financial strength, all the fundamentals are in place to support our continued growth and to deliver value to our shareholders.

Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Tom MacKinnon with BMO Capital Markets. Please proceed.

Tom MacKinnon

Yes. Thanks very much. Good afternoon. Just two questions here. My first question relates to the new reinsurance arrangement you’re speaking up. Just a little bit more color here on what you’re doing. Are you like replacing a current reinsurance arrangement with a new one and in the process you’re getting some more favorable terms in pricing. And does that mean you’re getting some earnings gains going forward? Or is this like a new reinsurance arrangement that you’re embarking in doing you’re getting capital reserve relief? And then maybe you can elaborate on what additional protections you’re going to be taking here. Does that mean you’re getting some relief capital in reserve relief from the insurance, and you’re going to strengthen reserves elsewhere? Just a little bit more color on that. And I have a follow-up. Thanks.

Jacques Potvin

Okay. Jacques speaking. About reinsurance and I will mention right away that we have not finalized all the negotiation for that strategy. So I will be – I’ll keep some information to not lose some bargaining power because we want really to try to increase the shareholder value. But reinsurance okay, we’ve signed – we’ve already signed some of the deal and for sure they will provide positive value. That value is coming from two sources, okay. One is like you said, we will no longer require because we will no longer bear that risks. So we will no longer need to have the margin in our reserve and the capital ratio will be lower. The capital required for that business will be lower. So it’s ROE equity.

But the good news is that the reason why we strike the deal because almost all year, we kicked the [indiscernible] and we look at the reinsurance market. But this year, we feel really that we have to take that deal because that was a very good deal on the Streets. So reinsurance is seeing more profit in the future business that what we’re seeing. But like I said in my note is that – I’m not planning to release that profit in Q4 because I know that there will be some headwinds coming from the COVID situation. It’s a situation that is very fluid, so far so good. After three quarter, we’ve been hit a lot by volatility in Q1. Q2, Q3 COVID has been, I would say neutral, but we don’t know what the second wave will bring to us, we don’t know if the government will continue with their same program. So I will try to be cautious here and to keep those margin to manage that path.

Denis Ricard

Yes. The only thing I’m going to add is – Tom, if you don’t mind. I just add one thing here. Regarding reinsurance, we are not dogmatic about it. Meaning that, like Jacques said, from time-to-time, we do check how the market is, and it also gives some – for us some comfort about our assumptions as well. And this time we thought that the convergence of these good reinsurance deals and the fact that COVID, we need to be more, I would say prudent in terms of some of the assumptions. So the convergence of the two, I think was quite done at the right time. So we’re trying to be forward-looking in the way we look at reinsurance and also not being dogmatic.

Tom MacKinnon

Is there any impact on earnings?

Jacques Potvin

To complete on your first question, it’s new reinsurance agreement on business. It’s not replacing an old reinsurance agreement. And the impact on the earning, it’s too soon to say. So in Q4, I’ll be able to provide that.

Tom MacKinnon

Okay. And my follow-up is on the amortization of finite life intangibles related to acquisitions that you disclosed on Slide 22. So this non-cash expenses essentially doubled from 2019 levels, and it’s almost entirely due to the IAS acquisition. Now is this expense is included in core earnings and I get it, it wasn’t particularly immaterial in 2019 or in the prior year, there is only maybe about 4% at core earnings or so on an after tax basis.

But now with the IAS acquisition, it’s essentially doubled and it’s over 8% of your core EPS. And as you know, the Canadian banks have the Street focus on adjusted net income, which in addition to excluding restructuring and integration expenses also excludes expenses related to the amortization of finite life intangibles related acquisitions. And these are probably about 2% to 3% of the bank’s income. In fact financial also presents operating earnings, which excludes these non-cash expenses as well.

So can you help us understand why you have decided to include these non-cash expenses as part of your core earnings? Because like the way I calculate it, the $0.27 EPS, 2021 accretion you talked about from IAS and the $0.38 you got it due for 2022, these would probably be like $0.28 higher, more like $0.55 and $0.66 if you had followed the same kind of reporting adjustments that the Canadian banks and Intact Financial make when they exclude these non-cash earnings from their “core earnings”. So maybe some color with respect to that, please.

Jacques Potvin

Okay. Jacques speaking. Tom, you’re making a great point. What historically in the life insurance industry, it’s my understanding that we’ve always reduced the core earnings by the amortization of those numbers, but like you point out it’s not done in the bank industry, not done in – for Intact. So that’s a really good point with the fact [indiscernible] with the acquisition of IAS. So for sure that’s why we change our strategy this quarter. We provide the information in the slide package and that’s a good information. But like I said, historically reinsurance industry didn’t recognize it. So it’s a good point that which will be compared on level playing field.

Tom MacKinnon

So like when you look at IAS, you looked at it on an EBITDA basis. So I assume that when you looked at it, because you gave us some pricing metrics on an EBITDA basis. So I assume on that EBITDA basis, you’re excluding these non-cash expenses just the same way, the banks and Intact exclude them. So do you think we should be looking at IAS here on an EBITDA basis? Maybe you can think about that in terms of how you want to disclose the impact of IAS because if we allocate those non-cash expenses to IAS, like maybe we should be looking at IAS on an EBITDA basis that excludes those non-cash expenses.

Denis Ricard

Tom, it’s Denis here. I think you’re right. And I must say to you that we are in the process of reviewing our calculation of our core earnings for next year, what does include and what it does not include, and certainly your comments will be taken into consideration. I think you are right to say that this should be excluded.

Tom MacKinnon

Okay. Thanks for that.

Operator

Our next question comes from Scott Chan with Canaccord Genuity. Please proceed.

Scott Chan

Good afternoon, everyone. Just with the second wave that really started post quarter, post Q3, maybe too early as you just alluded to, but is there any lessons or what you can draw from the first wave that maybe has affected your business growth or your overall business thus far?

Denis Ricard

Yes. I think Mike you should follow-up on that question.

Michael Stickney

Okay, thanks. Yes. We’ve learned it. It’s hard to predict I guess. And I guess when I look through the company in terms of our various businesses, we have learned how to manage with it. And I’d say all of these businesses some better than others, obviously. I mean, I’m really quite impressed with how we’ve done with our Individual Insurances businesses in both countries. Obviously, there’s a lot more digital sales and so on. And going through our other businesses, same sort of thing. Obviously, our dealer business is a little tough because we’re dependent on car sales and there’s some headwinds there because of COVID. And I guess the other one that’s hitting – hit hard, but it’s a small business, is the travel insurance business.

So in terms of the second wave, that’s part of this, that’s hard to predict. In my mind, it all depends on government lockdowns. They’ve come back. You’re seeing that in Europe right now. My own view is Canada is leading yet. The infection rates are still, I think, pretty well managed or under control in Canada. The U.S. has got higher traction rate, but it also has a very unusual political situation right now. So I don’t think there’s a political world to make it happen to U.S. So my best guess would be, we carry on for the next few quarters just as we have for the last quarter.

Denis Ricard

Maybe one thing I would like to add on this is that – Mike mentioned that that we’ve been resilient. I mean, a lot of our businesses is being distributed through advisors and whether it’s on the wealth management side, the life insurance side, Canada, U.S. Maybe we should talk about it much more, but our technology were quite advanced versus our peers. And it allowed us to maintain and even increase the level of ourselves because all of a sudden the distributors, they needed to have tools to be able to make their living to obviously grow their business.

And we were able to provide them with those tools very quickly. I mean, we haven’t started investing in the toxicology during pandemic. We had started doing it in the recent past, I mean, over the next – the last few years. It really paid off. I think that’s the lesson here of this pandemic that’s going to help us through the second wave is that because we have invested so much in technology and we are still continuing it, that we should be in good shape if a second wave is going to hit us seriously.

Scott Chan

And my second question is just on IAS. I guess you included from May 22. So just over a month and you kind of called that it added a bit of a sense, can you quantify how much IAS impacted Q3 in terms of earnings?

Jacques Potvin

What you have in the number is $0.04, so if you subtract that cents if you want to other kind of a run rate for Q3, it would be $0.03.

Scott Chan

Okay. And just lastly, you called it, the vehicle inventories are weak, and obviously it’s from the pandemic in the U.S. Do you have any visibility on when that improves? As I think you said it’s the lowest level it’s been during the quarter.

Michael Stickney

Yes. Mike Stickney here. The industry predictions that I’ve seen, I guess, is that inventory levels should be back to, let’s say, close to normal Q1, Q2 next year. So it’s just kind of a temporary phase we’re going through.

Scott Chan

Okay. Thank you very much.

Operator

Our next question comes from Meny Grauman with Scotiabank. Please proceed.

Meny Grauman

Hi, good afternoon. Just a question on – really hoping you could update your thinking on your real estate exposure especially in the context of the scale of the residential mortgage portfolio. So I noticed there was some commentary in terms of looking at during the real estate and infrastructure review tied to the annual assumption review. So just to sort of an update there in terms of your thinking and in terms of overall real estate and where the market’s going from that asset class specifically?

Jacques Potvin

Jacques speaking. In regard of real estate, we are using external valuation to look at all our real estate portfolio. And during those result performance, our views of some cash flows, believe it or not, some are positive, some are negative in the current context. Overall, since the beginning of the year, I can tell that at the end of Q3, we already have $130 million worth of present value in reserve impact – the negative impact, but it has been compensated by all the management action, which we’ve done so far this year.

And this one is quite important to understand that every year we do management action, but this year the value of those management action went through the roof because of the widening of the spread in Q1 and Q2. So we’ve been able to create a lot of margin to phase those don’t work for sure. So that’s what we’ve done there. So the situation is good in regards of that, but when we look at where we’re heading, we’re quite fine to where we are right now.

Meny Grauman

And in terms of the thinking on the residential real estate portfolio, what was the driving thought behind that?

Jacques Potvin

Okay. We exited the market. We mentioned it. The decision was taken last year. We exited the market. So we closed the transactions during the quarter. That’s what happens during that quarter, but it’s really that we had that business for many years. At the time it proved well, it was useful to match our liabilities. But recently when we did our strategic thinking a couple of years ago, we decided that it no longer serve our purposes. We will have to invest into it. So far was the best value for our shareholder was to set it. So that’s it.

Meny Grauman

And then just, if I can ask on topic that Tom talked about. The COVID uncertainty there, definitely two quarters in now, it looks like your business is very resilient to COVID. I think in Q2, you talked about the 2020 results being better than initially assessed. So maybe a little bit more specific in terms of where the concerns lie as you look ahead. Where did the risk fall on your view? Which specific businesses is really the source of your concern or where you think there’s elevated risk that you wanted to adjust?

READ ALSO  Oil Prices Climb Higher As The EIA Reports Inventory Draw

Jacques Potvin

Actually, I would say mortality, when we look at the mortality in the U.S., Q3 has been very bad, Q2 was less bad. We don’t know is that fluctuation. And we said that half of the mortality is coming from COVID, but the fact that because of the sensation, people are consulting less physician, there are ripple effects in regards of mortality. So this one is tough to call, but this one, I want to be prudent on it. After that, one of the thing that we mentioned is the governmental program that gave money to many people if ever gets stopped, will we see a spike in claims on [indiscernible] because it will put a lot of pressure on the household and that’s the kind of stuff.

So just remember, our thinking in May when we said that we were seeing a lot of things that were back in Q2, like you said, we’ve been very resilient and we are very happy with that. We had good news, IAS dealer services has been – also claims has been the word unexpected and all that kind of stuff. But will they continue the same as the negativity? Quite tough to say. So for me, it’s that – when I look at lapse, lapse has been positive so far this year, which is great. But it’s tough to say that it will continue that way. So those are the things that I will look at.

Denis Ricard

Just one thing to add on this. I think I would say – I think it should give comfort to investors that we are able to deliver such a strong quarterly results, and at the same time being able to get some additional comfort. The examples that Jacques gave regarding some of the management actions that we’ve taken the reinsurance treaty that we’re working on right now. So I think you should give comfort. And this has benefit as I feel the company trying to be prudent at the same time being looking forward.

Meny Grauman

Got it. Thanks.

Operator

Our next question comes from Gabriel Dechaine with National Bank Financial. Please proceed.

Gabriel Dechaine

Hey, good afternoon. Just to follow-up on that reinsurance question. I know you don’t want to quantify stuff, but could you tell me what blocks of business, what risks reinsured? What downside issues are you trying to address I guess, or mitigate?

Jacques Potvin

Okay. Like I said earlier, every year we kick the tar about reinsurance. And this year, when we look at all the quotes we got, we felt pretty comfortable with our assumption, where we are. There was a small adjustment I will make at year-end. That would be an adjustment. It’s not about not that – the improvement is really the level for the ultimate mortality for product that the table has not been well construct. So there’s one thing that we will fix there, but overall, the mortality we’re expecting in the future were quite fine with where we’re sitting. And that’s the message. That’s the conclusion, when I look at that. However, that deal is because there was aggressiveness in the market. The reinsurance market is [indiscernible]. So it’s a good value in our ROE basis and it’s for Individual Insurance in Canada and also in the U.S. for final expenses.

Gabriel Dechaine

So it’s mortality related.

Jacques Potvin

Mortality related, yes.

Gabriel Dechaine

Got you. And I guess, while we’re on mortality, you did touch upon it earlier, but there’ve been a few quarters here where we’ve seen mortality losses and gains on the pension side, but losses in the insurance businesses, too early to call it a trend. But let’s – maybe like – are you thinking any differently about it this quarter than you were in last quarter? Because last quarter you also said it wasn’t a trend, but it might be.

Jacques Potvin

That’s a good question. No, it’s pretty much the same as last quarter actually except that we are advancing, we’re progressing on our experience study. And I referred to a trend that started. It was very, very small last year. It’s starting to show this year, but it will only grow if we don’t fix it. So that’s why we will fix it at year end. But if we look at this year, it’s probably a lot temporary year because of the COVID situation, the fact that people are not seeing their physician and all that kind of stuff. So that’s why the difficulty decision is really to figure out what’s permanent, what’s temporary. And most of it I would expect it’s temporary.

Gabriel Dechaine

Got it. And then to wrap up my questions here on IAS. I guess the premise I’m going to go with here is that there were maybe still are some concerns that due to low sales and maybe change – while obviously changes in the macroeconomic environment, the goodwill that was – that could have came with that acquisition was maybe looking too high and maybe subject to a write-down. Based on the communication you’re giving us today, sales are looking up and profits are in line with expectations. Is it still something we should be thinking about or can we put that to bed? And if last year position, maybe give me some clarity on why?

Jacques Potvin

Okay. Jacques speaking again. The outlook has not changed at all since the last conference call. So we don’t expect a goodwill write-down now and in the foreseeable future. And I will give you three reasons for that. First, it’s really a short-term plus WET – that the COVID, we don’t see long lasting effect on that. It’s temporary. And remember that IAS acquisition is a growth story. And just keep in mind that we have the financial strength to go through that crisis as our working capital ratio is showing as our market protection not showing and that market is a very fragment. So we believe that we will try after the COVID period because there are many moment that don’t have our financial strengths. So the road for the future, we still believe in it and that part is intact.

We said also in Q2 that on integration we will go further than what we add in our acquisition model. And the reason why is because of work from anywhere experience, we are living through with the COVID situation, make us see that we can go further and we can be more efficient. You don’t need to be in the same city to do some of the thing efficiently.

So that’s another added value that we would have compared to the acquisition plan. And the term which – reason which is nonetheless, we will completely consolidate those operation with the DAC operation, it will be only one company at the end of the day. And just remember we bought DAC two years ago and the value of DAC has increased a lot since that time because both on growth side and on profitability side it has been always above expectation, so it will give an additional comfort to what I said in Q2.

Gabriel Dechaine

Got it. Thank you. Have a good rest of the week.

Operator

Our next question comes from Doug Young with Desjardins Capital Markets. Please proceed.

Doug Young

Good afternoon, Jacques. Maybe this is for you. If I think the – just going back to IAS and the accretion. And so the accretion for the quarter was $0.01. If I take out the incremental increase in the amortization for acquisition-related items and after tax, that’s about $0.08. So it get to about $0.09. And then it looks like your accretion integration expenses was better than you had built into your expected profit. So there was a gain of $0.02 related to that. So then if I take that out, I get to $0.07 accretion post the noise around the amortization. Is that seem reasonable and is that what we should be thinking of as a baseline going forward? And I get those five extra weeks related to May to June that’s included in there, so maybe a $0.06. Is that a reasonable approach to think about it?

Jacques Potvin

Not necessarily. I will say the best way to look at IAS because one of the things that I need to confess is the fact that IAS okay, was not calculating, was not doing its financial statement on the IFRS basis. So when we did our plan and our expected profit, our amortization of intangible and so on, we put all amortization of intangible into the surplus line. We didn’t put anything into the expected profit. And in reality, there will be some asset that will be amortized at the subsidiary level, which will be included in expected profits. So the best way to eliminate all that noise is really to look at it overall from an overall basis.

So the accretion for Q3, the number you have is $0.04, but the best is what we said in Q2 is really that we expect that the accretion for this year would be 5 to 10 bps lower, and the same next year then what we said. So for next year, what it means for 2021 it’s between $0.17 and $0.22, that’s what we expect for the moment. That’s the best information I can provide.

Denis Ricard

Yes. And that does not consider the amortization on finite life intangibles. So if we were to consider that we would add another…

Jacques Potvin

$0.24.

Denis Ricard

$0.24, yes.

Doug Young

Okay. So $0.17 to $0.22 is including the amortization, okay. Yes, it’s been while I’ve never seen a situation where there’s been a gain on the amortization or the integration costs. Anyways, that’s maybe something, it just adds a little bit of confusion there. And then just on the actuarial assumption review for Q4, I think you’ve been crystal clear, you don’t expect a material net impact from other moving pieces. And then you’ve announced this real estate or reinsurance transaction or deals that’s going to create a gain. Is that the view that the actuarial assumption review is not going to have a material impact on results, include the gain from the reinsurance transactions or those two separate?

Jacques Potvin

Those two, I look at them separately as I’m trying to show on Slide 13. I’m really doing my actual assumption the same as I was doing in previous year. I look at the long-term view. I conduct the experience that day, and I will put my assumption for that. The reinsurance, what I will do with that is not look at the short-term negative impact that COVID will bring to us. So what are the headwinds? So it’s really two different things that are attached together at the end of the day because those are assumptions, but it’s really to the second way of looking at it. I don’t want to change my normal annual process of actuarial review.

Doug Young

Okay. So they’re separate. So that’s not – you’re not including the gains from the reinsurance deals and the fact that it’s going to not being – the assumption review is not going to be material. Okay. So then just thinking about what you’ve talked about on Slide 11, and I think it’s interesting and I mean, if you went to – but basically it maybe a puzzle, say like, and you can tell me if I’m thinking about this, right. If you went to a mark-to-market model on equities, private and public that are backing liabilities versus the quarter approach, your LICAT would be seven points higher, albeit you would add more volatility in earnings, you’d have a higher LICAT ratio. So there’s a bit of a trade off between the two. Is that the right way to think of it?

Jacques Potvin

Yes. That’s the right way.

Doug Young

And would you ever move to the mark-to-market model? I mean, you’ve never been under it, you’ve always used the corridor approach, but like if you ever got down to that level or would you ever switch?

Jacques Potvin

Actually, not at all. I really like to be in that position right now. I think it allow us really to do a transaction looking at the long-term value, long-term protection, instead of having a short-term pressure to do transactions. So I prefer to be in that. The bad consequences is – and that’s what we’re trying to do this quarter actually is to bring visibility to that extra margin that has proven to be very useful for us, but that we have not done a great job to put in front of everyone. But the thing that we need to remember as well is IFRS 17 will change everything – all the rules here.

Denis Ricard

Yes. We’ve been a strong believer in that methodology because of the long-term nature of our business. In my mind it didn’t make sense that because of some, let’s say, changes in long-term interest rates from one quarter to the other that the income statement, which was such a volatility. So I’m using interest rate by stock market is same here. So for us, it’s been a, I would say a consistent way of measuring our earning power, which is based on the long-term nature of our business. But Jacques is right. I mean, the IFRS 17 is going to bring a new world here.

Doug Young

No, hands down for sure. And then just lastly on IAS, can you quantify what the contribution to expected profit was from IAS?

Jacques Potvin

Yes. So many numbers in my head, so I don’t want to answer that one because I would probably confuse every one. So I will stick with what I said earlier, the best way to look at it.

Denis Ricard

Yes. The best way to look at it is really the $0.04 EPS accretiveness on a core basis in 2020. And then like Jacques said, if you want to know for next year, our best guess is something around $0.20 on a core basis for 2021.

Doug Young

Okay. Thank you.

Operator

Our next question comes from Darko Mihelic with RBC Capital Markets. Please proceed.

Darko Mihelic

All right. Thank you. Actually my question was on the U.S. Operations and expected profit and similar, basically the same thing. I mean, if I look at your supplemental and I look at the source of earnings for the U.S. Operations, and this would be on Page 8 of your supplemental. As you can appreciate from the outside looking in, there’s a lot of moving parts this quarter. We have IAS now in there, plus it’s in there since May, we have bouncing back and we have U.S. Operations had bad mortality. So as I look at this source of earnings and I see the expected profits and a few other line items that are kind of moving all over the place, it would be very helpful.

READ ALSO  Book-binding - Bertelsmann snags Simon & Schuster | Business

Jacques if you can take some time and walk through these line items with me. Do you want to do it another time, that’s fine. But for modeling purposes, it’s very difficult to build a model without some sort of run rate assumptions here on all of these line items, if you know where I’m coming from. So I realize you can’t speak to it now, but maybe just a thought to give us a hand with the source of earnings model, especially for the U.S. Operations given all the noise this quarter. And I’ll leave it at that. I guess if you can’t speak to it now, it would be helpful at some point if you could.

Jacques Potvin

Okay. I got the point Darko, so we will get in touch for that. And like I said, we did our best at the beginning of the year to try to put the model of IAS there. However, like I said, they didn’t produce anything on an IFRS basis. So we took a shortcut putting things intangible, and this is bringing noise right now. The fact that we closed the transaction later than expected also is bringing us compared to the expected. So that’s not an issue here, so next year it will be better, but I will certainly contact those that want to have more information to give the details.

Darko Mihelic

That would be great. Thank you.

Operator

[Operator Instructions] Our next question comes from Paul Holden with CIBC World Markets. Please proceed.

Paul Holden

Thanks. Good afternoon. So we’ve heard your messaging on the capital position and that you’re quite comfortable with the solvency ratio given where it sits versus target and the protection you have put in place on it. One of the common feedbacks we hear from investors is the ratio is lower than peers. Just curious, how you think about your solvency ratio versus your cost of capital, like, how are you thinking about balancing that equation?

Denis Ricard

If I understand correctly, your question is, you want to know how do we perceive our capital ratio versus our peers to some extent. And the way I would respond to that is that it’s not fair to only compare the absolute amount of the LICAT ratio. I think what is better to look at is really the sensitivity of the ratio versus the target. And what we’ve demonstrated is that our capital ratio is much less sensitive to macroeconomic factors. And I was also embedded in it some have protective cushion.

So the way I look at it myself is that if we were to be mark-to-market, we would be at 132%. That’s the way I look at it. Obviously there would be more volatility from one quarter to the other. To me it’s more fair. And that is why we tried this quarter to be a bit more visible in terms of this because it’s unfair to see you are at 125%, that means you’re lower than the others. That means it’s more risky. That’s not the case. We are lower, but we have additional caution. And if we did not have put this additional caution, we would be at a much higher level.

Paul Holden

So that is helpful. And sort of a follow-up question to that because Denis last quarter, I think you said your capital priority is to continue to build the ratio over M&A, and clearly you can’t do buybacks or dividend increases right now. So any more context in terms of your thinking what the right capital ratio is would be helpful?

Denis Ricard

Yes. Well, I would say, there’s the COVID period and the post-COVID period. In terms of the COVID period, I don’t mind to be in a position where our capital ratio is let’s say, higher than what we would otherwise try to stay with. So right now we’re probably – I think it’s much higher than where it is. We would want to be in the long run. So in a post-COVID, certainly we would think about doing buyback shares or maybe thinking more about M&A.

So for the time being during the COVID, we’re pleased with where we are and the fact that it increases, what the pace increases right now, but certainly when the COVID, is behind us, we will be again, look at how is it that we deploy capital. And as we said in the past, our priority is to grow the company and for some reasons there is no opportunity then there’s other ways like buying back shares.

Paul Holden

That’s helpful. Thank you. One final question. I mean a big theme across financials is obviously lower bond yields and well aware that you’ve put in many layers of protection on the existing book of business. Just wondering how we think about your investment allocation on new sales. Is anything evolving there to help protect margins? And maybe simply, you’ve increased price on the product and therefore, investment allocation doesn’t need to change, but I’m curious on an update there.

Jacques Potvin

That’s really a good question. Actually, we discuss about investment strategy every time we develop new products, so we want to make review. But the good thing is the market allowing us to be able to increase our price and continue to get the sale, and that’s exactly what we demonstrated in Q3. We just raised the price of the long-term guaranteed product because of a decrease of interest rate and our pace of continuing to increase. And the market has – some competitor have done the same thing because we are all in the same ballpark. We are all in this thing in the same kind of asset.

And in regard of investment strategy, I will say that we try to optimize always the balance, the risk we’re taking, diversification of the risk versus the present value that is bringing. And like I said in an earlier answer, in Q1 and Q2, we certainly took much more credit risk because we were paid to take it. In best year, we were very shy of getting credits, but this year condition was simply amazing. So our investment team have really are doing a great job of optimizing that.

Paul Holden

That’s very helpful. And those are all the questions I had. Thank you.

Operator

Our next question comes from Mario Mendonca with TD Securities. Please proceed.

Mario Mendonca

Good afternoon, Jacques. I’m sorry to do this to you, but I do need to go back to the IAS deal. You talked about the $0.04 accretion, including that tough period from Q2. That number is pretty hard for me to get when I just play with the numbers that you’ve already provided for us. Specifically, we know that the U.S. expected profit was up as much as almost $22 million, sequentially. And we also know that the $11.4 million associated with the amortization of the intangibles. What that would suggest to us then that the IAS contributed something like $10 million maybe even $11 million in expected profit in the quarter? And I can’t find other areas to subtract from that number to get me down to the force accretion because obviously I’m a lot higher than $0.04 accretion if I stop at the expected profit and then just tax effect. So is there something I’m missing that gets us down to the $0.04?

Denis Ricard

Well, it’s Denis here. I guess, I still have Jacques on that one. I think you have to subtract in the line income and capital. The fact that we’ve obviously paid the price and there are some less income on capital. So it’s the net of the increasing expected minus the amortization that we discussed earlier, minus some of the income on capital that we don’t earn anymore.

Mario Mendonca

So Denis, I went straight to that to see if I could find it there, because that was my initial impression. And I looked at the financing line on Page 22 of your presentation and the financing line hasn’t changed at all. So my next obvious step was go to investment income. I see that investment income is down, but that’s really a function of the software charges and other charges in the quarter, not so much lower investment income. So I kind of have done my homework, trying to look for an entry here and from what you’ve disclosed, I can’t see where the offset is. Where is the negative to IAS because it’s not apparent in the schedule?

Jacques Potvin

Okay. For sure, it won’t show in the financing line because financing is really related to the debenture we issued. So it’s really income on surplus that will be lower because of the fact that we have a goodwill and tangible – net intangible, which earned no return before the acquisition. We add asset that were earning return. So I don’t believe that will be isolated. So that’s why it’s a little bit tough to get to that number.

Denis Ricard

So I think here it’s a similar question we had before, and maybe the – with the offline, we can work on the numbers just to reconcile the accretiveness with you guys, so it would be pleasure for us to do that.

Mario Mendonca

But just to be clear, the decline in investment income, it appears on Page 22. I imagine a portion of it could be the lost capital, but most of that decline is associated with the software write-off because that’s where it went through. That’s my understanding from looking the disclosure. But I think it should be pretty clear from the nature of our discussions that the success and failure of IAS plays an important role in how investors are looking at your company. So really transparent disclosure around its accretion. We need more than just saying $0.04. I think we all need to understand this better to look around it.

Jacques Potvin

Okay. So maybe that’s why I say there’s so much noise because of the way that our gain and loss is working. So that’s why the best summary is really to remember that we mentioned that acquisition IAS and Lubrico, and [indiscernible] they are immaterial. Let’s say it’s only IAS here. We said $0.15 earlier this year, okay. Now in Q2, we said it could be $0.05 to $0.10 lower than that. So it means that for this year, we expect it would be between $0.05 and $0.10. What we’re seeing in the current result of Q3, what you’re all seeing is plus $0.04. That’s what you’re seeing right now. We will see in Q4, what will it be. But overall really IAS is bringing – will bring between $0.05 and $0.10 this year. That’s what we’re saying actually.

Mario Mendonca

I understand. And what I’m suggesting to you is that for something that’s important to the company.

Jacques Potvin

Yes.

Mario Mendonca

Not sufficient information to understand what’s going on with IAS. And I think that was the point Darko was making.

Denis Ricard

Yes. Thank you, guys. I mean, this is very helpful information and it’s funny because we’re trying to be as transparent as possible. Our source of earnings provides much more detail than what you would find in, I mean, per sectors, for example, then what you would find elsewhere. But I realized on that one that we can go to an extra step to be even more detailed.

Mario Mendonca

Yes. This is completely insufficient to understand it. On a different note, when I saw that, there’s a reinsurance gain coming down the pipe, and you also talk about maybe allocating it to other areas of uncertainty. The cynic in me immediately turned to the subprime auto lending. Is there any potential here that this could be allocated to further shore up the provision against the subprime auto?

Jacques Potvin

That’s not at all what we’re contemplating because actually, if you look at the experience of the car loan, we succeed of having great results. And even if you look at the experience was better than expected. So we added an additional $3 million over the provision during the quarter. So our provision now is sitting at $27 million and we are very comfortable with that. So that’s not our intention to use the reinsurance gain for that at all.

Mario Mendonca

So what hole is it that you need to fix going into Q4?

Jacques Potvin

It really depends. If I look at – if you’re speaking particularly about the reinsurance agreement, I mentioned earlier that [Fortune] mortality specifically in the U.S., but there’s some mortality as well in Canada that there could be some impact coming from [lab] so far, it has been positive, but not sure it would be the same. I have also to think about maybe some infrastructure, some private plus equity, some more private bonds, maybe some real estate. So there are things like that that we are thinking through right now. What are the thing that has not gone well since the beginning of the crisis? What are the things that have been going well, but because of government programs, so that’s thinking we’re having, and I want to look at that. That for me be a couple of thinking that those effect will last for a couple of years. So that’s really the thinking behind that.

Mario Mendonca

Okay. That covers it. Thank you.

Operator

Mr. Ricard, there are no further questions at this time. Please continue with your presentation or closing remarks.

Denis Ricard

Well, thank you. I think you’ve seen that our strong results for this quarter is a testimony of the resilience of our business model. One thing that I think is very important, or two things that are very important is, as I mentioned before, the fact that we’ve invested significantly technology and has been – we’ve developed competitive advantages on that. And you can see that very clearly on our sales results this year.

And the second thing is, and we try to emphasize this quarter is on the strength of our capital, and you’ve seen it on Slide 11, to compare it on a fairly basis with let’s say any other players that we’ve got additional cushion in our balance sheet to compensate of any downturn in the market. I think it’s very important that we had to explain that. It’s very important for us. So anyway, good quarter, and thank you very much.

Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.



Via SeekingAlpha.com