CA - Intact Financial: Still Digesting The RSA Acquisition

2023-04-26 11:50:13 ET

Summary

• Intact has been digesting its 2021 acquisition of RSA by rationalizing some of the business components.
• This streamlining includes an exit from the UK&I auto insurance market and a buy-in transaction to extricate the company from some legacy pension obligations acquired through RSA.
• While these transactions are expected to have a short-term impact on EPS and BVPS, they position Intact to earn better ROE and achieve a better combined ratio.
• In addition to the company's most recent 10% dividend increase, Intact has the balance sheet strength to pursue further M&A.

Author's Note: All figures in Canadian currency unless otherwise noted.

Eating an Elephant One Bite at a Time

Since I last wrote about Intact Financial Corporation ( IFC:CA ): A Roll-Up Strategy That Is Paying Dividends , the company has posted a solid quarterly operating EPS result of $3.34, well ahead of the $3.03 consensus.

Over the long term, Intact's growth has come primarily through 18 significant acquisitions since 1988. These acquisitions have ranged in size from small tuck-ins, to massive transformational deals such as the 2021 purchase of RSA's Canadian, UK, and Irish business for $5.8B. The total purchase of RSA was $12.3B with Tryg A/S, a Scandinavian insurance company purchasing RSA's Norwegian and Swedish operations for $7.2B.

With this bisection of RSA between Intact and Tryg largely completed on geographic terms, there has been a period of processing and incorporating individual business lines for fit. Over the past two years, Intact has been digesting and de-risking this purchase and has announced some significant transactions to this end. Over the past few months, the company announced transactions including exiting the UK&I Personal Auto Segment and a UK Pension Liability. According to Intact CEO Charles Brindamour on the company's Q4 2022 earnings call :

We expect to operate this business in the low 90s over the next 12 months. Despite challenges in the fourth quarter, our UK&I business remains on solid footing overall. At closing, we indicated that it would take approximately two years to fully evaluate our propositions across the UK&I portfolio and take the action necessary to drive outperformance. And while that timeline remains, we've already taken significant steps by exiting over $500 million of business with a combined ratio above 110%.

These strategic retreats will have short-term EPS and book value implications, however, I think they will be positive maneuvers in the medium to long term that will enable Intact to remain nimble and capitalized for future M&A opportunities.

Exiting the UK&I Personal Auto Market

On March 28, 2023, Intact announced that it was exiting the U.K. Personal Auto market. Intact's U.K. Personal Auto business is responsible for approximately £120M of direct premiums written, around 1% of Intact's total premiums written. In addition to the foregone revenue, restructuring costs are expected approximately to amount to £35 million. Exiting this business should free up £60 million of capital held against the liabilities in the personal auto business line and generate a small consideration through client referrals.

When Intact acquired RSA's UK&I portfolio in 2021, personal auto accounted for approximately 10% of net premiums written. Where RSA was the top two personal property insurer and a top five commercial insurance provider, it was only in the top 20 auto insurance providers in the UK&I market with a modest market share of 1% in a highly fragmented business. By contrast, RSA is a leader in UK home insurance with a market share of 8%, and the second largest pet insurer in the country with a market share of 16%.

The UK&I personal auto has been a performance drag on Intact's combined ratio. This is indicative of higher combined ratios across all UK&I lines relative to North America. While Intact doesn't break out UK&I auto results from its larger personal insurance lines, the combined ratio on personal insurance lines in the UK&I was 106% for the full year 2022, lagging the comparable Canadian lines by approximately 16%. Across the entire portfolio, the automotive insurance segment has been diminishing in weight relative to the commercial, specialty, and other property lines. For 2022, personal auto results accounted for 25% of direct premiums written compared to 45% five years ago.

Lacking scale to compete in this business line, Intact will transition customers to Atlanta-based Swinton Insurance when policies are up for a renewal. The strategic retreat from this line will allow Intact to target combined ratio improvement in the commercial, pet, and property lines in the UK & Ireland. Removing the auto segment, Intact expects the combined ratio of the continuing UK&I business to be in the mid-90s by late 2023. Intact has shared that despite this exit, the company is still on track to meet its initial RSA acquisition targets IRR above 20% and NOIPS accretion of approximately 20%.

Leaving the UK Pension Business

At the end of February 2023, Intact announced that it had reached a deal with UK-based Pension Insurance Corporation plc to exit RSA's pension position through a buy-in transaction. This move will see Intact contribute £500M up front to remove the future funding liability of £6.5B of future pension liabilities inherited through Intact's 2021 purchase of RSA.

Intact will fund the upfront contribution through approximately $300M of excess capital, $300M of hybrid capital, and short-term debt. In the weeks following this announcement, Intact launched two tranches of $300M 5-year notes bearing 7.338%. DBRS Morningstar recently finalized a provisional rating of BBB [HIGH] with a Positive trend on Intact's first series of capital notes.

This transaction removes Intact's annual contribution obligation of £75M to the pension scheme and releases approximately £150M of capital held against this liability. Intact's timing for this transaction takes advantage of higher interest rates to pay out reduced commuted future pension liabilities. The company highlighted that this move will support continued high returns on equity and de-risks the portfolio by:

transferring substantially all remaining economic and demographic risks associated with the Pension Schemes to a strong and specialized insurance counterparty, removing balance sheet exposure to pension risks that are non-core to Intact's business.

Outcomes

As a result of the buy-in agreement for the pension scheme, Intact anticipates a 1.5% reduction of operating EPS in the first full year along with an approximately 5% reduction of BVPS. These two transactions are short-term pain to improve the business over the long term. Not only will shedding pension liabilities and exiting a fragmented auto market help operating ROE and the combined ratio, they tidy up these business lines to sell should the right opportunity present itself.

Even with the short-term reduction in operating EPS following these two transactions, the company remains well positioned to reward shareholders. Intact's dividend payout ratio remains in the mid-30% range allowing for future increases of similar magnitude to the 10% boost announced in February. In addition to its recent dividend increase, Intact has been authorized to buyback up to 5,257,709 common shares, representing approximately 3% of float over the next 12 months. The company's adjusted debt-to-total capital ratio of 21.2% provides financial flexibility for Intact to continue pursuing growth through M&A.

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