Definity Financial Corp T.DFY

TD Notes (DFY and TSU)

[retiredcf]

P&C Insurance Q2/23 Outlook

Forecasting another sharp drop in auto underwriting income Earned rates expected to exceed severity trends by late 2023

Canada's P&C insurance companies are scheduled to report Q2/23 results on August 2 (Intact Financial [IFC-T]) and August 3 (Definity Financial [DFY-T]). Trisura Group [TSU-T] is expected to report around the second week of August. We forecast IFC and DFY reporting operating EPS of $2.51 (down 20% y/y; 8% below consensus) and $0.31 (down 24% y/y; 37% below consensus), respectively. The overarching theme for the quarter remains challenging conditions in personal auto insurance.

For DFY, we forecast underwriting income in personal auto falling 71% y/ y reflecting a weaker claims environment. Combining the current year underlying claims ratio with development, we expect the claims ratio to be up 533bps against a strong Q2/22 reflecting higher severity (particularly total losses), frequency (return to work), and elevated theft. Note that in the first half of 2022, the industry benefited materially from lower frequency related to pandemic-related lock-downs. We expect DFY to continue to prioritize rate over unit count. Management has cautioned that top-line growth could slow to the mid single-digits from upper single-digits in the near term. We expect performance to improve later in 2023. Management guided to 12% written rate increases across the entire auto book by late in 2023, double the current rate increases.

DFY Outlook: We expect low double-digit DWP growth y/y (above industry-average), a lower expense ratio (shift to digital channels — Sonnet), and higher leverage to drive an absolute and relative improvement in DFY's operating ROE. We believe an investment in Definity offers exposure to a stable business model with good upside potential if the company can grow through acquisitions. Despite the near term headwinds in personal auto, we rate the stock BUY.

TSU Outlook: We expect solid growth in the top-line this quarter (although slowing), driven by momentum in the existing businesses as well as contribution from new growth verticals (U.S. admitted platform, U.S. surety and corporate insurance, and fronting in Canada). We believe the recently launched initiatives position TSU well for growth even if the macro environment slows and further diversifies its earnings mix. Investments to support these new initiatives, as well as the outsized growth we have seen in existing business lines over the past few years, could lead to an elevated expense ratio over the next few quarters, in our view, as the company expands its workforce and improves operational infrastructure. Investment income is expected to provide a tailwind over the next several quarters as the benefit of higher rates and a larger portfolio continue to roll through results. The company has achieved impressive growth over the past three to five years, which we believe supports our outlook of the earnings trajectory in 2023 and beyond. We continue to rate the stock BUY and see significant upside potential to our target price.