DBRS Morningstar Changes Trends on Definity Financial Corporation and Its Affiliate to Positive from Stable, Confirms Ratings

DBRS Limited (DBRS Morningstar) changed the trends on Definity Financial Corporation (Definity or the Company) and its related entity, Definity Insurance Company, to Positive from Stable. At the same time, DBRS Morningstar confirmed all ratings, including Definity’s Issuer Rating at BBB and Definity Insurance Company’s Financial Strength Rating and Issuer Rating at A (low).

KEY RATING CONSIDERATIONS
The change in the trends to Positive from Stable recognizes Definity’s consistent premiums growth in recent years and its improved underwriting performance and profitability. The strategic undertakings over the past few years, and fewer claims compared with prior years, have contributed to steadily improving performance. Indeed, the combined ratio and ultimately earnings have steadily improved over the past five years. DBRS Morningstar expects the improved financial performance to continue, although not at the same level of profitability seen in a strong 2021.

The rating confirmations reflect the Company’s established presence in the Canadian property and casualty (P&C) insurance market where it offers a diversified mix of insurance products. The ratings also consider Definity’s good risk profile, which includes a conservative investment portfolio with a moderate exposure to equity risk. Definity maintains good liquidity in the form of a highly marketable investment portfolio, recurring premium inflows, and available contingent liquidity sources. The Company’s resilient capitalization reflects its zero leverage, capital flexibility, and appropriate regulatory solvency ratio.

RATING DRIVERS
DBRS Morningstar would upgrade the ratings if Definity maintains its recent improvement in underwriting performance and overall profitability while retaining strong regulatory capital ratios.

The trends would revert to Stable if the Company fails to maintain its recent improved underwriting performance. Lastly, a ratings downgrade would occur if there is a substantial deterioration in the Company’s risk profile and market positioning.

RATING RATIONALE
The Company has good franchise strength and is well established in the Canadian P&C insurance market. Definity has a 4.8% market share in Canada’s fragmented P&C market, where only one insurer has a market share greater than 10.0%. The Company operates primarily in Ontario, which accounts for 58% of its Q1 2022 gross written premiums. Other geographic areas include British Columbia (10%), Québec (9%), the Atlantic provinces (8%), and Alberta and the Prairies (15%). The Company's product mix is diversified, with personal auto representing 43% of Q1 2022 gross written premiums, personal property representing 27%, and the remaining 30% consisting of various commercial lines products (Auto, Property, and Liability). Over the past several years, Definity has positioned its business for future growth by investing heavily in its scalable digital channels (Sonnet and Vyne) and broadening its product range.

Definity has a good/moderate risk profile. Much of the risk relates to the planning and execution of its strategic goals. These plans, while beneficial in the long term, carry some execution risk because of their size and complexity. Definity has prudently managed its portfolio mix, entirely avoiding nonliquid assets such as real estate or other alternative assets. There is some legacy underwriting risk as the Company’s combined ratio has been higher than 100% for three of the past five years. Nonetheless, the Company’s increased focus on pricing actions and data analytics to improve underwriting should help sustain its profitability. Definity has appropriate reinsurance to allow it to mitigate the impact of large claims losses caused by occasional extreme catastrophic weather events.

DBRS Morningstar views Definity’s earnings ability as good/moderate. The Company’s premium growth trend is positive and will likely continue as a result of Definity’s business growth initiatives. However, Definity’s return on equity has been negative in two of the past five years, in part because of significant investments in technology to strengthen its online platforms and set-up costs of Sonnet. This was further exacerbated by high claims costs in the prior years (2017–19). However, Definity’s various actions to improve profitability and reduce earnings volatility have paid off. The Company's net earnings results improved significantly in 2020 and 2021 and are trending well in 2022 based on the results of the first quarter, despite equity market volatility, which had a negative effect on investments. This improved performance underpins the Positive trend.

DBRS Morningstar considers Definity's liquidity position to be strong/good. The invested assets portfolio comprises primarily cash and equivalents, equities, and high-quality fixed income investments. There are no below investment-grade bonds in the fixed income portfolio. The Company’s liquid assets are more than enough to cover all policyholder liabilities, ensuring adequate policyholder protection. Most products are short term in nature, so Definity can reprice its insurance policies annually on renewal if premiums prove inadequate compared with claims experience.

Definity has strong/good capitalization and asset quality. The Capital Test ratio for Definity Insurance Company was 215.1% as at Q1 2022, which is above the supervisory target ratio of 150.0% set by the regulators. Following the demutualization in 2021, Definity's capital flexibility has improved, allowing the Company to raise additional capital from the stock market. The fixed income portfolio is high quality, with the vast majority rated "A" or higher as at YE2021.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
Environmental concerns regarding climate and weather risks are relevant to the ratings of Definity and its affiliate as a P&C insurer but do not affect the assigned ratings or trends. As part of its P&C product offering, Definity is exposed to weather-related losses from natural catastrophic events such as wind, wildfire, hail, flooding, and other extreme weather events. These events can lead to earnings volatility and increased reinsurance cost. DBRS Morningstar considered this E factor as part of product risk when assessing the Company’s risk profile. In September 2021, Definity became an official supporter of the Task Force on Climate-Related Financial Disclosures. The Company is committed to achieving a net-zero operational footprint and investment portfolio mix by 2040 or earlier.

There were no social or governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The Grid Summary Grades for Definity are as follows: Franchise Strength – Good; Risk Profile – Good/Moderate; Earnings Ability – Good/Moderate; Liquidity – Strong/Good; Capitalization – Strong/Good.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (July 16, 2021; https://www.dbrsmorningstar.com/research/381667). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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