DBRS Confirms Intact Financial Ratings at A (low) and Pfd-2 (low)

DBRS has today confirmed the Issuer Rating of Intact Financial Corporation (Intact or the Company) at A (low) and its Senior Unsecured Debt rating at A (low). DBRS has also finalized the provisional rating of Pfd-2 (low) on the Non-Cumulative Rate Reset Preferred Shares. The trends are Stable. The Company’s operating subsidiaries continue to be among the stronger performers in the Canadian property and casualty (P&C) insurance industry in terms of underwriting profit and overall profitability. Overall industry profitability started to stabilize in 2010, in part as a result of the auto insurance reforms in Ontario and more benign weather patterns in 2010. For the first time in several years, Intact had an improved underwriting result, with a decline in its combined ratio.

Notwithstanding the improved overall results in 2010, the Company’s results have shown some decline in the past few quarters as a result of the early arrival of winter weather affecting the fourth quarter of 2010 and the after-tax catastrophe losses of $50 million related to the Slave Lake fires in Q2 2011. The Company continues to see improving conditions in the Ontario auto market as a result of stepped-up industry-wide vigilance against fraudulent claims and the continued impact of the Ontario auto reforms enacted in September 2010. Although over the last ten years Intact has outperformed the industry by 3.8% in terms of its combined ratio, the impact of these events on the Company’s results demonstrates that Intact remains vulnerable to the unpredictable, cyclical and reactive nature of the P&C insurance industry.

The Company’s consistent underwriting strength and industry outperformance reflect its relative scale and strong market position in the Canadian P&C insurance market, where it is the largest competitor, with more than an 11% share of direct written premiums. Intact leverages its scale advantages through the application of superior underwriting capabilities, market segment pricing, technology, investment, claims and general expense management. With the pending acquisition of AXA Canada, the Canadian subsidiary of AXA Group and Intact’s sixth largest competitor in 2010, Intact should increase its relative scale advantages, with more than 16% market share of direct written premiums, nearly double the number two competitor (Aviva Canada Inc.) and nearly three times the size of the number three competitor (Co-operators General Insurance Company). In addition, unlike previous acquisitions, AXA Canada is already a very profitable operation with a five-year average return on equity (ROE) of 14%.

DBRS believes the AXA Canada transaction will have a positive impact on Intact’s business risk profile. On a combined basis, the Company will have better geographic and product diversification across Canada. In 2010, Intact generated about 45% of its direct premiums written in Ontario; after the acquisition, Ontario will represent approximately 40% of direct written premiums. Relative to Intact, AXA Canada has lower exposure to the higher-risk Ontario auto insurance market and higher exposure to commercial property and other commercial insurance. As a combined entity, the Company will have approximately 24.9% market share in Québec, 13.2% in Ontario and 16.0% nationwide.

In 2010, the Company added financial leverage to its balance sheet at the holding company level through the issuance of $500 million in senior debt. At year-end 2010, the Company’s debt ratio was 13.9%, which increased to 14.4% at the end of June 2011. At the end of June 2011, Intact’s regulatory minimum capital test (MCT) ratio was a robust 227.4%, up from 217.7% for the prior-year period. Based on the June 30, 2011, MCT ratio, the Company has about $723 million of capital in excess of its 170% target level at the operating company level. As a portion of this excess capital (approximately $425 million) will be used to finance the AXA Canada acquisition, DBRS expects the MCT ratio to be at about 200% at year end. The financing for the acquisition has more than used up the Company’s available debt capacity at the current rating category. DBRS estimates that after closing the acquisition, Intact’s debt plus preferred share-to-total capitalization ratio will exceed the 15% to 25% range for the “A” rating category, as defined in DBRS’s “Rating Canadian Property and Casualty Insurance Companies” methodology. As a result, the Company is unlikely to continue its normal course issuer bid programs in the near term. However, the Company has indicated that it will retain more of this internally generated capital and use some of it to pay down some of the acquisition debt to help reduce the leverage. Should Intact not succeed in reducing its financial leverage to levels acceptable for an “A”-rated company in this industry over the next few years as planned, this could result in negative rating action.

Intact’s previous investment strategies had left it exposed to the unprecedented decline in global capital markets in 2008 and in early 2009. This led to increased impairment charges and higher realized losses as a result of the Company’s decision to actively reduce its exposure to common equity investments in financial services companies while increasing its holdings in Canadian government bonds. In 2010, the Company shifted some of its corporate exposure to bonds from preferred shares, reflecting changes to regulatory capital requirements and more efficient tax treatment. A more conservative portfolio is expected to put downward pressure on investment earnings over time but had a neutral impact year over year in 2010.

The DBRS rating on the Company reflects its holding company status. While Intact has very strong operating entities, their regulated nature and the structural subordination of holding company obligations result in a rating assignment for the parent that is at least one notch below where the operating subsidiaries might be rated in their own right.

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

The applicable methodology is Rating Canadian Property and Casualty Insurance Companies, which can be found on our website under Methodologies.