Qualitas Controladora SAB de CV

BMV:Q

Earnings Call Analysis

Strong Quarterly Performance and Market Leadership

In the third quarter of 2023, Qualitas reported impressive growth, with written premiums increasing by 23.9% for the quarter and 29.6% year-to-date. This reflects the company’s strong position in the Mexican auto insurance market, where it holds a record high market share of 33.1% and contributes significantly to the sector's profitability, accounting for 83% of underwritten industry results and 44% of net results. Notably, the fleet business demonstrated remarkable growth, up 26% quarterly and 41% year-to-date, indicating strong demand and strategic execution.

Anticipated Changes and Future Outlook

While the current growth trend is robust, the company acknowledged early signs of a deceleration in underwriting growth, projecting overall growth for 2023 to be between 20% to 25%. In 2024, the company expects a further moderation in growth, primarily due to a more cautious consumer environment and increased competition, indicating a return to a historical growth level around 10% in 2025. This forecast aligns with broader economic trends in Mexico, where GDP growth is expected to soften to 1.5% this year and potentially lower next year.

Investment Income and Financial Health

Qualitas's investment income showed a healthy increase, growing 16% in the quarter and 18% year-to-date, underscoring the company’s sound financial management. The total portfolio stands at approximately MXN 49 billion, with 87% invested in fixed income, yielding an average maturity of 9.3%. Year-to-date returns on investments are currently at 12.6%, incorporating unrealized gains reflecting currency benefits. This proactive investment strategy positions Qualitas well against market fluctuations.

Loss Ratio Trends and Seasonality Effects

The third quarter saw a claims ratio of 59.2%, reflecting both seasonal impacts due to weather events and a 6% average increase in spare part costs year-over-year. The company faced a particularly challenging quarter with up to 600 claims related to hurricanes, but these have been accounted for through careful reserves constitution. Historical analysis indicates that about one-third of the claims increase stems from weather events, one-third from U.S. operations, and the remainder from general inflation in repairs. Despite these challenges, the company maintained expected targets for loss ratios.

Strategic Acquisitions and Market Expansion

Qualitas announced an acquisition of a glass spare parts and automated painting distribution company valued at MXN 500 million, aiming to enhance vertical integration and expand service offerings within its subsidiary portfolio. This move is expected to bolster e-commerce sales and broaden service capabilities, demonstrating Qualitas's strategy to reinforce its operational foundation while capturing market opportunities. Notably, the company is also advancing into Colombia with plans to launch operations within the next 3 to 4 months, reinforcing its commitment to geographical expansion.

Regulatory Challenges and Resilience

The management addressed ongoing regulatory discussions regarding VAT interpretations, noting a firm legal stance supported by the industry. The company has actively engaged with regulatory authorities, signaling confidence in a favorable outcome. Overall, Qualitas's operational resilience has allowed it to maintain profitable margins and a robust combined ratio of 95.6%, aligning within the long-term target range of 92% to 94%. This performance not only reflects sound underwriting discipline but also positions the company favorably for future challenges.

Commitment to Shareholder Value

Qualitas's commitment to returning value to shareholders remains strong, targeting a payout ratio of approximately 90% of profits in dividends. Despite potential impacts from lower interest rates and ongoing markets, the investment approach emphasizes sustainable growth. The strategic allocation of capital will focus on balancing dividends, share buybacks, and maintaining sufficient reserves for future development, as highlighted by their proactive capital management strategy.

Earnings Call Transcript 2024-Q3

[Operator]

Thank you for standing by. This is the conference operator. Good morning, and welcome to Qualitas's Third Quarter 2023 Earnings Results Webcast. The conference will begin now. It is my pleasure to turn the call over to Andrea Gonzalez, Qualitas's IR Manager.

[Andrea González, executive]

Good morning, and thank you for joining Qualitas Third Quarter and 9 Months 2024 Earnings Call. Jose Antonio Correa, our CEO; and Roberto Araujo, our CFO, are joining us today.

As a reminder, discussions in this event may include forward-looking statements. These statements are based on management's current expectations, they are subject to many risks and uncertainties that could cause actual events and results to differ materially from those discussed during today's call. Let's turn it over to Jose Antonio, our CEO, for his remarks.

[Jose Correa Etchegaray, executive]

Thank you, Andrea, and good morning, everyone. As mentioned in prior calls, this year, we are celebrating our 30-year anniversary of which we have been leaders for the past 18 years by maintaining our focus, agility and flexibility while continuing to provide the best-in-class service and actively listening to our agents and policyholders. Our company has shown exceptional resilience over the past 3 decades, successfully navigating the range of economic and political climates while thriving in highly competitive environments.

A true example of these are latest auto insurance industry figures, which reflect that Qualitas is not only the leader in terms of written premium market share with a record high of 33.1% participation, but also show that Qualitas represents 83% of the total underwriting industry results and 44% of the industry net result posting the best combined ratio within the top five companies. We still believe in the potential of more profitable growth to come.

These remarkable stats reflects Qualitas commitment to create value. And I would highlight the importance of the unique and close relationship we have with our more than 22,000 non-exclusive agents who represent 2/3 of year-to-date written premiums. In September, Qualitas Mexico was awarded the fifth consecutive year with the title of [indiscernible] or the ideal insurance company by a specialized magazine where agents themselves are the voters. Honored and motivated by this distinctions throughout this quarter, Qualitas C-suite, me included, held several seminars with agents across Mexico over the past several months.

We cover multiple regions, including the Central Zone, the North and the Bajio with over 4,000 agents participating and getting important information about new tools, products and changes in processes to become better and faster. We are grateful to each one of them for their presence, unwavering commitment and most of all, for their transparent feedback on opportunities where we can further develop as a company and improve our service and products.

Now let me dive into our 9 months performance. And as I mentioned throughout this year, we see 2024 as a year of two tales. The first half that has reflected the strong momentum in terms of the writing, and the second half, where we recognize we will have a more cautious consumer behavior with lower benefit from pricing. Quarterly speaking, we achieved 24% growth ahead of our expectations taking year-to-date to a 30% growth. With in mind, the 9 months of new car sales resulted in a 10.5% increase versus the same period last year. With September posting a slowing in the pace for the first time in 28 months, with a 1.4% decrease in growth versus the same month of 2023.

As of today, AMDA adjusted its annual growth estimates to around 11%. Despite these early signs of change in growth pace, which will continue to be positive or not as steep as prior years, and with our current network of more than 578 service offices and [indiscernible] plus Qualitas cost efficiency efforts, we foresee significant opportunities to keep on delivering positive margins and ROE levels within targets.

Before I hand it over to Roberto, our CFO, we communicated to the market in early August as cyber security incident for which we activated our information technology protocol and implemented our protection and response controls. Qualitas operation and service to policyholders remain uninterrupted through backlog procedures and maintain underwriting activity. Thanks to our preventive measures, the company avoided any material impact. Proof that this solid and quarterly results already being discussed. Recognizing this is a risk that will prevail across industries and countries, we have strengthened our team, including external advisers. And furthermore, we will continue to leverage our ability to create value, enabling us to anticipate challenges and seizing opportunities by positioning Qualitas capabilities to deliver strong returns for our shareholders and establish a solid long-term investment opportunity.

Our enduring spirit of resilience, not only shapes our history, but also empowers us to navigate the present landscape with confidence and to move toward a prosperous future. And with that, let me pass it on over to Roberto. Roberto, please.

[Roberto Araujo, executive]

Thank you, Jose Antonio, and good morning, everyone. Our results continue to reflect solid top line performance and a combined ratio within our long-term range, underscoring the company's ability to deliver results. Our primary focus remains and will continue to be on providing short- and long-term value. Let me provide you with more details about our performance. Written premiums were up 23.9% for the quarter and 29.6% year-to-date. With the traditional segment accounting for 67% of our total written premiums growing at the rate of 23% for the quarter and 33% year-to-date. From this segment, our fleet business stands out with a quarterly increase of 26% and year-to-date of 41%. Lastly, financial institutions, which accounted for 28% of total written premiums on a cumulative terms, portray consistent growth rates of 27% for both the quarter and for the first 9 months of the year.

As Jose Antonio alluded earlier, we have seen early signs of churn towards an easening in top line trend. The third quarter underwriting growth has started to de-accelerate versus the 28% growth experienced in previous quarter. Given this equation a slowdown from the 2023 pricing benefits, we do expect to see more de-acceleration in the months to come. And while we continue to adjust prices our increases will be more in line with local and industry inflation expected to be at mid-single digits. Still, the current growth trend makes us believe we will be able to reach a 20% to 25% growth for the full year which is remarkable growth pace within the current macro landscape.

Year-to-date, written premiums from our international subsidiaries represented 5.4% of the total holding company underwriting. As reported, LatAm subsidiaries were up 25.5%, and in line with our strategy, the U.S. subsidiary is focusing on reshaping the mix towards being profitable, resulting in premium diminishing 9.3% year-to-date as well. As a reference, our international subsidiaries each quarter reached positive milestones. For example, our Peruvian subsidiary is a true case of growth and value creation. Our written premiums grew 63% and 30% quarterly and year-to-date, respectively. We inaugurated our sixth service office in [Sudarujillo], the third most relevant city in that country. We now have more than 700 agents working with Qualitas in the region, which is a 12% increase versus the same period of last year. enhancing market presence and providing Qualitas has been capable of identifying areas for development and capitalizing on opportunities.

Also, it is worth celebrating the credit rating improvement for both our Costa Rican and Salvador subsidiaries. In the U.S., our focus strategy is on track. Our portfolio composition by September end was only 6.6% domestic cross-border portfolio has shown a 63% increase during this third quarter compared to the same period 2023. This quarter, we made an additional reserve composition based on our external actual team recommendation. And as I mentioned before, we expect to reach a breakeven performance by 2026.

Having knowledge of the business profitability and the low permutation, we believe the opportunity to continue operating the cross-border niche in which we have no more than 25% of market share at the moment, and we consider it's a tactical growth opportunity for our company. We're making a cross-sales effort looking to create synergies between clients we have in Mexico that may require have or need this cross-border product and currently that are not attended by us. Knowing shifting gears will take time, but we are confident on our capacity to deliver a positive outcome from this.

Including all subsidiaries, we closed the quarter with almost 5.7 million insured units, which represents a new record high for the company. 366,000 additional units during the first 9 months of the year.

Back to our financials. Earned premiums were up 20.1% for the quarter and 25.6% in cumulative terms, reflecting a reserves constitution in line with our solid top line growth base. During third quarter, we constituted MXN 814 million reserves that represents MXN 548 million, more than the third quarter of last year, closing the first 9 months of the year, with a constitution of MXN 3.6 billion reserves that represents MXN 2 billion more than the same period of last year. Technical reserves constitution is based on approved regulatory models and speak to the high premium growth. They have helped our investment portfolio size and should expect to see earned premiums grow at a higher pace once the growth stabilizes.

Now moving to our costs. The claims ratio stood at 59.2% for the quarter and a 66.4% year-to-date. This quarterly ratio posted a 3.5 percentage points increase versus second quarter. This increase is aligned to our expectations, considering the heavy springs seasonality an extraordinary unit gains taking place every year in Q3, which was particularly evident during last September when Mexican Coast experienced three hurricanes. For which claims attendance related to weather events increased 50% versus third quarter 2023. At this point, cumulative hurricanes represent up to 600 claims cases for the company for which we have composed reserves accordingly. But it's important to read its magnitude. In terms of claims, they represent only 20% of Hurricane Altice from last year.

An additional factor is still impacting our costs are spare parts and repairment prices. Our average claim cost for the quarter increased 6% versus same period of last year. And year-to-date, we have seen average cost of a spare part increase of 7%, reflecting supply chain constraints and freight cost is still hitting prices given the supply and demand and reflecting prices to behave above inflation rate. Our Mexican subsidiary posted a quarterly 67.6% loss ratio, a 1.7 percentage point decrease versus same period a year ago and a 64.9% year-to-date ratio, a 5 percentage point noticeable improvement versus last year. which is quite consistent to our loss ratio target range.

Throughout this year, we have witnessed a 16% Mexican peso depreciation, leading to many inquiries regarding its impact on our costs. As mentioned before, FX does not immediately distress our costs. The correlation between currency depreciation and our cost is not linear. Prices for spare parts are determined by supply and demand. Commodity prices and shipping costs. Therefore, despite recognizing that from our total claims costs, 50% are related to material damages and from those, 20% to 25% are related to imports of spare parts and others, it is still too early to assess the true impact of FX volatility on our overall costs. but we remain diligent for any rate adjustments.

Regarding thefts, year-to-date robberies have increased 3% for Qualitas and have remained almost neutral for the industry. Remember that these stats reflect our higher unit growth versus industry and the leading market share, especially in the heavy equipment segment where we have almost 45% market share. And they also reflect our insured motorcycles that increased number of units but have a lower insured value. Nevertheless, we are not only market leaders in terms of share, but also in terms of risk management and prevention, Qualitas recovery rate stands at 41.4%, outperforming the rest of the industry.

Moving on to our acquisition ratio. It stands at 22.7% for the quarter and 22.3% in the cumulative terms, in line with our historical range. Commissions remain unchanged and by September end, our portfolio composition was 81% annual and 19% multiyear policies. Then our operating ratio for the quarter stood at 3.8% and a 4.2% in cumulative terms. Year-to-date, employee profit sharing provision has doubled itself given the positive performance of our company. However, if we were to exclude this provision that by law, must be incorporated into our operating expenses, the ratio would have stood at 3.3% for the quarter and a 3.1% in cumulative terms, in line with our historical range.

All of the above resulted in a combined ratio of 95.6% for the quarter and a 92.9% in cumulative terms. When incorporating this quarter's loss ratio seasonality, our year-to-date combined ratio is entirely within our 92% to 94% target. Which speaks to the underwriting discipline and our ability to continue growing profitably.

Now moving to the financial side of our business. Investment income grew 16% for the quarter and 18% year-to-date. We continue to be mainly invested in fixed income, representing 87% of our MXN 49 billion total portfolio with an average duration of 1.6 years and a 9.3% year to maturity. In the case of our Mexican subsidiary, the yield to maturity stands at 10.2%. We expect to close the year with a duration of around 1.7 years.

With the current portfolio composition for each 25 basis points as rates decreased, the impact on our portfolio valuation is around MXN 178 million on an annual basis. The remaining of our portfolio is invested in equities. Mostly placed on ETF following the U.S. market and other global markets. Only 3% of our equity portfolio is invested in Mexican rates, given we believe they create value through their attractive dividend distribution. All our investment assets follow accounting guidelines classified as available for sale. So their performance, whether gains or losses is considered on our balance sheet until they are realized.

We delivered an investment income of MXN 1 billion during the quarter and a MXN 2.9 billion year-to-date, implying an 8.7% and 8.8% quarterly and year-to-date ROI, respectively. Year-to-date, unrealized gains are in the magnitude of MXN 1.3 billion, including FX benefit. When considering all positions as market to market, ROI would stand at 12.6% year-to-date. Around 22% of our portfolio is invested in U.S. dollars given our international presence. For every peso that FX appreciates, or depreciate the estimated annual impact is MXN 560 million, playing as a natural hedge for FX depreciation.

Third quarter effective tax rate stood at 30% and 32.8% in cumulative terms, which shows more normalized levels reached throughout the year, given we're no longer experiencing inflation benefits. We should expect normal levels to be around 30%. All in all, Qualitas posted a MXN 1.1 billion net income for the quarter and a MXN 3.7 billion net income year-to-date, with a 7% and a 7.8% net margin, respectively. Our 12-month ROE stood at 22.4%, already within our long-term target.

We are proud of the performance that our team has delivered, driving industry-leading profitability. We're executing against the strategy with earnings durability and capital efficiency Qualitas is well positioned to maintain industry leadership operationally and financially. Our regulatory capital stood at MXN 5.3 billion, with a solvency margin of MXN 15.8 billion equivalent to 398% solvency ratio. Recent capital allocation determines our 12-month earned premium to capital ratio at 2.5x.

Now as an update from Qualitas capital allocation and corporate development plan, last week, we announced the acquisition of a glass spare parts and automated paint distribution company. A transaction of around MXN 500 million. This acquisition strengthens our unique vertical integration, complementing the potential of our subsidiary flag by expanding our national coverage network of branches with inventory and systems to provide the highest level of distribution and logistics by increasing our e-commerce sales, by adding automated painting services to our portfolio and by increasing our client portfolio for glass distribution and repermits.

Regarding geographical expansion, Qualitas Colombia is moving in the right direction, making progress on final legal authorization with the expectation to start operations in the next 3 to 4 months. The team is currently working on many initiatives to strive assertively the Colombian market, which represents a new avenue to access more than 17 million units and a growing industry. As of 2023, the market had a notable increase of 12% year-over-year growth on written premiums. We believe Qualitas business models represent the perfect fit for a market such as Colombia.

Now before entering into our Q&A session, it is worth mentioning there is no news from the fiscal authority regarding the audit procedures and the VAT interpretation. This matter continues under assessment in the corresponding instances, and we have not received any conclusive or final resolution. Qualitas position stands firm with the corresponding legal arguments to support the industry criteria and those we trust authorities will reach a reasonable resolution. As mentioned before, we will timely communicate any relevant progress to the market.

In summary, we had another record-setting quarter in many different fronts, and we're well positioned to continue producing outstanding results going forward. Underwriting conditions overall continue to be favorable, thus we're confident in our ability to continue delivering on target earnings through our top line growth, underwriting margins and investment income.

I would like to conclude my remarks by recognizing the resilience and daily adaptability demonstrated by Qualitas people, it is simply outstanding. As I start a journey with Qualitas being already 3 months into the role, I am proud and honored to be part of the senior leadership team that is fully committed to pursuing true value creation for the company's stakeholders, including our customers, our workforce, shareholders and the communities we serve. Now operator, please open the line for questions.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Andres Soto.

[Andres Soto, analyst]

Thank you so much for this presentation. I have a question related to your loss ratio or specifically your claims this quarter. If you guys can please help me break down the performance in terms of claims. What is attributable to weather? What is the normal claim related to inflation pressures that you mentioned before. And how much is related to the additional reserves that you are making for your U.S. operation.

[Jose Correa Etchegaray, executive]

Thanks for the question. Thirdly, a loss ratio and the claims cost is a question that will come to mind to all our investors. As we have shared previously, we would have expected Q3 with high seasonality. We know that heavy rains and hurricanes are always present in Q3. Getting to your question, I would say that 1/3 of that impact was coming from the U.S., 1/3 was coming from whether it was seasonality and 1/3 would come from either claim cost or spare part increases.

Now let's put it also in perspective. When we look towards the previous year decrease, we see a significant improvement versus last year. And also, when we look at our Mexican subsidiary loss ratio on a year-to-date basis, we look at 54.9% within our loss ratio target. I hope that answers your question.

[Andres Soto, analyst]

Absolutely, Jose Antonio. And when you look ahead, should we expect improvement at the same pace that you were delivering in the second quarter? Or you believe that the big improvement in loss ratio is already over and you are already reaching sort of normalized levels at this point?

[Jose Correa Etchegaray, executive]

Let me say, Andres, that we clearly, and as Roberto mentioned, this is a seasonality impact that we usually have in the third quarter. and Roberto address the causes of that. But you see that, I mean, heavy rains and hurricanes were particularly high over [indiscernible] the last literally 4 weeks or so. So it has had a significant impact.

Now having said that, I do expect that they will return to lower levels as has in the past. But also as Roberto indicated, it is important to mention that we are well within the targets for the year that we have set in terms of where we would be in the combined ratio as well as in the claims ratio. So yes, answer more specifically, we should be declined to target levels.

[Andres Soto, analyst]

And when you combine this with your market trade evolution, you had said in the past, you guys are not focused on market share. You were focused on profitability. If I look at the second quarter numbers and compare it with those of the industry, I see that you have gained 240 basis points of market share at that point over the past year and even on a quarterly basis, 1 additional percentage point. Yet, you are mentioning that you don't expect a significant price increases. But what would be the reason not to increase prices if you are capturing additional share and you are seeing other sources of pressure in terms of loan ratio.

[Jose Correa Etchegaray, executive]

Let me start addressing that, Andres. I'm telling you that, as we have said, this is an interesting question because we have always discussed that we are not aiming for market share. We have always said and will continue to do is to improved service in any way we can. And all our efforts are geared to make sure that the services to the levels that our clients and customers and policyholders expect. And that will continue to be our guiding principles, so to speak. But let me tell you that because of that, policyholders prefer Qualitas to some extent. So regarding the price part of your question is that we have taken significant increases over the past now already 2018 to almost 24 months.

So we should be that. And we indicated that in past two calls. And where we said that this year was going to be a story of 2 years with the first half, still getting the benefit of the -- frankly, high increases that we have late last year. But now, yes, we see that the market is softening on that regard. And first of all, we have seen the decline in terms of the claims index. So the combined -- also the combined ratio is going back to levels that we anticipate to be the target ones. So we don't see the need to that. And I can tell you that I can see there has been pressure in the market. And we have in the heavy equipment, we have increased very substantially in pricing.

Obviously, [Terico] are claims costs -- and in the auto business, it has been -- the market has seen an increase in competition in terms of pushing prices not so high. So we continue to see that. That will allow us -- or that will make us not to be able to increase prices as significant. But the important part in all of this, Andres, is the fact that we are going to our target levels in both the claims index and combined ratio. I don't know Roberto, do you want to expand?

[Roberto Araujo, executive]

No, maybe just to complement, I think it's all about service. And despite the Q3 combined ratio overall in the long term. We're delivering a profitable combined ratio within our target and actually, that is helping us, combined with profitable business and service is giving us more units, and we're increasing our share. So it's a perfect equation to continue going forward.

[Operator]

Our next question comes from Thiago Paura.

[Thiago Paura Mascarenhas, analyst]

I have two questions from my side, if I may. The first one is still on the loss ratio theme here. I understand we saw a spike in claims due to the weather seasonality in Mexico this quarter. But if we take a look only at the contribution to the loss ratio from outside of Mexico, it has also increased sequentially. You mentioned a higher contribution from provisions from the U.S. subsidiary. So I just want to further understand if this additional provision is some kind of trend? Or if you should expect a deceleration on that front as well, driving to a faster decline in the loss ratio in the short term?

And the second question is related to top line growth. In Q2, Jose Antonio mentioned that Qualitas should end the year in the low to mid-20s growth, as we should sales slow down in the second half of the year. And in fact, Q3 decelerated a lot versus the first half of the year, but it was too strong 24% year-over-year growth and ahead of expectations, as you mentioned. So just double checking here if the outlook remains the same, because it would suggest a big deceleration in the last quarter of the year and what to expect for the year to come for 2025?

[Jose Correa Etchegaray, executive]

Yes. Let me take the second one first. Thiago. Thanks for joining us at the conference. And the top line growth, let me tell you that we have been somewhat surprised in the growth that we have, both in 2023, which was a significant growth to recoup obviously, claims costs. In 2024, there was some impact regarding the momentum that we have on pricing. But let me tell you that, Yes, the third quarter was a little bit of a nice surprise in terms of data. It continues to -- our business continues to grow strong. And I still see that's what I said earlier, I mean, in prior calls that we are going to be in the low 20s and then in the low 20s, still, I think that this quarter, we should also be showing decent growth rates.

And I would expect that for 2025, mostly, we should return to levels more in the low 10s as has been historically. Historically, we have grown around the 10-ish in the past years. But I believe that this increase in terms of the cost increases of cars, the cost increases of trucks, et cetera, was because of technology, they have increased significantly over the past 24 months, it's now leveling off. So we should be having this top line growth, we're also going to levels closer to the low 10s.

Now well, that's what I would say in terms of the top line growth. Additionally, usually important to note also is the economy. Typically, in our business, we grow around 3x the GDP of the economy. And as you all know, the Mexican economy is softening, and this year it's expected to be around 1.5% growth and GDP growth. And for next year, it is even expected to go a little bit lower, like 1.2%, around 1.2%, 1.4% depending who you ask. So yes, all these elements make that we would return to, let's call it, historical levels in terms of the growth for the top line growth in 2025. Having said that, we will continue to manage our business to having the targets that we have set for both claims ratio and combined ratio. But very importantly, Thiago is that we are committed to our ROE, as you can see and the ROE that we have for the reported results, it's about 20%, and it is very well within what we have anticipated, which is our long-term target. So that's the way I would answer the part of the top line. I don't know, Roberto, do you want to take the loss ratio?

[Roberto Araujo, executive]

Yes, absolutely. Thanks, Thiago, for the question. And going to your claims ratio, I think you're referring mostly on the international or the Latin American subsidiaries, including the U.S. And a big portion of that delta comes from the U.S., as I alluded earlier, so only 1 percentage point of that comes from making the reserves from our actual recommendation from actual team recommendation. And what we see is certainly the cross-border reach of our business is certainly growing despite that we still have opportunities on our domestic business. Just to give you a reference of what has been decreasing in our domestic business.

We -- by September end, we -- in 2023, we had a 35% composition of our business for domestic and 6.6% of our portfolio is currently domestic. We still are reserving for those legal cases that are still in provisions and that we have a liability. And therefore, to your questions on moving forward, what should we expect on our international subsidiaries in the U.S. it's coming. We should expect continuous reserve adjustments depending on how the trials and the liabilities coming as well.

But when we look at Mexico, our loss ratio, we sincerely as already Jose Antonio alluded earlier, we should expect to see an improvement in Q4 given the seasonality. And remember, in the U.S., it's something that it should not be a surprise. This is something that we're turning around. We are seeing an improvement, but still we have work to do, and we'll see losses in 2024, in 2025, and we'll be back on track and breakeven in 2026. So something to your general...

[Jose Correa Etchegaray, executive]

Just let me add what Roberto indicated because it is important, and I'm glad that he mentioned that 2026 because as we have discussed over the past 4 or more quarters, and the user strategy has been to refocus on the cross-border business, and we are, as Roberto indicated, we are moving very well into that direction. As also, we have indicated that the strategy costs in addition for the cross-border business, which we are executing, we have a strengthened organization and remember that we had a new CEO last year and you have the teams in claims, et cetera. And we will continue to adjust tariffs. So let me tell you that we are on track for the strategy that we have set for the U.S. over the past 1.5 years or so.

[Operator]

Our next question comes from Jitendra Singh from HSBC.

[Jitendra Singh, analyst]

So I have two quick questions. One on your operating cost ratio. So it has been higher in 9 months, around 4%. And we know this is mostly due to profit sharing. Do you think this is the level we should expect in coming quarters or next year? Because I think the historical level has been slightly lower.

And second question is on your recent acquisition. I mean, how this new acquisition will complement Flekk? And are there concerns about overlapping services or competition between the two subsidiaries?

[Roberto Araujo, executive]

Great question. So let me address the first one on operating ratio. As you pointed out, our operation ratio for the quarter stood at 3.8% on a quarterly basis and 4.2% on a year-to-date basis. A portion of that is related to profit sharing as we've been sharing, as we are more profitable in our business we give that back as part of our regulatory requirements as a profit-sharing bonus to the employees.

So to your question was how should we move this forward? As long as we keep within our range of 92% to 94% we will continue to see significant provisions on profit sharing. Let's also keep in mind that if you exclude this profit-sharing impact from 3.8% in the quarter it would be 3.3%, as I explained before. And also from a 4.2% will be dropping almost a point of 3.1%. So that should be.

Also related to operating expenses, there is the service office professional fees that also impacts our operating ratio. And it also is linked to our profitability. So the more profitable we are, we will be also accruing for those and we were paying those for our service offices. So the equation should be the more profitable we'll see the operating ratio on a variable will continue to be reflected in our income statement. Hope that answers your question.

[Jose Correa Etchegaray, executive]

Let me add to Roberto's comment on that one. Clearly, we have -- Well, increased a certain level of cost in terms of the operating ratio in order to keep and to maintain a good level of service. The important part here is that the way we internally measure the operating expense is more between the 3% and 4% that we always indicate to you as a target without the profit sharing because the profit sharing -- I mean, you could argue that the best the company does that is going to increase, which is a nice to have problem, so to speak. .

But to me, the important thing is that we are targeting between the 3% and 4%. And over the past 18 months, I would say, we have increased some, we have strengthened in some areas in the company to maintain a good level of service. And we will continue to do so. So going forward and excluding the profit sharing, we should be, again, as we have said, between the 3% and 4%, and that is the way we will be moving in that range.

Now you asked a second question, which I couldn't understand very well. Can you repeat and is related to the acquisition, I believe. What can you explain?

[Jitendra Singh, analyst]

Yes. So I think my question was related to this, like how this complements Flekk and are there concerns about overlapping services or maybe the competition between these two, Flekk and the new acquisition.

[Jose Correa Etchegaray, executive]

No.Well, let me tell you that. First of all, we quite as we're very pleased about having completed this acquisition. And that's part of our vertical integration. And we are very pleased with that because something that I didn't mention is that clearly we have mentioned before, but not in this call, is the fact that we continue to be very cost conscious and we will continue to execute in that part. So that gets into the strategy of making sure that we remain very competitive cost wise.

So let me tell you that I'm very happy about this. It took a little bit longer time than we wanted. But it is a company that has a lot of experience. It's a lot of experience that has a strong market presence across all Mexico. They have more probably than 100 locations, et cetera. And it adds a number of things that we can do so. So that should help us into several things, including generic equipment and some other repair stuff. So I think that established pretty well within the Flekk strategy. And that add to service both Qualitas and other insurance companies. And it will continue to provide service the way they have been doing it. And we will obviously gradually incorporate the learnings that we have within Qualitas to be able to have better costs for all the companies that use the Flekk services.

[Operator]

Thank you. Our next question comes from Tiago Binsfeld.

[Tiago Binsfeld, analyst]

We have two questions from our side. The first one on financial results. Can you discuss a little bit what drove the increase in the investment portfolio balance from the second quarter to the third quarter? And also how you're thinking in terms of asset allocation mix? And if you could also remind us your expectation for interest rates this year and also for 2025? And then I can ask my second question later.

[Roberto Araujo, executive]

Regarding your first question, thank you, Tiago. What we saw is, as I alluded in my remarks, we saw a double-digit growth in our investment income at 16% versus the previous quarter and also at an 18% year-to-date. Remember, we have 87% of our portfolio is on a fixed out of our MXN 49 billion total portfolio with a duration of 1.6% and a 9.3% yield to maturity. We believe that what is reflected in our income statement is only on the market sales available for sale, our portfolio and network equities.

Let's keep in mind that also a portion of that, when we look at our mark-to-market, we would be seeing a much higher return on our investments, actually would have been at a 12.6% on a year-to-date basis. That in our balance sheet is reflecting a MXN 1.3 billion, including our FX benefit.

Going to the second part of your question is getting to how do we see our overall rate for the following year, given that we have a 1.6%, 1.7%, correctly 1.6% for our target is to land at 1.7% year duration by the end of the year, we would continue to see a good return on our investments in 2025, and we're probably going to see a decline in 2026, but again, it's depending on how the interest rates will play out.

Also part of our comments were, if we were to -- for every 25 points -- basis points that the interest rate will decline, we will be having an impact in our fixed portfolio of MXN 178 million going forward. So we'll have to see how that rates adjust over time. But certainly, we'll continue to see at least in 2025 a good investment income resulting from our portfolio.

[Jose Correa Etchegaray, executive]

Let me add to Roberto, that as we -- over the past 3 years or so, the strategy was to have a very short duration back in 2021, and we started changing that in 2022 and 2023. At the time, the rates that we were having were around 5% or so. And now we move to around the 10%. And the important thing is that as we move over the past, let's call it, the past 12 months or 18 months, we are closer to the tenth and the duration as Roberto indicated is that we are, let's call it, "cover" for 2025.

[Tiago Binsfeld, analyst]

This is clear. And if I may, a second question as well. We saw the acquisition ratio picking up a bit. So can you detail a little bit more? I mean, I think you mentioned in the release, there were no changes in the commissions paid. So is this mostly a reflection of mix? And how do you expect this to evolve in the coming quarters?

[Jose Correa Etchegaray, executive]

That is mostly a reflection of mix. We have not changed any of our commissions in the company. We maintain that this is something that we continue to be paid with customers, but we are very clear that we cannot go that route. So it is mostly a mix situation that one [indiscernible], Yes. .

[Operator]

Okay. Thank you. We only have time for one last question today for Ernesto Gabilondo.

[Ernesto María Gabilondo Márquez, analyst]

Thank you, Ernesto Gabilondo from Bank of America. Hi, good morning, Jose Antonio and Roberto. So my first question will be a follow-up on your loss ratio. As you mentioned in your press release, those have seen now to increase during the quarter because of elections. So how much do you think is related to the depreciation of the peso against the dollar. I remember in the past debts were stealing the cars and then selling the auto parts in the black market. So is this the same trend that you saw this quarter? And on the other hand, how much of your loss ratio is related to spare part costs or auto parts? I think I heard Roberto saying around 25%.

So I just wanted to double check. And I remember that the auto part prices are not in dollars, but they move similar to the changes in the dollar. So do you have a sensitivity analysis of what could be the impact if we have a sustained depreciation of the dollar in 12 months in your loss ratio. Anything that you can share from what happened in other periods like when the peso depreciated last time, I think, would be very helpful. And then I have a question on your capital allocation. So you are returning buybacks, dividends, but at the same time, you're expanding into new regions, doing M&A activity, the recent acquisition. And then at some point, you will have the impact of lower rates in your capital, as you mentioned. Now you have all the securities are classified as available for sale.

So can you elaborate on how should we think about the distribution of your capital, meaning, for example, your dividend policy, if we should think about the midrange buyback, what could be the size how much extra do you have for M&A? How much are you allocating for the hip product or for new products? Anything on that, that I think will be helpful. And then lastly on the litigation process on the VAT. So as you mentioned, there are not any additional comments, but just wanted to hear if your external auditors continuing to recommend not to provision anything. And also if you have some visibility, if there could be a potential first resolution against any other auto insurance company that could be taken as a reference for Qualitas and for the sector. So any time line on that will also be very helpful. So thank you again. And just because of timing, I prefer to do all the questions at the same time.

[Jose Correa Etchegaray, executive]

Yes. Yes. Thank you, Ernesto. Good to have you with us. Let me take the last two questions, the other ones were somehow discuss and Roberto will talk about them, but let me talk about the capital allocation.

I would say that in terms of dividend, clearly, you know that we have the policy of 90% of the profits and that -- I expect that to be the case for the result of this year. Now regarding the acquisitions and the capital that we have used for some of the acquisitions that we have been doing what we have been doing with the latest acquisition in Qualitas Salud, now Qualitas Colombia, I would say that in terms of acquisitions, we are pretty much what we have on our plate and we don't foresee any anything further. Obviously, we are going to be ready for opportunities. But at this point in time, I think that we have our plate pretty full and making sure that what we have works well.

Now in terms of using capital, Yes, it is within both for Colombia -- for Qualitas Salud, it is along the levels that we have been using over the past 24 months. So I don't see any particular thing. Now to me, the important thing in this part of the capital of our potential special dividend. It is too early to tell in the sense that GPT is slowing in Mexico. We have some items related to the elections that just happened in Mexico in June. And we are waiting to see what happens with elections in the U.S. There has been some discussions about the free trade agreement, et cetera. So we want to be very cautious on the capital on distributing additional dividends. But for the policy that we have, we will surely recommend to the general assembly to go with that obviously to the Board to do that.

So that should be the way in which we would deal with capital allocation short term.

Now regarding value-added tax, let me tell you that. Yes, there are no new news, and that there are no news in this one. We are not providing for any provision neither Qualitas nor any of the insurance companies that have been audited by the tax authorities. And in terms of -- you asked about potential first resolution. We don't know anything about a potential resolution. But let me tell you that I am personally very involved with the industry and with the sector to make sure that the new government is aware of the situation of that and how what we see in terms of the legal weight, which has been actually worked in the past. So I am very close to that, and we will continue working with the industry to make sure that this is done right. And now we are confident that our authorities will be listening somehow. And it's simply we need to wait for a resolution. But let me tell you that we are very much on top of this situation. And certainly, I do not expect anything in the short term to impact our results.

And Roberto, do you want to take the other ones?

[Roberto Araujo, executive]

Sure. So thank you, Ernesto. Let me go on your second question, was just clarifying. It's 1/3 on the seasonality, 1/3 on spare parts and 1/3 of the impact on the U.S. Going to robberies, what we've seen is, yes, Qualitas has seen an increase versus in the Q and in the year-to-date. However, let's keep in mind our recovery rate, which is much an improvement from the industry. And overall, the robberies have been decreasing over time. Just to give you a sense, in the whole industry when we compare Third quarter 2023 to 2019, overall, OCA figures have decreased 30%, while we have been able to decrease but also increase our recovery rate. And what was the third question related to?

[Andrea González, executive]

Depreciation.

[Roberto Araujo, executive]

Depreciation, Yes. So the depreciation of peso has been a constant question since we've seen a depreciation of 16% on a year-to-date basis. Now please keep in mind that in claims, we get 50% of our claims cost is related to material damages. And out of that, 50% between 20% to 25% are related to imports. So there is an impact, but it's still not an immediate impact that we'll see in our P&L. What is going to happen is there is inventory in the market and depending on how that plays -- that portion of the spare parts are reflected into the market and inflation starts coming in, we're certainly going to see prices slightly going up and also, we will be adjusting prices or rates accordingly.

So it's still open for debate as to how that is going to play out. Remember, when we were last year at MXN 16 per dollar, we didn't really see so much of that inflation or going down or prices going down. Still, there is some margin that the spare parts distribution companies will still have in place. I hope that answers your question, Ernesto.

[Andrea González, executive]

Thank you, guys. We're going to try to take one last follow-up question, we believe from Andres Soto.

[Andres Soto, analyst]

Thanks for the opportunity again, very quickly. We saw significant increase in reserve constitution this quarter. You mentioned seasonal factor. But even if I compare on a year-over-year basis, this is 3x as big as you had last year. So I would like to understand if this is related to a change in the duration of your policies is for multi-annual policies, you will need to make additional reserves. And if that's the case versus the structure that you have now in terms of single year and multi-annual. What is your target in terms of the duration of your policy portfolio?

[Roberto Araujo, executive]

Actually, this is explained by our strong growth, our double-digit growth written premiums over time. Remember, we've been growing at 36%, 28% and 24% every quarter. and that is mostly aligned to our growth in our earned premium. When constituted to your point, MXN 130 million for reserves that compares to MXN 266 million during the last quarter, and we have constituted MXN 3.6 billion in reserves, almost MXN 2 billion more than the same period last year.

In terms of our composition of annual multi-annual, we remain constant 80-20, 80 being annual and multi-annual being close to 20 as we presented earlier. So we don't see a major mix in that regard.

[Jose Correa Etchegaray, executive]

There is a seasonality effect, obviously, out of the hurricanes and the claims that we have for the period that also plays in how we build the reserve. But the actuaries are doing that. As Roberto indicated, there are no changes in the way we manage that research generates.

[Andres Soto, analyst]

That was very helpful, Jose Antonio. So just to be clear, part of the impact in terms of reserves is related to the impact of hurricanes and if that normalizes, you will reach another normalized level of reserve constitution -- is that a accurate conclusion?

[Jose Correa Etchegaray, executive]

No, Andrea, it's related to our growth. As we continue to grow, we will be in a cumulative terms constituting reserves.

[Andres Soto, analyst]

Absolutely. But that was the case also for the second quarter and the reserve was not that high. Right?

And we continue on that growing plan. As we will see a little bit more stabilization on that, we will continue to see more of our earned premium going up, and the research constitution will start going down. Because I remember at the beginning of the year, we were expecting the earned premium line to exceed the written premium line by the second half of the year. And that clearly didn't happen in the third quarter.

[Roberto Araujo, executive]

Yes. And the good news is that the growth continues has been accelerating. So moving forward, we'll continue to see as it stabilize a much less research constitution Andres.

[Andrea González, executive]

Thank you all. This concludes today's conference call. Thank you for participating, and have a pleasant day.