Definity Financial Corp

TSX:DFY

Earnings Call Transcript 2024-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the Definity Financial Corporation First Quarter 2024 Financial Results Conference Call. [Operator Instructions] This call is being recorded on Friday, May 10, 2024.I would now like to turn the conference over to Dennis Westfall, Head of Investor Relations. Please go ahead.

[Dennis Westfall, executive]

Thanks, Joelle, and good morning, everyone. Thank you for joining us on the call today. A link to our live webcast and background information for the call is posted on our website, definity.com, under the Investors tab. As a reminder, the slide presentation contains a disclaimer on forward-looking statements, which also applies to our discussion on the conference call. Joining me on the call today are Rowan Saunders, President and CEO; Philip Mather, EVP and CFO; Paul MacDonald, EVP of Personal Insurance & Digital Channels; and Fabian Richenberger, EVP of Commercial Insurance and Insurance operations. We'll start with formal remarks from Rowan and Phil followed by a Q&A session, where Paul and Fabi will also be available to answer your questions.With that, I will ask Rowan to please begin his remarks.

[Rowan Saunders, executive]

Thanks, Dennis, and good morning, everyone.We reported first quarter results last night that get the year off to a strong start and continue to deliver on our financial targets. In the quarter, solid underwriting income, robust net investment income and ongoing contributions from our insurance broker platform resulted in operating net income of $75.2 million or $0.65 a share. Our combined ratio of 93.9% reflected improved underlying results and continued expense efficiencies, partially offset by an increase in catastrophe losses. The benefit of higher earned rates flowing through the business, combined with milder winter driving conditions to generate improved core accident year loss ratios in our personal auto and commercial lines.Following proactive rate actions in 2023 to protect the profitability of our auto business, we're in a stronger competitive position to grow the underwriting income generated by this broker business in what is now a firm market. The rapidly firming conditions in auto, continued favorable conditions in commercial insurance and our strong broker proposition combined to generate significant growth momentum in the quarter as premiums increased 12.8%.Operating results again benefited from growth in net investment income, driven primarily by higher interest income that was enhanced by our active management of the portfolio in the current interest rate environment. Combined with ongoing contributions from our expanded broker distribution platform, our financial performance led to an operating ROE of 9.4%.Turning to the industry outlook on Slide 6. We believe the operating environment is one that remains conducive to sustaining favorable market conditions overall. We expect conditions in auto lines to remain firm as insurers aim to keep pace with the combined impact of elevated theft and lingering cost pressures. We also expect firm market conditions in personal property will persist, particularly following a second consecutive year of industry cat losses north of $3 billion and the dynamics of recent reinsurance renewals. In commercial insurance, we expect the market to remain firm as carriers focus on ensuring long-term profitability and sustainable availability of capacity. Overall, we expect the industry's return on equity to be close to its long-run average in 2024.Slide 7 shows our key financial targets for 2024. I've already touched on our ability to deliver on our growth and our combined ratio targets. We view this combination of mid-90s core with above-industry growth as an effective way to create shareholder value. As I mentioned last quarter, the strength in underwriting profitability, combined with expansions in investment and distribution income are expected to increase operating ROE to 10% or more in the second half of 2024 and beyond.Slide 8 illustrates the progress we've made last year to diversify and strengthen the earnings profile of the business with repeatable distribution income that complements our underwriting operations. McDougall and McFarlan Rowlands have well-established operations in Ontario, while our late 2023 edition of Drayden provided an immediate scale in Alberta. Looking ahead, we expect continued M&A activity and the organic growth potential of the business to result in $1.5 billion of managed premiums in the next 3 to 5 years. We continued our recent momentum with a couple of additional deals in the quarter and maintain our expectations for 2024 operating income from this part of the business.And with that, I'll turn the call over to our CFO, Phil Mather.

[Philip Mather, executive]

Thanks, Rowan.I'll begin on Slide 10 with personal auto. Premiums were up 15.6% in the first quarter of 2024 driven by a double-digit increase in written rates and a return to unit count growth in our broker business, reflective of our significantly improved competitive position in a firm market environment. Higher premiums assumed from industry pools also contributed 2.8 points to the overall growth. We expect our broker business to benefit from continued strong retention, increased portfolio transfer activity and the inherent scalability of our buying platform, combined impact of which should support a strong pace of growth in the coming months. We will continue pursuing additional rates and segmentation actions to maintain our target profitability.Focusing on our direct business, Sonnet, we are maintaining our disciplined approach, and we remain on track to reach our run rate breakeven target by year-end. Our approach includes focusing on areas of the business where we see opportunity for profitable growth. In the current environment, this excludes Alberta, where we maintain our pause on all Sonnet marketing activities. Personal auto reported a solid combined ratio of 97.1% in the quarter, 3.8 points better than a year ago. Our overall claims ratio improved 1.6 points as the benefits of earned rates and mild winter weather was somewhat muted by the negative impact of industry pools.Theft continues to be a major challenge for both us and the industry as a whole, though signs are pointing to a stabilization in recent months. We maintain our underwriting and claims initiatives aimed at addressing theft and also recovery. Overall, earned rate levels remain above current loss cost trends, reinforcing our expectations for personal auto to generate a mid- to upper-90s combined ratio in 2024.Turning to personal property on Slide 11. Growth of 5% picked up slightly from the pace in Q4 but remained below prior periods, which have benefited from unusually high levels of portfolio transfers. Our continued actions to address risk concentration in cat-exposed regions further slowed growth in the quarter. We expect this line to grow at a mid- to upper-single-digit pace for the full year given the firm pricing conditions prevalent in the industry.Focusing on the bottom line, we reported a combined ratio of 91% in Q1, essentially unchanged from the same quarter a year ago. Higher favorable prior year claims development and an improved expense ratio, largely offset by an increase in catastrophe losses driven by a deep freeze in British Columbia. Continued to target a mid-90s combined ratio for the personal property line of business on an annual basis.Slide 12 outlines the highlights in the quarter for our commercial business as double-digit growth in commercial lines continued with gross written premiums up 15.8% versus the prior year. Strong growth momentum was driven by targeted growth across strategic segments with strong retention and rate achievements in a firm market environment and further expansion of our small business and specialty capabilities. We expect commercial insurance to maintain growth at double-digit to low-teen pace in 2024.Commercial lines benefited from continued focus on underwriting and execution with a combined ratio of 92.1% in Q1 of '24 compared to 90.9% in Q1 of 2023. The increase in the combined ratio was driven primarily by nonweather-related catastrophe losses, which can vary from quarter-to-quarter as well as lower favorable prior year claims development. These were partially offset by improvements in the core accident year claims ratio and the expense ratio. The solid performance to start the year, we expect -- we continue to expect our commercial insurance business to sustainably deliver an annual combined ratio in the low-90s.Putting this all together on Slide 13, consolidated premiums increased 12.8%. Disciplined nature of our growth through our underwriting expertise, pricing strategies and product expansion, along with the continued focus on expense management resulted in a first quarter combined ratio of 93.9%, 1.4 points better than the solid Q1 of last year. Our expense ratio of 31.3% was 1.4 points improved from the prior year, benefiting from the investments we've made to improve productivity, along with our disciplined expense management. We view much of the improvement as sustainable and expect 2024's expense ratio to come in at the lower end of the 31% to 32% range.Focusing on distribution income when adjusting for an unusually strong CPC benefit in the first quarter of 2023, underlying income essentially doubled year-over-year, reflecting the inorganic expansion of the platform last year. It also points out that distribution income is expected to experience a similar seasonality to our overall written premiums, which tend to be lower in the first quarter each year. As we mentioned on our last call, all impacts from our national broker platform also includes a benefit to consolidated expenses in the form of a commission offset. In aggregates, we maintain our full year target of $75 million for finance costs, taxes and minority interests and expected to have a roughly 70-30 split between distribution income and commission offset.Slide 14 shows our investment portfolio in greater detail. Our net investment income, again increased meaningfully in the quarter of more than $7 million from Q1 of '23 due to higher interest income from increased book yields captured through active management of fixed income portfolio. Growth is expected to slow from double digits to mid-single digits in '24 as book yields and market yields converge. We, therefore, maintain our expectations for full year net investment income exceeding $190 million.As you can see on Slide 15, our financial position remains robust with over $1.3 billion of financial capacity now that we've continued to the CBCA. Strong operating income and investment gains supported growth in our capital in the first quarter and combined to generate sequential growth in book value per share of 2.5%. Slide 15 shows recent capital management actions and longer-term priorities. When it comes to deploying our capital, the primary focus remains in support of our robust organic growth strategy. We also intend to continue growing our dividend over time. With an objective to build the company into a top 5 player in the industry, we are actively pursuing inorganic growth, including both insurance carriers and distributors. Following our initial build of the platform via our partnership with McDougall, recent broker acquisitions have been more programmatic in nature, which we expect to continue.With that, I will turn the call back over to Rowan for some final remarks.

[Rowan Saunders, executive]

Thanks, Phil.As Phil described, while our financial performance and operating results continue to meet or exceed our financial targets, we believe they are controllable organic levers that we can pull to further enhance our operating ROE. We've discussed 2 of them already, namely the removal of Sonnet's current drag on performance once its reach breakeven and the continued march lower in our expense ratio. Third lever is our claims transformation to Guidewire ClaimCenter. I've spoken previously about becoming the first P&C insurer in Canada to transition our core insurance platform to Guidewire Cloud by modernizing and digitizing our core infrastructure. In this way, we've become better positioned to effectively scale our business and improve our service quality.Just last month, we began managing new automobile claims using ClaimCenter. This modern platform helps us speed up claims resolution, improves communication and transparency and gives our customers real-time updates on the status of their claims. This marks an important milestone in our continued claims transformation, easing opportunities to modernize and digitize our claims processes to create better broker and customer experiences. Performance improvements are expected to come from our increased ability to optimize our indemnity and expense management practices. Further benefits will be targeted once we've completed the claims transformation with property claims currently targeted to transition late next year.And with that, I'll turn the call back over to Dennis to begin the Q&A.

[Dennis Westfall, executive]

Thanks, Rowan. Joelle, we are now ready to take questions.

[Operator]

[Operator Instructions] Your first question comes from Mario Mendonca with TD Securities.

[Mario Mendonca, analyst]

Let me start first with a question on commercial. The commercial has been a big part of this company's story since demutualization, a big part of the growth and I think the profitability. But over the last couple of quarters, you've made reference to nonweather-related cats, and I'm assuming that means fires or stuff of that nature. Could you speak to what's driving that? And if you're concerned that this is a trend you'll need to address with pricing or some other underwriting mechanism?

[Rowan Saunders, executive]

Well, thanks, Mario, for the question. And I'm going to let Fabi take that. I think I just reiterate the point you've made. We've put a lot of effort into building and shaping the portfolio with growth in commercial. And as you noted, it's really being a big part of the story. It's grown significantly over the last couple of years. And as we've built out multiple segments, not just small business, middle market and specialty, we're building teams and capabilities. I would say at the macro level, we're delighted with this business. We see strong future potential as well. And there is no concerns from our perspective in terms of how this business overall is projecting and performing at this stage. So we continue to be very, very pleased. But with that, let me pass it to Fabi to kind of give you a bit more specific insights to the nature of your question.

[Fabian Richenberger, executive]

Yes, Mario. So very much in line with what Rowan just outlined. The big picture is that we have no concerns whatsoever with our large loss in margins that you've seen over the last couple of quarters in our commercial business and as you know, large losses will always vary a little bit quarter by quarter. You'll have a quarter where you have two or three large losses and then you have a quarter where you don't have any large losses. And overall, we have a very sound underwriting, very sound pricing approach. We have a very kind of diligent risk management and governance practice around our large account practice, that business has been profitable over the last 4 years. And even if you look at the performance over the last 2 quarters, we are still making adequate margin in that business because we are collecting an adequate amount of premium. And we do expect that we have about 10 large losses any given year. And again, the big picture is that we're not concerned about it. And we do feel that we have a very good opportunity to keep that business profitable going forward as well.

[Mario Mendonca, analyst]

Not to put too fine a point on it, but are you talking about fires here when you say non-cat losses, nonweather-related cat losses?

[Fabian Richenberger, executive]

That's it. Yes. So in our commercial portfolio, $1.2 billion, about 60%, as you know, is in the P&C space, 40% is in the auto space. And if you look at our loss margins in Q1, we had 2 large fire losses and 1 large auto loss. But again, in both lines, they're very much in line with our price assumptions, and we are making the margins that we're going to have in that place. And what is important to note as well is that we have specific reinsurance protection in that business as well. So it's not really a severity concerns that we have in that business because our reinsurance will kick in of our retention of $5 million and then the team that we have hired 4, 5 years ago that is running the business, they literally have 20-year experience, and they are also adding second safety insurance for some of the places that we have. So again, absolutely no concerns about the large loss in margins that you've seen in the large loss segment.

[Mario Mendonca, analyst]

Now Rowan, your comments about improving the ROE through those 3 approaches, the claims, Sonnet and the expense ratio. I've often -- I've held the view that the company's ROE is sort of stuck in that 9.5%, 10% range until you can do a large acquisition, but it sounds like through those 3 approaches, you're a little more optimistic than I would be on what that ROE can get to. So maybe let me ask the question this way, absent the transaction, what can those 3 approaches do for the ROE?

[Rowan Saunders, executive]

Yes, Mario, I think that -- as you said, there's a combination of factors that we think that will improve over the next couple of years. And for sure, the ones that are a bit more opportunistic are the ones where we can deploy the capital through M&A. So of course, we'll keep working on that. The other ones we referred to as more kind of controllable. And I think that we've kind of shared that the path for Sonnet to breakeven by the end of this year is what we've been targeting and we're encouraged about that journey. And then it will start being more contributive. So there's -- if you do the math on Sonnet, there's a couple of points that we've had to drag for a while. So that will be helpful.I think if you looked at last year and continuing into this year, you now start to see us gaining some traction on that expense ratio. And I think what's encouraging there is when you look into that expense ratio, it's essentially a combination of underwriting expenses, operating expenses and then commissions. And the year-on-year improvement this year is really all in the operating expenses. And that's about the tools that we put in place, the productivity tools are working, there's good expense discipline. But we're now starting to certainly get a bit of operational leverage in the business with revenues able to outpace the growth of expense kind of growth.I think what we feel there is there's a couple of points over a couple of years. What we're trying to do is going to glide into a lower expense ratio. And we felt that there is a couple of points of opportunity over the next couple of years as we do that, continue to fund what we do, the innovation and the growth story. And then the other area which we just commented on the call on here is certainly the claims transformation. And if you just step back over the last couple of years, I mean, what we really did in terms of transforming economical into Definity was really around the front part of the business before the claims operations. And this has really supported the ambition and the growth story. We're now well in flight in the claims transformation.And given automobile is a big part of our business, it's logical. That's where we're in first. That has just launched literally in April. And so we think that over the coming quarters, there will be both indemnity benefits as well as expense ratio benefits. And then we'll get to property next year. That transformation of the operating model for the property parts of the business is, again, just started. So I don't think it's fair to kind of stack them all up because some of that will be reinvested. But I think it definitely appeals to us like there's some opportunity to get a few points of operating ROE expansion. And that's before we do something inorganic, which then allows us to deploy the excess capital and introduce some leverage into the balance sheet. So that's the way we're thinking about that.

[Mario Mendonca, analyst]

So if I could just pull this together, you referred to a couple of points in all cases, Sonnet, expense and claims, that would be, in just doing this math, 600 basis point improvement in the ROE. That's clearly not what you're suggesting, I think when you said stacking up.

[Rowan Saunders, executive]

Yes.

[Mario Mendonca, analyst]

So what are you suggesting? Is Definity a 12% ROE company without a deal? Is that reasonable over the 2- to 3-year period?

[Rowan Saunders, executive]

Yes, Mario, that's reasonable. I think if we think about our internal kind of plans, that's the way we think about it because there will be some of that reinvestment. As you said, you can't stack them all up. And I think one of the things that's coming ahead is we're going to be sending out notification of an Investor Day in September, and that will be kind of a good double click for us to kind of get into quite a bit of detail on the actions, the path and the credibility of improving that operating ROE through those 3 organic or let's call them controllable levers.

[Operator]

Your next question comes from Tom MacKinnon with BMO Capital Markets.

[Tom MacKinnon, analyst]

Great. Probably just more numbers questions really on -- if we look on Slide 13, there's what's called other. That seems to be up quite a bit year-over-year and probably quarter-over-quarter as well. What's driving that? And how should we be thinking about that other line going forward? And there's a follow-up.

[Philip Mather, executive]

Thanks, Tom. It's Phil calling. I think within that, you've got a little bit of seasonality -- not seasonality, but onetimers that happens. So within the $13.9 million, there's a recurring component, which includes the public company expenses includes the interest expense within the business. So I'd say, overall, we'd normally expect that number to be in the $11 million to $12 million range. What's causing some of the variance year-on-year? Partly, it's the interest expense is up. So as we've drawn down on the credit facility as part of the broker acquisitions, obviously, that's increased that level by about $1.5 million that we'd see as more kind of structural increase. But there's also just a little bit of lumpiness coming on from a couple of the associate positions. That can move quarter-on-quarter. I think historically, it's been more or less a wash. This quarter, it's a small drag on a swing basis. And there's also about $1 million in there that we clearly see as a bit of a onetimer. So big picture, I think we see that more in the kind of $11 million to $12 million range. And the increases on prior year is more about the interest expense as we've drawn on the facility.

[Tom MacKinnon, analyst]

Okay. That's great. And I don't know if you've talked -- if we just move to the next slide there, 14, we seem to have plateaued in terms of both interest income and dividend income. With such a growing portfolio and probably a gap between new money rate and your book rate, I would have expected that dollar amount to increase. Any thoughts around why it hasn't increased quarter-over-quarter?

[Philip Mather, executive]

Yes. Thanks, Tom. Again, there's a couple of component parts in there. So overall, when you look year-on-year, obviously, we're still running up a sizable increase compared to this point last year, and that's the interest income driving that as the yields kind of [ burn ] in. Quarter-on-quarter, there's a couple of components there. In the fourth quarter, each year, we get a onetime dividend payout that comes from foreign equity pooled fund. So there's about $1 million of dividend income there that pops in the fourth quarter. So the underlying dividend trend is pretty consistent. And you'll see it's been pretty consistent over the last several quarters as we haven't really added to the overall equity exposure, but it causes a bit of a trend quarter-on-quarter.And then the other factor I'd call out is just the cash flow drain in the first quarter of the year. So Q1 is always a cash flow consumptive quarter, more so this year than in others because we have the traditional payouts for incentives, the traditional payouts for CPCs, we also had a largest payout on taxes, and we have the deployment of capital into the broker portfolio. So a little more exaggerated there, and that's what's really depressed the interest income as we've utilized some of the funds from the portfolio. Later on in the year, you get more cash generative. So we would expect that to tick back up as we're able to then deploy positive cash flows into the portfolio. Overall, though, we're still very comfortable with our overall projection. We still see north of $190 million for the full year.

[Operator]

[Operator Instructions] Your next question comes from Geoff Kwan with RBC Capital Markets.

[Geoffrey Kwan, analyst]

Just wanted to follow up on the earlier question I think, Mario, on the ROE. So if you think over the next couple of years, you can get to a 12% ROE without a deal, when you optimize the capital structure, is that maybe adding like a couple of points to the ROE? Or how do you think about what the optimized capital structure ROE looks like?

[Philip Mather, executive]

Yes. Thanks, Geoff. Yes. So the way we kind of expressed it is on a controllable basis, we think we can push up towards the top end of the double digits, but below teens. It's the kind of way we think about it. Optimizing the balance sheet, we definitely think that adds a couple of points. We also think it helps us sustainably land within the teens range. So if we can get that additional scale, if we can optimize the balance sheet and just pull away some of the equity drag, that isn't -- is obviously earning 4% or so in the investment portfolio as opposed to a double-digit return on the investment. Not only does that push us into the low to mid-teen range, it also keeps us there from our perspective and helps us balance some of that volatility. So I think that's the opportunity, and that's a structural one. Obviously, once you get the scale advantages, you can build from the -- but that's a good way to put it together.

[Geoffrey Kwan, analyst]

Okay. The other question I had was -- I apologize, I was on the call a bit late. I don't know if you talked about it. On the auto side, the impact of the industry pools on premium growth, has that contribution or that impact increased over the past year? Just wondering like given where rates are and if players have been a bit more picky on underwriting. Just trying to understand what that impact has been both on the top line and also to has it added more or less kind of also looking at the combined ratio?

[Philip Mather, executive]

Yes. Thanks, Geoff. The answer to your question, bluntly, is, yes. So what we've seen in the last probably 3 or 4 quarters, certainly, the last couple is that the industry usage of the pool has gone up. And when we look at the pools, you see -- you only see half the story in the gross written premium. So within there, you get what we assumed back from the pools. So that is -- and the risk sharing pools and also the facility association. In recent quarters, you've definitely seen the industry activity pick up. So that has resulted in a high degree of growth coming from the pools and a quarter-on-quarter. And you'll see this quarter, it was 2.8% of the overall auto growth. Historically, it wouldn't have been as high as that. Now that's the one side of the picture.The other side is we're seeding more into the pools as well. So as we're seeing high theft vehicles, and we think that's a big driver of it. We're increasing our sessions, not quite at the same pace. But if you think through to the bottom line on a net underwriting basis, it's more muted than you see on the gross written premium itself. Total impact on the quarter was just under 1 point of drag on the 97% personal auto rates. Historically, the pools have been a bit of a wash for us. So when you look through to the combined ratio, it's kind of washed. We're keeping an eye on it because it is being used at a higher rate. And in this theft environment, it's not surprising that peers are also utilizing the pools at a high clip. So bigger picture, I would say the usage has gone up from the industry. Our sessions have also gone up. The overall impact on the quarter at a point, that's not unusual. You'll see quarters like that, but it is something we're going to keep an eye on.

[Geoffrey Kwan, analyst]

Okay. Sorry, if I can clarify. So -- and when you're talking about it, you're talking about both the risk sharing pools as well as the FA...

[Philip Mather, executive]

That's correct.

[Geoffrey Kwan, analyst]

...in terms of seeing that contribution. And your comment about like the auto theft is, like, anecdotally, you're seeing players in the industry kind of putting more of the -- I guess, by the vehicles that are typically [ haven't missed ] theft, putting those into the risk sharing pools? Or is that what your point was?

[Philip Mather, executive]

That's a -- yes, that's totally the point.

[Operator]

Your next question comes from Jaeme Gloyn with National Bank Financial.

[Jaeme Gloyn, analyst]

Just wanted to make sure that I firmly understand the contingent profit commission profile here. So my understanding or for my take from your commentary, this is purely a Q1 phenomenon. It's not something we should expect to reoccur throughout the rest of 2024 where CPC accruals in '23 were higher than where we are today. Is that correct? Or should we see some sort of drag from that in upcoming quarters as well?

[Philip Mather, executive]

Yes. So the way I'd look at it is the -- if you look at the prior year comparison, we had about $9.5 million of distribution income. About $4.5 million of that was a true-up from 2022 CPCs. So if you go back to that period of time, 2021 and 2022 were very good years for the industry and were strong years from a CPC perspective for the brokers. So there was more upside that came through against the original expectations when we closed off the books at the end of that year. Also, we'd only just acquired McDougall at that point in time, and we were working with them to understand the kind of accrual practices. So when you look at the year-on-year comparison, the 10, really, we'd say, is more comparable to a 5, if you isolate for an item. And when we looked at this year's accruals, we were very close. So we didn't really see that same true-up, if you like, that came through.So first comment I'd make is, that's why we think the underlying growth pattern is very representative of the expansion of the business. So the outlook for CPCs, we have factored that in our guidance of the $75 million before the minority interest, finance and taxes. So we were not expecting the same level of scale coming through from CPCs for brokers, nor have we been paying them. So it's a bit of what you saw in the second half of last year, really driven by the cat events. So we see that as probably being a little more of a headwind for the brokers overall, but we'd already factored that in to our estimate for the full year. So that was fully reflected in our expectations.

[Rowan Saunders, executive]

I think just to add, I think the big picture is that, as Phil said, we're comfortable with our guidance on distribution income for the full year. So we definitely think that $75 million is on track, [ which is ] explained the first quarter. And look, I mean, I think we continue to be delighted with the performance of McDougall and the acquisitions we've done. We closed a reasonably sized acquisition in Alberta in the first quarter of this year. So that will kind of help earn in as it goes on. And a couple of the small ones, the pipeline kind of looks good and the business from an organic perspective, continues to operate very strongly. So the strategy is unfolding exactly as we anticipated. We like it. We think it's going to continue to diversify the earnings. And despite a bit of noise, which really was more of a '23 item than a '24 item, as Phil explained, we're good with the guidance.

[Jaeme Gloyn, analyst]

Yes. Understood. So still on the broker channel, just curious to get an update as to how some of these more recent acquisitions and even like, I guess, the McDougall, McFarlan, how is the integration of those businesses going? Are you seeing an uptick in penetration of Definity premiums through these brokers in Ontario and Alberta? And then maybe wrap it up with a commentary around the environment for further broker M&A at this point. I see one of your peers is very active. And so just curious on your take on that front.

[Rowan Saunders, executive]

Yes. I think, the macro view here is that we think that consolidation in the broker sector is continuing. As you know, there are several players that are involved in consolidating and making acquisitions. There's a certain profile that fits very well with McDougall and that likes our model. So we don't win whole deals. The pipeline, I would say, is pretty healthy as maybe commented at the end of the year last year, there's something unique about the model we have. They like the fact that they continue to run operational independent models. They like the fact that they can keep maintain equity and wealth creation opportunities in the model.And as far as kind of the integration is concerned, it's different, of course, for us because we don't integrate these businesses. We own them and we support them. There is some logical synergies that happened. And I think that for -- in a broker model, clearly, there's some back-office opportunities and common technology platforms, but a lot of it actually comes with expertise and new product and new sales kind of capabilities that they can bring to particularly some of the smaller brokers that are rolled up. And of course, that keeps the margins pretty high. So we like this. It's been positive for us. We think it's going to continue to grow.I think the guidance we've said, if you remember when we acquired McDougall, it was a $0.5 billion business, in just over a year, we doubled that to a $1 billion business. And we're very comfortable that between the normal organic growth of these brokers and some programmatic bolt-on activities. We will end up about $1.5 billion or so in the next few years. So it's likely going to continue to help support our earnings and, of course, diversify earnings.

[Jaeme Gloyn, analyst]

Okay. And last one just on one of the components of the ROE expansion. You mentioned the top of the questions is the Sonnet breakeven towards the end of this year. But maybe just a quick update as to where we are on that path towards that breakeven. Are you -- it looks like there's a little bit more advertising, at least in Toronto area. So where are you starting to generate a lot more flow or more volume activity in Ontario? And is that setting up on that path to hit the right level of premiums?

[Rowan Saunders, executive]

Yes. Let me just start with that and ask Paul to give us some color there. I think that the reality is we have indicated that we felt -- we have plans in place to get Sonnet to breakeven by the end of this year on a run rate basis. And I think the macro story is very consistent. That still looks to be on track for us. But Paul, why don't you just add some more color to the progress of Sonnet.

[Paul MacDonald, executive]

Yes, absolutely. Thanks, Rowan. And yes, that's correct. We are actually seeing an increased interest in the market, but we're seeing an increased focus on quote volume and bond volume. And we are supporting that with increased marketing attention to the segments that are profitable for us. So although when you look at the aggregate level, our unit count is relatively flat. Underneath that actually is a contraction in Alberta as we mentioned previously, and mid to mid-high single-digit growth outside of Alberta. So we're quite pleased with that.One other highlight I would say, is I previously mentioned how much more profitable and sustainable our affinity business is. And I'm delighted to share that, that is going very well for us. Whereas last year, it represented about 20% of our GWP in the Sonnet portfolio. It's now up to almost 28%. And on a unit growth -- unit basis, it used to be about 25% of our units last year, and it's now up to 33% of our units. So we continue to market to that segment in particular, that segment is very interested in the digital self-serve capabilities that we have to offer. And so we'll continue to drive that entire portfolio to that path to profitability by the end of this year.

[Operator]

Your next question comes from Paul Holden with CIBC.

[Paul Holden, analyst]

I apologize I got on a little bit late, so hopefully, you haven't already answered these questions, but a few for you. I guess, first off, an update on personal auto and where earned rates sit versus written and then, of course, where claims inflation is as well, please?

[Rowan Saunders, executive]

Go ahead, Paul.

[Paul MacDonald, executive]

Yes. Thanks for that question. And so on a written basis in Q1, we're about 13%. And on an earned basis, we're just over 10%. So that was a strong contribution to that 15.6% growth that we experienced in the quarter. In terms of actual severity and inflationary statistics, what we are seeing is a continued stabilization of the year-over-year inflationary or severity increases. And so we are in about the mid-single digits and essentially all of the lines, both on the physical damage side and on the casualty side, which is reassuring because it's given us an opportunity for our rates to begin to catch up. And as we mentioned in Q4, we crossed over where rate achievement was in excess of the trend.One highlight I will add to that is theft. We've talked about theft extensively before. And so theft continues to be very elevated relative to prepandemic levels. However, theft was very elevated last year. So on a year-over-year basis, actually, the impact is very flat. And if you unpack that, what we are seeing is a slight increase in severity of --on individual theft, that's really representative of the fact that there are more new vehicles now becoming available in the marketplace, shoppers are buying more vehicles and therefore, more new vehicles with higher content are being stolen. But on a positive note, we are seeing a significant -- almost a double-digit decrease in frequency in theft year-over-year.So our frequency and our rates are covering the severity components, and that's why it leads to a flat year-over-year result. And we are watching this space carefully to make sure that we continue on in a positive manner. If we continue to see frequency reductions as is, that bodes well for the future. And of course, we're working actively with IBC and various governments to ensure that we take every action possible to reduce the impact of theft on our portfolios.

[Paul Holden, analyst]

Okay. That's great. A couple of follow-up questions on that. In terms of the difference between the written rate and earned rate, should I assume the earned rate migrates towards that 13%? I think so, but tell me if I'm wrong. And then second question is that 13% is abnormally high number. How long can that continue for? Can we see that kind of written rate continue at least through the remainder of '24?

[Paul MacDonald, executive]

Yes. I think to answer your first question, yes, it's reasonable to expect that our earned rate will tick up by a couple of points for the remainder of the year as that high written rate activity from last year and at the beginning of this year earns through the portfolio. So again, that's positive for the profitability of this line. To answer your second question, we believe it is a firm market. The entire market is taking double-digit rate. It was necessary after a prolonged period of very flat and in some cases, negative rates. Obviously, with the inflationary severity trends we've seen in the marketplace, that the entire market had to take that rate. So our expectation is it will remain at that level for the duration of this year.

[Paul Holden, analyst]

Great. One last question for me. hearing a number of questions, and I guess some data points suggesting a slowing or less firm rate market in commercial. Are you seeing any evidence of that? Because it certainly doesn't show up in your premium growth, which remains very strong, but wondering if you're seeing any early indications of not soft markets, but I don't know, less firm, less hard.

[Fabian Richenberger, executive]

Yes. Fabi here. Maybe to give you a little color on your question. We have seen a couple of segments in the commercial space that have become a little more competitive, but I would say, overall, the commercial marketplace is remaining firm and very attractive for us to drive growth in. And maybe that are our 3 additional insights I want to share with you in relation to the question that you just asked.As you've seen from our disposures, service grown by 15.8% in Q1 and about half of that growth has been generated through rate and inflation adjustments and that gives us a great deal of confidence that we are continuing to cover our loss trends in our portfolio. And with that in mind, we are very confident that we can continue to run the commercial portfolio in that low-90s kind of a combined ratio range.The second point I would like to make is that outside of the rate growth that we've had, as you know, from prior disclosures, we are focusing on driving growth in our small business. In our [indiscernible] segment, we have a very strong value proposition in those segments. We have great support from our broker partners. And most importantly, we have very strong underwriting capabilities, and we are very comfortable with the margin position that we have in those segments. So the new business that we have been adding to our portfolio, we do expect to be profitable as well. And then despite the increased competition that you're referring to, our retention rates are holding quite nicely in that mid-80s to high-80s ranges. So overall, no concerns with the growth and the profitability that we have in our commercial segment overall.And then maybe the last point to add is that if you look at our portfolio, what is important to understand is that the vast majority of our portfolio is in premium bands of $100,000 or less. And given the fact that the pricing elasticity in those bands is not lower, we have a very good opportunity to retain our profitable business at attractive rates and retention numbers. So overall, very pleased with the growth momentum that we have in commercial, very pleased with the underlying profitability that we have. And as you know, we are always putting a premium on protecting our profitability. So maybe the growth rate might come down by a couple of points as we are making the right trade-off decisions between growth and margin protection. But with the strength that we have in our teams, a very strong underwriting culture, a very strong actuarial capability that we have built the last for 5 years, we're very confident that we can sustain the combined rates in [ low-80s ] and keep the growth in that low double-digit range as well.

[Paul Holden, analyst]

Okay. Sorry, I have to ask a follow-up because the price elasticity point you brought up was really interesting. You're suggesting where you're competing in the market because it's, I think, smaller to midsize accounts, less price elasticity versus large commercial where that might be the opposite, higher price elasticity. Do I understand that correct?

[Fabian Richenberger, executive]

Yes, very much so. That is a typical sign of a less firm market environment. So if you're a company that has $250,00, $500,000 in premium expenses, new capacity coming into the marketplace, these are the accounts that are being chased more. I think the other point that is important to recognize is that in that lower premium band, we have a very strong value proposition that are mitigating the impact of price. So in that small business space, we've developed that digital capability that allows our brokers to close and buying business in an automated fashion and our renewals segment are on an automated basis as well. And so that additional benefit of service and ease of doing business is mitigating the importance of price quite effectively. So looking at this quarter and the last 2 quarters, we are quite comfortable that we can sustain attractive rates and renewal rates in that smaller end of commercial marketplace.

[Operator]

[Operator Instructions] Your next question comes from Doug Young with Desjardins Capital Markets.

[Doug Young, analyst]

Phil, you mentioned the Facility Association, and so I just wanted to kind of dig into this in terms of what you're seeing within that book, specifically in Alberta, but in general? And is there anything to worry about in terms of what you're seeing in terms of the growth of the Facility Association? Is pricing adequate within the Facility Association, is it below where the industry is pricing? Just hoping to get a little bit of color.

[Philip Mather, executive]

Yes. I guess I [ lumped ] FA in there with the risk sharing pools. It's more of a pickup that we're seeing in the risk sharing pools themselves than the pure FA and that's the increased usage from the industry. We're not seeing really a big change from the Facility Association itself. So I think it's more about the usage of the pool. We just talk about them collectively when we think of it in that fashion. But Facility Association was still seeing as pretty normal kind of behavior and stability and activity coming back from it. It's the pools where we've seen the increased activity. Well, I don't know if you want to put any flavor [indiscernible] piece of that?

[Paul MacDonald, executive]

Yes. Just a bit more color on there -- as Phil mentioned, the industry is utilizing the pools more, particularly around the theft area. But of course, the industry itself is taking significant rate to cover theft. So we would expect that trend to mediate a bit throughout the year. And so the pools naturally grow from that perspective, and then there's an assessment back to that. And we'll watch the space carefully and to see how this develops.

[Doug Young, analyst]

So we're not seeing a return to the bad days of the Facility Association is essentially the messaging that I'm getting there.

[Philip Mather, executive]

We're not seeing that. We're just seeing increased usage of the pools, but we're also responding with increased usage ourselves. So it's more muted when they actually take it through to the net impact.

[Doug Young, analyst]

That's fair. And then just back on the M&A side and broader, bigger question, and I understand the strategy around the roll-up in the broker side and looking at manufacturing and insurance in Canada. Have you started to -- if you can't find anything of size in Canada, have you started looking outside beyond the Canadian region in terms of opportunities to deploy capital? Or does it strictly remain just Canadian focus?

[Rowan Saunders, executive]

Yes. Look, I think our priority and definitely, the focus is on Canada. I mean when you think about -- I mean, the thesis that we do think consolidation is going to continue to pick up in Canada after a bit of a pause. When you think about the platform we've built in Canada, which really has been built for a bigger business than we are the natural synergies, we would get the support from the broker distribution and the fact that we've got a very seasoned experienced team that knows how to operate here in Canada. That is clearly any in-market acquisition is definitely top of our list and top of our priority. And I think at this stage, we don't feel that it's necessary to kind of depart from that in terms of priority. That doesn't mean like we never say no to ever. And of course, we'd have to think very carefully about that. They have to be in a certain line of business, et cetera. But what I would share to you, where we're active and where we're putting our attention in is definitely in market carrier focus.

[Operator]

Your next question comes from Stephen Boland with Raymond James.

[Stephen Boland, analyst]

I apologize if this was asked. Just in terms of optimizing your balance sheet, looking to do, I guess, some term debt. Is there a possibility that you come to the market before there's actually a need? Or is it going to be coincident with some sort of acquisition?

[Philip Mather, executive]

Yes. Thanks, Steve. I think it's more likely that we do it coincident with M&A activity. The only caveat to that one is you'll see we have drawn somewhat on the debt facility that we have in place. And to the extent on the broker distribution side, that runs up to a sizably enough fashion to support an issuance from ourselves. We might look at that. But it's more likely in the scenario of a more concerted deployment of capital through M&A.

[Stephen Boland, analyst]

Okay. And the second question, again, I apologize if it's asked, is the Alberta government recently or the regulator commissioned 2 reports, I think consensus is that they're not very effective or not telling a true story. I'm just wondering if you have any comments on the reports.

[Rowan Saunders, executive]

Go ahead, Paul.

[Paul MacDonald, executive]

Thank you. We share the industry's general concern with the reports, in particular, the report that tried to calculate the impact of the cost to consumers in comparing various different jurisdictions and different methods. So we've shared those concerns through the industry and directly with the government. We continue to work proactively with government as their performs. And we are encouraged to hear that they are looking to put reforms through the system. But we are certainly watching that space and determining the extent to which and the timing of those reforms will impact the portfolio. But yes, they are concerning reports in terms of the methodology.

[Rowan Saunders, executive]

The only thing I would just add to that is, look, I mean, I think that as we've kind of shared in the past, obviously, the kind of environment in Alberta is less attractive to us than other provinces. When we think about our portfolio in Alberta, it's only 12% of our total auto portfolio. We've got 5% of that in Sonnet and 7% in the broker business. The broker business is in a different position from our Sonnet business. Broker's a much more mature business and whilst there is some compression on the margin as this takes time to unfold. We do think eventually the government will end up with some form of a reasonable outcome and reforms in place. But in the meantime, we continue to contract our Sonnet business. We've been in discussions with the government. I think our business in Sonnet now is down to about $66 million. So whilst there's been a drag. The drag is getting smaller for us. And Paul and his team have turned the marketing off there. So really, that position, we keep risk managing that area and all the other growth has really been redirected to other more attractive divisions -- regions. So we'll kind of continue to engage and watch how that unfolds.

[Operator]

[indiscernible] for the questions. At this time, I will now turn the call over to Dennis for closing remarks.

[Dennis Westfall, executive]

Thank you, everyone, for participating today. The webcast will be archived on our website for 1 year. A telephone replay will be available at 2:00 today until May 17, and transcript will be made available on our website. Please note that our second quarter results for 2024 will be released on August 1. Please also note that we'll be hosting our inaugural Investor Day on Thursday, September 19. Additional details will be posted on our website closer to the event. That concludes our conference call for today. Thanks, and have a great one.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.