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iA Financial Corporation Inc
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Greetings and welcome to the Industrial Alliance First Quarter Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, May 7, 2020. I would now like to turn the conference over to Marie-Annick Bonneau, Head of Investor Relations. Please go ahead.
Good morning and welcome to our first quarter conference call. All our Q1 documents, including press release, slides for this conference call, MD&A, and supplementary information package, are posted in the Investor Relations section of our website at ia.ca. This conference call is open to the financial community, the media, and the public. I remind you that the question period is reserved for financial analysts. A recording of this call will be available for 1 week starting this evening. The archived webcast will be available for 90 days, and a transcript will be available on our website in the next week.I draw your attention to the forward-looking statements at the end of the slide package. A detailed discussion of the company's risk is provided in our 2019 MD&A available on SEDAR and on our website with an update in our Q1 2020 MD&A released earlier today.I will now turn the call over to Denis Ricard, President, and CEO.
Good morning, everyone, and thank you for joining us on the call today. I will, first, introduce everyone attending the call on behalf of iA. First, Jacques Potvin, Chief Actuary, and CFO; Mike Stickney, Chief Growth Officer; Alain Bergeron, Chief Investment Officer; Renée Laflamme, in charge of Individual Insurance and Annuities; Carl Mustos, responsible of our Mutual Fund Business and Wealth Management Distribution Affiliates; and Sean O'Brien, in charge of our Dealer Services, iA Auto and Home, and Special Risk Business. Q1 was marked by the COVID-19 pandemic. This situation had an impact on our results, of course, but more importantly, it had an impact on our people, our employees, our advisers, our clients, and our community. We wish everyone to be safe, healthy, and to follow measures to reduce the spread of this pandemic. And for those of you who are more directly affected by COVID-19, please note that our thoughts are with you. As a result of the pandemic and of the lockdown, we knew that many of our clients were experiencing financial hardship. It was a priority for us to provide various forms of relief to help them in these difficult times.We also wanted to support our communities. And since March, iA has made special donations of about $2 million to hospital foundations, health research centers, senior isolation programs, and food banks, among others. As for our operations at iA, from the very beginning, our priority was to carry out business continuity in a manner that will protect the health and safety of our employees, advisers, and clients. We were very proactive in implementing preventative measures, and most of our employees started to work from home prior to the government's request. More than 97% of our employees work from home, a level that was reached very quickly when the COVID-19 crisis started, thanks to a vision that started to take place 18 months ago. I am proud and grateful to our employees and distribution networks for their agility in adapting business processes and operations to the new reality very quickly. Our advisers now sell at a distance using their high performance digital tools that we have developed in the last few years. As a result, our clients are continuing to get high quality client experience.On the financial side, despite a considerable market turmoil, we managed to maintain our financial strength as well as the excellent quality of our investment portfolio. Our tradition of managing conservatively the balance sheet on both sides, i.e., the asset and liability side, is serving us well. Our solvency ratio increased, and liquidity is adequate to meet all requirements and cash flow needs and our dividend is sustainable. The current level of our solvency ratio and its sensitivity to the various risks the company face makes us very comfortable even during the actual COVID-19 crisis. In other words, our capital position is very strong and resilient to the current situation. This illustrates well iA's operational and financial resiliency. Now looking at the first quarter results, 2020 was off to a very strong start as sales were excellent in virtually all business units. In fact, even with the slowdown that started mid-March, sales results are conclusive and impressive. As for earnings, indicators were green until the onset of the pandemic. For Q1, our core EPS of $1.41 was up 10% year-over-year. On a reported basis, Q1 earnings at $0.37 EPS were affected by macroeconomics and pandemic related items. We estimate the total impact related to the pandemic, including resulting macroeconomic variations, at $1.12 EPS. Looking forward, we decided to withdraw our 2020 earnings guidance. The effects of the pandemic are multiple with a wide range of outcomes depending on the duration and the severity of the pandemic, the effect on the economy and the efficiency of the measures taken by the governments. Due to this uncertainty, in the short term, it would be difficult to accurately predict the various combinations of factor that may impact our financials. Once the situation stabilizes, we intend to reinstate guidance. While we will not be providing specific financial guidance in the short term, we will continue to manage iA prudently and efficiently with a long-term view and in the best interest of our clients and shareholders. I will conclude my remarks by saying that over the coming months, our focus will be to preserve our financial strength, but also to seize opportunities that may arise from the crisis. I will now let Mike comment on business growth. Following Mike's comments, Jacques will give an update on the earnings and capital; and Alain Bergeron, our Chief Investment Officer, will comment on investments. On that note, I'll pass it over to Mike.
Good morning, everyone. The beginning of the year has been very strong in terms of business growth, as evidenced by the 19% year-over-year increase in premiums and deposits. Assets under management and under administration decreased by 3% year-over-year, primarily due to the pandemic and the decline in equity markets at the end of March. Please refer to Slide 5 for sales results by line of business. Individual insurance had a strong start to the year with sales totaling more than $45 million. This represents a 10% year-over-year increase, with growth in minimum premium sales of 11%. For Individual Wealth Management, starting with the guaranteed products, sales continue to be excellent, totaling more than $205 million. Segregated fund sales also continue to be robust, with gross sales up 43% year-over-year. We remain #1 in the Canadian industry with net sales totaling $424 million for the quarter. Of note, more than 90% of our seg fund sales in Q1 2020 and in 2019 were in low-guarantee products. Moving to the mutual fund business, gross sales were up 27% year-over-year at $693 million. Net sales were positive through early March during the last weeks of the month, amid economic uncertainty with COVID-19, significant redemptions led to net outflows of $99 million. Sales were also strong in Group Insurance -- in the Group Insurance businesses totaling $357 million, which represent a 16% year-over-year increase. As for our Group Savings and Retirement sector, sales were up 82% year-over-year for accumulation products but were minimal for insured annuities. As for U.S. operations, sales momentum remained very strong in individual insurance as they increased by 53%. In dealer services, sales were up 7% and did slow down sort of towards the end of the quarter because of the impact of the pandemic.I will end the sales overview with iA Auto and Home, where written premium continued their steady growth and increased by 12% year-over-year. Prior to the social distancing measures and the lockdown imposed by governments to limit the spread of the pandemic, sales in Q1 range from good to very strong. Please see -- please go to Slide 6 to see how we expect the COVID-19 pandemic, the preventive measures, and the resulting economic downturn to impact sales in our different business units.For some business units such as seg fund, Individual Insurance in the U.S., and iA Auto and Home, sales are expected to be only slightly affected, if any. On the other end, for other business units such as dealer services in Canada, the decrease in sales may be more important, while car dealerships remain closed. With the caveat that April sales cannot be indicative of our sales of the coming month, it is interesting to note that April sales results are in line with or in some instances more favorable than expectations that appear on Slide 6. In any event, the slowdown in some of our business unit sales will only be temporary. Its duration will depend on the evolution of the pandemic and on the success of the actions taken by our governments. As we will emerge from the pandemic, we expect sales to return to the levels seen in early 2020. I would now like to comment briefly on acquisitions. In January, we announced the acquisition of WGI and Lubrico. These acquisitions will strengthen our leading position in the Canadian vehicle warranties market. Earlier in December, we announced the acquisition of IAS Parent Holdings. Subject to regulatory approval, this acquisition is expected to close in the second quarter. Also in the second quarter, we expect to close the sale of iA Investment Counsel, which was announced in early March. To conclude, I want to outline that the current situation has been an opportunity for us to leverage our outstanding digital platforms. These platforms are valued by distribution networks as they make their work easier and they will continue to use them in the longer-term. In times of crisis, the value of advice becomes even more important, and our distribution networks are a valuable asset for the ongoing success of our growth strategy. I will now turn it over to Jacques to comment on Q1 earnings.
Thank you, Mike, and good morning, everyone. I will start with our core EPS of $1.41, which increased by 10% year-over-year and was within management expectation, as shown on Slide 7. Reported EPS was lower, mainly due to the COVID-19 pandemic.Now moving to Slide 8, where you can see that almost all of the deviations from expectation are related to the pandemic for a global estimated impact of minus $1.12. The bulk of this deviation comes from macroeconomic variations of minus $0.80, including a loss from seg fund hedging program, which Alain will explain later. A second item of importance was a goodwill impairment of $0.22 for PPI management, which mainly stems from the pandemic. Indeed, up to mid-March, PPI recent results were in line with our projections. Due to the pandemic, we had to increase the risk premium used in the calculation, in the projection discount rate and to acknowledge a temporary decrease in projected future revenues. Policyholder experience, which generate a $0.06 EPS total loss, is detailed on Slide 9. In Individual Insurance, the loss of $0.05 can be explained by unfavorable experience from mortality and policyholder behavior. A loss of $0.02 was also recorded on the disposal of a impaired private bond. Please note that these losses in Individual Insurance are not related to the current pandemic. In Group Insurance, the negative deviation results mainly from the unfavorable long-term disability experience. We also increased the provision for future car loan credit losses based on revised projections that take into account the economic downturn resulting from the pandemic. This provision represent an amount of $0.07 EPS and is expected to be sufficient to cover losses that may occur over the next 18 months. As for the other 3 lines of business, Individual Wealth Management, Group Savings and Retirement, and U.S. operations, experience was very close to expectations. At iA Auto and Home, experience was much favorable -- more favorable with $0.11 gain due to lower claims in both Auto and Home Insurance. Almost all of this gain was realized prior to mid-March and therefore is not pandemic related. Strain on new business accounted for 12% of sales for the quarter. This result factors in an adjustment to reflect the first quarter drop in interest rates. Without this adjustment, strain will have been within guidance.Moving to taxes. The company generated a tax recovery during Q1, mainly from the impact of the experience losses that I just mentioned in addition to again due to the company's status as a mid-national insurer. Please refer to Slide 14 for our capital position. Our solvency ratio continues to stand strong at 137%. The ratio increased during the quarter from a debt issue in February, organic capital generation of $35 million, and a positive impact from interest and market variations.The increase was partly offset by acquisition in January, the hedging program loss, and the negative impact from credit spread widening. The latter can be explained by the widening of provincial spreads in Q1. As you know, provincial spreads tend to be more stable, which explains that our vector for sensitivity to credit spread is based on corporate credit spread variation only. Overall as shown on Slide 15, the updated sensitivity of our solvency ratio continues to be low.Following the already announced acquisition of IAS and sale of iA Investment Counsel, our pro forma solvency ratio is 121%, above our target range. With the solvency ratio and a leverage ratio of 25.9%, the company is in a robust financial position, which we will continue to preserve.I now want to refer you to Slide 17, which will give you some color as to how the COVID-19 pandemic may impact earnings for the remaining of 2020. This slide presents a directional view of the main earnings drivers that may be impacted positively or negatively by the pandemic in 2020. There may be some headwinds with the COVID-19 situation, most of which would be nonrecurring and will only have a temporary impact on our business. Additional information on our sensitivities and on potential impact on earnings is provided on Slide 18 to 21. I will conclude by pointing out that thanks to the strategies we've implemented since 2008 to reduce our macroeconomic sensitivity, iA is now well equipped to remain strong in this difficult environment. In addition to our capacity to generate profit, solvency ratio is above target, leverage ratio is sound, liquidity is adequate and reserves are well positioned.I will now turn it to Alain, our Chief Investment Officer.
Thank you, Jacques, and good morning, everyone. As a result of the COVID-19 pandemic, financial markets became extremely volatile in March. And in the management of iA's investment portfolio, our approach has always been conservative with a long-term view. Our asset allocation, the quality of our assets, our hedging programs are all consistent with this approach. And this explains why since the crisis began, the impact on iA's assets has been so far quite contained in relation to the chaos in the financial market. In addition, the approach -- this approach coming into the crisis gives us dry powder. As you know, crisis often creates great investment opportunities, and we entered this crisis in a position to be able to seize some. Today, I will focus on the positioning of our investment portfolio. But first, I would like to comment on our hedging program for seg funds. Our hedging programs was implemented in 2010, with the objective of mitigating the risks associated with our seg funds with high guarantees. Despite the extreme volatility in the market, the hedging program did its main job successfully, namely protecting iA's balance sheet. Indeed, during the quarter, at its highest point, the value of the hedge guarantees increased by $575 million. The program performed as expected, and this amount was almost entirely offset by the change in value of assets under the hedging program. I would now refer you to Slide 11. It's important to keep in mind that in the long run the main goal of this hedging program is not to be profitable but to reduce risk. That being said, since 2010, the program generated a cumulative gains of $0.77 EPS, up until 2020. In the first quarter of this year, in the context of the financial turmoil, the program generated a loss of $0.57 EPS, which can be explained by 2 main items: first, a loss due to the extreme market volatility; and second a loss due to other risk, mainly the basis risk. Market volatility risk emerged from the difference between realized volatility and our long-term volatility assumption. And in a normal market volatility condition, the program should cost less than expected and hence, generate a profit. But when the markets are highly volatile, they were in margins fixed to be expected to incur some losses, the more volatility, the bigger the negative impact to the nonlinear exposure and the matrix on Slide 12 displays this behavior. In the long run, the infrequent but large losses that are incurred during high volatility are expected to roughly equal to sum of the more recurrent small products. And as you know, volatility in March was extraordinary. It was the most volatile month in the history of the TSX, for example. The volatility of most equity markets was about 85%, which is quite extreme and explain the results. As for the second part of the hedging loss during Q1, it mainly comes from the basis risk. Basis risk emerges from the return difference over time between the funds that are held by clients and the hedging instruments in the program. And so the basis risk outcomes can be positive or negative. Now a few words about the hedging program in April. The volatility in April was still high but closer to normal. In this context, the April hedging resulted in a loss of less than $2 million as high volatility was offset by a positive from other risks. Now to conclude on this topic and despite the loss that we incurred in Q1 with the program, it behaved as expected in these market conditions and, as such, met its purpose. It protected iA against large losses of economic value associated with the seg fund guarantee. Now I'd like -- now looking at the overall investment portfolio. Thanks to the general quality of our assets, our diversification, and despite the chaotic Q1, the impact of the COVID-19 on our assets has been relatively well contained so far. And our investment -- and our portfolios continue to be well positioned. Slide 22 present the composition of our investment portfolio. About 2/3 of our portfolio is composed of bonds, half of which are government, and the other half corporate bonds rated BBB and higher. At 32% of overall assets, our corporate bond allocation is lower than our peers. Our direct exposure to the oil and gas sector is less than 1%. Our aggregate bond exposure to sectors such as travel, retailer, automobile, mine and metal is just over 1%. Well, as for real estate, almost half of our real estate properties are occupied by iA or by government, and 2/3 of our leases are due for renewal after 2025. Several months ago, we mentioned that we've replaced a significant allocation of our public equity allocation to an option strategy. One reason was to protect the downside against large and sudden market moves, which also made us more effective with our capital. Now as the market collapsed in March, the strategy behaved as expected and significantly outperformed the public equity that they replaced. Of course, we need to take risk to generate returns. But by highlighting these facts about our portfolio, I'm hoping that it demonstrates the high-quality of our portfolio. This then puts us in a good position to seize attractive opportunities as they arise. We are now getting paid more for taking risk than a few months ago. We have room to add high-quality corporate bonds in our portfolio, and we have already started to make some purchases. At the same time, we're doing so in a very deliberate and prudent manner. Since we don't know exactly how the crisis would unfold, we always have in mind our capital and believe that to generate risks -- to generate attractive risk-adjusted return we need to be very selective in the assets we buy, especially given our long-term horizon.Operator, we will now take questions.
[Operator Instructions]Our first question comes from Tom MacKinnon with BMO Capital Markets.
And the first question is with respect to PPI and the impairment take in there. Is there anything unique to PPI that would -- I mean, you've made a lot of other distribution acquisitions. You talk about sales for Individual Insurance being lower. But I wouldn't have thought that would have stressed PPI as much to be able to lead to the goodwill impairment. So is there anything unique about PPI that would have led to this? And did you conduct the same kind of goodwill test with respect to your other distribution acquisitions you've made?
Thank you, Tom, Jacques speaking. I will answer the last part first. Yes, we did that with all of the other distribution and everything is fine. About PPI, maybe just to remember what we did last year because it was quite important to remember that goodwill impairment we took last year was to put us in line with the earn-out formula. So it was retail management view when we did the transaction. And like Denis explained at that time that the accounting rule require us to put a big goodwill so that support the -- our view, in fact, because if we take a small goodwill when we made such an acquisition, when there's an earn-out formula, if the -- I would say the scenario proved to be exactly what we were expecting, we will have to take a loss. So if you remember well, we took a goodwill impairment, but the earn-out formula was a positive for us. Once that said, what is happening with PPI right now is happening with all, I would say, MGAs into Canada and even the U.S. is that sales distributor have to move from face-to-face meeting to non-face-to-face meeting. Also, keep in mind that PPI also do business in the very high-end market and in that market it's impossible to do medical tests right. So really, the impairment is really temporary in regard of revenue. We see those revenue reducing for 2020, probably 2021. However, what we have to play with here is really an accounting rules. And that accounting rules normally should be for permanent impairment. Business-wise, we see that as being a temporary impairment but, unfortunately, we have to follow the accounting rule. The other element, like I mentioned in my allocation, is really the risk premium. As the spread widened a lot, we need -- we had to recognize that into the accounting formula for the test of impairment. So that's really what explain PPI.
Yes, maybe -- it's Denis here. I just want to add something. And as Jacques mentioned, the accounting rules are the accounting rules. And the matter of fact is that they are one-sided. And this is a pretty good example where we believe that long-term the value of PPI is not diminished. But because the accounting rules forces us to look at the short-term impact on the cash flows or revenues and also, at the same time, assume, let's say, a higher discount rate, well, we needed -- we had to take a hit. Now when things go back to normal, guess what, the accounting rules will not allow the organization to put back the value in the balance sheet. So it's a one-sided rule, and we have to abide by that. But for us, what is most important is that we don't believe that there is a permanent decrease in value when we think long-term.
Okay. Thanks for that. And you mentioned that PPI with no medical tests for high net worth, it's really making sales difficult. You did give a little bit of color on April sales, but maybe you can elaborate a little bit more in terms of -- I think you said they're just doing better than expected, but maybe you can provide a little bit more color by some of your lines of business.
Yes. Well, I think I'm going to ask Mike to or even Renée to go over the -- specifically the individual lines, but also at the same time, review some of the other lines for April.
Sure. I'll take it on. So going by line of business, individual insurance in Canada had very good results in April. We're plus 14%, but that's probably not indicative of what's coming. We expect that to kind of trend down because there's a lag in the sales process as I'm sure you're aware. Seg fund sales are up 11% in April. These are year-over-year numbers. Mutual fund gross sales, plus 5%, employee plans, plus 1%. The dealer business overall is down 64%. No real change in GSR. SMS off 7%, and that's going to trend down because the travel insurance market is kind of dried up for now. U.S. life is up 48%. And basically, what's happened in the U.S. in the life business is we had a very strong year last year, as you know when it trended up a lot in the second half of the year, and that trend is just continuing. And so -- and I guess on top of that, we've been selling through call centers for a number of years. And we sort of built up capability to support remote sales like other than face-to-face sales. So that's really become a powerful tool, obviously, in this market. My own view is there's probably a bit more demand out there for final expense type products, given, obviously, people are feeling at risk. And the other issue that's going on and working on our advantage is, as Denis said at the outset, we moved to work from home pretty quickly right across the board in the U.S. as well. And some of our competitors in this market in the U.S. life are struggling. They've moved to work from home, too, but their service is pretty poor. So we're picking our business that way, too. And then finally, our U.S. dealer business is off 14% in April.
Our next question comes from Scott Chan with Canaccord Genuity.
So just going back to the U.S.-based IAS vehicle warranty acquisition. And maybe educate maybe us a little bit on kind of pre-COVID and post-COVID within that industry and maybe related to IAS.
I guess, Mike, you can take that one.
Yes. Mike Stickney again. Basically, our view is that the IAS business and our U.S. dealer business, in general, it's going to attract car sales. And car sales are -- have slowed down starting in late March. And interesting about the U.S. is there's a lot of good data in -- on this market. It's studied extensively, and we've been looking at a few of these reports. And one, in particular, we've been relying a lot on is J.D. Power, which publishes weekly. And basically, car sales right now are based off about 50%. This is in the month of April on a week-by-week basis and -- but it's trending up. So the expectation is that it's going to improve through the balance of this year. And if things resolve themselves reasonably well with the pandemic say by the end of the year, they're projected to be close to normal, say, by that time, say, at the end of the year. And we expect our sales to kind of track pretty close to the car sales.
And just on the -- I guess, on the Canadian side with the nonprime car loan portfolio, you talked about loss rates over the trailing 12 months. But have you noticed anything in Q1? And have you stress tested the portfolio in a worst-case scenario if this pandemic is extended?
I will leave it to Sean.
Again, this is Sean here. So when the -- so the first part of the question, no, the losses haven't hit yet. They probably won't hit until Q4. We're deferring customers as they call in. We've got a pretty strict deferral process. But what we used on the assessment of the provision was we just looked at the portfolio and sort of the -- we used Fort McMurray as kind of a proxy where in a total sort of industry shutdown, there's about 25% of customers' credit we're looking at deferrals to that period. And then we looked at our own experience on deferrals, which is a tool we've had in our belt for quite some time, and we said, typically, a customer has a deferral over the life of that loan, we'll see about a 50% increased loss over the expected. Then we applied that to our expected deferral rates of 25%, which probably won't go that high, but potentially. And that's how we came up with the provision that we took in Q1 of $9.7 million. The losses itself won't actually -- will come in probably later this year. And as it's a gradual return to work, I expect we'll see a gradual increase of losses as people realize their actual financial situation. We're also seeing early signs of some relief. The COVID relief has been helping. Our customers are taking sense of use of that and also so the unexpected forced savings that our customers are seeing as well, just given their isolation, but that's what we're seeing on that side.
Our next question comes from Paul Holden with CIBC World Markets.
So 2 questions. First is with respect to iA Auto and home. Obviously, you [ hinted ] a positive experience in Q1. Given the premium relief measures that I'm assuming started in Q2, should we reasonably expect experience to be more neutral over the next couple of quarters?
Sean -- go ahead, Sean.
Yes. Yes. It's Sean here. Yes the -- although we are giving back as a direct insurer, we are giving some premium relief to our customers. But the positive impact on -- because of the lower claims given customers aren't driving and they're keeping close in their homes is more than offsetting the benefit. So it will -- we're still expecting a strong year for Home and Auto.
Okay. Got it. That's helpful. And then with respect to IAS, wondering if you can comment on thoughts around purchase price consideration. Obviously, you're not going to give us any specifics there. But given the change in environment, is there an opportunity to negotiate or have a further negotiation around transaction value?
It's Denis here. I want to reiterate that we are committed to finalize the deal. It's not closed yet. And because it's not closed yet, it's -- I don't think we should, at this point, add anything to it. But we are certainly committed to finalize it based on the information that you already know.
Okay. Fair enough. I'm sorry, I will ask one more, and that's with respect to the hedging program. So within your prepared remarks, you commented that it behaved as expected in Q1 despite the losses. But within your news release, you also made some references to some changes, I think, that have been made post-March or at some period in March. Can you discuss what changes have been made to the hedging program, whether it's on seg funds or on the VA?
Yes. So Alain, I'll leave it to you.
Yes. Sure. So on the -- I mean, we've made some improvements, and we're still working on some others. But I don't want to send the message that if we were having quarters like Q1, then we wouldn't have that type of experience. So we've made improvements at the margin. We had several initiatives, like a lot of things are important to us. We are improving them over time. So when the volatility hits, some of them, we've -- we can simply accelerate and put more resources there to accelerate. And we've got some benefit from that. I'll give you a couple of examples. One of them is on the operational side of things. So we had been invested in some of our risk system and ability to understand more rapidly the risk exposures that they are changing dynamically. So increasing the speed of that has been something that's been helpful.The second is we have a list or a series of instruments that we're using for hedging. There was -- and then I can't be too specific here, but I'll say that there was one of them that we have been looking, trying to find for a while and the team has been working on. And we finally found a way to add that instrument in a way that was not prohibitively expensive. And that would improve future results. I know it's not exactly what you say, but I think another test is the month of April and the month of April was fairly volatile, maybe not quite as March, but fairly volatile. And we experienced overall a loss of $2 million. So the volatility being high, something consistent with the matrix that we've put on the slide, but then some other risks like the basis risk was positive.
Our next question comes from Meny Grauman with Cormark Securities.
First question is on Slide 6. If you note that in the U.S. dealer services business that you don't expect it to be as affected as Canada? And I'm just wondering what are the factors that are driving that relative performance, U.S. versus Canada, or the expectation of the relative performance?
Well, I guess -- it's Mike Stickney here. The way I look at it is, obviously, there's 2 different countries. Things are a little different in the U.S. There's -- the whole political environment is different. There's less of a social safety in that. And there's just more pressure, too, for the economy to open up. And so a good example here in Phoenix is car dealers -- car dealerships rather never shut down any time over since COVID started up. And car sales are only in -- on this J.D. Power thing I referred to earlier, they actually report our car sales by major cities. And car sales in Phoenix are only off 25% through -- let's say, through April. And you're seeing similar results at Texas. And so when I compare that to Canada, a lot of car dealerships are closed in Canada or have been and they're just starting to open up now. So our view is that things -- sales will be slower in Canada as compared to the U.S. just based on the data we're seeing.
Okay. And then, Denis, on the last call, you talked about the expectation for elevated expenses in 2020 [Technical Difficulty] to increasing investment in productivity and growth and then also the implementation of IFRS 17. So I'm wondering how you would revise that outlook on expenses given everything that's happened in your outlook.
Well, obviously, with what happened, we had to look again at our plan for 2020 looking forward. And we have changed some of our priorities, obviously, everything it has to do with improving the distribution experience like non-face-to-face, end-to-end processes. We've put our money there because it's basically -- we want to make sure that the revenue are going to be there. Even though we had already started a lot of digital initiatives over the last several years, we have accelerated the investments that we're making there. So we -- at this point, we are tightening up our expenditure, but we are reallocating it towards where is it that it's going to make much difference in the COVID environment.
Okay. And then just finally for me, what's the risk of elevated claims coming down the pipe from COVID specifically in Special Markets Solutions group? But I don't know if there's any other areas like the travel part of that. Are there big claims that we could potentially see from that business?
Jacques speaking. No, for SMS division, pretty much everyone are at home. They are not traveling. It's very short-term businesses. So we are not exposed to that kind of travel experience. So we would be pretty good with that.
Yes. I know that in the industry, there were some concern about the cancellation of trip insurance type of benefit, but we don't have much exposure there.
Our next question comes from Doug Young with Desjardins Capital Markets.
First question is for Jacques. And just on Slide 18, just the equities backing liabilities. It looks like the floor moved down to 11,700 versus 13,000. So you've got a buffer of about 13% before you'd have to strengthen reserves. Did you actually strengthen reserves this quarter? Just trying to get a sense of why there was that move from 13,000 down to 11,700.
Thank you, Doug, for the question. That topic is a little bit complex because the metric we're providing on that slide is the TSX. However, our real exposure is comprised of private equity of options that replicate equity, Canadian equity, and we have a small part of Canadian equity. So the trigger -- and as an example, private equity didn't go down as much as public equity in Q1. So that's why we look overall at all the decline of our portfolio, and we make an estimate what's the decline in the metrics that is equal to where the trigger will play. But in reality, in the quarter, things will move differently from all those parts. So that's really what happened here. So the good news here is even during the worst of the crisis in Q1, we still add, not deplete, the stock buffer entirely, so which is a great news. And the other information I will provide because I promised that to many investors I had discussion with during March, is that if ever, okay, knock head goes very bad again, what we're providing, if that trigger is, I would say, reach, we are providing the sensitivity of the impact on reserve strengthening.
Okay. Fair enough. And then second question, just on the hedging, the $0.57 hedging, just maybe I can -- the way I think about it, the $0.31 is essentially the slippage because I think you dynamically hedged and the volatility was so significant you had to trade around that. And you don't use put options. You short equity futures, correct me if I'm wrong. And therefore, because of that volatility, that's where -- that's a $0.31. Is that correct?
Yes.
Yes. Okay. Then the $0.26 is just the difference between your hedging the market and versus the actual performance of your funds. So that's the other component. Do I have that right?
I would say 95%, right? The other part is the -- I guess, it's the hedging instruments that -- so for example, a manager could have a benchmark of the TSX composite. But it's expensive to trade-in and out of the composites. So we trade the TSX 60%. And so there's a small spread in normal time and in a crisis when there's big volatility, the small -- even though they're highly correlated, the small basis -- the small basis risk can increase. And that's part of that other number.
So on the first part, have you thought of or have you shifted over to use more put options where volatility is more embedded in? And so you don't have that same level of risk? Or is it still too pricey to do so?
Yes. No, you're right. This is at the center. I mean, if I take a step back, the goal of the program yet is to protect the company against extremely unfavorable market. And it's done that, right? But the second is to do that at a reasonable cost in the long run. And then buying a lot of volatility or buying puts or selling or buying exotic options to upload that risk makes it quite costly in the long run. So that's the balance that we have to reach. And as these discussions are happening, they happen between the actuaries, the business lines, the investment department. And -- but to put it in perspective, if you look at the last 10 years, even with this Q1, there's still a $0.22 of EPS, that's, call it, in the money. But what this also masks is that the year-after-year cost of running that strategy is lower. But this is a continuum and finding exactly the optimal place is a challenge, but we've -- like they call it the departments involved have deemed that we are aiming for a long -- relatively low long-term cost.
So I guess that's the argument against pricing in the product versus pricing in the hedge. So the put options are still too expensive to essentially implement in this. So is there discussions about having changes in the pricing of the product?
Maybe Jacques, I'll let you answer this one.
Yes. Actually, Doug, you're -- yes, the pricing of the product was stick at the beginning when we sold. We're speaking here about legacy product. We have to remember that because the sales we make nowadays have lower guarantees. So -- but so pricing of the product were there. And like Alain mentioned, long-term costs versus short-term volatility. That's really the trade-off we need to do here. And that's what we did and the program work as expected.
Yes, it's Denis here. I just want -- it's Denis here. I just want to -- on Slide 11, as you've seen, when we look at the history of the performance of that program, we are quite pleased. And we've just experienced the worst and the extreme and the worst of the extreme. But when you look at the -- all the other quarters, we've benefited all in, up to now. But I think the program does this job. I mean there's a compromise to be done. I mean, at some point, you may want to hedge everything, but the cost would be super heavy too that there's no point. Here is that we are accepting some kind of volatility for the program to be cost-effective at the end of the day. But this quarter was the worst of the worst.
Fair enough. Fair enough. And then just lastly, the tax rate in the quarter on a net or reported basis was a recovery. When I look at the $1.41, what's the embedded tax rate in that, Jacques? Or what's the tax rate if we were just to back out all the experience losses? Because it sounds like that's where the tax impact came through.
If we were to remove all those losses, the tax rate would be favorable. We disclosed a gain of $0.04 coming from our status as a multinational insurer. Apart from that, it will have been write on within the guidance.
So in line. So if we -- on your $0.41, it's in line with guidance. And then that $0.04 gain, is that a recurring item? Or is that just a onetime item that you recognized this quarter?
You know what, we -- I think we discuss the -- our status as a multinational every quarter. There will always be fluctuation, okay? There will always be fluctuations. So we see that as a fluctuation.
Our next question comes from Steve Theriault with Eight Capital.
Jacques, just to complete the loop on the tax rate. When we've talked in the past, you talked about your -- that status, ultimately helping the tax rate over the medium term. So like is there the potential for that tax rate guidance which I think was 20% to 22%, like we're talking about it every quarter. Like is there a view that, that will go lower ultimately?
You can rest assure that we're working to -- we will always work to bring that as low as possible. However, what we provided in our guidance was really with all the initiative we have in mind what would be our expectation. So this was the best we can do in for 2020.
Okay. Okay. And I wanted to ask a follow-up or 2 on the subprime auto business. Just you gave some numbers there, but does -- the hit you took this quarter. Does that -- if I'm doing the math right, does that imply the loss rate rising from the 5.5% you're seeing today that maybe hasn't gone up yet to sort of 6.5% or 7%? Is that sort of what you've got in your numbers? And then as bad as you expect the losses to get over the next sort of 12 to 18 months?
Sean, do you want to comment?
Yes. This is Sean. Yes. The 7% number is roughly where we see it peaking when the losses start to come in. So yes, I think your math is good on that.
Okay. And in terms of the deferrals, can you give us a sense of what level of deferral you've seen in that book up until now?
Yes. So I mean the deferral process we're doing is it's a one month only. We have to -- a customer has to reach out to us. The customer does have to make a principal payment to engage it. So it's kind of a handle to assess the situation month-to-month. And so far, we're running under 20% cumulative deferral so far that we've seen. And the requests are coming off substantially in the last -- recently. So it's -- it appears to repeat.
Okay. And then last thing for me, probably for Jacques, in terms of the solvency sensitivity disclosure on Slide 13. Can you just talk briefly -- maybe it's complicated, but why the credit spread sensitivity went to 0 across the board?
Good observation, Steve. Actually, it took that big widening of spreads during Q1 to discover that the vector we table at last quarter was missing an element. Actually, when there's -- and here, we're speaking about corporate spread. We're not speaking about provincial spread. So there's 2 leg to it, one in the present value of PfAD, the other one in the solvency buffer. So all in all, net, our sensitivity is really 0 there. It's only that what we provided in Q4 was missing one part.
Our next question comes from Gabriel Dechaine with National Bank Financial.
Just to confirm something on this old goodwill write-down stuff. The sense I'm getting is it's largely related to sales and profits zeroing off those sales. And as it relates to like DAC, your -- as long as the sales progresses, you were kind of describing earlier, you don't think there'll be a goodwill write-down?
Not at all.
Okay. And I mean, it hasn't closed yet by IAS. Is it similar -- similarly positioned?
Like Denis mentioned earlier, the transaction has not been closed yet. So we will keep quiet on that one for the moment.
All right. Now Slide 17, I think it is here? Yes. Slide 17, pandemic related impacts. You did have some negative experience items in the quarter in individual insurance and group. Just wondering what you're thinking. The illustration here has 3 negative to 2 negatives. So it's one of the worst things, I guess, that could happen in this list. So what in the quarter do you see as maybe a recurring issue? And if you can describe those? And then what new issues do you foresee materializing in the next few quarters as far as policyholder behavior and other stuff goes, please?
Okay. Perfect. Jacques speaking. I would tackle Q1 first. So when I look at Q1, and you have, I would say, the information on the front slide here. It can be complex to follow. Individual Insurance, it's mortality and lapse half and half. And here, I would say that we see that as being a blip for the moment. It's not a trend. That's not the way we see it. Is it COVID related? I would give you only an example for lapse. There's one big policy that was lapsed last year that was reinstated in Q1 and that cost $0.01 and was -- as a client changed his mind because of COVID-19, we will never know. So we don't know for that.If you look at group experience in Q1, you have the car loan provision we discussed about. You have the visibility. So visibility -- long-term visibility was negative in Q1. However, in April, so far, we are doing fine. So we saw that as being a blip. So Q1 is really blip and iAAH is not related, like we said, also, is not related to COVID. We had such great experience before the mid-March. When I look -- looking forward on Slide 17 about the minus, minus, minus-to-minus, minus, it's really pandemic related. It's not the normal, I would say, gain and loss we will experience. It's really the pandemic related. And here, what we want to say, here, mortality will -- because of pandemic mortality, we will have -- it's manageable, what we're expecting, but mortality won't be positive. We expect with the social distancing measure that it will put pressure on visibility. Like Mike explained on dealer, if we are not doing business, profitability will reduce. Well, distribution, it's tougher to make recruitment of new people. It was already included. And this sign -- those is in relation with the guidance we provided at the end of the year. So we wanted to give you the directional and kind of magnitude idea compared to our original guidance. That's what we provide there. And we spoke also about SMS, Special Markets Solution. Nobody are traveling. So we won't sell business. We won't make profit there. So there are small elements that will add up.
Yes, Denis here. I want to just add one thing to this slide. Obviously, this slide, the one number that is very important is the number of the first line, which is 2020. We're talking about 2020. In fact, we were trying to show you our thinking in terms of what's going to happen, let's say, during the COVID-19. The other very important line is the fact that we believe that in our business model post-COVID, there's no permanent damage. So it's a way for us to tell you, okay, during the post-COVID -- sorry, during the -- during COVID, which we don't know. I mean, you and I, we don't know exactly how long this is going to last. But during the COVID-19, this is the kind of results that could happen. But we still believe that getting out of this crisis, that our business model is strong and that we're going to get back to where we were before.
Okay. And just a quick one if I could, is you got the impairment, the $0.02 item. Can you describe what asset sector, et cetera, that was related to?
Actually, it was a private bond that we were owning that we already impaired a few times in the past. We finally sold that asset but we sold it at a lower value than the book value.
Our next question comes from Darko Mihelic with RBC Capital Markets.
Just a couple of questions here. First, I would note that the AMF seems to have harmonized with OSFI on a number of issues, including suggesting that you're not supposed to raise dividends and buy back stock. I'm curious if the market volatility has -- and given the results of your hedging program, I'm curious if there's anything else the AMF is considering with respect to your operations and specifically with seg funds and the relief you get from a capital perspective. Is there anything else that you've had in terms of conversations with the AMF with possible changes coming forward from the pandemic?
For the moment -- Jacques speaking. For the moment, no, not at all. Like I mentioned in my introductory note, we have a very strong capital position even with pro forma. And actually, what we did, we run a test. It's shown on Slide 21. We run scenarios in which we were doubling the, I would say, the population infected in Canada, in the U.S. compared to what it is right now, what we're seeing right now. We put the TSX at 9,000. We reduced interest rate -- long-term interest rate by an additional 1%. And even under that big stress tests, we still end up with capital ratio that is above 117%. So we are in a very good position. So we're not in a discussion with the regulator on those stuff.
Okay. And my second question is going back to the car loans. And surprising -- it's somewhat surprising that the peak loss rate is considered to be 7%. And if you're already at 20% deferral. So the question is, if you start to -- I mean, what does it take to -- or at what loss rate would you be required to build another reserve? Or maybe let me ask it a different way. If I assume 7% annual loss, is that the size of the reserve against the $760 million loan book? Is that the way I should think about that?
The reserve we're building right now is we're -- the measure we're using outside of our regular provisioning method, which looks at a 3-month sort of loss rate is the deferrals that we're applying to it. So we're going to watch that deferral rate pretty close just to see where it flows through. Again, it really comes down to how quickly people come back to work and to what level does the sort of the unemployment numbers sort of settle in at. But yes, we -- it's -- again, the provision is packed in around. It's based on the deferrals, but the peak loss rate would come in around 7%. I hope that answers your question.
Okay. So when you say peak loss rate, I mean, I guess this is if we see the loss rate rise materially like next month or month after. Is this like an action -- I guess my question is, is it an actuarially created reserve? Or is this like a loan loss accounting reserve that you guys have built here?
Darko, Jacques speaking. Actually, what we looked at in the past, there -- like Sean mentioned earlier, we already has been in a situation where we were providing clients with deferral in such financial hardship. And we had that experience. So we know what was the real loss following those kind of crisis. So here, what we did, we used the number of deferral that was there. We put some margin on it. So we work with more than 20%. For now, we are lower than 20% like Sean mentioned. And we applied the loss -- the expected loss based on past experiences and past crisis. That's really what we did. So it's kind of an accounting way. There's no creativity here. So it's our -- really the best thing, the best value we can put as a provision.
Right. So I guess where I'm going with that is, as you have a loss, you will recognize the loss and write-down the reserve rather than having some sort of a loss or is expected loss kind of thing, right? Is that correct.
Darko, Jacques speaking again. I would say yes to that, but we will continue to monitor the number of deferral and all that as well. So there could be provision adjustment as well. So you're right saying that if there's no additional deferral, that's exactly what you're explaining.
Okay. And just a precision, if there is no additional deferrals versus the scenario of the provision. I mean, it's because we are more conservative in the number of deferrals that we used.
Okay. And what's the assumption on car values?
We haven't adjusted the used car value expectation in the -- for the provision at this point.
Our next question comes from Sumit Malhotra with Scotiabank.
Two, hopefully quick ones. First off for Denis. You were asked about pricing for the IAS acquisition earlier. I want to ask one very specific question. Did this transaction include any material adverse change clause that does allow you to go back and either renegotiate or perhaps even walk away if the economic environment or other assumptions in the transaction have changed? Does that clause exist in this transaction?
Because we have not closed yet, I will reiterate that I don't want to make any comment at this point.
Okay. That's plain enough. And then the last one is on Page 19, likely for Jacques. Certainly from the time Denis took over, it was a communication that the company wanted to reduce its interest rate sensitivity. And we see that with the IRR. 2-parter here. iA has historically been ahead of peers in reducing any ultimate reinvestment rate assumption for what's going to be mandated. Is that something you're considering in the near term? And secondly, I can see the IRR is now down to 0. But is there any aspect of the business that you would highlight to us as being particularly impacted in the very near-term by what's happened with the long end of the curve in the last few months?
Thank you, Sumit. About URR for the moment, what I'm hearing from the Canadian suite of actuary, I don't see there will be a URR change. That's what I see -- I'm hearing. But I will continue to monitor that. There's no final decision there. The thing is that, like you see on that slide, we are -- the impact for us is on -- is $66 million. About IRR, we have to keep in mind that we are targeting 0 every quarter. However, in real life, we're adding new business. There's some management action and policyholder behavior is slightly different from our expectations. So there will always be some noise here. So we are targeting 0, but the reality, we will be probably between plus or minus $5 million is acceptable for us as the total remains on that. And we're quite pleased with the situation we're in regarding the interest rate with the rate that decreased a lot recently.
There are no further questions at this time.
Okay. So I will conclude. I think it's important just to mention here. I mean, in 2008, during the crisis, I'd at the time was the CFO of the company. And I have to tell you that I feel much, I would say, even more optimistic today versus our balance sheet strength. We are very strong. We've done a lot of initiatives since then, like the IRR hedging, or the seg fund guarantees hedging since 2008. That makes us quite optimistic about the future. And in fact, when you look at 2008, we have rebounded. It didn't take long for the company to come back to the original profitability of the company. So we have resiliency, even more today than before. Our strategy of the various business lines are intact. We will go through this COVID-19 crisis. We probably get out of this even more stronger in our business model because we are investing in digital capabilities like never, never before. And so we are ready to seize the opportunities. So with that said, that's my conclusion. And I will leave the final thought to Marie-Annick. She's got a message for you.
To conclude this call, as mentioned in our earnings press release of this morning, please note that due to the pandemic, our Investor Day, which was planned for June 5, 2020, is postponed. A new date will be determined when appropriate based on guidance from health and governmental authorities. Also, I would like to remind you that our Annual General Meeting will be held virtually this afternoon at 2:00 p.m. Thank you, everyone.
That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.