DBRS Morningstar Assigns an Issuer Rating and Financial Strength Rating of A (low) to Economical Mutual Insurance Company; All Trends Stable

DBRS Limited (DBRS Morningstar) assigned an Issuer Rating and Financial Strength Rating of A (low) to Economical Mutual Insurance Company (Economical or the Company). All trends are Stable.

KEY RATING CONSIDERATIONS
The ratings and Stable trends reflect the Company’s evolving and diversified franchise, resilient liquidity position, and top-tier regulatory capital levels. The Company benefits from a well-articulated strategy and an extensive multichannel distribution network.

The ratings and trends also consider profitability metrics that lag peers, as well as the heightened strategic and operational risks associated with the Company’s ongoing demutualization process and the significant investment in a direct channel platform (Sonnet).

RATING DRIVERS
DBRS Morningstar would upgrade the ratings of the Company if Economical is able to materially improve overall profitability while maintaining its current market positioning and strong regulatory capital ratios.

Conversely, the ratings would be downgraded if there is a sustained deterioration in overall profitability, capitalization, or market positioning.

RATING RATIONALE
The Company is the seventh-largest property and casualty (P&C) insurance company in Canada and the second-largest mutual P&C insurer in Canada. Economical has a 4.4% market share in Canada’s fragmented P&C market, where only one insurer has a market share greater than 10%. Economical operates primarily in Ontario, with 59% of its 2020 gross written premiums being generated there. Other geographic areas include British Columbia (10%), Québec (8%), the Atlantic provinces (9%) and Alberta and the Prairies (14%). Economical has been investing heavily to position its business for future growth with a focus on opening additional distribution channels, broadening its product range and implementing scalable systems. In demutualizing, the Company expects that the new structure will enable it to compete more effectively, especially in an industry that is rapidly consolidating. With a stock structure rather than the mutual structure, the Company will be able to raise capital more effectively, enabling it to make acquisitions in order to grow its scale and market share.

Economical has a good/moderate risk profile. Much of the risk relates to the planning and execution of its strategic goals. These plans, while beneficial in the long term, carry some execution risk due to the size and complexity of the undertakings. Economical's risk management framework and functions are aligned with the size and complexity of its business model. The Company has taken measures to reduce any channel conflict that may arise from having both direct and broker channels, primarily by launching its Sonnet platform under a separate, independently operating brand. Sonnet's target market also differs from the one targeted by brokers. Vyne, the Company’s broker platform launched in 2018, is an investment in the broker channel and reaffirms the Company’s commitment to traditional distribution, which remains the dominant distribution channel in Canada.

DBRS Morningstar views Economical’s earnings ability as moderate/weak. The Company's premium growth trend is positive and DBRS Morningstar anticipates that this trend is likely to continue as a result of business growth initiatives. However, Economical's return on equity has been negative in three of the past five years, due in part to significant investments in technology to strengthen its online platforms and set-up costs of Sonnet. This was further exacerbated by high claims costs in the prior years up to 2019. Benefitting from these investments, the Company's results improved significantly in 2020 and are trending well in 2021. Economical’s historical combined ratio is not optimal in today’s low interest rate environment, as companies need to generate more earnings from underwriting profits to offset lower income generated from invested assets. However, the combined ratio improved significantly in 2020 to 94.6% (105% in 2019) driven by pricing and underwriting actions taken to improve profitability, lower frequency in automobile claims, and benign weather.

DBRS Morningstar considers Economical’s liquidity position to be strong/good. The invested assets portfolio is comprised primarily of cash and equivalents, equities, and high-quality fixed income investments. There are no below-investment grade bonds in the fixed income portfolio. The Company holds some preferred shares (8.0%) and a minimal amount of pooled funds (0.1%) in its portfolio as at Q1 2021. The Company’s liquid assets are more than enough to cover all policyholder liabilities, ensuring adequate policyholder protection. Most products sold are short term in nature, with Economical retaining the ability to reprice its insurance policies annually on renewal if premiums prove inadequate compared to claims experience.

Economical has strong/good capitalization and asset quality. As Economical is incorporated as a mutual company, there are no shareholders and hence no dividend payouts. Consequently, the Company has significant capital surplus. The Minimum Capital Test ratio for the consolidated company was 274.5% as at Q1 2021 (268.3% as at YE2020), which is well above the supervisory target ratio of 150% set by the regulators. Higher capital ratios provide capacity to withstand reasonably severe adverse events while supporting the underwriting of new business. Following the demutualization, DBRS Morningstar expects the Company to still hold high levels of capital.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (July 16, 2021; https://www.dbrsmorningstar.com/research/381667). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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

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

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

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

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