with the recent acquisition of the Canadian operations of Bloomington, Ill.-based State Farm Mutual Automobile Insurance Co., Lévis, Que.-based Desjardins Group has taken a definitive step to beef up its property and casualty (P&C) insurance business. The acquisition provides a dedicated sales force that strengthens Desjardins’ distribution capabilities outside Quebec.

This transaction also enhances Desjardins’ life insurance business, particularly outside Quebec. The deal doubles the volume of Desjardins’ individual life insurance premiums in force and solidifies the firm’s position as the fourth-largest life and health insurer in Canada.

“This will represent a significant increase in our [life insurance] sales for our business outside Quebec,” says Denis Dubois, vice president of claims and acquisitions for Ontario, Atlantic and Western regions with Desjardins’ general insurance group.

However, some insurance industry observers say the transaction boosts Desjardins’ P&C exposure at a time when that sector faces multiple headwinds, such as the growing frequency and severity of natural disasters, changing regulations and low interest rates.

State Farm and Desjardins announced in mid-January that they had reached an agreement for Desjardins to acquire State Farm Canada’s P&C and life insurance businesses and its Canadian mutual fund, loan and living-benefits companies. The transaction is expected to close in January 2015, subject to regulatory approval.

The deal will effectively double the size of Desjardins’ P&C business to $3.9 billion in annual gross written premiums from $2 billion, making Desjardins the second-largest P&C insurance provider in Canada. Says Dubois: “This is significant on the P&C side.”

The move is a strategic one, at a time when Canada’s P&C sector is experiencing a wave of consolidation, Dubois says: “We strongly believe that the P&C market will be developing the same way as the life insurance market developed in the early 2000s. You will see two or three giants emerge that will have significant scale benefit over the others. Desjardins has decided to try to position itself as one of the leaders that will emerge in the P&C sector.”

The acquisition also includes State Farm’s network of 500 captive sales agents, which represents a strategic asset on the distribution side, Dubois notes. Although Desjardins traditionally has distributed its products primarily through independent advisors, the firm began developing a network of captive P&C insurance agents in Quebec two years ago, planning to expand that network into other provinces eventually.

“This speeds up the plan that we already had in place,” Dubois says. “This brings an increased reach to our organization.”

Because many State Farm agents also are licensed to sell mutual funds and life insurance products, this network should bolster sales across all Desjardins product lines.

“It’s not just to the benefit of P&C,” Dubois says. “It’s to the benefit of all products across all of the business units Desjardins has.”

Many State Farm advisors were caught off guard by the news of the acquisition, says Paul Childs, a State Farm agent in Strathroy, Ont., who has been with that firm for more than 30 years: “It’s come as a shock to most of us who are longtime agents.”

Furthermore, Childs notes, State Farm had celebrated its 75th anniversary in the Canadian market just last year: “It’s upsetting when you work for a company for 30 years and then it pulls the rug out from underneath us. It’s almost a feeling of abandonment.”

State Farm decided to sell its Canadian operations, says John Bordignon, spokesperson for State Farm Canada in Aurora, Ont., in order to make way for a larger company that will be focused exclusively on the Canadian market and better equipped to meet the needs of clients in this country.

“It enables both companies to achieve a better competitive position together,” he says, “and much faster than if State Farm continued to go on its own in Canada – and if Desjardins continued to go on its own in Canada as well.”

That said, State Farm is not exiting the Canadian market completely. As part of the deal, State Farm will invest $450 million into Desjardins’ P&C business in order to provide the capital necessary to support the vast new scale of the business. In addition, Crédit Mutuel, a France-based co-operative financial group and long-term partner of Desjardins Group, will invest $200 million into the business.

Industry-watchers are not surprised to see consolidation in this industry, given the plethora of challenges facing P&C insurers.

“The industry is dealing with sustained low interest rates, low investment income and weaker underwriting results,” says Ron Stokes, partner with Ernst & Young LLP‘s financial services transactions unit in Toronto. “The opportunity to consolidate in the marketplace [creates] the ability to have cost reductions in [insurers’] back-office processes… to offset the drop in interest rates and investment income on the financial side.”

The weakness in underwriting results has been particularly pronounced in recent years, as insurers have faced hefty losses associated with various natural disasters. State Farm’s P&C companies, for example, reported significant underwriting losses of $3.7 billion in 2009, $3.1 billion in 2010, $4.5 billion in 2011 and $1.7 billion in 2012.

Given these challenges, credit-rating agencies have raised concerns about the risks that the State Farm acquisition presents for Desjardins. These agencies have flagged the Ontario auto insurance market as an area of particular concern, because the government plans to mandate a 15% cut in premiums over the next two years.

According to a report from New York-based Moody’s Investors Service Inc.:“The high level of ongoing exposure to Ontario auto insurance will make Desjardins’ P&C insurance operations a less predictable source of earnings.”

Desjardins is monitoring the risks in this area, Dubois says, and the firm is pleased with the steps that State Farm has taken to manage them.

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