Qualitas Controladra Sab

Thank you for standing by. This is the conference operator. Good morning and welcome to Qualitas' fourth quarter and full year 2022 earnings results webcast. The conference will now begin. It is my pleasure to turn the call over to Mr. Santiago Monroy, Qualitas IRO. Please go ahead.

Thank you. Good morning and thank you for joining Qualitas' fourth quarter and full year 2022 earnings call.

I'm Santiago Monroy, Qualitas IRO.

Joining us today are our CEO, José Antonio Correa, and our CFO and international CEO, Bernardo Rizul. As a reminder, information discussed on today's call may include forward-looking statements regarding Qualitas results and prospects, which are subject to risk and uncertainty. Actual results may differ materially from what is discussed here today, and the company cautions you not to place undue reliance on these forward-looking statements.

while it does undertake no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events, or otherwise. Let's turn it over to José Antonio, our CEO, for his remarks.

Thank you, Santiago. Good morning, everyone. Great to be with you all again, wishing you all the best for you and your families during this year. 2022 was a year of major challenges across most industries worldwide. We witnessed inflation levels continue in decades, supply chain restrictions, geopolitical tensions, financial market corrections combined with selfish monetary policies. And above all, we all have experienced a new normality after coming out of two years of pandemic. In the auto insurance industry, particularly in Mexico, we faced, in addition, new mobility trends with changes in driving and consumption behaviors. Supply chain constraints on both, new cars and spare parts, technology and digitalization disruptions, hybrid and electric vehicles accelerated growth, among many others. While every year has its challenges and particularities, I must say this one was quite unique. In times of windbreak change, we acknowledge that challenging circumstances are always an opportunity to learn and keep on growing. As insurance is a cyclical business, and in 2022, we anticipated the cycle, taking actions early while staying agile to adjust and take advantage of these opportunities. Throughout 2022, we have to keep it in our strategy, which enables us to strengthen our market-leading position. Despite we will never be fully satisfied and we will never stand still, there are many reasons to be proud of. Let me say a few of them. The number of quality of insurance units reached a record high, ending the year at 4.8 billion. which represents more than 320,000 units during two years. Top line year for the year came above expectations, growing 10% during 2022. It was reassuring that sequential growth in every single quarter for the year showed improvement, with the fourth quarter being the best in several years. Growth was driven by our unique business, where we continue highlighting our closeness and relationship with our agents, reaching 20,000 agents of 77%, and our unique commercial footprint reaching 551 offices representing 29 offices during the year. One of the development offices, those that reached 100,000 people locality, continue to be an engine of growth. We can bring this coming from what we call our ODQs, have shown a 13.5% compounded annual growth rate in the past five years. If they were a standalone insurance company, Mexico, they would take the position number 14 in the insurance industry. Also, profit continues to be challenging as the combined index continues to increase. Important to note, we continue to outperform our competitors by being the only one of the top five with combined index below 100 in Mexico, and better than many global peers. Our vertical integration continues to expand, and by doing so, extremely competitive advantages, including cost and service. We are pleased on how our vertical subsidiaries serve new customers, consolidating themselves as an engine of profitable growth. For business diversification journey, there's important steps. First, geographically, where we continue to consolidate our specialized in other countries. replicating what has made us the best auto insurance company in Mexico. Operations outside Mexico are still young, and while there are still adjustments to be made, especially in the U.S., we are encouraged by the concern potential. Many opportunities have been identified in our U.S. business, and we are in the midst of addressing them, as Bernardo will elaborate later on. Secondly, our expansion into health Qualitas Salud launched sets a cornerstone to becoming our first entry in non-related outdoor business. Health is a sector with the largest growth and potential for prevention and direction in service coupled with value proposition. We seek to satisfy an unmet need of the 90% of the Mexican population without private insurance. As a reminder, we decided to enter organically to learn and adjust our model. We expect Qualitat Salud Superior to start being relevant in three to five years and an important part of our business in 10 years. 2022 was also a key year for our commitment to sustainability. As part of our AESG efforts, we committed to a net zero emission scheme that was to 2050. That will be reached through currently analyzed measures and processes that will compose our corporate carbon support policy. These are just some highlights. We continue to set the foundations for a bright future entering 2023 with strong momentum and initiatives. Moving forward, we will continue executing on our three standard strategies. First, strengthening our leadership in domestic and insured markets. Second, prioritize our profitability in our international operations for them to be at around 20% of the objective. And third, Execute our corporate development plan using our strong capital position, diversification, and the right engine to grow within the insurance system will be crucial for the sustainability of our results. I want to make something very clear. We acknowledge our competitive advantages and what has led us to be the best auto insurance company, and we have to recognize that we have opportunities. Therefore, we have identified actions to further strengthen our operation, not only in Mexico, but in the rest of the countries in which we operate. All managed members are focusing on the 2023 game plan, along with the defined key parts of GPS. We are also working hard on our organization, especially on the development of our top employees, which will continue to be our most important asset. And with that, Let's move to the financial details and a deeper dive on the quarter and year results. Bernardo, could you please?

Good morning, everyone. As Jose Antonio mentioned, Qualica has navigated a defiant year, coming out stronger by staying true to our core competitive strengths and our service commitment to policyholders and agents. We are, however, conscious that near term will not be easy as we continue to manage inflation and focus on fixing some identified opportunities. going deep into our financials. Top line closed ahead of expectations of 17% for the quarter and 10% for the year, setting a record high. Including the pandemic, the highest quarterly growth in six years. When detecting growth, strong performance was seen across all Mexico sub-segments and international markets, except for the U.S., in which I will shortly expand. Also important to note, Around half of the growth is explained by tariff increases during last year, while the rest is organic, coming from incremental volume and mix. Worth to highlight is our traditional 70% of 18% for the year and a consistent driver of growth with a compounded annual growth rate of 7.5% over the past five years. As a reminder, new car sales are the biggest source of growth for the insurance industry and posted a 7% recovery versus 2021, but it's still 18% below 2019. Performance drove our financial institution segments up 23% in the quarter, confirming signs of recovery, but still only 2% up for the year. Our portfolio composition closed with 78% annual policies and the remaining 22% in multi-annual. For 2023, as new car sales continue to recover, we may see an increase in multi-annual policies. Earned premium is up 70% and 11% for the quarter and the full year respectively, reflecting the company's underwriting growth pace. Research behavior came in line with what we have seen historically, where in the fourth quarter we have high research contributions This quarter we constituted 1.6 billion pesos of reserves, which is basically the same amount constituted in the year. Now, going into our international operation, we closed the year with them representing 8% for the total holding company on the right. Let me break international into LATAM and U.S., providing more visibility from now on. On the former, El Salvador, Costa Rica, Peru are doing well. We have steady growth above 20 percent. They're profitable and aligned and already yielding ROE in the high single digits and improving. On the other hand, our U.S. operation has been facing challenges that, as mentioned in prior calls, resulted in the decision to shift strategy, where we will no longer focus on accelerated growth but rather on profitability. Since I am already on it, let me expand on our U.S. business that had a large impact on this fourth quarter and the total year results. Fixing our U.S. operations has now become a top priority for the company. As backup, we launched this business back in 2014 to satisfy the unmet need of Mexican customers needing coverage in the U.S., border states, and vice versa. Due to demand and opportunity, it started expanding into the domestic U.S. market as well. Over the past quarters, and given the long tail litigation process and legal particularities, mainly in Texas, we have been impacted by some other claims up to six years that have closed at a much higher cost than initially reserved. This also forced us to re-look at our own historic claims reserves, adjusting them to the offset. This quarter, and as anticipated, we finalized the actuarial assessment in partnership with an external firm which confirmed the need to increase reserves, specifically the IDNR, which stands for incurred but not reported, to comply with regulatory requirements. Total amount was $22 million during this quarter, impacting lost costs and consequently a direct hit to profits. Important to note, this is not yet an expense or an outflow on cash, the amount will continue to be part of our portfolio, and hopefully we can release back some of those funds as we continue to see the business turning around. We know there's a large market potential in the U.S. Incentives for nearshoring in Mexico are high for companies serving the U.S. market, and being the one insurance company that can provide unique service on both sides of the border is a competitive advantage we want to continue exploiting. Our revised strategy considers four main changes. First and foremost, a major refocus on the cross-border business, while importantly reducing appetite for domestic trucking, where legal environment is complex, has been the largest impact for us and for the industry overall. Second, we have strengthened our organization. We have a new CEO in place, a stronger claim, and internal actuarial teams. Third, we have and will continue to adjust tariffs. Some businesses are up more than 50% versus 2021 and more than 150% versus pre-pandemic levels. Lastly, we have also re-engineered our pay processes, which will now include mandatory use of telemagics, selective lockers, and specific KPIs. It has been a negative year for the U.S. subsidiary. We reiterate there is potential, and therefore, we have made this a priority. Considering the nature of our business, we believe this is a two-year turnaround. We should post a significant improvement in 2023 as several of the above-mentioned changes are already in place. Moving back to Qualitas Controladora, performance and cost, starting with the most important one. Our gloss cost and ratio continues to expand on the expected trend, even the business side, the effects of the mentioned industry inflation, mobility trends, and supply chain constraints. The last ratio for the quarter was 76% and 20.5% for the full year, an important but expected increase versus year-ago, and above our desired technical objective of 62% to 65%. For further reference, our last ratio performance in domestic subsidiaries stood at 70.5% for the quarter and 68.5% for the full year. To cope with cost-increased trends, we have and will continue to be disciplined on both service increases and cost control. On the former, we have leveraged specialization to make dealer adjustments where needed every four months. We have increased our service 14% on average since its lowest point in 2020, recognizing important differences by business. We will continue adjusting next ones happening in this first quarter, as we rather maintain smaller and constant increases than big, steep changes. Supporting our cost discipline, we continue relying on our vertically integrated structure to have advantages on spare parts and claim impairments, which are part of our material damages and make up for 50% of our . We're also improving specialization on claims with a full and comprehensive scan of condition and professionally trained team and computerized diagnosis procedures to prevent fraud and to support our service for customers. In addition to our risk and fraud prevention, technology plays a key role in our operations. An example of it is our already known Express Adjustment Tool, representing better service, quality quality at a lower cost since remote or desk claim officers have a three-to-one productivity versus a traditional claim officer. During the entire year, 25% of our claims were ascended through these tools. Finally, as shown in the past year, a stable and resilient metric compressor should also help our operations through this economic cycle. Moving to other metrics, our quarterly and full-year acquisition ratio stood at 22% and 23%, respectively, along with historic average. Commissions paid to agents remain unchanged, and bonuses are always aligned with the growth, health, and profitability levels of their portfolios. Operating ratio for the quarter was 0.8%, benefited by the strong underwriting performance, which represented higher income from underwriting fees, as well as adjustment from some provisions. Year-end ratio stood at 3.1%. In a highly patient environment, it is also important to address productivities. Our recent premium versus operational staff ratio increased 7.6% versus 2021, becoming our highest average. Organization and payroll will grow accordingly to cost without needing the highest excellent service. Quality tax has always seeked to align compensation to productivity. All of the above resulted in a combined ratio of 98.5% for the quarter, ending the year at 96.4%. being north of our 90 to 94% range. Now, in a year with global auto insurance failures in the U.S., Europe and Mexico are posting combined index well above 100%. We're proud of our ability to create value and being true to our commitment to stay profitable at an operational level, even in a deep-seated context. Moving forward to our financial performance, we delivered $794 million during the year, during the quarter for a cumulative financial income of $1,420, implying a 3.1% annual ROI. As a VC phase, we're starting to turn the corner on what was an optimal performance of our portfolio up through the third quarter. We are very well positioned to benefit from high industry environments, especially medical, which currently stands at 10.5%. For reference, Our ROI for the quarter was 7.7%. It was a tough year for the market, and our annual performance has adjusted. We expect financial income to play a key positive role in the next years, and it will certainly be a tailwind in 2023 as we continue to navigate the inflationary environment. Let me further give you some color on our portfolio statistics and why we're so confident in the future performance. We have 89% on fixed income and 11% in equity. This overexposure to fixed income seeks to benefit from the mentioned high interest rate, especially considering the duration of our portfolio, which now stands at 0.6 years. A way to take a lead and start taking longer-term positions. Important to note, by December 31st, yield to maturity of our entire portfolio, including geographical distribution, stands at 8.5%. 360 basis points above year-end 2021. On the equity side, despite tough performance, we have kept most of our positions as we believe their fundamentals pose them for recovery. Yet, we have not increased exposure, not planned to boost aggressively in the next month. What is the supposed 607 million net income for the quarter? 2,209 million for the year, representing a 5.3 margin margin. Tax rate was beneficial, especially in the fourth quarter and full year as well, due to the reported loss in our U.S. subsidiary and our equity position, as well as the annual inflation adjustment. Moving forward, we could expect tax rate to be much closer to our historical average of 30%. Regarding our financial ratio, our 12-month ROE stood at 11.1%, reflected the impact in our performance, but also our strong capital position. Price-to-goop value stands at 1.7, and just as a reference, if we were to exclude one-timers, ROI would have been around 16%. Next, we closed the year with a higher-than-expected top-line growth and a great momentum. We delivered positive operational profits that have strengthened the industry and an investment portfolio that, while under delivery in 2022, is well poised for the future. All this confirms quality and resilience and efficient adapting capacity. So with that said, let me now shift gears and talk about 2023, a year in which we expect to keep navigating conflict dynamics. As anticipated by Antonio, we will continue executing against our three-pillar strategy, and all actions will intend to deliver sustainable value creation to stakeholders. Considering the uncertainties and variables, we believe best not to share a quantitative detailed guidance, but rather give you some color on expectations for this new year. Starting with the top line, we will aim high single to low double-digit growth and the recovery in new car sales. We expect pricing competition to continue, and we will continue to adjust targets, ensuring our value equation supported by excellence in service remains unmatched. In 9-wheel strategy, top line will be led by Latin markets, including Mexico, as they continue with a consistent growth pace, while the U.S. is expected to decline. Now moving to our loss ratio, as inflation continues to pressure costs, we first need to see industry inflation stabilize. In addition, spare parts supply and industry evolution on robberies will be important factors. Robberies for quality tests continue to be 21% below 2019 levels. At this point, our base assumption would be to another year above our long-term target of 62-65%, with equation progress along the year and a better performance than this 2022. As we continue to experience improvement in financial institutions underwriting, acquisition costs should increase accordingly on the high end of our historical range, given they imply a higher acquisition cost. As mentioned, financial performance for the year should have a significant recovery mainly driven by the rate environment. We should expect an annual ROI to be in light or slightly ahead to average reference rates. All in all, 2023 will bring a significant recovery returning to steady growth top and bottom line with an ROE much closer to a long-term objective of 20%. As we start 2023, let me also give you some perspective on capital allocation. At the end of the year, regulatory capital for the holding company is at $4,040 million, with a sovereignty margin of $14 billion, equivalent to 446% sovereignty ratio. We're also incorporating another metric for capital, broadly using the industry, which relates to the earned premiums divided by equity ratio. It currently stands at 2.05%, versus what we consider a normal ratio of three. Either way we look at it, our performance allows to be in a strong capital position, ready for future projects of growth while providing value to shareholders. As Antonio mentioned, we have a defined corporate strategy, a clear path from which we, from a sustainable growth for the current company, will come from. the insurance ecosystem, and where there is an opportunity to replicate our unique business model and create value. As anticipated in our last earnings call, we currently have two open due diligence processes, one to strengthen our data analysis and our risk and fraud prevention competitive advantage in Mexico, and another to strengthen our vertical integration operations. If both projects are approved according to quality terms and conditions, First half of 2023 would be a conclusive date for them. Both M&As will represent no more than $50 million combined. And in both of them, we truly believe that our DNA and business model will provide significant upside. Additionally, and related to our geographical expansion, we have set eyes in the four-glider economy in the town, with 51 million people and vehicles fit over 170 million units. I'm talking about Colombia, a country without any specialized automobile insurance company, and neither are really prevention-focused ones. The size of the market and insurance penetration of only 40%, including the obligatory insurance, would enable to replicate quality of business model and closes with future agents in that country. As always, we're planning for an organic entry in a slow and gradual pace, We're starting to approve a legal process with the local authorities, and we would like to start operations by the end of this year. Though we won't provide more details, we have more perspective, given some items are outside our control. Finally, we have proved that we have a consistent policy and appetite for cash dividend payments, as we have done so over the past seven years. We will continue to comply with our revised dividend policies that establishes a dividend payment between 40% and 90% of the previous year's net profit. While it's still early Tuesday and there's a process to follow, we expect to be on the high end of the stated range. On top of that, we have an active share buyback fund with the main objective of improving liquidity. As of December 2022, we have held position 16 in the Mexican Marketability Index trading above $5 million on average per day. It's a record high and well above other relevant public companies in Mexico. By year-end, we have 6 million shares in Treasury, so we will assess implications of another share calculation to create value without affecting the long-term fleet. Quaditas continues to provide best-in-class service to our policyholders and agents and a solid performance in a dynamic environment. Positive outcome of 2022, by the dedication, professionalism, and hard work of Qualitas' more than 5,000 employees, as well as the familiarity of our board of directors and experience management team. Qualitas people continue to lead the way. Our well-defined 2023 game plan to grow, stop, and follow in our growth, we have proved our commitment to create and increase long-term value for all stakeholders. I am confident and excited for the future ahead. So with that said, I will be more than happy to address your questions. Operator, can you please open the light for Jenny?

Thank you. We will begin the question and answer session. To join the question queue, you may press star, then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. We will pause for a moment as callers join the queue. Our first question comes from Ernesto Gabinondo of Bank of America. Please go ahead.

Hi, good morning. I'm Antonio Bernardo. I'm Santiago. Thank you for the opportunity to take questions. My first question is on premiums growth. I would appreciate if you can elaborate what will be the expectations per segment, how much growth do you expect in the traditional business, in financial institutions? What will be the growth in each of the subsidiaries? You mentioned that probably U.S. could be contracting, but what about Mexico, Central America, Peru, and potentially Colombia? And also, how should we think about the growth of the medical product? And also, related to the same topic, how much do you expect subsidiaries and the medical products to represent of total premiums in 2023? Yeah, a lot of questions that are better related to my first one. And then the second one is on your claims cost ratio. I don't know if you can break down the ratio on how much is related to weather impact, how much is related to inflation, how much related to effects, and how much to accidents. And when do you think that the claims ratio could be normalized into the historical average? of 62% or 65%. And finally, my last question is in the respected ROE for this year. I don't know if it would be reasonable to expect a 90% dividend payout ratio this year, a 40% ratio of 400%. And I don't know if that suits that 18% ROE. Just wanted to hear if that sounds reasonable. Thank you.

Good morning. Good morning, Ernesto. I'm glad that you joined us for this morning's session. Well, let me take the first one. Let me try to see. We usually are not, we do not show too much detail on premium growth going forward. Having said that, let me tell you that my view is that it will depend a lot on how the economy goes too, no? because as you know, the expectation for, in our biggest business, which is M1, the GDP growth is expected to cool off a little bit to around 1%. Now, the nice thing is that the insurance business is a little bit counter-cyclical, and that should be helping us. So to give you an answer on this sort of question that you have, I think that we are having a good day because we have been very disciplined to increase our tariffs according to the cost that we have been seeing, the inflation that we have seen in square parts, et cetera. But I can say that I expect that we have some, I should say, tailwind in helping us being in the high single digits growth. It is not unlikely that we will see around 10% in terms of growth. I am very pleased, and I was discussing this with my team earlier this week, in terms of how we have seen the behavior for each of the four quarters that we have in 2022 and have the strong momentum. So I see that there is a strong likelihood that we would be double-digit in that one in terms of domestic and subsidiary. Fortunately, in the Latin, we are also double-digit. I mean, we have a very good result for the 2022. This has been something that we discussed with our teams in that time. That continues to be the case for 2023. Now, if we move to the U.S. subsidiary, as Bernardo indicated during his words to all the analysts, what we have seen in the U.S. that we are We're shaping strategy, making sure that we go back to basics and go back to where we started. So we see that we are not additionally involved in the U.S. Rather, the U.S., we're wondering to improve profitability in this way and go back to order products that we believe are the right thing to do and that will help us get back in track in that business. So also, I would say that... Premium growth, I think it's going to be, we have a good chance that it will improve both in our major markets in Mexico and also in Latin America. As it relates to by business learning, it's kind of difficult, but we still need to keep up the insurance, I mean, sorry, the auto insurance, the auto business are going to go, the new auto sales will be. I've been talking to some of the largest manufacturers in Mexico, And we are all a little bit optimistic on that one. So we should be seeing the middle single-digit growth in the industry. There are some that are even closer to 10%. So that will depend on that. We will be focusing a lot on the one that we really want. We will continue focusing on the kids. It's going to be a little bit more complicated because there has been some big competitive pressure in there. But I believe that our competitors are going to be getting now, we are going to be getting the impact of having low tariffs in the fifth segment. And the individual one, it performed well, and we will see that WG growing there. But that will give you somewhat of the color I expect. for the premium growth going forward?

Let me address your second and third question. First of all, the same cost. Defection rate loss ratio is the biggest concern. What is that in the product industry? Most of the cost increases come from the audit service. We've seen them increase 10%, so that's a couple above inflation this year. We're starting to see some signs of stabilization, so we're hoping that that peaks somewhere in the first half. Related to frequency, because you well mentioned there's two elements. You can have the cost increases, but you can also have frequency increases. We did see frequency going up. Frequency was 26.1% this year. That compares to 24%. That's So there are indeed not only more expensive planes, but also more planes that have vehicles out there. Traffic is certainly higher as we see the opening of business and schools and vacations. And we're hoping that frequency remains stable in the future. The biggest challenge of frequency remains on trucks, which are heavier accidents, those expensive accidents. for our prevention program comes into play, and we're expecting that to help. There are no effect impacts this year. Unfortunately, there's no benefit. We saw the FESO appreciate it. We're not seeing prices going down in that timeline, but at least that hasn't been an impact, and we're not expecting that to become an impact next. So just to wrap up the second question, when are we expecting to be back in the 62% to 65% range? It's unlikely it's going to be in 2023. We are expecting to be slightly above, certainly below in 2022. And the most important piece would be how we close the 2023. So Q4 of 2023, that's what we're expecting to stabilize the business, and we see it closer to that 65%. which will give us a good indicator on 2024. In that regard, my final comment would be we're expecting that Q1 and Q2 will still be challenging from a claim standpoint, and we're expecting that first half to be the peak of claim costs. And moving to the third question on dividend yield, let me just reiterate once again Confirm and reiterate our commitment to pay dividends. We've done so for the past years, and we'd like our shareholders to continue getting that dividend. I think it would be fair to expect dividends on the high end of that 40% to 90% range. I wouldn't commit to a 90%, but it's always an option. Also, I think we'll have more as we approach the General Assembly, which is the official time which will be paid dividends.

Perfect. Thank you very much, Jose Antonio Bernardo. Just a follow-up in the last point. And anything related to the solvency ratio, would it be reasonable to have a level of 400% in 2023?

We do not have a target of solvency ratio.

We do so for the insurance, insurance company. We always want to make sure quality stands out as a company that is solvent So the excess capital will remain at the control level, and on that we will be funding and fueling the growth in our strategy and the projects that we laid out. We do not have at this point any indication for extraordinary dividend payment, but as we said, that's always something that is having a table, and once we lock a structured plan for ongoing growth, we can always put that again for discussion Thank you very much.

And just on Colombia, I know that you are entering the business and likely you will initiate operations by the end of the year. Any color on how much did you pay to enter that country? Because I think it's the first time that you are actually mentioning this. So any color on that would be very helpful.

Yeah, we wanted to start giving more transparency on Colombia, the one market and only market where we're looking for geographic expansion. The size of Colombia, the conversations that we have with agents there have indicated that there is a space for a company with quality DNA to come and create value. We're not banking for any growth happening in 2023, although we're aiming to issue our first policies late in the year. And regarding capital, we believe we have somewhere in the $5 to $10 million that would include the capital that we are required to have as part of the consolidation of the insurance company.

Let me tell you just a little bit on the Columbia part, too, Ernesto. And, you know, you probably know about the market in Columbia, but it is similar in Mexico in terms of that the top five companies hold almost 70% of the of the insurance market. And it is important for us to know that we have some risk management practices in Mexico that we haven't seen in Colombia. And we have some advantages that we believe we can put in there. So that's why we are targeting that market. And the numbers that Bernardo said in terms of the capital .

Thank you very much again.

Our next question comes from Juan Ponce of Predesco. Please go ahead.

Hi. Good morning, everyone. Thank you for taking my question. My question is more on the labor cost side, especially in Mexico, given the impact on minimum wage hikes, 20% this year, more vacation days, and the gradual increase of of employer pension contributions. So what are your expectations on these pressures this year? And I mean, you mentioned in your initial remarks that you will be increasing prices, but do you think this will be enough to offset this part, or is this just to catch up with the higher costs of the auto parts sites? Thanks.

Excuse me, Juan. Can you please ask just the second part of your question to be clear?

Yeah, so the second part would be how will you be able to mitigate these cost pressures if you see any?

Let me take just some of it. Clearly, inflation is a hot topic, I would say, because I personally, I've lived through high inflation periods in Mexico, and I know that one inflation So that's something that is of some concern clearly for me, generally speaking. For insurance companies, as long as rates are high, as we have in Mexico, that is not that bad. Now, going back to your question in terms of patients and salary, you know, minimum wage increases, et cetera, clearly we have a general impact in inflation. In the specific case of Qualita, what I can say is that our operating costs are very well under control. We have the lowest percent of premiums of the industry. And so we expect them to have some impact. We are in our calculation . So it will be some impact, but not very major. And we are considering . I don't know, Bernard, if you have anything to say to that.

We never rely only on pricing to adjust or compensate for cost increases. We always look at productivity. We'll look at automation. So things that will help us compensate. So it's not a straightforward link between cost increases and inflation. We target increases.

And let me add just to that that we are, we have a significant investment in systems. We have started over the past years and 2023 will be no different. And a number of those things are going to be geared to productivity improvements as well.

Okay, so it's safe to say that there's basically no, not much of an impact from these labor cost pressures in 2023.

Yes, I would prefer to say that even with those impacts, we will be with an operating target between 3% and 4%.

Perfect.

Thank you so much.

Our next question comes from Gilberto Garcia of Barclays. Please go ahead.

Hi, good morning. Thank you for the call. I had a couple of specific questions and then a more general one. Firstly, on the financial income, did you recognize any impact from your Unifin stake in the fourth quarter, and can you provide us the current book value that you carry on that?

Good morning. So most of the UNIPIN impact was already reflected on Q3. There are no significant, actually I doubt there's any impact on UNIPIN since the equity has been on hold. That was something that we discussed at length on Q3. What we still have remains a small piece on the P&L. which is around 35 million pesos valuation. And then we still have like 90 million pesos at the balance sheet, the way they're structured. So at this point, if it were to go to zero, the value, the impact would be around 120 million pesos. On the other side, there's still upside and recovery. We're not banking on that. Our financial income does not consider it. But I think there's still dialogue that could put one thing back on the table, and hopefully that will be a nice recovery on 2023.

Okay, that's very clear. Thank you. And then second, on operating costs, they have been rather stable throughout the year, around $400 million per quarter. This quarter, it was substantially lower. lower, similar to the fourth quarter of last year, or 2021, rather. But, you know, we don't really see that seasonality in previous years. You mentioned that there were some provision releases that helped that line this quarter. But I guess what should be the – and you mentioned 34% in the previous question. Is that the wrong rate? So I guess what I'm trying to ask is the extent of the one-offs that benefited the operating expenses like this quarter.

So, Gil, let me just provide on the fourth quarter, we usually do see a lower operating cost. If you look at last year, it was 0.9%. This year, it's 0.8%. Third, there's one main factor that benefits the operating cost, which relates to premium rights. So every premium right, there's an extra charge that is intended at that market track that is intended to cover part of the cost. So as we see more number of premiums being written, we will see a higher benefit and it reflects on the operating expenses. So that's one of the things that benefits, especially in fourth quarter, that we have a higher number of premiums. The other thing, the ongoing range, it is 3% to 4%. We were at 3.1%. That's on the low end of that range. And a lot of that has to do with the or employee profit sharing. For regulatory reasons, we would take that expense not as taxes but as part of the cost. These years, we adjusted because we recognized that it wasn't going to be as high. That's just a percentage of the projections. And that was the adjustment that we did. And there's also some minor returns related to compensation. And as the year did not turn out to be as good as we all have hoped for, we also adjusted. And that adjustment always happened on the fourth quarter.

Just let me add on that, Gilberto, and I'm glad that you are with us today. Let me tell you that obviously as we expect our profits to pick up in 2023, obviously we will be seeing part of the that would increase and probably move it closer to 3.5 or 3.5. But we are also going to get the benefit of the improvement that we see in the premiums that we will be writing in 2023. So we are confident that we will remain within those ranges that Bernardo mentioned.

Okay, very clear. Thank you. And a final one on the increase in the frequency. I don't know if you could provide more color on what the potential reasons for that is. In addition, obviously, to there being more traffic, But I guess the question is, is this increase in frequency structural or more temporary in your view at this point? Thank you.

That's something that is happening, Humberto. Obviously, there has been an increase in frequency versus 2021 and 2020. However, the frequency that we have goes back to the frequencies that we have seen in 2018 and 2019. So there's no worry in that part, and it's more of the sustainable level of the frequency. But the change versus the 2021 is something that obviously goes back to explaining the results.

Okay. Thank you very much again.

Our next question comes from Andres Soto of Santander. Please go ahead.

Good morning, Jose Antonio. Thank you for the presentations and congratulations on the recovery this quarter. I have a few questions. The first is related to the U.S. operations. I would like to understand at this point how much of that is onshore business versus the cross-border business. and to what extent we can expect additional reserves being created this year. And if you are planning to reflect those reserves directly as loss ratio as it happened in the fourth quarter or is part of the reserves in the top line and this is going to be another detractor from your top line improvement this year.

So, Andres, good morning.

Let me take back your question, and then we'll go on with any remaining ones that you have. So, the U.S. operation, top year for it. Yet, overall, we lost $35 million in the year. Part of that comes from the mentioned IDNR increase of $22 million this quarter, and a lot of the impact both in IDNR and case costs would come from claims that trace back prior years, now 2021 and before even 2016. So, this is not a one-year effect. We're reflecting it, but it comes from the operation that has been in place for several years. The domestic market, which is the one that we started accelerating back four years ago, came up to represent 70% of the operation. We're now pulling back. We accept that it represents around 30% to 35% in very niche categories or accounts customers that have been consistently proving to be good and healthy customers. On the opposite, our cross-border, which again, the niche where we have a right to win, where we believe we have more control and better chance of being profitable, that is yet to become the main part of our business. hoping to reach between 60% and 65% each year. So that is an important shift that speaks for the strategy change we have alluded broadly in the conversation. Naturally, with that, we covered what you wanted to discuss.

Thank you, Bernardo. Just a follow-up on that point. So these 22 million adjustments that you made this quarter, should we anticipate more of these in 2023?

So we believe we have reflected what we needed, and it's not what we believe is what the technical models show. We're at the low end of the technical range of research, so we're hoping that there's no adverse development. Could expect some, but it's certainly going to be at a much, much lower level than we had in 2022. This is, as I mentioned, a three-year turnaround, and we're happy to provide priority updates on the U.S. business, since, again, this is one of the priorities for the company.

Got it. So you're saying three years from now, you basically will be focused basically on the cross-border business rather than the onshore one.

Yes, totally. It's a cross-border and borderless business focus.

Perfect. My second question is regarding capital, your capital position. You mentioned the audio was really bad, so I didn't fully get it, but you are mentioning a new metric of earned premiums to equity, I believe. What is the target that you look for this new metric, and based on this, what is your assessment of the excess capital of Qualitas at this point?

So again, we come back and look whether being 50% above the capital requirement was the single measure that we needed to address or that we could use another one. So in the auto insurance, there's another one that relates to the investment and the capital or earned premiums and capital ratio. And on that one, it took earned premiums divided by capital ratio What the market, the industry expects is to be healthy is to be around three times. We're now at two times. That means that the excess cash is not as much as the $600 million that you would see laid out. It would be more in the $320 million dollars. So we will be talking about metrics we're considering. That is not that we are walking away from or that we're solely looking at one. What we wanted to be transparent and say actually comes from some analysts and investors that have called out the opportunity to use this metric as well for capital, excess capital or capital.

Understood. So you say the excess capital actually is 320. Did I get it right?

Yes, we believe that at 320 or so, it's a better and more educated reasonable number of excess capital that we totally look at the 600 million. Yes.

Got it. And from that, you're marking 60 million for the acquisitions and entrusting to new markets.

Yeah. Both of the due diligence that we have in progress, we total 50. That's 5-0.

The 10 million that you are going to allocate to Colombia, right?

Yeah.

Perfect. And my final question is very specific on taxes. We saw very low tax rate. I'd like to understand what is driving your tax burden and how we should think about this looking in 2023.

Yes, let me take it again. Let me just state that there are absolutely no planning strategies as part of this low tax. I think this is not only an internal commitment, but it also gets audited by internally and our external auditors. The reason to see such a low effective tax rate in the fourth quarter relates to the losses that we report in the U.S. operations, the losses that we also reflect in our equity investment portfolio, and the inflationary adjustment, which is a tax-deductible item for every company in Mexico. As we see higher inflation, we're also able to deduct at a higher percentage. Total year tax rate was also lower than the average, and I think, as I mentioned, our tax rate to be considered moving forward should be more closer to the 30% as we have historically had.

Perfect. Those were my questions. Thanks again, and congratulations.

So, for the sake of time, I think we have some written questions, but we are not going to be able to address all of them, so I will just pick one. So, we have one from Tiago Paura from DPG that says, congrats on the results. Just one question from my side on the financial results.

Does that previous guidance of 100 and 150 basis points over the Mexican rate should now be understood as zero basis points over the Mexican reference rate for 2023?

I mean, just in line with the average rate of the year, is it fair to assume? Thanks.

Thank you very much, Seattle. Let me tell you that with the financial markets in turmoil that we have had in 2022 and now the beginning of 2023, with inflation impacts across the world and some undefined things in terms of the growth of the economy, for us, yes, the guidance is going to be closer to the... to the reference rate. Now, at this point in time, as you know, the Mexican rate is around 10.5%, which is good. We are in short-term position. So we are really getting ourselves in a way that we can somehow capitalize that part, and we are going to start moving over to this rate. We are still expecting, you know, that the Mexican rate has been following the set increases. We don't know what's going to happen with the Fed. There's still a number of analysts that say that the Fed will continue increasing. You know, the headline inflation in Mexico recently went a little bit up versus the prior latest numbers. So chances are that we will continue with that. So it is fair to assume that we will be closer to the reference rate in the case of Mexico for 2023.

And I think we're already at 10, so thank you, everyone, for joining.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.