Property Insurers to Stop Buying?

On May 16, the Globe published a piece titled Property insurers warn proposed federal tax change to preferred shares could hurt the sector that has caused a fair amount of comment on the web and interest from Assiduous Readers. According to the Globe:

Louis Marcotte, Intact’s executive vice-president and chief financial officer, told The Globe and Mail that the company has been a significant investor in Canadian dividend-generating securities for decades, and is encouraging the government to “consult widely” on the proposed change to ensure it is supporting its “local market champions.”

“Most Canadian equity investments held by Canadian insurers like Intact Financial Corporation, are held for the long term with a view of providing a safe return for policy holders and investors,” Mr. Marcotte said in an e-mail. “The loss of the dividend deduction could have a knock-on effect on premiums but also on the availability and diversity of funding sources for Canadian corporations.”

The loss of income from the dividends deduction would effectively raise Intact’s tax rate by almost two percentage points, the company said.

“It also would increase the tax imbalance for us but also all Canadian insurers when facing their foreign counterparts,” Mr. Marcotte added.

Canadian property and casualty (P&C) insurers hold at least 12 per cent of all outstanding preferred shares in Canada – about $6-billion, according to a recent report by SLC Asset Management, Sun Life Financial’s asset-management division.

I discussed the proposed taxation change in the post Dividend Capture by Banks Now Less Profitable, but only in the context of dividend capture trading strategies. The Globe article highlights further-reaching possibilities.

So what are the implications of a potential exodus? I don’t think prices will be immediately affected: right now the market is extremely depressed – there hasn’t been much new issuance in the last three years, and that tells you something right there – and the institutions aren’t going to have a fire-sale of perfectly good assets just because the tax situation has changed unfavourably. What might happen is that any future ascent in prices gets slowed down because the holders sell into market strength, but I don’t think they’ll sell otherwise.

Liquidity will be adversely affected; but much more in the world of block-trades (more than 10,000 shares on a single ticket) and the dealer market (the proprietary traders at the big firms who make a significant portion of their paycheques by arranging these trades for their clients). At the retail level, which dominates the market so much that the average daily trading value for the universe is a mere $100,000, not so much.

A more insidious effect, I think, is that there will be some capital exiting the business. A decline in block trading will be a direct hit to dealer profits and the firms will react by reducing the amount of capital available to their proprietary desks. We saw this writ large during the Credit Crunch, when the prop-traders basically stopped doing business due to lack of capital and as a result there were enormous intra-day price swings, $1.00 gaps between successive trades, up to $2 range on a single day. Those days were glorious for those among us who supply liquidity to the market in our modest way: to some extent I see this happening again.

Another source of liquidity in the market that may be affected is ETF arbitrage. There are a few players who spend a great deal of time exploiting the equation “ETF-1 + ShareBasketA – ShareBasketB = ETF-2” and trading accordingly. A decline in liquidity will disproportionately hurt them and if they can’t make any money with a fully hedged position they’ll have to find some other market to play in.

A decline in liquidity and a shortage of big buyers will also mean that issue sizes will tend to shrink. We’ve seen some massive issues over the past decade – e.g., TRP.PR.K, $500MM, 2016, redeemed in 2022; TD.PF.H, 1,000MM, 2016, redeemed in 2021; TD.PF.G, $700MM, 2016, redeemed in 2021. I don’t think we’ll be seeing that kind of size very often if 12% of the market takes its ball and goes home.

And really, that’s all I got. Our illiquid market will become a little more illiquid, helped along by OSFI’s determination to create an OTC preferred share market (dealt a blow by the proposed tax change?) for institutional investors (see this comment). But there should be no adverse price effects relative to the current subterranean levels; perhaps a slower ascent on the way back up; and probably a greater degree of intra-day volatility.

5 Responses to “Property Insurers to Stop Buying?”

  1. DR says:

    for those among us who supply liquidity to the market in our modest way

    just stay out of my names please. barely enough room for me

  2. stusclues says:

    “But there should be no adverse price effects relative to the current subterranean levels; perhaps a slower ascent on the way back up; and probably a greater degree of intra-day volatility.”

    This would be an ideal outcome for those of us that have the ability and willingness to pay attention during the trading day. More time to buy low and more liquidity selling.

    “just stay out of my names please. barely enough room for me”

    Ditto! Unless you are on the other side of my orders 🙂

  3. peet says:

    I’ve been wondering about the status of this particular Budget proposal.

    The bulk of the March Budget was passed at the end of June, but it did not include this tax change. This suggests that by the end of June there was still some ongoing (re)consideration of same.

    That would be consistent with a critical submissions from July 6 posted on the web site of something called CALU which describes itself as the “national professional membership association of leaders in the life insurance and financial advisory industry”. If they are correct — they only state that “we are advised” — they point out that “disallowance of the DRD for life insurance companies will result in additional taxes payable in the range of $250 million per year. In turn, approximately 80 per cent of this tax ($200 million per year) will ultimately be passed on to existing and new life insurance policyholders in the form of lower benefits and/or higher premiums” and they mention that it will particularly impact participating life insurance policyholders. And these people vote!

    All that to say this March proposal is getting long in the tooth. Beyond that, who knows…

  4. peet says:

    I should have added that according to the September 12 2023 article in the G & M, the Ministry of Finance said that it will launch public consultations on the additional tax measures proposed in March.

  5. […] the fears previously expressed that property insurers would stop buying (and maybe even sell! They’re about 12% of the […]

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