DBRS Confirms Ratings on Empire Life

DBRS has today confirmed its ratings on The Empire Life Insurance Company (Empire or the Company), including its Claims Paying Rating of IC-2, its Issuer Rating of “A” and its Subordinated Debt rating of A (low). All ratings have a Stable trend. The assigned ratings reflect the Company’s smaller scale and focused product range. The Company enjoys modest levels of profitability, but has yet to suffer a major loss despite the recent difficult market conditions.

A five-year average return on equity of 6.4% and the volatility of earnings in the individual life insurance segment would normally not result in an “A” rating for a life insurance company under the DBRS rating methodology, especially given the Company’s limited geographical diversification. However, mitigating this profitability concern is the Company’s unique market niche, focused on developing close relationships with distribution partners that are more naturally available to a smaller competitor, and effective risk management processes and procedures that demonstrably contained the Company’s exposure to the financial and market crisis of the past few years. Strong regulatory capital and the accompanying financial position and supportive upstream ownership are additional factors supporting the ratings.

Empire’s individual life insurance line represents about three quarters of its policy liabilities and, therefore, exposes the Company to earnings volatility associated with these long-duration liabilities, due to changes in actuarial assumptions around mortality and investment returns. The Company purposefully retains a higher proportion of its mortality risk, which accrues to income as mortality experience continues its current trend and improves. In the meantime, however, new business strain remains elevated, affecting profitability.

Mitigating the risk of the individual insurance segment are the more stable business segments of wealth management and employee benefits. By virtue of conservative product design, the wealth management segment has not been affected by adverse reserve development associated with segregated fund guarantees, especially with respect to the guaranteed minimum withdrawal benefit (GMWB) product. Expenses per assets under management are higher than the peer group average, which reflects both the Company’s absence of scale and chosen product mix. Nonetheless, this area is targeted for improvement through a number of strategic initiatives that are expected to reduce costs through outsourcing and more efficient allocation of resources. The employee benefit segment has a short-duration book with the ability to re-price on annual policy renewals to address experienced losses. Earnings on capital and surplus continue to contribute positively.

The Company continued to manage down its overall equity exposure in 2012 to be more consistent with industry peers, by completing its efforts to shift equity out of the surplus account into the long-duration liability accounts. This redeployment is also expected to reduce some of the earnings volatility associated with interest rate movements. Overall, the Company’s asset mix is more conservative than that of the industry, with lower exposure to mortgages and real estate and a higher proportion of high-grade bonds, the corporate portion of which has been increased as attractive spread enhancement opportunities have prevailed in the wake of the financial crisis and the Company entered the private placement debt market with additional credit management resources.

Financial leverage, as measured by assets relative to shareholders’ equity and debt (including preferred equity) as a percentage of capitalization, is more conservative than that of the peer group. Similarly, the Company’s regulatory capital ratio is conservative at 212% (as at March 31, 2013). Some of this conservatism is prudent given Empire’s limited product range and geographic diversification, and lack of access to equity capital markets. Despite a relatively low level of normalized profits, the existing interest charges were covered adequately: 7.4 times last year and on average, 5.6 times over the past four years.

Empire’s controlling shareholder, E-L Financial Corporation Limited (E-L), is in turn controlled by the Jackman family. With a long-term perspective on the Company’s potential to create value, E-L has traditionally been prepared to accept the trade-off between the short-term adverse impact of higher new business strain and the more favourable impact in the long term arising from the secular improvement in mortality experience. The owners have demonstrated a commitment to the Company’s continuance through capital injections and an accommodative dividend policy, which has allowed Empire to organically grow its regulatory capital.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Canadian Life Insurance Industry, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.