DBRS Confirms Empire Life’s Ratings at “A” and A (low)

DBRS has today confirmed the ratings of The Empire Life Insurance Company (Empire or the Company) as follows: its Claims Paying Rating at IC-2, its Issuer Rating at “A” and its Subordinated Debt rating at A (low). All ratings have a Stable trend. The Company enjoys modest levels of profitability, consisting of steady financial performance in its wealth management and group benefits lines, offset by more volatile and lower earnings in its longer-duration individual protection lines. Individual insurance profitability has recently been subject to downward pressure and volatility from changes in actuarial assumptions as a result of low interest rates. Individual insurance profit volatility in recent years also occurred due to management actions to rebalance the investment portfolio backing the long-duration liabilities, investment experience and mortality experience. Expenses per assets under management (AUM) are higher than the peer group average, which reflects the Company’s absence of scale, but are targeted for improvement through the implementation of a strategic transformation project that is expected to channel resources into more profitable and sustainable growth.

A five-year average return on equity (ROE) of less than 10% and the associated volatility of earnings in the individual life insurance lines would normally not result in an “A” rating for a life insurance company under the DBRS rating methodology, especially given the Company’s lack of geographical diversification. However, mitigating this profitability concern are the following: the Company’s unique market niche focused on developing the close relationships with distribution partners that are more naturally available to a smaller competitor; its effective risk management processes and procedures, which demonstrably contained the Company’s exposure to the financial and market crisis of the past few years; its very strong regulatory capital and accompanying financial positions; and a supportive, strong upstream ownership.

In the context of the life insurance company universe rated by DBRS, the ratings of Empire reflect its concentration in Canada, specifically in the province of Ontario, and its relatively small size, with less than 5.5% market share in each of its chosen market segments. By comparison, the three largest domestic life insurance competitors control more than 60% of the domestic market and their large international operations contribute to diversification. Although larger scale is associated with greater diversification of revenues and earnings and lower unit costs, the Company’s small size allows it to focus on relationship marketing and superior customer service aimed at particular markets and distribution channels.

Having had a relatively large exposure to common equities in the past, Empire has managed its overall equity exposure (ownership of common stock and exposure to segregated fund guarantees) to be consistent with the overall equity exposure levels of industry peers by shifting some equity exposures out of the surplus account into long-duration liability accounts. The Company’s asset mix is otherwise more conservative than the industry average, with lower exposure to mortgages and real estate and a higher proportion in high-grade bonds, the corporate portion of which increased as attractive spread enhancement opportunities prevailed in 2009 and the Company entered the private placement debt market with additional credit management resources. The Company’s segregated fund product has been designed to limit equity guarantee exposures, even as a relatively high 75% of segregated fund assets are in equities.

Financial leverage, as measured by assets over equity and debt as a percentage of capitalization, is more conservative than the peer group. Similarly, Empire’s regulatory capital ratio is among the highest in the peer group at 243% at year-end 2010. Some of this conservatism is to be expected given the Company’s relatively narrow product lines and general lack of diversification. In addition, the Company is prepared to operate with higher regulatory capital than might otherwise be required, pending the prospective introduction of new regulatory capital requirements and the uncertainty surrounding the implementation of International Financial Reporting Standards (IFRS) accounting for insurance contracts, which is expected to occur over the next several years.

Empire’s controlling shareholder, E-L Financial Corporation Limited (E-L), is controlled by the Jackman family, members of which have overseen the business of the Company for more than 50 years through three generations of ownership and oversight. 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 accommodating dividend policy, which has allowed Empire to build up its regulatory capital base.

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

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