DBRS Confirms Ratings on Great-West Life and Affiliates

DBRS has today confirmed the ratings of Great-West Lifeco Inc. (GWO or the Company) and its affiliated operating subsidiaries, including the Claims Paying Ratings at The Great-West Life Assurance Company, The Canada Life Assurance Company and The London Life Insurance Company; all trends are Stable. The existing ratings for the Company and its operating subsidiaries reflect the contribution from a diversified portfolio of businesses, including leading market shares across the Canadian insurance industry and attractive market niches in Europe, in the U.S. financial services market and in reinsurance. In the wake of the global financial crisis, the Company has continued to outperform its Canadian peer group in terms of ROE, reflecting its conservative product offerings, and low-risk investment portfolio.

Like its major peers, the Company is anchored by its Canadian operations which benefit from an oligopolistic industry structure which limits the worst of price competition. Increasing scale in the U.S. retirement saving administration and focused niches in Europe, primarily in the United Kingdom, represent stable sources of earnings contributions. The Company avoided the adverse reserve development which was experienced by a number of competitors on account of Guaranteed Minimum Withdrawal Benefits (GMWB) segregated funds inasmuch as GWO did not begin to offer the product until it had arrived at an efficient and effective hedging strategy which complemented its conservative product design.

As the largest seller of participating life insurance products in Canada, the Company enjoys a strong market position in a highly risk-mitigated product which supports its strong ROE. In the context of a generally conservative asset portfolio, the Company holds $2.5 billion of U.K. bank paper as part of its over $30 billion of general assets invested in the U.K. market. The weakness of the U.K. banking sector over the past few years resulted in certain deeply subordinated U.K. bank debt instruments deferring interest payments or converting to new, more equity-like investments. The Company also has over $1 billion of assets invested in the PIIGS (Portugal, Ireland, Italy, Greece and Spain) countries including both sovereign debt and financial institutions. While the Company has established conservative credit loss provisions against these positions, it remains more highly exposed to the European credit markets than its peer group. In any event, these positions do not represent a material portion of the Company’s overall portfolio.

Having grown by acquisition in the past, the Company’s current strategy appears more focused on leveraging its diversified distribution channels to generate organic growth through untapped markets or taking market share from competitors. In this context, the Company has identified the need to be among the most cost-efficient providers while also ensuring that it has made the necessary investments in technology required to maintain a high level of customer service and ease of use. While DBRS believes that the market for retail financial services is likely to continue to evolve with lower-cost direct investment options for retail investors, there is still a growing market for the advice-driven channel that the Company targets, which is supported by demographics and the legitimate concerns on the part of retail investors, who want to protect their beneficiaries and not outlive their assets.

Putnam continues to be a source of challenges for the Company following the write-off of more than $2 billion in goodwill and customer contract values in late 2008. A new and experienced management team, which came largely from the Fidelity organization, has spent most of the past two years improving investment fund performance while eliminating administrative costs in order to achieve profitability at a lower break-even AUM. Despite the strength in equity markets which has more than offset net redemptions of Putnam’s AUM over the past two years, the contribution of Putnam to the Company’s financial results continues to be negative with a $43 million loss in 2010, albeit down from a $90 million loss in 2009. Net sales of funds actually turned positive in Q1 2011 on consistently stronger reported investment performance. Notwithstanding the slow progress in returning to consistent profitability, Putnam has a good platform for long-term growth in AUM, given its brand, its entrenched distribution network of independent financial advisors and its recovering presence in the institutional market.

The MCCSR ratio of the Company’s major regulated operating subsidiary has hovered around 200% for the last two years. While this is lower than the peer group’s, it reflects the Company’s lower risk asset portfolio and insurance liabilities and does not include $700 million of cash at the holding company that could easily be advanced to the regulated entities in the form of capital, if required. With longer experience as a shareholder-owned company, GWO has traditionally operated with higher financial leverage than most of its Canadian peers, a reflection of its debt-financed M&A activity and the historical attention paid to the efficient use of shareholder capital. At 34.2% at the end of March 2011, the Company’s total debt plus preferred as a proportion of capital remains aggressive but increasingly in line with the industry as competitors have increased their use of financial leverage. Fixed charge coverage ratios at GWO nevertheless remain healthier than those of its peers, reflecting stronger profitability, albeit lower than historical. GWO also continues to employ a higher proportion of innovative/hybrid capital instruments which keep its adjusted debt ratio (giving equity treatment to certain capital instruments) relatively low. The Company is actively retiring capital instruments issued at its operating companies in order to have a higher proportion of capital issuance at the holding company level which will serve to reduce its double leverage ratio. In short, DBRS considers the Company’s financial leverage and capital position to be consistent with the current rating category as long as it continues to operate conservatively. However, financial flexibility is limited at this rating category.

As an integral component of the Power Financial group of companies, GWO benefits from its parent’s financial support and its strong governance and risk management controls and procedures, which reinforce the conservative bottom-line focus of the Company.

Note:
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.