DBRS Confirms Ratings of Industrial Alliance and Affiliate

DBRS has today confirmed the ratings of Industrial Alliance Insurance and Financial Services Inc. (IAG or the Company) and its related entity, including IAG’s Claims Paying Ability at IC-2. All the trends are Stable. The ratings reflect the Company’s success in remaining profitable while growing its life insurance and wealth management franchises across the Canadian market through selective acquisitions. The Company’s market position is complemented by a conservative risk culture, which has limited the Company’s earnings exposure to equity and credit market volatility through the recent financial crisis while positioning it for sustainable growth.

Over the past few years, the Company’s capitalization has become a bit more aggressive, bringing the total debt ratio (including preferred shares) in line with that of the Canadian life insurance industry at 31.3% as of March 31, 2011. Even though the Company has restored normal profitability, the increase in financial leverage has caused the Company’s fixed-charge coverage ratios to fall in recent years. By both measures, however, financial leverage is acceptable for the assigned ratings. The Company’s regulatory solvency ratio (similar to the Minimum Continuing Capital and Surplus Requirements (MCCSR) ratio set by the Office of the Superintendent of Financial Institutions (OSFI)) is prudent at 196% at March 31, 2011, down slightly from 202% at year-end 2010, following the Company’s transition to International Financial Reporting Standards (IFRS), the recent auto dealer credit insurance acquisitions and the higher equity backing of its general accounts, which increased the Company’s capital requirement. Nevertheless, regulatory capital is within the Company’s target of 175% to 200%, which is prudent given the Company’s conservative risk profile.

Strategically, the Company is challenged to achieve growth as a mid-sized competitor in a relatively concentrated market where competitive scale is critical. The three largest Canadian life insurance companies control between 60% and 70% of the market in most product lines, forcing IAG to distinguish itself in very specific market niches, where it can exercise a competitive advantage while also pursuing the goal of growth and diversification. The Company has been focused on broadening its product exposure in the Canadian financial services market to include a larger proportion of wealth management products and enhancing its geographic diversification to include the United States and the non-Québec Canadian market. A conscious decision to pursue a multichannel distribution strategy has facilitated this diversification strategy, with a career sales force serving Québec and independent brokers and managing general agents (MGAs) serving the balance of the Company’s markets. Nevertheless, the Company remains disproportionately exposed to the Canadian market and to universal life insurance specifically, which represented 54% of its individual life insurance sales in 2010. Universal life is in turn more highly exposed to interest rate and equity market risks. An alternative insurance policy offering that shares more of the associated risks with the policyholder would address some of this concern. In group lines, the Company must continue to enhance its administrative service platforms to ensure that it is in line with the technical capabilities of the “big three.” With less geographic and product diversification than its largest competitors, IAG is more vulnerable to competitive pricing pressures, which could potentially erode its share of the market and undermine its profitability in these segments.

The Company balances its market vulnerability with a more conservative risk tolerance. For example, IAG’s product design and actuarial assumptions with respect to mortality, reinvestment rates and equity market returns are sufficiently conservative that there is a large cushion available to protect Company earnings in the event of adverse market experience, as seen in the 2008–2009 financial crisis, when the Company came through better than most of its competitors. To mitigate its exposure to low interest rates, the Company has increased the portion of equities backing its liabilities, albeit assuming a higher capital charge as a result. The Company retains a higher proportion of mortality risk than its peers rather than reinsuring it since it is confident that the long-term improvement in mortality will ultimately accrue to the Company’s benefit given the Company’s relative exposure to individual life insurance liabilities. Investment policies are similarly conservative in order to minimize the Company’s capital charge and market exposures.

On balance, the Company has achieved a sustainable business model, couched in actuarial conservatism, that will cushion its earnings in the event of adverse market experience. The Company’s improving diversification of revenues and income across both product lines and geographical markets has helped it return to attractive levels of profitability before many of its larger competitors. Nevertheless, it is also vulnerable to competition from larger and more diversified competitors that would conceivably have more staying power in an adverse market or competitive environment.

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.