DBRS Places Industrial Alliance Insurance and Financial Services Inc.’s Ratings Under Review with Negative Implications

DBRS has today placed the Subordinated Debt and Preferred Shares ratings of Industrial Alliance Insurance and Financial Services Inc. (IAG or the Company) Under Review with Negative Implications. The Industrial Alliance Trust Securities (IATS) rating of Industrial Alliance Capital Trust has also been placed Under Review with Negative Implications. IAG’s Claims Paying Rating of IC-2 is not affected by this rating action.

Following the DBRS annual review meetings with IAG management and certain disclosures included in the Company’s Investor Day (June 12, 2012) presentation, DBRS remains concerned that the Company’s exposure to the current low interest rate environment has impaired its financial flexibility at the current rating categories.

The Company’s total debt ratio has increased to 36.6% pro forma the $150 million preferred share issue completed in May 2012, which is above the range established by the DBRS rating methodology for the life insurance industry at the current rating category. Beyond our concerns for the Company’s financial leverage, DBRS observes that the Company continues to have higher-than-average exposures to interest rates by virtue of the relatively large exposure to long-duration life insurance liabilities with embedded interest rate guarantees that are more challenging to meet in the current rate environment.

While the Company is reducing some of its exposure to interest rate risk in the short run through more efficient asset liability matching and forward interest rate locks, and in the longer term through price increases and product redesign, the Company has also suggested that if rates do not increase before year-end 2012, it is likely going to have to take an estimated $120 million charge on account of lower ultimate reinvestment rate assumptions. The Company’s priority is to offset this adverse development with additional one-time earning gains while it waits for a more sustainable interest rate environment.

In the meantime, the Company is operating at a lower Solvency Ratio (the AMF’s MCCSR equivalent) of approximately 186% (March 31, 2012), which, while below the industry average of over 200%, factors in the Company’s inherent conservatism that is estimated to depress the ratio by close to 15 points. Nevertheless, the nine points gained by the addition of $150 million of preferred shares in May was more than absorbed by adverse market developments in April and May, which suggests that the Company and its regulatory capital ratio remain quite vulnerable to exogenous market forces.

With little demonstrable financial flexibility at the current rating category in terms of debt or preferred share capacity and the prospects of continued earnings and market volatility, which has a direct impact on regulatory capital ratios, the Company warrants the Under Review-Negative status at this time. DBRS expects to complete its review of the Company within the next two months.

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

The applicable methodology is Rating Companies in the Canadian Life Insurance Industry (March 2011), which can be found on our website under Methodologies