DBRS Confirms Ratings of Industrial Alliance Insurance and Financial Services Inc.; FSR at A (high)

DBRS Limited (DBRS) confirmed the Issuer Rating and Financial Strength Rating of Industrial Alliance Insurance and Financial Services Inc. (IAG or the Company) at A (high), its Subordinated Debentures rating at “A” and its Non-Cumulative Preferred Shares rating at Pfd-2 (high). All trends are Stable.

IAG is the fourth-largest life insurance organization in Canada based on 2016 direct premiums. It offers a broad suite of life and group insurance and wealth management products, including annuities, segregated funds and mutual funds. The Company has good franchise strength, which is evident in its good market positions in several product segments as well as in its operations in several niche market segments, including a home and auto insurance operation targeting the provincial Québec market and a growing Dealer Services business (providing insurance and financing for car loans). The Company continues to increase its diversification by product and expand existing distribution channels, such as mutual fund dealers and securities brokerages. IAG’s August 2017 acquisition of HollisWealth, a financial advisory firm with $33 billion in assets and 800 advisors, serves the twofold purpose of diversifying away from capital-intensive products and strengthening its distribution network. The September 2017 agreement to acquire Dealers Assurance Company, a U.S.-based manufacturer and distributor of extended warranties, will be the Company’s first foray into the extended vehicle warranty business in the United States and is expected to increase the scale of the Company’s warranty business by more than 200%.

As a comparatively smaller player in an industry that is dominated by the three largest insurers, which capture almost 60% of the 2016 total Canadian direct written premium market, IAG faces some risk of market erosion by competitors that are better able to leverage their scale to achieve lower unit costs and achieve profitable growth. IAG has generally been able to maintain its competitiveness, reporting stable earnings in its individual insurance and wealth management businesses for YTD 2017. The Company also experienced an improvement in net flows from the prior year in its mutual fund business and an improvement in Employee Plans sales. IAG demonstrated strong segregated fund sales in 2017, where it is focusing on selling less risky products with lower guarantees, even as this business line is seeing some fee pressure.

The Company’s good risk profile reflects its changing product mix and thorough risk management. IAG has higher interest rate exposure than its peers because its product mix is more heavily weighted toward products with long-term guarantees. Management is focusing on reducing interest rate exposure -- one of the key risks faced by IAG through its large existing block of universal life products -- particularly in light of the additional volatility in capital and earnings that is expected to result from the implementation of the new regulatory capital regime (effective January 2018) and from IFRS 17 in 2021. IAG is attempting to shift its sales mix to sell fewer products offering long-term guarantees, which, along with pricing actions, has served to materially reduce its new business strain in the past two years. Nonetheless, IAG is materially exposed to any adverse movements in interest rates and equity markets, as well as adverse policyholder behaviour, although these risks are managed in a prudent manner through conservative reserving methods, liquidity and asset-liability management as well as through hedging techniques. IAG’s conservative risk management is reflected in its strong capitalization, which is illustrated by its low financial leverage ratio of 22.8% at Q3 2017; the continual improvement in its EBIT fixed-charge coverage ratio to 8.6 times (x) at 9M 2017, compared with 7.7x at 9M 2016 and 6.8x at 9M 2015; and a strong solvency ratio of 213% at Q3 2017, although this ratio is expected to decline as a result of recent acquisitions.

DBRS’s assessment of IAG is positively affected by the Company’s good earnings ability. IAG’s return on equity has generally been in the 10.0% to 13.0% range for most of the last five years (11.4% for YTD 2017), in line with its target range of 11.0% to 12.5%. Despite the current sustained low-interest environment, IAG has demonstrated resilience in earnings, combined with lower income volatility than most peers. IAG’s focus on further strengthening its distribution networks, as demonstrated by its acquisition of HollisWealth in 2017, proactive pricing decisions and good claims management, has allowed it to maintain strong earnings.

The Stable trends on IAG’s credit ratings take into account the Company’s good financial metrics, comprehensive risk management and strong capital levels.

RATING DRIVERS

Negative ratings pressure could arise from a sustained erosion in market share in key lines of business, indicating a significant weakening of the franchise, an inability to mitigate adverse impact of lower interest rates, equity market declines or adverse policyholder behaviour, or from acquisitions of risky businesses. Positive pressure on IAG’s ratings could emerge from substantial, successful growth and diversification of earnings in stable businesses, a material reduction in its exposure to interest rate and stock market value fluctuations combined with significantly stronger earnings, financial flexibility and capital levels, or a significant, sustainable increase in market share in its main business lines.

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 on the issuer page at www.dbrs.com.

The applicable methodologies are Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (December 2016) and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2017), which can be found on our website under Methodologies.

Lead Analyst: Stewart McIlwraith, Senior Vice President, Head of Insurance - Global FIG

Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com.