DBRS Confirms Ratings on The Empire Life Insurance Company, FSR at “A,” Stable

DBRS Limited (DBRS) confirmed The Empire Life Insurance Company’s (Empire or the Company) Financial Strength Rating and Issuer Rating at “A,” as well as its Subordinated Debt rating at A (low). The Preferred Shares rating has also been confirmed at Pfd-2. All trends are Stable.

KEY RATING CONSIDERATIONS
The confirmation of Empire’s ratings reflects the Company’s position as a consistently performing life insurer with a proven track record of generating stable earnings while maintaining a conservative risk profile. The Company is a smaller player in the largely consolidated Canadian life insurance industry, maintaining a market share of approximately 2% of industry direct premiums compared with its strong competitors. The Company’s strengths lie in its prudent risk management, high regulatory capital ratios and excellent liquidity. The Company has experienced some deterioration in its leverage and fixed-charge coverage ratios during the last quarter. However, these metrics are expected to improve as the Company executes its planned redemption of $300 million of subordinated debt at the end of May 2018. Market-related exposures are significant, considering the Company’s large block of individual life insurance. Countering the exposure to market risks is Empire’s strong Life Insurance Capital Adequacy Test (LICAT) ratio (177.5% as of Q1 2018), which provides a solid capital cushion that should serve to mitigate risks that may arise from adverse movements in equity markets and interest rates.

RATING DRIVERS
The Stable trends consider Empire’s resilient fundamentals and its ability to adapt to its current operating environment. The ratings are well placed within their rating categories with upward pressure unlikely in the near to medium term. During the longer term, the demonstration of sustained growth in individual and group life insurance sales while maintaining a prudent risk profile could result in upward rating pressure. Conversely, ratings may be negatively pressured if the Company experiences a loss of distribution accompanied by eroding earnings and market share. Deterioration in the leverage and coverage ratios to a level below that supported by the existing rating category would also create downward rating pressure.

RATING RATIONALE
Empire has managed to maintain its market position, including in the competitive group business market, where it does well in the small group (fewer than 200 employees) segment. The Company benefited from good claims experience in 2017, resulting in an increase in profitability, primarily as a result of actions taken to reprice its block of business in order to improve margins. Individual insurance sales were lower in 2017 than the prior year, partially as a result of the Company’s decision to stop selling Universal Life policies and to instead focus on participating whole life and term insurance. Mutual fund sales were weak in 2017, and assets under management (AUM) declined to $172.1 million from $191.0 million in Q1 2017. The Company’s mutual fund business faces many of the headwinds facing the asset management industry and, as such, has struggled to grow to a significant size since it was launched in 2012. Segregated fund net sales have declined following the launch of the new version of the Company’s Guaranteed Minimum Withdrawal Benefit in October 2017, even as the decline in sales was offset by higher fee income and an increase in segregated fund AUM. Empire has been successful in growing its market share (by AUM) in the segregated fund space.

Factored into the ratings confirmation is Empire’s good earnings ability, which has shown resiliency with good return on equity values (10.8% as of Q1 2018). Financial leverage, at 38.9% in Q1 2018, has increased from historical levels, as the Company increased its capitalization levels to provide an additional buffer in the case of adverse equity market and interest rate movements. The additional capital has been raised through the issuance of a combination of preferred shares and subordinated debt. At 5.6 times (x) earnings as of Q1 2018 (three-year average of 11.4x earnings), the Company’s fixed-charge coverage ratio is lower than usual but expected to improve as the Company goes through its planned debt redemption. Empire has a conservative investment portfolio comprising primarily of fixed income assets (77.4% of invested assets as of Q1 2018) and a negligible amount of intangibles on its balance sheet.

Empire benefits from a well-articulated strategy, conservative management and a supportive primary shareholder. The Company is currently focusing on achieving organic growth by targeting streamlined insurance and wealth products toward the middle-income Canadian market. Empire has demonstrated expertise in developing digital capabilities to serve both advisors and clients. The Company’s use of technology to further its customer-centric strategy is done in a cost-effective and innovative manner. The Company is also focused on enhancing its distribution capabilities and maintaining access to advisors amid the acquisition of independent MGAs by carriers.

One of the Company’s primary risks arises from its sensitivity to interest rates and to equity markets in both its general fund and segregated fund portfolios. While the sensitivity of regulatory capital ratios to adverse movements in interest rates appears to have significantly declined under LICAT, the Company has significant exposure to equity market risk from its segregated fund portfolio. However, the segregated fund risk lies with maintaining regulatory capital ratios for its tail risks rather than an immediate cash need. The Company’s increase in capitalization and the resultant high LICAT ratio should allow it to maintain adequate solvency ratio levels against equity market swings. Empire has taken actions to reduce risk within its product mix, including selling segregated funds with less generous guarantees, focusing on sales of less capital-intensive products and discontinuing sales of products no longer deemed profitable. Mortality and longevity risks are appropriately reserved for, and there is a sizable, yet manageable, amount of policyholder-behaviour-related risk.

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 (January 2018) 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: Komal Rizvi, Assistant Vice President - 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.