DBRS Morningstar Upgrades iA Financial Corp. to “A” and Industrial Alliance Insurance and Financial Services to AA (low); Stable Trends

DBRS Limited (DBRS Morningstar) upgraded the Issuer Rating of iA Financial Corporation Inc. (iA or the Company) to “A” from A (low) and the rating on iA’s Subordinated Debentures to A (low) from BBB (high). For Industrial Alliance Insurance and Financial Services Inc., iA’s major insurance operating subsidiary, DBRS Morningstar upgraded the Issuer Rating and Financial Strength Rating (FSR) to AA (low) from A (high), the Subordinated Debentures rating to A (high) from “A,” and the Non-Cumulative Preferred Shares rating to Pfd-1 (low) from Pfd-2 (high). DBRS Morningstar also removed the ratings from Under Review with Positive Implications, where they were placed on December 10, 2020. All trends are Stable.

KEY RATING CONSIDERATIONS
The rating upgrades reflect the significant efforts made by iA in the past few years in improving its risk profile, in particular its sensitivities to market-related risks. Indeed, the Company has materially reduced its sensitivities to interest rate movements, an important consideration given the relatively large proportion of individual insurance products in the Company’s product portfolio and the sustained low interest rate environment that continues to put pressure on life insurers. Exposure to equity market movements has also declined, with the Company continuing to refine its hedging programs, keeping a minimal amount of public equities in its investment portfolio, and using derivatives to manage net income volatility. The Company has also experienced some success in shifting its product portfolio toward less capital-intensive products, reducing the level of guarantees offered and increasing its proportion of fee-based businesses.

The FSR of AA (low) and Stable trend reflect the Company’s strong market position in Canada (iA is the fourth-largest life insurer by gross premiums written), particularly in individual insurance and in segregated funds, where it continues to generate good sales and profitability. The Company’s extensive franchise in Canada is supported by a comprehensive and growing distribution network, including both exclusive and independent agents, among other channels. Investments in distribution and digital technology have allowed the Company to maintain a trajectory of strong sales and good profitability during 2020 despite instances of market volatility and a weak economic environment. Also supportive of the ratings, iA maintains a conservative, high-quality investment portfolio. Moreover, the Company’s relatively low leverage ratio of 24.8% and high EBIT fixed-charge coverage ratio of 8.0 times as at YE2020 lends good financial flexibility and positions the Company well in terms of being able to realize its growth initiatives. The ratings also consider iA’s still sizable exposure (although reduced from historical levels) to adverse policyholder behaviour and equity markets resulting from its large individual life insurance and segregated funds portfolio, making the maintenance of an adequate regulatory capital buffer key to maintaining the ratings.

RATING DRIVERS
Further positive rating actions are unlikely in the near term, given the recent rating upgrade. In the longer term, a rating upgrade would occur from sustainable increases in market share in key business lines while maintaining a prudent risk profile. Further reduction in the Company’s exposure to the market risks arising from its large individual insurance and segregated funds portfolio, combined with capital levels that provide a larger buffer to deal with adverse scenarios, would also result in a ratings upgrade.

Conversely, a material decline in capital levels to be closer to regulatory minimums, providing limited protection against market volatility, would result in a ratings downgrade. Ratings would also be downgraded if there is a sustained erosion in market share in key lines of businesses, indicating a significant weakening of the franchise or from increased volatility in earnings resulting from macroeconomic movements or adverse policyholder behavior.

RATING RATIONALE
iA’s operations are well diversified by business line, with sizable operations in individual insurance and in wealth management complemented by a smaller presence in group insurance and group pension. The Company has a strong market presence in the family market, with a leading market position in terms of number of life insurance policies sold, even as the face amounts of the policies are generally smaller. The Company is a strong competitor in the segregated funds space, consistently generating positive net sales. iA also participates in several niche segments, including personal property and auto insurance in Québec, the dealer services space in Canada and the U.S., and travel insurance, among others. The Company has historically operated primarily in Canada, with only a small life insurance segment in the U.S., but has expanded geographically in the U.S. in recent years with the acquisitions of two U.S.-based dealer services companies.

iA’s ratings benefit from its stable earnings metrics. The Company continued to generate strong sales growth and good earnings in nearly all business lines in 2020, with the exception of lower sales in its travel-related business. Earnings were negatively affected by market volatility in Q1 2020 but improved for the remainder of the year as market conditions improved. The Company also had some adverse mortality experience related to the Coronavirus Disease (COVID-19) pandemic, particularly in its U.S. insurance business. Nonetheless, all major lines of business, including individual life and disability insurance, and segregated funds, remained profitable despite the pandemic. Profitability in the auto and home business and some areas of group insurance (such as health and dental benefits) benefitted from lower claims. Meanwhile, mutual fund net flows improved in 2020 relative to prior years, partially as a result of stronger sales from affiliated distribution channels, even as the operating environment continued to face multiple headwinds, including fee pressure and a movement toward lower-cost, passive funds. To maintain strong revenues, iA is continuing to strengthen its distribution networks, both by investments in digital tools and technology for brokers as well as by increasing scale through acquisitions. The Company’s earnings have historically benefitted from the diversity of business lines and products offered. Earnings may become further diversified as the Company continues to make progress expanding into the U.S. dealer services space. Some operational risk remains because of the size of recent acquisitions in this area, including that of IAS Parent Holdings, Inc. in late 2019 for USD 720 million, the largest acquisition in iA’s history.

The Company has taken multiple steps in recent years to reduce its market-related exposures, which was the primary driver of the ratings upgrade. Specifically, the Company’s exposure to adverse movements in equity markets has declined, with iA taking steps to further reduce this exposure through hedging programs and changes to its investment portfolio. The Company has also received hedging credit from the Autorité des marchés financiers (the Québec regulator) for its segregated fund portfolio, which helps reduce the amount of required capital for this block of business. DBRS Morningstar is cognizant of the Company’s proactive approach in managing its market-related risks, given the Company’s portfolio of long-dated liabilities, even as there is a potential loss of some of the benefits of a rising rate environment or positive equity markets on earnings should these occur. The Company has also made good progress in shifting its sales mix to reduce the proportion of products sold offering long-term or high guarantees, which, along with pricing actions, has served to materially reduce its new business strain compared with historical levels. The Company’s risk management is thorough and iA has demonstrated pricing and operational discipline over the years.

The continued presence of adequate capital above regulatory minimums is key to maintaining the ratings, especially considering that at 130% at YE2020, the Company’s solvency capital ratio is slightly lower than peers. The sensitivity of the regulatory solvency ratio to market-related movements, particularly to changes in interest rates, has materially reduced in the past few years, both as a result of company actions as well as the implementation of the Capital Adequacy Requirements Guideline (CARLI)—Insurance of Persons regulatory regime in January 2018. The CARLI capital regime is inherently less volatile than the prior guideline. Management has also stated that it maintains additional protection against adverse equity market movements in the way it determines its reserves, further reducing the volatility of the ratio. The Company’s capital profile is enhanced by its relatively low leverage as well as strong organic capital generation.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

The Grid Summary Grades for iA are as follows: Franchise Strength – Strong/Good; Risk Profile – Strong/Good; Earnings Ability – Strong/Good; Liquidity – Strong; Capitalization and Asset Quality – Strong/Good.

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

The principal methodology is the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (July 21, 2020; https://www.dbrsmorningstar.com/research/364260/global-methodology-for-rating-life-and-pc-insurance-companies-and-insurance-organizations). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.com.

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577