DBRS Confirms Great-West Lifeco at AA (low)

DBRS has today confirmed the ratings of Great-West Lifeco (GWO or the Company) and its affiliated operating subsidiaries, including GWO’s Senior Debentures at AA (low); all the trends are Stable. The Company has come through the financial crisis in better shape than many of its peers owing to its conservative diversified products, distribution channels and geographies. Underwriting disciplines allowed the Company to avoid the substantial adverse reserve development experienced by many of its competitors in the industry in connection with the Guaranteed Minimum Withdrawal Benefit (GMWB) product. The Company’s asset portfolio was relatively unmarred by credit losses and writedowns, reflecting a more conservative investment posture than that of the industry.

The most negative development for the Company in 2008 was the write-off of more than $2 billion in goodwill and customer contract values that had been assigned following the $4.3 billion acquisition of Putnam Investments, LLC (Putnam) in 2007, which resulted in a $1.3 billion after-tax charge to income in 2008, albeit offset somewhat by the $649 million net gain from the sale of the now-discontinued U.S. health-care business. Excluding these two items, DBRS calculates that the adjusted return on equity for the Company in 2008 remained at a healthy 19.5%, falling to just less than 13% in the first half of 2009 as a result of lower fee income earned on a 13.2% reduction in average fee-earning assets under management (AUM) and a $1 billion increase in shareholder equity as a result of a new $1 billion issue in late 2008. In the face of slowing business growth and reduced fund sales, the Company and its subsidiaries continue to be focused on expense reductions and maximizing operational efficiency.

The existing ratings for the Company and its operating subsidiaries reflect the contribution from a diversified portfolio of businesses, including leading market shares across the Canadian insurance industry and attractive market niches in Europe, in the U.S. financial services market and in reinsurance. While DBRS believes that the market for retail financial services is likely to continue to evolve with lower-cost direct investment options for retail investors, there is still a growing market for the advice-driven channel the Company targets, which is supported by demographics and the legitimate concerns on the part of retail investors, who want to protect their beneficiaries and not outlive their assets. Notwithstanding the recent writedowns, Putnam has a good platform for long-term growth in AUM, given its brand, its entrenched distribution network of independent financial advisors and its growing presence in the institutional market. The new management team at Putnam is expected to turn around the net sales performance through a greater focus on investment fund performance and the introduction of attractive new products. Even though DBRS believes that the acquisition of Putnam was largely a strategic decision taken to benefit Power Financial Corporation, which controls 70% of the Company, rather than GWO directly, it remains confident that the Putnam acquisition has a better strategic fit and is more complementary to the Company’s chosen strategy than the U.S. health-care platform.

While GWO may in fact be one of the more conservative life insurance companies in terms of operating risk profile, it remains one of the more aggressively capitalized, with significant debt and preferred shares outstanding at both the operating company and the holding company levels. The consolidated total debt-to-capitalization ratio remains relatively high at 33.6%, albeit reduced from 41.2% at year-end 2007 as half of the $1.6 billion proceeds from the sale of the U.S. health-care business in 2008 was used to pay down the Putnam acquisition debt. In late 2008, the Company also raised more than $1 billion in common equity to maintain its debt ratio at the improved level following the writedown of the Putnam investment. Double leverage remains relatively pronounced at 124%, down from year-end 2007 level of 143%. At the end of June 2009, financial leverage in the form of innovative and hybrid capital instruments represented 27% of common equity, well above the ratio employed by its peer group. These instruments earn a certain level of equity treatment in the DBRS calculation of the adjusted debt ratio, which has fallen to 16.7% from 25.6% at year-end 2007.

Since the Company appears comfortable with its current financial leverage and there is no need to inject capital into its operating subsidiaries, the proceeds of the 2008 common share issue and the two most recent preferred share issues, totalling close to $1.4 billion, are being largely held in liquid investments at the holding company, which will be a ready source of regulatory capital and debt repayment if required. Notwithstanding the recent reduction in financial leverage, the relatively aggressive capital structure following both the Canada Life Financial Corporation acquisition in 2003 and the Putnam acquisition in 2007, in combination with weaker fee income and high cash balances at the holding company, has caused the Company’s normalized fixed-charge coverage to fall below 6.0 times from a level of closer to 10.0 times prior to the Putnam acquisition. While debt service coverage remains adequate, the Company may be close to the limit of its access to incremental debt and hybrid capital at the current rating levels, at least until it chooses to deploy its cash balances more effectively.
As an integral component of the Power Financial Corporation group of companies, GWO benefits from its parent’s financial support and its strong governance and risk management controls and procedures, which reinforce the conservative bottom-line focus of the Company.

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

The applicable methodology is Rating Canadian Life Insurance Companies, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.