DBRS Returns Industrial Alliance Ratings Trend to Stable from Negative

DBRS Limited (DBRS) has today restored the Stable trend to the debt and preferred share ratings of Industrial Alliance Insurance and Financial Services Inc. (IAG or the Company), following the recently announced issue of $237 million in common equity, the proceeds of which are to be used to retire outstanding debt issues, including the Industrial Alliance Trust Securities (IATS) issue on December 31, 2013. The return to a Stable rating trend reflects DBRS’s comfort with the Company’s return to a reasonable level of leverage that no longer impairs financial flexibility, as well as its longer term earnings stability, despite a higher level of risk exposure to low interest rates than its industry peers.

On September 7, 2012, DBRS assigned a Negative trend following a period, beginning June 15, 2012, in which the Company’s ratings were Under Review with Negative Implications. At the time, DBRS was particularly concerned that the Company’s financial flexibility had been impaired by an increase in financial leverage, which had taken the Company’s total debt (including preferred shares) ratio to over 35% at year-end 2012 and reduced its fixed charge coverage ratios. The proceeds of recent capital issues have been used to add to the Company’s regulatory capital ratios, which ended the year at 217%, up from 189% a year ago.

On February 27, 2013, IAG closed a previously announced issue of common shares with total net proceeds of $237.4 million. The proceeds of the common equity issue are expected to be used to redeem certain debt issues, including the $150 million 8.25% subordinated debenture due March 27, 2019, which will be called as of April 1, 2013, and the $100 million IATS, which will be callable at par on December 31, 2013. The net impact of these transactions will be to restore financial leverage to a level which is more consistent with A-rated companies, as outlined in the DBRS methodology Rating Companies in the Canadian Life Insurance Industry. This common stock issue also addresses funding concerns about the Company’s $500 million in debt and preferred share refinancing, scheduled to occur before the end of June 2014. At December 31, 2012, financial leverage calculated as debt plus preferred shares as a proportion of total capitalization was 35.6%, making the Company one of the most aggressively capitalized insurance companies in the Canadian peer group. Pro forma the common equity issue and the proposed debt redemption, this ratio will drop sharply to 29.6%. Correspondingly, fixed charge coverage ratios are expected to strengthen. Following the recent common equity issue, DBRS feels that the financial flexibility of the Company has been satisfactorily restored.

Regulatory capital ratios ended the year at 217%, up from 189% the previous year. The sale of the U.S. annuity business added 12 points. A change to required capital respecting lapse risk, which disproportionately benefits IAG among its peers, will have increased the ratio to 230% as at January 1, 2013, a ratio which DBRS regards as very conservative. DBRS expects the Company to maintain its regulatory capital ratios in excess of 200% in the medium term. The Common equity issue will also have improved the quality of regulatory capital.

While DBRS is aware that the Company has mitigated much of its interest rate risk exposures through active reduction of its asset liability mismatch, interest rate exposure is greater than that of its peers. However, the Company remains among the most conservative of its peer group in its underlying interest rate assumptions, having sourced $120 million in offsetting earnings through management actions to afford a reduction in its assumed ultimate reinvestment rate (URR) to 3.2% from 3.4% during 2012. In order to better position the Company for profitable growth, including a large reduction in its reported new business strain, the Company successfully raised prices on its popular Universal Life products on two occasions in 2012 and continued to refine its product offerings to reduce market risk exposures. New business strain has correspondingly been reduced.

In the meantime, the Company performed very well in 2012, with strong individual insurance sales in Canada and the United States. Wealth management sales weakened, as the Company terminated sales of GMWB segregated funds. The non-traditional products and specialized business lines of the Company, including auto dealer solutions, special markets and general insurance, continue to sell well, justifying these favourable diversification initiatives. ROE was relatively strong at 12.6% and core fixed charge coverage ratios were 5.4 times, which is expected to increase to more than 6 times pro forma the announced debt retirement.

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 by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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

This rating is endorsed by DBRS Ratings Limited for use in the European Union.