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

DBRS Limited (DBRS) has today confirmed The Empire Life Insurance Company’s (Empire or the Company) Financial Strength Rating and Issuer Ratings 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.

The confirmation considers Empire’s good franchise strength as indicated by its success as a capable insurer in maintaining its market share of approximately 2% of industry direct premiums against its strong Canadian life insurance competitors. While smaller than other players, the Company has managed to maintain its market position, including in the competitive group business market where Empire does well in the less than 100 lives segment. Individual insurance sales were lower in 2016 than the prior year as the Company sold fewer universal life policies and focused instead on participating whole-life and term insurance. There is some uncertainty regarding how legislative changes concerning the tax treatment of life insurance, effective January 2017, will affect future individual insurance sales. Mutual fund sales were weak in 2016, although assets under management have grown consistently to reach $191 million in Q1 2017. Segregated fund net sales declined in 2016, although the decline in sales was offset by higher fee income.

Factored into the rating confirmation is Empire’s good earnings ability, which has shown resiliency with good return on equity (15.7% at Q1 2017). Financial leverage of 32.3% in Q1 2017 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 $149.5 million in preferred shares in February 2016 and $200.0 million of subordinated debt in December 2016. At 10.3 times earnings (Q1 2017), Empire’s fixed-charge coverage ratio is more than adequate. The Company has a conservative investment portfolio 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 oriented strategy is done in a cost-effective and innovative manner. Empire is focused on increasing process efficiencies throughout the organization and, as a result, is seeing some improvement in operating expenses. The Company is also focused on enhancing its distribution capabilities as it faces the headwinds of an aging sales force and increasing customer demands.

One of the Company’s primary risks arises from its sensitivity to interest rates and to equity markets in both its general funds and segregated fund portfolio. The segregated fund risk lies with maintaining regulatory capital ratios for its tail risks rather than an immediate cash need. The increased capitalization should stabilize the solvency ratio against equity market swings. Empire has taken actions to reduce risk within its product mix, including selling segregated funds with lower guarantee levels and higher fees, focusing on sales of less capital-intensive products and discontinuing sales of products that are no longer deemed to be profitable. Mortality and longevity risks are appropriately reserved for and there is a sizable, yet manageable amount of policyholder behaviour-related risk.

RATING DRIVERS
The Stable trend considers Empire’s resilient fundamentals and its ability to adapt to the current environment. If the Company’s fundamentals weaken because of a sustained erosion of earnings or if it is unable to maintain a sufficient coverage for its minimum continuing capital and surplus requirement to endure a severe equity market decline, the ratings could be pressured. Ratings may also be negatively pressured if Empire loses significant market share or experiences distribution losses. Positive ratings pressure could arise if the Company achieves a significant gain in distribution and market share, accompanied by reduced exposure to interest rate and equity market movements, a sustained improvement in profitability and a materially positive trend in life insurance sales.

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 principal 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 2016), which can be found on dbrs.com 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. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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