DBRS Confirms Ratings of Sun Life Financial Inc. at “A” and Sun Life Assurance at AA (low), Stable

DBRS, Inc. (DBRS) confirmed Sun Life Financial Inc.’s (SLF or the Company) Issuer Rating and Senior Unsecured Debentures rating at “A” as well as its Subordinated Unsecured Debentures rating at A (low) and Preferred Shares rating at Pfd-2. DBRS also confirmed Sun Life Assurance Company of Canada’s (Sun Life Assurance or SLA) Financial Strength Rating and Issuer Rating at AA (low) as well as its Subordinated Debt rating at A (high). At the same time, DBRS confirmed Sun Life Capital Trust’s SLEECS Series B rating and Sun Life Capital Trust II’s SLEECS Series 2009-1 rating at “A.” All trends are Stable.

KEY RATING CONSIDERATIONS
SLF has maintained its excellent franchise strength with operations that are well diversified by product, geography and distribution channel. The Company is the second-largest Canadian life insurer based on gross written premiums with a 20% market share. SLF has good business diversification through operations in the United States, Asia and its asset management businesses. Regulatory capital at the Company is well above the required Life Insurance Capital Adequacy Test (LICAT) ratio at 145% as of Q3 2018, which provides an ample cushion to deal with a stressed scenario. Earnings have also remained solid and well diversified across its four core business segments. The Company also benefits from a comprehensive and well-developed risk management framework as well as excellent liquidity to deal with potential cash demands. The ratings also incorporate ongoing risks pertaining to managing policy lapse and market risk arising from SLF’s legacy blocks of business and product guarantees, as well as asset risk in the Company’s high proportion of BBB-rated bonds and corporate loans in the bond portfolio. In addition, the ratings take into account the operational and geopolitical risk from SLF’s operations in multiple jurisdictions. The Stable trends consider the Company’s resilient fundamentals and its ability to adapt to the current challenging economic environment.

RATING DRIVERS
DBRS views SLF as well placed in its current rating category and sees the potential for positive rating action as limited in the near term; however, positive ratings pressure may arise from (1) significant progress in strengthening SLF’s franchise by enhancing its market position in Asia and the United States while managing product and operational risk arising from operating in multiple jurisdictions with varying degrees of geopolitical risk; (2) continued success in managing policy lapse and market risk arising from product guarantees and legacy blocks of businesses; and (3) improved asset quality, including a reduction in the proportion of BBB-rated bonds and corporate loans as a percentage of its total bond portfolio.

Negative ratings pressure could arise with (1) deterioration in the Canadian franchise strength or a sustained decline in this segment’s profitability; (2) a material decline in SLF’s regulatory capital ratio caused by an adverse credit event or reserve strengthening; (3) significant cash flow declines from the Company’s asset management segment and; (4) a sustained increase in financial leverage above 30% and a decline in fixed-charge coverage ratios below 7.0 times (x).

RATING RATIONALE
The Company’s large insurance and asset management businesses provide strong and consistent revenue generation and earnings. Management operates a four-pillar strategy focusing on Canada, the United States, Asia and Asset Management. SLF aims to grow each of these segments and leverage its advantages in markets where it has a leading market position. The U.S. asset management subsidiary, Massachusetts Financial Services (MFS), has $626 billion in assets under management as at Q3 2018. MFS has achieved good fund performance and fee income has been level despite net outflows and pricing pressures. The operating environment for mutual fund managers remains challenging as money continues to flow into passive funds from active funds in pursuit of lower fees.

SLF Asia has delivered robust growth in insurance and wealth solution sales over the last two years. The Company is focusing on strengthening its distribution capabilities in Asia where it operates in seven countries. This geographical segment presents an opportunity for higher growth and potentially significant product sales, especially considering North America’s mature and well-saturated insurance markets. Net income in SLF’s Asia market segment is expected to represent about 15% to 20% of total net income in the near term. While DBRS views the Company’s business and earnings diversification as a positive for the rating, DBRS also recognizes that SLF is exposed to geopolitical risk through its operation in multiple jurisdictions outside North America.

The Company has a comprehensive and well-developed enterprise risk management framework that ensures that risks are well understood and controlled across its businesses. This framework guides product development and review. SLF aims to deploy its capital in areas that are aligned with its strategy of growing business lines that are generally less capital intensive and less exposed to market risk than previous product designs. The Company faces residual risks as a result of its sizable legacy businesses with runoff blocks of life insurance businesses in the United States and the United Kingdom. The U.S. legacy block had reserve strengthening in Q3 2018 while the U.K. block is currently profitable. SLF’s investment portfolio has generally been balanced across asset classes, except for a somewhat elevated exposure to BBB-rated bonds and corporate loans in its bond portfolio. The Company’s extensive hedging programs help to mitigate most of the volatility in earnings and regulatory ratios that may arise from adverse movements in equity markets or interest rates.

DBRS views SLF as having excellent earnings ability with well-diversified earnings across all four business segments. SLF Canada and SLF Asset Management are expected to remain the larger profit contributors in the near term, each generating about one-third of common shareholders' net income. The Asia and U.S. businesses each contributes about 15% to 20% of net income, but DBRS expects this contribution to grow over the medium term under the Company’s current strategy. SLF generates a good overall return on equity (ROE) with a three-year average of 12% and 11% for FY 2017. The Company continues to experience some earnings volatility from its U.S. life runoff block and new business development in SLF Asia.

SLF is considered to have excellent liquidity, maintaining ample liquid assets to deal with potential cash demands. The Company’s investment portfolio comprises a high proportion of marketable bonds and equities with about 60% of its investment portfolio in cash, public bonds or equities. Cash on hand of $2.7 billion as of Q3 2018 at the holding-company level and standby credit facilities, is adequate to meet financial obligations under reasonably adverse stress scenarios. SLF has only a limited proportion of non-liquid assets in its investment portfolio.

DBRS views the Company’s capital position as good. SLF maintains high Canadian regulatory capital levels at the consolidated holding-company level with a LICAT ratio of 145% as of Q3 2018, which is well above the required level of regulatory capital and provides ample cushion to deal with a stressed scenario. Regulatory capital of the Company’s major operating subsidiary, SLA, continues to be conservative with a LICAT ratio of 130% as of Q3 2018. DBRS expects that SLA will continue to meet or exceed a LICAT supervisory ratio of 100% and regulatory minimum of 90%. Its financial leverage remains conservative at 23.6% with a fixed-charge coverage ratio of 8.4x for FY2017.

The Grid Summary Scores for SLF are as follows: Franchise Strength – Excellent; Risk Profile – Good; Earnings Ability – Excellent; Liquidity – Excellent; Capitalization and Asset Quality – Good.

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

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 (November 2018), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Hema Singh, Vice President, Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: February 8, 2005
Last Rating Date: December 13, 2017

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.