DBRS Morningstar Upgrades Sun Life Financial Inc. to A (high) and Sun Life Assurance to AA

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

KEY RATING CONSIDERATIONS
The ratings upgrade recognizes the Company’s improved franchise strength, the increasing diversification of earnings across its four core business segments and its excellent capitalization. Furthermore, DBRS Morningstar has gained comfort from management’s actions over the past year to turn around the performance of SLF’s legacy U.S. individual life block that is in run-off, including the reserve strengthening, which should reduce the probability of the block adversely impacting results. The ratings also consider the Company’s exposure to operational risk arising from operating in multiple jurisdictions with varying degrees of geopolitical risk in Asia, as well as its guaranteed products in Canada that can result in profit volatility. Also a ratings constraint is SLF’s higher proportion of mortgages, BBB-rated bonds and corporate loans in the Company’s investment portfolio relative to those of similarly rated peers.

RATING DRIVERS
Positive ratings pressure could arise from continued progress with SLF’s business diversification strategy, as well as an improvement in asset quality, including having a higher proportion of higher-rated bonds in its investment portfolio.

Negative ratings pressure could arise if the Canadian business, a strong contributor to overall results, were to report a sustained decline in earnings indicating a weakened franchise. Moreover, an adverse event that causes regulatory capital to decline substantially or a sustained deterioration in financial leverage over 30% could also have negative rating implications.

RATING RATIONALE
SLF is a leading financial services company with extensive operations in Canada, the United States and multiple countries in Asia. Supportive of the ratings, SLF is one of the top three dominant life insurers in the Canadian life insurance market. Overall, the Company has positive brand recognition, a diversified business model both by product and geography, while having strong product distribution capabilities. SLF continues to make good progress in realizing benefits from its four-pillar strategy. Specifically, SLF remains focused on further building out its market-leading positions in Canada, growing the Company’s market presence in several segments of the U.S. employee benefits market, expanding in Asia and growing its already substantial asset management businesses organically or through acquisitions.

The ratings also benefit from the Company's comprehensive and well-developed risk management framework that encompasses its diverse businesses, operations in multiple countries and investment risks, which ensure that risks are well understood and mitigated. 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 United States legacy block had reserve strengthening in the last two years, which in DBRS Morningstar’s view could significantly reduce the probability that this block will adversely impact results going forward. Meanwhile, 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, which is partly mitigated by the Company’s strong credit risk management approach to its privately placed bond holdings. The investment portfolio is delivering good investment yields that have contributed to SLF's strong and stable earnings performance in the last several years and impairments remain low. 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.

Positively, the Company has made progress with the diversification of its four-pillar enterprise strategy. SLF’s asset management segment is now generating about 30% of common shareholders' net income and is an important component in diversifying SLF’s earnings in non-insurance business. At Q2 2019, total assets under management and administration reached a substantial $1.1 trillion. Meanwhile, the Canadian operations are generating over 35% common shareholders' net income. These two segments are expected to remain the larger profit contributors in the near term, providing considerable earnings stability. SLF Asia and the U.S. businesses are each contributing about 15% to 20% of common shareholders' net income with some manageable volatility. Growth-related expenses are pressuring earnings in Asia, while SLF’s U.S individual life block operating performance has adversely affected the U.S. segment earnings. Overall, SLF generates a good return on equity with a three-year weighted average of 11.9%, which is in line with peers.

DBRS Morningstar views the Company as having excellent liquidity supported by its investment portfolio that comprises a high proportion of marketable bonds and equities with about 58% of its portfolio consisting of cash, public bonds and equities. As of Q2 2019, the Company had ample resources, including $2.2 billion in cash at the holding-company level, as well as standby credit facilities, to meet financial obligations under adverse stress scenarios. Positively, SLF has only a limited proportion of non-liquid assets in its investment portfolio.

SLF and its main operating insurance subsidiary, SLA, are maintaining strong regulatory capital ratios. Indeed, with sizable cushions over regulatory minimums under the Life Insurance Capital Adequacy Test (LICAT) framework that was implemented in 2018, DBRS Morningstar views the Company as very well positioned to navigate adverse scenarios. As of Q2 2019, the LICAT for the consolidated holding company was 144%, higher than SLA’s LICAT of 133%, as the holding company held $2.2 billion of additional assets comprising cash and other liquid assets. Solid earnings in the last five years have also contributed to the Company’s strong capitalization level. Moreover, financial leverage remains conservative at 20.4% with a fixed-charge coverage ratio of 9.0 times as of Q2 2019.

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

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

The applicable methodology is the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (September 2019), which can be found on our website under Methodologies & Criteria.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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.

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

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