DBRS Morningstar Confirms Ratings on The Empire Life Insurance Company at “A,” Stable Trends

DBRS, Inc. (DBRS Morningstar) confirmed The Empire Life Insurance Company’s (Empire or the Company) Financial Strength Rating and Issuer Rating at “A,” as well as its Subordinated Debt rating at A (low) and its Preferred Shares rating at Pfd-2. All trends are Stable.

KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect Empire's long-standing presence in the consolidated Canadian life insurance market. The Company's franchise strengths lie in its diverse suite of primary products, including life and group insurance products, as well as wealth-management products, sold through a multichannel distribution strategy. Empire has good earnings generation, prudent risk management, and strong capitalization relative to the risks undertaken. The ratings also consider the adverse impact of sharp declines in equity markets and the current economic environment on the Company's earnings and capitalization in Q1 2020. Common shareholders' loss was primarily due to the significant increase in the insurance contract liabilities supporting the Company’s segregated fund guarantees. The Company’s Life Insurance Capital Adequacy Test (LICAT) ratio is sensitive to equity market volatility, due primarily to increased liabilities and capital requirements related to its segregated fund guarantees. Nonetheless, Empire has consistently maintained sufficient capital cushion above the required level of regulatory capital that supports its stressed capital targets, implemented hedging strategies, and utilized reinsurance to mitigate its equity market exposures and product guarantees risks. DBRS Morningstar views the success of these strategies as essential support for Empire's current ratings as the Company’s results for Q1 2020 would have been much weaker without these strategies. Positively, Empire’s LICAT ratio of 155% at YE2019 helped to offset some of these market displacements. The LICAT ratio remains strong at 132% with a substantial cushion above the regulatory supervisory minimum of 100%. The increase in regulatory capital requirements does not support direct payable items, so capitalization will likely remain manageable over the short- to medium-term horizon.

RATING DRIVERS
Given the current economic environment, an upgrade is unlikely at this time. Over the longer term, an upgrade to the ratings would require the Company to strengthen its market position in its individual and group insurance segments, balance growth for product offerings with guarantees, and maintain appropriate capitalization relative to the risks undertaken.

A downgrade to the ratings would likely be driven by a sustained deterioration in profitability and capitalization or loss of access to distribution channels, resulting in eroding earnings and market share.

RATING RATIONALE
The Company’s earnings ability remains good across all three major product lines, though net income attributed to common shareholders will likely deteriorate for full-year 2020 as a result of equity market declines. In the last five years, Empire has generally generated a good return on equity in the 9.4% to 13% range. The three-year weighted average at YE2019 remained stable at 10.9%. Common shareholders’ net income increased to $174 million at YE2019 from $137 million at YE2018. Higher claims and benefits expenses in the group segment offset operating income growth in 2019, which benefitted from strong profitability in the individual lines compared with the prior year as well as higher fee income from the wealth management segment. Positive growth in expected profitability on in-force business in all three product lines in Q1 2020 helped to offset some of the significant increase in the insurance contract liabilities supporting the Company’s segregated fund guarantees. Expected profitability on in-force business increased to $55 million in Q1 2020 compared with $51 million in Q1 2019. Nonetheless, the Company reported common shareholders’ net loss of $32 million, a sharp decline from net income of $43 million in Q1 2019.

Additionally, top-line revenue growth could likely moderate because of suppressed business activities and rising unemployment. In the current economic environment, rising unemployment will shrink the size of some groups, leading to reduced premium volumes in the group benefit line. Group supplemental health and dental premiums represent a relatively small percentage of overall spending for employee health benefits. The lower cost could provide support for employers to keep funding this benefit in the short term, even if employers furlough or shrink their workforce. Annualized individual insurance premium increased in 2019 from the prior year as the Company maintained good sales of its term life and whole life insurance products with profitability rising from 2018. Empire also launched a guaranteed-issue life insurance product in 2018 with full digital distribution capabilities and health status questionnaire for customers. The Company recorded solid sales volume in Q1 2020 from the distribution on non-face-to-face sales products.

Past earnings have benefitted from strong growth in gross segregated fund sales, and the Company has successfully increased the level of segregated fund assets under management (AUM) over the years, reaching $8.5 billion at YE2019. Empire's segregated fund AUM declined to $7.1 billion as of Q1 2020, primarily due to the heightened equity market volatility and disruptions in the global economy from the ongoing Coronavirus Disease (COVID-19) pandemic. AUM has rebounded somewhat since Q1 2020; however, if market volatility continues for the remainder of 2020, this will likely result in lower fee income.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for Empire are as follows: Franchise Strength—Good/Adequate; Risk Profile—Good/Adequate; Earnings Ability—Good/Adequate; Liquidity—Excellent/Good; Capitalization—Good.

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

The principal methodology is Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (September 16, 2019).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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