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), its Limited Recourse Capital Notes at BBB (high), 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 (employee benefits) 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 Company’s Life Insurance Capital Adequacy Test (LICAT) ratio is sensitive to equity market volatility, primarily because of increased liabilities and capital requirements related to its segregated fund guarantees. Nonetheless, Empire has consistently maintained a 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 continued success of these strategies as an essential support for Empire's current ratings. The LICAT ratio remains strong at 148% as at Q1 2021 with a substantial cushion above the regulatory supervisory minimum of 100%. However, the LICAT ratio was unusually high as at Q1 2021 because the Company was preparing to redeem its preferred shares on April 17, 2021.

RATING DRIVERS
The ratings would be upgraded if there were a material strengthening of the Company’s market position in its individual and group insurance segments, with balanced growth for product offerings with guarantees while maintaining appropriate capitalization relative to the risks undertaken.

Conversely, the ratings would be downgraded if there were a sustained deterioration in profitability and capitalization or loss of access to distribution channels, resulting in material erosion of earnings and market share.

RATING RATIONALE
The Company has generally achieved a good return on equity in the 8.5% to 13.0% range over the past five years. The three-year weighted average at YE2020 remained stable at 9.4%. Net income decreased to $157 million at YE2020 from $191 million at YE2019. The reduction in earnings was due, in part, to a large one-time gain recognized in 2019 associated with a reinsurance recapture initiative. Empire Life reported strong Q1 2021 net income of $163 million compared with a net loss of $33 million in Q1 2020. The increase Q1 2021 net earnings was driven primarily by a reversal of policy liabilities for segregated fund guarantees that were strengthened in Q1 2020 because of unfavourable market movements and released in 2021 as equity market and interest rate conditions improved.

Empire maintains very high levels of liquidity with $290 million of cash and short-term liquid assets on its balance sheet at Q1 2021. However, cash levels as at March 31, 2021, were inflated because of the imminent redemption of the $149.5 million preferred shares scheduled for April 17, 2021. Moreover, the Company's low concentration (1.6% of the investment portfolio as at YE2020) of nonliquid assets, such as uninsured mortgages, and its high proportion of government bonds provide available liquidity that is more than adequate.

The Company's LICAT ratio is sensitive to equity market volatility, primarily because of increased liabilities and capital requirements related to its segregated fund guarantees. Nonetheless, Empire has consistently maintained a 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. The LICAT ratio remains strong at 136% as of YE2020 (148% as of March 31, 2021), with a substantial cushion above the regulatory supervisory minimum of 100%. This sizeable cushion strengthens the Company's capacity to withstand adverse market movements, particularly in light of its high proportion of long-tailed liabilities. Empire has improved its capital buffer in recent years to ensure that it can remain solvent in extreme stress scenarios with additional capital added in the form of subordinated debt and hybrid debt.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

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

The principal methodology is the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (July 21, 2020; https://www.dbrsmorningstar.com/research/364260). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262 ).

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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