DBRS Morningstar Confirms Sun Life Financial Inc.’s Issuer Rating at A (high), Stable Trend, Following DentaQuest Acquisition Announcement

DBRS Limited (DBRS Morningstar) confirmed all ratings of Sun Life Financial Inc. (SLF or the Company) and its related entities, including SLF’s Issuer Rating at A (high) and Sun Life Assurance Company of Canada’s Financial Strength Rating at AA. All ratings have Stable trends.

KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect DBRS Morningstar’s view that the acquisition of DentaQuest is aligned with SLF’s strategic plan to significantly expand its dental segments and U.S. employee benefits business. DentaQuest will provide SLF with strong economies of scale in the U.S. and will be a key growth platform for the Company once the acquisition is concluded. SLF has announced that the USD 2.5 billion transaction is expected to be funded through a combination of cash (40%) and subordinated debt (60%). As a result, SLF’s consolidated financial leverage (measured as consolidated debt and preferred shares over total capitalization) is anticipated to increase to 27.6% based on pro forma Q2 2021 financials considering DentaQuest acquisition and preferred share redemptions (24.7% at the end of H1 2021). This is still below the average for peers and should not negatively affect the Company’s financial flexibility despite the ongoing Coronavirus Disease (COVID-19) pandemic. As with any large acquisition transaction, execution risk remains. However, SLF’s strong historical record of successfully integrating prior acquisitions helps to mitigate execution risk concerns.

RATING DRIVERS
Given the already high rating level and uncertain macroeconomic environment, a rating upgrade is unlikely in the near term. In the longer term, an upgrade could arise from continued progress with SLF's business diversification strategy while maintaining a conservative risk profile, as well as from an improvement in asset quality, including having a larger proportion of higher-rated bonds (rated “A” or higher) in its investment portfolio.

The ratings would be downgraded if the Canadian business, a strong contributor to overall results, reported a sustained decline in earnings, indicating a weakened franchise. Moreover, a substantial decline in regulatory capital levels or a sustained deterioration in financial leverage over 30% would result in a downgrade.

RATING RATIONALE
DentaQuest is the largest provider of Medicaid dental benefits in the U.S. with growing Medicare Advantage, commercial, and U.S. Affordable Care Act (ACA) exchange businesses. Currently, DentaQuest has more than 33 million members in 36 states and approximately 2,400 employees. In addition to its leadership in Medicaid and children’s health insurance programs, DentaQuest has grown in its Medicare Advantage program and other segments, including offerings through health plan partners as well as individuals on the U.S. ACA healthcare exchanges.

CareQuest Institute for Oral Health, the current parent organization of DentaQuest, is a U.S.-based nonprofit organization. Centerbridge, a minority shareholder of DentaQuest, will also sell its stake in DentaQuest to the Company. The announced transaction is well aligned with, and increases the scale of, SLF’s U.S. business. This positions the Company as a leading dental benefits provider in the U.S. and sets it up for growth in U.S. commercial, government program, and care delivery spaces. DentaQuest has been outgrowing peers in recent years, with an estimated compound average growth rate of 14% from 2018 to 2021, and SLF expects this rate of growth to continue. DentaQuest’s business model does not require a significant amount of capital to operate and generates considerable cash flow. SLF indicated that this transaction doubles the size of the Company’s U.S. business by revenue. Overall, SLF expects the acquisition to be immediately accretive to earnings.

SLF successfully integrated recent international acquisitions, including Pinnacle Care International (2021) and Crescent Capital Group LP (2021). DBRS Morningstar anticipates that the integration of this acquisition will be relatively straightforward. SLF estimates that the run-rate of cost synergies from this acquisition will be around USD 60 million pre-tax to be achieved in 2024. SLF plans to maintain appropriate regulatory capital ratios. As of H1 2021, the Life Insurance Capital Adequacy Test (LICAT) for SLF was 147%, while Sun Life Assurance Company of Canada’s LICAT was 125%. SLF has good organic capital generation capabilities because of its consistent earnings profile.

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 SLF are as follows: Franchise Strength – Strong; Risk Profile –Strong/Good; Earnings Ability – Strong; Liquidity – Very Strong; Capitalization – Strong.

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (July 16, 2021; https://www.dbrsmorningstar.com/research/381667). 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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