Insurance. Pacific LifeCorp. And Life Insurance Subsidiaries Full Rating Report. Life Insurers / U.S.A. Key Rating Drivers. Rating Sensitivities

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1 Pacific LifeCorp And Life Insurance Subsidiaries Full Rating Report Life Insurers / U.S.A. Key Rating Drivers Ratings Security Class Rating Insurer Financial Strength A+ Issuer Default Rating (IDR) A Senior Unsecured Debt BBB+ Note: See page 16 for a complete ratings list. Rating Outlook Stable Financial Data Pacific LifeCorp ($ Mil.) 12/31/14 Shareholders Equity 10,125 Total Debt 2,369 a Net Income 541 Operating ROE (%) 9.0 RBC (%) 677 a Excludes nonrecourse borrowings. Note: RBC ratio for Pacific Life Insurance Company. Source: GAAP and statutory company reports. Related Research 2016 Outlook: U.S. Life Insurance (Low Interest Rates Remain an Earnings Headwind) (December 2015) Life Insurers Investment Portfolios (Results of Fitch s Year-End 2014 Survey) (August 2015) U.S. Life Insurers Mortgage Update (Commercial Mortgages Supporting Portfolio Yield) (June 2015) Solid Competitive Position: Pacific LifeCorp, with its insurance subsidiaries (collectively PLC), is one of the leading providers of individual life insurance and retirement savings products in the U.S. The company maintains a strong competitive position within the affluent market. The company also benefits from an extensive distribution network. Strong Statutory Capital: As of Sept. 30, 2015, the company s total adjusted capital (TAC) grew by $2.2 billion since year-end PLC has diversified and derisked its product portfolio and strengthened its variable annuity (VA) hedging program, which should lessen the capital impact if equity markets experience significant deterioration. Reduced RBC Volatility: In 2012, PLC formed a captive subsidiary to reinsure a portion of its VA business. During third-quarter 2013, Pacific Life Insurance Company (PLIC) changed the valuation basis/method for VA statutory reserves, which produced statutory reserves greater than the required minimum standard basis. Both actions have reduced RBC volatility. At yearend 2014, the company s RBC ratio was 677%, up slightly from 673% at the prior year end. Earnings Volatility from Legacy VAs: PLC s $19 billion closed block of legacy VA business with living and death benefit riders, which was primarily written between 2006 and 2008, has caused higher than expected GAAP and statutory earnings volatility. Fitch Ratings expects prospective returns to be less volatile due to the company s more diversified earnings stream, but to lag precrisis levels due to hedging costs, lower investment yields and higher interest expenses. Moderate Investment Risk: Fitch views the overall quality of PLC s investment portfolio as generally good, but Fitch notes that the company s large exposure to corporate bonds rated BBB could have a material effect on earnings and capital in a severe credit market downturn. While being well managed, PLC s large commercial mortgage portfolio makes it susceptible to weakness in the real estate market. Macroeconomic Uncertainty: Ongoing low interest rates and geopolitical uncertainty pose risks to Fitch s outlook for life insurers and could have a material negative effect on PLC s earnings and capital. Rating Sensitivities Reduced Leverage: A decline in financial leverage below 20% could lead to a positive rating action. PLC s total financing and commitments (TFC) ratio of more than 1.2x at June 30, 2015 is high relative to peers. A decline in the TFC ratio below 1.0x would be favorable to the ratings. Analysts Tana M. Higman tana.higman@fitchratings.com Julie A. Burke, CPA, CFA julie.burke@fitchratings.com Sustained Improvement in Operating Performance: Other factors that could result in an upgrade include sustained improvement in operating performance as evidenced by an increase in GAAP EBIT/interest coverage ratios to near 10x and proven success in expanding PLC s product lines and reducing the company s VA exposure. Significant Earnings and Capital Volatility: Factors that could result in a downgrade include a sustained decline in statutory capital of 10%, losses or rapid growth at the aircraft leasing subsidiary or an increase in the TFC ratio above 1.4x.

2 Corporate Governance Corporate governance and management are deemed adequate and neutral to the rating. PLC complies with the NAIC Model Audit Rule and manages SEC independence and transparency standards. Deloitte & Touche is PLC s auditor. PLC s board members are elected by policyowners. Eleven of the 13 members of the board are considered independent. Market Position and Size/Scale Solid Market Position and Size/Scale Overall, PLC is a top 20 U.S. life insurer. Focus on universal life (UL). Broader mix of retirement products. Strong distribution channels. Overall, PLC Is a Top 20 U.S. Life Insurer PLC ranks among the 20 largest life insurers in the U.S., measured in terms of admitted assets or capital and surplus. The company has a solid competitive position in the affluent and emerging affluent market. PLC is also among the 15 largest annuity writers and is the thirdlargest structured settlement provider. Prior to 2008, the company s growth was largely driven by VA and universal life with no-lapse guarantee (ULNLG) product sales. Since then, PLC has diversified its product portfolio and migrated away from capital-intensive products with a greater emphasis on fixed annuity (FA) and more simplified VA as well as UL products without nolapse guarantees. PLC has also deemphasized or exited certain institutional products, such as guaranteed investment contracts (GICs) and funding agreements. Life Insurance Division Sales Mix (Nine Months Ended Sept. 30, 2015) UL & Interest Sensitive Whole Life 8% VUL 17% VUL-COLI 3% UL with LTC Rider 6% Term Life 1% Indexed UL 65% UL Universal life. VUL Variable universal life. LTC Long-term care. ULNLG Universal life no-lapse guarantee. COLI Corporated owned life insurance. Source: PLC, Fitch. Focus on Universal Life (UL) Related Criteria Insurance Rating Methodology (September 2015) PLIC s largest life product line is UL, where it is the largest writer of indexed universal life (IUL) and the second-largest writer of variable universal life (VUL) in the U.S. ULNLG sales are down to approximately 2% of total life sales. The company has also introduced a single-premium UL policy with long-term care benefits. The company further enhanced its shift toward mortality risk with the 2011 purchase of Manulife Financial Corporation s (Manulife) life retrocession business and the 2014 transaction with RGA Reinsurance Company to assume $200 billion of in-force individual life reinsured amount at risk. Broader Mix of Retirement Products PLC has rebalanced its product mix, and VA sales are now down to 47% of total Retirement Solutions Division sales from 93% in FAs, mutual funds and structured settlements have a much larger contribution to sales than in the past. Fitch also believes the risk profile of VA sales has improved. PLC has discontinued certain VA guarantee Retirement Solutions Division Sales Mix (Nine Months Ended Sept. 30, 2015) Mutual Funds 18% Institutional and Structured Products 12% Retail FA 23% IOVA 29% VA with Rider 18% IOVA Investment-only variable annuity. FA Fixed annuity. VA Variable annuity. Source: PLC, Fitch. Pacific LifeCorp 2

3 riders, reduced features and increased fees aimed at managing changes in both volatility and interest rates. Strong Distribution Channels PLC focuses on diverse third-party, independent distribution channels as opposed to captive distribution. While the independent channels require less fixed cost, the basis for competition is product design and compensation, which can be competitive areas. However, PLC has a long track record with many of these organizations, which continues to provide stability as the company executes its product strategy. Ratings Range Based on Market Position and Size/Scale IFS Rating Category AAA AA A BBB <BBB Senior Debt Rating Category AA A BBB BB <BB Large Market Position and Size/Scale Medium Market Position and Size/Scale Small Market Position and Size/Scale Ownership Is Neutral to Rating PLC is an intermediate holding company formed in 1997 as the result of the conversion of PLIC, the organization s key operating subsidiary, to a mutual holding company structure. PLC is owned by Pacific Mutual Holding Company, a mutual holding company that was also formed as a part of the conversion. Pacific Mutual Holding Company must always own at least 51% of PLC, and PLC must always own 100% of PLIC. Fitch believes that relative to stock ownership, a mutual ownership structure offers fewer conflicts in owner and creditor interest and a stronger focus on maintaining financial strength. Also, mutual companies generally have the ability to adjust policyholder dividends to protect Simplified Organizational Chart Pacific Mutual Holding Company Pacific LifeCorp Pacific Life Insurance Company Pacific Life Re Holdings LLC Pacific Life Reinsurance (Barbados) Limited Pacific Annuity Reinsurance Company Pacific Life and Annuity Company Aviation Capital Group Corp. Pacific Asset Holding LLC Pacific Select Distributors Inc. Pacific Alliance Reinsurance Company of Vermont Pacific Life Fund Advisors LLC Pacific Baleine Reinsurance Company Rated by Fitch. Source: Company filings. Pacific LifeCorp 3

4 Sovereign- and Country- Related Constraints Fitch rates the local currency sovereign obligations of the United States of America at AAA with a Stable Outlook, and the country ceiling is similarly AAA. The local currency sovereign rating expresses the maximum limit for local currency ratings of most, but not all, issuers in a given country. At current levels, the ratings of U.S. insurance organizations and other corporate issuers are not likely to be constrained by sovereign or macroeconomic risks. capital from unexpected losses. During the financial crisis, mutual insurers clearly benefited from having a stronger capital buffer than stock insurers that were more focused on growth and return targets. Offsetting these favorable ownership considerations is the generally more limited capital market access of mutual insurance companies relative to stock companies. Moreover, PLC does not benefit from the policyholder dividend flexibility enjoyed by most mutual insurers because the company does not sell participating products. Industry Profile and Operating Environment U.S. Life Industry Has Strong Balance Sheet Fundamentals A majority of U.S. life insurers in Fitch s rated universe have IFS ratings in the AA and A categories and Stable Outlooks. This reflects very strong balance sheet fundamentals and generally stable operating performance. Balance sheets reflect very strong capital and liquidity, reasonable financial leverage and high-quality investment portfolios. The industry s profitability benefited in recent years from improved asset-based fee income associated with higher asset levels, partially offset by lower interest margins due to continued low interest rates. Key risk factors include asset risk tied to investment leverage, exposure to variable annuity living benefit guarantees, persistent low interest rates, and uncertainty tied to macroeconomic conditions and regulatory environment. While improved financial market conditions and enhanced hedging strategies have reduced the risk associated with the industry s large variable annuity exposure, industry earnings and capital remain exposed to financial market volatility and uncertain policyholder behavior. Cyclical improvement in the U.S. economy, strong recovery in the equity markets and a benign credit environment combined to mitigate the effect of prolonged low interest rates. Under Fitch s base case scenario, the U.S. macroeconomic environment is expected to modestly improve in 2016, which should allow life insurers to maintain balance sheet fundamentals and financial performance consistent with Credit-related investment losses are expected to increase in 2016 but remain below long-term averages. Ratings Range Based on Industry Profile/Operating Environment IFS Rating Category AAA AA A BBB <BBB Senior Debt Rating Category Life Insurance AA A BBB BB <BB Annuities Accident and Health Composite Pacific LifeCorp 4

5 Peer Comparison Insurer Financial TAC Asset Operating Risky Assets/ Financial Leverage Pretax Return on Total Assets Operating Return (Year-End 2014) Strength RBC (%) ($ Mil.) Leverage (x) Leverage (x) TAC (%) Ratio (%) Post-Dividend (%) on TAC (%) Pacific Life A , AIG Life & Retirement A , Lincoln National A , Minnesota Life AA 527 2, Principal AA 422 5, Prudential A , TAC Total adjusted capital. Note: Asset leverage consists of statutory assets divided by TAC. Operating leverage consists of statutory liabilities divided by TAC. Source: SNL Financial, Fitch. Peer Analysis PLC Fits Well in the A+ Category PLC generally compares favorably with other life and asset accumulation writers in the A+ category. The company s investment risk and operating leverage are better than peers. Historically, PLIC s reported RBC exhibited more volatility than peers. This was partially explained by the company s decision to retain a vast majority of its VA risk in its key insurance subsidiaries. Most VA writers have reinsured all of their VA riders with captives. Currently PLIC cedes a small percentage of the existing VA block and new business to a captive. During 2013, PLIC changed the valuation basis/method for VA statutory reserves to include a voluntary reserve component. Both of these actions have reduced RBC volatility. Pacific LifeCorp 5

6 Capitalization and Leverage 12/31/11 12/31/12 12/31/13 12/31/14 9/30/15 Fitch s Expectation Total Adjusted Capital ($ Mil.) 6,277 6,934 7,068 7,835 8,337 Assuming equity markets remain near current RBC (%) N.A. levels, PLIC s year-end 2015 RBC ratio is forecast to remain above 650%. Financial Asset Leverage (x) leverage is expected to decrease modestly Operating Leverage (x) over the near to intermediate term due to a growth in shareholders equity. Financial Leverage (%) N.A. Not available. Note: Financial leverage is calculated on a consolidated GAAP basis. Source: SNL Financial, Fitch. Statutory Capital Is Strong, but TFC Ratio Is High Strong statutory capitalization, reduced RBC volatility. Financial leverage is consistent with the rating category. ACG drives high TFC ratio. Strong Statutory Capitalization, Reduced RBC Volatility PLC s insurance subsidiaries are well capitalized for the rating level. As of Sept. 30, 2015, the company s TAC grew by approximately $2.2 billion since year-end This was driven by improved operating results as well as various capital management initiatives, including the contribution of PLC s ownership of Aviation Capital Group Corp. (ACG) to PLIC. PLIC had almost $52 billion in VA net account value at Sept. 30, Approximately 65% of PLIC s account value had a guaranteed minimum death benefit (GMDB) plus some form of living benefits, the majority of which was a guaranteed minimum withdrawal benefit (GMWB). PLIC historically did not reinsure VA guarantees to a captive. As a result, the company s RBC ratio fluctuated with equity market movements. However, in 2012, PLC formed Pacific Annuity Reinsurance Company (PARC), which is a captive subsidiary used to reinsure PLIC s base VA contracts and contract guarantees. PLIC initially ceded 5% of its existing VA business to PARC and continues to cede 5% of its new VA business. During 2013, PLIC changed the valuation basis/method for VA statutory reserves to include a voluntary reserve component. Both of these actions have reduced RBC volatility. TFC is a nonrisk-based leverage measure that expands on traditional measures of financial leverage to include all forms of debt, including match-funded and other operational debt, as well as debt supporting long-term capital needs as well as liquidity and working-capital needs. During periods of market disruptions, and lost access to capital markets funding, such operational and offbalance sheet commitments, can become a direct source of vulnerability to an organization. Financial Leverage Is Consistent with the Rating Category The total borrowings that Fitch ultimately views to be reliant on the insurance operations are almost $2.4 billion and results in a financial leverage ratio of approximately 20%. At Sept. 30, 2015, the surplus note component of TAC is approximately 10%, below Fitch s tolerance of 15%. As a result, the ratings on the surplus notes reflect standard notching. ACG Drives High TFC Ratio PLC s TFC ratio was 1.2x at Sept. 30, 2015 versus the life insurance industry average of 0.6x. PLC s TFC ratio is driven by the capital-intensive profile of the company s aircraft leasing subsidiary, ACG. Fitch views these activities as well managed and related risks are captured in Fitch s ratings. The ACG debt is nonrecourse to PLC. However, ACG could have difficulty meeting its obligations if the environment for aircraft lease finance companies deteriorates significantly or future funding proves more difficult. Excluding ACG, the TFC ratio is 0.4x. The TFC ratio also includes $1.2 billion of financing instruments outstanding for Pacific Alliance Reinsurance Company of Vermont (PAR Vermont), Pacific Life Reinsurance (Barbados) Limited and Pacific Baleine Reinsurance Company (Pacific Baleine) as well as $1.5 billion of debt related to an investment in commercial mortgage-backed securities (CMBS) variable interest entities that is nonrecourse to PLC. Pacific LifeCorp 6

7 Debt Service Capabilities and Financial Flexibility 12/31/11 12/31/12 12/31/13 12/31/14 9/30/15 Fitch s Expectation Total Interest Expense ($ Mil.) GAAP interest coverage will be in the 6x 8x Adjusted Interest Expense ($ Mil.) range. Statutory interest coverage will remain above the median ratio guideline of 3x for a GAAP Interest Coverage (x) company rated A. Maximum Statutory Dividend Capacity ($ Mil.) Statutory Interest Coverage (x) Note: GAAP interest coverage consists of earnings before interest and taxes divided by adjusted interest expense. Statutory interest coverage consists of maximum statutory dividend capacity divided by adjusted interest expense, less interest paid on surplus notes. Adjusted interest expense excludes interest on operating debt, match-funded and ACG debt. Source: PLC financial statements, Fitch. Adequate Coverage but Constrained Financial Flexibility Interest coverage in line with rating expectations. Financial flexibility somewhat constrained. Back-up liquidity available. Interest Coverage in Line with Rating Expectations Fitch views PLC s debt-servicing capabilities as adequate for the rating level. GAAP interest coverage, based on pretax operating earnings, was 7.4x thus far in 2015, up from 6.5x in Based on Fitch s earnings expectations, GAAP EBIT/interest coverage ratios are expected to remain in the 6x 8x range over the near to intermediate term. Maximum dividend capacity without regulatory approval in 2015 is $668 million. As of Sept. 30, 2015, no ordinary cash dividends have been paid by PLIC. Financial Flexibility Somewhat Constrained Fitch views PLC s future financial flexibility as somewhat constrained given the limited access to external equity capital and modest organic statutory earnings generation prospects. The company has demonstrated its ability to access the debt markets through the issuance of surplus notes during the financial crisis and subsequent senior debt issuances. Favorably, PLC and PLIC have no debt due until Back-Up Liquidity Available Other liquidity sources include PLC s $600 million revolving credit facility that is in place through October PLIC maintains a $700 million commercial paper program, which is backed by a $400 million bank line of credit that matures in October At Sept. 30, 2015, there was no outstanding debt under these facilities. The insurance companies also have access to funding from the Federal Home Loan Banks (FHLBs) of both Topeka and San Francisco, which depend on the value of the qualifying collateral. At Sept. 30, 2015, there was no debt outstanding with either FHLB. Pacific LifeCorp 7

8 Financial Performance and Earnings ($ Mil.) 12/31/11 12/31/12 12/31/13 12/31/14 9/30/15 Fitch s Expectation Pretax Gain from Operations (587) Fitch expects volatility in operating results in the short term. Over the Net Income (719) 1, longer term, operating return on TAC is Pretax Return on Total Assets Post-Dividend (%) (0.6) forecast to remain in the 8% 11% range and ROE on a GAAP basis is Operating Return on TAC (%) (10.2) forecast to be in the 7% 9% range. Growth in Revenues (Before Realized Gains) (%) TAC Total adjusted capital. Note: Statutory accounting principles. Combined Pacific Life Insurance Company and Pacific Life & Annuity Company. Source: SNL Financial, Fitch. Less Volatile, Albeit Lower, Earnings Earnings volatility driven by legacy VA block. Core life insurance performing reasonably well. Product diversification reduced earnings volatility. Earnings Volatility Driven by Legacy VA Block PLC s large VA exposure resulted in GAAP and statutory earnings volatility over the past several years. The statutory net loss in 2011 was primarily driven by increases to Actuarial Guideline 43 (AG43) reserves as a result of equity market volatility and a decline in interest rates, as well as the impact of a ceding commission paid in connection with the purchase of Manulife s life retrocession business. GAAP results in 2013, 2014 and thus far in 2015 have benefitted from strong sales and investment performance partially offset by hedging losses, unfavorable mortality experience in 2014 and 2015, and one-time expenses related to the surplus notes tender in January PLC's GAAP Net Income Trends ($ Mil.) (200) (400) PLC GAAP Net Income S&P 500 Growth (% Growth) (15) (30) (45) /30/15 Note: 2011 and prior numbers have not been restated to reflect FASB ASU , which was adopted on Jan. 1, Source: Company reports, Bloomberg. Core Life Insurance Performing Reasonably Well Overall, Fitch views PLC s life insurance earnings quality to be solid. Similar to other life companies, PLC experienced higher mortality in 2014 and 2015, but persistency experience remains strong. Additionally, the company has pricing flexibility in its UL products since the crediting rate remains above the minimum guaranteed rate. Product Diversification Reduced Earnings Volatility PLC diversified its earnings stream through expanded product offerings and acquisitions. Longer term, Fitch expects earnings will be less volatile as PLC s policyholder account balances become more balanced between interest rate, mortality and equity market risk. PLC is focused on increasing fee-based revenues by growing its asset management business. However, the company s earnings are susceptible to potential changes in the dividends received deduction (DRD) tax benefit. Pacific LifeCorp 8

9 Investment and Asset Risk 12/31/11 12/31/12 12/31/13 12/31/14 9/30/15 Fitch s Expectation Cash and Invested Assets ($ Mil.) 46,798 48,432 51,338 55,469 58,498 No significant changes expected in the investment portfolio. Credit-related losses are Below Investment Grade Bonds/TAC (%) forecast to remain moderate. PLC s Risky Assets Ratio (%) N.A. investment yield volatility is due to derivative Investment Yield (%) accounting for hedges on VA risks. VA Variable annuity. N.A. Not available. Note: Statutory accounting principles. Combined Pacific Life Insurance Company and Pacific Life & Annuity Company. Source: SNL Financial, Fitch. Moderate Investment Risk Commercial mortgages and real estate investments performing well. High-quality corporate bond portfolio. Modest uptick in Schedule BA and private placement exposure. Investment Portfolio ($63.0 Bil. as of Sept. 30, 2015) All Other 2.6% Policy Loans 11.5% Mortgage Loans 16.6% Cash and Equivalents 4.1% Real Estate 0.6% Note: GAAP fair value. Source: PLC financial statements. Common and Preferred Stock 0.2% Fixed-Income Portfolio ($40.6 Bil. as of Sept. 30, 2015) RMBS 6.6% Gov. (U.S., Foreign and Municipal) 7.4% Bonds 64.3% Other ABS 2.2% CMBS 2.1% CDOs 0.2% Corporates 81.5% RMBS Residential mortgage-backed securities. CMBS Commercial mortgage-backed securities. CDO Collateralized debt obligation. ABS Asset-backed securities. Note: GAAP fair value. Source: PLC financial statements. Commercial Mortgages and Real Estate Investments Performing Well PLC s investment strategy for mortgage loans and real estate emphasizes niche property types that exhibit stable fundamental characteristics and allow PLC to employ conservative underwriting standards. As a result of this strategy, PLC s capital losses as a percentage of mortgage assets remain lower than the industry. In recent years, PLC s focus within its commercial mortgage portfolio has been on the apartment and office sectors, while reducing its exposure to hotel and resort properties. Credit metrics are good with an average loan to value at Sept. 30, 2015 of approximately 52% and a weighted average debt service coverage ratio of approximately 2.1x. Fitch believes this portfolio is well managed, and while PLC will not be immune from the challenges facing this sector, Fitch expects its losses will continue to trail that of its peers. High-Quality Corporate Bond Portfolio PLC s bond portfolio is heavily weighted toward corporates, which account for 82% of the total bond portfolio. The average rating on the corporate bond portfolio is BBB with 5% of the portfolio below investment grade. Fitch believes the corporate portfolio is well diversified between sectors. However, Fitch notes that PLC s above-average exposure to corporate bonds in the BBB category could have a material effect on earnings and capital in a severe credit market downturn. Modest Uptick in Schedule BA and Private Placement Exposure Similar to other life insurers, PLIC has made a modest allocation shift into less liquid asset classes, including alternative investments and private placement corporate bonds in an effort to increase yields in the current low rate environment. PLIC s Schedule BA assets as a percentage of total invested assets increased to 2.6% in 2014 from 1.8% in 2011 while private placement corporates increased to 18.5% in 2014 from 17.5% in That said, PLC s exposure to Schedule BA assets remains below the industry average and its exposure to private placement corporates is slightly above the industry average. Pacific LifeCorp 9

10 Asset/Liability and Liquidity Management (%) 12/31/10 12/31/11 12/31/12 12/31/13 12/31/14 Fitch s Expectation Liquidity Ratio PLC s liquidity ratio will remain strong at near Operating Cash Flow Coverage (x) Public Bonds/Total Bonds Total Adjusted Liabilities and Deposits ($ Mil.) 96,523 93,939 98, , ,315 Note: Statutory accounting principles. Combined Pacific Life Insurance Company and Pacific Life & Annuity Company. Source: SNL Financial, Fitch. 75%, and its operating cash flow coverage will remain at or above 1.3x. PLC s ratio of public bonds to total bonds will remain below the industry average of approximately 72%. Asset/Liability and Liquidity Management Are Strong Favorable cash flow-testing results. Minimal disintermediation risk. Fixed annuities benefit from good surrender protection. Derivatives used to manage interest rate risk. Favorable Cash Flow-Testing Results Fitch views PLC s asset/liability management (ALM) practices to be strong. For its 2014 cash flow testing, both insurance operating companies passed all New York 7 interest rate scenarios and sensitivity analysis produced positive results in all scenarios. At Sept. 30, 2015, the company s net duration mismatch in aggregate was negative 0.9 years, within its target limit of less than 1.5 years. Adjusted Liabilities and Deposits (As of Dec. 31, 2014) Separate Accounts 55% Life Reserves 24% Note: Statutory accounting principles. Consolidated Pacific Life Insurance Company and Pacific Life & Annuity Company. Source: SNL Financial, Fitch. Annuities and Pension Deposits 21% Minimal Disintermediation Risk Historically, the primary source of disintermediation risk for Pacific Life was related to PLC s institutional products, which the company has almost completely wound down. PLC s outstanding balance of funding agreement-backed note programs has been reduced to $320 million from $6.1 billion at Dec. 31, PLC s synthetic GIC portfolio of $21.2 billion (notional) is among the largest in Fitch s rated universe. PLC raised wrap fees, improved contractual terms and instituted more conservative investment guidelines. At Sept. 30, 2015, the market-to-book value ratio was 102.1%. A sharp, sudden increase in interest rates could negatively affect this portfolio. However, maturity extension provisions reduce the likelihood PLC would have to make a book value payment. Fixed Annuities Benefit from Good Surrender Protection Fitch believes that PLC s fixed products are well protected against product withdrawal risks due to contract provisions, duration and cash flow matching, and disciplined investment processes. Approximately 93% of the company s total annuity actuarial reserves and deposit liabilities were subject to market value adjustments, surrender charges equal or above 5%, or were not subject to discretionary withdrawal, which discourage surrender and protect PLC from liquidity risks. Derivatives Used to Manage Interest Rate Risk The primary goal of PLC s hedging program is to protect statutory capital. The company currently performs dynamic hedging at the division level. PLC uses various interest rate swaps to better match the cash flow characteristics of certain assets and liabilities. They are also used to manage the company s exposure to variability in cash flows due to changes in foreign currencies and the benchmark interest rate. Pacific LifeCorp 10

11 Reinsurance and Risk Management Enhanced Risk Mitigation Viewed as a Positive Robust VA hedging program. VA block partially reinsured. Use of Vermont captives for bulk of ULNLG business. Robust VA Hedging Program Fitch views positively the company s strengthened VA hedging program, which should lessen the capital impact and smooth GAAP net income if equity markets experience significant deterioration. Under AG43, the company s current hedging program qualifies as a clearly defined hedging strategy. The company has a VA delta dynamic hedging program to reduce GAAP earnings volatility while at the same time protecting statutory surplus. PARC utilizes a dynamic hedging program designed to hedge specified percentages of VA GAAP reserve changes attributable to equity, interest rate and volatility. PLC uses total return swaps and equity put options. Fitch believes PLC s derivative counterparty risk is low since all transactions are exchange-traded or with counterparties rated A or better. VA Block Partially Reinsured Living and death benefit riders on VA contracts issued between Jan. 1, 2007 and March 31, 2009 were partially covered under coinsurance agreements. Additionally, PLC reinsured a portion of the VA business under modified coinsurance agreements between Jan. 1, 2006 and March 31, Currently, 14% of the company s VA rider guarantees and 10% of the base contracts are covered under reinsurance, concentrated in issue years 2007 and In the second quarter of 2015, PLC began reinsuring 50% of new VA sales with GMWB riders. The reinsurance covers only the rider risk and is effective for two years. Use of Vermont Captives for Bulk of ULNLG Business ULNLG is subject to rigorous reserving levels mandated by AG38 (also known as regulation AXXX). PLIC uses its wholly owned subsidiaries, PAR Vermont and Pacific Baleine, to reinsure certain reserves related to its ULNLG business and takes reserve credits that enhance the company s capital position. Statutory reserves Ceded to PAR Vermont ceded to PAR Vermont are supported 69% by an LOC facility, which is nonrecourse to PLC. In November 2011, PAR Vermont entered into a Direct ULNLG Rider Reserves (As of Sept. 30, 2015) Ceded to Pacific Baleine 8% Fully Reinsurred to Non-Affiliates 16% Fully Retained by PLIC 7% ULNLG Universal life no-lapse guarantee. Note: Statutory accounting principles. Source: PLIC. 20-year LOC agreement for up to $843 million, which replaced the prior short-term LOC arrangement thereby reducing the company s refinancing and liquidity risk. As of Sept. 30, 2015, $662 million was issued. Statutory reserves ceded to Pacific Baleine are supported by a promissory note facility, which is credit enhanced by a third-party reinsurer, and held in a reinsurance trust for the benefit of PLIC. The agreement allows for the issuance of up to $400 million and expires in December As of Sept. 30, 2015, $145 million had been issued. Pacific LifeCorp 11

12 Key Noninsurance Operations/Exposure ($ Mil.) 12/31/11 12/31/12 12/31/13 12/31/14 9/30/15 Fitch s Expectation Total Revenue Operating performance could improve moderately over the near to medium term. Total Outstanding Debt 5,012 5,435 5,677 5,499 5,624 Leverage will remain around 3.0x 3.5x over the medium term, which is lower than Total Equity 1,153 1,290 1,394 1,635 1,720 historical levels of 4.0x-4.5x. Source: Aviation Capital Group, Fitch. ACG Generates Stable Earnings, but Increases PLC s TFC Ratio Consistent profitability and stable cash flows. Concentrated exposure to BB+ credit. Reliance on capital markets, but improved funding profile. Consistent Profitability and Stable Cash Flows PLC s aircraft leasing subsidiary, ACG, is considered among the top five aircraft lessors in the world with an owned and managed portfolio of 253 aircraft as of Sept. 30, The company has a strong track record of generating stable operating earnings and cash flows and has been the primary contributor of non-insurance earnings for the past several years. Concentrated Exposure to BB+ Credit Fitch views PLIC s ownership of ACG as a concentrated exposure to an entity with a standalone credit profile of BB+. PLIC s current 100% ownership of ACG s equity represents a meaningful portion of the insurance company's equity base. Ownership of an aircraft leasing business provides more active control of assets than a passive investment in aircraft securitizations. The investment also provides valuable tax benefits to PLC, and a portion of ACG s debt agreements require that PLIC retain, at a minimum, a 51% ownership interest in ACG. The current ratings on both ACG and PLC implicitly assume that PLC would provide a modest level of support if necessary. Reliance on Capital Markets, but Improved Funding Profile The aircraft leasing business is capital-intensive and ACG relies on access to capital markets for attractive financing. Fitch views ACG has having sufficient available cash on hand and availability under its various funding facilities to meet upcoming debt maturities and new aircraft funding commitments. PLC announced that it is considering a partial public listing of ACG primarily intended to give ACG access to additional capital to execute its growth strategy. While the magnitude of the offering remains unknown, PLC has publicly stated that it intends to retain a majority equity stake in ACG after the IPO and that ACG will remain an important component within PLC's diversified portfolio of businesses. ACG continues to make significant progress in diversifying its funding profile and broadening its capital markets access across various funding sources. In third-quarter 2015, ACG completed a $900 million, SEC rule 144A bond transaction at attractive terms. With the recent issuance, ACG s unsecured debt grew to approximately 66% of total funding. Due to its predominantly unsecured funding profile, ACG has a significant pool of available unencumbered assets, which provides material support to the unsecured noteholders and is viewed positively by Fitch as it provides additional balance sheet flexibility in times of market stress. Pacific LifeCorp 12

13 Pacific LifeCorp Debt ($ Mil., As of Sept. 30, 2015) Insurance Debt 9.250% Surplus Notes Due June 15, % Surplus Notes Due Dec. 30, % Senior Notes Due Feb. 10, % Senior Notes Due Sept. 15, % Senior Notes Due Jan. 30, Total Insurance Debt 2,369 Non-Insurance Debt Debt Recourse Only to ACG 5,112 ACG Revolving Credit Facility 5 ACG VIE 507 Other 1,716 Total Financial Services Debt 7,340 Total Debt 9,709 Reported Shareholders Equity 10,107 Accumulated Other Comprehensive Income (Primarily SFAS 115 and SFAS 133) 929 Adjusted Shareholders Equity 9,178 Minority Interest 98 Total Capital 18,985 Insurance Capital 11,645 Total Debt/Total Capital (%) 51.1 Total Insurance Debt/Total Capital (%) 20.3 ACG Aviation Capital Group. VIE Variable interest entity. Source: Company reports, Fitch Ratings. Appendix A: Additional Financial Exhibits Net Amount at Risk for Variable Annuity Riders ($ Mil.) GMDB GLB S&P 500 Close (S&P 500) 15,000 2,500 12,000 2,000 9,000 1,500 6,000 1,000 3, Q08 2Q09 4Q09 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 Source: Company reports, Bloomberg. Statutory Capital and RBC Trends Total Adjusted Capital RBC RBC Ratio (RHS) ($ Mil.) (%) 9, , , , , , /30/15 Source: Company reports. Pacific LifeCorp 13

14 Appendix B: Other Ratings Considerations Below is summary of additional ratings considerations of a technical nature that are also part of Fitch s ratings criteria. Group IFS Rating Approach Fitch s rating on Pacific Life & Annuity Company (PL&A) is based on its relationship with PLIC, and reflects Fitch s view that PL&A is a Core operating company within the organization. PLC owns London-based Pacific Life Re Limited (PLR). To help support PLR, a guarantee agreement exists between PLR and PLC. In the agreement, obligations of PLR align with the senior unsecured obligations of PLC. A second guarantee agreement was put in place between PLIC and PLR in March 2010 that would only be triggered in the event of nonperformance by both PLR and PLC. Pacific Life Re s (PLR) ratings are tied to PLIC s ratings based on this support agreement. Notching For notching purposes, the regulatory environment of the U.S. is assessed by Fitch as being Effective and classified as following a Ring-Fencing approach. Notching Summary IFS Ratings A baseline recovery assumption of Good applies to the IFS rating, and standard notching was used from the IFS anchor rating to the operating company IDR. Holding Company IDR Standard notching was applied between the insurance operating company and holding company IDRs for a ring-fenced regulatory environment. No adjustments were made for financial leverage, coverage or significant holding company liquidity. Holding Company Debt A baseline recovery assumption of Below Average was applied to the senior debt. Standard notching relative to the holding company IDR was used. Hybrids Since PLIC s financial leverage ratio is below 15%, its surplus notes were notched down by one from the IDR of the insurance company on an assumption of Below Average recoveries (one notch), and Minimal Nonperformance Risk (zero notches). Regulators have historically appeared hesitant to impose deferrals on these instruments except under relatively severe stress. IFS Insurer Financial Strength. IDR Issuer Default Rating. Short-Term Ratings PLIC s short-term Issuer Default Rating (IDR) rating of F1 is based on the company s longterm IDR rating of A. Pacific LifeCorp 14

15 Hybrids Equity/Debt Treatment Hybrids Treatment Hybrid Amount ($ Mil.) CAR Fitch (%) Pacific Life Insurance Co. CAR Reg. Override (%) FLR Debt (%) Surplus Notes CAR Capitalization ratio. FLR Financial leverage ratio. Note: The CAR percentage shows a portion of the hybrid value included as Available Capital, both before (Fitch %) and the Regulatory Override. For FRL, percentage shows a portion of the hybrid value included as debt in numerator of leverage ratio. Exceptions to Criteria/Ratings Limitations None. Pacific LifeCorp 15

16 Appendix C: Complete Ratings List Ratings Issuer Security Class Rating Pacific LifeCorp Long-Term Issuer Default Rating A Pacific LifeCorp Senior Unsecured Debt BBB+ Pacific Life Funding, LLC Funding Agreement-backed Note Program A+ Pacific Life Global Funding Funding Agreement-backed Note Program A+ Pacific Life Insurance Company Long-Term Issuer Default Rating A Pacific Life Insurance Company Short-Term Issuer Default Rating F1 Pacific Life Insurance Company Commercial Paper F1 Pacific Life Insurance Company Subordinated Debt A Pacific Life Insurance Company Insurer Financial Strength A+ Pacific Life & Annuity Company Insurer Financial Strength A+ Pacific Life Re Limited Insurer Financial Strength A+ Aviation Capital Group Long-Term Issuer Default Rating BBB Source: Fitch. Pacific LifeCorp 16

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