Insurance. Scottish Widows plc; Clerical Medical Investment Group Ltd. United Kingdom. Full Rating Report. Key Rating Drivers

Transcription

1 United Kingdom Scottish Widows plc; Clerical Medical Investment Group Ltd Full Rating Report Ratings Scottish Widows plc Long-Term IDR Insurer Financial Strength Subordinated debt BBB+ Clerical Medical Investment Group Ltd Long-Term IDR Insurer Financial Strength Clerical Medical Finance PLC Subordinated debt Rating Outlooks Long-Term IDR Insurer Financial Strength Financial Data BBB+ Stable Stable Scottish Widows plc (consolidated figures include CMIG) (GBPm) Total assets 67, ,422 Total equity 3,566 6,289 Debt (including hybrids) 1,410 1,875 Gross written premiums 4,016 5,413 Net income Clerical Medical Investment Group Ltd (GBPm) Total assets 29,474 26,863 Total equity 1,465 1,455 Debt (including hybrids) Gross earned premiums 1, Net income (158) (10) Key Rating Drivers CMIG ligned with SW: The upgrade of Clerical Medical Investment Group Ltd s (CMIG) Long-Term IDR on 9 reflected Fitch Rating's decision to align the ratings of CMIG with those of Scottish Widows plc (SW), driven by the full integration of the management and operations of CMIG with those of SW. This follows a decision by the ultimate parent, Lloyds Banking Group (LBG) to manage all insurance operations as a single group from Ratings Constrained by Parent: The standalone profile of the SW group (ie SW and CMIG) is commensurate with an IDR of + but the IDR and the IFS ratings are compressed to as they are constrained by the Long-Term IDR of their ultimate parent (LBG; ''/Stable). LBG Ownership to Continue: Fitch views the impact of Basel III on bank-owned insurance entities cautiously, with the tougher capital requirements for banks that own insurance operations likely to weigh on groups' allocation of capital and potentially decreasing the attractiveness of owning insurance subsidiaries. However, LBG continues to consider its insurance operations as an important part of its business and the group benefits from the successful bank distribution of SW products, with a large proportion of SW's business being sold through LBG's bank branches. Fitch does not expect LBG to divest its insurance operations in the near term. Strong Franchise; Limited Diversification: The ratings reflect the strength of the SW franchise, with a leading position in the UK life, pensions and investment market. However, geographical diversification is relatively weak: the SW group is UK-focused. Strong Capital: Fitch views the SW group s consolidated capital on a risk-adjusted basis as strong for its rating level. Its regulatory capital was 1.9x the minimum required, at end Fitch is cautious that LBG can, to some extent, extract capital, as has happened in previous years through dividends, although the agency expects the SW group s solvency position to be maintained at its current strong level. Steady Financial Performance: The group s net income was GBP282m in 2011 (2010: GBP248m, excluding CMIG). Its new business profitability is relatively strong and improving, driven by a shift towards higher-margin protection business and the closure of some lowmargin product lines. Related Research UK Life Insurance Retail Distribution Review (September 2011) Lloyds Banking Group - Full Rating Report (January 2012) 2013 Outlook: UK Life Insurance Capital Strong (September 2012) nalysts Vanessa Flores vanessa.flores@fitchratings.com David Prowse david.prowse@fitchratings.com Fixed-Charge Coverage Low: Fitch considers the fixed-charge coverage ratio for SW and CMIG, which declined to 3.9x in 2011 (2010: 6.1x), to be low for their rating level. However, the decline was partly due to the impact of one-off restructuring costs, and the agency expects the ratio to improve for 2012 and What Could Trigger a Rating ction Upgrade Unlikely: n upgrade of SW or CMIG is unlikely, given that the ratings are constrained by LBG's Long-Term IDR, which is at its Support Rating Floor and unlikely to be upgraded in the near term. SW and CMIG could be downgraded if LBG were downgraded Weaker Standalone Profile: SW and CMIG could be downgraded if Fitch considered that their combined credit profile had worsened, as indicated by a sustained decrease in regulatory solvency to below 1.4x, a fall in fixed-charge coverage to below 3x or a significant deterioration of market position indicated by a material decline in the value of new business. 30

2 Market Position and Size/Scale Strong Market Position and Scale Strengthen Rating SW: large UK life insurer CMIG acquisition, simplified structure LBG: largest UK bancassurer Change in new business product mix SW: Large UK Life Insurer With GBP5.4bn of gross earned premiums (GEP) in 2011 (2010: GBP4.0bn), following the acquisition and consolidation of CMIG in the same year, the SW group maintains its position as one of the largest life insurers in the UK (ranked third by premiums in 2010). The SW brand is well-established in the UK. LBG s decision to sell all new insurance business using the SW brand reinforces Fitch s view of SW s strategic importance to its parent. CMIG cquisition, Simplified Structure SW acquired CMIG in July 2011 (for a total of GBP1,846m) to improve and simplify its organisational structure and improve the capital efficiency within LBG. These actions should improve LBG s capital position under Basel III and Solvency II. LBG: Largest UK Bancassurer Figure 1 SW Distribution Channels Bancassurance 31% Direct 6% Intermediary 63% By market share, LBG is the largest bancassurer in the UK and has one of the largest intermediary channels in the industry. Fitch views the bancassurance distribution channel positively in the context of the regulator s forthcoming Retail Distribution Review (RDR). Fitch believes that bancassurance may play a growing role in the distribution of life products, given the upcoming implementation of regulatory reforms that aim to cut sales-based commission to advisers. Change in New Business Product Mix Source: SW's consolidated annual accounts The SW group s sales focus in 2011 turned to more profitable protection products, rather than lower-margin products. Sales of protection products were up by 23% in terms of present value of new business premiums (PVNBP) and accounted for 22% of bancassurance distribution (2010: 13%). Figure 2 Ratings Range Based on Market Position and Size/Scale IFS Rating Category Senior Debt Rating Category Large Market Position and Size/Scale Medium Market Position and Size/Scale BBB BBB BB <BBB <BB Small Market Position and Size/Scale Source: Fitch Related Criteria Insurance Rating Methodology (October 2012) 2

3 Corporate Governance and Management Corporate governance and management are adequate and neutral to the rating. The majority of the board of directors are independent, as defined by the LSE. SW reports its results under IFRS, its operating subsidiaries report results according to statutory accounting principles. CMIG s FS returns are publically available. PricewaterhouseCoopers is SW and CMIG s auditors. The audit opinion for 2011 for LBG s group accounts was unqualified. SW and CMIG s ultimate parent is LBG. Recent restructuring has led to a moderately simple holding company structure with some insurance-subsidiary-stacking. Ownership is Negative to Rating The SW group s ultimate parent is LBG. LBG is a public company and is listed on the London Stock Exchange. The UK government currently holds a 39.2% stake in LBG. Fitch considers the life insurance units to be important to LBG, particularly in light of the opportunities to cross-sell bank and insurance products. The group s insurance operations accounted for 13% of the group s revenue in The standalone profile of the SW group (ie SW and CMIG) is commensurate with an IDR of +. However, ownership by LBG is negative to the ratings as they are constrained by the Long-Term IDR of LBG; ''/Stable. CMIG does not benefit from any formal support agreement from SW or LBG and the CMIG brand has largely been phased out in favour of SW. Certain CMIG products, particularly pensions, have been discontinued in favour of SW equivalents. However, CMIG is now wholly owned by SW in the new organisational structure and Fitch regards the company as Important to SW in the context of the agency s insurance group rating methodology, and grants some benefit to its ratings through aligning them with those of SW, to reflect the full integration of the management and operations of CMIG with those of SW. Figure 3 Structure Diagram Before fter Lloyds Banking Group plc Lloyds Banking Group plc LTBS Bank plc LTBS Bank plc HBOS plc LTSB-heritage GI Business Scottish Widows Group HBOS plc Scottish Widows Group HBOSheritage Life Business (Clerical Medical) HBOSheritage GI Business LTSB-heritage Life Business (Scottish Widows) Combined GI Business Combined Life Business Source: SW group 3

4 Sovereign and Country- Related Constraints Fitch rates the sovereign obligations of the United Kingdom at with a Stable Outlook, and the Country Ceiling is similarly. Therefore, the ratings of UK insurance companies and other corporate issuers are not directly constrained by sovereign or macroeconomic risks. Industry Profile and Operating Environment Strong Capital offset by Relatively High Leverage and Subdued Profitability majority of UK life insurers in Fitch s rated universe have IFS ratings in the or categories. Key risks the industry faces include: macroeconomic uncertainty, investment risks tied to fixed-income and equity holdings, prolonged low interest rates, price competition and regulatory changes. The sector s direct shareholder exposure to the sovereign debt of Greece, Ireland, Portugal, Spain and Italy is generally minimal. The implementation of Solvency II, the new risk-based regulatory regime for European insurers from 2014, and the Retail Distribution Review, which will end sales commissions for investment products from 2013, threatens disruption to the industry in the short term. The industry withstood the financial crisis reasonably well, with capital largely rebounding as a result of earnings retention, investment gains and de-risking of balance sheets. This capital strength balances with relatively high financial leverage and low interest coverage for rating levels, reflecting significant use of hybrid debt financing. Near-term expectations are for subdued profitability as yields on invested assets remain low. Most insurers are undertaking cost-cutting to bolster profitability. Figure 4 Ratings Range Based on Industry Profile/Operating Environment IFS Rating Category Senior Debt Rating Category Life Insurance Source: Fitch BBB BBB BB <BBB <BB Peer nalysis Scale Comparable to Peers ; Financial Performance Relatively Strong The SW group including CMIG is comparable to peers in terms of total assets and premiums. Its financial performance has been relatively consistent over the last five years (barring a dip in profitability during the crisis in 2008). Fitch expects profitability to continue improving. Capital is strong on a consolidated basis and SW s position in the UK life and pensions market is solid. SW s post-tax return on assets compares well with its peers. Figure 5 Peer nalysis 2011 IFS rating of primary operating entities ssets (GBPbn) Total equity (GBPm) IFRS profit (GBPm) Post-tax return on assets (%) New business margin (PVNBP basis) (%) Regulatory solvency ratio (x) Scottish Widows (consolidated figures, Stable 125 6, include CMIG) Friends Life +, RWN 124 5, Legal & General -, Stable 327 5, Standard Life +, Stable 160 4, Old Mutual +, Negative , Source: Companies, Fitch 4

5 Figure 6 Capitalisation and Leverage (GBPbn) a Fitch's expectation Total equity Fitch expects the SW group s capital to IGD surplus n.a remain strong for its current rating level. Total financing and commitments ratio (x) djusted financial leverage, including FF (%) a Including CMIG results Source: Company annual accounts, Fitch Capital is Strong for Rating Category Strong regulatory capital Ring-fenced with-profits capital supports standalone view Risk of capital extraction Financial leverage favourable relative to peers average Debt issued by CMF is guaranteed by CMIG Strong Regulatory Capital The SW group s (including CMIG) Insurance Group Directive (IGD) surplus a key regulatory measure of capital was GBP3.7bn at end This excludes surplus assets available in with-profits funds, which Fitch recognises as a potential source of capital. On July 2011, the group benefited from a GBP821m capital injection from LBG to purchase CMIG. Ring-Fenced With-Profits Capital Supports Standalone View In addition to working capital of GBP80m (end-2011), SW s with-profits fund benefits from support accounts held in the company s non-profit fund. These accounts were set up at the time of demutualisation and cannot be reduced below a certain level (depending on the asset shares of in-force policies that were issued before demutualisation). The support arrangement assets at end-2011 were GBP180m. Risk of Capital Extraction Fitch believes that LBG will continue to extract excess capital from the SW group, as and when it becomes available; although the agency expects the insurance businesses solvency to remain strong. Special dividends from the insurance operations to LBG have declined in recent years (SW paid GBP210m in 2010, compared with GBP1.8bn in 2007). However, regular dividend payments are planned. No dividend was paid in Financial Leverage Favourable Relative to Peers verage The SW group s financial leverage is favourable relative to most peers, and significantly below the peer average. The group s leverage decreased to 22% in 2011 from 27% in The increase in leverage in 2010 was the result of SW s internal issuance of GBP800m of perpetual debt to LBG. This action was part of a capital raising initiative which was designed to mitigate the Basel III capital requirements of LBG s ownership of the insurance entities. The debt issue is entirely accounted for as debt in Fitch s leverage calculation. Debt Issued by CMF is Guaranteed by CMIG Debt issued by Clerical Medical Finance (CMF) is guaranteed by CMIG. CMF s earliest call date is in July 2013, on its EUR219m issue. 5

6 Figure 7 Debt Service Capabilities and Financial Flexibility Fitch's expectation Fixed-charge coverage ratio (x) Fitch expects this ratio to remain only moderate as a result of lower earnings due to depressed operating conditions. Source: Fitch Fixed-Charge Coverage Low but Improving, Financial Flexibility Moderate Fixed-charge coverage low but improving Moderate financial flexibility Fixed-Charge Coverage Low but Improving Fitch considers the fixed-charge coverage ratio for SW and CMIG, which declined to 3.9x in 2011 (2010: 6.1x), to be low for their rating level and low relative to peers. However, the decline was partly due to the impact of one-off restructuring costs, and the agency expects the ratio to improve for 2012 and Figure 8 Peer Comparison Table Company 2011 Financial Leverage (%) 2011 Fixed-charge Coverage (x) Scottish Widows plc (consolidated figures include CMIG) Old Mutual Legal & General Standard Life verage Source: Company annual accounts, Fitch Moderate Financial Flexibility Fitch considers that the LBG group s ownership of the SW group limits somewhat the latter s financial flexibility as reflected in LBG s reliance on state aid. However LBG has been supportive of its insurance operations: demonstrated through the GBP800m of perpetual debt issued in June Moreover, Fitch believes that the SW group has an adequate credit profile to access the debt markets. 6

7 Figure 9 Financial Performance and Earnings (GBPm) Fitch's expectation SW net income Fitch expects the SW group to keep its focus on higher-margin SW post-tax return on assets (%) protection products, but the agency expects overall profitability to be constrained by the negative operating environment and low interest rates. Source: Company annual accounts, Fitch Improved Business Mix, Litigation Risk in Germany New business margins increasing Sales volumes down Uncertain adequacy of German litigation provision New Business Margins Increasing The group s net income was GBP282m in 2011 (2010: GBP248m, excluding CMIG). Its new business profitability is relatively strong and improving, driven by a shift towards higher-margin protection business and the closure of some low-margin product lines. Margins on new business sales were relatively high in 2011 rising to 4.0% from 3.5% in 2010 and 3.2% in This increase reflects a change in the mix of business written by SW group, with a move away from single-premium savings products to higher-margin protection business. Figure 10 New Business Margins Comparison PVNBP basis (%) Scottish Widows Friends Life Legal & General Standard Life Source: Companies, Fitch The margins shown in Figure 10 are heavily driven by business mix and by each company s choice of underlying embedded value reporting methodology and assumptions. nnuity business (which Legal & General writes in significant volumes) tends to be particularly highmargin (but carries significant credit and longevity risk), whereas unit-linked savings and pensions business (which dominates for Friends Life and Standard Life) tends to be lowermargin (but carries less risk). SW group write both types of business so its new business margin lies between those of the other companies. Sales Volumes Down SW group sales fell by 1% in 2011 to GBP10,219 on a PVNBP basis (2010: GBP10,316), partly reflecting the recent integration of CMIG business and the ongoing change in product mix towards protection products, which generate lower premiums (but more profit per premium) than savings and investment products. The drop also reflects a declining appetite for savings products as a result of unattractive investment yields and consumers increased preference for paying down their debt. 7

8 Uncertain dequacy of German Litigation Provision SW group has set aside a GBP175m provision for potential mis-selling claims relating to insurance policies sold by CMIG through intermediaries in Germany during The ultimate amount of compensation that may have to be paid and therefore the adequacy of the provision is not yet clear, so there is a risk that the group s earnings and capital may be negatively affected if the provision proves insufficient to cover the ultimate costs. 8

9 Figure 11 Investment and sset Risk Fitch's expectation SW non-investment-grade bonds/equity (%) Fitch expects SW to invest more in higher-yield assets SW unaffiliated equities/equity (%) to pursue higher investment returns. SW total risky assets/equity (%) Source: Fitch Figure 12 SW Group sset Split End-2011 With profits fund 29% Source: SW Figure 13 Shareholder assets 18% SW Debt Securities by Credit Rating End-2011: GBP237,580m 16% BBB 11% 7% Source: SW annual accounts Investment contracts 53% Non investment grade 3% 64% Investment Risks Low Low investment risk borne by SW With-profits fund asset risk hedged Fixed-interest investments of high quality Low Investment Risk Borne by SW The SW group s assets comprise: those backing unit-linked investment contracts where investment risk is borne by the policyholders, with-profits funds where investment risk is shared between the company and its policyholders, and shareholder assets where investment risk is borne by the company. Figure 12 gives an indication of this split. The with-profits fund has certain investment restrictions and assets backing annuities (shareholder assets) are largely invested in high-quality fixed-interest assets. Overall Fitch considers SW group s investment risk to be low, reflecting the business mix which is predominantly unit-linked and with-profits savings, with a relatively low proportion of annuities and associated credit-risk. With-Profits Fund sset Risk Hedged The with-profits fund is tested regularly to ensure its solvency. Shareholder exposure to asset risk in the with-profits fund has been mitigated with hedges, which are managed in the nonparticipating fund. Fitch views this risk mitigation positively. Fixed-Interest Investments of High Quality ssets backing annuities are matched to the projected liability cash flows. The investment policy is to hold investment-grade bonds with an average credit rating of or higher. 9

10 Figure 14 sset/liability and Liquidity Management SW liquid assets/policyholder liabilities (non-linked, %) Fitch's expectation Fitch expects SW s liquid assets/policyholder liabilities ratio to remain stable. Source: Fitch Sophisticated LM, High Liquidity Liquidity adequate for rating level Liquidity remains good under stressed scenarios Sophisticated LM enhanced by LBG Liquidity dequate for Rating Level SW s liquid assets/policyholder liabilities ratio is over 100%, which indicates a strong liquidity position. The group holds a diversified portfolio of marketable equities and highly rated debt securities. Fitch views this diversification positively and does not see liquidity risk as a major concern for SW or CMIG. Liquidity Remains Good Under Stressed Scenarios The SW group monitors its exposure to liquidity risk (excluding annuity business) by considering a stressed scenario of 12 months of surrenders and three months of maturities, and comparing this with the liquid assets available. In this analysis, SW does not take into account future premiums from policyholders, which is prudent. t end-2011, the group had sufficient liquidity to cover this scenario. Sophisticated LM Enhanced by LBG The SW group s invested assets are adequately liquid for its rating level and compare well with peers. The group has sophisticated LM processes, backed up by resources and skills from the wider LBG group. 10

11 Reinsurance, Risk Management and Catastrophe Risk dequate Reinsurance Programme Mitigates Insurance Risks Reinsurance strategy consistent with strategic aim Reinsurance on all significant lines of business Reduction of internal reinsurance arrangements Reinsurance Strategy Consistent With Strategic im The SW group s reinsurance policy aims to reduce the volatility of its profits. The group manages its insurance and credit risk in line with pre-set risk-appetite parameters. In common with most life insurers, the group has a low reinsurance utilisation ratio (2011: 4%). Reinsurance on all Significant Lines of Business The SW group has reinsurance treaties on all lines of business where there is significant morbidity or mortality risk in excess of the company s predefined retention limits for these risks. ll treaties are reviewed annually and new treaties must be approved by the Board. Reduction of Internal Reinsurance rrangements The SW group intends to recapture most internal reinsurance arrangements, as these could incur high charges under Solvency II. This will improve the regulatory capital strength of both companies under Solvency II. Fitch believes these actions are consistent with peers, and expects the group s life insurance operations to move to external reinsurance arrangements to insure the excess risks. 11

12 ppendix : Other Ratings Considerations Below is a summary of additional ratings considerations of a technical nature that are part of Fitch s ratings criteria. Group IFS Rating pproach SW s ratings are based on an analysis of the SW group s profile, which includes taking into account its ownership by LBG. CMIG is rated on a group approach, with CMIG being considered Important to SW. CMIG s ratings have been aligned with those of SW to reflect the full integration of the management and operations of CMIG with those of SW. Notching Fitch regards the United Kingdom as having a Strong regulatory environment, with restrictions on payments from the operating companies to the holding companies and with priority afforded to policyholder obligations. Notching Summary Holding Company Not applicable. IFS Ratings The standalone profile of the SW group (ie SW and CMIG) is commensurate with an IDR of + but the IDR and the IFS ratings are compressed to as they are constrained by the Long-Term IDR of their ultimate parent, LBG; ''/Stable. recovery assumption of Good applies to primary policyholders in the United Kingdom. Based on standard notching given the existence of policyholder priority, the IFS rating would normally be one notch higher than the IDR. However in this particular case, the IFS rating has been capped by the IDR of LBG and is therefore at the same level as the IDR. Debt Not applicable. Hybrids For the rated subordinated debt issues, a baseline recovery assumption of Below verage was used. In addition, all of the issues are regarded as having Material loss absorption features (such as ability to defer coupons). Based on the combination of these two characteristics, standard notching was applied, placing the Scottish Widows hybrid two notches below the IDR of Scottish Widows and the Clerical Medical Finance hybrids guaranteed by CMIG two notches below the IDR of CMIG. Short-Term Ratings Not applicable. 12

13 Hybrids Equity/Debt Treatment Figure 15 Hybrids Treatment Hybrid mount (GBPm) CR Fitch (%) CR reg. override (%) FLR debt (%) Scottish Widows Plc GBP560m, 5.125%, call 2015, perpetual GBP800m, 3-mnt Libor+5.1%, call Clerical Medical Finance PLC EUR388m 4.25%, call 2015, perpetual a EUR219m 6.45%, call 2013, mature 2023 a GBP51m 7.38%, call 2019, perpetual a CR Capitalisation ratio: FLR Financial leverage ratio. For CR % tells portion of hybrid value included as vailable Capital, both before (Fitch %) and after the Regulatory Override. For FLR, % tells portion of hybrid value included as debt in numerator of leverage ratio a Debt issued by CMF and guaranteed by CMIG Source: Fitch Exceptions to Criteria/Ratings Limitations None. 13

14 The ratings for Scottish Widows plc were unsolicited and have been provided by Fitch as a service to investors. The ratings for Clerical Medical Investment Group Ltd and Clerical Medical Finance PLC were solicited by, or on behalf of, the issuers, and therefore, Fitch has been compensated for the provision of the ratings. LL FITCH CREDIT RTINGS RE SUBJECT TO CERTIN LIMITTIONS ND DISCLIMERS. PLESE RED THESE LIMITTIONS ND DISCLIMERS BY FOLLOWING THIS LINK: IN DDITION, RTING DEFINITIONS ND THE TERMS OF USE OF SUCH RTINGS RE VILBLE ON THE GENCY'S PUBLIC WEB SITE T PUBLISHED RTINGS, CRITERI, ND METHODOLOGIES RE VILBLE FROM THIS SITE T LL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTILITY, CONFLICTS OF INTEREST, FFILITE FIREWLL, COMPLINCE, ND OTHER RELEVNT POLICIES ND PROCEDURES RE LSO VILBLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. Copyright 2012 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. 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