Insurance. AG Insurance NV. Composite Insurers / Belgium. Full Rating Report. Key Rating Drivers. Rating Sensitivities

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1 Composite Insurers / Belgium Full Rating Report Ratings AG Insurance Insurer Financial Strength Rating A+ Long-Term Issuer Default Rating A Subordinated bonds BBB+ Sovereign Risk Long-Term IDR Outlooks AA- Insurer Financial Strength Rating Stable Long-Term IDR Stable Sovereign Long-Term IDR Stable Financial Data AG Insurance (consolidated) 31 Dec (EURm) Dec 2015 Total assets 76,607 74,006 Total equity 6,501 6,810 Pre-tax profit Net premiums earned 5,608 5,134 Solvency II margin (%) Reported figures Source: AG Insurance Key Rating Drivers Core to Ageas Group: Fitch Ratings regards AG Insurance as the main insurance operating entity of the Ageas group and Core to the group. Its ratings are therefore derived from a combined assessment of the consolidated Ageas group. Very Strong Capital Adequacy: The ratings of AG Insurance benefit from its very strong solvency. Its regulatory Solvency II margin, calculated according to its partial internal model on non-life underwriting risk, was 207% at end Strong Financial Leverage: AG Insurance s financial leverage ratio was 22% at end-2016 (24% in 2015). We expect financial leverage to remain stable in the medium term. Adequate Financial Flexibility: Fitch views AG Insurance s financial flexibility as adequate. AG Insurance accessed debt capital markets through subordinated bond issuances in 2015 and in The company is not involved in litigation risk affecting its ultimate parent Ageas SA/NV, which is positive from the perspective of financial flexibility, Fitch believes. Strong but Pressurised Profitability: Profitability in 2016 continued to be strong and resilient to the low-yield environment. Underwriting conditions in Belgium remain challenging, however, and investment income is under pressure because of low interest rates. Fitch believes these conditions are likely to continue to put pressure on profitability. Interest-Rate Risk Mitigated: AG Insurance s life technical liabilities are subject to minimum guaranteed returns. However, the duration gap between assets and liabilities is low at 0.8 years. Individual investment products have a market-value adjustment clause if redeemed before eight years, meaning the surrender value would be equal to the value of the assets at the time of redemption. This protects the insurer against lapses due to unfavourable market movements. Strong Position in Belgium: AG Insurance is the largest insurer in Belgium. Access to extensive and diversified distribution channels, including the banking network of BNP Paribas Fortis SA/NV (Long-Term IDR: A+/Stable), benefits AG Insurance s rating. BNP Paribas has the right to terminate this agreement with three years notice starting on 1 January Even if the notice is given, Fitch expects Ageas s franchise to remain strong in Belgium, as the group would leverage existing customers and exploit alternative distribution channels, such as brokers. Rating Sensitivities Related Research Ageas SA/NV () Analysts Federico Faccio federico.faccio@fitchratings.com Nicola Caverzan nicola.caverzan@fitchratings.com Improved Profitability: The ratings could be upgraded if Ageas profitability improves over a sustained period, with a return on equity (ROE) above 10% (2016: 0.3%), a pre-tax operating return on assets of 1.1% (2016: 0.2%) or above, and group earnings being in line with 'AA'- rated peers. Deterioration in Capital Adequacy: Ageas s ratings could be downgraded if Ageas s Prism Factor-Based Model score falls to the Strong category from Extremely Strong on a sustained basis. Reduction in Profitability: The ratings could also be downgraded if Ageas s profitability weakens significantly on a sustained basis, with a (ROE) below 5% and a pre-tax operating return on assets below 0.4%. 23

2 Business Profile Very Strong Business Profile in Belgium Belgium accounted for 68% of the total cash remitted to the group in It also represents around 75% of technical liabilities. Belgium-based AG Insurance (Ageas s main operating entity) has a strong franchise in Belgium and can exploit its pricing power. It is Belgium s largest life insurer with a market share of around 27% measured by technical liabilities. AG Insurance is also the second-largest non-life insurer in the country, with 16.1% of the market, behind AXA Belgium (IFS rating: AA /Stable) with 17.7%, but ahead of Ethias S.A. (IFS rating: BBB+/Stable) with 11.2% and KBC Insurance (IFS rating: A+/Stable) with 8.4%. AG Insurance s life insurance total gross inflows (insurance plus investment contracts) were EUR4.2 billion in 2016 (2015: EUR3.8 billion), with higher inflows in individual and group life. In 1H17, inflows fell following lower sales of guaranteed products compared with 1H16. Non-life gross earned premiums stood at EUR1.8 billion in 2016, in line with AG Insurance is more active in accident and health insurance than peers, which benefits portfolio diversification, although it can make results more volatile. In 2016, AG Insurance generated 54% of life inflows and 18% of non-life inflows through the bank channel, of which a substantial part through an exclusive distribution agreement in Belgium with BNP Paribas Fortis SA/NV (LT IDR: A+/Stable) until the end of BNP Paribas has the right to terminate this agreement with three years notice starting on 1 January Even if the notice is given, Fitch expects Ageas s franchise to remain strong in Belgium, as the group would leverage on existing customers and exploit alternative distribution channels, such as brokers. Related Criteria Insurance Rating Methodology (April 2017) 2

3 Ownership Is Ratings Neutral Corporate Governance and Management Corporate governance and management are adequate and are neutral to the rating. Ageas SA/NV is the group s ultimate holding company, domiciled in Belgium. Ageas Insurance International N.V. is the group s intermediate holding company, through which the insurance operations are owned. Since May 2009, BNP Paribas Fortis has owned 25% of AG Insurance. The remaining 75% is owned by Ageas (formerly the Fortis group). BNP Paribas Fortis is 100% owned by BNP Paribas. Ageas is now active only in insurance business and holds a 75% stake in AG Insurance, and has interests in insurance companies in the UK, continental Europe and Asia. Ageas Group Structure Ageas SA/NV 100% Ageas Insurance International NV. Ageas UK Ltd 100% 75% Various Legal Entities Part of Ageas Asia Various Legal Entities Part of Continential Europe AG Insurance SA/NV 44.7% 100% 100% 100% 100% Royal Park Investments SA/NV Ageas Finlux SA Ageas Finance N.V Ageas B.V. Intreas B.V. Source: Ageas 3

4 Sovereign and Country-Related Constraints Fitch rates the local-currency sovereign obligations of Belgium at AA- with a Stable Outlook, and the Country Ceiling is AAA. Given these very high ratings, the ratings of insurance organisations and other corporate issuers in Belgium are not likely to be constrained by sovereign or macroeconomic risks, and in the specific case of AG Insurance, no constraints apply. Industry Profile and Operating Environment Belgium: Mature Market Under Pressure The Belgian life insurance market is facing challenges from falling premiums as a result of the reduction in minimum guarantees, competition from bank savings products, and the tax burden on life saving products. Total premiums have decreased since 2012, and although we expect the life market to have stabilised in 2016 after stronger demand for guaranteed products, this decline is likely to continue in 2017, despite the increasing appetite of life insurers for selling unit-linked products. We expect the non-life market to continue growing slowly. Belgian life insurers face a difficult operating environment, as persistently low interest rates constrain profitability and demand for life products. This trend is negative for margins on guaranteed products. Operating results in 1H17 were resilient, but we believe this followed a higher realisation of investment gains. We believe that recent decreases in the average guaranteed rate for new contracts (now 0.5%) will continue to suppress the demand for guaranteed products in 2H17, but this should be partly offset by growth in unit-linked products. The non-life market in Belgium is competitive but disciplined from a pricing perspective. Tariffs are under pressure but remain robust from an underwriting standpoint. The market can be prone to natural catastrophe claims (e.g. storms and floods in 2016). Results for 2016 were also affected by the terrorist attacks on Brussels. Fitch estimates the combined ratio in 1H17 to have improved to around 91% from 96% (1H16) for the market as the claims experience was more benign than in 1H16, and this should translate into a better combined ratio, which we expect to be around 90% in 2017, assuming a normalised level of weather-related claims in 2H17. 4

5 Peer Analysis Larger Scale, Strong Capital AG Insurance s peers are the mid-to-large Benelux composite insurers. AG Insurance is smaller than Achmea, but larger than other peers in the sample. Those insurers have limited exposure to non-domestic markets. In 2016, profitability was in line with the peer average, although AG Insurance s combined ratio deteriorated slightly to 96% (2015: 95%). Capitalisation, as measured by the Solvency II ratio, was strong and higher than for other peers in the sample. Peer Comparison 2016 Company IFS rating of primary operating entities Assets (EURm) IFRS equity (EURm) IFRS profit (EURm) Return on assets a (%) Combined ratio (%) Return on equity b (%) Financial leverage ratio (%) Solvency II ratio (%) AG Insurance A+/Stable 76,607 6, KBC Insurance A+/Stable 38,696 2, Ethias S.A. BBB+/Stable 19,499 2, SRLEV NV (VIVAT) BBB+/Stable 58,789 3, Achmea BV NR 93,015 9, a Group net income/ average total assets b Group net income/ average group shareholders' equity Source: Companies, Fitch 5

6 Capitalisation and Leverage (EURm) Fitch's expectation Total assets 66,775 67,237 74,024 73,783 76,331 Debt leverage, as calculated by Fitch, is Total equity 5,429 5,025 6,488 6,810 6,501 expected to remain at 20%-25% in the Financial leverage ratio (%) medium term. Solvency should remain Regulatory solvency ratio (x) a very strong. Total financing and commitments (TFC) ratio (x) a Solvency I until 2014; Solvency II (Pillar I, Partial Internal Model) since 2015 Source: Fitch, AG Insurance Very Strong Capital Adequacy and Strong Financial Leverage Very strong capital Strong debt leverage High total financing and commitments ratio (TFC) Very Strong Capital Fitch considers AG Insurance s capital adequacy to be strong, based on the regulatory solvency ratio. At end-2016, its regulatory Solvency II margin, calculated according to its partial internal model on non-life underwriting risk, was 207%. It increased to 220% at end-june AG Insurance s risks are well diversified due to its involvement in life and non-life businesses. However, geographical diversification is negligible, due to the company s focus on the Belgian market. Strong Debt Leverage AG Insurance s financial leverage ratio was 22% at end-2016 (24% at end-2015) according to Fitch s calculation. The ratio does not include leverage related to real-estate operations, which we consider is operational. Fitch expects financial leverage to remain stable in the medium term. Relatively High TFC The TFC ratio, which is designed to measure the total debt, financing, and capital markets footprint of an organisation and its overall reliance on access to funding sources, is relatively high, at 1.0x at end This reflects AG Insurance s use of repurchase agreements to hedge specific investments with resettable interest rates and for cash management, and the use of operational debt. Fitch views AG Insurance repurchase agreements as reasonably matched from an asset and liability management (ALM) perspective as funds are invested in highly rated securities. 6

7 Debt Service Capabilities and Financial Flexibility (x) Fitch's expectation Fixed-charge coverage ratio (including realised and unrealised gains) Source: Fitch Fitch expects AG Insurance s run-rate fixed-charge coverage ratio to remain above 7x. Adequate Financial Flexibility Subordinated debt issued directly Adequate fixed-charge coverage (FCC) Subordinated Debt Issued Directly Until December 2012 the debt issued by AG Insurance was fully owned by Ageas Hybrid Financing and therefore the company had no outstanding public debt. However, in 2013 and 2015, AG Insurance issued subordinated debt directly in its own right, demonstrating its access to debt capital markets. Adequate FCC AG Insurance s FCC, excluding realised and unrealised gains and losses, was 9x for We expect the FCC ratio to remain above 7x, which is Strong. 7

8 Financial Performance and Earnings (EURm) Fitch's expectation Net income Fitch expects AG Insurance s profitability to Combined ratio (non-life) reported (%) remain strong but under pressure as Pre-tax operating earnings (excl. nontechnical interest rates remain low. We expect the gains and losses) Fitch calculated combined ratio to be below 95% in Net income return on equity (%) Pre-tax operating return on assets (including realised and unrealised gains) (%) Source: Fitch, Ageas Strong but Pressured Profitability Strong net profitability Solid life profitability Adequate underwriting profitability for non-life business Strong Net Profitability Fitch considers that AG Insurance s profitability is strong and stable over time. This is despite investment income being under pressure due to low interest rates. Fitch believes these investment conditions are likely to continue in Profitability, measured by net income ROE, remained strong at 8% in Nonetheless, AG Insurance s earnings are sensitive to financial markets volatility, as investment earnings come largely from realised investment gains, which may not recur. Fitch s analysis of earnings growth suggests that AG Insurance has expanded its life and nonlife businesses in line with the Belgian market over the past five years. Solid Life Profitability The life operating margin on guaranteed products, measured by operating return on assets (ROA), was a strong 1.1% in 2016, supported by realised gains. AG Insurance has a loyal customer base in Belgium; its savings contracts have an average maturity of more than eight years and lapse rates are low. Adequate Underwriting Profitability for Non-Life Business AG Insurance s non-life underwriting profitability is adequate. The combined ratio deteriorated slightly to 96% in 2016, better than Fitch s expectations, from 95% in The result was negatively affected by the terrorist attacks and weather-related events in 1H16. AG Insurance is exposed to retained risk on natural catastrophes, which creates some volatility in the ratio. We expect the combined ratio to improve in 2017 because of the non-recurrence of costly events and to come in below 95%. It was 90.3% in 1H17. Competition remains strong in most lines of business in Belgium, preventing underwriting profitability from improving greatly. AG Insurance s strong market position in workers compensation and other liabilities lines in Belgium partly explains its relatively high combined ratios in these lines (98% and 103%, respectively, in 2016, improving yoy) as they are long-tail. 8

9 Investment and Asset Risk (%) Fitch's expectation Unaffiliated shares/equity Fitch expects AG Insurance s exposure to Non-investment-grade bonds/equity risky assets to remain commensurate with Investments in affiliates/equity the current rating level. Risky assets a /equity a This ratio is a combination of the speculative-grade bonds (including unrated commercial loans), unaffiliated common stock, and investment in affiliates Source: Fitch Prudent Investment Policy Overall Cautious investment allocation Strong risky assets-to-equity ratio Significant real-estate and loans exposure Cautious Investment Allocation AG Insurance s consolidated investments, excluding unit-linked investments, stood at EUR66 billion at end The investment breakdown was 77% fixed-income securities, 12% loans and mortgages, 6% equity, 4% real estate and 1% cash. Bonds are the major asset class on AG Insurance s balance sheet, 62% of which are government bonds. The credit quality of the bond portfolio is good, with 83% rated A or higher at end-2016 and 1% sub-investment grade or unrated. AG Insurance s government bond portfolio is highly concentrated, with 52% in Belgium and 19% in France. Loans are predominantly to government and official institutions of high credit quality; 35% of the loans to banks and commercial loans are sub-investment grade or unrated, but they represent about 30% of the total loans. Strong Risky Assets-to-Equity Ratio AG Insurance's risky assets-to-equity ratio, as calculated by Fitch, is moderate. This reflects the group's investment focus on Belgian government and corporate debt. It deteriorated in 2016, however, as AG Insurance increased its exposure to equities. Significant Real Estate and Loans Exposure AG Insurance has significant exposure to real estate, in the form of investment properties and mortgage loans (residential and commercial). The market value of AG Insurance s real-estate portfolio was EUR3.8 billion at end-2016, which was 5% of total invested assets, but 58% of shareholders funds. Property investment comprises warehouses, office buildings, shopping centres, care homes and car parks. Offices are mainly located in the Brussels area, which is stable in value, thanks to the presence of the EU administration. AG Insurance has diversified its real-estate portfolio with investments in France, Spain and Germany. The real estate portfolio carried gross unrealised capital gains of EUR1.4 billion at end-2016, according to AG Insurance s estimates, in line with Fitch views AG Insurance s real-estate portfolio as being of good quality and ratings neutral. Among unrated loans (EUR2 billion out of total EUR7.8 billion, including loans to government and official institutions), mortgages were EUR1.3 billion, mainly retail positions in Belgium. They represent 20% of shareholders funds, although they are protected by more than EUR1.1 billion of overcollateralisation. 9

10 Asset/Liability and Liquidity Management (%) Fitch's expectation Liquid assets/policyholder liabilities (total) Fitch expects AG Insurance s asset-liability management structure and performance to remain adequate. Note: Liquid assets exclude loans Source: Fitch Adequate Liquidity Profile Decreasing minimum guaranteed rate Interest-rate risk mitigated Decreasing Minimum Guaranteed Rate Life technical liabilities are subject to minimum guaranteed returns. Technical provisions relating to policies carrying guaranteed interest rates are falling in the existing portfolio. Breakdown of Technical Reserves by Guarantee 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: Ageas 4.75% 3.25%-4.75% <3.25% FY10 FY16 The Belgium regulator does not impose formal requirements for guarantees on new individual life products. However, the level of interest guarantee offered by AG Insurance has decreased for new business written, along with the continued reduction in the Belgium Obligations Linéaires Ordinaires since January 2012 for individual retail products, despite intense competition. In guaranteed retail life, minimum guaranteed returns on new contracts (mainly single premium) were set at 0.25% from 1 November In group life contracts, minimum guaranteed returns are set at 0.75% on products with an interest guarantee on reserves and at 0.25% on products with an interest guarantee on reserves and future premiums. There is also no longevity risk in AG Insurance s books as customers receive a lump sum at retirement age that is not annuitised. Interest-Rate Risk Mitigated AG Insurance's duration gap between assets and liabilities is low at 0.8 years. This enables the company to achieve a better and more stable solvency ratio, at the expense of potential profits (or losses) from taking a position on interest rate movements. An additional mitigating factor is that individual investment products have a market-value adjustment clause if redeemed before eight years, meaning the surrender value would be equal to the value of the assets at the time of redemption. This feature protects the insurer against lapses if there are unfavourable investment market movements. 10

11 Reserve Adequacy (%) Fitch's expectation Reserve development/prior year equity Fitch expects AG Insurance s reserve ratio to Reserve development/net earned premium remain stable and prior-year reserve releases Loss reserves/cy incurred losses to remain positive overall (with some further Loss reserves/phs potential negative variances in certain liability CY paid losses/incurred losses lines). Change in loss reserves/earned premium ratio One year reserve development/py loss reserves Note: Negative numbers denote positive reserve developments CY: Current year PHS: Policyholders surplus PY: Prior years Source: Fitch Adequate Non-Life Reserves Adequate reserve growth and experience Tail risk in Belgium from workers' compensation Adequate Reserve Growth and Experience Fitch believes AG Insurance s loss reserves have grown at a rate commensurate with growth in underwriting exposures over the past five years. Analysis of the group s claims development triangles indicates negative reserve development until 2014, in particular for certain liability lines, however development has been positive since. Fitch nonetheless believes the level of technical provisions is prudent, in light of regulatory requirements and practices in Belgium, taking into account the company s technical commitments, the return on its investment portfolios, and its expenses. Tail Risk in Belgium from Workers' Compensation AG Insurance underwrites workers' compensation lines. These lines have a long tail and are difficult to estimate reserves for. This largely explains some reserve deficiency in certain years. Despite this deficiency, Fitch views AG Insurance s overall reserving adequacy as robust and supportive of the current rating level. 11

12 Reinsurance, Risk Management and Catastrophe Risk High retention rate Mostly non-proportional cover High Retention Rate AG Insurance, in line with the Ageas group, is not a big purchaser of reinsurance, as shown by its high retention rate, which was 97.3% in non-life insurance in This reflects the low risk profile of its book of business, which mostly comprises savings-type life and protection business. Most of the ceded premiums relate to non-life product lines. Mostly Non-Proportional Cover AG Insurance purchases reinsurance coverage with excess-of-loss and stop-loss programmes. The major uses of external reinsurance include the mitigation of the effect of natural disasters (e.g. hurricanes, earthquakes and floods), large, single claims from policies with high limits and multiple claims triggered by a single man-made event. The largest reinsurers are Swiss Reinsurance Company Ltd (IFS Rating: AA-/Stable), Munich Reinsurance Company (IFS Rating AA/Stable) and SCOR SE (AA-/Stable). 12

13 Appendix A: 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 Approach Fitch considers AG Insurance as strategically key and an integral part of Ageas business and therefore Core to the consolidated group. Fitch therefore applies a group approach i.e., applies the derived group Insurer Financial Strength (IFS) rating to this rated entity. The ratings are based on an assessment of the consolidated Ageas group. Notching For notching purposes, the regulatory environment of Belgium is assessed by Fitch as being Effective, and classified as following a Group Solvency approach. Notching Summary IFS Ratings For AG Insurance, a baseline recovery assumption of Good applies to the IFS rating, and standard notching was used from the IFS anchor rating to the implied operating company IDR. Operating company debt Not applicable. Holding company IDR Not applicable. Holding company debt Not applicable. Hybrids For the two issues rated by Fitch (USD550 million perpetual subordinated bond issued in March 2013 and EUR400 million dated subordinated bond issued in March 2015), a baseline recovery assumption of Below Average is assumed, and they are deemed to have Moderate risk of non-performance due to mandatory deferral triggers linked to a regulatory solvency event, meaning that the ratings are two notches lower than the IDR of the insurance company. Source: Fitch 13

14 Hybrids Equity/Debt Treatment Hybrids Treatment Hybrid Amount (EURm) CAR Fitch (%) CAR reg. override (%) FLR debt (%) AG Insurance Fixed perpetual subordinated notes 500 a Fixed to floating dated subordinated notes Fixed to reset dated subordinated notes CAR Capitalisation ratio: FLR Financial leverage ratio For CAR % includes portion of hybrid value included as available capital, both before (Fitch %) and the regulatory override For FLR, % includes portion of hybrid value included as debt in numerator of leverage ratio a USD550m Source: Fitch Criteria Variations None. 14

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