Global Credit Research Credit Opinion 1 DEC 2008 Credit Opinion: Helsinki, Finland Ratings Category Rating Outlook Insurance Financial Strength Moody's Rating STA A1 Contacts Analyst Phone David Masters/London 44.20.7772.5454 Jeffrey Gomez/London Simon Harris/London Key Indicators [1] 2007 2006 2005 2004 2003 Total Assets (EUR Mil.) 3,719 3,726 2,740 3,158 2,807 Equity (EUR Mil.) [2] 536 517 755 629 548 Net Income (EUR Mil.) [3] 105 71 136 142 118 Gross Premiums Written (EUR Mil.) 944 877 808 714 739 Net Premiums Written (EUR Mil.) 895 822 740 646 668 Gross Underwriting Leverage 4.9x 5.0x 3.2x 3.6x 4.6x Return on Equity (1 yr.) 20.0% 11.2% 19.6% 24.2% 22.9% Sharpe Ratio of Growth in Net Income (5 yr.) 15.3% 25.7% Financial Leverage [4] 0.5% 7.6% 7.2% 5.0% 6.0% Earnings Coverage (1 yr.) [4][5] 16.6x 12.8x 87.6x 89.1x 76.6x High Risk Assets % Invested Assets [6] 30.2% 27.7% 21.9% 29.7% 33.4% Reinsurance Recoverable % Equity 7.3% 9.9% 5.7% 2.4% 6.7% Goodwill % Equity [7] 27.0% 27.0% 20.0% 1.5% 1.6% Adv/(Fav) Dev. % Beg. Reserves (1 yr.) -2.8% 1.0% 0.3% -0.2% 2.3% [1] Information based on IFRS financial statements in relation to Pohjola Non-Life Insurance business from 2004 onwards, local GAAP for 2003 [2] Includes adjustments for unrealised gains/losses and tax liabilities [3] Net Income figures estimated using statutory tax rates [4] 2005 and prior figures do not included adjustments for pensions and operating leases [5] Estimated where limited disclosures [6] 2003 do not included adjustments for below investment grade securities [7] Figures are for Pohjola Bank for 2005 onwards, Pohjola Non Life Insurance for 2003-4 Opinion SUMMARY RATING RATIONALE Moody's A1 insurance financial strength rating (IFSR) on (PIL) reflects its good stand-alone fundamentals, together with its strategic importance to Pohjola Bank (Aa1/C+/P-1) which is the main subsidiary of the Finnish cooperative banking group, OP-Pohjola Group (B BFSR). On a stand-alone basis, credit strengths include Pohjola's strong non-life market position in Finland, as well as its good financial fundamentals with consistent profitability and very low financial leverage. These strengths are off-set by its relative lack of brand reach and geographic diversification, a relatively high proportion of high risk assets in recent years, and although recent returns on equity have generally been very strong they have been achieved within a favourable operating
environment (until summer 2007) with a historical reliance on realised gains. Notwithstanding its successful and well-managed integration to-date within OP-Pohjola, Pohjola's non-life business (collectively known as Pohjola Non-Life Insurance, "PNLI") is not covered by OP-Pohjola's joint and several liability support mechanism, although in October 2008, Pohjola Bank Plc injected a total of Eur 65m into PNLI to support its solvency position. Following the acquisition of Pohjola Group Plc by OKO (subsequently renamed Pohjola Bank/OP-Pohjola Group), PNLI, which has retained the Pohjola brand name and the vast majority of which is accounted for by PIL, from 1 January 2006 became one of two divisions of OKO, together with Banking & Investment Services. PIL is separate to the other main but smaller Non-Life operation, A-Insurance Ltd, which provides insurance for commercial truckers and taxi service branches. At YE 2007, PNLI's business, which is almost exclusively conducted in Finland, is split around 53% corporate customers, 41% private customers, with the balance being Pohjola's Baltic operations. Credit Strengths -Ownership by Pohjola Bank. -Strong market position in Finland. -Very good profitability, with significant improvement in combined ratio in recent years, although reliance on realised gains. -Very low financial leverage. Credit Challenges -Almost exclusive concentration in Finland. -Increase market share without compromising profitability. -Sustaining combined ratio below 95%. -Relatively high proportion of high risk assets. Rating Outlook The published A1 IFSR was upgraded in November 2008 following the capital injection from Pohjola Bank Plc and the ongoing integration of the insurance entities into the wider OP-Pohjola Group. What Could Change the Rating - Up -Stand-alone fundamentals of PIL remaining good with, for example, a combined ratio, on an IFRS basis, of 90% or better. -Solvency margin consistently above 70%. -Meaningful geographic and product line diversification without sacrificing profitability -An upgrade of Pohjola Bank's BFSR and senior debt rating. What Could Change the Rating - Down -A downgrading of Pohjola Bank's BFSR and senior debt rating. -Material weakening of market position. -Failure to produce a combined ratio, on a cross-cycle and IFRS basis, of under 95%. Notching Considerations Not applicable. Recent Results
At Q3 YTD 2008, the non-life division reported insurance premium revenue of Eur 697m (Q3 2007: Eur 639m), pre-tax and fair value adjustment earnings of Eur 73m (Q3 2007: Eur 125m) and an operating combined ratio of 90.0% (Q3 2007: 93.0%). DETAILED RATING CONSIDERATIONS Moody's rates PIL A1 for insurance financial strength which is two notches higher than the A3 adjusted rating indicated by the Moody's insurance financial strength rating scorecard. This rating differential reflects the company's strategic importance to OP-Pohjola as described under Other Rating Considerations. Insurance Financial Strength Rating The key factors currently influencing the rating and outlook are: Factor 1 - Market Position, Brand and Distribution: Baa With its strong market position in Finland, in which it is currently the largest non-life player with a 27% market share at YE2007, PNLI's market share metrics are excellent. Going forward, Pohjola has publicly declared its intention to become the No.1 non-life player in Finland by 2010, and although the OP-Pohjola Group connection is helping to enhance its customer base, Moody's believes that a challenge for PNLI will be to increase its market share meaningfully without compromising profitability. Notwithstanding its strong market position, Pohjola operates almost exclusively in the relatively small Finnish market which means it lacks the franchise strength and brand reach which characterises a number of other European P&C operations including some Nordic peers, and we consider the market position, brand and distribution to be overall consistent with a Baa rated company. Factor 2 - Product risk and Diversification: Baa Product focus is considered good, although with a Commercial account (c.50%) and Liability orientation (close to 50%), Moody's views the portfolio as potentially more volatile than some of its Nordic peers, for example. Product diversification is also considered good with three distinct lines of business- Motor, Liability, and Propertyproducing at least 10% of premium. However, this is off-set by the concentration in Finland, which itself is highly concentrated, and in two business lines- Statutory Workers' Compensation and Motor which together account for a little over 50% of premiums. Factor 3 - Asset Quality: A Moody's considers PNLI's overall asset quality to be good. At YE 2007, reinsurance recoverables only represented around 10% of net assets, but this is off-set by the amount of goodwill at the group level, and in particular by the relatively high proportion of high risk assets. At YE 2007, equities are a relatively high 15% of invested assets with a relatively high equities concentration in the Finnish market, although Moody's notes that this has decreased significantly during 2008. Factor 4 - Capital Adequacy: A Following recent dividend payment to the group as part of the new 70-75% solvency ratio target (YE 2007: 73%), PNLI's gross underwriting leverage and reported solvency ratio metrics have deteriorated significantly from 3.2x and 107% at YE 2005 to 4.9x and 73% respectively at YE 2007 and therefore compare much less favourably with peers. Moody's further notes that as at Q3 2008, the reported solvency margin had fallen to 65% and hence a capital injection totalling Eur 65m was made to the insurance operations in October 2008 to restore the solvency position to almost 70%. Moody's considers PNLI's business to be higher risk than some of its Nordic peers in view of the liability and commercial account orientation, although consistent delivery of bottom-line profits and enhanced reinsurance cover are noted, and overall we consider capitalisation to be good. Factor 5: Profitability: A PNLI's five year average return on equity (excluding fair value gains/losses) is a very strong 20% although this is off-set by a Sharpe ratio, which considers volatility, in the Baa range. Furthermore, the operating environment for Nordic P&C players in recent years has been very favourable with 2005-2007 perhaps the peak, and PIL's net realised gains, for example, from 2002-2006 have averaged around 95% of pre-tax operating income. However, during Q3 YTD 2008, negative changes in fair value reserves totalled approximately Eur 140m, which have impacted both capitalisation levels and overall levels of profitability. Overall, Moody's currently considers profitability to be consistent with an A rated company. Factor 6: Reserve Adequacy: A The reserve adequacy metric is excellent driven by only moderate evidence of net reserve deterioration on average over the last five years. However, Moody's considers reserve adequacy to be good, as opposed to excellent, because of the presence of longer-tail lines which presents the challenge of associated reserving risk.
As has been seen in recent years, PNLI's reserves are vulnerable to longevity risk and a lowering of the discount rate, the latter for example negatively impacting the 2005 combined ratio by 3% points. Factor 7: Financial Flexibility: A Overall financial flexibility is considered good. Financial leverage is very low and Moody's notes that the internal Eur 40m subordinated loan was repaid before the 2007 year end. However, on a stand-alone basis, none of the Pohjola non-life companies are listed in their own right and access to capital is not viewed as comparable to larger European players. Other Considerations Nature and Terms of Implicit Support PIL's stand-alone insurance financial strength rating of A3 currently derives a two notch uplift as a result of its strategic importance to Pohjola Bank, the issuer rating of which benefits from it being the central bank and main subsidiary of the OP-Pohjola group the B BFSR of which translates into a baseline risk assessment of Aa3. The integration to-date of Pohjola's non-life business into Pohjola Bank and OP-Pohjola Group has been successful and well-managed, with 229 OP service outlets currently providing both banking and non-life insurance services. Furthermore, OKO Bank plc renamed itself as Pohjola Bank plc, effective as of 1 March 2008. Most Pohjola nonlife branch offices have now moved to premises of the member banks, and most IT and administrative services have been combined with corresponding functions of Pohjola Bank. Furthermore, the risk management functions of PNLI and OP-Pohjola are integrated. OP-Pohjola Group's support mechanism in which all the member banks provide each other with joint and several guarantees providing immediate and direct support in case of distress, does not cover, by law, insurance operations. However, Moody's views the recent demonstration of capital support to the insurance operations as being further evidence of the increasing importance of the insurance business to the OP-Pohjola Group as a whole. Rating Factors Financial Strength Rating Scorecard [1] Aaa Aa A Baa < Baa Score [2]Adjusted Score Business Profile A Baa Market Position, Brand and Distribution (25%) Aa Baa Market Share Ratio Relative Market Share Ratio Expense Ratio % NPW Product Focus and Diversification (10%) A Baa Product Focus P&C Product Diversification Geographic Diversification Financial Profile Aa A Asset Quality (5%) Aa A High Risk Assets % Invested Assets [3] 30.2% Reinsurance Recoverable % Equity 7.3% Goodwill % Equity [4] 27.0% Capital Adequacy (15%) A A Gross Underwriting Leverage 4.9x Profitability (15%) A A Return on Equity (5 yr. avg.) 19.6% Sharpe Ratio of Growth in Net Income (5 yr.) 15.3%
Reserve Adequacy (10%) Aa A Adv/(Fav) Reserve Dev. % Beg. Reserves (5 yr. 0.1% avg.) Financial Flexibility (20%) Aaa A Financial Leverage [5] 0.5% Earnings Coverage (5 yr. avg.) [5][6] 56.5x Aggregate Profile Aa3 A3 [1] Information based on year end IFRS financial statements in relation to PNLI from 2004 onwards, local GAAP for 2003. [2] The Scorecard rating is an important component of the company's published rating, reflecting the standalone financial strength before other considerations (discussed above) are incorporated into the analysis [3] 2003 figure does not included adjustments for below investment grade securities [4] Figures are for Pohjola Bank [5] 2005 and prior figures do not included adjustments for pensions and operating leases [6] Estimated where limited disclosures Copyright 2008, Moody's Investors Service, Inc. and/or its licensors including Moody's Assurance Company, Inc. (together, "MOODY'S"). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided "as is" without warranty of any kind and MOODY'S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY'S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY'S have, prior to assignment of any rating, agreed to pay to MOODY'S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody's Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody's Investors Service (MIS), also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody's website at www.moodys.com under the heading "Shareholder Relations - Corporate Governance - Director and Shareholder Affiliation Policy."