Fitch Affirms Legal & General's IFS at 'AA-'; Outlook Stable
KEY RATING DRIVERS
The ratings reflect L&G's strong capitalisation, operational scale and market position as one of the leading UK life insurers. However, its concentration in the UK market is an offsetting factor. The company's diversification benefit from other markets is limited relative to peers rated in the 'AA' category.
L&G's high capital buffer is a major positive rating factor, allowing the group to withstand volatile investment markets. The company's score on Fitch's Prism factor-based capital model is 'extremely strong', based on end-2014 results, and it reported a regulatory solvency ratio of 198% and a with-profits surplus of GBP0.8bn at end-1H15.
L&G's financial leverage was 30% at end-2014 and 27% on a pro forma basis after the redemption of EUR600m hybrid debt in June 2015. This is high for the rating and a negative driver. However, the group's fixed-charge coverage of 10.0x (2014) is in line with the ratings, and Fitch views the group's financial flexibility and liquidity as strong.
L&G's earnings are well diversified by product type in its main market. In addition, L&G owns one of the UK's leading asset managers, Legal & General Investment Management (LGIM), which adds to the group's earnings diversification and cash generation. In 2014, 23% of L&G's operating profit came from LGIM. L&G generates around 11% of its sales internationally, predominantly in the US.
L&G's net profitability in 2010-2014 was fairly stable, in the range of GBP0.7bn to GBP1.0bn. Fitch expects L&G to maintain this level of profitability, which supports the ratings.
Fitch expects L&G to manage capital and financial leverage in line with current levels, with other key credit metrics also likely to be stable in the near term.
L&G has high exposure to credit markets through the large portfolio of corporate and government bonds backing its UK annuity business of GBP44bn (end-2014). While this is a negative rating factor, it is largely offset by the large credit default reserve (GBP2.3bn) that the company has maintained, despite negligible net default experience in recent years.
L&G has high exposure to longevity risk through its large UK annuity book. It is also exposed to pricing risk when insuring large pension scheme liabilities.
We believe L&G will be resilient to the negative effects of recent pension reforms on the UK annuity market, as it is a large group with a diverse product range. In particular, it has a market-leading bulk-purchase annuity business and the capability to take on more bulk annuities to fill the gap from reduced individual annuity sales.
L&G's bulk annuity business is already larger than its individual annuity business. Bulk annuities accounted for GBP6.0bn of the GBP6.6bn annuity premiums written by the company in 2014, and GBP28.8bn of its GBP43.4bn total stock of annuity assets at end-1H15 was derived from bulk-annuity transactions.
Under our insurance rating methodology, we consider Banner Life and William Penn (together, Legal & General America (LGA)) as core to L&G and therefore align their IFS ratings with that of Legal & General Assurance Society Ltd, the other core rated operating entity in the group. Their core status reflects their long ownership by L&G; their importance to L&G's growth strategy; the diversification benefit for L&G between mortality risk in LGA and the longevity risk in the UK business; L&G's long history of direct capital funding to support LGA's growth; materiality (LGA represented 22% of L&G's insurance gross written premiums in 2014 and 11% of its value of new business); shared management; and consistency of branding.
The ratings could be downgraded in the event of a fall in the group's Prism factor-based capital model score to low in the 'very strong' range, an increase in financial leverage to more than 35% or interest cover below 5x for a sustained period. Banner Life and William Penn's ratings could also be downgraded if their profitability or market position deteriorates to such an extent that Fitch no longer views them as core to L&G.
An upgrade is unlikely in the medium term, given the group's concentration in the UK market and high financial leverage for the ratings. However, over the long term, an increase in international diversification could lead to an upgrade.