Midland National Life Insurance Co. And NACOLAH 'A+' Ratings Affirmed On Criteria Review; Outlook Stable

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1 Research Update: Midland National Life Insurance Co. And NACOLAH 'A+' Ratings Affirmed On Criteria Primary Credit Analyst: Ferris Joanis, New York (1) ; Secondary Contact: Donald H Chu, CFA, Toronto (1) ; donald.chu@standardandpoors.com Research Contributor: Rennie E Parris, New York (1) ; rennie.parris@standardandpoors.com Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria And Research Ratings List JULY 11,

2 Research Update: Midland National Life Insurance Co. And NACOLAH 'A+' Ratings Affirmed On Criteria Overview Following a review under our revised insurance criteria, we are affirming our 'A+' ratings on Midland and NACOLAH, collectively Sammons. The ratings on Sammons reflect our view of the company's business and financial risk profiles as strong, and a positive one-notch holistic adjustment reflecting the strength and consistency of its operating performance relative to peers'. The stable outlook is based on our view that Sammons will maintain its strong business and financial risk profiles and above-average operating performance relative to peers'. Rating Action On July 11, 2013, Standard & Poor's Ratings Services affirmed its 'A+' long-term counterparty credit and financial strength ratings on Midland National Life Insurance Co. (Midland) and North American Co. for Life & Health Insurance (NACOLAH), collectively Sammons. The outlook is stable. Rationale The ratings on Sammons reflect our view of the company's business risk profile (BRP) and financial risk profile (FRP) as strong. We derive an 'a' BRP/FRP anchor for Sammons based on the overall strength of its financial profile. Sammons' BRP benefits from the company's well-balanced business mix of fixed-indexed annuities and life insurance, well-established distribution relationships, and very favorable operating performance. Sammons' FRP, although somewhat constrained by capital adequacy that is only marginally supportive of our benchmark for 'A+' ratings based on our capital model, is well-supported by its high-quality and well-diversified investment portfolio and exceptional liquidity. We derive an 'a+' group credit profile (GCP) by applying a positive one-notch holistic adjustment to the 'a' anchor. The holistic adjustment reflects the strength and consistency of the company's operating performance. Sammons operates within the highly developed U.S. life insurance market and therefore faces low industry and country risk. Our view of Sammons' low country risk is driven by stable economic growth prospects, relatively effective and stable political institutions, sophisticated financial systems, JULY 11,

3 and strong payment culture in the U.S. However, we see Sammons' sensitivity to interest rates and even to some extent equity-market volatility as offsetting this strength somewhat and potentially burdening long-term operating return prospects. We view Sammons' competitive position as strong, reflecting the company's well-balanced portfolio of individual annuity, life insurance, and corporate market products as well as its proven ability to generate profitable growth in all of its key business segments. Sammons is a top-five producer of index annuities in the U.S., but at the same time its overall operating earnings remain well balanced at roughly 55% and 45% between its annuity and life divisions (including corporate markets), respectively. Sammons' above-average operating performance is supported by its low-cost, compact organizational structure that enables it to design and deliver attractive products profitably through its well-established distribution network. We expect Sammons to maintain its strong competitive position in the indexed annuity market, well-balanced business mix, and above-average operating performance through its focus on disciplined expense management. We view Sammons' capital and earnings as strong and consistent with the rating, although capital is only marginally supportive of our benchmark for 'A' rating targets, based on our capital model. The company's total adjusted capital (TAC) improved in 2012 to $3.5 billion from $3.0 billion as of year-end The TAC in 2012 benefited from strong statutory net income, but also reflects Sammons' continued capital-optimization strategies, which include using reinsurance and captive reinsurers to fund excess economic statutory reserves on its term and universal life products. In 2012, Sammons generated about $474 million of statutory net income, up from $454 million in Despite Sammons' strong earnings capability, capital adequacy remains only marginally supportive of the ratings largely because of the level of capital required to support the company's continued strong growth. We believe that Sammons' earnings and financial resources available from its parent, Sammons Enterprises Inc. (SEI; not rated), and reinsurance access will be sufficient to maintain capital redundancy at the 'A' level. To the extent that capital strain from rapid growth outpaces these resources, capital adequacy could erode below the levels we expect for the ratings. We view Sammons' risk position as intermediate, reflecting its high-quality, well-diversified investment portfolio. Guggenheim Partners Investment Management Inc. (Guggenheim) is Sammons' investment manager and implements the company's generally conservative investment guidelines and appropriate credit risk management. Overall, its speculative grade and 'BBB' rated bond holdings are below industry averages, and the credit quality of its bond portfolio remains strong with an average rating of 'A+'. Relative to the industry, Sammons allocates a significantly higher portion of its bond portfolio to municipal bonds and asset-backed securities (largely floating-rate securities). This is offset by an overall lower allocation to investment-grade corporate bonds, which is about half that of the industry's allocation as a percentage of fixed-income assets. In general, we believe Sammons' municipal bond and asset-backed securities portfolios are well managed and provide a JULY 11,

4 level of diversification from the corporate bond market. We expect the company to maintain a high-credit-quality asset portfolio and conservative investment practices. Sammons' financial flexibility is adequate and supported by its earnings, ability to issue surplus notes, and the unused debt capacity of its parent, SEI. At the same time, its financial flexibility is constrained by the company's limited access to public debt and equity markets. Financial flexibility is further constrained by Sammons' reliance on reinsurance to limit the capital strain from new business. Without the considerable excess capital it had historically, the company is increasingly challenged to finance high growth or significant acquisitions internally while maintaining capitalization consistent with the ratings. This has resulted in reduced flexibility that may limit Sammons' ability to keep pace in an increasingly competitive and consolidating industry, where efficiencies and flexibility of scale are increasingly important. We view Sammons' management and governance as satisfactory. Sammons' management focuses on developing sustainable, profitable growth and competitive advantages in its lines of business by emphasizing efficiency and service over price. The company has a leading competitive position in the index annuities market and a solid market position in the life insurance and corporate markets. Management turned its strategy into constructive action by developing a diversified distribution network and maintaining a disciplined expense structure--which were key to its profitable growth. We consider Sammons' board of directors to be relatively insular. Seven of the 10 board members are either members of Sammons or SEI's management, which implies a lack of sufficient board independence from management. However, the company's audit committee is 100% independent, which mitigates the insufficient board independence. Moreover, the board historically has shown independence from management in its decision making, and there has been no evidence of executive dominance. We view Sammons' enterprise risk management (ERM) as adequate. The company's risk management practices are organized primarily along functional lines: Its investment/asset liability management (ALM) practices follow management policies that are consistent with established prudent industry practices. A corporate ERM committee manages and aggregates risks across the various functional lines, and the company has an assigned chief risk officer. Although we generally view the company's formalized ERM practices as favorable, its overall ERM framework is still a work in progress. Sammons is currently developing more-robust and well-defined financial standards and risk tolerances. Because its risk profile lacks significant specialized exposures, we consider the moderate pace at which it's developing its ERM framework to be adequate. We regard Sammons' liquidity as exceptional, reflecting the high quality and liquidity of the company's investment portfolio and its stable insurance liability structure. Sammons' term life insurance products are well-protected JULY 11,

5 from shock lapses and don't have policyholder withdrawal options. The company's permanent life products are well-seasoned and its indexed annuity liabilities have relatively high, long-duration, surrender charges and market-value adjustment features. These characteristics all support a very stable book of business. Sammons' liquidity ratio was 310% in 2012, as measured by our liquidity model. We expect the company's liquidity to remain appropriate for the rating, but in the long-term the liquidity ratio may decline gradually as demand liabilities age and the strong surrender protections expire on an increasing portion of in-force business. Outlook The stable outlook reflects our expectation that Sammons will sustain its very strong competitive position in its key target markets, above-average operating performance, and capital adequacy at the 'A' level. We could lower the ratings if, contrary to our expectations: The company's capital adequacy falls below the 'A' level as measured by our capital model; Sammons experiences a significant loss of market position, brand strength, or geographic diversity that leads us to revise our view of its competitive position to adequate instead of strong; or Sammons' operating performance advantage over peers deteriorates and leads us to remove the positive holistic adjustment. We are unlikely to raise the ratings on Sammons in the next 24 months. Ratings Score Snapshot Financial Strength Rating A+/Stable/-- GCP a+ BRP/FRP Anchor Business Risk Profile IICRA Competitive Position Financial Risk Profile Capital & Earnings Risk Position Financial Flexibility a Low Risk Intermediate Risk Adequate Modifiers +1 ERM and Management 0 Enterprise Risk Management Adequate Management & Governance Satisfactory JULY 11,

6 Holistic Analysis +1 Liquidity Exceptional Support 0 Group Support 0 Government Support 0 Related Criteria And Research Insurance Rating Methodology, May 7, 2013 Enterprise Risk Management, May 7, 2013 Group Rating Methodology, May 7, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Principles Of Credit Ratings, Feb. 16, 2011 Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008 Ratings List Ratings Affirmed Midland National Life Insurance Co. North American Co. for Life & Health Insurance Counterparty Credit Rating Local Currency A+/Stable/-- Financial Strength Rating Local Currency A+/Stable/-- Complete ratings information is available to subscribers of RatingsDirect at and at All ratings affected by this rating action can be found on Standard & Poor's public Web site at Use the Ratings search box located in the left column. JULY 11,

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