Penn Mutual Life Insurance Co. And Penn Insurance & Annuity Co.

Transcription

1 Penn Mutual Life Insurance Co. And Penn Insurance & Annuity Co. Primary Credit Analyst: Shellie A Stoddard, Hightstown (1) ; shellie.stoddard@standardandpoors.com Secondary Contacts: David M Zuber, New York (1) ; david.zuber@standardandpoors.com Elizabeth A Campbell, New York (1) ; elizabeth.campbell@standardandpoors.com Table Of Contents Rationale Outlook Base-Case Scenario Company Description: An Established Position In Individual Life, With Complementary Distribution Channels Business Risk Profile Financial Risk Profile Other Assessments Accounting Considerations Related Criteria And Research FEBRUARY 12,

2 Penn Mutual Life Insurance Co. And Penn Insurance & Annuity Co. SACP* Assessments SACP* Support Ratings Anchor a+ + Modifiers 0 = a+ + 0 = Financial Strength Rating Business Risk Strong ERM and Management 0 Liquidity 0 Group Support 0 A+/Stable/-- Financial Risk Very Strong Holistic Analysis 0 Sovereign Risk 0 Gov't Support 0 *Stand-alone credit profile. See Ratings Detail for a complete list of rated entities and ratings covered by this report. Rationale Business Risk Profile: Strong Strong competitive position with a solid market presence in the U.S. affluent individual life insurance and annuity markets Well-developed and diversified distribution channels Expense ratio higher than larger peers', but smaller scale may limit its ability to increase market share profitably Prolonged low interest rates and volatile equity markets pose challenges consistent with those the entire industry faces Financial Risk Profile: Very Strong Very strong capital adequacy supported by conservative investment approach and redundant AXXX reserves that are currently mostly unfinanced Capital erosion from statutory new business strain Operating performance modest on a GAAP measure Exceptional liquidity, supported by predominance of investment-grade bonds and good asset-liability matching FEBRUARY 12,

3 Outlook: Stable The stable outlook reflects our expectation that Penn Mutual Life Insurance Co. and its wholly owned subsidiary Penn Insurance & Annuity Co. (collectively, Penn Mutual) will maintain their strong competitive position and very strong capital and earnings. We expect the insurer to generate roughly $140 million to $150 million in generally accepted accounting principles (GAAP) after-tax operating income (excluding the corporate segment and realized gains) in We also expect it so generate roughly $150 million to $160 million in 2014 and an after-tax operating return on equity (ROE) of roughly 5% for the next two years. We expect Penn Mutual to continue to decrease its annuity sales while growing life sales to reach a new business mix that will lower its statutory reserve strain. Consistent with our base-case scenario, leverage (debt plus hybrids to total capital, GAAP basis) remains flat in the 15% area, and liquidity remains exceptional and well supported by Penn Mutual's investment strategy and liability profile. Downside scenario We could lower the rating if capital adequacy declines meaningfully, or if Penn Mutual increases its allocation to higher-risk assets, signaling an increased risk-position tolerance. We could also lower the rating if the company's competitive position weakens or if after-tax operating ROE (GAAP basis) falls to less than 4%. Upside scenario We consider an upgrade unlikely during the ratings horizon, given that we do not expect statutory earnings to contribute materially to capital growth during the next two years. However, if Penn Mutual demonstrates a sustained increase in its capital adequacy at a 'AAA' level, we would consider raising the ratings. Base-Case Scenario Macroeconomic Assumptions The U.S. economy continues to improve slowly with real GDP growth reaching 3.3% in 2015 from 1.9% in 2013 and 3.0% in Average 10-year U.S. Treasury note yield increases by 70 basis points (bps) in 2014, to 3.0%, and 30 bps in 2015, while the average 'AAA' corporate bond yield increases by 60 bps in 2014 to 4.8%, and 10 bps in S&P 500 Index exceeds 1,800 average level during 2014, increasing about 11% in 2014 and 5% in Company-Specific Assumptions Capital adequacy remains very strong, continuing to exceed the prospective risk-based capital requirement at the 'AA' confidence level. Penn Mutual experiences modest growth in operating income through year-end Statutory net income should turn positive during the next year, through intentionally lower annuity and less new business strain overall. Leverage (debt plus hybrids to total capital, GAAP) remains roughly 15%; liquidity remains exceptional. FEBRUARY 12,

4 Key Metrics --Year ended Dec (Mil. $) 2014* 2013* S&P capital adequacy/redundancy AA AA AA AAA AAA Financial leverage, statutory (%) Return on equity, GAAP (%) Net income from ordinary activities, GAAP *Forecast data reflect Standard & Poor's base-case assumptions. Company Description: An Established Position In Individual Life, With Complementary Distribution Channels Penn Mutual has an established position in the upscale individual life insurance market through its focus on relationship-oriented producers and a well-balanced emphasis on two complementary distribution channels: career agents, and independent agents and independent broker-dealers. Penn Mutual has consistently ranked in the top 30 companies based on total life insurance sales, ranking as the 21st largest for 2012 per the LIMRA U.S. Individual Life Insurance Sales Survey. Revenues totaled $2.7 billion in 2012 (statutory basis) and Penn Mutual was the 12th largest U.S. insurer based on new universal life sales (LIMRA). We believe that Penn Mutual has a strong competitive position in the affluent customer base; its average new policy size remains between two and three times the industry average. The rating reflects our view of Penn Mutual's strong business risk profile and very strong financial risk profile. Under our criteria, these factors lead to an anchor of either 'a' or 'a+'. We believe the company's career agency force, consistent strategy and execution, and commitment to very strong capital adequacy combined are more consistent with the assigned 'a+' anchor. Business Risk Profile: Strong We regard Penn Mutual's business risk profile as strong. The company operates predominantly in the U.S. life insurance industry, which has low risk in our assessment. In addition, Penn Mutual's commitment to a mutual ownership structure (versus a stock ownership structure) facilitates the execution of management's long-term strategy--to provide face-to-face value-added distribution to affluent markets. This is a key support to our strong business risk profile assessment. Furthermore, the mutual ownership structure provides management sufficient flexibility to undertake other long-term initiatives such as making significant investments in information technology and strengthening and expanding its well-diversified distribution network. Insurance industry and country risk: Low Our assessment of Penn Mutual's industry and country risk as low stems from our view of the very low country risk and intermediate industry risks in its U.S.-only life insurance operations. Our view of the company's very low country FEBRUARY 12,

5 risk arises from the stable economic growth prospects, relatively effective and stable political institutions, sophisticated financial systems, and strong payment culture in the U.S. In our view, Penn Mutual's life insurance operations are exposed to low industry risks due to moderate product risk, as demonstrated by its strong track record of maintaining asset-liability management mismatch to within one year. The availability of fixed-income instruments of sufficient duration to match insurance liabilities in the capital markets greatly supports this capability. But we see sensitivity to interest rates and equity-market volatility as offsetting this strength somewhat and burdening long-term operating returns. We believe persistent low interest rates and intense competition will limit the sector's growth prospects and potential for higher operating margins. Table 1 Industry And Country Risk Insurance sector IICRA Business mix (%) U.S. life Low risk 100 Competitive position: Strong Penn Mutual has a strong competitive position, in our view, due to its solid market presence in the affluent individual life and annuity markets in the U.S. and its broad complementary distribution channels. In addition, its retail broker-dealer subsidiary, Janney Montgomery Scott LLC, provides a diversified (noninsurance/fee-based) revenue stream, with revenue sources approximating 80% retail and 20% institutional. Penn Mutual's strong competitive position is enhanced by its national retail distribution network, with an established presence in affluent markets. Production is well diversified across channels, and the breakdown among the channels remains fairly consistent from year to year at approximately 40% career and 60% independent. Penn Mutual does not benefit from a highly controlled distribution (which we define as approximately half of its premiums, per our criteria) but we view the independent channels engaged by Penn Mutual somewhat favorably as we note that productivity and performance have been similarly strong across both channels. Furthermore, Penn Mutual avoids deferential treatment toward either channel and allows for a producer to change channels relatively easily. The average face amount for new policies rose roughly 3% during 2012 to $721,000 (nearly 3x the industry average of $250,000), reflecting the company's continued success in penetrating the targeted affluent market and, potentially, increased operational scale in larger face amounts. Life sales growth remained strong for the first half of 2013 at $81 million, versus $69 million in the year-ago period. Penn Mutual has offered variable annuity products opportunistically in an effort to boost both customers and distribution while building brand loyalty. Nevertheless, Penn Mutual maintains annuity products in line with its risk tolerances. It has altered its annuity offerings over time to limit its exposure to guaranteed death benefits and guaranteed income benefits. Furthermore, the company employs a comprehensive hedging strategy to address the risks associated with specific product features. Operating performance is neutral to the rating. We believe Penn Mutual's strong competitive position will improve its earnings gradually as the pressure from low interest rates and equity market volatility lessens under our base-case scenario. Also, the company's efforts to derisk its products and better align field compensation with product profitability support our expectation for longer-term improvement in its earnings profile. In the short term, however, FEBRUARY 12,

6 Penn Mutual's strategy of managing its annuities sales lower to shift its business mix will constrain its growth in earnings. We estimate the company's return on adjusted equity will be modest and flat through 2014 at roughly 5%. Our base-case assumption for insurance revenue growth through 2014 is supported by our view of moderate economic recovery and favorable demographic changes in the U.S. Table 2 Penn Mutual Combined Competitive Position --Year ended Dec (Mil. $) Gross premiums and annuity considerations 2,214 1,980 1,772 1,524 1,104 Change in gross premiums and annuity considerations (%) (11.3) Net premiums and annuity considerations 2,029 1,831 1,633 1,415 1,002 Change in net premiums and annuity considerations (%) (13.5) Total assets under management 16,167 14,522 13,388 12,032 10,736 Growth in total assets under management (%) (8.0) Reinsurance utilization (%) Financial Risk Profile: Very Strong We view Penn Mutual's financial risk profile as very strong, benefiting from very strong capital adequacy. AXXX financing has slightly offset the 2013 statutory earnings strain from new business. Penn Mutual maintains a conservative financial profile, which is demonstrated by the amount of excess capital it holds and its high-quality and liquid investment portfolio. In addition, management is committed to the mutual company structure, which relieves the emphasis on shorter-term investor objectives. This has allowed management to focus on long-term strategies to the benefit of the organization. We expect management to continue to run the company prudently, as it demonstrated when it chose to issue $200 million in surplus notes in 2010 to fund future growth. Penn Mutual has a history of self-funding of AXXX reserves for universal life with secondary guarantees, including a recent $130 million financing, and we expect the company to continue to pursue this type of financing. Furthermore, we believe that the company has an adequate hedging strategy to address the risks associated with its product profile. Capital and earnings: Very Strong We view Penn Mutual's capital as very strong and expect the company to maintain capital adequacy that supports the current rating under our base-case assumptions. Penn Mutual has very strong capital adequacy. According to our risk-based capital model, Penn Mutual was redundant at the 'AA' confidence level as of year-end We expect capital adequacy to remain very strong during the next two years. We expect management's shift in new business mix and its expense management to result in stable to improved profitability, earnings, and capital adequacy in the longer term. Also, statutory strain from new business lessens under our base-case scenario. FEBRUARY 12,

7 Table 3 Penn Mutual Combined Capitalization Statistics --Year ended Dec (Mil. $) Total assets 16,167 14,522 13,388 12,032 10,736 Adjusted total assets 16,160 14,511 13,385 12,025 10,722 Capital and surplus 1,495 1,543 1,521 1,364 1,393 Change in capital and surplus (%) (3.1) (2.1) (1.8) Total adjusted capital (TAC), regulatory required 1,569 1,609 1,593 1,414 1,504 Change in TAC (%), regulatory required (2.5) (6.0) (0.3) Reinsurance and reserves (%) Reinsurance utilization Reinsurance recoverables to capital and surplus N.A. N.A. N.A. N.A.-Not available. Penn Mutual's GAAP net income grew to $114 million through Sept. 30, 2013, a $26 million improvement year over year, primarily due to higher product fees and income from growth in the company's in-force business, along with favorable mortality. We believe the company will shift its earnings mix during the next several quarters to lower sales of its reserve strain products. As a result, we expect new life sales to comprise roughly 27% of total new sales and annuities to comprise roughly 71% of sales during In addition to GAAP operating measures, statutory operating metrics also inform our view. Table 4 Penn Mutual Combined Earnings Statistics --Year ended Dec (Mil. $) Total revenue 2,755 2,496 2,207 1,963 1,575 EBIT adjusted (9) (21) (40) 76 (1) Net income (63) (3) (49) 69 (46) Return on revenue (%) (0.3) (0.8) (1.8) 3.9 N.A. Return on revenue (including realized gains/losses) (%) (2.1) (0.6) (3.2) 3.8 (3.1) Return on assets (excluding realized gains/losses) (%) (0.1) (0.2) (0.3) 0.7 N.A. Return on capital and surplus (%) (4.2) (0.2) (3.4) 5.0 (3.3) Expense ratio (%) General expense ratio (%) Prebonus pretax earnings/total assets (%) N.A. (0.1) (0.2) N.A.-Not available. Risk position: Intermediate We view Penn Mutual's risk position as intermediate, reflecting the diversity of its investment portfolio. The portfolio has no significant sector or single-name concentration--98% of the portfolio's fixed-income investment is investment grade with a weighted average rating of 'A' (as of Sept. 30, 2013). We consider its exposure to high-risk assets, at 69% of total adjusted capital, as neutral. FEBRUARY 12,

8 Penn Mutual invests in structured securities such as commercial mortgage-backed securities (CMBS, 19% of fixed-income assets as of June 30, 2013), asset-backed securities (9%), non-subprime residential mortgage-backed securities (7%), and agency instruments (< 1%). The company typically invests primarily in the relatively stable tranches of securities that have more predictable cash-flow characteristics, to limit risks. However, since 2010, its 'AAA' rated CMBS investment level declined to 35% of total CMBS investments (as of year-end 2012) from 61%. As a result, the average CMBS stressed loss factors in our capital adequacy model for Penn Mutual have risen. Penn Mutual's CMBS portfolio has experienced no credit impairments since We also view this portfolio as potentially problematic if the macroeconomic environment were to deteriorate; however, this is not considered within our current base-case assumption given the moderate economic recovery. Table 5 Penn Mutual Combined Risk Position --Year ended Dec (Mil. $) Total invested assets 10,203 9,416 8,442 7,764 7,683 Change in total invested assets (%) Separate account assets 5,443 4,649 4,543 3,790 2,775 Net investment income Realized capital gains/(losses) (49) 7 (30) (3) (47) Unrealized gains/(losses) (42) (29) N.A. (101) 30 Net investment yield (%) Net investment yield including realized capital gains/(losses) (%) Net investment yield including all gains/(losses) (%) Portfolio composition (% of general account invested assets) Cash and short-term investments Bonds Unaffiliated equity investments N.A Real estate Mortgages N.A. N.A. N.A. N.A. N.A. Investments in affiliates Investments in partnerships, joint ventures, and other alternative investments Other investments N.A.-Not available. Financial flexibility: Adequate Penn Mutual has adequate financial flexibility, primarily due to its low GAAP debt leverage of roughly 15%. As a mutual insurance company, Penn Mutual's only direct means of raising external capital is by issuing surplus notes. The company has two surplus notes outstanding of $400 million, with GAAP EBIT interest coverage of approximately 5x based on an annual interest payment of $29 million. We expect the company's debt leverage ratio and minimum GAAP interest coverage to remain at their current levels. Penn Mutual's financial flexibility reflects its reasonable access to external capital and significant excess capitalization that amply support its plan for modest growth in The company demonstrated its ability to access the capital FEBRUARY 12,

9 markets with its first surplus note issuance ($200 million) in 2004, which it followed with another note issuance ($200 million) in The resulting financial leverage in the mid-20% area is above average for a mutual company. However, we expect the company's capital base (including recent proceeds from the financing of AXXX non-economic reserves) and earnings to be more than sufficient to support its business growth over the rating horizon. Table 6 Penn Mutual Combined Financial Flexibility --Year ended Dec (Mil. $) EBIT interest coverage (x) (0.3) (0.7) (1.9) Debt leverage (%) N.A. N.A. Financial leverage (%) Debt/EBIT (x) (43.6) (18.5) (9.6) 2.6 (311.5) Cash Flows Net cash flow from operating activities Net cash flow from investing activities (784) (860) (817) (322) (143) Net cash from from financing activities (3) (31) 18 N.A.-Not available. FEBRUARY 12,

10 Other Assessments We consider Penn Mutual's enterprise risk management (ERM) program as adequate and we view its satisfactory management and governance practices as consistent with our ratings. We view liquidity as exceptional. Enterprise risk management: Adequate Our adequate view of Penn Mutual's ERM reflects our view of the company's risk-management culture, risk controls, and strategic risk management actions as appropriate for a company with this scale and product profile. Penn Mutual has grown its block of variable and universal life products--and, as a result, its equity risk and need for hedging have increased. We therefore view ERM as being of moderate but growing importance to the rating. The company, too, acknowledges the growing importance of ERM and recently added a designated Chief Risk Officer (previously, the risk functions were part of the CFO's duties). Management and Governance: Satisfactory We view Penn Mutual's management and governance as satisfactory, reflecting our view of its strategic positioning, operational effectiveness, financial management, and governance. We consider management to be of sufficient depth, without key-man risk, and with sufficient expertise in operating its major business lines. Liquidity: Exceptional We consider Penn Mutual's liquidity to be exceptional because demand-sensitive liabilities are limited and high-grade investments provide ample resources to meet potential liquidity needs. As of year-end 2012 the company's liquidity ratio was 334%, supported by the large portion of assets in investment-grade bonds. Accounting Considerations Penn Mutual, as a mutual company, is not required to produce audited GAAP financial statements. However, management provides summary GAAP statements, which PricewaterhouseCoopers audits. The auditor provided an unqualified opinion for the 2012 financial statements. We primarily analyze Penn Mutual's operating performance based on GAAP after-tax operating income (excluding the corporate segment and realized gains). Penn Mutual's statutory capital base includes $400 million of surplus notes (one $200 million, 30-year note issued in 2004, and a second $200 million, 30-year note issued in 2010), both of which contribute to long-term capital. However, we do not give full equity credit to the 2010 issuance because combined proceeds for the two surplus notes exceed the 15% maximum for capital credit under our criteria. We include approximately $45 million of the $200 million surplus note proceeds as equity in our calculation of Penn Mutual's 2012 total adjusted capital. We consider the company's $130 million AXXX financing as operating leverage in our calculations. Rating Score Snapshot Financial Strength Rating A+/Stable Anchor a+ Business Risk Profile Strong IICRA* Low Risk FEBRUARY 12,

11 Rating Score Snapshot (cont.) Competitive Position Strong Financial Risk Profile Very Strong Capital & Earnings Very Strong Risk Position Intermediate Risk Financial Flexibility Adequate Modifiers 0 ERM and Management 0 Enterprise Risk Management Adequate Management & Governance Satisfactory Holistic Analysis 0 Liquidity Exceptional Support 0 Group Support 0 Government Support 0 *Insurance Industry And Country Risk Assessment. Related Criteria And Research Group Rating Methodology, Nov. 19, 2013 Insurers: Rating Methodology, May 7, 2013 Enterprise Risk Management, 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 Methodology For Assessing Capital Charges For Commercial Mortgage Loans Held By U.S. Insurance Companies, May 31, 2012 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 Detail (As Of February 12, 2014) Operating Companies Covered By This Report Penn Mutual Life Insurance Co. Financial Strength Rating Local Currency Counterparty Credit Rating Local Currency Subordinated A- Penn Insurance & Annuity Co. Financial Strength Rating Local Currency Issuer Credit Rating Local Currency A+/Stable/-- A+/Stable/NR A+/Stable/-- A+/Stable/-- FEBRUARY 12,

12 Ratings Detail (As Of February 12, 2014) (cont.) Domicile Pennsylvania *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. FEBRUARY 12,

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