Insurance. NN Group N.V. And Insurance Subsidiaries. Composite Insurers/Netherlands. Full Rating Report. Key Rating Drivers. Rating Sensitivities

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1 Composite Insurers/Netherlands And Insurance Subsidiaries Full Rating Report Ratings Long-Term Foreign-Currency IDR Sovereign Risk Long-Term Foreign-Currency IDR Outlooks Long-Term Foreign-Currency IDR Sovereign Long-Term Foreign-Currency IDR Financial Data (Consolidated) A AAA Stable Stable 31 Dec 31 Dec (EURbn) Total assets Total equity Gross premium income 9 9 Net income Key Rating Drivers Very Strong Capital Position: Fitch Ratings views s (NN) consolidated group capitalisation as very strong, as measured by all solvency metrics, and commensurate with the rating level. Fitch s Prism factor-based model (Prism FBM) score for the group at end-2015 was extremely strong. NN holds significant cash balances at the holding company level, which it could use to support its operations if needed. The group s financial leverage, as calculated by Fitch, was 23% at end-2015, which is consistent with the rating level. Established Dutch Market Position: NN is a large insurer with a wide range of products and distribution channels. It is a leading player and household name in its home market, the Netherlands. NN has a diverse insurance footprint in Europe, primarily offering life insurance and pension products to retail and small to medium-sized business customers. In Japan, NN is a top-three player in corporate-owned life insurance products. Investment Risk Low: The group s general account assets, for which NN bears investment risk, are predominantly invested in fixed-income instruments, largely rated A or higher, with adequate diversification by region and issuer type. Fitch estimates the group s risky assets to equity ratio to be around 51%, a level that supports the rating. Profitability Weak for Rating Level: Low profitability and significant exposure to the challenging Dutch life sector are rating weaknesses. NN s net income return on equity (ROE), although improved (2015: 8%; 2014: 3%), remains weak for the rating level. We expect profitability to stabilise around current levels, with further expense savings the likely source of normalised profit growth in the near term. Financial flexibility is supportive of the rating, with fixed-charge cover of 13x in 2015 (2014: 10x). Variable Annuities Carry Guarantee Risk: NN Japan has a run-off book of variable annuity (VA) business (end-2015: EUR10bn; end-2014: EUR13bn). VAs include embedded guarantees, which give rise to risks that are long-tailed and difficult to hedge and reserve for, in Fitch s opinion. However, we view NN s VA risks as manageable, particularly in light of the group s capital strength, its hedging programme to mitigate financial market risks on VA business, and a rapid run-off projection for the book. Rating Sensitivities Improvement in Financial Leverage/Profitability: The ratings could be upgraded if, over a sustained period, financial leverage improves to below 20% or net income ROE rises to above 9%. Deterioration in Financial Leverage/Profitability: Conversely, the ratings could be downgraded if financial leverage rises above 30% or net income ROE falls to below 5%. Weaker Capital: The ratings could also be downgraded if capitalisation weakens significantly, as measured by a fall in the Prism FBM score to below very strong. Analysts Willem Loots willem.loots@fitchratings.com Harish Gohil harish.gohil@fitchratings.com 10

2 Market Position and Size/Scale Large, Diversified European Insurer Strong, diversified position in the Netherlands Europe and Japan add diversification Significant closed block business Figure 1 Ratings Range Based on Market Position and Size/Scale IFS rating category Senior debt rating category Large market position and size/scale Medium market position and size/scale Small market position and size/scale Source: Fitch AAA AA AA A A BBB BBB BB <BBB <BB Strong, Diversified Position in the Netherlands The Netherlands is NN s core market, accounting for 68% of the group s operating result in Nationale-Nederlanden Life is the largest Dutch life insurer measured by technical reserves. Nationale-Nederlanden Schade, NN s Dutch non-life business, is the third-largest non-life insurer (11% 1 market share). Figure 2 Ongoing Business Operating Result a, 2015 Netherlands non-life 8% Asset management 8% Japan life 11% Insurance Europe 13% Netherlands life 60% a Operating result before tax, excluding central costs, central investment income, NN Bank and NN Re Through its various subsidiaries NN offers an integrated suite of financial solutions, including protection, retirement services, savings and mortgage products to the Dutch market. Distribution varies by product type and spans various channels, including regular and mandated brokers, bank distribution and the internet. NN Investment Partners is an international asset manager based in the Netherlands. It manages the assets of NN Group s insurance businesses and offers actively managed investment products to the institutional and retail market (EUR187bn assets under management at end-2015). Related Criteria Insurance Rating Methodology (September2015) 1 Source: NN Group. 2

3 Europe and Japan Add Diversification NN has a diverse insurance footprint in Europe (Belgium, Luxembourg, Spain, Greece, Poland, the Czech Republic, Slovakia, Bulgaria, Hungary, Romania, Turkey), primarily offering life insurance and pension products to retail and small to medium-sized business customers. It has a top 10 market position in most of these markets but operations are sub-scale in some markets. NN has built its business in Japan as a top-three player in corporate-owned life insurance (COLI) products. It offers a range of COLI products to owners and employees of SMEs in Japan through independent agents (more than 5,000 registered) and banks (more than 50 bancassurance partners). Significant Closed Block Business NN has significant closed block individual life books in the Netherlands and Japan, together comprising approximately 46% of the group s life insurance provisions. The Dutch individual life closed block is running off gradually, with the group expecting 50% of technical reserves to run off by It is a significant source of premium and cash generation to the group. NN s Japan closed block business comprises single premium VA individual life policies with minimum guarantee obligations sold predominantly between 2001 and Approximately 90% of the portfolio is projected to run off by the end of 2019, reflecting the short-term maturity profile of these products. 3

4 Ownership Is Neutral to Rating Corporate Governance and Management Corporate governance and management are adequate and neutral to the rating. NN Group listed on the Euronext Amsterdam stock exchange in July 2014, having previously been a subsidiary of ING Groep (ING). Under its restructuring plan, developed as a condition for the Dutch state aid it received in 2008/2009, ING was required to reduce its equity stake in NN to zero by end On 14 April 2016 ING announced the completion of its divestment of its stake in NN Group. Figure 3 Simplified Organisational Chart 100% Operating Division Netherlands Life Legal Entity Name Nationale-Nederlanden Levensverzekering Maatschappij N.V. 100% Netherlands Non-Life Nationale-Nederlanden Schadeverzekering Maatschappij N.V. 100% Asset Management NN Investment Partners Holdings N.V. 100% Netherlands Bank Nationale-Nederlanden Bank N.V. 100% Reinsurance NN Re (Netherlands) N.V. 100% Japan Life NN Life Insurance Company, Ltd. 100% European Insurance Various European Operating Entities Source: Company 4

5 Sovereign and Country Related Constraints Fitch rates the local-currency sovereign obligations of the Netherlands at AAA with a Stable Outlook, and the Country Ceiling is also AAA. At current levels, the ratings of Dutch insurance organisations are not directly constrained by sovereign or macroeconomic risks. Industry Profile and Operating Environment Cost Management Critical in Saturated Market The Dutch insurance market is mature and has one of the highest insurance penetration rates in the world and the second-largest premium volume 2 per capita in Europe 3. The market is concentrated, particularly in the life and health segments, with the six largest groups accounting for approximately 70% 4 of total market share. There is little opportunity for organic growth. Given the limited growth opportunities, cost efficiency is a key driver of profitability. Dutch insurers have been successful in achieving their cost-cutting targets, and Fitch expects that further streamlining and optimisation of cost structures will be achieved in Life Insurance Shrinking and Barely Profitable Market The life insurance market has declined sharply since 2007 as a consequence of tax changes allowing banks to compete on equal terms with insurers in the savings market. In addition, demand for unit-linked and single premium business dropped in the wake of the financial crisis. Sales of group life business a smaller part of the life insurance sector have been stable since While pensions business could represent an opportunity for growth (especially if the second pillar of occupational pensions is made mandatory), it is dependent on political developments and competition is tough. Overall, Fitch expects the life market to continue contracting in This is negative from a rating perspective but counterbalanced by the benefits of cost cutting. Stable Operating Environment in Non-Life The Dutch non-life market has been stable and profitable since the financial crisis began in 2008, with profitable underwriting amid sluggish growth. This stability is likely to continue in 2016, in Fitch s view, despite the increasing shift to price aggregators that could put pressure on pricing. Figure 4 Ratings Range Based on Industry Profile/Operating Environment IFS rating debt Life insurance Source: Fitch AAA AA AA A A BBB BBB BB <BBB <BB 2 Includes health insurance premiums. 3 Source: Dutch Association of Insurers, Source: Dutch Association of Insurers,

6 Peer Analysis Market Position Lags European Peers NN s peers are most of the pan-european insurance groups and the largest Dutch composite insurers. Although NN has a strong position in the Netherlands, its market position and scale compare less favourably with pan-european peers. However, NN s capitalisation, as measured by its regulatory solvency position, is stronger than its rivals. In the Dutch peer group, Aegon has substantial non-dutch insurance operations and is therefore more comparable to NN than other Dutch insurers that operate predominantly in the Netherlands. Aegon has a larger balance sheet and a stronger and more diversified international profile than NN, but weaker capital and profitability, and higher financial leverage. Figure 5 Peer Analysis 2015 (%) IFS rating of primary operating entities Assets (EURbn) Solvency II SCR coverage Financial leverage Net income return on equity Allianz AA/Stable a 13 Prudential AA/Stable Aegon AA-/Negative Aviva AA-/Stable AXA AA-/Stable a 10 Legal & General AA /Stable a 16 Zurich AA-/Stable b,c 23 6 NN A+/Stable Achmea N.R a 25 4 a Fitch estimate b End-June 2015 c Swiss Solvency Test SCR Solvency Capital Requirement EUR/GBP: USD/GBP: Source: Companies, Fitch 6

7 Figure 6 Capitalisation and Leverage (EURbn) Fitch s expectation Shareholders equity Fitch expects NN's group capitalisation Total financing and commitments (TFC) (x) to be stable in the near term and Financial leverage (%) a n.a financial leverage to remain above 20%. Regulatory capital ratio (Solvency I, %) Solvency II capital ratio (%) n.a. n.a. n.a. 239 n.a. - Not available/not applicable a Fitch-calculated Very Strong Capitalisation, High Financial Leverage Extremely strong Prism score Solvency II well managed Adequate financial leverage Extremely Strong Prism Score From a Prism factor-based capital model (Prism FBM) perspective, NN scored extremely strong based on end-2015 results. The Prism FBM score is a ratio of total available capital (TAC) divided by target capital (TC) at various stress levels, with the Prism score itself being equal to the highest category where TAC exceeds TC. Fitch views the group s capital position as very strong relative to peers, both on a regulatory basis and measured by Prism FBM. Solvency II Well Managed Solvency II came into force on 1 January Fitch believes that NN was well prepared for Solvency II and that its capital position is strong, despite the relatively strict application of Solvency II by the Dutch regulator, De Nederlandsche Bank (DNB). In December 2015, NN received approval from DNB for its partial internal model for the group and its Dutch insurance subsidiaries. NN aims to manage capital at each operating unit to remain within a defined risk appetite. At end-2015 all main operating units had sound coverage of Solvency II capital requirements. Moreover, NN aims to keep sufficient cash in its holding company to cover a 1-in-20 year scenario without needing to raise funds externally. Adequate Financial Leverage NN s financial leverage, as calculated by Fitch, was 23% in 2015, which is consistent with the rating level. Fitch expects financial leverage to remain broadly stable. Overall borrowing has fallen in recent years, to EUR3.7bn at end-2015 from around EUR5bn at end

8 Figure 7 Debt Service Capabilities and Financial Flexibility (EURbn) Fitch s expectation Cash at holding company Fitch expects the coverage ratio to decline to less Fixed-charge coverage ratio (x) than 13x based on expected normalised earnings. Holding Company Liquidity Fitch views s liquidity profile as strong. Financial Flexibility Adequate Financial flexibility normalised in 2015 Significant cash at holding company Fixed-charge coverage in line with ratings Financial Flexibility Normalised in 2015 Fitch believes that NN has strong financial flexibility, having successfully listed on the Amsterdam Stock Exchange and following the planned reduction in ING s shareholding. The group placed two tranches of subordinated debt in Significant Cash at Holding Company NN holds significant cash at the holding company level (end-2015: EUR2.0bn), which provides extra financial flexibility and liquidity. Strong cash generation in 2015 was partly used to fund significant share repurchases and dividend payments. Cash generation improved significantly in 2015, driven by the Dutch life operations, with all operating units contributing positively to cash remittance to the holding company (see chart). Figure 8 Dividends Upstreamed by Business Segment (EURm) Netherlands life Netherlands non-life Insurance Europe NN Japan life Asset management NN Re Other Fixed-Charge Coverage in Line With Ratings Financial flexibility is supportive of the ratings, with NN s fixed-charge coverage at 13x in Fitch does not expect interest expenses to increase significantly in the near term. 8

9 Figure 9 Financial Performance and Earnings (EURm) Fitch s expectation Net result 1, ,565 Fitch expects NN's run-rate operating profit to Operating result ,086 1,435 stabilise, and as a result net income ROE to Net income ROE a (%) stabilise within the the 6%-9% range. In the Pre-tax operating ROA (including realised n.a long run profitability growth is dependent on and unrealised gains) a (%) successful execution of future growth initiatives. Non-life combined ratio (%) n.a Net result = Net income attributable to shareholders; operating result = operating result from ongoing businesses n.a. - Not available/not applicable; ROE = return on equity; ROA = return on assets a Fitch-calculated Financial Performance to Stabilise Strong improvement in 2015 Cost savings important Strong Improvement in 2015 Fitch views NN s profitability as weak for the rating level, despite net income return on equity (ROE) having improved to 8% in NN s operating result from ongoing businesses improved significantly in 2015 to EUR1,435m, driven largely by higher investment and technical margins in the Netherlands life businesses and continued administrative expense reductions across the Dutch businesses. Higher investment margins were supported by strong private equity dividends of EUR221m. We expect profitability to stabilise around current levels as the profits of the Dutch life unit return to run-rate profitability, with further expense savings the likely source of normalised profit growth in the near term. Cost Savings Important NN Group has achieved significant administrative expense savings in its Dutch operations since its initial public offering in 2014, and is targeting approximately EUR100m further reduction in this expense base by the end of The group aims to achieve these savings by improving its operating model, simplifying business processes and streamlining customer services. 9

10 Figure 10 Investment and Asset Risk (%) Fitch s expectation Risky assets to equity n.a. n.a. 51 Fitch expects NN s investment risk to remain Equities a /equity commensurate with ratings. Non-investment-grade bonds/equity n.a. n.a. 7 n.a. - Not available/not applicable a Includes investments in affiliates Investment Risk Low Conservative general account investments Significant exposure to mortgages Conservative General Account Investments NN s general account, where NN bears investment risk, is predominantly invested in fixedincome instruments, including mortgages. Of the general account bond portfolio, 88% is rated A or higher (end-2015), with adequate diversification by region and issuer types. Fitch expects the group to increase its exposure to equity, real estate and corporate bonds in search of higher yields in the Dutch life business. However, the group s ratings are relatively immune to small changes in the investment risk profile. Figure 11 Figure 12 General Account Investments Total EUR117bn, FYE15 Fixed Income Securities a By Credit Rating, Total EUR70bn, FYE15 Real estate 4% Cash 7% Equities 3% Other 2% A 21% BBB 10% <BBB/Not Rated 2% AAA 34% a Includes mortgages Fixed incomeª 84% a Excluding mortgages AA 33% Significant Exposure to Mortgages By European standards, the share of mortgages in NN s overall portfolio is high, reflecting a unique Dutch market practice in which life insurance policies and residential property mortgage loans are sold to individual customers as packaged financial products. Fitch views the group s risk management of its mortgage exposure as adequate. 10

11 Figure 13 Asset/Liability and Liquidity Management Fitch s expectation Liquid Assets to Policyholder Liabilities a (%) n.a. n.a Fitch expects NN's liquid asset ratio to remain stable in the medium term. a Fitch estimates, includes provisions for risk of policyholders Strong Liquidity and Asset-Liability Management Strong liquidity Good asset-liability matching Strong Liquidity NN Group monitors the liquidity position of each of its operating companies and manages overall liquidity by reference to a liquidity risk framework which stresses the group s liquidity requirements for a 1-in-20 year stress event. Fitch views overall liquidity as strong, as measured by liquid assets to technical reserves, and supported by significant cash kept in the holding company. Good Asset-Liability Matching NN manages its economic interest rate risk by matching assets and best estimate liability cash flows as closely as possible. The company s Solvency II capital position is sensitive to a possible reduction in the prescribed ultimate forward rate, which is used for discounting ultra-long liabilities and currently set at 4.2%. However, we do not consider this a weakness in NN s asset-liability management, particularly given the group s very strong coverage of its Solvency II capital requirements. 11

12 Reinsurance, Risk Management and Catastrophe Risk Risk Management Adequate Risk appetite framework adapted for Solvency II Reinsurance guided by group risk appetite Japan closed bock adequately managed Risk Appetite Framework Adapted for Solvency II NN has defined its risk appetite statements to align with the Solvency II framework. Its primary quantitative statement aims to ensure that the group s Solvency II capital ratio can withstand a 1-in-20 annual risk sensitivity. NN identified insurance risk, mainly driven by longevity risk on Dutch pension business, to be the most significant risk factor in a 1-in-20 scenario, followed by market and credit risk. Fitch views this own funds at risk methodology as supportive of good risk management. Reinsurance Guided by Group Risk Appetite NN sets its reinsurance programme by reference to its group risk appetite statements. Fitch views NN s maximum retention as conservative relative to its capital resources. The group monitors the credit quality of its reinsurance panel, with all reinsurers used rated in the A category or above. Japan Closed Block Adequately Managed Fitch believes the group s management of the risks arising from the Japan closed block VA book to be adequate, and expects these risks to decline rapidly as the business runs off. VAs include embedded guarantees, which give rise to risks that are long-tailed and difficult to hedge and reserve for, in Fitch s opinion. NN runs a hedging programme to mitigate the financial market risks on this business. However, perfect risk mitigation is not possible in practice, which results in a net hedge result on this activity each year. This mismatch result was positive for four of the past six years ( ) and generated a cumulative profit over this period. 12

13 NN Bank Small NN Bank s Strategy Complements Group NN Bank complements the group by supporting its strategy of being an integrated financial solutions provider in the Netherlands, providing cross-selling opportunities and generating investible assets for the group and its asset management clients. The contribution to the group s profitability is small but positive. NN Bank reported a net operating result of EUR28m in 2015, an increase of approximately 41%, driven by an increase in total assets to EUR12bn (end-2014: EUR9bn). NN Bank s portfolio of mortgages relates only to residential property in the Netherlands. A small portion of this book is funded through residential mortgage backed securities (RMBS). In 2015, NN Bank closed two public RMBS transactions, raising a total amount of EUR1.3bn of funding from institutional investors. These transactions follow earlier transactions closed in 2013 and 2014 respectively. The related structured entities are consolidated by NN Bank. 13

14 Appendix A: Other Ratings Considerations Below is a summary of additional ratings considerations of a technical nature, that are also part of Fitch s ratings criteria. Group IFS Rating Approach Fitch views the group s Dutch life insurance subsidiary, its main operating entity, as Core. Figure 14 Complete Ratings List Entity Rating type Rating Outlook Nationale-Nederlanden Levensverzekering Insurer Financial Strength Rating A+ Stable Maatschappij N.V. Long-Term Issuer Default Rating A Stable Subordinated (XS ) Long-Term Rating BBB Subordinated (XS ) Long-Term Rating BBB Subordinated (XS ) Long-Term Rating BBB Senior (XS ) Long-Term Rating A- Source: Fitch Notching For notching purposes, the regulatory environment of the Netherlands is assessed by Fitch as being Effective, and classified as following a Group Solvency approach. Figure 15 Notching Summary IFS ratings A baseline recovery assumption of Good applies to the IFS rating, and standard notching was used from the IFS anchor rating to the operating company IDR. Holding company IDR Standard notching was applied between the implied insurance operating company and holding company IDRs for a Group Solvency regulatory environment. Holding company debt A baseline recovery assumption of Below Average was applied to senior debt. Standard notching relative to the IDR was used. Hybrids For XS issued by, a baseline recovery assumption of Poor and a nonperformance risk assessment of Moderate were used. Notching of -3 was applied relative to the IDR, which was based on -2 for recovery -1 for non-performance risk. For XS issued by, a baseline recovery assumption of Poor and a nonperformance risk assessment of Moderate were used. Notching of -3 was applied relative to the IDR, which was based on -2 for recovery -1 for non-performance risk. For XS issued by, a baseline recovery assumption of Poor and a nonperformance risk assessment of Moderate were used. Notching of -3 was applied relative to the IDR, which was based on -2 for recovery -1 for non-performance risk. Source: Fitch 14

15 Figure 16 Hybrids Treatment Rated Instruments Only Hybrid Type Amount (EURm) Issuance date First call date Maturity date Coupon (%) FBM FBM regulatory FLR debt Fitch (%) override (%) (%) XS Subordinated May May May XS Subordinated 1,000 8 Apr Apr Apr XS Subordinated 1, Jul Jan 2026 Perpetual FBM Prism factor-based capital model; FLR financial leverage ratio For FBM, % is the portion of hybrid value included as available capital, both before (Fitch %) and after the regulatory override For FLR, % is the portion of hybrid value included as debt in numerator of financial leverage ratio Source: Fitch Exceptions to Criteria/Ratings Limitations None. 15

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