Credit Opinion: Aegon USA Life Group (Cons)

Transcription

1 Credit Opinion: Aegon USA Life Group (Cons) Global Credit Research - 24 Jun 2015 United States Ratings Category Moody's Rating AEGON N.V. STA Senior Unsecured A3 Senior Unsecured MTN (P)A3 Commercial Paper P-2 LT Issuer Rating A3 Subordinate Baa1 (hyb) Transamerica Life Insurance Company STA Insurance Financial Strength ST Insurance Financial Strength A1 P-1 Transamerica Premier Life Insurance Company STA Insurance Financial Strength A1 ST Insurance Financial Strength Transamerica Financial Life Insurance P-1 Company Insurance Financial Strength STA A1 Contacts Analyst Phone Laura Bazer/New York City Scott Robinson/New York City Robert Riegel/New York City Stefan Kahandaliyanage/New York City Key Indicators Aegon USA Life Group (Cons)[1][2] As Reported (U.S. Dollar Millions) Total Assets 209, , , , ,641 Total Shareholder's Equity 9,532 7,834 8,178 7,658 7,974 Net income (loss) attributable to common shareholders ,843 (2,484) 918 Total Revenue 37,972 28,279 22,988 21,572 22,170 Moody's Adjusted Ratios High Risk Assets % Shareholder's Equity 76.3% 95.2% 104.3% 123.3% 117.3% Goodwill & Intangibles % Shareholder's Equity [3] 47.4% 61.5% 55.8% 67.6% 83.2% Shareholder's Equity % Total Assets 5.2% 4.5% 5.1% 4.7% 4.8% Return on avg. Capital (1 yr. avg ROC) 9.8% 7.0% 19.1% -26.0% 18.6% Sharpe Ratio of ROC (5 yr. avg) 30.8% 28.4% 11.9% 3.0% NA 27.7% 31.2% 30.6% 34.4% 35.4%

2 Financial Leverage [3] 27.7% 31.2% 30.6% 34.4% 35.4% Total Leverage [3] 37.6% 44.2% 45.4% 48.4% 54.1% Earnings Coverage (1 yr.) [3] 3.1x 2.3x 3.4x 1.9x 3.6x Cash Flow Coverage (1 yr.) [3] NA NA NA NA NA [1] Information based on SAP financial statements as of Fiscal YE December 31 [2] Certain items may have been relabeled and/or reclassified for global consistency [3] Information based on IFRS financial statements of AEGON N.V. as of Fiscal YE December 31 Opinion Rating Rationale Moody's A1 insurance financial strength (IFS) rating (stable outlook) of three operating life insurance companies in the Aegon USA Life Group (Aegon USA - i.e., Transamerica Life Insurance Company, Transamerica Premier Life Insurance Company, and Transamerica Financial Life Insurance Company) - is based on the group's leading position in the U.S. life insurance and asset accumulation markets, strong business line and distribution diversification, and generally good earnings capacity from its core, non-variable business lines. The group's sales - largely variable annuities (VAs) and group pensions - and revenues have continued to improve in recent years with the US economy and equity market. Aegon USA remains the largest, most important operation -- in terms of global assets, revenue, and income - of Aegon N.V. (Aegon; senior debt at A3, stable outlook), the global Netherlands-based insurance group. We note that consolidated leverage metrics, which are high for the Aegon N.V. group's ratings, have been declining as debt is repaid. Aegon USA's strengths are mitigated by the growing risk of the company's liability profile, in terms of level premium term life (XXX), no-lapse universal life insurance (AXXX UL), and annuity businesses (fixed, indexed, and particularly variable (VAs)) - the primary focus of recent sales growth. Annuities and no-lapse UL are interest sensitive, while VAs, although de-risked, expose the company to equity market and hedging risks, and greater earnings, reserves, and capital volatility. The term and UL products additionally engender the extensive use of structured transactions at on- and offshore captives to reduce strain and optimize capital. This diminishes the quality of the group's reserves, asset quality, and regulatory capital on a consolidated basis. Other corporate challenges include the company's greater strategic focus on lower margined asset-based fee business, which may result in a lower and more volatile earnings profile for the group over time. Although we view Aegon USA's credit profile as being positioned at the low end of the range for A1 IFS issuers, we see positive trends in earnings and the continued sale of a diversified portfolio of products as mitigating the company's weaknesses somewhat. That said, disproportionate growth of products, like variable annuities, which increase the risk profile and capital markets sensitivity of the company's liabilities, could pressure the ratings. Credit Strengths - Broad product offering and top-tier position in the domestic life insurance and accumulation businesses; - Well-diversified business lines, product offerings, and distribution channels; - Generally good underlying earnings diversity and capacity. Credit Challenges - Sizable and growing use of captives, with the quality of investments, reserves, and regulatory capital weakened by lower capital levels and potential calls on liquidity and/or reserves at, or arising from captives, both on- and offshore; - Rising liability risk in terms of sizable and growing books of XXX/AXXX and VAs, which increase aggregate, interest rate, equity market, hedging, and other risks; - Potential parent company calls on capital, given public shareholder pressures and holding company needs.

3 Aegon USA's ratings have a stable outlook. What to watch for: -Additional structured transactions, allowing for increased dividends paid to the parent company; - Earnings and earnings volatility trends. What Could Change the Rating - Up The following factors, taken in combination, could lead to an upgrade of Aegon USA's ratings: - Return on statutory capital (ROC) of the US operations consistently above 8% with a sustained reduction in volatility; - Materially less reliance on reinsurance captives from current levels in the US (as measured by total reserve credit and modco reserves) ; - Consolidated total leverage at Aegon group below 30% and earnings coverage consistently above 8x. What Could Change the Rating - Down The following factors could result in a downgrade of Aegon USA's ratings: - Return on statutory capital (ROC) of the US operations consistently below 4%; - Materially more reliance on reinsurance captives from current levels in the US and offshore; - Combined NAIC RBC ratio of less than 325% (CAL), after adjustment for intercompany loans and reinsurance captives; - Consolidated total leverage at Aegon group sustainably above 40% and earnings coverage consistently below 4x. Notching Considerations The spread between the A1 IFS rating on the US operating subsidiaries and the A3 senior unsecured debt rating at Aegon USA's ultimate parent company, Aegon N.V., is 2 notches, which is narrower than the typical three-notch spread between a holding company and the composite IFS rating of its operating subsidiaries. The two-notch differential is primarily driven by the benefits of a relatively high degree of geographic earnings diversification within the Aegon N.V. group (e.g. significant U.S., U.K., and Dutch operations). DETAILED RATING CONSIDERATIONS Moody's rates the life subsidiaries of Aegon USA A1 for insurance financial strength, which is in line with the adjusted rating indicated by the Moody's insurance financial strength rating scorecard. Insurance Financial Strength Rating The key factors currently influencing the rating and outlook are: MARKET POSITION AND BRAND: A - GOOD MARKET SHARE GROWTH, BUT DEPENDENT ON STRONG VA SALES Aegon USA is building its brand, and maintains strong market positions in its major pension and life insurance business lines, particularly in individual life insurance (where the company ranked among the top 10, as measured by sales, in term, universal and whole life in 2014). It has continued to gain share in the VA market, where once a relatively small player, the company ranked 5th in 2014, as VA market leaders pulled back their sales. The sale of pensions, a lower risk product, also grew in 2014 relative to prior years. As a result, the company is currently positioned at the low Aa level on an unadjusted scorecard basis. However, because the company's increase in market share continues, in large part, to be driven by a strong VA sales, which involve higher risk insurance products (i.e., compared with traditional whole life), we believe Aegon USA's score is better positioned at the A level on an adjusted basis than Aa.

4 DISTRIBUTION: A - MULTIPLICITY OF LARGELY INDEPENDENT CHANNELS HELPS EXTEND DISTRIBUTION REACH Aegon USA has good distribution diversity, with key channels that - despite the exit/de-emphasis of certain lines of business - include independent and captive agents, direct marketing, and worksite marketing, consistent with A- rated peers, both on an unadjusted and adjusted scorecard basis. Aegon USA's distribution network is largely independent, which affords it less control generally and less robust policyholder persistency than a captive-driven distribution model; however, the group's multiplicity of channels has helped it extend its distribution reach significantly. PRODUCT FOCUS AND DIVERSIFICATION: A - GROWING LIABILITY RISK, WITH XXX/AXXX AND ANNUITY CONCENTRATIONS, AND GROWING VA RISKS Aegon USA maintains strong product line diversification within the U.S. life insurance sector. Its key principal product lines are individual life, individual variable annuities, 403(b)/401(k) products, and fixed annuities (deferred, payout, etc.). Following the financial crisis, the company de-emphasized fixed annuities, and other interest sensitive businesses, (i.e., institutional investment products (IIP), BOLI/COLI, and reinsurance). However, sizable blocks of fixed deferred annuities remain (approximately $14 billion, on an IFRS basis), and other interest-sensitive concentrations continue to grow (i.e., long-term care ). In addition, XXX term life sales, and, until recently, AXXX no-lapse universal life sales (the company announced its withdrawal of this product in Q1 2015), have resulted in Aegon USA's material dependence on third-party financed captives to reduce resultant reserve and capital strain, as well as liquidity risk at the Aegon USA holding company, which guarantees certain AXXX structures. In addition, continuing VA sales growth exposes the company to increasing equity market and hedging risks, as well as greater reserve, earnings and capital volatility. As a result, Aegon USA remains consistent on this factor with A-rated peers, in terms of both the unadjusted and adjusted metrics. ASSET QUALITY: A - ASSET LOSSES DOWN, BUT PARENTAL GUARANTEE WEAKENS ASSET QUALITY AT CAPTIVES The group's high-risk asset ratio continued to decline in 2014 to about 76% (from 95% at of year-end 2013), as higher-risk asset holdings fell slightly in 2014 on a higher surplus base. Exposures largely to below-investmentgrade bonds, equities, and alternative investments place the high risk assets subfactor score in the A-range, on an unadjusted scorecard basis. The company also has a significant exposure to higher risk assets that are not included in the simple scorecard metric. These include non-agency structured housing-related securities amounting to roughly 18% of invested assets on an IFRS basis (i.e.,alt-a, subprime, RMBS, as well as CMBS, CML, and bank hybrid securities. However, gross losses in 2014, including fair value adjustments for energyrelated investments at year-end, are lower than historical industry averages (i.e., basis points per annum) to date in Consolidated goodwill and other intangibles represented 64% of Aegon N.V.'s shareholders' equity as of year-end 2013, which is high. However, most of the intangibles are in the form of deferred acquisition costs, which are generally substantial for life companies, and are more readily realized into real equity than goodwill. For this reason, we have raised Aegon USA's adjusted score to A from the unadjusted score of Baa for this factor. CAPITAL ADEQUACY: A - NOMINAL RBC RATIO STRONG, BUT BOOSTED BY STRUCTURED TRANSACTIONS AT CAPTIVES AND PARENTAL GUARANTEES Aegon USA's unadjusted scorecard metric of capital-to-total assets aligns with a Baa rating, depressed primarily because of the asset-intensive liabilities the company writes. However, we believe that the NAIC risk-based capital (RBC) ratio is a better indicator of the group's capitalization. Aegon USA's combined year-end 2014 NAIC RBC ratio, on a weighted-average basis was approximately 568% (company action level), which is typically consistent with Aaa-rated peers. However, both the transfer of significant reinsurance risk to both onshore and offshore captives (e.g., variable annuities; "redundant" reserve structures for Reg. XXX term life and Guideline AXXX universal life; embedded value transactions) - including an onshore captive, whose primary asset is a $1.8 billion guarantee from Aegon USA's US holding company -- diminish the quality of the group's consolidated regulatory capital. The non-recognition of reserve credit for these transactions, including one in 2014, which are only partially included in the consolidated RBC ratio (for example, a $0.8 billion of the parental guarantee is included in the capital of TLIC), would cause the RBC ratio to drop significantly, if regulatory changes or a stress situation precipitated the denial of credit for the guarantee or the recapture of the underlying business. For these reasons, and because shareholder pressures will likely lower the nominal RBC ratios of public companies, like Aegon, industry-wide, we believe Aegon USA's score for this factor remains more consistent with low A-rated than Aaa-rated peers.

5 PROFITABILITY: A - EARNINGS REMAIN HEALTHY, BUT VOLATILE Aegon USA's unadjusted profitability is consistent with Baa-rated peers, due largely to significant accounting volatility from VA hedging and captive reinsurance transactions. On a U.S. statutory basis, in 2014, the company reported net income $894, largely unchanged from 2013 (i.e., $909 million), but down more than 50% from the $1.8 billion of net income in 2012, largely due to captive reinsurance transactions, and net realized capital gains and losses caused by derivatives used primarily for hedging VAs. As a result, the company's 1-year average ROC, swung to 9.7% in 2014 from 6.9% in 2013, having dropped from 19% in High earnings volatility (as measured by the Sharpe ratio) is caused by VA hedging swings, reinsurance, and other transactions, which in aggregate are not accounted for through the income statement, and they drag the score to the Baa-range, on an unadjusted basis; however, we believe that Aegon USA's underlying profitability - adjusted for the accounting volatility produced by hedging gains/losses - is more consistent with A-rated issuers on an adjusted scorecard basis and we have raised the score from the Baa unadjusted result. LIQUIDITY AND ASSET/LIABILITY MANAGEMENT (ALM): A - GOOD LIQUIDITY, BUT CHALLENGES FROM VA/UL LIABILITIES IN COMPLEX STRUCTURES AT CAPTIVES Aegon USA's unadjusted score on this factor is consistent with Aa-rated peers. However, we note that the group's ALM is complicated by its VA product offering (which includes various death and living benefit guarantees), and term and no-lapse universal life insurance guarantees, most of which have been transferred to onshore and offshore captive reinsurers via complex transactions. Some of these structures, which are with banks, include provisions that would require Aegon USA to provide liquidity to the counterparty under certain stress conditions. Because of these additional liquidity and ALM risks, we have lowered the adjusted score to A from the unadjusted score of Aa. FINANCIAL FLEXIBILITY: A - LEVERAGE HAS IMPROVED Moody' analyzes Aegon USA's financial flexibility at the consolidated Aegon N.V. level and views it in line with an A score. The majority of the group's borrowings are either directly attributable to or guaranteed by Aegon N.V. The debt profile has changed over the last ten years, with the vast majority of issuance post 2004 being perpetual in nature and containing other hybrid features. In 2014 financial leverage decreased to 27.7% (2013: 31.2%), capturing the result of deleveraging actions. In 2014, Aegon redeemed USD550 million and USD1,050 million of capital securities, with the latter largely financed by the issuance of EUR700 million subordinated notes. In our financial leverage ratio, financial debt includes pension deficit which increased by almost 50% in 2014 to EUR4.1 billion. However, Aegon holds some assets backing these pension liabilities; if we take into consideration these assets, pension deficit significantly improves and financial leverage decreases by around 6 percentage points. Total leverage, which includes operational debt and does not incorporate equity credit for hybrid securities has improved to 37.6% in 2014 (2013: 44.2%), benefiting from the material increase in group's equity. The difference between the total leverage and the financial leverage mostly reflects the use of structured transactions to reduce new business strain and optimize capital in its US operations. Liquidity Profile: Aegon USA's US holding companies have no debt outstanding, since debt is issued by Aegon N.V., however, bank letters of credit do support certain of its captive XXX and AXXX transactions. In 2014, Aegon USA paid a statutory dividend of $732 million to its ultimate holding company in the Netherlands. Statutory dividends ranged from $385 million to $1.2 billion between 2012 and Other Considerations Aegon USA clearly benefited in the past from the ownership and support of its parent, Aegon N.V. and its strong financial flexibility, as seen during when large losses at Aegon USA were offset by large capital contributions from Aegon. Aegon's strategy has been to refocus its insurance operations on a larger global scale, with somewhat less emphasis and dependence on the U.S. However, even after achievement of greater global diversity, Aegon USA still accounts for at least half of Aegon's global operations, by a variety of measures. Because Aegon's A3 senior debt rating will continue to be primarily driven by its U.S. operations, we do not believe that Aegon USA's stand-alone A1 rating should be uplifted due to the ownership by Aegon. Rating Factors

6 Aegon USA Life Group (Cons)[1][2] Financial Strength Rating Scorecard Aaa Aa A Baa Ba B Caa Score Adjusted Score Business Profile A A Market Position and Brand (15%) Aa A - Relative Market Share Ratio X Distribution (10%) A A - Distribution Control X - Diversity of Distribution X Product Focus and Diversification (10%) A A - Product Risk X - Life Insurance Product Diversification X Financial Profile Baa A Asset Quality (10%) A A - High Risk Assets % Shareholder's Equity 76.3% - Goodwill & Intangibles % Shareholder's 47.4% Equity [3] Capital Adequacy (15%) Baa A - Shareholder's Equity % Total Assets 5.2% Profitability (15%) Baa A - Return on Capital (5 yr. avg) 5.7% - Sharpe Ratio of ROC (5 yr. avg) 30.8% Liquidity and Asset/Liability Management (10%) Aa A - Liquid Assets % Liquid Liabilities X Financial Flexibility (15%) Baa A - Financial Leverage [3] 27.7% - Total Leverage [3] 37.6% - Earnings Coverage (5 yr. avg) [3] 2.9x - Cash Flow Coverage (5 yr. avg) [3] Operating Environment Aaa - A Aggregate Profile A3 A1 Aaa - A [1] Information based on SAP financial statements as of Fiscal YE December 31 [2] The Scorecard rating is an important component of the company's published rating, reflecting the stand-alone financial strength before other considerations (discussed above) are incorporated into the analysis [3] Information based on IFRS financial statements of AEGON N.V. as of Fiscal YE December 31 This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved.

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