Credit Opinion: Guardian Life Insurance Company of America

Transcription

1 Credit Opinion: Guardian Life Insurance Company of America Global Credit Research - 18 Oct 2013 New York City, New York, United States Ratings Category Rating Outlook Insurance Financial Strength Surplus Notes Guardian Insurance & Annuity Company, Inc. Rating Outlook Insurance Financial Strength Moody's Rating STA Aa2 A1 (hyb) STA Aa2 Contacts Analyst Phone Shachar Gonen/New York City Neil Strauss/New York City Robert Riegel/New York City Key Indicators Guardian Life Insurance Company of America[1] Total Assets (USD millions) ,091 54,716 51,928 47,743 42,549 Shareholders' Equity (USD millions) Net Income (USD millions) 9, , , , , Total Revenues (USD millions) High Risk Assets % Shareholders' Equity 9, % 8, % 8, % 8, % 8, % Goodwill & Intangibles % Shareholders' Equity 35.1% 40.4% 49.7% 58.4% 91.8% Shareholders' Equity % Total Assets Return on Capital (1 yr.) 15.7% 5.0% 15.8% 2.3% 16.1% 5.0% 16.0% 3.2% 15.4% 2.1% Sharpe Ratio of ROC (5 yr.) Adjusted Financial Leverage 248.8% 7.1% 115.3% 5.6% % % % Total Leverage 8.1% 6.7% 5.9% 6.4% 4.1% Earnings Coverage (1 yr.) Cashflow Coverage (1 yr.) 14.0x 8.1x 17.9x 26.3x 9.7x [1] Information based both on statutory/regulatory and GAAP financial statements Opinion SUMMARY RATING RATIONALE Moody's Aa2 insurance financial strength ratings of The Guardian Life Insurance Company of America (Guardian) and its subsidiary, The Guardian Insurance & Annuity Company, Inc. (GIAC), reflect Guardian's strong business profile, which is supported by its stable block of individual life insurance business and career-agent distribution, as well as the company's modest exposure to higher risk assets. The Aa2 IFS rating also reflects the company's low

2 asset/liability management and liquidity risk, which stems from the non-interest sensitive nature of its liability mix. In addition, the company's modest financial leverage, excellent capitalization (NAIC company action level (CAL) Risk Based Capital ratio of 490% as of June 30, 2013), and consistent earnings in its group non-medical business all contribute to Guardian's strong credit profile. A key factor in Guardian's credit profile is its strong regulatory capital position, even under investment stress scenarios. In addition, Guardian's credit profile benefits from a high degree of financial flexibility through its participating policyholder dividend mechanism on its large block of whole life insurance policies. Guardian has a high quality bond portfolio, relatively modest exposure to non-agency RMBS securities and manageable CMBS and commercial mortgage loan exposures. However, Guardian's exposure to real estate and real estate limited partnerships is above industry averages, but in line with mutual peers, and could be a source of higher losses under a stress scenario. The company's strengths are tempered by Guardian's exposure to low-margined variable products and non-life insurance lines of business, which could produce earnings volatility. The individual disability segment could experience earnings pressure from elevated claims leading to a higher loss ratio. Another non-life insurance business that could lead to volatile profitability is the small case group non-medical business. Guardian's profitability is also challenged by efforts to grow its Mutual Funds and 401(k) businesses, which are not currently at scale. The company has exited company owned life insurance (COLI) due to concerns about profitability and the long-term care (LTC) business due to the low interest rate environment, which we view as positive steps. Credit Strengths Guardian's credit strengths include: - Stable and profitable in-force block of core individual life insurance with excellent persistency; - Productive career agency field force continues to produce increasing individual life sales; - Product mix presents relatively little asset/liability management and liquidity risk; - Good financial flexibility due to participating dividend mechanism and modest financial leverage; - Diversified group product offerings, with emphasis on non-medical products. Credit Challenges Guardian's credit challenges include: - Lower-margined fee-based investment products subject the company to equity market volatility in its earnings; - Exposure to equities and real estate limited partnerships that is above the industry average, but in line with mutual peers; - Exposure to the individual disability business, which creates potential earnings volatility. Rating Outlook The rating outlook is stable. What to watch for: - Economy-driven increased disability claims; - Growing block of variable annuity product with guarantees. What Could Change the Rating - Up Given Guardian's somewhat limited market presence and national brand, and its strategy, which relies heavily on somewhat higher-risk group non-medical products in its business profile and earnings mix, upward rating movement is unlikely. However, upward ratings pressure could emerge if Guardian (1) maintains return on capital (ROC) above 7%, without increasing the risk profile of its liabilities, and (2) reduces high risk assets as a % of GAAP shareholders' equity below 35%.

3 What Could Change the Rating - Down Guardian's ratings could go down as a result of: - NAIC CAL RBC ratio of less than 375%; - Below investment grade bond exposure of more than 10% of cash and invested assets; - Return on capital of less than 4%. DETAILED RATING CONSIDERATIONS Moody's rates Guardian Aa2 for insurance financial strength, which is in line with the adjusted rating indicated by Moody's insurance financial strength scorecard. MARKET POSITION AND BRAND: Aa - STRONG MARKET POSITION IN WHOLE LIFE Guardian enjoys an excellent market position, in line with Aa companies. While Guardian is a top 5 player in the whole life insurance industry, the company is much smaller than its other top-tier competitors from an earnings, revenue, and capital perspective. Although Guardian would rank in the A range based on its relative market share ratio, we have adjusted this factor upward to Aa because of its strong market position in participating whole life insurance in the high net worth segment. Guardian is also a strong competitor in the small-case group benefits market, particularly in dental. The company experienced modest sales growth in 2012 and the first half of 2013 and continues to grow its variable annuity, asset management, and 401(k) businesses to help reach adequate scale. DISTRIBUTION: Aa - WELL POSITIONED AND PRODUCTIVE CAPTIVE AGENCY FORCE Guardian's distribution is well aligned by product type and cost, in line with expectations for a Aa score on this rating factor. The unadjusted scorecard ranking of A is influenced by Guardian's relative lack of diversity, which we believe is effectively offset by the company's well positioned and productive captive agency force--guardian's primary arm for distributing its life insurance products. The tied nature of this distribution channel has contributed to the company's consistently strong life insurance agent retention rate and we believe that this distribution force is one of Guardian's key strengths. Further, Guardian's 4-year average agent retention rates are among the highest in the industry. PRODUCT FOCUS AND DIVERSIFICATION: Aa - EXCELLENT PRODUCT DIVERSIFICATION WITH FEW RISKY PRODUCTS Guardian has excellent diversification in its U.S. life insurance product portfolio, including individual life products, group life, disability and dental products, individual disability income products, and individual annuity products, which places the company solidly in the Aa range. The overall risk profile of Guardian's product portfolio, which is well-positioned among Aa peers, is supported by the company's large block of participating life insurance, one of the lowest risk products sold by U.S. firms. However, we view Guardian's growing individual disability and annuity businesses as incrementally adding to risk relative to the par whole life business. Moody's views the product risk of the company's increasing variable annuity sales as modest, as most contain minimal guarantees, and these are largely reinsured or hedged. We have left this factor consistent with the unadjusted scorecard result of Aa. ASSET QUALITY: Aa - STRONG CAPITAL POSITION WITH LOW VOLATILITY UNDER STRESS SCENARIOS The exposure of Guardian's investment portfolio to high risk assets (particularly common stock and noninvestment grade bonds) is approximately 55% as of year-end 2012 and flat with the prior year-end. The ratio is consistent with Moody's expectation for A-rated companies. The company's below-investment grade bonds accounted for 7.2% of total bonds as of December 31, 2012 down slightly over the past year. Guardian's exposure to equities, below investment grade corporate bonds and real estate limited partnerships is above the industry average, but in line with some of its mutual peers. However, we believe that much of the risk from these higher risk investments is mitigated by the company's strong capital position and by the participating nature of a large part of the Guardian's product liabilities, where policyholder returns are adjusted in line with the company's overall investment results. Somewhat offsetting this, exposure to sub-prime residential mortgage securities is deminimus. Guardian's exposure to commercial mortgage loans, real estate equity and real estate limited partnerships could expose the company to investment losses if the current weak economic environment leads to a deterioration in the real estate environment.

4 Guardian's goodwill and other intangibles (primarily DAC related to individual life business) as a percent of equity was 35% as of December 31, 2012, which positions Guardian in the A range. However, Moody's views the DAC associated with stable, participating life insurance as good quality, and likely to be converted into tangible equity over time as the DAC is amortized into income. Total other-than-temporary-impairments were deminimus in 2012 and the first six months of 2013 relative to a $35 billion investment portfolio. Given Guardian's expected low capital volatility under investment stress scenarios, we have moved the scorecard result up to Aa from A. CAPITAL ADEQUACY: Aaa - CONSISTENT AND EXCELLENT CAPITALIZATION Guardian's GAAP equity to total assets metric was very strong at 15.7% as of year-end 2012, and in line with the expectations for Aaa-rated companies. This view is reinforced by Guardian's NAIC CAL RBC ratio of 490% as of June 30, 2013 (470% as of year-end 2012). For year-end 2013, the GAAP equity to total assets metric is expected to be at a similar level as the prior year-end. Given the company's conservative management practices, relatively low-volatility in its investment portfolio, and the flexibility embedded in managing policyholder dividends for its participating life insurance business, we expect the company's capitalization to remain exceptional and consistent with Aaa expectations. PROFITABILITY: A - MODEST PROFITABILITY EXPECTED TO IMPROVE OVER TIME Guardian's earnings have historically been and are expected to remain modest. The 5-year average GAAP ROC of 3.5% for was in line with Baa rated companies. Return on capital was 5% for calendar year 2012 and Moody's expects profitability to be at similar or slightly better levels at year-end However, Guardian's large block of participating life policies affords the company tremendous flexibility to adjust its policyholder dividends, which can reduce volatility in earnings. In addition, the company's very strong capitalization depresses reported return on capital measures, making it difficult for Guardian to achieve a GAAP ROC profitability metric consistent with the company's rating. Guardian's profitability faces a moderate drag in the near- to intermediate-term from expenditures to grow the Mutual Funds and 401(k) businesses, which are not currently at scale. However, they are expected to increase profitability and earnings diversification longer-term. Guardian's profitability could also be pressured by increased claim costs in the individual disability business. Under a stress scenario, Moody's believes that high sustained unemployment levels might pressure the disability business as well as other business lines, including dental. Given the restraint on profitability due to the company's high capital level and the expectation of limited volatility, we have maintained the adjusted score the same as the unadjusted score of A. LIQUIDITY AND ASSET/LIABILITY MANAGEMENT (ALM): Aaa - ROBUST LIQUID ASSETS WITH STABLE LIABILITY PROFILE The score on this factor is Aaa as Guardian has extremely low asset/liability management and liquidity risk as a result of the non-interest sensitive nature of its liability mix, dominated by participating whole life insurance reserves. This allows the company to maintain a more flexible investment posture than if it had sold shorter duration interest-sensitive products. Guardian has not marketed products subject to greater liquidity and ALM risks such as funding agreements and other institutional investment products that can result in material cash flow planning challenges. Compared to many of its peers, Guardian's reserves have minimal optionality and the company's variable annuity business has modest exposure to secondary guarantees. This combination makes asset liability management a less problematic function for Guardian. FINANCIAL FLEXIBILITY: Aa - STRONG FINANCIAL POSITION EVEN DESPITE ACCESS TO THE PUBLIC EQUITY MARKETS With Guardian's first ever debt issue of $396 million of surplus notes in September 2009, and promissory notes issued in total of $40 million for calendar year 2012, the company's total financial leverage was 8.1% at year-end 2012, slightly higher as compared to 6.7% at year-end 2011, and still remains solidly in the Aaa range. Guardian issued the surplus notes opportunistically to bolster its already strong capital position. Guardian's one-year earnings coverage metric was also solid at 14.0x, in line with a Aaa factor score. Nevertheless, as a mutual company, Guardian's lack of access to the public equity markets limits its financial flexibility compared to its large public counterparts, and this consideration moves the adjusted score to the Aa range. That said, given its strong financial position, we believe that Guardian could easily issue additional surplus notes or tap the bank market, should the company need to raise capital. Liquidity Profile Guardian has only one surplus note issuance (bearing interest at 7.375%) of $396 million, which does not mature until The company has ample cash and liquid resources to meet annual interest payments on the notes of

5 $29.5 million and the $40 million of promissory notes due in Additionally, Guardian has an unused $75 million bank line of credit available. Rating Factors Guardian Life Insurance Company of America Financial Strength Rating Scorecard [1][2] Aaa Aa A Baa Ba B Caa Score Adjusted Score Business Profile A Aa Market Position and Brand (15%) A Aa Relative Market Share Ratio X Distribution (10%) A Aa Distribution Control X Diversity of Distribution X Product Focus and Diversification (10%) Aa Aa Product Risk X Life Insurance Product Diversification X Financial Profile Aa Aa Asset Quality (10%) A Aa High Risk Assets % Shareholders' Equity 54.9% Goodwill & Intangibles % Shareholders' 35.1% Equity Capital Adequacy (15%) Aaa Aaa Shareholders' Equity % Total Assets 15.7% Profitability (15%) A A Return on Capital (5 yr. avg) 3.5% Sharpe Ratio of ROC (5 yr. avg) 248.8% Liquidity and Asset/Liability Management (10%) Liquid Assets % Liquid Liabilities X Financial Flexibility (15%) Aaa Aa Adjusted Financial Leverage 7.1% Total Leverage 8.1% Earnings Coverage (5 yr. avg) 15.2x Cashflow Coverage (5 yr. avg) Operating Environment (0%) Aaa - A Aggregate Profile Aa3 Aa2 Aaa Aaa Aaa - A [1] Information based both on statutory/regulatory and GAAP financial statements [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 2013 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

6 CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATIONS") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable, including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moody's Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and

7 preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at under the heading "Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy." For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited ABN AFSL and/or Moody's Analytics Australia Pty Ltd ABN AFSL (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act By continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for retail clients to make any investment decision based on MOODY'S credit rating. If in doubt you should contact your financial or other professional adviser.