Global Credit Research Credit Opinion 10 APR 2008 Credit Opinion: Meritz Fire & Marine Insurance Co Ltd Meritz Fire & Marine Insurance Co Ltd Seoul, Korea Ratings Category Outlook Insurance Financial Strength Moody's Rating Stable A3 Contacts Analyst Phone Sally Yim/Hong Kong 852.2916.1250 Daniel Wong/Hong Kong 852.2916.1251 Jerry Chien/Hong Kong 852.2916.1106 Key Indicators Meritz Fire & Marine Insurance Co Ltd[1] 2006 2005 2004 2003 2002 Total Assets (KRW bil.) $ 3,748 $ 3,110 $ 2,676 $ 2,332 $ 2,151 Equity (KRW bil.) $ 260 $ 230 $ 227 $ 198 $ 187 Net Income (KRW bil.) $ 36 $ 26 $ 21 $ 20 $ 34 Gross Premiums Written (KRW bil.) $ 2,180 $ 1,877 $ 1,695 $ 1,544 $ 1,544 Net Premiums Written (KRW bil.) $ 1,943 $ 1,593 $ 1,413 $ 1,208 $ 1,208 Gross Underwriting Leverage [2] 3.1x 3.2x 3.4x 3.8x 4.2x Return on Equity (1 yr.) 14.6% 11.6% 9.9% 10.4% 20.4% Sharpe Ratio of Growth in Net Income (5 yr.) 1.8% --- --- --- --- Financial Leverage 0.2% 0.4% 0.6% 0.9% 1.1% Earnings Coverage (1 yr.) 396.2x 218.1x 140.2x 125.7x 657.7x Cashflow Coverage (1 yr.) 319.7x 175.5x 111.4x 87.8x 557.4x High Risk Assets % Invested Assets 38.1% 33.4% 31.2% 30.9% 18.2% Reinsurance Recoverable % Equity 12.1% 17.3% 15.8% 15.9% 18.7% Goodwill % Equity 0.0% 0.0% 0.0% 0.0% 0.0% Adv/(Fav) Dev. % Beg. Reserves (1 yr.) [3] 4.9% 5.3% 6.7% 4.1% 0.7% A&E Net Funding Ratio (1 yr.) N/A N/A N/A N/A N/A [1] Information based on both statutory/regulatory and GAAP financial statements [2] Represents P&C business only [3] Estimates based on information provided by company Opinion SUMMARY RATING RATIONALE Moody's A3 insurance financial strength rating of Meritz Fire & Marine Insurance Co Ltd (MFM) reflects the company's solid market position and established franchise as the fifth largest non-life insurer in South Korea, as well as its good capital adequacy position. MFM's overall profitability has been achieved without using any financial leverage, and is improving due to its focus on selective underwriting in auto lines and the shift towards more floating-rate long-term policies. These strengths, however, are tempered by the competitive gap between MFM and the top 4 players in Korea,
which have better economies of scale. Underwriting profitability remains a challenge, with an overall combined ratio at 102.1% for the nine-month period ended December 31, 2007. It also holds a relatively high proportion of equities, loans and real estate in its investment portfolio, which Moody's considers high risk. This could subject the company to higher volatility in earnings and capital. MFM also needs to manage the long-term business-related risks under an appropriate risk management framework. MFM underwrites motor, commercial and long-term business, including accident and health business. It mainly distributes its products through tied solicitors, financial consultants, agents and banks. Credit Strengths - Well-established and long operating history in the South Korean market; consistently ranked amongst the top five - Improved capital adequacy has better positioned MFM for growth - Effective management of its growing long-term insurance business, adopting a sensible combination of protection risk and interest rate risk exposure - MFM's focus on the South Korean market means less catastrophic risk when compared to other Asian countries,such as Taiwan or Japan Credit Challenges - Underwriting profitability, though improving, remains a challenge on the back of keen competition in the South Korean market from online auto insurers - Significant exposure to long-term insurance coverage, thereby requiring monitoring of its pricing risk in relation to the insured population's morbidity experience as well as interest rate risk exposure - High risky asset mix within the invested asset portfolio; sizeable exposure to loan and real estate - Uncertainty and execution risks surrounding company capital and management structure in the event it sets up a financial holding company Rating Outlook The stable outlook reflects Moody's expectation that MFM will maintain around its current capital adequacy level and continue to improve on its underwriting profitability. If MFM were to invest in other new businesses or set up a financial holding company, Moody's expects that the capital level for its non-life business would not materially decrease. What Could Change the Rating - Up - Improvement in profitability by delivering a stable stream of income with return on average equity consistently above 15% and overall combined ratio below 103% - Continued improvement in its capital adequacy measures, as demonstrated in a local solvency above 200% with gross underwriting leverage falling below 5x - Maintaining high-risk asset to invested assets ratio below 30% - Gradual improvement in overall market position in the Korean non-life market, at least keeping up with industry average growth What Could Change the Rating - Down - Material reduction in its market position and earnings, such that deterioration in its average return on equity falls to 5%, or significant volatility in its net income level over time - Weakening of local solvency margin to below 200% and/or an increase of gross underwriting leverage such that it exceeds 7x - Sizeable increase in its risky asset class within its risky asset mix reaching 40% or more Recent Results and Developments
For the nine months ended December 2007, MFM reported an overall loss ratio of 78.7%, mainly driven by better loss experience in the auto and long-term lines of business. Its net income grew almost 1.9x to KRW 72.3 billion, attributable to higher underwriting income and growth in premiums. In September 2007, MFM completed its secondary rights offering of KRW 225.7 billion. See discussion in the "Capital Adequacy" section. In February 2008, MFM announced its stock repurchase plan of KRW 54.0 billion, equivalent to about 5.7 million shares. DETAILED RATING CONSIDERATIONS Moody's rates Meritz Fire & Marine Insurance Co Ltd A3 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: Factor 1 - Market position, brand and distribution: A As the fifth largest non-life insurer in South Korea and with the longest operating history, MFM enjoys a strong local presence. Its market position ranks it among the top second tier non-life insurers in South Korea, though it still lags behind the top four non-life companies which have significant economies of scale. Given the intensely competitive environment, its market position is expected to remain around the same level in the near to medium term. The company's underwriting expense ratio for its P&C business is quite high relative to its peers, though offset by the low distribution cost for its fast-growing long-term business. Overall, MFM's market position, brand and distribution are consistent with our expectations for an A-rated company. Factor 2 - Product risk and diversification: Baa MFM's business composition has changed over the last five years, with a much stronger focus on the long-term insurance business. This shift in its business mix is partially as a result of (1) downward pressure on pricing and underwriting margin due to fierce competition from online auto insurers; and (2) loss of major commercial business from Hanjin Group, MFM's previous holding company. Despite this, MFM's net premiums earned continued to grow at 20.6% in 2007, given the relatively sizable premium volume coming from its long-term insurance business. Because of its significant exposure to long-term insurance coverage, Moody's believes that MFM needs to monitor its pricing risk in relation to the insured population's morbidity experience, as well as for its interest rate risk exposure which is relatively higher than most P&C insurers. Moody's believes that the company's product risk and diversification are consistent with our Baa-rated companies. Factor 3 - Asset quality: Baa MFM has a moderate asset risk level with high-risk assets representing 38% of total investment for FY2006, which is a result of the company's sizeable exposure to the equities and property markets. The investment mix remains around the same level evident in December 2007. This level is relatively high compared to some of its international peers. Moody's also notes that MFM holds a relatively high position in loan portfolios, though such loans are partially related to policyholders and the percentage of non-performing loans has been relatively low. Considering the potential liquidity risk associated with the asset mix, given the nature of its insurance business, Moody's believes that MFM's overall asset quality is more in line with a Baa-rated company. MFM also had some exposures in sub-prime-related CDOs. It had to recognize some mark-to-market losses over the past year. While the losses represent more of an earnings event for the company, Moody's notes that it is essential for MFM to instill strict risk management practices when engaging in such complex investment structures. Factor 4 - Capital adequacy: A Prior to the secondary offering in September 2007, MFM's capital adequacy was weaker than its similarly-rated peers. Its solvency margin ratio improved from 180.9% as of June 2007 to 262.9% as of December 31, 2007, which is slightly above the industry average. We now consider MFM's capital position to be more in line with the current rating level. For MFM's long-term business, Moody's takes into consideration the associated longer liability duration as compared to the traditional non-life insurance business, and the company's asset-liability management practices and liquidity. While not perfect, MFM's duration matching between assets and liability is improving, even as floating-rate policies take up a larger portion (now over 70%) of its long-term business book.
Nevertheless, in view of MFM's recent stock repurchase plan and its intention to set up a financial holding company, Moody's notes that there is significant uncertainty relating to the level and structure of its capitalization plans. The current rating incorporates an expectation that the solvency ratio would be maintained above 200% to support MFM's rapid growth in its long-term business. Factor 5 - Profitability: A MFM recorded a five-year average return on equity (ROE) of 13.4% over the period FY2002-2006, indicating a healthy profitability level. However, earnings growth has been volatile during this period. Moody's notes that MFM's relatively weak underwriting profitability -- as illustrated by combined ratios of over 100% for long-term and auto lines -- remains a constraint on the rating at this time. While MFM's long-term business is demonstrating profitable growth, its auto business underwriting margins remain under pressure due to competition in the Korean market, especially from on-line auto insurers. MFM will likely have to rely on investment income (which could be volatile subject to market conditions) to offset its underwriting losses over the near to medium term. As such, its profitability level is consistent with the single-a level. Factor 6 - Reserve adequacy: Baa MFM has demonstrated moderate reserve development during the past five years, with relatively sizeable movement in reserves each accident year. However, Moody's notes that the company is in full compliance in terms of reserve computation, with rules stipulated by Financial Supervisory Service (FSS), and no discounting factor has been applied. Closer assessment of the payment patterns for bodily injury claims across the different accident years has not shown signs of reversing. Furthermore, most bodily injury claims are settled within twelve months and are fully settled within 72 months. Moody's considers the reserve adequacy to be consistent with a Baa-rated company. Factor 7 - Financial flexibility: A Unlike many of its Asian peers, MFM currently does not issue any debt due to regulatory constraints. When compared to some of its global peers, its ability to raise additional capital quickly is rather limited in case of stress. As a result, Moody's believes that MFM's financial flexibility is more in line with an A-rated company. Rating Factors Meritz Fire & Marine Insurance Co Ltd Financial Strength Rating Scorecard [1] Aaa Aa A Baa < Baa Score [2]Adjusted Score Business Profile A A Market Position, Brand and Distribution (25%) A A Market Share Ratio Relative Market Share Ratio Expense Ratio % NPW Product Focus and Diversification (10%) Baa Baa Product Focus P&C Product Diversification Geographic Diversification Financial Profile Aa A Asset Quality (5%) Aa A High Risk Assets % Invested Assets 38.1% Reinsurance Recoverable % Equity 12.1% Goodwill % Equity 0.0% Capital Adequacy (15%) A A Gross Underwriting Leverage 3.1x
Profitability (15%) A Baa Return on Equity (5 yr. avg.) 13.4% Sharpe Ratio of Growth in Net Income (5 yr.) 1.8% Reserve Adequacy (10%) A Baa Adv/(Fav) Reserve Dev. % Beg. Reserves (5 yr. 4.3% avg.) A&E Net Funding Ratio (5 yr. avg.) N/A Financial Flexibility (20%) Aaa Aa Financial Leverage 0.2% Earnings Coverage (5 yr. avg.) 307.6x Cashflow Coverage (5 yr. avg.) 250.4x Aggregate Profile A1 A3 [1] Insert appropriate footnote regarding accounting (see below) [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 Copyright 2008, Moody's Investors Service, Inc. and/or its licensors including Moody's Assurance Company, Inc. (together, "MOODY'S"). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY 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, such information is provided "as is" without warranty of any kind and MOODY'S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. 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 credit ratings and financial reporting analysis 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. NO WARRANTY, EPRESS 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. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY'S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY'S have, prior to assignment of any rating, agreed to pay to MOODY'S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody's Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody's Investors Service (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 on Moody's website at www.moodys.com under the heading "Shareholder Relations - Corporate Governance - Director and Shareholder Affiliation Policy."