Fitch Affirms Legal & General's IFS at 'AA-'; Outlook Stable

Fri Aug 8, 2014 10:36am EDT

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(The following statement was released by the rating agency) LONDON, August 08 (Fitch) Fitch Ratings has affirmed Legal & General Assurance Society Ltd's Insurer Financial Strength (IFS) rating at 'AA-'. Fitch has simultaneously affirmed Legal & General Group Plc's (L&G) Long-term Issuer Default Rating (IDR) at 'A'. The agency has also affirmed the senior unsecured debt issued by Legal & General Finance PLC and guaranteed by L&G at 'A-' and L&G's subordinated debt ratings at 'BBB'. The Outlooks on the Long-term IDR and IFS rating are Stable. KEY RATING DRIVERS The ratings reflect L&G's strong capitalisation, operational scale and market position as one of the leading UK life insurers. However, its concentration in the UK market is an offsetting factor; the company does not benefit from any significant diversification from other markets. Fitch regards L&G's high capital buffer as a major positive rating factor, allowing the group to withstand volatile investment markets. L&G's regulatory capital position is strong, with a regulatory solvency ratio of 236% and a with-profits surplus of GBP1.3bn at end-1H14. Fitch also considers capital as strong on a risk-adjusted basis and relative to peers'. L&G's end-2013 financial leverage of 27% is high for the rating level and is a negative rating driver. However, the group's fixed-charge coverage of 10.1x (2013) is in line with the ratings, and Fitch views the group's financial flexibility and liquidity as strong. L&G's earnings are well diversified by product type in its main market. In addition, L&G owns one of the UK's leading asset managers, Legal & General Investment Management (LGIM), which adds to the group's earnings diversification and cash generation. In 2013, 26% of L&G's operating profit came from LGIM. L&G generates around 12% of its sales internationally, predominantly in the US, France and the Netherlands. L&G's net profitability over the last four years has been fairly stable, falling within the GBP700m to GBP900m range. Fitch expects L&G to maintain this level of profitability, which is supportive of the ratings. L&G has high exposure to the credit markets through its large portfolio of corporate and government bonds (GBP30bn at end-2013) that backs its UK annuity business. While this is a negative rating factor, it is largely offset by the large credit default reserve (GBP1.8bn, equivalent to 56bp of defaults over the life of the portfolio), which the company has maintained despite negligible net default experience in recent years. L&G has high exposure to longevity risk through its large book of UK annuities (end-2013: GBP34bn). It is also exposed to pricing risk when insuring large pension scheme liabilities. In March 2014, L&G completed a bulk annuity arrangement with the ICI Pension Fund, covering GBP3bn of annuity liabilities, the largest bulk annuity contract to date in the UK. Fitch believes that L&G will be resilient to the annuity market changes announced in the March 2014 UK Budget. Customers will no longer have to use their pension savings to buy an annuity and Fitch expects the GBP12bn-a-year individual annuity market to shrink by at least one-third, with many savers choosing to access their pensions as cash or via drawdown products instead. Annuities are a large and fairly profitable business for many life insurance companies, including L&G, which is one of the market leaders, so any significant shrinking of this market could be negative for their operating scale and earnings. However, Fitch believes that L&G will be able to absorb the negative effects of the pension reforms as it is a large group with a diverse range of insurance and investment products in addition to its annuity business. In particular, it has a market-leading bulk-purchase annuity business, and the capability to take on more bulk annuities to fill the gap from reduced individual annuity sales. Bulk-purchase annuities, like individual annuities, have high reported profit margins. L&G's bulk annuity business is already larger than its individual annuity business. Bulk annuities accounted for GBP2.8bn of the GBP4.1bn annuity premiums written by the company in 2013, and GBP21.1bn of its GBP34.4bn stock of annuity assets at end-2013 was derived from bulk-annuity transactions. L&G's bulk annuity deal with the ICI Pension Fund is indicative of L&G's growth in this market. RATING SENSITIVITIES The ratings could be downgraded in the event of a fall in the group's regulatory solvency ratio to below 200%, an increase in financial leverage to more than 35% or a deterioration in profitability such that interest cover falls to below 5x for a sustained period. An upgrade is unlikely in the medium term, given the group's concentration in the UK market and high financial leverage for the ratings. However, over the long term, an increase in international diversification could lead to an upgrade. Contacts: Primary Analyst Clara Hughes Senior Director +44 20 3530 1249 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst David Prowse Senior Director +44 20 3530 1250 Committee Chairperson Federico Faccio Senior Director +44 20 3530 1394 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. Additional information is available at www.fitchratings.com. Applicable criteria "Insurance Rating Methodology", dated 13 November 2013 are available at www.fitchratings.com. Applicable Criteria and Related Research: Insurance Rating Methodology here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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