Fitch Ratings has affirmed Zurich Insurance Company’s (ZIC) Insurer Financial Strength (IFS) rating at ‘A+’ and Long-term Issuer Default Rating (IDR) at ‘A’. The Outlook is Stable. ZIC is the core part of the Zurich Financial Services (ZFS) group. A full list of rating actions is provided at the end of this release.
The affirmation follows Fitch’s review of ZFS’s full-year 2010 results as well as the company’s announcement that it will enter into a 25-year strategic distribution agreement with Banco Santander SA (Santander). ZFS will pay USD1.67bn upfront plus an earn-out mechanism for its 51% participation in Santander’s insurance operations, including the respective distribution agreements. ZFS intends to finance the majority of the upfront payment with existing cash resources and the issuance of hybrid debt.
Fitch believes that the acquisition is marginally negative for ZFS’s capital position but in line with its strategic goals to grow its life business and increase its presence in Latin America. Fitch recognises that the transaction will be immediately accretive to earnings and cash flow positive. However, Fitch notes that the issuance of hybrids will increase financial leverage and that the transaction will likely result in additional goodwill and intangible assets on ZFS’s balance sheet.
The rating rationale is based on ZFS’s solid level of capitalisation, continued strong earnings generation and conservative investment portfolio. These positives are offset by the company’s significant amount of goodwill and intangibles, relatively high use of financial leverage, and the headwinds the company faces due to the difficult economic environment, competitive market conditions and declining investment yields.
Fitch views ZFS’s capitalisation as supportive of the current rating level and recognises substantial improvements in capital adequacy since year-end 2008, mainly reflecting the increase in shareholders’ funds. This was primarily driven by an increase in unrealised gains on investments, and retained earnings, which have been only partly offset by dividend payments.
Based on Fitch’s assessment, ZFS’s capital adequacy further benefited from a decrease in capital charges for its non-life book due to a reduction in premium volume, offset by an increase in equity charges due to the revaluation of ZFS’s investment in New China Life Company Ltd. Fitch notes that the quality of ZFS’s capital is negatively affected by goodwill and intangibles, which totalled USD8.1bn at end-2010 (end-2009:USD9.3bn), or 24% of shareholders’ funds, and the agency regards this as relatively high compared with peers.
Fitch views ZFS’s financial leverage as relatively high but within acceptable levels for the current rating level. Positively, operational debt declined in 2010, mainly due to decreasing repurchase agreements.
ZFS’s asset quality remains high, with equity, hedge fund and private equity exposure amounting to only 5% of total group investments at end-2010. ZFS has a sizeable corporate bond portfolio (31% of total group investments) and ABS/MBS portfolio (13%) but the credit quality is high. Exposure to troubled sovereign debt is moderate at 5% of total group investments and predominately relates to Italy and Spain.
Fitch notes that ZFS’s mortgage loan portfolio within its non-core operations deteriorated in 2010, which resulted in impairment charges. The agency believes there is potential for further losses on this portfolio in 2011-2012, although given the small size of the portfolio the charges are unlikely to have a material impact on capital.
The ratings continue to reflect ZFS’s good operating performance and the strength of the group’s business position in its key markets. Underlying earnings remain broadly in line with Fitch’s expectations in light of challenging investment and market conditions. The reported combined ratio increased to 97.9% in 2010 (2009: 96.8%) due to increased levels of major catastrophe and large-claim losses partially offset by 4.7 percentage points from prior- year reserve development.
Fitch views favourably ZFS’s plans to offset the impact of declining investment yields by reducing run-rate operating expenses, re-underwriting its poorest-performing books of business and improving its claims-handling process. Other positive rating factors include the strength of ZFS’s relationship with the Farmers Exchanges and the stable and reliable income stream that this generates, as well as the solid new business margins that continue to be achieved in the life business.
Fitch believes that ZFS is well-positioned in terms of liquidity and believes that the company’s access to capital markets is strong, as evidenced by several debt and equity issuances in 2009 and 2010. The agency notes that the group has access to a number of credit facilities, which were unused at end-2010.
Source : Fitch Ratings Press Release
