Rating agency Fitch Ratings has confirmed the insurer financial strength (“IFS”) rating at ‘A+’ and long-term issuer credit rating (“ICR”) at ‘A-‘ of Torchmark Corp. (TMK) and its insurance subsidiaries. The ratings also carry a stable outlook.
Fitch’s rating affirmation acknowledges Torchmark’s strong capital position and solid cash flow. Torchmark had $16.7 billion in assets and $3.8 billion in shareholder equity as of March 31, 2012. Strong operating performance of its subsidiaries ensures consistent operating cash flow for the parent, that is used for debt repayment and share repurchases, thus strengthening the parent’s capital and bottom-line earnings.
Fitch also reviewed Torchmark’s profitability, taking into account its Return on Assets (“ROA”), which stood at 3.9% at the end of first quarter 2012. Its debt service capability, as measured by interest coverage ratio, also stood at 9.4x. Fitch noted that though both these metrics lagged behind the historical average of 4-5% and 10x-13x for ROA and interest coverage respectively, it fared relatively better than peers with 1.4x and 8.0x for similar metrics.
The affirmation of Torchmark’s IFS ratings comes on the back of its adequate risk based capital levels. According to Fitch, the company’s current risk based capital and adjusted capital stands at 333% and $1.4 billion, respectively, which aligns with the 325% limit for risk-based capital set by the company itself.
One of the factors offsetting the strong ratings was Torchmark’s enhanced financial leverage, which stood at 26%, higher than Fitch’s comfort level of 25%. However, the rating agency views this as a temporary phenomenon driven by $395 million or 10% decline in shareholders’ equity. The reduction and consequent rise in leverage was driven by the impact of the new accounting rules for Deferred Acquisition Cost (“DAC”).
On January 1, 2012, the company adopted Accounting Standard Update 2010-26, which changed the rules regarding the deferral of acquisition cost. This standard changes the timing of GAAP profits to the extent that certain expenses deferred under the previous rules will no longer be deferred.
However, it does not affect Torchmark’s overall profitability, cash flow or statutory earnings. The company adopted the new rule retrospectively, which implies that the DAC was written in a way as if the new standard had already been in practice. The new rule is likely to impact earnings through a reduction in expenses deferred on newly issued policies, somewhat offset by the reduced amortization of DAC resulting from the retroactive write-down.
The rating agency, however, notes that Torchmark has a strong capital profile, which will enable it to fulfill its commitments reflected through its total financing and commitment ratio of 0.41x as of March 31, 2012, stronger than most of its peers and within the comfort range of 0.54x set by Fitch Ratings.
The rating agency also laid out the factors, which may cause an uptick in ratings. These include risk based capital of more than 370% and enhanced business diversification. The rating agency may take a reverse action if the company incurs more-than-expected losses in its investment portfolio; the risk based capital falls below 290%, financial leverage is higher than 25%, total financing and commitment ratio breaches the maximum limit of 0.55x and interest coverage ratio drops below 5x.
Earlier during the month, another rating agency A.M. Best undertook a rating action on Torchmark as a part of its yearly review exercise. It affirmed the financial strength ratings (FSR) of ‘”A+” and the ICR of “aa” for the company’s subsidiaries while Torchmark’s ICR of "a-" along with its existing ratings were also affirmed. All the ratings carried a stable outlook.
Peer Assurant Inc. (AIZ) also carries an ICR of “bbb” with a stable outlook. Torchmark currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. We are also maintaining our long-term Neutral recommendation on its shares.
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