The upgrade of Cathay Life reflects the insurer's structural improvement in profitability, improved capitalization and strong financial flexibility.
Cathay Life has put a higher focus on traditional life regular-premium products with longer premium terms. Moody's expects this trend to continue and support stronger earnings over time. Moreover, a shift towards investment-linked policies also generates stable fee income to supplement earnings.
The product shift has led to improvements in its profit margins. The insurer's value of new business margins — using the first year premium equivalent as a basis — rose to 71% in the first nine months of 2018 from 63% in the prior year period.
In addition, its cost of liabilities declined consistently to 4.05% in the first nine months of 2018 from 4.23% in 2016, while its pre-hedging recurring yield has gradually risen, reflecting the lower crediting rates it offered for its products. Its annualized return on capital (ROC) measured 9.1% in the first nine months of 2018, up from 7.7% in 2017, due to higher interest income.
Cathay Life's risk-based capital (RBC) ratio was solid at 325% at 30 June 2018 and has stayed above 300% since the end of 2016. Cathay Life has strengthened its capital base via the issuance of TWD42 billion in common equity to Cathay Financial in June 2018. In addition, the insurer's improved earnings enhanced its retained earnings.
Cathay Life's credit profile also benefits from the strong domestic capital market access of Cathay Financial. Cathay Financial issued TWD92 billion of preference shares in total in 2016 and 2018. Part of the proceeds was used to subscribe the common equity issued by Cathay Life as mentioned above. Despite the issuance of the preference shares, the group's financial leverage has remained moderate, at around 18% at 30 September 2018, with also a strong earnings coverage.
Cathay Life's A3 IFSR also reflects its strong and stable business profile. The insurer is the largest life player in Taiwan in terms of total premiums, with an outstanding market position. Cathay Life also has strong channel control, given that its products are mainly distributed by its tied agency. Agency productivity is good, as reflected in stable policy persistency ratios, which stood at 98.5% (13 months) and 94.4% (25 months) in the first nine months of 2018.
These strengths are offset by the insurer's high equity exposure relative to its capital base, which exposes its capitalization to high volatility. For example, the sharp Taiwan and US equity market corrections in Q4 2018 diminished the insurer's capitalization and earnings. The insurer expects its RBC ratio at the end of 2018 to decline but still well above 250%, which shows a good buffer against the regulatory minimum level of 200%.
Moreover, the insurer holds significant overseas investments, which made up 65% of its total investments at 30 September 2018. This sizable allocation, which is partly unhedged and partly hedged through proxy hedges, exposes the insurer's earnings to exchange rate volatility.
The rating outlook is stable, reflecting Moody's expectation that Cathay Life's profitability will remain stable and it will maintain a solid capital position.
Cathay Life's rating could be upgraded if: (1) the insurer reduces its equity and unhedged overseas investment significantly with its high-risk assets declining below 175% of shareholders' equity on a sustained basis; (2) the insurer's RBC ratio remains above 350% and adjusted capital/total assets exceeds 7.5% (8% if excluding separate account assets) on a sustained basis; or (3) its earnings further improve, with ROC consistently above 12%.
However, the rating could be downgraded if: (1) its profitability erodes, with its ROC below 7% on a consistent basis; or (2) its capitalization weakens, with the local RBC ratio declining below 250% and adjusted capital/total assets declining below 5% (5.5% if excluding separate account assets) on a sustained basis; or (3) the insurer engages in material acquisitions, which could significantly weaken its capital strength; (4) its holdings of risky assets including equity and unhedged overseas investment rise significantly; or (5) Cathay Financial's financial leverage rises above 30% and earnings coverage falls below 8x on a sustained basis.
The upgrade of Cathay Financial's issuer rating to Baa1 reflects the rating upgrade of Cathay Life, the group's largest subsidiary as measured by assets, shareholders' equity and net income. In addition, this considers the fact that the credit profile of the other major subsidiaries, namely Cathay United Bank and Cathay Century, have been stable.
Cathay Financial's Baa1 rating reflects the aggregate weighted-average financial strength of its main subsidiaries and also the structural subordination of the holding company to its operating subsidiaries. In addition, Cathay Financial benefits from the diversification in sources of earnings through its life insurance, non-life insurance and banking subsidiaries.
The rating also incorporates certain degrees of government support for Cathay United Bank, which has a well-established franchise and sizable market share of loans and deposits in a mature market.
In recent years, Cathay Financial has maintained a moderate level of financial leverage, registering around 18.0% at 30 September 2018, and a strong earnings coverage.
Cathay Financial and its subsidiaries have also demonstrated good access to the domestic capital markets, having issued long-dated capital instruments at low costs (3%-4%) since 2016. In addition, Cathay Financial's double leverage ratio remained moderate at 115% at 30 September 2018, following the capital injection into Cathay Life in June 2018.
Moody's expects that Cathay Financial will continue to manage its dividend policy prudently to maintain adequate capital at its subsidiaries and at the holding company level. Liquidity at Cathay Financial and its major subsidiaries remains adequate.
The rating outlook is stable, in line with the stable outlooks for all of the other major subsidiaries, including Cathay Life, Cathay Century and Cathay United Bank.
A rating upgrade of Cathay Financial's key operating subsidiaries, mainly Cathay Life and Cathay United Bank, could lead to an upgrade of Cathay Financial's rating.
However, the rating could be downgraded if: (1) there is a rating downgrade of Cathay Financial's key operating subsidiaries, mainly Cathay Life and Cathay United Bank; or (2) the group's double leverage rises significantly; and/or its financial leverage rises above 30% and earnings coverage falls below 8x on a sustained basis; or (3) the group engages in significant acquisitions or expansion that would exert significant negative pressure on the group's financial profile; or (4) the group's business mix of life and non-life insurance and banking operations becomes less diversified.
The principal methodology used in rating Cathay Life Insurance Co., Ltd was Life Insurers published in May 2018. The principal methodologies used in rating Cathay Financial Holding Co., Ltd were Life Insurers published in May 2018, Banks published in August 2018, and Property and Casualty Insurers published in May 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
Cathay Life Insurance Co., Ltd is the largest life insurer in Taiwan. At 30 September 2018, its total assets stood at TWD6.4 trillion and shareholders' equity at TWD449.4 billion.
Cathay Financial Holding Co., Ltd, listed on the Taiwan Stock Exchange, is one of the largest financial holding companies in Taiwan. At 30 September 2018, its total assets and shareholders' equity on a consolidated basis measured TWD9.2 trillion and TWD611.7 billion, respectively.