OREANDA-NEWS. Fitch Ratings has affirmed the Insurer Financial Strength (IFS) ratings of Legal & General Group Plc's (L&G) core rated operating entities, Legal & General Assurance Society Ltd, Banner Life Insurance Company and William Penn Life Insurance Company of New York, at 'AA-'.

Fitch has simultaneously affirmed L&G's 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 Ratings 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's diversification benefit from other markets is limited relative to peers rated in the 'AA' category.

L&G's high capital buffer is a major positive rating factor, allowing the group to withstand volatile investment markets. The company's score on Fitch's Prism factor-based capital model (Prism FBM) is 'extremely strong', based on end-2015 results. L&G reported a regulatory solvency ratio of 217% and a with-profits surplus of GBP0.6bn at end-2015.

Any widespread downgrades of UK corporate debt arising from "Brexit" would weaken L&G's capital position both in Prism FBM and under Solvency II. L&G estimated that its Solvency II coverage ratio was about 156% on 27 June 2016.

L&G's financial leverage was 30% at end-2015. This is high for the ratings and a negative rating driver. However, the group's fixed-charge coverage of 11x at end-2015 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 the group's 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 2015, 24% of L&G's operating profit came from LGIM. L&G generates around 14% of its profit internationally, predominantly in the US.

L&G's net profitability in 2010-2015 was fairly stable in the GBP0.7bn-GBP1.1bn range. Fitch expects L&G to maintain this level of profitability, which supports the ratings. The agency expects L&G to manage capital and financial leverage in line with current levels, with other key credit metrics also likely to be stable in the near term.

L&G has high exposure to credit markets through the large portfolio of corporate and government bonds backing its UK annuity business of GBP43bn (end-2015). While this is a negative rating factor, it is largely offset by a large credit default reserve (GBP2.2bn) that the company has maintained despite negligible net default experience in recent years.

L&G has high exposure to longevity risk through its large UK annuity book. It is also exposed to pricing risk when insuring large pension scheme liabilities.

We believe L&G will be resilient to the negative effects of recent pension reforms on the UK annuity market, as it is a large group with a diverse product range. 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.

L&G's bulk annuity business is already larger than the group's individual annuity business. Bulk annuities accounted for GBP2.4bn of the GBP2.7bn annuity premiums written by the group in 2015.

Under our insurance rating methodology, we consider Banner Life and William Penn (together, Legal & General America (LGA)) as core to L&G and therefore align their IFS ratings with that of Legal & General Assurance Society Ltd, the other core rated operating entity in the group. Their core status reflects their long ownership by L&G; their importance to L&G's growth strategy; and the diversification benefit for L&G between mortality risk in LGA and the longevity risk in the UK business. It also factors in L&G's long history of direct capital funding to support LGA's growth; the material share of LGA in L&G's business (25% of L&G's insurance gross written premiums in 2015 and 6% of its value of new business); shared management between LGA and L&G; and consistency of branding.

RATING SENSITIVITIES

The ratings could be downgraded in the event of a fall in the group's Prism FBM score to the low end in the 'very strong' range, an increase in financial leverage approaching 35% or interest cover below 5x for a sustained period. Banner Life and William Penn's ratings could also be downgraded if their profitability or market position deteriorates to such an extent that Fitch no longer views them as core to L&G.

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.