Fitch Ratings has revised the Outlook on Suncorp Group Limited's (SGL) Long-Term Issuer Default Rating (IDR) and AAI Limited's IDR and Insurer Financial Strength (IFS) Rating to Stable, from Negative.

At the same time, Fitch has affirmed SGL's Long-Term IDR at 'A+', Short-Term IDR at 'F1' and subordinated debt at 'A-'. Fitch also affirmed AAI's IDR at 'A+', IFS Rating at 'AA-' and subordinated debt at 'A'.

We assess SGL's ratings based on the group's consolidated operating profile, and consider its Australian non-life operating entity, AAI, to be a core member of the group. AAI generated 84% of the group's non-life premiums in the financial year ending June 2020 (FY20). The non-life division has historically been the largest contributor to group profit (FY20: 68%).

KEY RATING DRIVERS

The Outlook revision reflects our expectation that SGL's capitalisation will not be affected by a sharp deterioration in the asset quality of SGL's banking subsidiary, Suncorp-Metway Limited (SML). SGL could see higher Covid-19 related business interruption (BI) claims, but we think this risk is manageable given the insurer's reserving strength and sound capital buffers. We expect SGL's profitability and capital metrics to stay within the tolerances of its rating level. Our expectations for SGL are more favourable than the pro forma results implied by our 2020 Covid-19 stress test analysis, which was the basis for the prior Negative Outlook.

The affirmations reflect SGL's 'Very Strong' capitalisation and leverage, 'Strong' financial performance and earnings and 'Favourable' business profile. Offsetting these strengths to some extent is the group's large banking exposure via SML, which has a weaker standalone profile, as reflected in its Viability Rating of 'a-'.

The pandemic's impact on non-life claims has been broadly neutral, with fewer motor claims offsetting higher provisions for potential BI claims. SGL has strengthened capital buffers at all of its regulated entities in light of the uncertainty caused by the pandemic and held AUD1.4 billion of total capital in excess of internal targets at end-2020 (FY20: AUD1.2 billion).

SGL's Fitch Prism Model score was 'Very Strong' at FYE20 and we estimate a similar result at end-2020. The score is sensitive to SML's risk-weighted assets, which remained flat at AUD33 billion during 2020. We think a sharp increase in risk-weighted assets due to asset quality weakening is unlikely, as Australia has controlled the spread of the coronavirus well, resulting in the economic outlook strengthening. The non-life prescribed capital amount coverage ratio improved to 1.74x at end-1HFY21, from 1.68x at FYE20, and is towards the top-end of our criteria guidelines for a 'AA' rated insurer. Meanwhile, shareholders' equity increased to AUD13.2 billion, from AUD12.8 billion, due to retained earnings.

SGL recorded a Covid-19 related BI claims provision of AUD214 million in anticipation of higher claims due to adverse litigation outcomes. This is largely due to exposure from policies with exclusions that refer to the outdated Quarantine Act and also from certain prevention of access clauses. There is still some uncertainty around the ultimate cost of BI claims, but SGL's overall outstanding claims liability includes risk margins to achieve a 90% probability of adequacy, a level similar to previous years.

The non-life combined ratio increased to 96% in 1HFY21 (FY20: 94%) due to high catastrophe losses and BI-related reserve strengthening, which more than offset the motor claims frequency benefit experienced due to mobility restrictions in 2020. SGL's combined ratio averaged 93% in the last three years; well within our criteria guidelines for a 'AA' rated insurer. Underwriting performance has been supported by SGL's strong reinsurance programme, but the insurer has been continually increasing its allowance for natural hazards due to the higher frequency of extreme weather events and rising reinsurance costs. The allowance for FY21 increased to AUD950 million, from AUD820 million.

We think SGL should be protected from catastrophe losses in 2HFY21 - including the current severe flooding experienced in New South Wales and south east Queensland. Catastrophe losses in 1HFY21 did not trigger reinsurance recoveries and continued to erode aggregate deductibles on reinsurance treaties. The maximum first-event retention under SGL's main catastrophe programme is AUD250 million, with an upper limit of AUD6.5 billion.

SGL's borrowings at the holding company level to support SML's capitalisation have not been overly burdensome, and the group's financial leverage ratio, which factors in financing debt of the insurance operations as well as SGL's borrowings on behalf of the bank, was low at 12% at end-1HFY21.

We rank SGL's business profile as favourable against all other Australian non-life insurers due to its solid market presence and strong brand franchise. SGL commanded a 2020 non-life market share (based on net earned premium) of 20% and 24% in Australia and New Zealand, respectively, and is also one of New Zealand's top-five life insurers by risk in-force. We score SGL's business profile at 'aa-' under our credit factor scoring guidelines in light of this ranking.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Deterioration in SGL's business profile, including a weaker franchise or a large drop in market share

Weaker Viability Rating for the banking operation

Non-life combined ratio of over 98% for a sustained period

Financial leverage ratio above 23% for a sustained period

Weaker capitalisation, with a Fitch Prism Model score below 'Very Strong', coupled with the non-life total prescribed capital amount coverage falling below 1.50x

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Further improvement in SGL's business profile, with greater geographical diversification of the non-life operations coupled with a stronger standalone bank profile and maintaining a Fitch Prism Model score well in to 'Very Strong'

Strong operating performance across all businesses

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING		PRIOR
Suncorp Group Limited	LT IDR	A+ 	Affirmed		A+
	ST IDR	F1 	Affirmed		F1

subordinated

	LT	A- 	Affirmed		A-
AAI Limited	LT IDR	A+ 	Affirmed		A+
	Ins Fin Str	AA- 	Affirmed		AA-

subordinated

LT	A 	Affirmed		A

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

(C) 2021 Electronic News Publishing, source ENP Newswire