Overview -- Fidelity & Guaranty Life Insurance Co.'s (FGLIC's) 2011 statutory results showed continued positive trends from 2010, with strengthened capitalization. -- Under its new parent company, Harbinger Group Inc., FGLIC has continued to derisk its investment portfolio. -- As a result, we are raising our unsolicited issuer credit rating on FGLIC to 'BB' from 'BB-'. The outlook is positive. -- The positive outlook reflects our view of FGLIC's favorable operating performance and sales trends, which we expect to continue. Rating Action On May 30, 2012, Standard & Poor's Ratings Services raised its unsolicited issuer credit rating on Fidelity & Guaranty Life Insurance Co. (FGLIC) to 'BB' from 'BB-'. The outlook is positive. Rationale The upgrade and positive outlook reflect FGLIC's continuing positive operating performance, its strengthened capitalization, the decreased risk in its investment portfolio, and its improving sales. In 2011, FGLIC had an adjusted statutory net income of $148 million. The 2011 adjusted net income included net realized capital losses of $6 million and unrealized capital losses on derivatives of $99 million, and excluded one-time charges of $136 million resulting from reinsurance transactions in 2011. In comparison, FGLIC's adjusted statutory net income was $168 million in 2010. The 2010 adjusted net income included net realized capital losses of $49 million and unrealized capital losses on derivatives of $80 million. When analyzing statutory net income, we adjust earnings to include the unrealized gains or losses on the derivatives backing the equity-indexed annuities (reported as a component of capital and surplus) to match it against the offsetting credit to reserves (reported in income from operations). The year-over-year decline in FGLIC's net income was primarily due to declines in net investment income. FGLIC improved its year-end 2011 risk-based capital (RBC) ratio to 371% from 350% in 2009, despite a $40 million dividend to Harbinger Group Inc., primarily as a result of positive statutory earnings. Harbinger had identified certain investments that should be excluded from FGLIC's portfolio in order to fulfill the terms and conditions for its acquisition of FGLIC. Accordingly, in 2010 and 2011, FGLIC disposed of those investments to lower the risk in its portfolio, without incurring significant losses. Although 97% of FGLIC's bonds were rated investment grade as of Dec. 31, 2011, the firm's above-average credit exposure to 'BBB' rated investments offsets its below-average exposure to speculative-grade assets. High risk assets (speculative-grade bonds and common and preferred stock) as a percentage of total invested assets declined to 5.0% in 2011 from 6.8% in 2010--below the industry average. FGLIC strategically reduced its weighted average bond duration to 10.0 years in 2011, which was in line with industry averages, sacrificing yield for asset-liability matching. FGLIC recently returned to a top five position in indexed-annuity sales as of March 31, 2012; a position it last held in 2007. As of Dec. 31, 2011, the company's indexed-annuity sales increased 10% from year-end 2010 levels. However, FGLIC's narrow business profile may affect its competitive positioning going forward. The ratings on FGLIC reflect its marginal competitive position, which it derives from its product-manufacturing capabilities and distribution relationships in its niche markets. FGLIC's concentrated business profile focuses primarily on the highly competitive annuity market. Outlook The positive outlook reflects our view of FGLIC's positive operating performance and sales trends, its strengthened capitalization, and its continued derisking of its investment portfolio. There is a one-in-three probability that we could raise the rating within the next year if FGLIC's operating performance remains positive and it maintains capitalization at current levels. We could lower the rating if Harbinger allows capital to erode to an RBC ratio of less than 300%, if FGLIC manages the investment portfolio more aggressively, or if the company's competitive position weakens. We expect that FGLIC's 2012 equity-indexed annuity sales will increase 5%-10% from 2011 levels. We also expect that FGLIC will produce at least $100 million in adjusted statutory net income in 2012 and maintain a top 10 position in its primary niche businesses: equity indexed annuities and equity indexed life insurance. Related Criteria And Research -- Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010 -- Analysis Of North American Life Insurance Operating Performance, May 13, 2009 Ratings List Upgraded To From Fidelity & Guaranty Life Insurance Co. (Unsolicited Ratings) Counterparty Credit Rating Local Currency BB/Positive/-- BB-/Positive/-- Financial Enhancement Rating Local Currency BB/Positive/-- BB-/Positive/-- Financial Strength Rating Local Currency BB/Positive/-- BB-/Positive/-- This unsolicited rating(s) was initiated by Standard & Poor's. It may be based solely on publicly available information and may or may not involve the participation of the issuer. Standard & Poor's has used information from sources believed to be reliable based on standards established in our Credit Ratings Information and Data Policy but does not guarantee the accuracy, adequacy, or completeness of any information used. 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