PrefBlog

Manulife Financial Corporation has released its 3Q10 Financials. The Press Release states:

The net loss attributed to shareholders of $947 million included the following notable items:

• Net gains of $1,041 million related to higher equity markets and lower interest rates.
• Charges of $2,031 million related to basis changes resulting from the annual review of all
  actuarial methods and assumptions.

• A $1,039 million (US$1,000 million) goodwill impairment charge on our U.S. Insurance business related to the economic outlook and the repositioning of that business.
• Other notable items netted to a $303 million gain and are described in more detail below.

After adjusting for these notable items, adjusted earnings from operations was $779 million.

They made a lot of Long-Term Care sales in the States … but was it profitable and can it be sustained?

John Hancock Long-Term Care (“JH LTC”) sales increased 20 per cent in the third quarter compared to the prior year, driven by sales of retail products which increased in advance of June new business price increases taking effect. As a result of the recently completed claims experience study and the continuing low interest rate environment, JH LTC has temporarily suspended new group sales and is planning other retail product changes. JH LTC sales are expected to decline in the fourth quarter of 2010. In addition, JH LTC will be raising premiums on in-force business and is actively working with regulators to implement increases that are on average 40 per cent and affect the majority of the in-force business.

There are not enough details given to form a firm opinion … but a 40% increase in rates? on average? That has all the hallmarks of a major fuck-up. Do these guys know what they’re doing?

They do provide a clearer warning of the effect of OSFI’s new risk requirements:

The Office of the Superintendent of Financial Institutions (“OSFI”) has been conducting a review of segregated fund/variable annuity capital requirements. On October 29, 2010, OSFI issued a draft advisory containing new minimum calibration criteria for determining capital requirements for segregated fund business written after January 1, 2011. It is expected that the new calibration criteria will increase capital requirements on these products and our 2011 product offerings will be developed and priced taking into account these new rules. As drafted the new capital requirements will also apply to subsequent deposits to existing contracts and to contracts that reset their guarantee levels after January 1, 2011.

… and the capital requirements for seg funds will be getting even stricter:

OSFI is also expected to continue its consultative review of its capital rules for more general application, likely in 2013. OSFI notes that it is premature to draw conclusions about the cumulative impact this process will have, but the general direction has been one of increased capital requirements. OSFI has stated that increases in capital may be offset by other changes, such as hedge recognition. The Company will continue to monitor developments. However, at this time, it appears that it is more likely than not that the capital requirements for in-force business will increase and this increase could be material.

They are worried by the IFRS Exposure Draft on Insurance Contracts (see also commentary on SLF 3Q10) and are busily sleazing around the regulators and politicians to get an exemption:

This mismatch between the underlying economics of our business and reported results and potentially our capital requirements could have significant unintended negative consequences on our business model which would potentially affect our customers, shareholders and the capital markets. We believe the accounting rules under discussion could put Canadian insurers at a significant disadvantage relative to their U.S. and global peers, and also to the banking sector in Canada. We are currently reviewing the proposals contained in the Exposure Draft, and, along with other companies in the Canadian insurance industry, expect to provide comments and input to the IASB. The insurance industry in Canada is also currently working with OSFI and the federal government with respect to the potential impact of these proposals on Canadian insurance companies, and the industry is urging policymakers to ensure that any future accounting and capital proposals appropriately consider the underlying business model of a life insurance company and in particular, the implications for long duration guaranteed products which are much more prevalent in North America than elsewhere.

Sadly, Prentice has already been bought hired by CIBC, but there are probably many other politicians for sale eager to devote their expertise to the private sector.

DBRS comments:

DBRS has reviewed the Q3 2010 results of Manulife Financial Corporation (Manulife or the Company) released today and believes that, notwithstanding the negative net earnings figure, the Company is on the right track to restoring sustainable profitability. The ratings of Manulife and its affiliates remain unchanged, including the Issuer Rating of its major operating subsidiary, The Manufacturers Life Insurance Company (MLI), at AA (low). The ratings were recently downgraded on August 9, 2010.
…
The Company has been actively repositioning its product offering by selectively increasing prices and emphasizing products that are less capital intensive. Integrated risk management and control is leading to a systematic reduction in equity and interest rate risk through portfolio shifts. As part of its risk management framework, the Company has now hedged 54% of its variable annuity exposures to equity markets and has plans to use actions based on time schedules and market triggers to reach its risk reduction goals. The Company expects to reduce its equity sensitivity by approximately 60% by 2012 and approximately 75% by 2014. It also expects to take actions to further reduce its interest rate exposures, as measured by the impact on shareholders’ net income, by approximately 25% by the end of 2012 and approximately 50% by the end of 2014. While this could ultimately be expensive for the Company, DBRS believes that ridding itself of this equity market and interest rate risk hangover is fundamental to restoring market confidence in the Company’s longer-term outlook.

DBRS did not comment on the size of the write-down due to changes in actuarial assumptions: they had previously estimated a charge of $700- to $800-million.

Moody’s downgraded the operating subsidiaries:

Moody’s Investors Service downgraded the insurance financial strength (IFS) ratings of Manulife Financial Corporation’s (Manulife; TSX: MFC, unrated) subsidiaries to A1 from Aa3. These subsidiaries include Manufacturers Life Insurance Company (MLI) and John Hancock Life Insurance Company (USA) (JHUSA). Short-term ratings were affirmed. The rating outlook for Manulife’s subsidiaries is stable. These rating actions conclude the reviews for downgrade initiated on August 5, 2010.
…
The rating agency said the downgrades follow MFC’s announcement of a nearly $1 billion net loss in 3q10 and incorporated the following business developments. First, Manulife’s acknowledgement of higher morbidity experience within its US long-term-care block and the resulting need for an average rate increase exceeding 40% in coming months. Also, the company faces the challenge of redesigning products to restore earnings power, combined with the possibility of continued earnings volatility until the firm’s enhanced market-risk hedging program is substantially complete.

Moody’s said the downgrades also reflect Manulife’s diminished financial flexibility because of reduced earnings coverage and increased financial leverage. At the end of the third quarter, Moody’s estimates that Manulife’s adjusted financial leverage is now over 30%, which exceeds Moody’s limit on this rating sub-factor. Furthermore, the company faces further goodwill charges as it adopts IFRS accounting in 2011. Although these goodwill write-downs are non-cash, they will lead to further deterioration on Moody’s leverage metrics. MLI reported a 234% minimum continuing capital and surplus requirements (MCCSR, the Canadian regulatory capital ratio for life insurers) ratio at the end of the third quarter, which Moody’s views as strong; however, this was due in part to the downstreaming of proceeds from debt raised at the parent as capital to MLI. As the firm’s total leverage increases, management’s ability to deploy double leverage to capitalize the operating company decreases.
…
According to Moody’s, upward pressure on the ratings would result from a substantial completion of the company’s equity and interest rate hedging programs, the maintenance of a MCCSR ratio above 220% and an NAIC RBC ratio at JHUSA of at least 325% on a sustained basis, with improved financial flexibility including adjusted leverage below 30% and earnings coverage above 8x on a sustained basis. Downward pressure would result from a failure to complete the hedging programs, a MCCSR ratio that dropped below 200%, and/or an NAIC RBC ratio at JHUSA of less than 275%.

S&P had the grace to admit the actuarial change was larger than expected:

2010–Standard & Poor’s Ratings Services today said it placed its ‘A’ counterparty credit rating on Manulife Financial Corp. (TSX/NYSE:MFC) on CreditWatch with negative implications. At the same time, Standard & Poor’s placed its ‘AA’ counterparty credit and financial
strength ratings on MFC’s core and guaranteed insurance operating subsidiaries on CreditWatch with negative implications.
…
“We placed the ratings on all of the companies in the Manulife group on CreditWatch negative because of Manulife’s continuing earnings volatility and material noncash goodwill impairments that could reach C$3.2 billion,” said Standard & Poor’s credit analyst Robert Hafner. “These goodwill impairments include $2.2 billion under IFRS accounting rules that could follow in the
first quarter of 2011.”

“The earnings volatility is evident in the group’s consolidated third-quarter loss of C$947 million that includes a basis change charge of about C$2 billion arising from its annual review of all actuarial assumptions and methods,” said Mr. Hafner. “These charges somewhat exceed the amount we assumed when we lowered the ratings on the group on Aug. 5 and assigned a negative outlook.”

Industrial Alliance has released its third quarter financials, and managed to do so without mentioning any prospects for regulatory change. This is the same policy as was followed with the 2Q10 Shareholders’ Report.

However, it was another good quarter:

Top-line growth in the third quarter continued to show strong momentum. Premiums and deposits increased 15% to $1.4 billion and the value of new business rose 44% to $41.4 million. For the nine-month period, premiums and deposits were up 31% over 2009 and 7% over 2007 – the Company’s record year. This growth is fuelled primarily by the Individual Wealth Management sector that continues to benefit from stock market gains and high net sales.
…
Top-line growth in the third quarter continued to be strong for the fourth quarter in a row. Almost all sectors contributed to this growth, with Individual Wealth Management in the lead as a result of the upswing in equity markets. For the period ended September 30th, this sector had gross sales of $686.7 million, up 29% over the previous year, and net sales of $243.3 million, up 52% over 2009. For the first nine months of 2010, Industrial Alliance ranked second in Canada for net sales of segregated funds, with a 34.1% market share, and fifth in terms of net mutual fund sales.

There are a few changes planned for their asset mix and hedging practice:

Management has taken a number of initiatives to reduce its sensitivity to interest rate risk. These initiatives are in the process of being implemented and will include a 5% increase in the proportion of stocks backing long-term liabilities. Had these initiatives been in place at September 30, 2010, the Company expects that it would be able to absorb a 15% decline in equity markets and that provisions for future policy benefits would not have to be strengthened as long as the S&P/TSX remains above 10,500 points.

Additionally, as part of its risk management process, the Company has implemented a dynamic hedging program to manage the equity risk related to its guaranteed annuity (GMWB) product, effective October 20th, 2010. The GMWB portfolio represents approximately $1.5 billion of assets under management, including $900 million in equities. The Company also entered into a reinsurance agreement during the third quarter to share 60% of the longevity risk related to its $2.5 billion insured annuity block of business.

As far as current sensitivities are concerned:

The Company’s sensitivity analysis varies from one quarter to another according to numerous factors, including changes in the economic and financial environment and the normal evolution of the Company’s business. The results of these analyses show that the leeway the Company has to absorb potential market downturns remains very high overall.

At September 30, 2010, the analysis was as follows:

• Stocks matched to the long-term liabilities – The Company believes that it will not have to strengthen its provisions for future policy benefits for stocks matched to long-term liabilities as long as the S&P/TSX index remains above 9,400 points.
• Solvency ratio – The Company believes that the solvency ratio will stay above 175% as long as the S&P/TSX index remains above 7,650 points, and will stay above 150% as long as the S&P/TSX index remains above 6,450 points.
• Ultimate reinvestment rate (“URR”) – The Company estimates that a 10 basis point decrease (or increase) in the ultimate reinvestment rate would require the provisions for future policy benefits to be strengthened (or would allow them to be released) by some $44 million after taxes.
• Initial reinvestment rate (“IRR”) – The Company estimates that a 10 basis point decrease (or increase) in the initial reinvestment rate would require the provisions for future policy benefits to be strengthened (or would allow them to be released) by some $25 million after taxes.

They estimate that a sudden 10% decline in equity markets would take $18-million off their net income; unfortunately, they neither provide pro-forma figures reflecting the asset mix changes, nor provide estimates of the effect of larger equity market declines – which will, of course, not be proportional to the adverse effect of such a normal correction.

Sun Life Financial has released its 3Q10 Financials. They had a decent – not great – quarter, but I’m more interested in their commentary on the capital rules:

In Canada, the Office of the Superintendent of Financial Institutions Canada (OSFI) is considering a number of changes to the insurance company capital rules, including new guidelines that would establish stand-alone capital adequacy requirements for operating life insurance companies, such as Sun Life Assurance, and that would update OSFI’s regulatory guidance for non-operating insurance companies acting as holding companies, such as Sun Life Financial Inc.

These proposals from the US Treasury (hopping mad about AIG) are now over a year old and can’t be implemented too soon according to me. Julie Dickson alluded to the possibility in a speech.

In addition, OSFI may change the definition of available regulatory capital for determining regulatory capital to align insurance definitions with any changed definitions that emerge for banks under the proposed new Basel Capital Accord.

Presumably this (mainly) refers to efforts to make the loss-absorption potential of regulatory capital more explicit (although the proposals are framed in such a way that it simply represents a regulatory-political end-run around the bankruptcy courts).

OSFI is considering more sophisticated risk-based modeling approaches to Minimum Continuing Capital and Surplus Requirements (MCCSR), which could apply to segregated funds and other life insurance products. In particular, OSFI is considering how advanced modeling techniques can produce more robust and risk-sensitive capital requirements for Canadian life insurers. This process includes internal models for segregated fund guarantee exposures. On October 29, 2010 OSFI released a draft advisory, for consultation with the industry and other stakeholders, setting out revised criteria for determining segregated fund capital requirements using an approved model. It is proposed that the new criteria, when finalized, will apply to qualifying segregated fund guarantee models for business written on or after January 1, 2011. The Company is in the process of reviewing the advisory to determine the potential impact of the proposed changes, and will continue to actively participate in the accompanying consultation process.

It is very disappointing that they are not more specific, given that implementation is two months’ away.

In particular, the draft advisory on changes to existing capital requirements in respect of new segregated fund business may result in an increase in the capital requirements for variable annuity and segregated fund policies currently sold by the Company in the United States and Canada on and after the date the new rules come into effect. The Company competes with providers of variable annuity and segregated fund products that operate under different accounting and regulatory reporting bases in different countries, which may create differences in capital requirements, profitability and reported earnings on these products that may cause the Company to be at a disadvantage compared to some of its competitors in certain of its businesses. In addition, the final changes implemented as a result of OSFI’s review of internal models for in-force segregated fund guarantee exposures may materially change the capital required to support the Company’s in-force variable annuity and segregated fund guarantee business.

Scary words, but no meat in the sandwich.

Similar was their commentary on the proposed rules regarding hedging:

On July 30, 2010 the International Accounting Standards Board (IASB) issued an exposure draft for comment, which sets out recognition, measurement and disclosure principles for insurance contracts. The insurance contracts standard under IFRS, as currently drafted, proposes that liabilities be discounted at a rate that is independent of the assets used to support those liabilities. This is in contrast to current rules under Canadian GAAP, where changes in the measurement of assets supporting actuarial liabilities is largely offset by a corresponding change in the measurement of the liabilities.

The Company is in the process of reviewing the exposure draft, and is working with a number of industry groups and associations, including the Canadian Life and Health Insurance Association, which submitted a comment letter to the IASB on October 15, 2010. It is expected that measurement changes on insurance contracts, if implemented as drafted, will result in fundamental differences from current provisions in Canadian GAAP, which will in turn have a significant impact on the Company’s business activities. In addition, the IASB has a project on accounting for financial instruments, with changes to classification, measurement, impairment and hedging. It is expected the mandatory implementation of both these standards will be no earlier than 2013.

The IASB continues to make changes to other IFRSs and has a number of ongoing projects. The Company continues to monitor all of the IASB projects that are in progress with regards to the 2011 IFRS changeover plan to ensure timely implementation and accounting.

The proposed new standard has been discussed on PrefBlog. The CLHIA letter does not appear to have been made public by the CLHIA but has been published by IFRS. I can’t say I find the CLHIA arguments – or those of the sell-side analysts quoted in the appendix – particularly convincing. It boils down to another round of the market-value vs. historical cost debate, but they spend more time discussing why fair value will be so inconvenient than on why it is inferior.

As far as earnings are concerned:

Sun Life Financial reported net income attributable to common shareholders of $453 million for the quarter ended September 30, 2010, compared to a loss of $140 million in the third quarter of 2009. Net income in the third quarter of 2010 was favourably impacted by $156 million from improved equity market conditions, and $49 million from assumption changes and management actions. The Company increased its mortgage sectoral allowance by $57 million, which reduced net income by $40 million, in anticipation of continued pressure in the U.S. commercial mortgage market, however overall credit experience continued to show improvement over the prior year. The net impact from interest rates on third quarter results was not material as the unfavourable impact of lower interest rates was largely offset by favourable movement in interest rate swaps used for asset-liability management.
…
In its interim MD&A for the third quarter of 2009, the Company provided a range for its “estimated 2010 adjusted earnings from operations”(2) of $1.4 billion to $1.7 billion. Based on the assumptions and methodology used to determine the Company’s estimated adjusted earnings from operations, the Company’s adjusted earnings from operations for the third quarter of 2010 were $353 million and $1,087 million for the nine months ended September 30, 2010. Additional information can be found in this news release under the heading Estimated 2010 Adjusted Earnings from Operations.

So it looks like, at best, they’re going to just squeeze in to the bottom of that range.

Q3 2010 adjusted earnings from operations

($ millions) Q3’10
————————————————————————-
Adjusted earnings from operations(1) (after-tax) 353
Adjusting items:
Net equity market impact 156
Management actions and updates to actuarial estimates and
assumptions 49
Tax 16
Sectoral allowance in anticipation of continued pressure in
the U.S. commercial mortgage market (40)
Net interest rate impact (15)
Currency impact (6)
Other experience gains (losses) (includes $32 million
unfavourable mortality/morbidity experience and $4 million
unfavourable credit impact) (60)
————————————————————————-
Common shareholders’ net income 453
————————————————————————-

and

Market risk sensitivities

September 30, 2010
————————————————————————-
Changes in Net income(3)
interest rates(1) ($ millions) MCCSR(4)
————————————————————————-
1% increase 225 – 325 Up to 8 percentage points increase
1% decrease (375) – (475) Up to 15 percentage points decrease
————————————————————————-

Changes in equity markets(2)
————————————————————————-
10% increase 75 – 125 Up to 5 percentage points increase
10% decrease (175) – (225) Up to 5 percentage points decrease
————————————————————————-
————————————————————————-
25% increase 125 – 225 Up to 5 percentage points increase
25% decrease (575) – (675) Up to 15 percentage points decrease
————————————————————————-

Given that the Globe & Mail reports .. :

[UBS analyst Peter] Rozenberg calculated that the weighted average equity markets in the United States, Canada, Japan and Hong Kong increased 9.7 per cent quarter over quarter.

… it is a bit disappointing not to see a better match-up between the published sensitivity to a 10% equity market decline and the adjusting entry in the derivation of operating earnings.

It is also disappointing to see that their commentary on potential regulatory changes is so similar to their commentary in the 2Q10 report.