PrefBlog

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.

This entry was posted on Thursday, November 4th, 2010 at 1:05 am and is filed under Issue Comments, Regulation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.