Some will recall that Muddy Waters / Carson Block have shorted Manulife shares in a move that looks prescient regardless of the details:
Muddy Waters has found its latest target: Canadian insurer Manulife Financial Corp.
Short seller Carson Block, who runs Muddy Waters, announced a short position in the firm Thursday, and said its life-insurance subsidiary just concluded a trial with a hedge fund that could lead to billions in losses. Block expects a verdict this year. Manulife said in a statement that it disagrees with Block’s conclusions.
In a report, Muddy Waters said it believes investors aren’t aware of the material risks to Manulife posed by the trial. The insurer was taken to court by hedge fund Mosten Investment LP, which claims it should be allowed to deposit unlimited amounts of capital with Manulife and earn at least 4 per cent in annual interest based on a 1997 universal life insurance policy it owns.
In an era of higher interest rates in the late 1990s, two predecessor companies of Industrial Alliance Insurance and Financial Services Inc. and Manulife Financial Corp. issued life insurance policies that allowed holders to invest in side accounts that guaranteed rates of up to five per cent and four per cent, respectively.
These side accounts did not contain an explicit limit on the size of investment, which means in today’s low-rate environment they are potentially lucrative for their holders and a significant liability for the companies that wrote them.
At least three limited partnerships purchased such policies several years ago in Saskatchewan, one of only four Canadian provinces that permit the purchase of insurance policies from their original holders. These investors are in court in Saskatoon to force the insurers to accept their money.
So it looks potentially dangerous, eh? But Manulife was defiant:
The Muddy Waters report is a short seller’s attempt to profit at the expense of our shareholders, and we disagree with its conclusions. Manulife continues to believe that Mosten’s position is legally unfounded. We firmly believe that the consumers purchasing universal life policies, and the insurers issuing these policies, never intended to have the policies function as deposit or securities contracts. We have a sound, highly rated global franchise. We expect we will prevail with respect to this matter and that it will not affect our business operations or our ability to meet obligations to our customers, vendors and other key stakeholders.
Industrial Alliance Insurance and Financial Services Inc. (iA Financial Group) is responding to media reports regarding litigation involving Ituna Investment LP (Ituna). As part of this litigation, Ituna is seeking to make unlimited deposits into a universal life insurance contract that it purchased from a policyholder. The life insurance contract was originally issued by National Life, a company acquired by iA Financial Group in 1988.
The application was heard by the Court of Queen’s Bench in Saskatoon (Saskatchewan) in September 2018 and the parties now await the court’s decision.
iA Financial Group believes that the position taken by Ituna is legally unfounded. Ituna’s position would result in life insurance contracts being used as deposit accounts or commercial paper, purposes that are unrelated to life insurance and for which they were never intended. Ituna’s interpretation is contrary to the language of the life insurance contract and the legislative framework that governs insurance in Canada. iA Financial Group believes its legal position in this matter is strong and expects that it will be successful in its defence.
But remember – this is Canada! Future employment possibilities for ex-regulators are limited and must be cherished, as we found out in 2008 when Manulife’s grossly incompetent investment strategy nearly left it bust:
On Sept. 30, the head of Canada’s regulator, the Office of the Superintendent of Financial Institutions, wrote an e-mail to various OSFI officials. “D’Alessandro just called and asked that we try to meet next week with the company to discuss capital,” Julie Dickson wrote, noting that the meeting would replace one that had been arranged for November. Mr. D’Alessandro wanted to discuss the capital requirements for the variable-annuity, or segregated funds, business, other e-mails show.
Discussions took place in October in which he laid out why he felt the rules were too onerous, and OSFI officials had a flurry of internal discussions. On Oct. 28, the rules were changed.
OSFI consulted with more than one insurer that month, but the changes were most important to Manulife.
Federal lobbyist records show that Mr. D’Alessandro also met with Prime Minister Stephen Harper on Nov. 6 to discuss “financial institutions.” It is not known what was discussed at the meeting with Mr. D’Alessandro.
So now the cavalry has arrived again!
A trio of lawsuits against three Canadian life insurers face new hurdles after the government of Saskatchewan updated its insurance regulations, instituting changes that could materially impact the ongoing court cases – as well as a short seller’s high-profile campaign against Manulife Financial Corp.
…
All parties are waiting for the judge to rule, and the decision is expected to take some time to come out. But late Monday the government of Saskatchewan added a new dimension to the litigation by updating its insurance regulations, inserting new language that limits how much money can be deposited in insurance policies and their related accounts.Manulife’s share price rose about 6 per cent on the Toronto Stock Exchange in early trading on Tuesday.
In an amendment to the Saskatchewan Insurance Regulations, the province added new language that states “no licensed insurer shall receive or accept for deposit funds or payments in excess of the amount required to pay the life insurance premium for the eligible period.”
The Saskatchewan regulations, published yesterday on the website of the Financial and Consumer Affairs Authority of Saskatchewan, limit the amount of premiums a life insurer may receive or accept for deposit in life insurance policies and associated side accounts. The basis of the claims by Mosten Investment LP (“Mosten”) against Manulife has been that life insurers can be compelled to accept unlimited premium payments. In effect, Mosten is seeking to use insurance policies to invest sizeable sums that have no connection to the insurance coverage.
…
Given the new Saskatchewan regulations, Manulife and the other life insurers involved in similar matters plan to make submissions to the court, asking it to dismiss the claims that life insurers can be compelled to accept unlimited premium payments. Manulife believes these regulations should accelerate the resolution, in its favour, of the principal matters in the Mosten litigation in Saskatchewan. With respect to any possible remaining ancillary matters in the litigation, Manulife continues to believe that it will prevail and that those matters are insignificant in any event.Because the public policy concern addressed in Saskatchewan is equally relevant across Canada, the Canadian Life and Health Insurance Association, which intervened in the litigation on behalf of the industry, plans to request other provincial and territorial governments to take comparable regulatory steps to avoid unnecessary, costly litigation in other jurisdictions.
… and, of course, other potential future employers of regulatory personnel voiced their support:
Industrial Alliance Insurance and Financial Services Inc. (iA Financial Group) welcomes the recent publication of Saskatchewan regulations limiting the amount of premiums a life insurer may receive or accept for deposit in life insurance policies and associated side accounts.
Explicitly affected issues are (other lifecos may have been affected by this as well):
MFC.PR.B, MFC.PR.C, MFC.PR.F, MFC.PR.G, MFC.PR.H, MFC.PR.I, MFC.PR.J, MFC.PR.K, MFC.PR.L, MFC.PR.M, MFC.PR.N, MFC.PR.O, MFC.PR.P, MFC.PR.Q and MFC.PR.R
IAG.PR.A, IAG.PR.G and IAG.PR.I
I have to say it, sorry James – good for the regulators! MFC is right and intention ought to matter, as should fairmindedness. The attempt here to destroy equity value and place MFC on permanent life support (if not accidentally killing it in the process) serves no useful purpose for society which is something that capital allocation ought to do.
MFC is right and intention ought to matter, as should fairmindedness.
That, presumably, has all been discussed at trial. In this case, the regulators are pre-emptively overruling the trial judge and invalidating (what might have been) a valid contract.
And doing this at breathtaking speed, to ensure that nobody gets a chance to object.
And, frankly, if MFC finally goes down due to repeated instances of gross incompetence … isn’t that what capitalism and gross incompetence are all about?
Good points James. I can dislike what the hedge funds are doing and think it is socially useless but that doesn’t mean the courts should be precluded from making the right decision. I retract 🙂
Well I’m biased, I own MFC prefs. I should have learned from the financial crises when I held some MFC common. MFC is the insurance company version of CIBC, both companies have a history of screwing up.
You recommend MFC heavily in your pref letter. If you think these guys are worthy of bankruptcy, why do you bother recommending them? Perhaps your criteria built around P2L and above ratings holds you back?
Secondly, this specific issue that is causing grief to MFC also affects IAG and parts of BMO. It’s entirely possible that GWO, SLF could have been impacted by this. And this isn’t some asbestos claim. It’s purely a bad faith effort by those who are looking to exploit loopholes in the system for their petty benefits. They would rather take down the entire Life Insurance industries in Canada for making a few bucks for themselves.
So I kind of don’t get your eliminate the capital gains tax/dividend taxation for wealthy taxpayers while going all out in support of US hedge funds that aim to destroy hundreds of thousands of jobs in Canada. Is that what you want in society? Rich hedge funds destroying genuine businesses by exploiting contract loopholes? If you read the case history, the main person(Insurance consultant turned cattle farmer) behind the lawsuit spent a decade hunting for these insurance policies all over Canada so that these specific clauses could be avoided and these institutions injured. What a way to invigorate competition.
As far as encouraging the elimination of dividend tax credit goes, if that happens, nobody would bother investing in preferreds…your own blog constantly touts the 1.3x yield equivalent…take that away and the reason for preferreds is gone.
Finally, as far as capital gains/dividend taxation is concerned, how can you realistically compare the risk profile of Joe Lunchpacker with Julie RiskTakingVentureBuilder? If she sells something for $10 million after bootstrapping and 10 years of life, the govt of Ontario would gladly take a good 54% out of it. And that will promote entrepreneurship, as you want in this country. Global talent market is very competitive. Canada has severe handicap in retaining and attracting good people. If capital gains/dividend tax policies change, there will be an enormous exodus of wealth builders. Be careful what you wish for!
If you think these guys are worthy of bankruptcy, why do you bother recommending them? Perhaps your criteria built around P2L and above ratings holds you back?
I believe the detailed commentary that goes with my recommendations provides a good amount of cautionary information regarding my views on MFC.
I don’t believe MFC will go bankrupt anytime soon, but they might well “go down” – it is not beyond the bounds of reason to speculate that at some point, given repeated management screw-ups in a bad economic environment, capital deficiencies could force a fire sale of assets, a fire-sale of equity, or – probably the worst realistic scenario – a forced sale to Sun Life or Great-West engineered by OSFI.
And remember, MFC preferreds – like all other Canadian insurance preferreds – are not compliant with the banks’ NVCC rules, so shareholders have a claim on the full par value for anything, anything at all, short of bankruptcy. It was anger over this sort of thing that brought the new rules for banks into being.
One mitigating factor when considering MFC’s repeated stumbles is … moral hazard. MFC proved during the crisis and have just proved it again: when the rules put the company in trouble, the rules will be changed. Simple.
It’s purely a bad faith effort by those who are looking to exploit loopholes in the system for their petty benefits.
Bad faith? Why bad faith? The funds directly concerned in the lawsuit and Muddy Waters have both put real money to work in order to profit from their analysis. In other words, they are doing exactly what their investors pay them to do.
I have a client who retired in 1990 when long-term Canadas yielded 10.85%. He put a big chunk of his liquid capital into an insurance company product that (as best as I can remember; the numbers might be out a little, but not much):
There was a substantial balance in this account when he came to me about 15 years ago for a portfolio review, when long-term Canadas yield about 5%; he was basically taking out the interest and leaving the principal intact.
He was very happy about this investment – of course! – and considered that the advisor who had recommended it to him was one of the world’s greatest financial geniuses. The story he had was that this product had been put together when the insurance companies didn’t know what they were doing and made the terms of these investments far too generous given the potential for a dramatic decline in yields. I don’t know how true that might be, but that was the story.
The most important advice I gave him was to cut his annual withdrawals down to the minimum required, which was substantially less than its earnings. If you’re short of cash, I told him, sell anything else, because you will not find anywhere an investment product that will pay you 11.5% on such good security, or anywhere even close to 11.5%. He took my advice and when the product finally matured a few years ago, made it plain that he thought I was one of the world’s second-greatest financial geniuses.
So my question to you is: does this story illustrate my bad faith effort to exploit loopholes in the system for my client’s petty benefits and show that I would rather take down the entire Life Insurance industry in Canada with the objective of making a few bucks for myself? Or was I, in my small way, doing a good job and helping capitalism to work the way capitalism is supposed to work?
As far as encouraging the elimination of dividend tax credit goes, if that happens, nobody would bother investing in preferreds…your own blog constantly touts the 1.3x yield equivalent…take that away and the reason for preferreds is gone.
When the business environment changes, my business model changes. If preferred shares disappear – and you will note that I do not in fact support the elimination of preferential taxation on dividends and capital gains, I merely support a cap on the benefits – then I’ll find something else to do. It will be disruptive and annoying, but then I find just about everything in life to be disruptive and annoying, so it’s no big deal.
I do not invent plausible arguments with the intent to promote my self-interest. That is simply intellectual dishonesty and it’s disgusting.
Finally, as far as capital gains/dividend taxation is concerned, how can you realistically compare the risk profile of Joe Lunchpacker with Julie RiskTakingVentureBuilder?
For any given dollar in passive investments, the risk profile is precisely identical.
I try not to romanticize entrepreneurs. Most of them come from comfortable enough backgrounds that they have the financial room to take a risk or two or three, a luxury not available to most. The entrepreneurs I consider noteworthy are the ones who didn’t dream of global empires and ocean-going yachts when they started … like the Red Hat guy said in an interview this week:
They tend just to want to make a living with a job that’s more interesting than their other choices. The dreams – and tax worries – come later:
There is, of course, lots of propaganda paid for by American billionaires regarding the relationship between entrepreneurship and taxes on investment income. I’m not sure how well-supported any of that is. I was able to find this paper from the Minneapolis Fed:
Canada has a lifetime capital gains exemption, but I can’t say that I personally have noted any sudden bursts and collapses of entrepreneurial activity in Canada that can be correlated with the changes in the capital gains rate.
I’m certainly open to refining my advocacy for a cap on capital gains and dividend preferential taxation to reflect a difference between ‘active’ and ‘passive’ investments, if anybody can give me a good reason to do so.
So my question to you is: does this story illustrate my bad faith effort to exploit loopholes in the system for my client’s petty benefits and show that I would rather take down the entire Life Insurance industry in Canada with the objective of making a few bucks for myself? Or was I, in my small way, doing a good job and helping capitalism to work the way capitalism is supposed to work?
No, this was not a bad faith effort. But this was a genuine insurance product offered to a genuine policy holder with a clear motive for personal savings.
What we are dealing with in these cases is someone who is specifically looking for contract anomalies and loopholes. And then loading up on potentially billions of dollars funded by hedge funds.
Your example has no resemblance to the case under consideration.
For any given dollar in passive investments, the risk profile is precisely identical.
You mean to say that a venture capitalist and a preferred share fund carry the same risk?( as an aside, the new passive investment rules in Canada penalize everyone alike) I somehow doubt that is the case. Extra risk demands extra rewards, that’s why so many governments across the world offer low tax or even zero tax setups to encourage entrepreneurship.
You complain a lot about the rentier economic structure of Canadian economy yet fail to recognize that higher taxes and higher regulation lead to strangulation of smaller businesses. And let the bigger rentier class businesses and monopolies thrive. Because they are the only ones who can afford to live in such strangulating environment.
Read up on Regulatory capture and how Canada and lots of Western Europe would be at the very top of that. There’s hardly any economic mobilization. Canada’s rich list doesn’t change at all. Forbes 400 is very dynamic on the otherhand.
Canada has the same top 100 richest with a couple of new names that make their fortunes outside of Canada.
If you want to see more empirical evidence, Canada has not produced even a single technology company of note in the last 20 years(Blackberry was 90s story). Shopify notwithstanding. Why?
One of the Uber cofounders comes from Calgary yet Calgary didn’t give any permission to Uber until 2016…
Same thing with Internet taxation…CRA had its tentacles on all new emerging businesses that didn’t let any Canadian ecommerce player emerge.
And the US had special internet Tax exemption for well over a decade.
And the result is that every big city in Canada wants to have HQ2 of Amazon…yet none of these guys want to pay the little price that is required to create such Amazons.
That could mean tax exemptions and encouragement…not more regulation and more taxation.
I could go on and on….but the direction in which we are going will drive more entrepreneurial people out of Canada. And we won’t see results for many years.
“Regulatory capture is a form of government failure which occurs when a regulatory agency, created to act in the public interest, instead advances the commercial or political concerns of special interest groups that dominate the industry or sector it is charged with regulating.” – Wikipedia
Lots of evidence of this in Canada for sure. To be fair to James, this post to which we are all replying is specifically about regulatory capture and why it is not good.
James: if you don’t mind telling me, how much of your personal portfolio is in Preferred Shares? Just a percentage would suffice. Do you also have your own money in your preferred fund?
My own beliefs in investment world are evolving and I think it’s best to follow only the advice of the person who really has a skin in the game.
What we are dealing with in these cases is someone who is specifically looking for contract anomalies and loopholes. And then loading up on potentially billions of dollars funded by hedge funds.
So, in the era of identity politics, there is also support for identity contract law, identity justice and identity investment management.
Well, we’ve already seen that in a stressed situation such as the ABCP collapse, that everybody’s OK with adjudicating claims based on who you are rather than what you own:
… but that’s just a populist version of crony capitalism. Very nice, as long as you’re part of the favoured group and external competition is suppressed.
Sorry, but you’ll always find me on the side of the rule of law.
Extra risk demands extra rewards, that’s why so many governments across the world offer low tax or even zero tax setups to encourage entrepreneurship.
It’s the job of the markets to assess risk, not the government’s. I’d rather not have my investment returns decreed by some shadowy Ottawa bureaucrat … or by a few bureaucrats in the Financial and Consumer Affairs Authority of Saskatchewan, for that matter.
You complain a lot about the rentier economic structure of Canadian economy yet fail to recognize that higher taxes and higher regulation lead to strangulation of smaller businesses. And let the bigger rentier class businesses and monopolies thrive. Because they are the only ones who can afford to live in such strangulating environment.
Do you have any citations to back this up? I haven’t been able to find any. It seems counter-intuitive to me, because a small business will have more room to optimize its tax profile – for instance, a small business paying bonuses to its owner-managers in order to reduce profits to an optimal level.
this post to which we are all replying is specifically about regulatory capture and why it is not good.
Thank you for that!
if you don’t mind telling me, how much of your personal portfolio is in Preferred Shares? Just a percentage would suffice.
It’s in excess of 20% of my net worth – that’s both direct and indirect (through my firm) holdings of MAPF.
I’ll be more specific in an eMail, if you like. It’s gone up and down over the years, but never due to investment outlook; solely due to fund flows from undertakings done with a primarily personal, rather than investment, purpose, although these projects were formally classified as investments. And I can make no guarantee the funds won’t be similarly required at some point in the future, such is the uncertainty of this world.