Thursday, July 13, 2006

Manulife Halts Japan VA Sales

RBC Capital Markets, 13 July 2006

Manulife Japan and its partner banks will suspend sales of certain variable annuity products pending tax clarification starting today.

Investment Opinion

• Certain VA Sales Suspended. Manulife Japan asked, and its partner banks complied, to suspend sales of certain Variable Annuity (VA) sales pending resolution of income tax treatment in the hands of annuitants. This impacts MFC’s recently imported Guaranteed Minimum Withdrawal Benefit VA product, so successful in the U.S. in recent years, but not yet a material product in Japan. Manulife is not pleased with the recent tax interpretation and potential for overtaxation of its customers. We think MFC is doing “the right thing”.

• Issue Highlights MFC’s EPS Diversity - Japan VA’s Not a Material EPS Contributor. First, Japan contributes only ~6% to MFC earnings, and most from insurance. Also, growing at 15-20% in USD terms (up 17% in Q106), Japan is an “in-line” EPS contributor, but no more, to Manulife’s 20%+ overall EPS growth. Further, the early-stage, high-growth VA business, in our view, is a not yet a material contributor to MFC Japan (actual is not disclosed). Second, the specific product suspension impacts an undisclosed, but we think, minority proportion of overall Japan VA sales, which were US$1.1B in Q1/06. The impact on in-force business is smaller still since the two new VA products impacted were only launched in November ‘05.

• Coveted Bancassurance Relationship? The real question is what impact, if any, will this have on Manulife’s coveted relationship with BOTM-UFJ – one of MFC’s three significant growth engines over the next 5-10 years (Hancock and China being the other larger two). Without background, this is difficult to assess; however, we would be concerned BOTM may choose to position Manulife as a scapegoat for this potentially embarrassing situation. We should also consider any potential for consumer liability if it turns out these products were sold without sufficient due diligence. Another outcome is that, as with the Portus hedge fund debacle and/or MFC’s Indonesian expropriation, Manulife is able to turn this in to a Public relations” coup.

• Valuation – No Changes to EPS estimates - Top Pick Reiterated. Our $43 target is based on 16.5x our forward EPS estimate, a 10% premium to our Canadian lifeco peer average of 15x, wider than the historical 3% premium to reflect the superior growth and capitalization as well as MFC’s enhanced global position. EPS risk centers on accelerated USD translation as nearly 2/3 of earnings are USD-based, and not hedged. Also, Manulife could be susceptible to a downturn in claims experience, unusually bad credit markets, or to an acquisition.