07 April 2009

Manulife's Variable Annuity Business Cushioned

CIBC Wood Gundy, April 2009

The primary concern surrounds Manulife’s variable annuities, which are equity-related products that guarantee customers will receive fixed annual income streams, even if stock markets fall. Although many of these products do not begin to mature for five to seven years, leaving considerable time for markets to recover, Manulife must set aside reserves to cover any potential shortfall between the value of the guarantees and the assets it has invested to cover the guarantees. Setting aside such reserves hurts the company’s earnings and lowers its capital ratios, which must stay above predetermined levels. As of March 12, when global stock markets were more than 10% below current levels, CIBC World Markets Inc. analyst Darko Mihelic estimated that Manulife’s capital ratios were still at the upper end of the company’s target range.

Mr. Mihelic believes, however, that Manulife could take steps to boost its capital ratios if markets were to decline significantly below their recent lows; such measures could include a dividend cut. Even if the company decided to issue additional shares to shore up its capital position — a worst-case scenario in Mr. Mihelic’s view — he believes Manulife could still earn $2.18 per share on a normalized basis, leaving its shares trading at an attractive 6.8x. If equity markets recover, the insurer’s stock could look even more compelling.

While the recent rebound in equity markets has already provided a lift to Manulife’s shares, if markets continue to rise, its stock could still be one of the biggest beneficiaries yet. Mr. Mihelic rates Manulife Sector Outperformer (Price Target: $25.00).
Financial Post, David Pett, 7 April 2009

The concerns about the health of Manulife Financial Corp.'s segregated fund and variable annuity business appears to be misguided based on the latest number crunching from Scotia Capital analyst Tom McKinnon.

In a new report that combs over Manulife's variable annuity guaranteed cash flows, reserve, required capital and related sensitivities, Mr. McKinnon says the lifeco is in solid shape.

He told clients that the minimum continuiing capital and surplus requirements for Manufacturers Life Insurance Company, the Manulife subsidiary from which all equity related business flows through, was 218% at the end of the first quarter and likely around 228% currently.

"We believe the company has more than an adequate cushion, and estimate that a 25% drop in equity markets from Mar. 31, 2009 levels (an S&P 500 below 600) would put the ratio at the bottom of its 180% - 200% target range," he wrote.

If markets fall by more than 25%, Mr. McKinnon still believes Manulife has options at its disposal to maintain its ratio at an adequate level, including a subsidiary reorganization, "whereby John Hancock Life Insurance Company, with no variable annuity exposure is consolidated into Manufacturers, thus reducing equity market sensitivity by one-third."

The analyst added that Manulife could also issue more debt or preferreds and possibly reinsurance.

He maintained his "sector outperform" rating and left his $30 one-year price target unchanged.
Financial Post, Jonathan Ratner, 7 April 2009

The decision by Seamark Asset Management Ltd.’s largest wrap partner to stop using the Halifax-based firm’s investment services has a growing list of analysts suggesting privatization is the only way out.

John Aiken at Dundee Capital Markets told clients the current environment shows no signs of a reversal for Seamark’s net redemptions, while the end solution is most likely a privatization by Manulife Financial Corp. or a management buyout. Manufacturers Life Insurance Co., a wholly-owned subsidiary of Manulife, is Seamark’s largest shareholder at 31%.

Mr. Aiken estimates that the departing client represents 40% to 50% of private client and wrap account assets under management. The move automatically triggers a review by other wrap program partners, which puts additional assets in jeopardy.

“With the departure of its largest customer (again) and negative headwinds facing Seamark, profitability is likely to take another hit as efficiencies are negatively impacted by additional declining scale,” the analyst said.

He reduced his earnings estimates to 8¢ per share for 2009 and 7¢ for 2010, down from 10¢ and 12¢, respectively. Mr. Aiken also cut his rating on the stock from “neutral” to “sell” and his price target from $1 to 80¢.

Michael Mills at Beacon Securities suggested that based on historical disclosures, BMO Nesbitt Burns is likely the partner in question. He noted that it represents an estimated $250-million to $350-million in assets, while Seamark’s entire wrap AUM at the end of December 2008 stood at $790-million.

“We believe the likelihood of a privatization or take-out of the firm increases with each passing week,” the analyst said in a research note on Monday. “Unfortunately, without sticky assets and a stable investment team, there is little value to be realized, in our opinion.”

Seamark shares are down about 70% in the past 12 months but have risen roughly 10% in 2009.
Financial Post, Jonathan Ratner, 26 March 2009

While insurance companies proved to be sensitive to stock markets on the way down, the same case can be made on the way up during this recent rally. Last fall, this sensitivity increased as off-balance sheet guarantees were assumed to be in the money.

With lifecos in Canada and the U.S. having fallen much further that the S&P/TSX composite index and S&P 500, respectively, there is a growing call for better disclosure about this sensitivity.

“If this information had been better understood before stock markets plunged in the second half of 2008, investors would have had a better sense of potential risks on an absolute as well as relative basis,” Desjardins Securities analyst Michael Goldberg told clients.

He noted that since September 2008, the S&P 500 has fallen by 29% and the TSX by 24%, while U.S. lifecos have declined 64% and their Canadian counterparts 55%. That equates to two or three times the market declines. U.S. and Canadian banks, meanwhile, have lost 54% and 32% of their respective values during the same period, which shows they are less sensitive to equity markets.

While Manulife Financial Corp. appears to be the most sensitive lifeco to equities, Mr. Goldberg still calls Canada the ‘Goldilocks of the insurers.’ “Market movements and sensitivity had explained a large portion of the relative performance of life insurers around the globe in the early 2000s, with the worst performance from European companies, followed by U.S., then Canadian companies, he said.

During the stock market decline and credit downturn of the early 2000s, it was relatively straightforward to understand what was expected from insurance companies in the U.S. and Europe. European insurance companies often had a substantial portion of their investments tied to their surplus capital invested in equities. Mr. Goldberg points out that this time around, European lifecos had equity investments equivalent to 80% to 100% or more of their surplus. “So when stock prices dropped by 30%, a significant chunk of their capital vapourized, which constrained their ability to grow.”

U.S. lifecos got hit because of their investment for income – earning them the label ‘yield hogs.’ They held a significant amount of high-yield debt and insurers who had been downgraded to non-investment grade, the analyst explained, which lead to many credit problems.

But Canadian lifecos, who invest for total return, did not suffer from these extremes. Mr. Goldberg says the domestic landscape is therefore like a bowl of porridge that is neither ‘too hot nor too cold,’ due to its balance of equity and debt investments.

If insurers provided additional disclosure in terms of their exposure to equity investments, he insists the sell-off in their shares would have been less indiscriminate and it would make it easy for analysts to predict these trends.

“This would have provided a more dynamic picture of the market equity exposure of life insurance companies than we currently have,” he added. “Not only would disclosure of this nature have been beneficial for investors for the reasons mentioned above, but also for the companies as they were affected by the indiscriminate sell-off resulting from uncertainty and fear of the unknown.”