Sun Life Q3 2009 Earnings

Scotia Capital, 6 November 2009

Q3/09 Misses on Credit - Significantly lowering EPS

• A miss, once again on larger credit hits than expected. A noisy quarter, with credit hits $0.10 higher than expected and the gain from equity markets $0.07 less than expected.

• Underlying EPS somewhere between $0.67 and $0.72 - our estimate was $0.72. Details are shown in Exhibit 1. SLF management suggests the underlying may be closer to $0.72, claiming an investment underperformance of $0.05 in EPS, that should be made up in the near term as SLF enhances yield.

• Credit woes continue. EPS hits for credit continue to disappoint, but the pace declines, totalling $0.35 in Q3/09, down from $0.78 EPS in Q2/09 and $0.44 in Q1/09. Of concern is a $4.4B structured products portfolio (just 4% of invested assets) which accounted for about half the credit hits in the quarter. This portfolio was 96% investment grade in Q1/09, falling to 95% in Q2/09 and 90% in Q3/09, with a 5% decline in overall market value. Slippage is largest in the non-agency RMBS portfolio (MV $931 million, 83% investment grade, down from $1B and 89% investment grade in Q2/09), and the CDO/Other ABS portfolio (MV $749 million, 76% investment grade, down from $796 million and 85% at Q2/09).

• Significantly reducing 2010E EPS in light of a more conservative credit outlook and management's view of 2010 "normalized" EPS. Management's $2.50-$3.03 2010 "normalized" earnings exercise (which excludes experience gains and assumption changes, which together have averaged about $0.30 EPS annually since 2004) will likely force down consensus from its $3.10 level (in line with our estimate). We outline our approach to a $2.80 2010E EPS estimate in Exhibit 2, which assumes equity markets will end 2010 at S&P 500 of 1,150, up 10% over 2009. We've assumed experience losses of $0.30, primarily credit driven, and no assumption

• U.S. sales were strong - but expect U.S. VA sales momentum to decline as company de-risks product - Canadian sales mixed, but momentum improving. SLF's momentum continued in the U.S. with U.S. domestic VA sales up 128% YOY and 32% QOQ (we expect momentum to turn negative in Q4 as the company de-risks the product, Q3/09 sales were likely strong in anticipation of a price cut), and core U.S. individual life sales up 23% YOY. Canadian sales were somewhat mixed, but momentum is improving, with individual insurance sales flat YOY (top 4 were up 7%) and down 10% QOQ (top 4 were up 3%), and wealth management sales down 13% YOY and down 14% QOQ.

• Solid quarter for MFS. $7.7B in net sales ($1.9B retail and $5.8B institutional) and margins, at 28%, were up from 23% at Q2/09 and 21% at Q1/09.

• Capital position remains strong. We estimate the MCCSR for SLF's Canadian subsidiary, at 219%, can withstand a 35%-40% drop in equity markets before it hits 200%. That said, we can't say the same with confidence about SLF's U.S. subsidiary (about 1/4 the company's total capital and 40% of the company's total equity market risk) which required $1B in capital in late 2008/early 2009. We expect the holdco has some capital, although it will likely decline by $400 million in Q4/09 to pay for Lincoln's U.K. block.

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Preview of Life Insurance Cos Q3 2009 Earnings

Scotia Capital, 19 October 2009

Canadian Lifecos – Another Noisy Quarter – Economic Backdrop Improving – Valuations Remain Very Attractive

• Another quarter with a lot of moving parts. As was the case in Q2/09, we expect the continued rebound in equity markets in Q3/09 will be offset to some extent by reserve increases, primarily related to declining long-term corporate rates, but also due to increasing policy persistency on lapse-supported products. Some have pre-announced, suggesting in Q2/09 earrnings releases that, given the pronounced market volatility, Q3/09 results would be affected by prospective actuarial assumption changes. In particular, MFC suggested in its Q2/09 release that preliminary information suggested a change in lapse assumptions for variable annuity/segregated fund guarantee business may result in a Q3/09 charge not to exceed $500 million ($0.30 EPS). MFC also suggested that changes in assumptions for other factors, which could not be estimated at that time, could result in additional charges to earnings. Our best guess is these charges, which we estimate to be $0.62 EPS, will be interest rate driven, as long corporate bond yields continue to fall. SLF also “pre-announced” at Q2/09, suggesting the company expects to take a Q3/09 charge of $350 million to $450 million ($0.80-$0.98 EPS) as it updates its stochastic economic scenario generator in accordance with updated professional guidance – guidance which we can gather applies only to SLF’s stochastic methodology, all others using a deterministic approach to which the revised guidelines do not apply. We’re somewhat uncertain as to whether IAG, the most sensitive of all the lifecos to interest rate changes, will book a charge for lower bond yields, in particular as they relate to long-term Quebec bonds (which generally support actuarial liabilities). However, our guess is that IAG will not, since it generally reviews this assumption at Q4, and the yields on these bonds have started to climb since the end of Q3/09. GWO, the least sensitive to changes in equity markets and interest rates, will likely have the least amount of noise in its results. Finally, we expect the Q3/09 to be marked with credit hits (although not nearly as high as in previous quarters) as companies continue to increase default provisions as bonds are downgraded and credit conditions – at least in the eyes of the rating agencies (often the last to move) – remain uncertain.

• Focus will be on underlying earnings. For Q3/09, we expect this to be $0.49 for GWO, $0.60 for IAG, $0.50 for MFC, and $0.72 for SLF. We expect SLF to provide some sort of clarification as to what the underlying earnings are/will be going forward.

• Modestly trimming 2010 EPS estimates – largely due to currency. We reduced our 2010E EPS estimates by $0.05 for MFC and SLF and $0.04 for GWO, largely to reflect the impact of currency. In keeping with Scotia Economics’ recent move, we bumped our average Canadian dollar estimate for 2010 to US$0.98 (from US$0.96) and £0.59 (from £0.56), and are keeping it at ¥87.

• While it could be argued to wait on the group until we get a quarter with good earnings visibility that further reinforces that underlying earnings are not only achievable, but more importantly beatable, we think it’s better to be early. We know lifecos are complicated enough as it is, and noisy quarters make it worse. And while it can be argued we need to wait for good earnings visibility, one could argue it’s better to be early, especially given the fact that equity markets continue to climb, and, perhaps even more importantly, long-term interest rates are climbing, which is clearly a positive for the group. In the last two weeks, U.S. long-term corporate A and AA yields have increased 25 basis points (bp), Canadian long-term provincial bond yields have increased 16 bp, and Canadian and U.S. long-term treasury yields have increased 20 bp. There are signs of momentum in the group as well. While Canadian lifecos have underperformed the U.S. lifecos and the Canadian banks by 30% and 5%, respectively, in the last three months, they have outperformed in the last 30 days, bettering the U.S. lifecos by 2% and the Canadian banks by 6%. And finally, they’re still very attractive relative to these other financials. There’s still a significant discount between the Canadian Lifecos (10x 2010E EPS) and where they historically trade vis-à-vis the U.S. lifecos (Canadian lifecos currently at a 4% premium on a P/E basis, well below the average 13% premium) and the banks (Canadian lifecos are at a 20% discount, well below the 1% discount average).

Great-West Lifeco Inc.
1-Sector Outperform – $31 one-year target, based on 2.3x 9/30/10E BVPS and 12.2x 2010E EPS
• We’re looking for EPS of $0.43 for Q3/09, $0.05 below consensus, with underlying EPS of $0.49. Our 2010 EPS estimate is $2.30, $0.02 below consensus.
• Should be a relatively clean quarter – unlike the other lifecos. GWO is the least sensitive in the group to changes in equity markets and interest rates
• Still some minor credit hits (we estimate $0.09 in EPS), largely related to U.K. hybrids, but should be of less concern as market values of these securities continue to climb.
• Good sales momentum in Canada likely to continue.
• Putnam margins likely to remain under pressure, but net sales could be encouraging (expect them to be negative US$1B-$US1.5B, the best they've been since early 2008)

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $33 one-year target, based on 1.5x 9/30/10E BVPS and 10.3x 2010E EPS
• We’re looking for EPS of $0.61 in Q3/09, $0.05 below consensus, with underlying EPS of $0.60. Our 2010 EPS estimate is $3.00, $0.16 above consensus.
• No credit hits expected, primarily based on IAG’s “Canada only” asset portfolio.
• Expect no Q3/09 EPS hit from declining interest rates (IAG is the most sensitive by far) – but keeping a close eye particularly on long-term Quebec bond yields – which have declined 28 bp in Q3/09. The fact that these rates have climbed 18 bp since Sep 30 is encouraging, but if they remain flat through Dec 31/09 we'd expect a $0.30 EPS hit.
• Sales likely to remain weak but could be plateauing.

Manulife Financial Corporation
1-Sector Outperform – $28 one-year target, based on 1.7x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for EPS of $0.34 for Q3/09, $0.04 below consensus, with underlying EPS of $0.50. Our 2010E EPS estimate is $2.30, $0.11 above consensus.
• A noisy quarter. We expect an estimated $0.81 EPS gain from equity markets will be offset by $0.92 EPS charge due to actuarial reserve assumption adjustments, which include $0.30 EPS in pre-announced lapse rate assumption changes on VA business and an estimated $0.62 EPS in reserve assumption changes related to declining interest rates
• The recent rise in long term Corporate rates (Corporate A rates up 23 bp since Sep 30) is very positive for MFC.
• We expect to hear more about steps the company is taking to mitigate the sensitivity of the company’s capital to changes in equity markets. The new structure we believe will reduce MCCSR sensitivity such that a 10% drop in equity markets will reduce the MCCSR ratio by 13% (new structure) as opposed to 20% (old structure).
• Sales will likely remain mixed. Strong in Asia but weak in the U.S.

Sun Life Financial Inc.
2-Sector Perform – $37 one-year target, based on 1.3x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for Q3/09 EPS loss of $0.06, $0.05 above consensus, with underlying EPS of $0.72. Our 2010E EPS estimate of $3.10 is in line with consensus.
• Another messy quarter – a lot of moving parts. We estimate a $0.90 EPS hit for reserve assumption changes related to new actuarial guidelines (affect SLF only), $0.06 EPS hit for declining interest rates, $0.25 EPS credit hits, offset by $0.36 EPS in equity market gains and $0.07 EPS gain from narrowing credit spreads.
• Company track record continues to make us a little nervous with respect to credit – we look for $0.25 EPS in credit-related hits.
• Looking for some “guidance” as to what is sustainable EPS.
• U.S. sales momentum likely to continue.

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Sun Life Q2 2009 Earnings

Scotia Capital, 7 August 2009

Event

• EPS was $1.05, beating our $0.95 estimate and consensus of $0.89.

Implications

• Credit hits continue to hurt EPS. SLF's track record in this regard has been extremely poor, in our opinion. Total credit hits in Q2/09 were $0.78 EPS, well above our $0.39 estimate.

• A very noisy Q2/09; we'd peg underlying EPS in line with our $0.72 estimate and underlying ROE at 10%. However, since credit hits are consistent and consistently high, we believe the likelihood of achieving this level in the near term is highly unlikely. We're lowering our 2010E EPS to $3.15 from $3.20, but credit remains a wildcard. We're forecasting just $0.18 in credit hits in EPS in 2010, but we remain very sceptical and uneasy.

• U.S. top-line starting to show some positive momentum,with Canada top-line mixed. MFS was strong, but at only 8% of underlying EPS, it's difficult for it to significantly move the needle.

Recommendation

• Positive momentum in U.S. sales is encouraging, but credit continues to be of concern. At 10.5x 2010E EPS, we believe SLF

Credit Woes Continue

• Noisy Q2/09 - but we'd peg underlying EPS in line with our $0.72 estimate. The details are outlined in Exhibit 1. Underlying EPS excludes the impact of credit hits. Since credit hits are consistent and consistently high, we believe the concept of underlying EPS and the likelihood of achieving this level in the near term is highly unlikely.

• Credit hits continue to hurt EPS. SLF's track record in this regard has been extremely poor, in our opinion. Total credit hits in Q2/09 were $0.78 EPS, well above our $0.39 estimate, and significantly higher than GWO's $0.27 and MFC's $0.13. SLF's total credit hits since Q3/08 (ex LEH/Wamu/AIG) have been $2.42 in EPS, well above MFC's $0.56 and GWO's $0.48. Included in the $0.78 in credit hits were $0.17 for CMBS and commercial mortgages, and $0.22 in impairment charges, including $0.12 for CIT.

• We're lowering our 2010E EPS to $3.15 from $3.20, but credit remains a wildcard - we're forecasting just $0.18 in credit hits in EPS in 2010, but we remain very sceptical and uneasy. We outline the details in Exhibit 2. As well, with Sun Life's gross unrealized losses on bonds trading below 80% of amortized cost for more than six months accounting for 5.8% of the company's bond portfolio, more than double that of MFC's (2.5%) and significantly higher than GWO (4.3%), we remain cautious. Our 2010E ROE is 10.4%. We expect the company will provide some form of core EPS potential for 2010 when it presents Q3/09 results.

• Q3/09 could be ugly. The company indicated it could take a $0.80-$0.98 EPS reserve-related hit in Q3/09, as it updates its actuarial methodology and assumptions related to interest rates and equity markets. More specifically, compliance with updated actuarial practice with regards to stochastic economic generators is driving the change. None of the other Canadian lifecos use a stochastic economic generator (they use deterministic), and therefore will not be affected. Combining this hit with likely $0.30 EPS in credit hits (a real wildcard once again) and about $0.25 in possible gains due to rebounding equity markets in Q3/09, we still arrive at an estimated $0.22 EPS loss.

• U.S. top-line starting to show some positive momentum. Sun Life's domestic U.S. variable annuity sales were up 63% YOY, and U.S. core (ex COLI/BOLI/PPVUL) individual insurance sales were up 33%, as company efforts to boost wholesaler productivity (reducing wholesaler count, but poaching some of the industry's best wholesalers from competitors) are beginning to bear fruit. The U.S. operations will embark on a rebranding campaign at the end of the year.

• MFS very strong - but at only 8% of underlying EPS it's difficult for it to significantly move the needle. Gross sales, including managed funds, were up 20% YOY and ex managed funds were up 8% YOY. Net sales were a very strong $4.9B, including retail net flows of $1.2B. While MFS is strong, it still accounts for only 8% of underlying EPS.

• Canada mixed. Ind. insurance sales were down 5% and wealth management sales fell 9%.

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Preview of Insurance Cos Q2 2009 Earnings

Scotia Capital, 20 July 2009

Canadian Lifecos – A Noisy Quarter Expected – Focus Remains on Credit – Capital Positions Very Strong

• Lots of moving parts this quarter. A sharp increase in equity markets quarter over quarter (QOQ) combined with continued uncertainty in credit conditions could lead to a noisy Q2/09 for the lifecos. Manulife has suggested that all of the gains from the rebound in equity markets, gains that arise predominantly from the mark-to-marketing mechanics of segregated fund/variable annuity reserving, may not all fall to the bottom line; variable annuity reserves need to be boosted for lower corporate bond rates and increasing persistency, and long-term care reserves need to be boosted for lower interest rates and a few swaps that went offside. While we don’t know what others will do, there could very well be similar reserve adjustments, although not to the same extent as the $1.00 in EPS we expect in the case of MFC. We’re also expecting some “guidance” if any as to what “underlying” EPS is for the quarter. We put underlying EPS in Q1/09 at $0.52 for GWO, $0.57 for IAG, $0.52 for MFC, and $0.72 for SLF. Exhibit 1 outlines the development of our Q2/09 estimates.

• We’ve modestly cut our 2009 and 2010 estimates – largely due to currency. For 2010 we took $0.09 in EPS off each of GWO and SLF and $0.17 off MFC, as we revised our FX assumptions to address what looks to be an increasing Canadian dollar versus foreign currencies. Scotia Economics now forecasts the Canadian dollar will average US$0.86 in 2009 and US$0.96 in 2010, £0.55 in 2009 and £0.56 in 2010, and ¥84 in 2009 and ¥87 in 2009. MFC is the most sensitive to changes in currencies. These revised forecasts also led to a $0.04 EPS reduction in 2H/09 for GWO, a $0.07 reduction for MFC, and a $0.06 reduction for SLF.

• A more measured view on long-term interest rates results in a reduction in EPS for IAG (by far the most sensitive), with little impact on others, apart from MFC interest rate reserve strengthening in Q2/09. After increasing steadily since the start of the year, new money rates have fallen since mid-June, with a 25 bp decline in long-term provincial bond yields (a good proxy, especially Quebec bonds, for IAG’s initial reinvestment rate for reserving or IRR), and a 40 bp decline in Moody’s AA corporate bond yields. For IAG, each 10 bp decline in the IRR results in a $0.30 EPS hit. We’ve decreased our 2009 and 2010 EPS estimates by $0.21 and $0.30, respectively, to reflect a more measured view of long-term interest rates. As MFC has suggested, a drop in corporate interest rates used to discount seg fund/VA liabilities, largely in the U.S., will result in a reserve hit in Q2/09. We suspect that given the recent volatility we’ve seen in these rates, MFC will significantly pad its assumption, and look for a total EPS hit in Q2/09 for interest rates that could be as high as $0.50. While we don’t forecast any reserve hits for interest rates for SLF, there certainly is a chance, and each 10 bp drop in new money rates across the yield curve results in a $0.05 EPS hit for SLF. GWO is the least affected by swings in interest rates, with a 10 bp decline hurting EPS by only $0.01.

• We suspect the lifecos will continue to increase reserves for asset default throughout 2009 as credit conditions remain uncertain. We forecast increases in assumption for credit default, largely given rating agency downgrades, as well as increases in reserves for lapse assumptions (we suspect policyholders will hold onto “lapse-supported policies” longer than expected, to the detriment of lifeco earnings) will translate into EPS hits in the second half of 2009. We estimate these “hits” will be just $0.03 for GWO and $0.01 for IAG, given their limited exposure to both U.S. commercial real estate (CRE) and U.S. commercial mortgages, as well as their modest segregated fund exposure. With relatively higher exposure to U.S. CRE and U.S. commercial mortgages, we expect these hits for MFC and SLF to be slightly higher (although exposures are still significantly below those of the U.S. lifecos) and expect these EPS hits in the second half of 2009 to be $0.17 for MFC and $0.15 for SLF. We must admit that we have a degree of cautiousness around SLF’s estimate, given its less-than-stellar history in terms of credit hits.

• Sun Life most likely to suffer as credit continues to weigh. SLF’s track record in this regard speaks for itself, with a total of $1.64 EPS in credit hits in the past three quarters (excluding LEH/Wamu and AIG) versus $0.21 for GWO, $0.22 for IAG, and $0.43 for MFC. As well, gross unrealized losses on fixed income securities trading below 80% of acquisition cost for more than six months represent 4.9% of fixed income assets for SLF, 5.7% for GWO, 1.5% for MFC, and 1.3% for IAG.

• We see healthy Q2/09 capital ratios. We peg MCCSR ratios at 213% for GWO, 230% for IAG, 255% for MFC, and 230% for SLF, all well above regulatory minimums (120%), regulatory watch-list levels (150%), and comfortably above target ranges (175% or 180% to 200%), although we do expect target ranges to be reset to levels above 200%. IAG can withstand a 32% drop in equity markets from current levels (i.e., S&P/TSX of 7,100) before its MCCSR ratio hits 175%, and a 45% drop (i.e., S&P/TSX of 5,450) before it hits 150% levels. We estimate MFC (on a “do nothing” basis, and without utilizing the $1.0 billion currently sitting at the holdco) can withstand a 30% drop in equity markets from current levels (i.e., to an S&P 500 level of 640) before its ratio hits 185%, and a 40% drop in equity markets (i.e., to an S&P 500 level of 525) before it hits regulatory watch-list 150% levels.

Great-West Lifeco Inc.

1-Sector Outperform – $27 one-year target, based on 1.9x 6/30/10E BVPS and 11.0x 2010E EPS

• We’re looking for EPS of $0.49 for Q2/09, $0.01 above consensus.

• Credit hits could be around $0.07 EPS, some related to U.K. hybrids and some related to other general provisions.

• Cautious on Putnam. We look for net sales of around negative $2 billion. Margins are expected to remain very weak as they have in the past.

Industrial-Alliance Insurance and Financial Services Inc.

2-Sector Perform – $31 one-year target, based on 1.4x 6/30/10E BVPS and 9.5x 2010E EPS

• We’re looking for EPS of $0.62 in Q2/09, $0.02 below consensus.

• "Canada only" likely leads to very modest credit hits - we expect just $0.02 in EPS.

• Keeping a cautious eye on long-term corporate interest rates – particularly Quebec long-term provincials where yields have declined 30 bp in the last seven weeks – IAG is by far the most sensitive.

• Sales will likely remain weak.

Manulife Financial Corporation

1-Sector Outperform – $30 one-year target, based on 1.7x 6/30/10E BVPS and 11.0x 2010E EPS

• We are looking for EPS of $0.45 for Q2/09, $0.25 below consensus.

• A lot of moving parts. We are expecting a noisy quarter, with $1.38 EPS due to the QOQ appreciation in the market (17% weighted average for MFC) offset by $1.22 EPS in reserve hits.

• Focus will be on “core” or underlying EPS. We look for some assistance from management in this regard. We believe core EPS could be in the $0.53 range.

• Update on capital plan - dividend cut unlikely, but remains an option (albeit at the bottom of the pecking order).

• MCCSR we expect to be 255%, well above its 180%-200% target

Sun Life Financial Inc.

2-Sector Perform – $33 one-year target, based on 1.3x 6/30/10E BVPS and 10.0x 2010E EPS

• We are looking for EPS of $0.95, $0.09 above consensus.

• Significant gains from rebound in equity markets should add an additional $0.55-$0.60 to EPS.

• Company track record makes us a little nervous with respect to credit - expect $0.32 in credits, significantly lower than prior run rate.

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Bloomberg, Sean B. Pasternak and Doug Alexander, 21 July 2009

Canadian banks, facing the biggest profit decline in seven years, are expanding their insurance businesses, using the Internet and stand-alone outlets to get around restrictions dating from at least 1923 on insurance sales in bank branches.

Royal Bank of Canada, Bank of Montreal and other lenders are increasing sales online and making acquisitions to skirt the rules and take a bigger slice of the country’s C$115 billion ($104 billion) insurance market.

“Banks are definitely trying to prod areas where there’s not a strict distinction between what a bricks-and-mortar branch is,” said John Aiken, an analyst at Dundee Securities Corp. in Toronto.

With insurance revenue rising by 53 percent last quarter at Royal Bank alone, the business is helping counter the biggest profit decline since 2002 for Canadian lenders. Profit before one-time items at Canada’s six main banks will fall an average of 9.5 percent for the year that ends Oct. 31 on higher loan losses, according to Aiken.

Royal Bank, the country’s largest lender, opened 43 insurance offices adjacent to their bank branches over the last four years to bypass the restrictions, and plans to open more. Bank of Montreal, the No. 4 bank, bought the Canadian life insurance arm of American International Group Inc. in April for C$329.5 million. The purchase may increase the bank’s earnings within a year.

Bank of Nova Scotia, Toronto-Dominion Bank, Canadian Imperial Bank of Commerce and Canadian Western Bank have followed suit, getting around government restrictions by offering life, health and property insurance on their Web sites.

Canada is “the only civilized country in the world that doesn’t allow our banks to sell insurance” through branches, said Larry Pollock, chief executive officer of Canadian Western Bank in Edmonton, Alberta.

The banks’ expansion into insurance is leading to a showdown with the country’s insurance brokers, who say the lenders are violating rules set up by the federal government in 1991. The guidelines state that banks can only promote insurance “outside of a branch.” They previously had been restricted from selling most types of insurance since at least 1923, according to the Department of Finance.

The banks’ insurance outlets should be “separate and distinct” from their branches, and not next door, says Dan Danyluk, CEO of the Insurance Brokers Association of Canada, which represents 33,000 brokers. Bank clients may feel “tied” to an institution that can package insurance together with mortgages and other bank products, he said.

“It’s not about the competitive disadvantage to insurance brokers,” Danyluk said. “The fundamental principle is that consumers are in a very vulnerable position when they’re seeking credit. If banks control that money, consumers aren’t in a strong position.”

Danyluk said that adjacent branches, along with Internet advertising and insurance pamphlets on display in branches, violate the spirit of the Bank Act.

Canada’s financial services regulator gave the banks a boost last month when it clarified that a bank Web site “is not a bank branch.”

“This was exactly what we were waiting for,” said Pollock, 62, who added that Canada’s eighth-biggest bank plans to ramp up its online insurance promotions.

Manulife Financial Corp., the country’s largest insurer, has lost little share to the country’s banks, said Paul Rooney, senior executive vice president for Canada.

Manulife supports the ban on insurance sales in branches because it ensures that clients have more options than just the bank’s own insurance products. The Toronto-based insurer uses a network of 10,000 brokers to sell its policies.

“If you have in-branch selling of insurance, I think it would be difficult for you to see a TD product being sold in a Bank of Montreal branch,” Rooney said in a telephone interview. Independent brokers “are so critically important in ensuring that the consumer gets the right product from the right company at the right price.”

Even with the ban, insurance sales at the banks are growing.

Insurance accounted for 19 percent of Royal Bank’s revenue in the first half of 2009, up from 15 percent a year ago. Premiums and deposits increased 38 percent in the second quarter to C$1.24 billion, helped by higher revenue from annuities and other products.

Royal Bank “cannot provide the value that we believe we bring to the marketplace in the current Bank Act until we do it on the Internet, over the phone and somewhere near the branch,” said Neil Skelding, the bank’s head of insurance.

Bank of Montreal says its purchase of the AIG unit, announced in January, makes it the largest bank-owned seller of life insurance in the country behind Royal Bank, based on direct premiums written. The Toronto-based bank plans to sell insurance through its existing network of brokers and the Internet.

Bank of Montreal had C$222 million in insurance income in fiscal 2008, a 37 percent increase since 2005. The figure excludes the AIG acquisition.

“This is really about accelerating our strategy,” Gordon Henderson, senior vice president of insurance, said in a telephone interview. “We have viewed insurance as a strategic priority for the enterprise for a number of years.”

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Sun Life's UK Acquisition Adds to Existing Run-off Operations

Scotia Capital, 16 June 2009

• Sun Life is buying Lincoln's U.K. operations for C$359 million cash.

Implications

• Virtually all of what Sun Life picks up is a runoff block of individual insurance and annuity policies, with nearly £4B of assets, about 60% of the size of Sun Life's current U.K. runoff business (£6.5B of assets, about 8% of SLF's bottom line).

• Sun Life says it's $0.08-$0.10 per share accretive in 2010, which implies the ROE on the Lincoln block of runoff business is a profitable mid-to-high teens, (1. Lincoln, in need of capital, was a bit of a desperate seller, shedding non-core. 2. runoff business, versus ongoing business, can be profitable to a lifeco since there are no commissions and other selling xpenses, and 3. SLF will likely benefit from synergies in combining two runoff operations together).

• Cash for deal might come out of holdco, but if it came out of Sun Life's operating life companies the impact on capital is an immaterial three to five points on the company's MCCSR.

Recommendation

• Good small tuck-in deal. Sun Life's likely not done buying. Reiterate 2-Sector Perform.

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Canadian Lifecos Less Exposed to CRE & Commercial Mortgages than Peers

Scotia Capital, 10 June 2009

• There is no doubt that commercial real estate (CRE) is increasingly becoming an issue for all financial services companies. As well, but perhaps not necessarily to the same degree, commercial mortgages and commercial mortgage backed securities (CMBS) are potential concerns.

• With significantly less exposure, we believe the Canadian lifecos look very good relative to their peers, namely U.S. lifecos and Canadian banks, with respect to these concerns.

Recommendation

• Not only are the Canadian lifecos significantly less exposed than their peers, but at under 9x 2010E P/E (GWO is 8.8x, IAG is 7.7x, MFC is 8.7x and SLF is 9.5x), they are also much more attractively priced. The Canadian lifecos trade at a 20% discount to P/E ratio (consensus 2010E) of the Canadian banks, versus their long-term average of a 2% premium.

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Financial Post, 8 June 2009

The news on Friday that job losses in the U.S. are declining at a smaller pace than expected is good for stocks and even better for Canada's life insurance companies, says Desjardins Securities analyst Michael Goldberg.

"With job losses getting smaller and doing better than consensus forecasts, investors are likely to view the jobs data as one of the 'green shoots' they have been looking for that signal pending economic recovery and contribute to improved investor confidence which has driven the stock market recovery since early March," said Mr. Goldberg in a note to clients. "We view this as particularly good news for lifecos,"

He noted that since March 9, when the current rally in North America began, Canadian stocks have outperformed U.S. stocks, Canadian banks have outperformed the market and Canadian lifecos have outperformed the banks.

The catalyst for the banks has been reduced fear surrounding potential dividend cuts, Mr. Goldberg said. Meanwhile life insurance companies owing to their higher beta, have benefited simply from the rally itself.

"What is good for stocks generally is even better for lifecos," he wrote, adding Manulife remains the most sensitive of the lifecos to stock market performance.

Mr. Goldberg was quick to remind clients, however, that while job losses may be moderating, there are now 5.9 million fewer people employed (4.3%) than at the cycle peak 16 months ago.

That means less income to spend, and people, businesses and banks are still vulnerable to bankruptcies, he wrote.

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Sun Life Q1 2009 Earnings

RBC Capital Markets, Andre-Philippe Hardy, 8 May 2009

Sun Life: Q1/09 EPS below expectations but good upside potential/downside risk protection

Q1/09 core EPS fell short of our estimate primarily driven by increases in actuarial reserves related to interest rates as the impacts of equity markets and credit were in line with our expectations. Regulatory capital levels were as expected; remaining high. Sun Life remains well capitalized and its stock offers investors an attractive combination of upside reward with more limited downside risk than the stocks of some of its peers.

Q1/09 core EPS of ($0.33) compared to our ($0.09) estimate, consensus estimates of ($0.01) and EPS of $0.93 in Q1/08.

• GAAP EPS of ($0.38) include $0.05 in restructuring costs aimed at lowering expenses.

• The after-tax impact of equity markets was $0.58 per share, close to our estimate of $0.51 per share.

• The after-tax impact of credit/impairments ($0.44 per share) was close to our estimate of $0.49 per share. Actual impairments were low in the context of challenged credit and equity markets and the size of the company's investment portfolio. Increases in reserves related to downgrades accounted for $0.30 of the $0.44.

• SLF increased actuarial reserves related to interest rates as well as an internal reinsurance transaction, which cost the company $0.17. If long term interest rates stay low, we believe that all lifecos will be pressured to increase reserves over time, although timing is difficult to predict.

Excluding the impacts of credit and equities and other unusual items, EPS would have been approximately $0.86, close to the company's recent “earnings power” (which we continue to believe that Sun Life will not earn in the near term, not accounting for lifts from equity markets in good quarters).

• We have increased our 2009 estimated EPS by $0.08 to $2.40. The increase in our estimated EPS reflects (1) the Q1/09 shortfall versus our estimates, (2) a more conservative view of experience gains related to asset fair value, credit impairments and group claims, which are more than offset by (3) the positive impact on earnings of the increase in equity markets seen so far in Q2/09.

o We believe there could be further credit hits in Q2/09 as downgrades continue and defaults are likely to rise and we expect group claims experience to be negatively impacted by rising unemployment.

o The rebound in equity markets (global markets are up 12-16% since the end of March) should more than offset, though.

o A 10% move in equity markets would have an impact on net income of $250-325 million ($0.45-$0.58 per share), according to management’s disclosed sensitivities.

• Our 2010 EPS estimate reflects a ROE of 10.6%, which is below what we would expect the company to earn in a normal year, reflecting our lack of clarity on near term earnings.

Capital ratios were line with our expectations, remaining high. We believe that Sun Life remains better capitalized than its peers, particularly when considering sensitivity to equity markets.

• The MCCSR ratio was 223% - versus our expectations for 220%-230%. The RBC ratio of 357% was slightly higher than the company’s target of 300-350% and well above the regulatory minimum of 200%.

• We believe that the company has additional capital at the holding company level that has not been down-streamed to the regulated entities, including the recent $500 million debt issue.

• We expect the recent downward pressure on the MCCSR ratio to abate in Q2/09 given the upward move in equity markets.

• The MCCSR sensitivity to equity markets is low relative to peers but it has increased on the downside - with 10% declines in equity markets now estimated to affect the MCCSR by 8%. A 10% upward move in equity markets would increase the MCCSR by 5%. Equity markets alone are not likely to cause the firm to raise capital as we believe a MCCSR ratio of 180% is appropriate, but even a 200% ratio seems unlikely to be reached only because of declines in equity markets.

• Flexibility has declined, however given the issues of capital securities in the last year, and reported losses which have offset the gain from the sale of CI. Debt and preferred shares now represent 27.0% of capital – up from 23.4% in Q1/08 but still at the lower end of the group.

• While the company’s number one objective is balance sheet strength, we believe that Sun Life is interested in taking advantage of current market disruptions to bulk up its U.S. presence. We also believe that Sun Life would ideally like to buy good assets from distressed sellers than buy entire companies. In that context, this is not something we would expect U.S. lifecos to agree to until their backs are up against the wall.

Credit-related hits were driven by downgrades more than by impairments. The investment portfolio was a drag on earnings, as discussed above, as Sun Life was not immune to global weakness in credit markets. If isolating writedowns and downgrades, the size of the credit-related earnings impact was low in the context of challenged credit and equity markets and the size of the company's investment portfolio

• The after tax impact of impairments ($34 million for credit and $42 million for equities) is in the context of a $104 billion investment portfolio. The impairments are net of the expected quarterly benefit of $40 million that results from the $160 million in additional credit reserves set aside in Q4/08 for 2009.

• Sun Life provided added disclosures around commercial mortgages, which provide us with comfort as we believe that U.S. commercial real estate will be a very challenged asset class. The company estimates an average loan to value of only 55% based on 2008 revaluations. Commercial mortgages amount for 15% of Sun Life’s investment portfolio. For holdings of commercial mortgage backed securities (which account for just under 2% of the investment portfolio) 80% were originated prior to 2006.

• We continue to believe that Sun Life and other Canadian lifecos’ earnings will be negatively impacted by the credit environment; but that they have the capital so do so and equity-related hits should abate.

• Unrealized losses on bonds rose $1 billion to $10 billion - a slower rate of increase than in the prior quarter. Credit spreads have tightened since Q1/09 ended, which should be helpful. Fixed income securities that have traded below 80% of cost for more than six months totaled $2.9 billion ($0.3 billion in AFS, $2.6 billion in available for sale), compared to $1.8 billion in Q4/08.

We were surprised by the vigor of the company’s sales, which were for some products were not as bad as we thought and for some other products were outright solid. We suspect that, outside of Canada, the company is probably perceived as financially strong which at the margin would help sales.

• In Canada segregated funds sales were up 17%, group benefits 97% and group retirement 32%. Only individual insurance sales were down, falling 17%, which compares to a range of -3% to -7% for peers.

• In the U.S. core individual sales rose 15%, as did employee benefit sales, fixed annuities jumped from $90 million in Q1/08 to $407 million, and domestic VA sales rose 8%. VA sales appear particularly strong in the context of industry sales. Fixed annuity sales are expected to decline, as we believe that the company sold an unusually large amount of fixed annuities in the quarter in order to replace maturing liabilities and keep related assets that it finds attractive.

• Value of new business (which is measured on a trailing 12 months basis) was down 26%, however, in contrast with the sales trends as margins implicitly declined. We believe that the decline in margins was driven by low interest rates, volatile equity markets and the increased cost of hedging. MFS set up to benefit from eventual rebound in mutual fund sales. MFS’ YoY assets under management and revenues were severely impacted by equity market declines and, as is typical of assets management companies, operating leverage worked against them, causing significant operating margin compression (although margins held up surprisingly well on a sequential basis given market declines). However, investment performance relative to peers, combined with sales that we would have expected to be weaker in these weak equity markets, leads us to believe that MFS will be well positioned when equity markets turn to benefit from rising AUM, rising sales and rising margins.

• Q1/09 average AUM declined 33% YoY, driven primarily by declines in equity markets. The revenue decline that resulted from the AUM declines, combined with negative operating leverage (the operating margin declined from 35% in Q1/08 to 21%), drove a drop in net income from US$59 million to US$23 million.

• Gross sales of mutual funds declined from $4.9 billion to $4.1 billion but redemptions declined faster so net sales improved by $1.3 billion to ($0.6 billion).

• Gross sales of institutional products dropped from $4.9 billion in Q1/09 to $3.9 billion, but net sales improved by $1.7 billion to $0.8 billion as outflows shrank.

• Three-year mutual fund performance as measured by Lipper is strong with 93% of U.S. retail fund assets ranked in the top half of their Lipper Category Average.

Embedded value rose as currency and the sale of CI offset credit and equity-related hits.

• Embedded value per share was disclosed at $31.16 – up from $30.14 in the prior year, as the negative impact of experience variances and changes in assumptions was offset by the positive impact of currency, the gain on sale of CI and expected growth of in force business and new sales.

• In theory, if actuarial assumptions were 100% accurate and the company never generated another dollar of sales, the present value of future cash flows from business sold in the past is $31.16, which implies that the current share price is cheap (or embedded value is about to fall…) as it implicitly assumes that the company will not ever create value from new sales. Canadian lifeco stocks have not historically traded on embedded value however.

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Preview of Insurance Cos Q1 2009 Earnings

Scotia Capital, 20 April 2009

Canadian Lifecos - Another Tough Quarter but Capital Positions Remain Strong - Focus Turns to Credit

• Declining equity markets make for another tough quarter. Obviously, Manulife is the most sensitive, and with equity markets, on a Manulife weighted average basis, down 9% quarter over quarter (QoQ), its EPS should suffer to the tune of $0.88, as outlined in Exhibit 1. Despite its hedging efforts, Sun Life’s EPS should be hit by $0.45 EPS, consistent with its guidance, and could suffer more pain depending on any extraordinary hedging breakage costs. Due to Industrial-Alliance’s unusual Q4/08 practice of reserving more than what was needed under mark-to-market accounting in what was a throwaway quarter, the company has softened the blow of declining equity markets in Q1/09 (we estimate by as much as $0.15 in EPS), making the EPS hit from a 3% decline in the S&P/TSX just $0.07, as per guidance. Finally, for Great-West Lifeco, the least sensitive Canadian lifeco by far to equity markets due to its lack of U.S. variable annuity exposure and its decision to write Canadian segregated fund business with minimal guarantees, guidance suggests a $0.10 hit to EPS from a GWO weighted 6% decline in equity markets.

• We’ve significantly cut our 2009 and 2010 EPS estimates for Sun Life, largely due to credit concerns. We took $1.00 and $1.20, respectively, off our 2009 and 2010 EPS estimates for Sun Life, in part to reflect continued concerns with respect to credit (Sun Life makes us the most nervous in this regard) and in part to reflect continued profitability issues with respect to its sub-scale U.S. operations. GWO and MFC 2009 EPS estimates were each trimmed by $0.20 to reflect a more uncertain credit environment, with 2010 EPS estimates reduced by $0.20 (MFC) and $0.08 (GWO). With no sensitivity to U.S. credit, estimates for IAG were left unchanged. Our estimates assume markets end 2009 at 925 (S&P 500) and 10,000 (S&P/TSX) with a further 8% appreciation in 2010.

• We see healthy Q1/09 capital ratios. We peg MCCSR ratios at 232% for GWO, 202% for IAG, 218% for MFC, and 228% for SLF, as outlined in Exhibit 2, all well above regulatory minimums (120%), regulatory watch-list levels (150%), and comfortably above target ranges (175% or 180% to 200%). IAG can withstand a 17% drop in equity markets from current levels (i.e. S&P/TSX of 7100) before its MCCSR ratio hits 175%, and a 35% drop (i.e., S&P/TSX of 5450) before it hits 150% levels. We estimate MFC (on a do nothing basis) can withstand a 20% drop in equity markets from current levels (i.e., S&P 500 of 625) before its ratio hits 180%, and a 35% drop in equity markets (i.e., S&P 500 of 515) before it hits regulatory watch-list 150% levels.

• An increasing focus on credit. In our opinion, equity markets often move first and credit issues generally lag. While equity market volatility will continue to be an issue, we see 2009 unfolding with an increasing focus on credit. We believe the commercial real estate sector will continue to face strain as the macro economic downturn worsens. Moody’s now forecasts peak-to-trough commercial real estate price declines of 30%-plus, and while it did not speculate on commercial real estate loan delinquency trends, at over 5% currently, there’s clearly more downside (1991 peaks were 12%). It also indicated that commercial mortgage-backed securities (CMBS) delinquency rates are approaching 1% for more recent vintages, and delinquency rates should continue to head higher as economic fundamentals deteriorate (historical average is 0.6%), with CMBX spreads widening dramatically over the past 12 months.

• Sun Life most likely to suffer as credit continues to weigh. SLF’s track record in this regard speaks for itself. A total of $1.20 EPS in credit hits in the past two quarters (excluding LEH/Wamu and AIG) versus $0.04 for GWO, $0.21 for IAG, and $0.14 for MFC. As well, gross unrealized losses on fixed income securities trading below 80% of acquisition cost for more than six months represent 3.1% of fixed income assets for SLF, significantly higher than 1.8% for GWO, 0.8% for MFC and 0.4% for IAG.

• Relatively low CMBS exposure and generally of good quality – but NAIC filings show SLF’s CMBS portfolio is trading 57% of amortized cost, significantly below peers. CMBS relative exposures for the Canadian lifecos are significantly less than those of the U.S. lifecos, at 24%, 22%, and 12% of BV (ex AOCI) for GWO, MFC, and SLF, respectively, versus 43% on average for U.S. lifecos. As well, 90% and 85% of MFC’s CMBS investments are in relatively safer AAA tranches and pre-2005 vintages (75% and 86%, respectively, in the case of Sun Life) versus just 76% and 62% on average for U.S. lifecos. NAIC filings disclose the MV of the CMBS portfolio, and, assuming the unlikely case that CMBSs are written down to MV (liquidity constraints have blown out spreads on what are traditionally long-term holdings), we can estimate the after-tax EPS hit. Sun Life’s CMBS portfolio, with a market value at just 57% of amortized cost per the NAIC statements, is the most questionable (GWO is 95%, MFC is 85% and the average for the U.S. lifeco group is 78%). Furthermore, a full impairment down to MV would result in a $1.04 EPS hit for SLF versus $0.10 for GWO, $0.39 for MFC, and a very high $1.70-$2.00, on average, for the U.S. lifeco group.

• Relatively low U.S. commercial mortgage and real estate exposure and significantly less than U.S. lifecos. Total after-tax exposure as a percent of BV (ex AOCI) is just 7% for GWO, 24% for MFC, and 18% for SLF, well below the 79% for MET and PRU and the 45% average for the U.S. lifeco group. As well, defaults and losses on the lifecos’ commercial mortgage portfolios should perform better than CMBS conduits (especially those of the post-2005 vintage) because the loans are less leveraged (generally around 60% loan-to-value), were made on higher-quality property, and with higher-quality borrowers.

• U.K. financials hybrid exposure – a 50% write-down, although not expected, would hurt GWO by $0.74 EPS, SLF by $0.49, and MFC by $0.11. We suspect some hits will be taken in 2009, but given the long-term nature of these securities, we suspect the hits will be confined to only the riskiest preferreds, largely those in Tier 1. This would put GWO’s potential EPS hit in the $0.20-$0.30 range.

Great-West Lifeco Inc.
1-Sector Outperform – $27 one-year target, based on 1.8x 3/31/10E BVPS and 10.5x 2010E EPS
• We are looking for EPS of $0.45 for Q1/09, $0.01 below consensus.
• Another weak quarter for Putnam. We expect net sales of negative US$3-US$4 billion.
• We expect the decline in equity markets to hurt EPS by $0.10 and credit hits to be $0.03 EPS – while U.K. financial hybrid exposure weighs, we do not expect any significant hit in Q1/09 and expect a modest charge ($0.20) in 2009.

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $28 one-year target, based on 1.2x 3/31/10E BVPS and 8.5x 2010E EPS
• We are looking for EPS of $0.60 in Q1/09, $0.02 above consensus.
• A cleaner quarter than the rest of the group, with the decline in equity markets hurting EPS by $0.07 and credit hits hurting EPS by just $0.03. IAG is most likely to come out of the quarter with an increase in EPS estimates.
• Top line could very well continue to be weak. The negative top-line momentum in individual insurance sales will likely continue, building on a 14% YOY drop in Q4/08, a 16% YOY drop in sales in Q3/08 (22% organically), and a 1% YOY drop in Q2/08 (8% organically).

Manulife Financial Corporation
1-Sector Outperform – $30 one-year target, based on 1.6x 3/31/10E BVPS and 10.8x 2010E EPS
• We are looking for EPS loss of $0.40 for Q1/09, $0.05 below consensus.
• We expect the decline in equity markets to hurt EPS by $0.88 (per guidance), and credit hits of $0.08 in EPS, but increasing yields since Dec 31/08 could provide a modest boost.
• Conference call should have lots of talk about capital and acquisitions – likely no deal in immediate term.

Sun Life Financial Inc.
2-Sector Perform – $33 one-year target, based on 1.2x 3/31/10E BVPS and 9x 2010E EPS
• We are looking for EPS loss of $0.20 for Q1/09, $0.59 below consensus.
• We estimate the decline in equity markets to hurt EPS by $0.45.
• Credit makes us nervous with SLF. SLF’s recent track record has been one of more credit hits than its peers, as does its CMBS portfolio ($2B and trading at just 57% of amortized cost), and its fixed income security portfolio (3.1% of which is more than 20% below amortized cost for more than 6 months), and its $500 million (MV) U.K. bank hybrid portfolio.

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RBC Capital Markets, 3 April 2009

Q1/09 results to be weak, but better than Q4/08, in our view

We expect the four lifecos to report YoY declines in earnings per share, driven by challenging equity and credit markets.

• Our EPS estimates for Industrial Alliance are in line with consensus, while they are below for the other three companies.

• Directionally, the short-term pressure on earnings is greatest on Manulife, in our view, driven by a much greater exposure to equities.

• Sun Life has the most exposure to deteriorating credit while Industrial Alliance has the least, in our view.

• We are lowering our Q1/09 EPS estimates for three of the lifecos. Our estimate for Manulife is up significantly as we had updated our numbers for the company near the market trough during the quarter.

Lifecos continue to be levered plays on equity markets

The most important factor for lifeco shares is equity market direction as, in the short term, the health of their capital positions is most impacted by movements in equity markets. This is particularly true for Manulife. Also key to the lifeco shares is the direction of credit spreads, which we view as a broad indicator of credit quality, although we believe that Canadian lifecos have less credit risk than both U.S. lifecos and Canadian banks.

Our favourite lifeco shares are Sun Life's

We think valuation (0.86x book value) is too low even though the company's performance in credit has been weaker than peers. Sun Life has a stronger capital position than peers and lower exposure to equities than Manulife. The company has exposure to a recovery in equities in 2009 as well as the higher U.S. dollar. The management changes in the U.S. division as well as the potential for acquisitions of assets from distressed sellers gives us hope that performance in the U.S. division, as well as the firm's competitive position, might improve. We rate Sun Life's shares Outperform.

ING Canada's shares are also attractive

We like the shares of ING Canada as the company has less exposure to credit and equity market challenges than banks/lifecos, in our view, and as a result the company is less likely to post weak earnings results. The company is well-capitalized, with $425 million in excess capital and no debt. We believe the probability of an acquisition this year has risen, and that it could be a positive catalyst for shares of ING Canada. In our view, ING Canada deserves a P/B multiple at the upper end of the industry, as it has a superior track record of ROE and underwriting outperformance, conservative reserving practices, a risk profile that is lower than that of the average U.S. P&C insurer and very little balance sheet leverage.

Company-specific highlights

Industrial Alliance (May 6)

• We expect Q1/09E core EPS of $0.56, in-line with consensus estimates of $0.58. Our EPS estimate represents a decline of 29% versus Q1/08 but is up significantly from the $1.47 per share loss in Q4/08.

• Our estimated Q1/09 hit from equity markets is $5 million ($0.06 per share), given the 3% drop in the S&P/TSX Composite Index since the end of Q4/08.

• Relative to its peers, Industrial Alliance should benefit from its more conservative credit exposure (62.5% of its bond portfolio is invested in government or government-related issuers and only 6.7% of bonds are BBB-rated, versus 22.1% for the Big 3).

• We expect EPS growth to face a relatively easy margin comparison on new individual insurance sales (at 56% of new sales in Q1/08, strain was slightly above management’s mid-term guidance of between 50% and 55%).

• We expect year over year comparisons in the company’s P&C insurance business to benefit from what we perceive to have been a relatively uneventful quarter in terms of harsh winter weather, particularly versus the difficult conditions faced in Q1/08. Q1 is typically the worst quarter for P&C insurance profitability.

• We reduced our full year 2009 EPS estimate by an additional $0.04 to reflect the negative impact of the company’s $100 million subordinated debenture issuance, which closed on March 27.

Great-West Life (TBD)

• We expect Q1/09E operating EPS of $0.37, below consensus estimates of $0.45. Our EPS estimate represents a decline of 38% versus Q1/08 and 37% sequentially, as the company’s earnings should be negatively impacted by weak credit and equity markets.

• Our estimated Q1/09 hit from equity markets is $190 million ($0.20 per share).

• The company disclosed that a 10% drop in equity markets would result in a $245 million increase in actuarial liabilities (assumes a 10% decline in the value of T.H. Lee – which we have excluded in our estimate). Our estimated impact from equity markets assumes a 9% blended decline in Q1/09 (Great-West has exposure to more than one country’s equity markets).

• Our estimated Q1/09 hit from credit markets is $115 million ($0.12 per share).

• We expect credit-related costs to be larger in Q1/09 than they were in Q4/08. We expect continued reserve strengthening as the ratio of downgrades to upgrades of bonds continued to climb in Q1/09. (Exhibit 7)

• We expect Putnam to report assets under management of US$99 billion as at the end of Q1/09, down 41% YoY and 6% sequentially. We forecast a pre-tax margin of negative 5.0% in Q1/09, well down from 14.2% in Q1/08 but an improvement from the negative 20.7% margin reported in Q4/08.

• We expect U.S. operations, which includes Putnam and financial services, to generate an $8 million loss in Q1/09 compared to $108 million in Q1/08. The primary differences versus Q1/08 are the negative impacts from credit and equity market weakness and the sale of the healthcare division (which closed on April 1, 2008).

• We expect the mid-Q1/08 $13 billion acquisition of Standard Life’s payout annuity block of business to positively impact Q1/09 earnings for the European division, but will likely largely offset by weakness in global credit and equity markets.

• Despite the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar, we do not expect currency translation to be material to Q1/09E earnings versus Q1/08, given weakness in the U.S. division. In a more normal year, we estimate that a 10% decline in the Canadian dollar versus all other currencies would positively impact Great-West’s earnings by 5%.

Manulife (May 7)

• We expect Q1/09E core EPS of ($0.18), slightly below consensus estimates of ($0.10). Our EPS estimate is well below the $0.57 reported in Q1/08 but an improvement from the $1.24 loss per share reported in Q4/08.

• Our estimated Q1/09 hit from equity markets is $1.4 billion ($0.86 per share).

• The company disclosed that a 10% drop in equity markets would result in a $1.6 billion decrease in earnings; our estimated impact from markets assumes a 9% decline in Q1/09, based on the company’s exposure to different equity markets worldwide.

• Our estimated Q1/09 hit from credit markets is $140 million ($0.09 per share).

• We expect credit-related costs to be above the $128 million reported in Q4/08 and expect continued reserve strengthening as the ratio of downgrades to upgrades of bonds continued to climb in Q1/09. (Exhibit 7).

• We expect sales growth to decline year over year, due to volatile equity markets and overall economic uncertainty.

• Recent price increases in certain product lines (i.e. U.S. retail LTC) and the revamping of the company’s U.S. variable annuity product line (less generous guarantees and higher pricing) will also hinder sales growth, in our view.

• Product introductions and the success of the still relatively new MGA channel in Japan should continue to bolster insurance sales in Asia/Japan, although we expect the pace to slow from the triple-digit growth of recent quarters.

• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales (outside the U.S.) will also begin to slow.

• We expect currency fluctuations to only modestly impact earnings this quarter versus Q1/08, as strength in the U.S. dollar versus the Canadian dollar and Japanese Yen versus the U.S. dollar (beneficial for MFC) are largely offset by weak expected results out of non-Canadian divisions. Manulife’s U.S., Hong Kong, Japanese and reinsurance operations typically account for almost 70% of earnings.

Sun Life (May 7)

• We expect Q1/09E core EPS of ($0.09), well-below consensus estimates of $0.21. Our EPS estimate represents a decline of 110% versus Q1/08, but an improvement from the $1.25 loss in the prior quarter. We believe consensus estimates do not fully reflect the negative impact from credit and equity market weakness during the quarter.

• Our estimated Q1/09 hit from equity markets is $285 million ($0.51 per share).

• Management has disclosed that each 10% decline in equity markets would reduce net income by $275-350 million ($0.49- $0.63 per share). Our estimated impact from markets assumes a 9% blended decline in Q1/09.

• Our estimated Q1/09 hit from credit markets (including credit spreads) is $272 million ($0.49 per share).

• Approximately $200 million of our estimated $272 million impact is related to writedowns and downgrades; we estimate that downgrades increased by 20% versus Q4/08.

• The remaining negative impact from credit relates to spread widening (primarily affecting the U.S. fixed annuity business). We expect the negative earnings impact to result from the widening of spreads on asset-backed securities, as CMBS spreads ended the quarter largely unchanged, despite widening significantly during the three months.

• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales will be challenged by the weakness in global economies.

• We expect MFS to report almost 60% lower YoY net income in Q1/09, primarily due to the impact of weak equity markets on AUM. Operating margins are likely to stabilize at 18% (they were 17% in Q4/08) but are well down from the 32% level in Q4/07.

• We expect currency translation to only minimally positively impact Q1/09E earnings versus Q1/08, as reduced earnings in the U.S. largely temper the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar. In a more normal year, we estimate that a 10% decline in the Canadian dollar versus all other currencies would positively impact Sun Life’s earnings by 5%.

Power Financial (May 12)

• We expect Power Financial to report Q1/09E EPS of $0.46, in line with consensus estimates. Our EPS estimate represents a decline of 31% versus Q1/08 and 22% sequentially.

• We expect Great-West to report Q1/09E EPS of $0.37, down 38% versus Q1/08. Great-West accounts for 70% of Power Financial’s Q1/09 estimated EPS.

• We expect IGM Financial to report Q1/09E EPS of $0.52, down 35% versus Q1/08. IGM Financial accounts for 22% of Power Financial’s Q1/09 estimated EPS.

• Pargesa and Other income are expected to report earnings of $26 million in Q1/09, above the $4 million recorded in Q1/08.

• Power Financial’s shares do not typically trade based on earnings as investors usually focus on net asset value.

Power Corporation (May 13)

• We expect Power Corporation to report Q1/09E EPS of $0.47, in line with consensus estimates. Our EPS estimate represents a decline of 27% versus Q1/08 and 12% sequentially. We expect lower earnings YoY at Power Financial to more than offset higher contributions from investment funds.

• Similar to Power Financial, Power Corporation’s shares do not typically trade based on earnings as investors usually focus on net asset value.

ING Canada (May 13)

• We expect Q1/09E operating EPS of $0.48, in line with consensus estimates. Our operating EPS estimate represents a decline of 14% versus Q1/08 and 23% sequentially. Note, consensus EPS is a blend of operating and GAAP EPS.

• The primary reason for our lower year over year EPS estimate is our expectation for lower interest and dividend income – the company’s investment portfolio (excluding cash) decreased from $7.2 billion to $6.1 billion in the past year.

• We believe a more benign winter for many regions of the country will positively impact year over year comparisons for Canadian P&C businesses. The company’s Q1/08 results were also negatively impacted by a $10 million increase in provisions for its Alberta auto business.

• We expect a 3.1% increase in earned premiums in Q1/09 versus Q1/08 primarily due to an increase in the number of insured risks and insured amounts in personal property and rate increases in personal auto.

• ING Canada began raising Ontario auto rates several quarters before its peers, however, based on the most recent available data, the industry’s rate increases have begun to close the rate gap (the entire industry raised rates by an average of 5.6% in 2008). Although being an early mover has hurt premium growth for ING Canada in recent quarters, we expect underwriting profitability and ROE to benefit longer term.

• Book value growth will once again likely be slowed by continued weakness in equity markets (although ING Canada’s exposure to common equities has decreased from 25% of invested assets to 12%).

• We estimate a net realized investment loss of $20 million (pre-tax) in Q1/09, given the combination of a 3% drop in the S&P/TSX Index and the company’s $134 million unrealized loss position on common equities as at Q4/08.

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Capital Trust Securities Q & A

CIBC Wood Gundy, Kory Brewster - Director, Fixed Income & Currencies, April 2009

Financial institutions have been issuing Capital Trust Securities (CTS) recently, prompting some questions by investors. CTS are investment grade debt instruments that currently offer attractive returns while still providing the stability common to bonds.

How Are They Structured – Why 99 Years?

Capital Trusts are structured as wholly owned trusts of the issuing financial institution. The trust holds an income-generating asset, such as a bank deposit note, which provides the funds to make coupon and principal payments to CTS holders.

Regulators require financial institutions to maintain specific levels of capital to provide depositors with protection against unexpected losses. The recent credit crunch has motivated many financial institutions to raise their capital ratios to satisfy regulators and investors alike, resulting in the issuance of new preferred and common shares, and CTS. To qualify as Tier 1 Capital, CTS must have 99 years to maturity, although their structure makes early redemption likely (more on that later).

CaTS, BaTS, BOaTS, CoaTS, TruCS, MaCS, SLEECS

The CTS available in Canada are named TD CaTS, BNS BaTS, BMO BOaTS, CIBC CoaTS, RBC TruCS, Manulife MaCS, Sun Life SLEECS, Great West GreaTS and Canada Life CliCS. While somewhat fun just to rhyme off, the significance of the names is that they all contain the letters “TS,” which stands for Trust Securities, or ”CS,” which stands for Capital Securities.

Why Are CTS Yields So High?

When investors see investment grade debt that yields 8% and higher, it gets their attention. Some may wonder why securities issued by high-quality financial institutions would have such high yields. There are five primary reasons.

Firstly, credit risk is a concern when holding these products since senior bonds have priority in the case of liquidation or asset distribution. For this reason, the credit rating for these products is lower than that for similar deposit notes.

Secondly, extension risk is the risk that the CTS will remain outstanding longer than the anticipated redemption date. Moreover, in cases where the regulator deems the issuer to be financially distressed, CTS could be converted into perpetual preferred shares.

Thirdly, interest is a pre-tax expense, making it more tax-efficient than dividends for the issuer. Yet for the investor, interest is taxed at a higher rate than are dividends; hence, the higher CTS yields help make their yields similar to those on preferred shares on an after-tax basis.

Fourthly, when trying to raise capital, issuers want to be sure that the deal is well received by the marketplace and that they are able to raise all the capital they require. The coupon rates on the last three CTS issues were all over 9.5% and all three issues were highly demanded.

Finally, the high yields are also a result of the ongoing credit crunch that has lifted the cost of borrowing. Some of the first CTS, which were issued back in 2000, offered yields that were about 150 basis points (bps) higher than that of a comparable Government of Canada (GoC) bond. The three most recent issues provide yield spreads of more than 650 bps.

What If Interest Rates Rise?

Interest rate risk is the risk that rising interest rates cause bond prices to fall. However, bond market yields would be expected to rise only as the economy recovers and inflation starts to creep higher. With the economy improving, it would be expected that yield spreads would start to narrow as the risk of default declines. Thus, there would then be two competing forces: rising government bond yields and tightening yield spreads. Yield spreads have increased much more than government bond yields have decreased during the crisis so if conditions revert to ”normal,” CTS prices could remain stable or even increase.

Where Do They Rank?

CTS are junior subordinated debt instruments which rank lower than senior debt. In situations of financial distress, all CTS are exchangeable into non-cumulative preferred shares at the issuer’s option. Therefore, they rank pari passu (equal) with preferred shares from a financial weakness/bankruptcy perspective. However, in terms of distributions, CTS have a “Dividend Stopper Undertaking” feature that prohibits the payment of any preferred or common share dividends if an interest payment owed to CTS holders is missed. Thus, from a distribution perspective, they rank ahead of preferred and common shares.

Will They Be Redeemed Early?

There are two compelling reasons why CTS are likely to be redeemed at their initial redemption dates, which are usually 10 to 30 years after their issuance dates. First, some of the older CTS give investors the right to exchange their holdings into preferred shares that in turn can be exchanged at principal value for common shares at a discount, which most issuers would prefer to avoid. As for the more recently issued CTS, if not redeemed, their coupon rates will reset to a specified Bankers Acceptance rate or GoC bond yield plus a very large spread. Second, issuers may face reputational risk, as investors purchased these products under the assumption that they would be redeemed early and that the 99 year final maturities were only there to satisfy regulatory requirements. If the issuer fails to redeem them early, they may have a difficult time raising capital using similar instruments in the future.

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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).

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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.

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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.

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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.”

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Dundee Capital: Long Insurance Cos & Short Banks

Financial Post, Jonathan Ratner, 18 March 2009

Go long on Canadian insurance companies and short on banks. That’s the advice from Dundee Capital Markets stragetist Martin Roberge, who says this recommendation is mostly a valuation call.

“With Canadian banks facing a technical roadblock, and lifecos deeply oversold and undervalued relative to banks, we believe the time has come to initiate a pair trade between the two groups,” he told clients.

Lifecos have deeply underperformed banks over the past six months as concerns about their hedging strategies on segregated funds and guaranteed notes weighed on market sentiment. The group has rebounded more than banks since the March 6 low, but at this stage in the stock market rally, Mr. Roberge believes that lifecos offer more upside potential – or lower downside risk.

If we are in fact past the worst point in the financial crisis, the strategist insists lifecos are too cheap relative to banks. He points out that lifecos trade at a 30% discount to banks on a price-to-book value basis. The lifeco group also has a higher dividend yield than banks for the first time in history.

“The last time that such depressed valuation metrics were seen was prior to the 2001 recession when investors became concerned about the economy,” Mr. Roberge said.

From a technical perspective, he noted that the Canadian bank index has ralled back to its 100-day moving average, which acted as an important roadblock in this bear market.

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Financial Post, Levi Folk, 16 March 2009

The last bastion of safety for bank dividends has to be with Canadian banks. The economic recession is laying siege to their gates, but so far dividends are intact and will remain that way according to a recent report by Canaccord Adams – assuming the “poor earnings” scenario does not last into 2011.

The US$1.1-billion payout to Bank of Montreal by the U.S. government in the wake of the AIG bailout is evidence that BMO took in at least one Trojan horse when it bought credit default swaps from the insurer. If it wasn’t for the U.S. government, those dividends indeed may have been cut.

The Canaccord report relays conversations with the CFOs of the five banks (CIBC to come) with focus on banks’ capital. The conclusion is that dividends and banks’ capital ratios hold up well under stress testing – a major earnings recession in 2009, for example.

In the case of RBC, Tier 1 capital would apparently fall from 10.6% to 9.7% were earnings to evaporate as happened in the early 90s recession. This is the end of the story for report authors Nick Majendie and Melanie Jenkins given the regulatory requirement for banks to maintain Tier 1 capital of 7%. That factor and added capital raisings from DRIP programs means dividends should are intact assuming the recession ends this year.

Tell that to investors in Citigroup who have completely lost faith in U.S. banks. Citigroup cut its dividend to a penny on acceptance of government money in January despite a Tier 1 capital ratio in near 12%.

There is also the burning question of the duration the current recession. Bank of Canada governor Mark Carney sees a big snap back to growth in 2010. His U.S. counterpart, Ben Bernanke has warned the recession could last into 2010. For Canadian bank dividends, the outcome is highly optimistic, but the jury is still out.

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Sun Life Q4 2008 Earnings

Scotia Capital, 13 February 2009

• $1.25 EPS loss (ex the $1.48 EPS gain from sale of CI), well below our $0.14 loss estimate and consensus of a $0.10 gain.

What It Means

• 2/3 of miss was due to much higher credit hits than anticipated (total credit hits were $0.95 EPS) and 1/3 of miss wasdue to higher equity market hits than anticipated (total of $1.22 in EPS).

• Credit woes continue - company suggests this could extend well into 2010. In Q3/08 ex LEH/Wamu and AIG credit hits for SLF were $0.25 in EPS, versus about $0.05 for the other Canadian lifecos. In Q4/08 it got worse. Credit hits were $0.95 EPS for SLF, versus $0.08 for MFC and $0.01 for GWO.

• MCCSR is 232%. A 10% decrease in equity markets hurts the MCCSR by just 3 to 5 points, so SLF's capital is fine even if markets fall very significantly.

• SLF upped its sensitivity from a $0.40 EPS to a $0.49-$0.62 EPS range. We've decreased our estimates for all the lifecos to assume a modest 1%-2% increase in equity markets in 2009, down from a 6%-7% increase.

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The Globe and Mail, Tara Perkins & Andrew Willis, 13 February 2009

Canada's biggest life insurers are scaling back takeover plans after an ugly quarter that saw their investments hammered.

The big three players in life insurance are still weighing acquisitions, but executives at Manulife Financial Corp., Sun Life Financial Inc. and Great-West Lifeco Inc. are more focused on hunkering down and preserving capital in the wake of fourth-quarter results.

"We are going through some extraordinarily difficult times," said Manulife chief executive officer Dominic D'Alessandro. "We've not seen markets behave like this in 100 years."

The insurers are focusing on their financial cushions and preparing for any trouble on the horizon.

"The theme for our whole industry is to build and maintain a strong capital position," said Sun Life chief executive officer Donald Stewart. Sun Life sees "considerable opportunities for acquisitions," and the price of deals has fallen, but the overall mood is cautious in the wake an unprecedented swoon in debt and equity markets, Mr. Stewart said.

Like Sun Life, Manulife is in the midst of exploring a few specific takeover opportunities. Both firms are expected to bid on small units of American International Group Inc., but not AIG's Asian crown jewels, which they coveted in the past. "It doesn't mean we're still not interested, but our primary focus is on maintaining our capital levels close to where they are," Mr. D'Alessandro said.

"And if we were to undertake M&A activity, it would be financed with capital appropriate not to weaken our overall position," Mr. D'Alessandro added.

As stock markets plunged by more than 20 per cent in the last three months of 2008, Manulife lost $1.87-billion. Sun Life lost $696-million, if a big gain from the sale of its stake in CI Financial Income Fund is factored out, although its final profit came in at $129-million in the quarter. Winnipeg-based Great-West Life lost $907-million after writing down the value of Putnam Investments, the U.S. investment business it bought in 2007, by $1.35-billion.

"Clearly we've got some tough slugging ahead and it's better to be safe than sorry and we're going to look at ways to bolster our capital," Mr. D'Alessandro said in an interview.

"I hope that at some point we'll be able to report to you that the tide has turned, and we're regaining or we're stopping the bleeding at least, and the strength of the franchise and our businesses will become apparent to you once again," Mr. D'Alessandro, who is scheduled to retire in May, told analysts on a conference call.

"Our facts are that our contracts are under water by about $26-billion," he said of Manulife's troubled variable annuity and segregated funds business.

Plunging stock markets have caused a shortfall in the amount of money the insurer has invested for payments that are due to be made to customers decades from now.

As a result, it is having to sock away billions of dollars, although it can release the reserves in the future if markets improve.

The situation overshadowed Manulife's underlying operating results, which executives say are among the best ever.

"Virtually every other measure of our operating success would indicate that this is one of our best years, but for that theoretical charge associated with the market," Manulife chief investment officer Don Guloien, who will succeed Mr. D'Alessandro in May, said in an interview.

"We've written a hell of a lot of profitable new business," Mr. D'Alessandro said.

During a conference call with analysts, Mr. Stewart faced criticism of the insurer's risk management skills, and the dependability of its dividend. His response was to point to Sun Life's strong balance sheet and explain: "While the dollar values [of the losses] are large, so too is the magnitude of the economic events we have experienced."

Great-West chief executive officer Allen Loney said that despite the writedown on Putnam, the company plans to keep expanding its U.S. wealth management division, but growth in that sector will likely slow.

"Our core continuing operations performed well, especially considering the global economic environment," Mr. Loney said.

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Preview of Life Insurance Cos Q4 2008 Earnings

RBC Capital Markets, 14 January 2009

Q4/08 results to be weak in our view

We expect the four lifecos to report YoY declines in earnings per share, driven by difficult conditions in equity and credit markets.

• Our EPS estimates for Manulife are in line with consensus, while they are well below for the other three companies.

• Directionally, the short-term pressure on earnings is greatest on Manulife, in our view, driven by greater exposure to equities. Great-West faces the least near-term pressure in our view.

• Sun Life has the most exposure to deteriorating credit while Great-West and Industrial Alliance have the least, in our view.

• We think the street will lower 2009 earnings estimates following the release of Q4/08 results.

Recent regulatory capital changes are positive

The Office of the Superintendent of Financial Institutions Canada (OSFI) announced proposed revisions to guidelines on capital adequacy late in the quarter.

• OSFI revised the methodology for calculating available capital whereby it will no longer require lifecos to reflect unrealized gains and losses on available for sale (AFS) debt securities in available capital - a positive for all four lifecos, but probably most so for Manulife and Sun Life.

• Segregated fund changes include the previously announced rule changes from October (see our report dated November 7, 2008 entitled "Primer on segregated funds/variable annuities" for more information), as well as allowing greater credit for effective hedges of segregated fund guarantee risk. We think the latter is most positive for Sun Life and the former is most positive for Manulife.

Lifeco stocks are a levered play on equity markets

We believe that the lifecos' shares offer attractive value relative to their long term earnings power, and what should be a better year in 2009 but the catalysts near term are not obvious, especially since we believe that street estimates for Q4/08 profitability are way too high.

We prefer the life insurance sector to the bank space

While we might be early with our call, we expect equity markets to rebound before the economy does and the lifecos have more exposure to equity markets while the banks have more exposure to the real economy. Furthermore, three of the four lifecos have strengthened their capital bases via either equity issues or the sale of a large stake in a publicly-traded company (in the case of Sun Life), which, combined with recent regulatory capital changes, increase the companies' cushions against declines in equity markets.

Company-specific highlights

Great-West Life (February 12)

• We expect Q4/08E operating EPS of $0.44, below consensus estimates of $0.52. Our EPS estimate represents a decline of 26% versus Q4/07 and 9% sequentially, as the company’s earnings continue to suffer from weak credit and equity markets.
• Our estimated Q4/08 hit from equity markets is $180 million ($0.20 per share).
• We expect experience gains and changes in assumptions to be negatively impacted by reserve strengthening for segregated funds, equities that back policy liabilities as well as those that back surplus capital.
• We do not expect credit-related costs to be as large in Q4/08 as they were in Q3/08, as the collapse of a number of previously highly-rated U.S. financial institutions had a negative impact on GWO’s earnings ($95.5 million or $0.11 per share). In Q4/08, while we expect lower pressure on earnings from impairments, we expect continued reserve strengthening as the ratio of downgrades to upgrades of high yield bonds continued to climb in Q4/08. (Exhibit 7)
• We expect Putnam to report assets under management of approximately US$106 billion as at the end of Q4/08, down 43% YoY and 22% sequentially. We forecast a pre-tax margin of 3.0% in Q4/08, well down from 25.5% in Q4/07 but an improvement from the negative 5.2% margin reported in Q3/08.
• Management reviews goodwill yearly (in Q4/08). We believe that some of the $3.5 billion in goodwill and intangibles related to Putnam could be at risk of being marked down as AUM have dropped from US$192 billion in February 2007 when the acquisition was announced to US$106 billion at the end of December.
• We expect U.S. operations, which includes Putnam and financial services, to generate $26 million of earnings in Q4/08 compared to $141 million in Q4/07. The primary differences versus Q4/07 are the negative impacts from credit and equity market weakness and the sale of the healthcare division (which closed on April 1, 2008).
• We expect the mid-Q1/08 $13 billion acquisition of Standard Life’s payout annuity block of business to positively impact Q4/08 earnings for the European division, but will likely largely offset by weakness in global credit and equity markets.
• We expect currency translation to positively impact Q4/08E earnings by approximately 5% versus Q4/07, as reduced earnings in the U.S. somewhat temper the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar.

Manulife (February 12)

• We expect Q4/08E core EPS of ($0.99), in line with consensus estimates. Our EPS estimate is well below the $0.75 reported in Q4/07 and $0.33 reported in Q3/08.
• On December 2nd, management provided guidance based on November 30, 2008 equity market levels. The Q4/08 expected loss, announced at the same time as the equity issue, was $1.5 billion, or approximately $0.98 per share.
• The loss would be primarily driven by reserve strengthening for segregated fund/variable annuity guarantees (which we estimate was a $1.8 billion after-tax hit). Equities that back policy holder liabilities as well as surplus capital would also have accounted for a portion of the loss (we estimate a $500-700 million after-tax impact).
• Global equity markets ended the quarter up only marginally from levels on November 30, 2008.
• We do not expect credit-related costs to be as large in Q4/08 as they were in Q3/08, as the collapse of a number of previously highly-rated U.S. financial institutions had a negative impact on MFC’s earnings ($253 million or $0.17 per share). In Q4/08, while we expect lower pressure on earnings from impairments, we expect continued reserve strengthening.
• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales (outside the U.S.) will also begin to slow following five consecutive quarters of double-digit year over year increases in sales. Insurance sales in Japan should continue to show solid YoY growth due to product introductions and expanded distribution.
• We expect currency fluctuations to positively impact earnings by approximately 7% this quarter versus Q4/07, as strength in the U.S. dollar versus the Canadian dollar and Japanese Yen versus the U.S. dollar (beneficial for MFC) are somewhat offset by weak expected results out of non-Canadian divisions. Manulife’s U.S., Hong Kong, Japanese and reinsurance operations typically account for almost 70% of earnings.

Sun Life (February 12)

• We expect Q4/08E core EPS of ($0.20), well-below consensus estimates of $0.33. Our EPS estimate represents a decline of 120% versus Q4/07, but an improvement from the $0.71 loss in the prior quarter. We believe consensus estimates do not fully reflect the negative impact from equity market weakness during the quarter.
• Our estimated Q4/08 hit from equity markets is $672 million ($1.20 per share). Management has disclosed that each 10% decline in equity markets would reduce net income by $200-250 million ($0.36-$0.45 per share).
• We do not expect credit-related costs to be as large in Q4/08 as they were in Q3/08, as the collapse of a number of previously highly-rated U.S. financial institutions had a negative impact on SLF’s earnings ($636 million or $1.13 per share). In Q4/08, while we expect lower pressure on earnings from impairments, we expect continued reserve strengthening. Management stated in a late November investor day that the company’s bond portfolio had not experienced significant defaults in Q4/08 at that point.
• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales will be challenged by the weakness in global economies.
• We expect MFS to report 50% lower YoY net income in Q4/08, primarily due to weak equity markets. Operating margins are likely to continue to decline to 21%, from 32% in Q4/07 and 24% in Q3/08.
• We expect currency translation to only minimally positively impact Q4/08E earnings versus Q4/07, as reduced earnings in the U.S. largely temper the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar. In a more normal year, we estimate that a 10% decline in the Canadian dollar versus all other currencies would positively impact Sun Life’s earnings by 5%.

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