National Post, Theresa Tedesco, 30 January 2010
The National Post investigates the impact of the global financial turmoil inside Manulife Financial Corp., Canada's most venerable life insurance company. The Post's examination reveals the drama behind the closed doors of the boardroom, the tense battle between the country's financial watchdog and Manulife's formidable former chief executive, and the reasons why the company's new CEO is bringing change to the insurance giant.
Donald Guloien, chief executive of Manulife Financial Corp., sits convivially in the boardroom adjacent to his 11th-floor suite at the insurer's downtown Toronto head office.
Sipping coffee from a large white mug, the 52-year-old betrays only momentary flashes of the conflict his organization has endured over the past 16 months. "I'm very proud to lead this company in good times and bad," Mr. Guloien said during a recent interview with the National Post. "But the last year has been interesting."
Nine months in the corner office -- one formerly occupied by the tough-minded Dominic D'Alessandro who, in 15 years, built Manulife into North America's largest life insurer-- Mr. Guloien believes it's a "charmed" life to lead the company and its 45,000 worldwide employees, despite its recent challenges.
Like other Canadian insurers, Manulife was sideswiped during the financial crisis due to its exposure to guaranteed annuity products it had sold to clients across North America and Asia. Most have issued significant amounts of new shares to raise their capital levels since stock markets plunged in the fall of 2008. A major player in the business, Manulife hadn't hedged its segregated funds. That exposure created a capital risk that attracted the attention -- and intervention-- of the Office of the Superintendent of Financial Institutions (OSFI), Canada's financial services regulator.
By the time the legendary Mr. D'Alessandro, 62, retired last May, Mr. Guloien began pulling back on selling variable annuities and lowering the life insurer's risk profile.
As a result, he admits he's landed in "very public disagreements" with Manulife's shareholders after making the unpopular decisions to cut the dividend and issue billions in shares.
"There's a real credibility issue here," says Len Racioppo, president at money manager Jarislowsky Fraser Ltd., which owns more than $1-billion worth of Manulife shares. "The credibility issue is not just with the current CEO. It's with past management and the board itself."
Mr. Guloien concedes it's all been "very humiliating." But he adds: "I don't get paid to have a happy ride. I get paid to make the right decisions for shareholders whether it causes me difficulty or not."
Since becoming a public company in 1999, Manulife delivered a steady ride for its shareholders. Now, many are wondering whether Mr. Guloien has embarked on a dramatic shift from the past or whether he's engaged in damage control.
Trouble began showing up on Manulife's radar in April 2006.
According to internal company documents reviewed by the Post, the insurer's chief risk officer made a presentation to the company's chief executive Mr. D'Alessandro, warning that the company's balance sheet at the time "could not absorb the growing equity risk."
According to the documents, Manulife had unusually high exposure to stock markets because of its large segregated fund variable annuity business. Manulife, like most insurance companies, cashed in as aging Baby Boomers flocked to the products to enhance their investment portfolios.
Back in 2004, Mr. D'Alessandro made a significant business decision: Manulife would dispense with the industry practice of hedging on equity positions in the variable annuity business to cover guaranteed payouts in the event of a market crash.
Sources told the Post that Mr. D'Alessandro had an aversion to hedging because it relied on derivatives. An accountant by training, the former CEO worried that hedging was not only costly, but could lead to unintended consequences. In his view, the practice was best avoided whenever possible.
Apparently, his approach to risk management was not popular among all members of the senior ranks at Manulife. Still, no one challenged the decision.
"Bringing up a topic like that wouldn't make you very popular," says the source familiar with Manulife who spoke on the condition of anonymity. "The decision wasn't discussed because no one wanted to oppose Dominic."
But by 2006, according to the company's internal documents, the insurer was now dealing with growing risk exposure caused by the gap between the amount it promised to pay its variable annuity customers in the future, and the amount set aside to meet those guarantees. The company decided to commence hedging, testing and refining various strategies.
By the end of 2007, Manulife was hedging a small percentage of its variable annuity business. But it would be too little, too late. By early 2008, the exposure had widened.
The company's board of directors was taking notice. According to sources familiar with events, some directors began asking Mr. D'Alessandro and then-chief financial officer Peter Rubenovitch pointed questions about the variable annuity business and the company's dependence on it.
"Most members of the board didn't really understand what was going on," said an official who asked not to be named.
Board members were urging Mr. D'Alessandro to hedge the insurer's exposure and curtail the sale of the profitable products. For Manulife's competitors, the costs of hedging cut into as much as one-third of profits. Although it's difficult to determine what percentage of overall earnings the products contributed to Manulife's bottom line, some say the company's strong growth was being driven by this division.
Mr. D'Alessandro acquiesced to the board by allowing some more hedging. He didn't want Manulife to lock in the losses, especially since the products wouldn't mature for years.
"There was this religion that Manulife had created a shareholder base that wanted a steady quarterly return, dividend and profit number," said the source familiar with the company. "Manulife wanted a predictable return and Dominic was going to supply it."
Then, the implausible happened. Stock markets around the world went into a free fall, shaving as much as 50% from leading market indices.
When markets collapsed in September 2008, Manulife's net exposure of guarantees from segregated fund products was $72-billion -- most of it not to be paid out for seven to 30 years. The company's capital levels, usually well above the minimum level set by the regulators, sank because of the massive stock portfolio associated with the variable annuities.
Inevitably, the country's financial services watchdog -- the Office of the Superintendent of Financial Institutions (OSFI) -- showed up at Manulife's door.
The giant insurer was assigned internal file number TP4300-MI-20/04-1-2 by the federal regulator, signalling the company would be subjected to a series of intensive "activity reviews" by OSFI. These included monitoring its financial condition, reviewing board mi nutes and scrutinizing selected presentations to the board, as well as various management committees.
Sources say the regulator felt Manulife wasn't moving fast enough to fix the problem of its growing risk exposure and capital shortfall.
OSFI also raised questions about Manulife's internal risk-control systems and sought a meeting to discuss its concerns with Manulife's new chairman of the board, Gail Cook-Bennett, and Richard DeWolfe, chairman of the audit and risk management committee in October 2008.
"Regulators tend to get very adamant when the horse is out of the barn. It should have had the conversation much earlier," says a money manager who asked not to be named. "Why weren't they aware of Manulife's position before the 2008 meltdown? Maybe because of D'Alessandro's [solid] reputation, they just assumed there was nothing really dangerous hiding there."
During its meetings with the watchdog, sources say Manulife's senior management explained the capital calculations on the variable annuity business had been stress-tested for a worst-case scenario of a 30% plunge in the stock market -- not the 50% nose dive experienced after September 2008. They sought to persuade OSFI that the capital requirements in the existing model didn't accommodate the new products. And Manulife officials argued that segregated fund guarantees are long-dated liabilities and that any return to normal market conditions would restore capital reserves.
But OSFI was adamant that Manulife shore up its capital position immediately. According to sources familiar with the meetings, the regulator wanted to know how Manulife's position could get so large. And couldn't the company see it was rolling the dice?
OSFI declined to comment for this article saying the regulator does not discuss individual institutions.
"OSFI got on Manulife because of its capital situation," said a source familiar with events who asked not to be named. "It insisted it do a series of transactions."
Among them, issuing common stock, preferred shares or bank loans to flush up Manulife's capital.
According to sources, this upset Mr. D'Alessandro, who found himself in the unusual role of having to defend himself to a blue-ribbon board of directors unaccustomed to being caught in the crosshairs of the federal regulator. He refused to consider diluting Manulife's shareholders with a share offering, insisting it was a last-resort option.
"OSFI wanted [Manulife] to raise more capital and [the company] kept complaining there was no way to raise capital in these markets because they were shut down," says the source familiar with events.
Claude Lamoureux, former chairman of the Ontario Teachers Pension Plan and a veteran corporate governance advocate, explained why OSFI might have taken such a position.
"The regulator is there for one thing -- to protect the policyholder," he said. "If the shareholder ends up with zero return, that's fine. That's not the concern of the regulator."
At the same time that OSFI was demanding Manulife bolster its capital levels, Mr. D'Alessandro took up his own fight with Superintendent Julie Dickson to loosen the capital requirements. His argument, embraced by others in the industry, was that insurers be made to set aside reserves only when there were large dips in the value of investments that back up those guarantees to customers.
He appeared to make headway when on Oct. 28, 2008, OSFI announced that after consultations with industry participants, it was making adjustments to its conditional tail expectation (CTE) requirements that would require levels of capital that better reflect when payments by insurers were likely to come due.
For Manulife, the amendments provided a little more breathing space.
But Mr. D'Alessandro didn't give up the battle.
Said another source close to events who asked not to be named: "She [Ms. Dickson] feels she's done enough but D'Alessandro is out of his mind [angry]."
The outspoken insurance executive argued that Ms. Dickson and her staff at OSFI were being short-sighted. His message: The capital requirements model used by OSFI was still exaggerated, punitive and regressive.
According to sources, Manulife's CEO apparently was also convinced the bureaucrats disliked him personally because of the strong stance he was taking.
Manulife's chief executive took his case to Ottawa, where he met with Bank of Canada Governor Mark Carney; Kevin Lynch, the Clerk of the Privy Council and Secretary to the Cabinet; and federal Finance Minister Jim Flaherty. He also requested time with Prime Minister Stephen Harper.
He warned it would become too expensive for providers, such as Manulife, to offer the guaranteed-income products because of OSFI's capital requirements. Sources say Mr. D'Alessandro questioned whether it was good public policy that these popular products would likely no longer be available to Canadians for their retirement planning.
In the end, his pleas fell on deaf ears. No one in Ottawa seemed anxious to wade into a battle between the formidable insurance executive and the emboldened federal regulator.
On Nov. 6, 2008, Manulife announced it had secured a $3-billion, five-year bank loan to strengthen its capital base. At the time, Mr. D'Alessandro reassured investors, "Even with the decline in global equity markets since Sept. 30, our capital position is a very comfortable one."
Meanwhile, OSFI was ratcheting up its scrutiny of Manulife.
According to documents reviewed by the Post, staff at the regulator began raising serious concerns about the "safety and soundness" of North America's largest insurance company.
In a confidential "supervisory letter" dated Nov. 12, 2008, OSFI informed Manulife that it had amended its intervention stage rating (ISR), from zero to stage one, an "early warning" level, indicating OSFI had identified deficiencies that needed to be addressed because they could lead to serious "material safety and soundness concerns."
In early December 2008, Manulife's board met with OSFI to discuss the intervention rating and ways to resolve the regulator's issues.
In a missive sent to Manulife after the meeting, OSFI staff said it continued to "express concern related to the company's relatively higher and growing exposure to equity markets and part of the products issued in the U.S., Canada and Asia." OSFI also highlighted "board-approved risk-tolerance policies," credit risk management and asset-liability risk management "as potentially higher risk areas."
In all, OSFI requested that Manulife develop a board-approved action plan with "specific trigger points" to demonstrate how the insurer would actively manage its capital and remain compliant with regulatory requirements. OSFI also recommended that the board consider adding members "with actuarial or risk-management expertise."
The deadline for delivery of the plan was March 31, 2009.
On Dec. 3, 2008, Manulife issued $2.275-billion in stock during a battered market, a move that executives described at the time as "humbling."
By the end of 2008, the insurer was hedging all of its new variable annuity business and its minimum continuing capital and surplus requirements ratio was a healthy 234%, well above OSFI's minimum target level of 150%.
A source familiar with the life insurer said senior management and the board not only thought they had "restored capital reserve levels" with the bank debt and share issue, they figured they had "weathered the storm."
They thought wrong.
The fallout from the financial meltdown -- and the subsequent regulatory intervention -- had put Manulife in the watchdog's penalty box.
Regulatory officials were increasingly concerned that Manulife's senior management may have taken risks without fully engaging the company's directors -- or worse, without the board's knowledge.
To that end, they met with Ms. Cook-Bennett and Mr. De Wolfe, who reassured the regulator that was not the case.
But OSFI staff was not persuaded. "OSFI had a theory that management had deliberately misled the board," said a source familiar with events who asked not to be named. "For a time, they became adamant, there's no question. It was really bizarre."
To allay its concerns, the federal supervisor demanded Manulife initiate an independent review of its internal practices.
The Post has learned that at OSFI's request, Manulife retained accounting firm Deloitte & Touche to conduct an independent examination of the insurer's risk-management processes for its segregated fund and variable annuity products.
A team of auditors from Deloitte spent the first two months of 2009 at Manulife's Toronto head office reviewing activities and documents dating back from Jan. 1, 2005 to Dec. 31, 2008. Twenty-four senior managers and board members were interviewed while the auditors communicated regularly with OSFI and Mr. DeWolfe.
Meanwhile, the regulator continued to actively monitor Manulife's financial condition.
In a "supervisory letter" dated Feb. 3, 2009, OSFI notified the company that it had assigned Manulife an "above average" composite risk rating. Generally, a financial institution with this rating is considered by the regulator to have above-average overall risk, which is not sufficiently mitigated by capital and earnings.
According to documents reviewed by the Post, OSFI raised its risk rating of Manulife because of the insurer's "continued exposure to negative movements in the equity markets and senior management's failure to effectively control the risk."
It was the first time the giant life insurer had been assessed such a high composite risk rating since becoming a public company.
Nine days later, on Feb. 12, Manulife reported another first -- a quarterly loss -a $1.87-billion loss for the fourth-quarter of 2008.
Less than two weeks later, the insurer announced it did not intend to raise common share capital over and above the $2-billion it already raised the previous December, in the absence of a strategic transaction.
In its Feb. 23, 2009 release, Manulife said that although equity markets had continued to decline, the company "continues to be well-capitalized and is able to withstand additional equity volatility."
However, the credit agencies -- Standard & Poor's and Moody's Investors Service Inc. -- responded by downgrading the insurer's ratings, citing Manulife's "weakened financial flexibility and capitalization, caused by the decline in equity markets globally."
Meanwhile, Manulife's hopes for acquiring the Asian assets of troubled U.S. insurance giant American International Group (AIG) were fading.
A month later, on March 23, 2009, Deloitte simultaneously delivered to Manulife and OSFI a draft of its findings in a 29-page report.
The review concluded that the insurer's internal risk reporting, including to the board, was "comprehensive."
Deloitte's review also found that Manulife had a "disciplined risk-management culture with a strong senior management team."
Still, the Deloitte report was not a complete vindication for Manulife. It outlined 14 key recommendations and observations, from "management should have initiated the required actions earlier," to the company's risk agenda also needed more focus and time at the board.
"We did not identify one overriding reason behind the challenging situation that Manulife faces with respect to its equity risk exposure," the report declared. "However, there appear to be a series of interrelated and complex factors that contributed to the significant equity risk issue."
Overall, Deloitte concluded it was clear senior management at Manulife had an "appetite for equity risk" and a number of executives and directors indicated there was a belief that the company's strong balance sheet could continue to support the growth of the products.
"We heard from most executives that many actions had been taken in recent years to address the growing risk exposure. However, the incremental nature of these actions was not sufficient to address the escalating magnitude of the total risk exposure," the review declared.
While Manulife began preparing to act on the recommendations, sources say OSFI was not satisfied and requested the report be revised. Mr. D'Alessandro and his senior management team agreed to allow Deloitte to modify the document as long as the substance of the findings was not changed.
When the final report was delivered to Manulife's board and OSFI in April, 2009, the executive summary, including laudatory comments about Manulife, were placed in the back and recommendations listing ways the insurer could improve its operations were moved to the front.
Amid this tense atmosphere -- and with millions of dollars shaved from the value of his own stock options -- Mr. D'Alessandro officially retired from Manulife as planned in early May 2009.
Publicly, he went quietly. Privately, sources say he was seething.
A proud man accustomed to calling the shots, not dodging them, Mr. D'Alessandro believed OSFI's intervention "dramatically disturbed a very important company that had everything going for it," said a source close to the former chief executive.
Mr. Guloien, a 28-year veteran of the company, became Manulife's new CEO on May 7.
In his inaugural address to shareholders, Mr. Guloien, who had also served as the life insurer's chief investment officer, said there was little difference in style or vision between himself and Mr. D'Alessandro-- only that they would be operating in different environments.
Yet in that first address to shareholders as CEO, Mr. Guloien gave early indications of the dramatic shift to come when he spoke of adopting a conservative approach to risk -- he advocated reducing it -- and strengthening capital levels. He also warned Manulife shareholders, who had learned of a $1.07-billion first-quarter loss, of "pessimistic scenarios" in capital planning.
Perhaps more important was what he didn't say. The company's board had begun mulling a possible dividend cut at a meeting on May 6 -the day before the annual general meeting.
Sources say most directors weren't comfortable with taking such a drastic step and angering shareholders.
"The last thing you do in this world if you're a financial institution is cut your dividend," said the source close to the company who asked not to be named. "You make sure you've examined every possibility because nobody will forgive you."
Manulife's board agreed to defer making a decision until a thorough review could be done by the new senior management team.
On Aug. 6, Mr. Guloien took his first dramatic first step away from his predecessor and made a move avoided by every other financial institution in Canada since 1992: Manulife slashed its dividend in half, from 26¢ to 13¢. The decision was estimated to save $800-million annually, but caused the stock price to tumble 15%.
"Cutting the dividend was a step toward building fortress capital," he said at the time.
Barely three months in the corner office, Mr. Guloien appeared willing to anger shareholders by making taking an unpopular measure to rebuild Manulife's balance sheet.
"Fortress capital" became his battle cry. Manulife's capital levels had to be boosted well beyond OSFI's minimum levels that it could withstand any a reasonable range of negative scenarios in the economy or financial markets.
Three months later, on Nov. 18, 2009, Manulife shareholders were faced again with a new money raise when the company issued a $2.5-billion share offer at $19 a share. The bought deal was the second largest in Canadian history.
"We believe this transaction achieves the fortress level of capital necessary to buffer against more conservative economic scenarios," Mr. Guloien said at the time of the issue.
After months of talk about fortress capital, the market began worrying there may be a deeper problem.
Genuity Capital Markets Inc. wondered "what exactly changed over the past few months and even weeks." In an analyst report, the Toronto-based investment firm noted that Manulife's management provided "comfort" on several occasions "(albeit nuanced) that an equity raise was not likely."
At the same time, credit-rating agencies and investors worried that Manulife still hadn't hedged most of its stock portfolio to avoid the risk of more capital troubles.
"They've taken a big reputational hit," says a major institutional shareholder who asked not to be named, referring to the two share issues and dividend cut. "I don't think the board gets the message about how disappointed shareholders are."
It was the kind of reaction Mr. D'Alessandro had feared.
Last year, Manulife was the worst performing stock of the top 10 financial institutions in Canada, declining in value by about 7%, while its major competitor Sun Life Financial gained 6.4%, and the rest appreciated by at least 29%.
Meanwhile, the company's double-A rating took another hit when it was lowered a notch by Standard & Poor's earlier this month.
Clearly, Mr. Guloien's challenge is weighing the interests of his various stakeholders -- policyholders, shareholders, debt holders and the requirements of the regulators.
In part, his early initiatives illustrate some of the difficult decisions many financial services executives have been forced to make in the post-meltdown environment.
"OSFI was not telling us to do this," Mr. Guloien said during his interview with the Post. "This was our read." He acknowledged that "it wasn't easy for me to do this," but added those who didn't support the equity raise, "don't have all the facts."
When asked about Manulife's relationship with OSFI, Mr. Guloien described it as "excellent." He added: "You know, when companies have challenges and I think it's only fair to say that Manulife had challenges, especially around the issue of these equity guarantees, people get unhappy on both sides."
On the topics of the regulator's increased intervention, the above average risk rating and the unusual Deloitte audit, Mr. Guloien had this to say:
"That's a matter of legality," he told the Post. "There are certain things that are absolutely privileged between the regulator and the company and we're not commenting."
Currently, the country's financial services regulator is conducting a comprehensive review of its guaranteed annuity requirements and is considering increasing the amount of capital insurance firms are required to hold against guaranteed annuities. As a result, most industry participants expect the requirements of insurers should increase this year.
His critics say that unlike Mr. D'Alessandro, the new CEO is genuflecting to the regulator. "Don Guloien is trying to buy himself a halo," said the money manager who asked not to be named.
They also point to his obsession with fortress capital.
"It's become a self-fulfilling prophesy," observed a source close to events. "He keeps talking about it and he keeps drawing attention to it. If the CEO of the company doesn't think he has enough capital, the rating agencies will start to question it as well."
Added the same source who asked not to be named: "What sane person behaves that way? If stock markets had collapsed further, maybe yes, but they didn't. It's not possible that he couldn't have foreseen the consequences [of a dividend cut and share issue]."
Still, there are others who believe Mr. Guloien is setting the right course for the company.
"I think they are in a lot better shape now," says Ohad Lederer, an analyst at Veritas Investment Corp. in Toronto, who switched his recommendation on Manulife's stock from a "sell" to "buy" after the equity offering. "He has taken defensive measures and the company now has more capital in the face of uncertainty."
Even Mr. Racioppo has found something to compliment.
"The board has gotten stronger with people who have more experience with finance and risk management," says the president of Jarislowsky Fraser. "They're going in the right direction but it's still a long haul as it is with any large organization."
Eventually, Mr. Guloien will have to take ownership of the life insurer's performance. "I want people to judge me by what happens on my watch," he says, adding that he's eager for that to happen. First, the new CEO will have to convince investors -and the regulators -- to put the past behind them.
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$4.3B : Manulife Financial shareholders net income for 2007
$517M : Manulife Financial shareholders net income for 2008
$533M : Manulife Financial shareholders net income first nine months of 2009
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Seg Funds 101
WHAT ARE THEY? Segregated funds are insurance (variable annuity) contracts. Like mutual funds, investors pool their money with others to share gains on professionally managed diversified investments. These include equity, bond, balanced and money market funds.
In addition to the return component, seg funds also come with an insurance policy that covers 75% to 100% of the principal investment if held for 10 years or upon death of the policyholder.
In either case, the contract holder or beneficiary will receive the greater of the guarantee or the investment's current market value.
The term "segregated" refers to the fact that investments are separated from the general assets of the insurance company.
All segregated fund contracts have maturity dates that are typically 10 years or longer.
HOW MUCH IS INVESTED IN THEM? Segregated fund assets were $79.5-billion at the end of 2009, the highest point in history and more than double the $36.8-billion of 10 years ago, according to Investor Economics.
HOW DO THEY WORK? While seg funds typically mirror the performance of corresponding mutual funds, higher fees have a negative impact on returns. The better the associated guarantee, the higher the cost or management expense ratio (MER).
WHAT ABOUT RESET OPTIONS AND WITHDRAWALS? In some cases, holders can lock-in or reset the protection on the principal when the policy has increased in value. This option also typically comes with a higher cost. Resets are available either twice a year or on the policy anniversary date.
HOW DO THEY DIFFER FROM MUTUAL FUNDS? Often referred to as "mutual funds with an insurance policy wrapper," seg funds are only sold by licensed insurance representatives.
Unlike mutual funds, they also offer a death benefit, maturity and reset guarantees. Seg funds provide the opportunity to bypass probate and may offer creditor and insurer insolvency protection.
Seg funds are deemed to be trusts for tax purposes.
Source: Jonathan Ratner, Financial Post, jratner@nationalpost.com
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3.1% : Manulife Financial share price performance for 2007
-48.7% : Manulife Financial share price performance for 2008
-7.1% : Manulife Financial share price performance for 2009
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The National Post investigates the impact of the global financial turmoil inside Manulife Financial Corp., Canada's most venerable life insurance company. The Post's examination reveals the drama behind the closed doors of the boardroom, the tense battle between the country's financial watchdog and Manulife's formidable former chief executive, and the reasons why the company's new CEO is bringing change to the insurance giant.
Donald Guloien, chief executive of Manulife Financial Corp., sits convivially in the boardroom adjacent to his 11th-floor suite at the insurer's downtown Toronto head office.
Sipping coffee from a large white mug, the 52-year-old betrays only momentary flashes of the conflict his organization has endured over the past 16 months. "I'm very proud to lead this company in good times and bad," Mr. Guloien said during a recent interview with the National Post. "But the last year has been interesting."
Nine months in the corner office -- one formerly occupied by the tough-minded Dominic D'Alessandro who, in 15 years, built Manulife into North America's largest life insurer-- Mr. Guloien believes it's a "charmed" life to lead the company and its 45,000 worldwide employees, despite its recent challenges.
Like other Canadian insurers, Manulife was sideswiped during the financial crisis due to its exposure to guaranteed annuity products it had sold to clients across North America and Asia. Most have issued significant amounts of new shares to raise their capital levels since stock markets plunged in the fall of 2008. A major player in the business, Manulife hadn't hedged its segregated funds. That exposure created a capital risk that attracted the attention -- and intervention-- of the Office of the Superintendent of Financial Institutions (OSFI), Canada's financial services regulator.
By the time the legendary Mr. D'Alessandro, 62, retired last May, Mr. Guloien began pulling back on selling variable annuities and lowering the life insurer's risk profile.
As a result, he admits he's landed in "very public disagreements" with Manulife's shareholders after making the unpopular decisions to cut the dividend and issue billions in shares.
"There's a real credibility issue here," says Len Racioppo, president at money manager Jarislowsky Fraser Ltd., which owns more than $1-billion worth of Manulife shares. "The credibility issue is not just with the current CEO. It's with past management and the board itself."
Mr. Guloien concedes it's all been "very humiliating." But he adds: "I don't get paid to have a happy ride. I get paid to make the right decisions for shareholders whether it causes me difficulty or not."
Since becoming a public company in 1999, Manulife delivered a steady ride for its shareholders. Now, many are wondering whether Mr. Guloien has embarked on a dramatic shift from the past or whether he's engaged in damage control.
Trouble began showing up on Manulife's radar in April 2006.
According to internal company documents reviewed by the Post, the insurer's chief risk officer made a presentation to the company's chief executive Mr. D'Alessandro, warning that the company's balance sheet at the time "could not absorb the growing equity risk."
According to the documents, Manulife had unusually high exposure to stock markets because of its large segregated fund variable annuity business. Manulife, like most insurance companies, cashed in as aging Baby Boomers flocked to the products to enhance their investment portfolios.
Back in 2004, Mr. D'Alessandro made a significant business decision: Manulife would dispense with the industry practice of hedging on equity positions in the variable annuity business to cover guaranteed payouts in the event of a market crash.
Sources told the Post that Mr. D'Alessandro had an aversion to hedging because it relied on derivatives. An accountant by training, the former CEO worried that hedging was not only costly, but could lead to unintended consequences. In his view, the practice was best avoided whenever possible.
Apparently, his approach to risk management was not popular among all members of the senior ranks at Manulife. Still, no one challenged the decision.
"Bringing up a topic like that wouldn't make you very popular," says the source familiar with Manulife who spoke on the condition of anonymity. "The decision wasn't discussed because no one wanted to oppose Dominic."
But by 2006, according to the company's internal documents, the insurer was now dealing with growing risk exposure caused by the gap between the amount it promised to pay its variable annuity customers in the future, and the amount set aside to meet those guarantees. The company decided to commence hedging, testing and refining various strategies.
By the end of 2007, Manulife was hedging a small percentage of its variable annuity business. But it would be too little, too late. By early 2008, the exposure had widened.
The company's board of directors was taking notice. According to sources familiar with events, some directors began asking Mr. D'Alessandro and then-chief financial officer Peter Rubenovitch pointed questions about the variable annuity business and the company's dependence on it.
"Most members of the board didn't really understand what was going on," said an official who asked not to be named.
Board members were urging Mr. D'Alessandro to hedge the insurer's exposure and curtail the sale of the profitable products. For Manulife's competitors, the costs of hedging cut into as much as one-third of profits. Although it's difficult to determine what percentage of overall earnings the products contributed to Manulife's bottom line, some say the company's strong growth was being driven by this division.
Mr. D'Alessandro acquiesced to the board by allowing some more hedging. He didn't want Manulife to lock in the losses, especially since the products wouldn't mature for years.
"There was this religion that Manulife had created a shareholder base that wanted a steady quarterly return, dividend and profit number," said the source familiar with the company. "Manulife wanted a predictable return and Dominic was going to supply it."
Then, the implausible happened. Stock markets around the world went into a free fall, shaving as much as 50% from leading market indices.
When markets collapsed in September 2008, Manulife's net exposure of guarantees from segregated fund products was $72-billion -- most of it not to be paid out for seven to 30 years. The company's capital levels, usually well above the minimum level set by the regulators, sank because of the massive stock portfolio associated with the variable annuities.
Inevitably, the country's financial services watchdog -- the Office of the Superintendent of Financial Institutions (OSFI) -- showed up at Manulife's door.
The giant insurer was assigned internal file number TP4300-MI-20/04-1-2 by the federal regulator, signalling the company would be subjected to a series of intensive "activity reviews" by OSFI. These included monitoring its financial condition, reviewing board mi nutes and scrutinizing selected presentations to the board, as well as various management committees.
Sources say the regulator felt Manulife wasn't moving fast enough to fix the problem of its growing risk exposure and capital shortfall.
OSFI also raised questions about Manulife's internal risk-control systems and sought a meeting to discuss its concerns with Manulife's new chairman of the board, Gail Cook-Bennett, and Richard DeWolfe, chairman of the audit and risk management committee in October 2008.
"Regulators tend to get very adamant when the horse is out of the barn. It should have had the conversation much earlier," says a money manager who asked not to be named. "Why weren't they aware of Manulife's position before the 2008 meltdown? Maybe because of D'Alessandro's [solid] reputation, they just assumed there was nothing really dangerous hiding there."
During its meetings with the watchdog, sources say Manulife's senior management explained the capital calculations on the variable annuity business had been stress-tested for a worst-case scenario of a 30% plunge in the stock market -- not the 50% nose dive experienced after September 2008. They sought to persuade OSFI that the capital requirements in the existing model didn't accommodate the new products. And Manulife officials argued that segregated fund guarantees are long-dated liabilities and that any return to normal market conditions would restore capital reserves.
But OSFI was adamant that Manulife shore up its capital position immediately. According to sources familiar with the meetings, the regulator wanted to know how Manulife's position could get so large. And couldn't the company see it was rolling the dice?
OSFI declined to comment for this article saying the regulator does not discuss individual institutions.
"OSFI got on Manulife because of its capital situation," said a source familiar with events who asked not to be named. "It insisted it do a series of transactions."
Among them, issuing common stock, preferred shares or bank loans to flush up Manulife's capital.
According to sources, this upset Mr. D'Alessandro, who found himself in the unusual role of having to defend himself to a blue-ribbon board of directors unaccustomed to being caught in the crosshairs of the federal regulator. He refused to consider diluting Manulife's shareholders with a share offering, insisting it was a last-resort option.
"OSFI wanted [Manulife] to raise more capital and [the company] kept complaining there was no way to raise capital in these markets because they were shut down," says the source familiar with events.
Claude Lamoureux, former chairman of the Ontario Teachers Pension Plan and a veteran corporate governance advocate, explained why OSFI might have taken such a position.
"The regulator is there for one thing -- to protect the policyholder," he said. "If the shareholder ends up with zero return, that's fine. That's not the concern of the regulator."
At the same time that OSFI was demanding Manulife bolster its capital levels, Mr. D'Alessandro took up his own fight with Superintendent Julie Dickson to loosen the capital requirements. His argument, embraced by others in the industry, was that insurers be made to set aside reserves only when there were large dips in the value of investments that back up those guarantees to customers.
He appeared to make headway when on Oct. 28, 2008, OSFI announced that after consultations with industry participants, it was making adjustments to its conditional tail expectation (CTE) requirements that would require levels of capital that better reflect when payments by insurers were likely to come due.
For Manulife, the amendments provided a little more breathing space.
But Mr. D'Alessandro didn't give up the battle.
Said another source close to events who asked not to be named: "She [Ms. Dickson] feels she's done enough but D'Alessandro is out of his mind [angry]."
The outspoken insurance executive argued that Ms. Dickson and her staff at OSFI were being short-sighted. His message: The capital requirements model used by OSFI was still exaggerated, punitive and regressive.
According to sources, Manulife's CEO apparently was also convinced the bureaucrats disliked him personally because of the strong stance he was taking.
Manulife's chief executive took his case to Ottawa, where he met with Bank of Canada Governor Mark Carney; Kevin Lynch, the Clerk of the Privy Council and Secretary to the Cabinet; and federal Finance Minister Jim Flaherty. He also requested time with Prime Minister Stephen Harper.
He warned it would become too expensive for providers, such as Manulife, to offer the guaranteed-income products because of OSFI's capital requirements. Sources say Mr. D'Alessandro questioned whether it was good public policy that these popular products would likely no longer be available to Canadians for their retirement planning.
In the end, his pleas fell on deaf ears. No one in Ottawa seemed anxious to wade into a battle between the formidable insurance executive and the emboldened federal regulator.
On Nov. 6, 2008, Manulife announced it had secured a $3-billion, five-year bank loan to strengthen its capital base. At the time, Mr. D'Alessandro reassured investors, "Even with the decline in global equity markets since Sept. 30, our capital position is a very comfortable one."
Meanwhile, OSFI was ratcheting up its scrutiny of Manulife.
According to documents reviewed by the Post, staff at the regulator began raising serious concerns about the "safety and soundness" of North America's largest insurance company.
In a confidential "supervisory letter" dated Nov. 12, 2008, OSFI informed Manulife that it had amended its intervention stage rating (ISR), from zero to stage one, an "early warning" level, indicating OSFI had identified deficiencies that needed to be addressed because they could lead to serious "material safety and soundness concerns."
In early December 2008, Manulife's board met with OSFI to discuss the intervention rating and ways to resolve the regulator's issues.
In a missive sent to Manulife after the meeting, OSFI staff said it continued to "express concern related to the company's relatively higher and growing exposure to equity markets and part of the products issued in the U.S., Canada and Asia." OSFI also highlighted "board-approved risk-tolerance policies," credit risk management and asset-liability risk management "as potentially higher risk areas."
In all, OSFI requested that Manulife develop a board-approved action plan with "specific trigger points" to demonstrate how the insurer would actively manage its capital and remain compliant with regulatory requirements. OSFI also recommended that the board consider adding members "with actuarial or risk-management expertise."
The deadline for delivery of the plan was March 31, 2009.
On Dec. 3, 2008, Manulife issued $2.275-billion in stock during a battered market, a move that executives described at the time as "humbling."
By the end of 2008, the insurer was hedging all of its new variable annuity business and its minimum continuing capital and surplus requirements ratio was a healthy 234%, well above OSFI's minimum target level of 150%.
A source familiar with the life insurer said senior management and the board not only thought they had "restored capital reserve levels" with the bank debt and share issue, they figured they had "weathered the storm."
They thought wrong.
The fallout from the financial meltdown -- and the subsequent regulatory intervention -- had put Manulife in the watchdog's penalty box.
Regulatory officials were increasingly concerned that Manulife's senior management may have taken risks without fully engaging the company's directors -- or worse, without the board's knowledge.
To that end, they met with Ms. Cook-Bennett and Mr. De Wolfe, who reassured the regulator that was not the case.
But OSFI staff was not persuaded. "OSFI had a theory that management had deliberately misled the board," said a source familiar with events who asked not to be named. "For a time, they became adamant, there's no question. It was really bizarre."
To allay its concerns, the federal supervisor demanded Manulife initiate an independent review of its internal practices.
The Post has learned that at OSFI's request, Manulife retained accounting firm Deloitte & Touche to conduct an independent examination of the insurer's risk-management processes for its segregated fund and variable annuity products.
A team of auditors from Deloitte spent the first two months of 2009 at Manulife's Toronto head office reviewing activities and documents dating back from Jan. 1, 2005 to Dec. 31, 2008. Twenty-four senior managers and board members were interviewed while the auditors communicated regularly with OSFI and Mr. DeWolfe.
Meanwhile, the regulator continued to actively monitor Manulife's financial condition.
In a "supervisory letter" dated Feb. 3, 2009, OSFI notified the company that it had assigned Manulife an "above average" composite risk rating. Generally, a financial institution with this rating is considered by the regulator to have above-average overall risk, which is not sufficiently mitigated by capital and earnings.
According to documents reviewed by the Post, OSFI raised its risk rating of Manulife because of the insurer's "continued exposure to negative movements in the equity markets and senior management's failure to effectively control the risk."
It was the first time the giant life insurer had been assessed such a high composite risk rating since becoming a public company.
Nine days later, on Feb. 12, Manulife reported another first -- a quarterly loss -a $1.87-billion loss for the fourth-quarter of 2008.
Less than two weeks later, the insurer announced it did not intend to raise common share capital over and above the $2-billion it already raised the previous December, in the absence of a strategic transaction.
In its Feb. 23, 2009 release, Manulife said that although equity markets had continued to decline, the company "continues to be well-capitalized and is able to withstand additional equity volatility."
However, the credit agencies -- Standard & Poor's and Moody's Investors Service Inc. -- responded by downgrading the insurer's ratings, citing Manulife's "weakened financial flexibility and capitalization, caused by the decline in equity markets globally."
Meanwhile, Manulife's hopes for acquiring the Asian assets of troubled U.S. insurance giant American International Group (AIG) were fading.
A month later, on March 23, 2009, Deloitte simultaneously delivered to Manulife and OSFI a draft of its findings in a 29-page report.
The review concluded that the insurer's internal risk reporting, including to the board, was "comprehensive."
Deloitte's review also found that Manulife had a "disciplined risk-management culture with a strong senior management team."
Still, the Deloitte report was not a complete vindication for Manulife. It outlined 14 key recommendations and observations, from "management should have initiated the required actions earlier," to the company's risk agenda also needed more focus and time at the board.
"We did not identify one overriding reason behind the challenging situation that Manulife faces with respect to its equity risk exposure," the report declared. "However, there appear to be a series of interrelated and complex factors that contributed to the significant equity risk issue."
Overall, Deloitte concluded it was clear senior management at Manulife had an "appetite for equity risk" and a number of executives and directors indicated there was a belief that the company's strong balance sheet could continue to support the growth of the products.
"We heard from most executives that many actions had been taken in recent years to address the growing risk exposure. However, the incremental nature of these actions was not sufficient to address the escalating magnitude of the total risk exposure," the review declared.
While Manulife began preparing to act on the recommendations, sources say OSFI was not satisfied and requested the report be revised. Mr. D'Alessandro and his senior management team agreed to allow Deloitte to modify the document as long as the substance of the findings was not changed.
When the final report was delivered to Manulife's board and OSFI in April, 2009, the executive summary, including laudatory comments about Manulife, were placed in the back and recommendations listing ways the insurer could improve its operations were moved to the front.
Amid this tense atmosphere -- and with millions of dollars shaved from the value of his own stock options -- Mr. D'Alessandro officially retired from Manulife as planned in early May 2009.
Publicly, he went quietly. Privately, sources say he was seething.
A proud man accustomed to calling the shots, not dodging them, Mr. D'Alessandro believed OSFI's intervention "dramatically disturbed a very important company that had everything going for it," said a source close to the former chief executive.
Mr. Guloien, a 28-year veteran of the company, became Manulife's new CEO on May 7.
In his inaugural address to shareholders, Mr. Guloien, who had also served as the life insurer's chief investment officer, said there was little difference in style or vision between himself and Mr. D'Alessandro-- only that they would be operating in different environments.
Yet in that first address to shareholders as CEO, Mr. Guloien gave early indications of the dramatic shift to come when he spoke of adopting a conservative approach to risk -- he advocated reducing it -- and strengthening capital levels. He also warned Manulife shareholders, who had learned of a $1.07-billion first-quarter loss, of "pessimistic scenarios" in capital planning.
Perhaps more important was what he didn't say. The company's board had begun mulling a possible dividend cut at a meeting on May 6 -the day before the annual general meeting.
Sources say most directors weren't comfortable with taking such a drastic step and angering shareholders.
"The last thing you do in this world if you're a financial institution is cut your dividend," said the source close to the company who asked not to be named. "You make sure you've examined every possibility because nobody will forgive you."
Manulife's board agreed to defer making a decision until a thorough review could be done by the new senior management team.
On Aug. 6, Mr. Guloien took his first dramatic first step away from his predecessor and made a move avoided by every other financial institution in Canada since 1992: Manulife slashed its dividend in half, from 26¢ to 13¢. The decision was estimated to save $800-million annually, but caused the stock price to tumble 15%.
"Cutting the dividend was a step toward building fortress capital," he said at the time.
Barely three months in the corner office, Mr. Guloien appeared willing to anger shareholders by making taking an unpopular measure to rebuild Manulife's balance sheet.
"Fortress capital" became his battle cry. Manulife's capital levels had to be boosted well beyond OSFI's minimum levels that it could withstand any a reasonable range of negative scenarios in the economy or financial markets.
Three months later, on Nov. 18, 2009, Manulife shareholders were faced again with a new money raise when the company issued a $2.5-billion share offer at $19 a share. The bought deal was the second largest in Canadian history.
"We believe this transaction achieves the fortress level of capital necessary to buffer against more conservative economic scenarios," Mr. Guloien said at the time of the issue.
After months of talk about fortress capital, the market began worrying there may be a deeper problem.
Genuity Capital Markets Inc. wondered "what exactly changed over the past few months and even weeks." In an analyst report, the Toronto-based investment firm noted that Manulife's management provided "comfort" on several occasions "(albeit nuanced) that an equity raise was not likely."
At the same time, credit-rating agencies and investors worried that Manulife still hadn't hedged most of its stock portfolio to avoid the risk of more capital troubles.
"They've taken a big reputational hit," says a major institutional shareholder who asked not to be named, referring to the two share issues and dividend cut. "I don't think the board gets the message about how disappointed shareholders are."
It was the kind of reaction Mr. D'Alessandro had feared.
Last year, Manulife was the worst performing stock of the top 10 financial institutions in Canada, declining in value by about 7%, while its major competitor Sun Life Financial gained 6.4%, and the rest appreciated by at least 29%.
Meanwhile, the company's double-A rating took another hit when it was lowered a notch by Standard & Poor's earlier this month.
Clearly, Mr. Guloien's challenge is weighing the interests of his various stakeholders -- policyholders, shareholders, debt holders and the requirements of the regulators.
In part, his early initiatives illustrate some of the difficult decisions many financial services executives have been forced to make in the post-meltdown environment.
"OSFI was not telling us to do this," Mr. Guloien said during his interview with the Post. "This was our read." He acknowledged that "it wasn't easy for me to do this," but added those who didn't support the equity raise, "don't have all the facts."
When asked about Manulife's relationship with OSFI, Mr. Guloien described it as "excellent." He added: "You know, when companies have challenges and I think it's only fair to say that Manulife had challenges, especially around the issue of these equity guarantees, people get unhappy on both sides."
On the topics of the regulator's increased intervention, the above average risk rating and the unusual Deloitte audit, Mr. Guloien had this to say:
"That's a matter of legality," he told the Post. "There are certain things that are absolutely privileged between the regulator and the company and we're not commenting."
Currently, the country's financial services regulator is conducting a comprehensive review of its guaranteed annuity requirements and is considering increasing the amount of capital insurance firms are required to hold against guaranteed annuities. As a result, most industry participants expect the requirements of insurers should increase this year.
His critics say that unlike Mr. D'Alessandro, the new CEO is genuflecting to the regulator. "Don Guloien is trying to buy himself a halo," said the money manager who asked not to be named.
They also point to his obsession with fortress capital.
"It's become a self-fulfilling prophesy," observed a source close to events. "He keeps talking about it and he keeps drawing attention to it. If the CEO of the company doesn't think he has enough capital, the rating agencies will start to question it as well."
Added the same source who asked not to be named: "What sane person behaves that way? If stock markets had collapsed further, maybe yes, but they didn't. It's not possible that he couldn't have foreseen the consequences [of a dividend cut and share issue]."
Still, there are others who believe Mr. Guloien is setting the right course for the company.
"I think they are in a lot better shape now," says Ohad Lederer, an analyst at Veritas Investment Corp. in Toronto, who switched his recommendation on Manulife's stock from a "sell" to "buy" after the equity offering. "He has taken defensive measures and the company now has more capital in the face of uncertainty."
Even Mr. Racioppo has found something to compliment.
"The board has gotten stronger with people who have more experience with finance and risk management," says the president of Jarislowsky Fraser. "They're going in the right direction but it's still a long haul as it is with any large organization."
Eventually, Mr. Guloien will have to take ownership of the life insurer's performance. "I want people to judge me by what happens on my watch," he says, adding that he's eager for that to happen. First, the new CEO will have to convince investors -and the regulators -- to put the past behind them.
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$4.3B : Manulife Financial shareholders net income for 2007
$517M : Manulife Financial shareholders net income for 2008
$533M : Manulife Financial shareholders net income first nine months of 2009
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Seg Funds 101
WHAT ARE THEY? Segregated funds are insurance (variable annuity) contracts. Like mutual funds, investors pool their money with others to share gains on professionally managed diversified investments. These include equity, bond, balanced and money market funds.
In addition to the return component, seg funds also come with an insurance policy that covers 75% to 100% of the principal investment if held for 10 years or upon death of the policyholder.
In either case, the contract holder or beneficiary will receive the greater of the guarantee or the investment's current market value.
The term "segregated" refers to the fact that investments are separated from the general assets of the insurance company.
All segregated fund contracts have maturity dates that are typically 10 years or longer.
HOW MUCH IS INVESTED IN THEM? Segregated fund assets were $79.5-billion at the end of 2009, the highest point in history and more than double the $36.8-billion of 10 years ago, according to Investor Economics.
HOW DO THEY WORK? While seg funds typically mirror the performance of corresponding mutual funds, higher fees have a negative impact on returns. The better the associated guarantee, the higher the cost or management expense ratio (MER).
WHAT ABOUT RESET OPTIONS AND WITHDRAWALS? In some cases, holders can lock-in or reset the protection on the principal when the policy has increased in value. This option also typically comes with a higher cost. Resets are available either twice a year or on the policy anniversary date.
HOW DO THEY DIFFER FROM MUTUAL FUNDS? Often referred to as "mutual funds with an insurance policy wrapper," seg funds are only sold by licensed insurance representatives.
Unlike mutual funds, they also offer a death benefit, maturity and reset guarantees. Seg funds provide the opportunity to bypass probate and may offer creditor and insurer insolvency protection.
Seg funds are deemed to be trusts for tax purposes.
Source: Jonathan Ratner, Financial Post, jratner@nationalpost.com
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3.1% : Manulife Financial share price performance for 2007
-48.7% : Manulife Financial share price performance for 2008
-7.1% : Manulife Financial share price performance for 2009
