Manulife makes progress on hedging equity risk

By Donna Glasgow | August 12 2010 03:42PM

Manulife Financial has now hedged half of its variable annuity business in an effort to reduce its level of equity exposure.

When stock markets collapsed in late 2008, Manulife felt the pain of its largely unhedged variable annuity business. By the end of that year, a shortfall between the guaranteed value of variable annuity and segregated fund contracts and the underlying assets supporting those contracts, reached $27 billion.

At Manulife Financial's annual meeting in May, Donald Guloien, President and CEO, underlined that the company has made significant progress hedging its variable annuity risk.

"Today, virtually all of our new variable annuity business is hedged as we write it and, of the in-force business, we have 51% of our exposure hedged or reinsured, which is more than double where it was last year at this time," he said.

Mr. Guloien says the company's capital position allowed it to hedge at an opportune time.

"We acknowledged that the unhedged volatility was too great. But instead of moving precipitously at the bottom of the market, we fortified our capital position, then we waited to hedge our equity exposure as markets strengthened. This ensured our shareholders were not penalized by crystallizing losses at the market lows."

During the first quarter of 2010 alone, Manulife hedged $15.2 billion of in-force variable annuity guarantee value, which brought the guarantee value hedged or reinsured to the 51% mark mentioned by Mr. Guloien at the annual meeting.

This compares to 35% of guarantee value hedged or reinsured at year-end 2009 and 20% at year-end 2008.

"As a result of hedging activities and increases in equity markets during the quarter, the net amount at risk, related to unhedged and unreinsured variable annuity products was $8.1 billion as at March 31, 2010, down from $11.6 billion at December 31, 2009 and from $28.3 billion at March 31, 2009," stated the company's Q1 2010 report.

Earlier this year, Manulife's equity exposure raised concerns among ratings agencies.

In January, A.M. Best affirmed its financial strength ratings of A+ (Superior) and issuer credit ratings of "AA" for Manulife Financial Corporation and its subsidiaries. However, A.M. Best said it was still "concerned with the group's significant exposure to equity market and interest rate risk, particularly within its insurance segments..."

A.M. Best commented that while progress has been made "in hedging its segregated fund products and de-risking its product portfolio, Manulife's earnings and capital remain exposed to equity market fluctuations as only a portion of the block is either hedged or reinsured."

The ratings agency added that "Manulife's net amount at risk associated with its variable annuity business has come down, substantially, largely as a result of improved equity markets."

Also in January, Standard and Poor's lowered Manulife Financial Corp.'s long-term counterparty credit rating from AA minus to A plus. In November 2009, S&P had warned that it would bring the ratings down a notch, reflecting the reorganization of the company's U.S. subsidiaries.

In that report, S&P also mentioned its concerns over the equity risk exposure. "MFC's risk tolerance remains high and the majority of its equity-linked liabilities remain unhedged. Also, earnings and capitalization are highly sensitive to volatile equity markets and changes in interest rates."

Manulife's net income for 2009 rose to $1.4 billion compared to $517 million for 2008. While an improvement, it is still a long way from earnings of $4.3 billion in 2007. However, 2010 showed strength with net income of $1.1 billion (See page 8, Life insurers off to a good start in 2010).

Sales decline

Manulife's first quarter variable annuity sales decreased by 39% versus the prior year. The Q1 2010 report states that "lower variable annuity sales continue to reflect the company's on-going initiatives to balance its risk profile across all geographies."

In the first quarter, Manulife announced that it had established separate Audit and Risk Committees. "As a result of the increased volatility in the financial markets since September 2008 and the changing risk environment, the Board of Directors has increased, and intends to continue to increase, its focus on risk oversight," stated the report.

In Manulife's 2009 annual report, the company elaborated on its risk management plans for its variable annuity products. "Key risk reduction actions taken in 2009 include the re-pricing and redesign of variable annuity products in Canada and the U.S., the launch of new products with lower guarantees, and the suspension of sales of certain products in Asia. As well, in April and December 2009 our hedging program was expanded to cover substantially all new variable annuity business written in Canada and Asia..."

Great-West Life benefits from prudence

Within its 2009 annual report, Great-West Lifeco's directors' report to shareholders stated that the company had delivered strong results despite difficult market conditions, especially when compared to its competitors. Net income for 2009 was $1.63 billion compared to $2.02 billion the year before.

Great-West's "return on equity (ROE) of 13.8% for the twelve months ended December 31, 2009 continued to rank among the strongest in the financial services sector," underlined the directors' report.

The report added that Great-West is reaping the benefits of "prudent and conservative investment policies and practices with respect to the management of their consolidated assets. In addition, our conservative product underwriting standards and disciplined culture in introducing new products have proven beneficial for Lifeco and its companies over the long term."

In particular, the report pointed to how, in Canada, Great-West had "maintained our segregated fund guarantees in a prudent and disciplined manner, thereby limiting our risk exposure. As a result of these disciplines, our balance sheet is one of the strongest in the industry."

The report also noted that in 2009, all five rating agencies which rate Great-West and its subsidiaries affirmed the credit and financial strength ratings for the Corporation, with a stable outlook. "These rating affirmations put Lifeco in exclusive company, and represent a very positive statement regarding the strength of the Corporation and its subsidiaries, given the economic environment over the past year."

Risk mitigation

Great-West's 2009 annual report noted that the company implemented a hedging program "to mitigate certain risks associated with options embedded in its GMWB (guaranteed minimum withdrawal benefit) products."

A senior management committee has been set up to monitor hedge performance analysis and make adjustments.

The report stated that as at Dec. 31, 2009, the amount of GMWB product in-force in Canada and Germany was $119 million. Great-West introduced a lifetime guaranteed withdrawal product to the Canadian market last fall.

Sun Life Financial earnings falter

Sun Life struggled with earnings in 2009. Net income dropped to 534 million, compared to $785 million for 2008. This is compared to net income of $2.2 billion in 2007.

The company's Q4 2009 and year-end report said, "Full year earnings in 2009 reflect the volatile market conditions experienced throughout the year, including substantial movements in equity markets, interest rates and credit spreads."

The company's results in 2009 benefitted from improved market conditions, which were "offset by the implementation of equity and interest rate-related actuarial assumption updates in the third quarter of 2009, as well as net impairments and downgrades on the company's investment portfolio," explained the report.

Sun Life's operating ROE was 3.5%, which was far below its goal of 13% to 15%. ROE based on common shareholders' net income was 3.4% in 2009, down from 5.1% in 2008 mostly due to lower earnings.

The annual report explained that, "The company's operating ROE was driven by a lower level of earnings generated in 2009. Net income for the full year 2009 was impacted primarily from the financial impact of downgrades of $670 million on the company's investment portfolio, the negative impact of the implementation of equity and interest rate-related actuarial assumption updates of $513 million in the third quarter of 2009 and net impairments of $431 million. These adverse impacts were partially offset by the favourable impact of improved equity markets of $306 million and increased interest rates of $206 million on the company's results."


Its weak results contributed to a downgrading this April by Standard & Poor's of Sun Life's long-term counterparty credit and financial strength rating to AA minus from AA.

"We believe Sun Life Financial Inc.'s 2010 after-tax operating earnings will come in below our expectation and that the U.S. investment portfolio will show further asset impairments, which will add pressure to the group's capital," said S&P's analysis.

"Based on weaker-than-expected operating earnings and expected future pressure on capital, we have lowered the ratings on SLF and its North American subsidiaries by one notch. The outlook on SLF's North American subsidiaries is stable, and the outlook on SLF is negative."

S&P says its rating action reflects its opinion that even though the group's "after-tax operating earnings are improving, it is unlikely that they will recover to levels expected for higher ratings in the next one or two years with reduced volatility. Sun Life's 2009 operating earnings were well below the $1.75 billion normal run rate required for the higher ratings... We believe SLF's 2010 after-tax operating earnings will also come in below our expectation of at least $1.75 billion."

Canadian operations strong

S&P also had positive comments about Sun Life's "very strong business profile and competitive advantages in Canada as well as its very strong earnings, capitalization, and investments."

Standard & Poor's credit analyst Robert Hafner stated "Within Sun Life's global profile, it is our opinion that its Canadian operations are a strength to the ratings, and its non-Canadian operations are collectively a weakness..."