The third quarter has been difficult for Canadian life insurers. Sun Life Financial and Manulife Financial each announced significant losses. Industrial Alliance Insurance and Financial Services saw its earnings decline. Only Great-West Lifeco reported improved results.
Insurers attribute the decline to several factors: volatility, stagnant long-term interest rates, and the implementation of the new International Financial Reporting Standards (IFRS) are to blame.
Manulife announced the largest loss: $1.277 billion dollars. The insurer cites low long-term interest rates, market volatility and actuarial changes in the third quarter as the explanations behind this loss. According to the company, the markets have seen extraordinary volatility and the actions of the Federal Reserve have lowered long-term rates both in the United States and elsewhere.
Finally, if it were not for the International Financial Reporting Standards (IFRS), Manulife claims that it would have reported net income of $2.2 billion in the third quarter. The IFRS rules require that insurers value their future obligations to policyholders at their market value. The results also show that Manulife’s capital adequacy ratio reached 219% as of September 30.
Thorough review
Still, the company has kept its standing with the rating firms Standard & Poor’s and A.M. Best, which have not lowered its credit rating. However, A.M. Best has warned investors that it is planning to conduct a thorough review of the insurer in the near future.
Manulife’s CEO, Donald Guloien, expressed disappointment at the loss suffered by the insurer in the third quarter. But he is happy with the firm’s hedging program.
“While we are disappointed with the reported loss for the quarter, we are pleased that our hedging programs worked during these volatile markets, eliminating the majority but not all of the risk,” he said. Mr. Guloien went on to say that Manulife’s hedging program allowed the company to generate a profit of over $3.3 billion after tax, which offset about 70 % of the $4.8 billion earnings impact of variable annuity risk and non-variable annuity equity-related losses in the third quarter. By comparison, the third quarter of 2010 was worse for Manulife, when it suffered a loss of $2.3 billion.
Sun Life Financial was also hit hard in the third quarter of 2010, to the point that before releasing official results, it announced that it was anticipating a loss of $621 million. Its net profit in the third quarter 2010 was $416 million.
The insurer said the loss was due to persistently low long-term interest rates that remain at historic lows as well as to wide variations in financial markets in the third quarter. “In the United States, treasury rates reached historic lows, with 30-year yields down 146 basis points to 2.91%,” said Sun Life CEO Donald Stewart. As for reported revenue (premiums and deposits), it declined to $7.5 billion in the third quarter of 2011, down from $7.7 billion in the same period last year. The insurer’s solvency ratio was 210% as of September 30.
While it was relatively unharmed, Industrial Alliance also points a finger at these two factors to explain the 28% drop in net profit during the third quarter versus the same period in 2010. The insurer reported a net profit of $45.7 million, compared to $63.5 million in the third quarter of 2010.
Yvon Charest, the CEO of Industrial Alliance, said that low long-term interest rates and equity market declines resulted in a loss of 19 cents per share in the insurance and individual wealth management segments during the third quarter. Mr. Charest noted that long-term interest rates are crucial to the profitability of these products, and pointed out that they are near all-time lows.
He expects further difficulties should the situation persist. “If interest rates fall further in the fourth quarter, we will have to strengthen our actuarial reserves and probably reduce our ultimate reinvestment rate,” he warned.
Risk management has also proved costly for the Quebec-based insurer. “About a third of the decline in net income is attributable to the dynamic hedging program put in place towards the end of 2010 to cover our guaranteed minimum withdrawal products. Profitability in the third quarter was also affected by adverse claims in the areas of individual insurance and group insurance,” said Mr. Charest.
New accounting standards
As for the impact of the new accounting standards, Industrial Alliance said in its quarterly report that the transition to IFRS has caused a 1% decrease in its capital adequacy ratio. These adjustments will reduce the solvency ratio “in a linear manner over a period of eight quarters stretching until 31 December 2012, a decrease that comes to 5 percentage points over the whole period.” As of September 30, 2011, the solvency ratio of the insurer stood at 197%, up from 194% on June 30, 2011.
Insurers with significant operations in the United States do not seem to be out of the woods just yet. On Sept. 21 the Federal Reserve committed to lowering long-term interest rates. By doing so, it hopes to help U.S. companies to boost their growth through loan making. The plan, known as “Operation Twist”, is to sell more than $400 billion of short term U.S. Treasury bonds in order to buy an equal amount of long term debt. According to a study by Eric Swanson, an economist with the Federal Reserve Bank of San Francisco, this strategy was already attempted in the 1960s and had a minimal effect on the rates, just 0.15%.
But the consequences could be disastrous for insurers, who take premiums received from their policyholders and invest heavily in long-term bonds. The resulting reserves are then used to fulfill their future obligations to their policyholders. However, they melt when long-term rates sink, no matter how small the decline may be.
Great-West Lifeco reported net income of $457 million in the third quarter of 2011, up 71.2% compared to the net income of $267 million it saw in the third quarter of 2010. Great-West Lifeco had a helping hand, noting in its report that net income for the third quarter of 2010 includes the impact of an additional provision related to litigation involving $204 million attributable to common shareholders.
The insurer also reported a return on shareholders’ equity of 16.6% for the quarter. The capital ratio of the insurer’s Canadian operation stood at 200% as of Sept. 30.
It is not possible to know Standard Life Canada's net profits for the third quarter. Asked about disclosing Standard Life’s results, a member of the National public relations firm told The Insurance and Investment Journal that the Canadian subsidiary only discloses its net income twice a year; once in the second quarter and again in the fourth quarter. This is in accordance with the business practices of its British parent company.