Many Canadian insurance industry leaders are looking back on the year 2008 as one of the most difficult ever, and 2009 is off to a rocky start for some. In particular, insurers with equity exposed products such as segregated funds and guaranteed minimum withdrawal benefit products saw profits slide as they shored up reserves.
Net income plunged for Manulife Financial Corporation in 2008 to $517 million, compared to net income of $4,302 million in 2007. For the first quarter of 2009, the company recorded a net loss of $1,068 million, compared to net income of $869 million in the first quarter of 2008.
On May 7, in his parting address as President and CEO of Manulife Financial, Dominic D'Alessandro explained to shareholders at the annual meeting the reasons behind the problems faced by the company as a result of the market meltdown. "The collapse in the world wide equity markets which began in the fall of 2008 had the effect of creating a shortfall between the guaranteed value of certain variable annuity and segregated fund contracts and the underlying assets held to support those obligations. This shortfall rose very sharply as markets fell and at the end of December stood at $27 billion."
The result was the company shored up its balance sheet reserves for variable annuities and seg fund guarantees to $5.8 billion at the end of December, compared to $526 million a year earlier. These actuarial reserves conservatively assume that there will be no stock market recovery for the next 10 years and should be sufficient to absorb any shortfall at that time, he said. This reserve strengthening largely explains the decline in the company's earnings. But should the markets recover in the coming years, "we can expect to recapture significant portions of these reserves into net income," he underlined.
Manulife has come under criticism for not adequately hedging its variable annuities and segregated fund risk. Mr. D'Alessandro responded to this criticism in his speech at the annual meeting. He explained that in 2006 Manulife made the decision to begin hedging and by the end of 2007 it had hedged a small percentage of its variable annuity risk. By the end of 2008 it was hedging all new variable annuity risk in the U.S. market. "In hindsight, we clearly would have implemented this strategy more quickly had we foreseen what became the worst and most rapid equity market declines in history..." he said.
In announcing its first quarter 2009 results in May, the company said that due to continuing equity volatility and sensitivity, the company conducted a strategic review of its segregated fund portfolio and had begun implementing changes to its products. "In the U.S., fees were increased, deferral bonuses were reduced, additional features were withdrawn, and equity exposure was reduced in several key funds. In Canada, the hedging program for new segregated fund business was successfully implemented at the end of March, and $1.5 billion of in-force business was hedged. New business is now hedged on an ongoing basis."
To bolster its capital during the equity market crisis, Manulife raised about $4.3 billion through bank financing and common equity. In the first and second quarters of 2009, it continued to raise capital with $450 million raised from the issuance of preferred shares in the first quarter. In April, it completed a medium term note offering raising another $600 million and on June 2 it announced that it had completed an offering for $1 billion in medium term notes and the next day it completed a preferred share offering that raised $350 million.
Other big players such as Sun Life Financial and Great-West Lifeco also went to market to raise capital during 2008.
Sun Life reported earnings of $785 million for 2008 compared to $2.2 billion in 2007. Excluding a gain related to the sale of the company's stake in CI Financial, Sun Life had an operating loss of $40 million in 2008 compared to operating earnings of $2.3 billion in 2007.
The insurer was hard hit in the fourth quarter of 2008 in particular with "$682 million in charges related to the equity markets, $365 million from asset impairments, credit related writedowns and spread widening, as well as $164 million from changes to asset default assumptions in anticipation of higher future credit-related losses" said the company in an announcement.
Donald Stewart, Sun Life's Chief Executive Officer stated that "While Sun Life's overall financial returns are very disappointing, reflecting negative equity markets and a stressed credit environment, our balance sheet remains strong and well diversified."
Sun Life reported a net operating loss of $186 million for the first quarter of 2009 compared to net operating income of $533 million during the same quarter of 2008.
With restructuring charges included, the company's net loss was $213 million. The restructuring charges relate to the company's actions taken to reduce expense levels and improve operational efficiency.
On March 31, the Sun Life completed a public offering of subordinated unsecured debentures that raised $500 million to use for general corporate purposes, including investments in subsidiaries.
For 2008, Great-West Lifeco reported consolidated net income attributable to common shareholders of $1.396 million compared to $2.056 million for 2007, a decrease of 32%. These results include a non-cash impairment charge for Putnam Investment goodwill and intangibles of negative 1.353 million after-tax. These results also include a gain of $649 million related to the sale of Great-West Healthcare business in the second quarter.
Great-West Lifeco's 2008 annual report explains that the Putnam impairment charge reflects the decline in the subsidiary's assets under management related to the deterioration in market conditions. Lifeco acquired Putnam in 2007.
In the Director's Report to Shareholders message in the annual report, the company prided itself on its "risk averse culture" and stated that "The majority of exposure to segregated fund guarantees is in Canada and towards the conservative end of the spectrum." As a result, Lifeco states that its balance sheet is one of the strongest in the industry and adds that it raised $1.23 billion in the equity market "augment Lifecos's capital and liquidity position and give the corporation an enhanced capability to take advantage of market opportunities."
Also in its annual report, Great-West Lifeco made some observations about seg fund market conditions. Due to the equity market declines and low interest rates, life insurers offering segregated fund and variable annuities have been adversely affected and market volatility has restricted the availability of reinsurance and increased hedging costs in this market, noted the report.
The expected result is that insurers are likely to revise product designs and increase pricing in this area. Great-West Lifeco then goes on to state that "the company will monitor developments in this area and will consider introducing lifetime income guarantee products in 2009 to reinforce our market leading position in Canada and to extend our U.S. and European product and distribution range."
Presently, none of Great-West Lifeco's Canadian subsidiaries offer a guaranteed minimum withdrawal benefit (GMWB) product. These products have brought a high level of sales to insurers such as Manulife, but have also contributed to reserving shortfalls during the market crisis.
Transamerica Life Canada (TLC) also suffered from equity exposure during 2008, reporting a net loss of $583 million. At the end of May for the second consecutive year, ratings agency A.M. Best downgraded the insurer. The company's financial strength rating was downgraded to B++ (good) from A- (excellent) and its issuer credit rating was downgraded to bbb+ from A-.
These downgradings reflect the insurer's continuing weak financial performance, stated A.M. Best. The net loss in 2008 was attributable to "$472 million of equity market related losses net of hedging that resulted in additional liabilities for future segregated fund guarantee payments and reduced management fees from universal life and segregated fund policies."
A.M. Best's outlook for TLC's financial strength rating is stable, while the outlook for the issuer credit rating is negative. This negative outlook reflects that the insurer's profitability is sensitive to equity market performance "as a result of exposure to segregated fund guarantees on unhedged business and equity basis risk on hedged business." During 2008, Transamerica implemented hedging programs for covering seg fund maturities through 2011, but "later maturities remain unhedged and represent one-third of the segregated fund portfolio" which totals $3.4 billion.
On the positive side, A.M. Best said its ratings also reflect the insurer's "solid market positions in its core business lines, multi-channel distribution, reduced risk profile and adequate capitalization" as well as the financial strength and support of its parent company AEGON N.V..
In his president's message in TLC's annual report, Douglas Brooks, President and Chief Executive Officer said, "Understandably, our earnings were severely impacted by market performance performance, particularly in the last quarter of the year. However, we ended the year with a balance sheet featuring high quality assets, strong reserves and more than ample capital to meet our obligations to all our policyholders in both the short and long term."
TLC's annual report (Notes to financial statements) also mentions that in addition to implementing hedging programs for its GrowSafe and Alliance blocks of segregated funds, it also "implemented an inforce reinsurance transaction which significantly reduced the required capital of the Company. The Company received capital infusions during 2008 totaling $430 million.
These infusions, together with the hedging and reinsurance initiatives implemented in 2008, resulted in an MCCSR ratio of 191% as of December 31, 2008" which well surpasses the regulatory target ratio of 150%.
Optimism and opportunities
In his incoming address as President and CEO of Manulife Financial, Donald Guloien, called 2008 "a pretty good example of hell and high water, and Manulife stood the test." While the company's stock price were buffeted by the forces of the global economic crisis, most importantly, "our policyholders and other customers have never had any reason to fear that Manulife would ever be unable to deliver on its promises," he said.
Other global companies cannot make that claim and have had to seek government assistance, he added. The fact that the company has been able to successfully raise capital shows its strength financially and in terms of its ratings he added. "Many other financial institutions cannot access capital markets, or can only do so at prohibitive cost," he said.
Some of the other positives highlighted by several Canadian insurers in their 2008 annual reports were healthy levels of capital and strong sales in certain markets, particularly for protection products such as term insurance, growth in foreign operations and demographic trends accelerating the need for insurance and guaranteed retirement income products. Because of the comparative strength of their financial situations generally, many also believe that Canadian life insurers are well positioned to take advantage of acquisition opportunities in Canada and in other parts of the world.
"There will be a whole round of consolidation in the industry. We expect to benefit from that trend," said Mr. Guloien.