Swiss Re Revives Ultra-Long Bond for Canada as Budget Looms

By Katia Dmitrieva | February 3, 2014

Swiss Re AG, the world’s second- largest reinsurer, wants to see a 50-year government bond in Canada as the company seeks investments that offset long-term liabilities while low interest rates depress returns.

The reinsurer is urging the government to follow through on its proposal last year to issue ultra-long bonds, according to Sharon Ludlow, chief executive officer of the Zurich-based company’s Canadian unit, which manages about C$10 billion (US$9 billion) in fixed income. The Ministry of Finance debated the plan without reaching a decision.

“We’ve started to prepare the federal government for discussions about issuing longer-term bonds,” Ludlow, 47, said in an interview at Bloomberg’s Toronto office on Jan. 28. “Can we do something up to a 50-year bond? There’s some real thinking around what the industry at large needs to invest in to match these very, very long-term duration liabilities we have.”

The insurance industry needs the bonds to fund obligations as policyholders live longer and a prolonged period of low interest rates cuts into returns. Swiss Re is part of the effort to revive the issue after the Ministry of Finance had second thoughts about it last year. The 30-year security is the government’s longest.

The Finance Ministry may refer to its consultations with the insurance industry in the budget that’s scheduled to be presented Feb. 11, said David Tulk, chief macro strategist at Toronto-Dominion Bank.

‘Big Appeal’                                                                                                                                                                                             “From the perspective of the government of Canada, their sole objective in terms of issuance is to achieve the lowest cost of financing,” Tulk said Jan. 29 from Toronto. “Over the last couple of years, the government has been trying to extend the maturity of its own bond portfolio. Very long-duration assets such as long bonds issued by the government of Canada — which we know is triple-A and lovely — does have very big appeal.”

Insurers rely on a stable fixed-income investment portfolio to back their policies, gaining from increases in interest rates. They have been challenged as the Bank of Canada has held its benchmark overnight rate at 1 percent since September 2010, the longest such stretch since the 1950s, and yields on government bonds have fallen.

‘Some Willingness’                                                                                                                                                                                 “We’ve made representations to the Department of Finance to consider long-term bonds, and I believe they’ve stated some willingness to take a look,” said Frank Swedlove, president of the Canadian Life and Health Insurance Association, which represents 99 percent of Canadian life and health insurers. “The government should really just consider doing it.”

Finance Minister Jim Flaherty unveiled the ultra-long proposal in the 2013-14 budget as the government planned to extend the maturity of its own bond portfolio in a bid to lock in low interest rates. That included considering a bond due in 2053, according to the budget, which was released in March 2013.

Then, in October, Flaherty questioned the market’s interest in debt that matures in four decades or more as investors prepared for the end of four years of unprecedented monetary stimulus by the world’s central banks.

Government-bond yields began rising in May after Federal Reserve Chairman Ben S. Bernanke said the U.S. central bank could reduce its stimulus if the economy showed sustainable improvement. The yield on Canada’s benchmark 10-year security climbed to a 2013 high of 2.82 percent on Sept. 10 from 1.67 percent on May 2. U.S. 10-year note yields rose to 3.03 percent on Dec. 31 from 1.61 percent on May 1.

‘Magnified Impact                                                                                                                                                                                      Investors including Pacific Investment Management Co., the world’s biggest bond-fund manager, began selling long-term debt to cut duration, or sensitivity to higher interest rates, to minimize losses from rising yields. An increase in yields cuts more value from longer-dated notes.

“By definition, any move in interest rates is going to have a magnified impact on the price,” John Braive, money manager at Canadian Imperial Bank of Commerce’s CIBC Global Asset Management unit, said Jan. 31 by phone from Toronto. “The government wants to have an orderly market in securities, and they don’t want to see investors getting upset that the market in these securities is absolutely dreadful and they can’t get out of the position.”

Bond yields have eased this month, with those on Canadian 10-year bonds closing at 2.34 percent on Jan. 31 and yields on their U.S. counterparts at 2.64 percent.

Bond Losses                                                                                                                                                                                                       Canadian government bonds maturing in 25 years and more lost 13 percent last year, according to a Bank of America Merrill Lynch Index. It was the biggest of their three annual losses since the measure was started in 1996.

The BofA Merrill Lynch Canada Government Index, the broad measure of federal bonds, declined 2.3 percent, while the BofA Merrill Lynch Developed Markets Sovereign Bond Index slipped 0.3 percent.

The proposal for longer-term Canadian bonds hasn’t been dropped, according to Jack Aubry, spokesman for the Finance Ministry.

“The government is assessing the potential benefits of issuing bonds with a maturity of 40 years or longer,” Aubry said in an e-mail statement. He declined to say whether the issue will be highlighted in the budget released next week.

Japan, Mexico                                                                                                                                                                                                   Ultra-long government debt is issued in Japan, which sells 40-year bonds. While Mexico issued 100-year securities, the so- called century bonds due in 2110 slid 19 percent last year amid speculation the Fed stimulus that fueled global risk appetite will dry up.

Government bonds accounted for 21 percent of the Canadian life-insurance industry’s investments in 2012, the second- largest share, according to 2012 CLHIA data. Mutual funds had the biggest share, 26 percent.

The insurance group has been in discussions with the Finance Ministry for several years. In a Nov. 15 submission to the department and the Bank of Canada, the organization said life and health insurers “strongly support” the government’s consideration of issuing debt maturing in 40 years or longer. CLHIA hasn’t heard back from the government on the comments, Swedlove said.

The group plans to send the government a set of policy recommendations relating to long-term investing in the months following the budget release, Swedlove said.

The so-called white paper “will be the catalyst for really moving the discussion forward,” said Ludlow at Swiss Re.

–With assistance from Ari Altstedter and Cecile Gutscher in Toronto and Anita Kumar in Princeton –  Editors: Greg Storey, Jacqueline Thorpe

 

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