Weak Markets to Hobble Canadian Insurer Results

By | October 24, 2011

Canadian insurers are looking at a bleak quarter of financial results due to a sharp drop in stock markets and bond yields, and analysts are staying cautious on the stocks even at rock-bottom valuations.

Sun Life Financial , Canada’s No. 3 insurer, has already said it will post a C$621 million (US$615 million) loss for the third quarter, and some expect an even bigger shortfall at larger rival Manulife Financial .

“Obviously you get the worst quarter in (years) for stocks and you get multi-generation lows in government bond yields, and you’re going to have pretty bad quarter for businesses like life insurers,” said Gavin Graham, president of Graham Investment Strategy in Toronto.

Property and casualty firm Fairfax Financial will kick off the insurer reporting season Thursday. The big life insurers, which also include Great-West Lifeco and Industrial Alliance, will begin to report the following week.

Canada’s benchmark S&P/TSX composite index fell 12.6 percent in the July-September period, while Canadian and U.S. long-term bond yields hit their lowest levels in decades.

“To say that the third fiscal quarter of 2011 was a perfect storm for the Canadian life and health insurers may ultimately prove to be an understatement,” Barclays Capital analyst John Aiken said.

Life insurers hold stocks and bonds to guarantee they’ll be able to pay future investment and insurance policy obligations. When the expected long-term returns of their portfolios fall, they use profits to bulk up reserves.

This has led to some messy quarters during the market turmoil of the past three years: In 2010, for instance, Manulife took C$3.2 billion [US$3.17 billion] in losses during the second and third quarters.

The life insurers have responded by hedging much of their exposure and disclosing their sensitivities to the market.

Despite that, Sun Life’s loss hit the market like a bombshell when it was disclosed early last week, sending shares of all four of Canada’s big life insurers lower.

Sun Life fell the most with a 9 percent drop, but analysts said the news also darkened the picture for the others.

“It wasn’t going to be great even before Sun Life,” said Peter Routledge, an analyst at National Bank Financial. “(And) for Manulife you will see a material loss.”

According to Thomson Reuters I/B/E/S, Manulife could take a net loss well above the C$966 million [US$956.66 million] it lost in the third quarter of 2010, when the company had fewer hedges on the books and was also dealing with several one-time charges.

This quarter, the company has said it could take a charge of as much as C$700 million [US$693.2 million as part of an annual review of actuarial assumptions at its U.S. business.

Great-West and Industrial Alliance, which both have much less market exposure than Manulife and Sun Life, are expected to report results about even with last year’s performance.

The recent difficult quarters and the continued volatility of markets have wrought havoc with shares in the sector, bringing valuations down to the point where Manulife and Sun Life are trading near book value.

Manulife is down 25.6 percent year-to-date, while Sun Life is down 19.9 percent. Great-West has retreated 18.7 percent, and Industrial Alliance has dropped 16.8 percent. The TSX composite is down 11 percent over that same period.

Analysts note that while the behavior of markets is eating into bottom-line profit, the companies’ underlying insurance businesses are, by and large, performing well, and their dividend yields are looking better and better with each day of stock declines. Sun Life, for example, currently yields 6.1 percent.

As well, if stock markets begin a sustained rise and bond yields regain their lost ground, the insurers will be able to release reserves, which would result in huge profit gains.

But the uncertainty surrounding markets – particularly, concerns that long-term bond yields could stay at generational lows for several years – has most analysts preferring the more expensive but stable Canadian banks over the insurers.

“With the insurers, it’s very choppy and very difficult to try to figure out what their true economic earnings are,” Aiken said.

“Ultimately there’s value in the group. The problem is how long are they going to have these choppy volatile markets that depress earnings? If I knew that, I’d be living on a beach somewhere.”

(Editing by Jeffrey Hodgson; editing by Peter Galloway)

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