November 7, 2011 / 8:35 PM / 6 years ago

Analysis: Manulife pays the price under Canada insurer rules

TORONTO (Reuters) - The easy way for Canada’s Manulife Financial (MFC.TO) to reverse its third-quarter loss would be to move a few hundred miles south to the United States, where accounting rules are less onerous.

Even though pulling up stakes probably isn’t feasible, the company’s C$1.3 billion shortfall, as calculated under Canadian accounting rules, would turn into a record C$2.2 billion profit under U.S. principles, according to company disclosures.

This gap - which also applies to a lesser degree at rivals such as Sun Life Financial (SLF.TO) - suggests the heavy quarterly losses that Canadian life insurers have taken over the past three years don’t tell the whole story about their financial health.

“It certainly adds to lumpiness,” said Edward Jones analyst Craig Fehr, referring to the up-and-down nature of recent quarterly results posted by the big insurers.

John Aiken of Barclays Capital said results such as Manulife’s loss don’t accurately reflect the true economic prospects of the companies.

“You truly need to take a longer-term approach for the insurers,” he said.

The gap between the results is due to the Canadian accounting requirement that life insurers revalue their assets and liabilities quarterly and take either losses or gains to make up the difference.

For instance, when bond yields fall, the projected return on the insurer’s long-term holdings retreat, forcing it to take millions from the profit line to ensure they can cover future policy or investment payouts.

U.S. insurers aren’t required to do so, leaving what insurance executives say is an uneven playing field.

“The Canadian (regime) is if far too reactive to the current circumstance,” Manulife Chief Executive Donald Guloien said on a conference call.

BILLIONS IN LOSSES

Guloien has good reason to be passionate on the subject, as market gyrations over the past three years have forced Manulife to take billions in quarterly losses.

He’s not alone in seeing inequality in the regimes. Reports issued by Standard & Poor’s and Moody’s last week highlighted the difficulty of comparing U.S. and Canadian insurance results.

Sun Life also suffered a markets-related loss in the quarter, ending with a shortfall of C$621 million. While the insurer does not break out its results under U.S. rules, it said the loss included a C$684 million markets-related charge.

“When you have U.S. life companies reporting significant profits and Canadian life companies reporting significant losses for businesses that are in many respect not that different... I do think it does put us in an unfair position,” Dean Connor, who will take over as chief executive of Sun Life in December, told Reuters.

While those losses would come back just as fast if bond yields and equities rise, the losses have real consequences.

Manulife’s markets exposure has led to the shares closely tracking stock and bond yield movements as the market anticipates market-related quarterly results. Sun Life, which has typically not has been as market-sensitive as Manulife, has fallen 17 percent since it pre-announced its loss on October 17.

As well, taking losses prompts regulators to require the companies to hold more capital on their balance sheets, which means they can spend less on expanding their businesses.

Manulife, for instance, sold its life retrocession business to Pacific Life during the quarter, giving up a revenue stream in order to boost its capital levels.

The losses also make it difficult for the Canadian insurers to buy back stock or raise dividends, which put additional strain on their shares.

Manulife and Sun Life and Canada’s No. 1 and 3 insurers, respectively. Canada’s second-largest insurer is Great-West Lifeco (GWO.TO), which reports on Thursday and typically has the least markets exposure of the three.

MIDDLE GROUND

While the rules lead to volatile results when markets are unstable, few advocate a full shift to a U.S.-style regime, as some worry it allows the insurers to hide the impact of market movements, which could be dangerous if a drop in stock markets or bond yields becomes a long-term phenomenon.

“I think the answer is somewhere between U.S. and Canadian (rules) if you’re looking for the right answer,” said Guloien.

Aiken agreed, while CIBC World Markets analyst Robert Sedran said he prefers the strictness of the Canadian rules, as they force the insurers to always be ready for the worst-case scenario.

“It’s more punishing to the companies,” he said.

“But I think it’s a better accounting system (because) from an analytical perspective, we get a little quicker view on what the macro environment’s doing to the result.”

Reporting by Cameron French

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