November 29, 2011 / 9:58 PM / 6 years ago

Analysis: Low rates put Canadian insurers under pressure

TORONTO (Reuters) - The prospect of a prolonged period of stagnant or falling interest rates could force Canada’s life insurers into a long-term struggle to raise the value of their shares from their current 2-1/2 year lows.

Because they are not reaping sufficient funds from investments, the insurers could be forced to go to markets to raise more capital, or to cut dividends, which would tend to push stock prices down even further. A dividend cut at Sun Life Financial is a possibility in the near term, analysts say.

The scenario of a multiyear period of rock-bottom interest rates reminiscent of Japan’s “lost decade” in the 1990s was up until recently seen merely as a theoretical worst-case scenario.

But the deepening slide of sovereign debt prices on both sides of the Atlantic has industry observers now taking the problem seriously.

In a speech this month, Julie Dickson, Canada’s superintendent of financial institutions, said a prolonged period of long-term low rates would be a “game changer” for the insurance industry.

“We encourage life insurers to recognize the transformational changes - like sustained low interest rates - that are occurring in their operating environment,” she said.

National Bank Financial analyst Peter Routledge also sees the industry in a precarious position.

He recently wrote a research note gaming out the impact of a “Japan-light” scenario of sustained low interest rates, including a 30-year bond rate of 2.62 percent, just below the 2.7 percent yield on the bond on Monday.

“Left unchanged it’s a disaster,” he told Reuters.

Canadian life insurers have already recorded billions in losses due to weak equity markets and low interest rates over the past three years.

If rates continue at current levels, the insurers will have to take more charges because their long-term investment strategies depend on higher rates.

Manulife Financial, Canada’s largest insurer, said in its most recent quarterly earnings report that if rates remain constant with September 30 levels - 2.77 percent for the Canadian 30-year bond - over the next 10 years, it would have to take losses of $2 billion-$3 billion.

If rates sink from current levels, the damage would be worse.


Market-related losses have already pulled Manulife’s shares to depths not seen since the 2008-09 market crash.

The stock, which traded above C$40 as recently as 2008, hit a 2-1/2 year low of C$10.69 last week.

Rival Sun Life Financial had been thought to be less market sensitive than Manulife before it took an unexpectedly steep third-quarter loss this year. Its shares fell as low as C$17.92 on Tuesday, which represented a 40 percent loss this year alone. Its high in 2008 was C$55.99.

Canada’s other two big insurers, Great-West Lifeco and Industrial Alliance, have also been hurt, but to a lesser extent than their rivals.

The uncertain outlook has raised expectations that Sun Life may cut its dividend, which currently yields a rich 7.8 percent due to the company’s low stock price.

“We do think that there’s at least some risk of a cut to the payout,” said Craig Fehr, an analyst at Edward Jones in St. Louis, Missouri.

Routledge sees a dividend cut as a possibility, but wonders if Sun Life might wait a quarter to see if markets rebound.

Even if rates decrease further, he says the Canadian insurers will fare better than their Japanese counterparts, some of which have collapsed.

He suggests, however, that the Canadian companies will simply maintain a defensive position, raise capital and wait for markets to turn around.

For policyholders, the impact will be negligible, but for investors it will be gloomy.

“We’re not going to have a Japan, but you would have life insurers trading at or below book value - the value of a company based on its assets - for a very long time,” he said.

Reporting by Cameron French; editing by Peter Galloway

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