Manulife Financial has released its 3Q09 results and – as they warned in the 2Q09 release – results were severely impacted by changes in actuarial assumptions:
the Company completed its annual review of all actuarial assumptions in the third quarter. This resulted in a charge to earnings of $783 million, including $469 million due to changes in assumptions of policyholder behaviour for segregated fund guarantee products (a charge that was within the Company’s previously communicated expectations of less than $500 million). The remainder of the charge included assumption changes related to morbidity and other policyholder behaviour, partially offset by assumption changes related to mortality, expenses and investment related items.
The morbidity charge comes as something of a shock, and details are a little skanty:
Driven by increases due to impact from higher projected net long-term care claims costs. Partially offsetting these increases were reductions from mortality releases in Japan and the Reinsurance Division.
They make particular note of the potential for being regulated at the holdco level:
In Canada, OSFI has announced that it (i) will be proposing a method for evaluating stand-alone capital adequacy for operating life insurance companies, such as MLI, (ii) is considering updating its regulatory guidance for non-operating insurance companies acting as holding companies, such as MFC, and (iii) is reviewing the use of internally-modeled capital requirements for segregated fund guarantees. The outcome of these initiatives is uncertain and could have a material adverse impact on the Company or on its position relative to that of other Canadian and international financial institutions with which it competes for business and capital.
They disclose their market risk sensitivity as:
The interest scenario we have adopted uses the structure of the prescribed scenario that currently produces the highest policy liability, which is a gradual decline in market interest rates from current market levels to lower assumed ultimate reinvestment rates over 20 years, with additional prudence introduced through use of lower ultimate reinvestment rates than the maximum levels permitted. The decrease in sensitivity to public equity market values reflects the impact of significantly improved equity markets in 2009, which has both reduced the liability for existing segregated fund guarantees and reduced the sensitivity of this liability to changes in equity market levels. Additional sensitivity reduction resulted from the increase in the amount of business that is hedged. Sensitivity to other non fixed income assets has increased from 2008 due to additional acquisitions of non fixed income assets in 2009 in support of the Company’s long-term investment strategy and the inclusion of the impact of future income taxes.
“Non Fixed Income Assets” are described as:
Other non fixed income assets include commercial real estate, timber and agricultural real estate, oil and gas, and private equities
Private equity, I’m convinced, is a way to dress up equities as bonds, valuing them on the basis of discounted cash flows since they don’t have a publicly quoted market price. Somewhere in the world, for some company, somehow, that masquerade is going to blow up some day. However, MFC is less than forthcoming on just how these investments – and their risks – are valued.
The fact that they will experience a loss due to interest decreases implies that their assets have lower duration than their liabilities.
Various leverage factors may be calculated as:
| MFC Leverage | |||
| Item | 3Q09 | 2Q09 | 4Q08 |
| Tangible Common Equity |
15,275 | 16,575 | 16,482 |
| Bond Exposure | 147,056 | 149,353 | 149,733 |
| Bond Leverage | 963% | 978% | 908% |
| Reported Bond Sensitivity | 2,000 | * | 1,300 |
| Bond Sensitivity / Equity | 13.1% | * | 7.9% |
| Equity Exposure | 10,437 | 9,688 | 8,240 |
| Equity Leverage | 68% | 58% | 50% |
| Reported Equity Sensitivity | 1,300 | * | 1,500 |
| Equity Sensitivity / Equity | 8.5% | * | 9.1% |
| “Non-Fixed Income” Exposure | 11,510 | 12,181 | 12,259 |
| “Non-Fixed Income” Leverage | 75.3% | 73.5% | 74.4 |
| Reported “Non-Fixed Income” Sensitivity | 700 | * | 600 |
| “Non-Fixed Income” Sensitivity / Equity | 4.6% | * | 3.6% |
| Tangible Common Equity is Common Shareholders’ Equity including all elements of Other Comprehensive Income less goodwill less intangibles | |||
| Bond Exposure is Securities-Bonds plus all elements of Loans | |||
| Bond Leverage is Bond Exposure divided by Tangible Common Equity | |||
| Reported Bond Sensitivity is the midpoint of the reported effect on earnings of an adverse 100bp move in interest rates, for AFS and HFT bonds taken together. | |||
| Equity Exposure is Securities-Stocks | |||
| “Non-Fixed Income” Exposure is Real Estate plus Other Investments | |||
I confess that I’m a bit perplexed at their sensitivity reporting. I have taken the sensitivities above from the table “Sensitivity of Policy Liabilities to Changes in Asset Related Assumptions” but in the section headed “Net Income Sensitivity to Interest Rate and Market Price Risk” they state:
The potential impact on net income attributed to shareholders as a result of a change in policy liabilities for a one per cent increase in government, swap and corporate rates at all maturities across all markets was estimated to be a gain of approximately $1,600 million as at September 30, 2009 (December 31, 2008 – approximately $1,100 million) and for a one per cent decrease in government, swap and corporate rates at all maturities across all markets was estimated to be a charge of approximately $2,000 million as at September 30, 2009 (December 31, 2008 –approximately $1,300 million).
… which are the same numbers. Taken literally, this would mean that changes in policy liabilities flow straight through to the bottom line, which would make sense only if their assets were comprised of 100% cash.
The earnings release quotes Chief Financial Officer Michael W. Bell as saying:
As a result of the decline in interest rates and changes in lapse assumptions, our interest rate sensitivity has increased.
Later on, just after the table showing the sensitivities, the release states:
The increase in the sensitivity to changes in market interest rates is primarily due to the impact of the current lower market interest rates on liabilities with minimum interest guarantees and changes in lapse assumptions.
I get the “minimum interest guarantee” part, but am a little fogged by the “changes in lapse assumptions”. I can only assume that they are assuming that this means they are assuming they will get fewer gifts in future from policyholders terminating agreements that are in the policyholders’ favour, but this is not spelt out – and neither is the breakdown between the two major components of the sensitivity.
Their presentation slides include the remark:
Changes in interest rates impact the actuarial valuation of in-force policies by changing the future returns assumed on the investment of net future cash flows
By and large, I’d guess they’re making long-term guarantees backed by short-term investments … the banks’ “maturity transformation” in reverse – and, what’s more, making this a big bet.
[…] on this specific topic are almost word-for-word identical with those of Mr. White) and warnings in MFC’s 3Q09 results and SLF’s 3Q09 results … I suspect that this is going to happen, sooner rather than […]