DBRS Downgrades Manulife Financial and Affiliates

DBRS has today downgraded its long-term debt and preferred share ratings on Manulife Financial Corporation (MFC or the Company) and its affiliates, including the Issuer Rating of its major operating subsidiary, The Manufacturers Life Insurance Company (MLI), to AA (low) from AA. The Claims Paying Ability and Commercial Paper ratings of MLI have been confirmed at IC-1 and R-1 (middle), respectively. All the trends are Stable. With earnings volatility expected to continue at elevated levels, notwithstanding the best efforts of management to contain market exposures, DBRS recognizes that the Company’s heightened risk profile and the associated adverse impact on regulatory capital and financial flexibility can no longer support the pre-existing ratings and have resulted in the negative rating action.

Contributing to this volatility is the Company’s exposure to equity markets, which is related to guarantees provided on variable annuity and segregated fund products that were sold aggressively in the years leading to the peak of the market in 2008. While the Company has introduced a dynamic hedging program to opportunistically lower these equity market exposures, following years in which such hedges were not deemed economically efficient nor necessary, close to 50% of the Company’s exposure remains unhedged and will be a source of continuing earnings risk as the corresponding positions are hedged.

In addition, the second-quarter $1.5 billion adverse impact of lower long-term interest rates on reserves also highlighted the Company’s exposure to long-tailed fixed-rate policy liabilities through its large Long-Term Care and secondary guaranties associated with Universal Life product liabilities in the U.S. market. The Company has indicated that during the third quarter of 2010, it is expecting to complete its annual actuarial review of the morbidity assumptions embedded in the reserves held against its Long-Term Care policy liabilities. The Company expects to incur a charge of between $700 million and $800 million related to this change in assumptions, although this could be offset somewhat by in-force price adjustments.

While the Company has taken necessary steps to build up its regulatory capital to deal with the risk of earnings volatility as it attempts to lower its exposures through product redesign, re-pricing and active hedging strategies, the degree of the drop in the minimum continuing capital and surplus requirements (MCCSR) – from 250% at the end of March 2010 to 221% at the end of June 2010 – suggests that another negative quarter will force the Company to raise additional capital. In the meantime, it is DBRS’s view that the Company’s financial flexibility has become increasingly constrained, as the most readily available sources of capital have already been tapped. In addition to two major common equity issues totaling close to $5 billion in 2008 and 2009, a 50% cut in the common dividend and a corporate re-organization designed to free up regulatory capital, the Company has raised close to $1.5 billion in debt and preferred share financings, which increased its financial leverage ratios to the point where DBRS was no longer comfortable with the Company’s pre-existing ratings. At the new rating categories, the Company has at least some additional room to issue debt capital instruments.

DBRS weighs this earnings volatility and diminishing financial flexibility against the Company’s broadly diversified business platforms, including the rapidly growing Asian markets, the strong market presence in the United States and an attractive Canadian franchise, including the successful Manulife Bank of Canada operation. The Company’s investment portfolio also continues to be conservative, with no additional adverse credit experience reported in recent quarters. Moreover, DBRS acknowledges that the Company, through its enhanced enterprise risk management system and controls, has been responding and continues to respond prudently to market conditions that are beyond its control.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Life Insurance Companies, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.