DBRS Comments on Manulife Q3 2010 Earnings

DBRS has reviewed the Q3 2010 results of Manulife Financial Corporation (Manulife or the Company) released today and believes that, notwithstanding the negative net earnings figure, the Company is on the right track to restoring sustainable profitability. The ratings of Manulife and its affiliates remain unchanged, including the Issuer Rating of its major operating subsidiary, The Manufacturers Life Insurance Company (MLI), at AA (low). The ratings were recently downgraded on August 9, 2010.

Manulife reported a $947 million loss for Q3 2010, which is a higher loss than expected. The financial results reflect a number of notable adverse items, some of which were anticipated at the time of the DBRS rating downgrade. Notable adverse items include charges of approximately $2 billion related to the Company’s annual review of actuarial assumptions, a $1 billion goodwill impairment charge and charges related to lower interest rates of $356 million. These charges were offset, in part, by solid core earnings from operations of $779 million, unusually high gains of $569 million on the sale of securities from the surplus account and a $700 million reserve release related to higher equity markets in Canada and the United States.

The Company’s annual review of actuarial assumptions included the adverse impact of higher morbidity experience in the long-term care segment ($755 million as expected), continued adjustment of the variable annuity parameters regarding potential equity market volatility, lower bond returns ($665 million, higher than expected), lower ultimate reinvestment rate assumptions ($309 million) and changes in policyholder lapse behaviour ($485 million).

A $1 billion goodwill impairment charge related to the U.S. life insurance business, while not expected, was also not surprising given the change in the Company’s product mix and the weaker economic environment.

As a result of close to $2 billion in recent debt issues on top of the Q3 2010 loss, the Company’s total debt (including preferred shares)-to-capital ratio has increased to 31.3% from 25.2% at year-end 2009, which is above the Company’s 25% target ratio but consistent with the current ratings. At the same time, the minimum continuing capital and surplus requirement (MCCSR) ratio for MLI increased to 234% from 221% at the end of June 2010. The increase in MCCSR was primarily the result of the $2 billion of debt raised in the third quarter by Manulife and deployed to MLI, coupled with strong investment-related gains and underlying earnings, which more than offset the policy reserve strengthening. MLI’s MCCSR ratios continue to be much higher than those of its peers, reflecting the Company’s higher product risks.

The Company has been actively repositioning its product offering by selectively increasing prices and emphasizing products that are less capital intensive. Integrated risk management and control is leading to a systematic reduction in equity and interest rate risk through portfolio shifts. As part of its risk management framework, the Company has now hedged 54% of its variable annuity exposures to equity markets and has plans to use actions based on time schedules and market triggers to reach its risk reduction goals. The Company expects to reduce its equity sensitivity by approximately 60% by 2012 and approximately 75% by 2014. It also expects to take actions to further reduce its interest rate exposures, as measured by the impact on shareholders’ net income, by approximately 25% by the end of 2012 and approximately 50% by the end of 2014. While this could ultimately be expensive for the Company, DBRS believes that ridding itself of this equity market and interest rate risk hangover is fundamental to restoring market confidence in the Company’s longer-term outlook.

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.