This article is part of Report on Business Magazine's annual top 1000 rankings. See the full website here.
Life insurance used to be the quintessential safe and boring business in Canada. No more. “It’s a terrible industry to be invested in right now,” says Peter Routledge, financial services analyst at National Bank Financial in Toronto.
During the 2008-09 financial crisis, share prices of the Big Three that dominate the market—Great-West Lifeco Inc., Manulife Financial Corp. and Sun Life Financial Inc.— plunged by more than half, and the strain on their capital reserves alarmed regulators in Ottawa. Now, more than three years later, Manulife and Sun Life shares are still mired near their post-crash lows, and those of Great-West, the healthiest of the three, aren’t doing much better. CEOs and regulators have made sweeping efforts to correct pre-crisis excesses and inject more old-style conservatism into the business. But an economic morass consisting of historically low interest rates, North America’s aging population and tougher new accounting rules is wreaking havoc with insurers’ results and making it almost impossible for them to earn a decent profit on their traditional basic products.
Indeed, volatility is the new norm in their reported earnings. Dramatic evidence can be found in our annual Top 1000 ranking. Last year, Manulife dove from No. 18 to No. 997 because it posted a $391-million loss in 2010, compared with a $1.4-billion profit the previous year. The company is still shaking off the hangover from its blistering expansion under Dominic D'Alessandro, who was CEO from 1994 to 2009. This year, Manulife has climbed back up to No. 140, based on its modest profit of $129 million; in the first quarter of 2012, however, it posted a $1.2 billion profit. One of the biggest losers is Sun Life, which plunged from No. 16 to No. 985 thanks to a $200-million loss in 2011. Yet it turned around and earned a $686-million profit in the first quarter of 2012.
Great-West, at No. 15 in this year’s ranking with a $2.1-billion profit in 2011, has been the only consistent performer. “Did you hear my numbers?” CEO Allen Loney asks me twice during an interview. “$7.4 billion in earnings over the last four years.” Great-West certainly deserves kudos. Yet Loney acknowledges that the prospects for the industry as a whole are weighing down his company’s share price, too. Thanks to the transition in reporting rules, “You’re going to find that reported income wanders all over the place,” he says. “It’s going to confuse investors.”
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Low interest rates are life insurers’ biggest headache. Both of their traditional basic products—life insurance and annuities—have long time horizons. A life insurance policy pays out a lump sum when you die. In the meantime, you may pay premiums for 20 or 30 years. An annuity pays out a regular stream of income as long as you live, usually starting when you retire. Back in the 1960s, when long-term rates were near more historic norms of, say, 5% or 6%, all this was a straightforward business: Sell a policy or annuity, then use payments from customers to buy and hold long-term government bonds and high-grade corporate ones to cover the obligations.
But long-term Canadian and U.S. government bond yields have sunk to below 3% since the financial crisis. Life insurers are still required to use those yields as a benchmark to calculate what they need to set aside to pay benefits far into the future. To take a very simplified example, say a company knows it will have to pay out $100,000 on a policy 20 years from now. If interest rates are 6%, it only needs to have $31,180 set aside today. If rates are at 3%, however, it needs to have $55,368 set aside. Worse, the current low rates are a problem for old policies as well as new ones. “Every year gets worse, because they get a new batch of premiums from their in-force policies and they have to reinvest those premiums,” says National Bank’s Routledge. “And today they’re reinvesting them in assets that don’t yield very much.”