Canada’s major life insurers report their fourth-quarter results in February, and, once again, the numbers are expected to be ugly, with analysts forecasting losses for both Manulife and Sun Life.
Blame Europe. As a result of the European sovereign debt crisis, interest rates continued along their downward trajectory in this latest quarter, which ran to the end of December. Canadian rules and regulations require the life insurers to effectively assume that the current rates will last forever, forcing them to bolster their reserves on the assumption that their investment portfolios will have trouble earning enough in the coming decades to pay out their policy holders.
“The interest rate environment is progressively deflating the valuations of the four largest Canadian life insurers,” National Bank analyst Peter Routledge points out in a note to clients. The Canadian government 30-year bond yield fell 28 basis points to 2.49 per cent in the final three months of 2011, while the U.S. government 30-year bond yield was flat at 2.89 per cent. “As a result, the average price-to-book value multiple for the four largest Canadian life insurers fell from 1.24 times at the start of the quarter to 1.06 times by quarter end,” Mr. Routledge notes.
“We believe investors will continue to flock to the safety of U.S. and Canadian government bonds because of European financial system stress,” he adds. “This drives down bond yields, which causes the chief actuaries of the Canadian life insurers to adjust their future interest rate assumptions down and effect a shift in reserves from shareholders’ equity to policy-holder liabilities. Until events in Europe begin to resolve themselves favourably, we do not expect interest rates to move materially higher and put upward pressure on insurance company valuations.”
Most of the analysts who cover the life insurers are still putting together their detailed estimates for the fourth-quarter financial results (and will privately acknowledge that predicting insurance earnings in this environment is a bit of a mug’s game). But the insurers have already warned that goodwill charges and other hits will be coming.
On the bright side, the stock market rose a bit during the quarter. But even that is unlikely to help, BMO analyst Tom MacKinnon wrote in a recent note, pointing out that “higher-than-average volatility in the quarter ... likely translated into a modestly net negative equity market impact on average for the group [of life insurers]”