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The Globe and Mail

Little to bank on with insurance industry stocks, analysts predict

Manulife Financial President and CEO Donald Guloien stands before speaking at their Annual Meeting in Toronto May 5, 2011. Analysts are forecasting further losses for Manulife Financial Corp.


Canada's life insurance companies are about to begin reporting quarterly results, an occasion that in recent years has been marked by big losses and unpleasant surprises.

Analysts are forecasting further losses for both Manulife Financial Corp. and Sun Life Financial Inc. , and insurers have already warned that goodwill charges and other hits will be coming. But the latest outpouring of financial confessions are likely to have a smaller effect on the stock prices of the insurers than the outlook for government bond prices.

Low interest rates on those bonds, as well as volatile stock markets, have hurt life insurers' ability to earn returns on their investments, the source of most of their profits.

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Rising stock markets have recently delivered a welcome boost to insurers' bottom lines. On the downside, the fear created by the European financial crisis has driven money into safe government bonds, pulling down yields.

Life insurers' performance has moved in-step with long-term interest rates. As rates fall, Canadian regulations require insurers to notch down future interest rate assumptions. This forces insurers to shore up their reserves to further protect their investment portfolios and ensure they will be able to make the payments that policy holders expect down the road.

Manulife and Great-West Lifeco Inc. post fourth-quarter numbers Thursday, followed by Sun Life and Industrial Alliance Insurance and Financial Services Inc. next week. Analysts expect only Great-West to deliver a profit.

While Canada's major insurance companies meet and exceed capital requirements, it's not entirely academic to be concerned about what could happen if interest rates remain depressed for an extended period. Low interest rates and poor investment returns helped cause the demise of Union of Canada Life. Last week, the small 148-year-old insurer received court approval to begin winding down operations after it was unable to maintain sufficient capital levels to operate.

In this environment, financial-sector investors have been turning away from insurers in favour of banks, focusing on lenders' growth, strong capital bases and more predictable earnings flow. But Michael Goldberg of Desjardins Securities says a smarter move this year might be to invest in the life insurance companies because the odds favour an increase in bond yields.

Since the start of January, yields on 10-year U.S. Treasuries have been rising. Reflecting that trend, shares of the major insurers have shot upward. Manulife shares, for example, have gained 15 per cent this year – although they remain down 31 per cent over the last 12 months.

UBS Securities Canada Inc. forecasts that U.S. 10-year bond yields will rise to 2.4 per cent this year, while 10-year Canadian yields will increase to 2.5 per cent. But analysts Peter Rozenberg and Andrew Kligerman warn that rates are not rising fast enough and will continue to hurt insurers.

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"While we project long bond yields to increase, they are expected to remain well below the interest rate assumptions currently priced into Canadian LifeCo products, undermining near-term performance," they wrote in a recent report.

Some sophisticated investors continue to make major bets against Canadian life insurance companies by "shorting" or selling borrowed shares. Manulife is the most heavily shorted stock on the Toronto Stock Exchange, and Sun Life and Great-West also rank high on the list. Combined, the three have a total short position on the TSX amounting to $2-billion worth of stock.

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