The U.S. Federal Reserve's drive to push down interest rates is taking a dramatic toll on Sun Life Financial Inc. , forcing one of Canada's biggest life insurers to warn of its first quarterly loss in two years.
Sun Life said it expects to post a $621-million loss for the July-to-September period when it officially reports its financial results on Nov. 2. That will be the final set of full financial results for outgoing chief executive officer Don Stewart, who retires next month after 13 years at the helm.
The company was hurt by falling stock markets and interest rates. A large reason for the disappointing showing is the latest actions that the U.S. central bank has taken in an effort to spur that nation's economy. "Operation Twist," the nickname for the program through which the Fed is trying to decrease long-term interest rates in order to stir business investment and home-buying, has worsened an already difficult environment for insurers like Sun Life.
The large loss, which caught analysts by surprise and sent the stock tumbling 9 per cent, underscores the costs to some financial companies of a policy of keeping interest rates very low. Life insurers are particularly sensitive to big moves in rates: They invest a large proportion of the premiums they receive from customers in the bond market, and low rates mean low returns. That, in turn, is reinforcing the belief that consumers will have to pay more, and insurance prices will continue their upward climb.
Prior to Sun Life's announcement, analysts had been expecting the company to report adjusted profit of $260.6-million, according to Bloomberg. The insurer does not plan to release more information until early November, meaning Mr. Stewart will have a lot of explaining to do at that time.
Shares of rival Manulife Financial Corp., which is scheduled to report its results on Nov. 3, fell 4.6 per cent to $12.34. North American stock markets dropped more than 12 per cent during the quarter and U.S. Treasury rates reached historic lows. Both of those factors are also expected to hurt Manulife.
Low interest rates not only affect the amount insurers earn from their large fixed-income portfolios; they also have an impact on the assumptions they make about how much money to put aside now in order to ensure they have enough for to pay future benefits to customers. Canada's life insurers have been arguing that Canadian accounting rules are particularly strict on that point, meaning that low interest rates have been more of a burden on them than on U.S. insurers.
Sun Life's warning was particularly surprising because the company posted higher-than-expected profits in the past two quarters. Canaccord Genuity analyst Mario Mendonca said he had expected charges related to financial markets of $310-million because of the sharp moves in stock and bond markets during the third quarter. Based on Sun Life's disclosure Monday, he now expects the charges will exceed $700-million.
Sun Life's profits are affected not only by absolute changes in interest rates, but by the degree to which long-term rates and short-term rates move in tandem. That's what makes Operation Twist, which is specifically designed to drive down longer-term interest rates but not shorter-term ones, particularly painful for insurers. André-Philippe Hardy, an analyst at RBC Dominion Securities, pointed out that the yield on 30-year U.S. government debt fell 1.46 percentage points during the quarter. But the yield on shorter-term U.S. government debt declined by a much smaller amount.
In response to difficult markets, insurers have been shrinking some of their riskiest U.S. businesses. Sun Life no longer sells some forms of universal life insurance in the U.S., and Manulife has slashed the amount of variable annuities that it sells in the U.S. by more than 75 per cent.
Insurers have also been raising prices. In Canada, Manulife recently disclosed its second round of rate hikes on universal life insurance in less than a year.