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Proceed with caution when straying from bonds, OSFI warns insurers

Julie Dickson, head of the Office of the Superintendent of Financial Institutions


Life insurers are shifting some of their massive bond portfolios into other types of investments, such as stocks and real estate in a quest for better returns, which could be a mistake, Canada's financial regulator warns.

Low interest rates are hammering insurers around the world and shrinking profits. But Canadian insurers are being penalized more than most because of rules requiring them to be extremely conservative and assume that today's low rates will last. As a result, they are more tempted by the quest for yield, said Julie Dickson, the head of the Office of the Superintendent of Financial Institutions, which regulates banks and insurers.

She wants insurers to proceed with caution when it comes to straying too much from bonds. "We think the companies should watch how far they get into this," she said in an interview Thursday.

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Insurers hold a mix of assets, but traditionally have always been heavily weighted towards fixed income investments. The country's life insurers have roughly $570-billion of assets held in Canada, according to the Canadian Life and Health Insurance Association. That includes $108.8-billion in federal, provincial and municipal government bonds and $95.5-billion of Canadian corporate bonds. They hold about $15.5-billion worth of real estate. The insurers also have large investments abroad.

Ironically, some insurers had been shifting into hard assets such as real estate in an attempt to protect themselves after the financial crisis, when it became clear many financial instruments were not as solid as they had thought. In 2009, Sun Life's then CEO Don Stewart said he would be shifting a greater proportion of the firm's investments into assets such as roads and bridges to prepare for further ugliness that could occur. "That's going to be an area of some emphasis going forward because in tough times you are left with a tangible asset," he said at the time. "The tangible asset may have less value, but it is a tangible asset."

But what such investments don't come with, Ms. Dickson said, is a promise to pay at some point. Investments such as bonds, which come with such a pledge, are generally the most prudent ones for life insurers, she said. And any major shifts towards alternative investments must involve the input of the board of the directors, as well as new resources devoted to risk management.

Alternative investments can have a place.

"Some people say that if inflation were to take off, you may be better in an alternative asset class," Ms. Dickson said.

"That's very true. The point we're making is this is a different risk profile. Watch the maturity of your obligations [the point at which insurers must pay policy holders], and the closer you get don't use alternative investments. Be very clear and discuss with your boards how far you want to go into this and why. We think that's good advice and we want to see all companies follow it."

At Manulife Financial Corp.'s investor day Thursday, chief investment officer Warren Thomson noted that about 86 per cent of the company's asset portfolio is invested in the fixed income space, and a little more than a quarter of it is in government securities. "You can see we have this very small piece of the pie at the bottom, which is our non-fixed income assets, and I refer to that pool of assets as spice in cooking," he said. "You just need a little bit to add some flavour to what you're trying to produce."

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Five per cent of the company's $224.8-billion portfolio is in stocks, and 9 per cent is in other alternative assets such as commercial real estate, timberland, and farms.

Mr. Thomson stressed that the firm's alternative asset portfolio is well diversified, and the majority of the assets in it are managed in-house.

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