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A pedestrian walks past the Manulife building in downtown Vancouver.

JONATHAN HAYWARD/The Canadian Press

An uptick in interest rates through North America is re-framing the outlook for bonds, mortgages and even student loans.

But few industries have earnings as deeply entwined with changing rates as life insurance companies, and Canadian insurers' earnings and book values stand to benefit from the increase as long as the markets co-operate, one expert says.

"The risk-reward profile for lifecos continues to improve across a whole range of market scenarios," Robert Sedran, analyst at CIBC World Markets, wrote in a note to clients.

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He recalled a previous note where he had likened the shareholder experience in the early days of an economic recovery to "getting repeatedly punched ... in the dark," but said conditions have since improved.

Indeed, life insurance stocks have been big winners in the markets this year, beating out banks and commodities with big gains. Manulife Financial Corp. stock is up 50 per cent in the past year, and Great-West Lifeco Inc. gained 30 per cent in the same period.

Insurers derive profits from rising yields on the bonds they hold as investments, but climbing rates effect the businesses far more deeply, swaying hedging costs and the reserves required to back the insurers' best guess of reinvestment rates, among many other factors, Mr. Sedran noted.

The financial crisis hit insurers hard as markets plummeted and a period of prolonged, ultra-low rates set in. These changes compressed profit margins, which caused insurers to look for more efficient ways to do business. But while equity markets have climbed back up, the low-rate environment and other structural and regulatory changes have contributed to structural, rather than cyclical changes to insurers' businesses.

While insurers have successfully tailored their product offerings and increased prices, these gains hinge more on equity market improvements and interest rate optimism than on financial results, which have been solid but not extraordinary.

U.S. Federal Reserve Board chairman Ben Bernanke's indications that the U.S. central bank could pull back on its quantitative easing gave way to suspicions that interest rates could be on the rise, but rates are not guaranteed to remain buoyant. So what's the outlook for these companies?

Mr. Sedran outlined three scenarios where long-term interest rates in North America rise a little, a lot or shed recent gains and found that, "not surprisingly given the recent improvements in the Canadian lifecos' core business … all three scenarios kick out more optimistic results than they did in the previous iteration of this analysis."

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And the ever-present market risks also seem to be abating, with insurers all fully hedged contributing to slower growth, but increased stability. When it comes to insurers' balance sheets market sensitivities have decreased materially, Mr. Sedran wrote, which "has helped reported earnings converge with core earnings, giving us more confidence in the ability to forecast earnings going forward."

(Jacqueline Nelson is a Globe and Mail Financial Services Reporter.)

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