DBRS Confirms Ratings on Manulife and Affiliates, Senior at AA

DBRS is today confirming the current ratings on Manulife Financial Corporation (Manulife or the Company) and its affiliates with a Stable trend, including the Company’s AA Issuer Rating and R-1 (middle) Commercial Paper rating. Earlier today, DBRS downgraded the senior debt of John Hancock Financial Services, Inc. (see separate press release).

The rating confirmations reflects the Company’s strong market presence in the North American life insurance and wealth management market, complemented by a growing market presence in the fast-growing Asian market, a conservative approach to investments and financial management, and a proven ability to make difficult financial and operating decisions in the face of adverse market conditions.

The economic and financial turmoil of the past 18 months has had an especially adverse impact on the financial performance of the Company as it is more leveraged to equity markets than its Canadian peer group. Falling equity markets negatively impacted sales of wealth management products, reduced the fee income associated with the level of assets under management (AUM), and increased policy reserves related to segregated fund guarantees.

The weak economy has been reflected in increased credit-related losses and impairments in the general account as well as in lower interest rates which have caused an increase in actuarial credit reserves. With strong in-force profitability, notwithstanding the reduction in fee income associated with lower AUM, the Company estimates that its adjusted earnings from operations, after removing the volatility associated with equity markets, interest rates, the impact of current economic conditions on credit and other factors, would be between $750 million and $850 million per quarter for the remainder of 2009 and 2010, representing an estimated ROE of 12%.

The heightened sense of risk exposure associated with unprecedented market conditions has generated a conservative response from the Company which supports its longer term financial strength and market franchise. The Company has recognized the need to have more-than-adequate capital (“Fortress Capital”) with which to confront potential earnings volatility associated with heightened equity and credit market exposures while preserving financial resources and liquidity. In the last 12 months, the Company has taken advantage of its financial strength and an opportunistic capital market to raise over $8.5 billion in net new capital, including over $4.5 billion in common equity, while also cutting its dividend in half and enhancing its dividend reinvestment plan, thereby retaining an incremental $1 billion in capital annually. Since 2008, weak equity growth and increased debt capital financing combined to increase the Company’s consolidated total debt ratio (including preferred shares) to a relatively high 29.1% at the end of September 2009 from 17.1% at the end of 2007. The adjusted debt ratio (which attributes some equity treatment to certain capital instruments) had increased to 20.7% from 11.7%. Following the recent $2.5 billion common equity issue, with $1 billion being used to retire the balance under the bank facility, the total debt ratio will fall on a pro forma basis to just over 25% (adjusted debt declining to 17.2%). The additional equity capital places Manulife solidly within its comfort with the current ratings.

Following the recent additions to capital, regulatory capital adequacy, as measured by the Minimum Continuing Capital and Surplus Requirement (MCCSR) ratio at the Company’s major operating subsidiary, The Manufacturers Life Insurance Company (MLI), would be well in excess of 240% once the remaining proceeds after the repayment of the bank line are advanced as Tier 1 capital to MLI, up from 229% at the end of September, 2009, and 193% a year ago. The Company is in an attractive excess capital position relative to the OSFI minimum of 150% and the Company’s target of 200% though given Manulife’s higher relative market exposure to the equity markets and the current uncertain economic environment, DBRS regards the higher regulatory capital ratios as prudent.

In response to the Company’s recent financial performance and given its cautious outlook, the Company’s comprehensive Enterprise Risk Management (ERM) framework has been engaged in reducing the Company’s exposure to equity market risks through more conservative product design and more appropriate pricing of its variable annuity product even at the cost of reduced new sales. In addition to hedging the guaranteed values of all new segregated fund sales in the United States and Canada, the Company is opportunistically hedging the outstanding book which the Company had chosen not to hedge initially. Over 30% of the Company’s gross Guaranteed Value was hedged or reinsured at the end of September, up from 20% in the fourth quarter of 2008, as the cost of hedges fell as the equity markets rallied during the past six months. The Company expects to begin hedging its variable annuity business GMWB sales in Japan in the fourth quarter of 2009. While unhedged equity market exposure under segregated fund guarantees remains the greatest challenge for the Company, given a reasonable outlook for equity markets, DBRS remains confident that the Company should benefit, in the long run, from the embedded profitability in the segregated fund product.

While equity and credit market risk exposure in the life insurance industry has always been there (increasing equity market exposures has been on the DBRS list of major challenges for Manulife for several years), the rapid fall in equity markets in 2008 and early 2009 has raised the profile of this concern. The Company is very aware of the risks that it has assumed and is now appropriately pricing for the expected outcomes, given the increased equity market volatility. Despite the noise of the past 18 months, DBRS is comfortable with the fundamental strength of Manulife’s business operations which it regards as substantial, reflecting excellent market presence in a diverse series of attractive geographical markets and products, sound operational and strategic management, efficient and proactive capital management, complemented by effective risk monitoring and controls which are consistent with the current ratings.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Life Insurance Companies, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.