DBRS Confirms Ratings of Manulife and Affiliates

DBRS has today confirmed its ratings on Manulife Financial Corporation (Manulife or the Company) and its affiliates, including The Manufacturers Life Insurance Company, its primary operating company. The rating trend is Stable. The ratings reflect the Company’s strong position in a number of geographic and product markets, including Canada and the fast-growing Asian market through the Manulife brand, and in the U.S. through the John Hancock brand. The Company is also well-diversified by customer, distribution channel, and product line. Risk management policies and procedures are increasingly rigorous giving rise to a high-quality asset portfolio, though legacy issues associated with the Company’s policy liabilities continue to be a potential source of adverse reserve development given the macroeconomic and regulatory environments. DBRS feels that the current ratings adequately reflect the Company’s earnings volatility over the past five years, as well as the active transition to lower-risk growth platforms. While DBRS positively regards the Company’s progress in reducing market-related risks, it recognizes that Manulife is undergoing a shift in its growth model, reducing its focus on growth of guaranteed long duration products.

While DBRS is prepared to acknowledge that, barring a major economic crisis, the Company has probably hit its nadir, it does not believe that the lost profitability associated with the U.S. operation will recover quickly, especially since the former earnings levels benefited from favourable equity markets and a more favourable interest rate environment. DBRS is also mindful that the Company’s core earnings performance is dampened by hedging costs, reduced earnings opportunities related to potential recovery in capital markets, and more competitive market conditions. The Company has indicated that it also expects to take another material charge in Q3 2012 related to changes in actuarial assumptions driven by new standards of practice and the ambient macroeconomic environment, though much of this specific charge will relate to products and policy liabilities that are not part of the Company’s current growth plans. Other sources of potential earnings volatility relate to the indeterminate policyholder behaviours that are not addressed by current hedging activity, and a possible additional write down of goodwill reflecting the adverse interest rate environment.

At the companies current level of core earnings as DBRS defines them, fixed charge coverage ratios are below 5x with a core return on equity (ROE) of about 10%, well below the greater than 10x coverage and greater than 15% ROE reported prior to the onset of the 2008 financial crisis. Without the heft of the Company’s business franchises in Canada, Asia and the United States, such ratios and the accompanying earnings volatility would not be consistent with the DBRS quantitative criteria for Company’s rated at the current levels. Should these business franchises deteriorate, there could be negative rating implications.

Since the beginning of the financial crisis, Manulife has been forced to confront challenges represented by its relatively large exposures to equity markets (through its variable annuity guarantees) and falling interest rates (through its long-tailed liabilities with embedded return assumptions and guarantees). For example, the Company has launched a hedging strategy that has dramatically reduced its exposures to exogenous market conditions. In addition, certain once-popular products, such as variable annuities, long-term care insurance and no-lapse guaranteed universal life insurance products, which have large regulatory capital requirements, have been de-emphasized in favour of products with lower capital requirements, such as mutual funds, retirement savings plans and new current assumption indexed universal life products with participating features. Product repricing and redesign has also been undertaken in order to reduce earnings volatility and capital requirements.

To meet its regulatory capital requirements over the same period of market disruption, the Company has raised over $14 billion in net capital through market issues of common and preferred shares, reduced cash dividends and senior and subordinated debt issues. Correspondingly, the Company has consistently reported strong regulatory capital ratios, as its financial leverage ratios (total debt plus preferred as a proportion of capitalization) have increased to 32.2% from 17.1% in 2007, and remain above the Company’s 25% target. The Company reported an MCCSR ratio of 213% for the period ending June 30, 2012, which is among the strongest ratios in the industry and well above a reasonable minimum level, especially given the Company’s risk-mitigating hedges for which the regulatory ratio gives no credit. However, given the unstable economic environment regulatory uncertainty associated with Solvency II, IFRS accounting for Insurance Contracts and Employee Benefits and OSFI’s and the Canadian Institute of Actuaries requirements regarding required capital for variable annuity guarantees, DBRS feels that the relatively high regulatory capital ratios are prudent at this time.

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

The applicable methodology is Rating Companies in the Canadian Life Insurance Industry (March 2011), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.