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Life insurers to come up short as market drifts

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A sluggish stock market is hitting Canada's life insurers with a double whammy, as this week's quarterly reports from Manulife Financial Corp. (MFC-T) and its competitors will once again demonstrate to the chagrin of their shareholders.

Manulife, Canada's largest life insurer, will likely post a loss for the second quarter, while its two main competitors -- Great-West Lifeco Inc. (GWO-T) and Sun Life Financial Inc. (SLF-T) -- look set to report lower profits, in part because of the weakness of financial markets during the reporting period.

To be sure, rising insurance premiums and recent moves to exit unprofitable businesses will pad their core results. Even so, the macro environment has hammered the insurers' stock prices and prompted analysts to recommend bypassing them in favor of more expensive bank stocks.

"These guys are really struggling. The environment is just not one that favors insurance companies, flat out," said CIBC World Markets analyst Robert Sedran.

Under Canadian accounting rules, the insurers must constantly adjust their massive investment portfolios to make sure their investments are sufficient to pay off future payout obligations, some of which have very long lives. Negative market moves force them to take reserves out of profits.

That's where the second whammy comes into play as the results, which begin with Great-West Lifeco on Wednesday, will likely push capital levels for the group lower, and could prompt some companies to issue shares at depressed prices, analysts say.

Weak markets also hurt their wealth management businesses, as well as remaining portfolios of financial products that were conceived under much different market conditions.

In the second quarter, the S&P/TSX composite index fell 6.2 percent, while the yield on the benchmark U.S. 10-year Treasury fell 57 basis points to 1.64 from 2.21. The 10-year bond has fallen again in July, suggesting more pain in the third quarter.

Manulife, which posted a strong profit in the first quarter thanks to an early-year market rebound, is expected to post a loss of 48 cents a share, according to Thomson Reuters I/B/E/S, compared with a year-before profit of 26 cents a share.

Sun Life is expected to come in with a profit of 18 cents a share, down from a profit of 73 cents per share.

Great-West, which has the least market exposure of the group, expected to post a profit of 48 cents a share, down from 55 cents a share.

Industrial-Alliance Insurance and Financial Services Inc. (IAG-T), a smaller insurer that takes the bulk of its market-related hit in the fourth quarter, is expected to notch a profit of 59 cents a share. It earned 78 cents per share a year earlier.

"We see few positive catalysts coming out of second-quarter reporting," Barclays Capital analyst John Aiken said in a note.

"We expect weak reported earnings and declines in capital ratios," he said. "We believe investors will have to remain patient and cautious above all else."

DE-COUPLING

The quarter will provide more evidence that the insurers' core businesses -- considered well managed with good growth prospects -- are decoupling from their market-driven earnings and share prices.

Weak markets have kept their stocks pinned well below the highs they reached before the 2007-09 financial crisis. Manulife is down nearly 77 percent from its 2007 record high, while the others are down at least 40 percent.

Even so, Manulife and Sun Life both have strong Canadian and U.S. presences and are both expanding in Asia.

Manulife, which owns U.S.-based John Hancock, earned 34 percent of its profit from its Asian division in 2011 and recently entered Cambodia, its 10th country on the continent.

Manulife has also submitted bids for parts of ING's Asian assets, which the Dutch company is in the process of selling, while Sun Life has been linked to interest in assets in the region.

Even so, the insurers' core businesses are not immune from the markets, which weaken their capital levels and make it less likely they would attempt large acquisitions in the current climate, analysts say.

Indeed, the quarterly results are expected to push capital levels down to a point at which insurers may have to consider issuing equity, an unattractive prospect with stock prices so low.

"The way I would characterize it is ... the macro variables are slowly bleeding capitalization in the industry," said National Bank Financial analyst Peter Routledge.

"The immediate reaction has been to fill that bleed with non-common forms of capital, such as preferred shares, subordinated debt. At some point, it will have to go to equity in order to maintain a stable healthy balance sheet."

Routledge expects Manulife to take an $800 million charge to lower its long-term investment assumptions and sees additional charges in the second half of the year.

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