Moody’s Investors Service has downgraded the insurance financial strength ratings of Manulife Financial Corp.’s subsidiaries to A1 from Aa3, following the firm’s quarterly loss.

The rating agency said the downgrades follows Thursday’s announcement by Manulife of a nearly $1 billion net loss in the third quarter along with several business developments, including Manulife’s acknowledgement of higher morbidity experience within its U.S. long-term-care block and the resulting need for an average rate increase of more than 40% in coming months.

“Also, the company faces the challenge of redesigning products to restore earnings power, combined with the possibility of continued earnings volatility until the firm’s enhanced market-risk hedging program is substantially complete,” Moody’s says.

Moody’s said the downgrades also reflect Manulife’s diminished financial flexibility because of reduced earnings coverage and increased financial leverage. Also, the company faces further goodwill charges as it adopts IFRS accounting in 2011. “Although these goodwill write-downs are non-cash, they will lead to further deterioration on Moody’s leverage metrics,” it says.

“The challenges of securing large rate increases while avoiding anti-selection to deal with higher morbidity and claims in the long-term-care block and diminished financial flexibility drove the downgrade” said Peter Nerby, a Moody’s senior vice president.

The rating agency affirmed the firm’s short-term ratings and it now has a stable outlook. “The stable outlook on the A1 rating reflects management’s commitment to an enhanced hedging program for interest rate and equity risk embedded in the variable annuity business, the solid capital positions at the insurance companies, and the firm’s excellent Canadian franchises as well as its strong position in Asia,” Nerby noted.

Moody’s cautioned that volatile capital markets conditions may lead to further earnings volatility at Manulife in 2011, or until the hedging program is substantially complete.

IE