Volatility in equities markets is still pushing Canadian insurers’ financial ratings downward, as they continue to work with regulators to draft new capital ratio reporting standards to reflect their risks.

Universally, the insurance companies’ exposure to equities markets through segregated funds having guaranteed minimum withdrawal benefits during the sharp downturn in 2008 and 2009 had put pressure on their financial strength ratings from both Standard & Poor’s Corp. of New York and A.M. Best Co.of New Jersey.

Throughout the downturn, the insurance product manufacturers’ actuarial calculations forced them to account for future liabilities by pushing earnings into the capital pools to pay for fund guarantees.

As well, regulatory requirements, known as “minimum continuing capital and surplus requirements” (MCCSR), set by the Office of the Superintendent of Financial Institutions in Ottawa, have forced manufacturers to pile up even more cash reserves.

Since then, better performance of the equities markets has eased the pressure on these firms greatly, while several factors have changed from within and outside the companies. Notably, manufacturers have started or extended hedging programs on their equities exposure in their product lines. Many of the companies have raised capital in various forms; and each firm has raised prices on the products and made feature changes to help lighten their capital ratio concerns.

“There were issues in both the U.S. and Canada with regard to the product being too aggressively priced,” says Steve Irwin, an analyst with A.M. Best, adding that financial advisors can probably expect to see more changes in the future.

Among the changes the companies have already made to seg funds with GMWBs so far:

> Sun Life Financial Inc. of Toronto has eliminated the option for clients to hold a 90% equities-based portfolio, telling clients they must reallocate their assets by the end of 2011.

> Kingston, Ont.-based Empire Life Insurance Co. has eliminated the reset options on its seg funds, which allow clients to set new high-water marks for their portfolios as equities markets rise, for policyholders who are more than 80 years old.

> Desjardins Financial Security of Lévis, Que., temporarily stopped offering a 100% capital guarantee against market downturns and upon death on its products as of last May.

> Transamerica Life Canada of Toronto has increased the fee on new policies and extended its 5% bonus to the age of 94 to encourage clients to wait longer to start making withdrawals.

> Industrial Alliance Insurance and Financial Services Inc. of Quebec City has increased fees on all of its products by 10 basis points.

Still, even as recently as November 2009, S&P placed Toronto-based Manulife Financial Corp.’ s AA+ financial strength on a “negative” outlook. The firm is by far the biggest seller of GMWB products.

“The outlook reflects the group’s continued sensitivity to equities markets and declining interest rates, and the pressure that remains on core operating earnings, fixed charge and capital adequacy,” says the S&P’s November report. “The outlook also reflects our view of the firm’s enterprise risk management, which we have changed to ‘strong’ from ‘excellent’.”

Notably, as of Jan. 19, Manulife’s rating by A.M. Best was A+ with a “stable” outlook.

In dropping the strength rating to A+ from A++ for Sun Life and all its subsidiaries in February 2009, A.M. Best cited many of the same concerns for the second-best seller of seg funds in Canada. The rating agency also said Sun Life has exposure to real estate-linked assets through investments and commercial mortgages loans, direct real estate, and residential and commercial mortgage backed-securities. In a call this late last month, A.M. Best confirmed those concerns remain.

The story is much the same for IA, the third-largest player in the seg fund market. A.M. Best confirmed IA’s overall A rating in early March, noting that the firm’s new preferred share offering merited a BBB+.

Says A.M. Best’s rating note on IA: “The group’s profitability is exposed to equities market volatility, vis-à-vis lower fee income from assets under management and administration, the potential for higher reserve charges and lower sales from its savings and investment products.”

A.M. Best has looked less favourably on Empire Life — the latest, much smaller entrant in the GMWB field — for some time. Last June, A.M. Best changed its outlook on the insurer to “negative” from “stable” while affirming its A financial strength rating.