Canadian life insur-ers are still building up capital reserves to account for liabilities, analysts say. But they add that Toronto-based Manulife Financial Corp., which has been hamstrung by massive underwriting liabilities in the U.S., has a stiffer challenge than its competitors, which are in a much better position.

“These companies have unused capital, and their unrealized liability positions are starting to moderate, flatten out — and even show gains,” says Mark Steinberg, an analyst with Oldwick, N.J.-based credit-rating agency A.M. Best Co. “How do they redeploy [the capital]? In some cases, we see intent; but no one is selling and no one is buying.”

That’s because all the companies are still gun-shy, he adds, and economic visibility is still not clear.

Over the past 18 months, the insurers — which are increasingly developing wealth-management platforms — have raised debt financing, floated share issues and sold notes. Manulife has even cut its dividend.

A report issued by Montreal-based National Bank Financial Ltd. states that the insurers each have amassed considerable capital in excess of their minimum continuing capital and surplus requirements (a.k.a. MCCSR), which are set by the Office of the Superintendent of Financial Institutions. Crudely put, if the companies were insolvent tomorrow, the capital reserve is the cash on hand in excess of their debts to policyholders.

In reality, the insurers set in-house MCCSR levels; but for the sake of discussion, NBF had set an industry-wide level of 175% in its report, which estimates that Winnipeg-based Great-West Life Co. Inc. has roughly $1.3 billion in excess; Manulife, approximately $5.8 billion; and Toronto-based Sun Life Financial Inc., about $2.6 billion.

Furthermore, Great-West’s MCCSR doesn’t include the $1.2 billion of common equity it raised at the end of 2008 because this money is held at the holding-company level rather than by the insurance subsidiary, notes the NBF report.

(NBF hasn’t initiated coverage on Quebec City-based Industrial Alliance Insurance & Financial Services Inc., which issued $100 million in preferred shares earlier this past spring.)

Although Manulife appears to have spare cash, the company, which 18 months ago was involved in any discussion about acquisitions in the insurance sector, is a special case. Donald Guloien, president and CEO of parent Manufacturers Life Insurance Co., says the firm is building “a fortress balance sheet” — more out of necessity than by choice, according to several Canadian equities analysts.

Ultimately, the only solution to Manulife’s lack of capital reserves is another equity share offering, with many analysts saying that will happen before the end of the year. Manulife is saddled with more than $101 billion in variable annuity contracts (known as segregated funds with guaranteed minimum withdrawal benefits in Canada), the bulk of it in the U.S.

Manulife has already raised subordinated-debt financing, floated preferred shares and other notes in an effort to build its capital. In August, it halved its annual dividend to 52¢ a share.

“I think the phrase ‘fortress capital’ is code for ‘We need to raise a lot of equity’,’’ says Colin Devine, an analyst and managing director with Citigroup Inc.’s investment research division in New York. “We think [Manulife] needs to raise common equity and, with all due respect, meaningful [mergers and acquisitions] will be the last thing on Guloien’s list for a while. First, he has to get his U.S. operations under control.”

Canadian advisors know the story of Manulife’s impressive IncomePlus GIF sales, but more than 80% of the firm’s liabilities reside in John Hancock Financial Services Inc., the U.S. subsidiary Manulife bought in 2004. Hancock has sold more than US$90 billion in variable annuities, which is what the GMWB seg fund product is called in the U.S. “Poorly written liabilities are immortal,” Devine says. “They will bleed you dry, in terms of reserve and capital needs.”

To illustrate Manulife’s challenge, Devine notes that most of the firm’s variable annuities business in the U.S. was in force as of Dec. 31, 2007, when the Standard & Poor’s 500 composite index was at 1,476. The S&P 500 was below 700 at one point last year, and today it’s above 1,100.

“[Manulife is] still far, far from out of the woods,” he says. “The variable annuities block is better than it was at the end of March, but it will remain an ongoing source of capital strain,” adding that it could last as long as 20 years.

@page_break@Guloien will use the new capital to shore up reserves, but also to restructure the company’s U.S. business, Devine says. He also notes Hancock was also a big seller of individual health insurance and universal life insurance with no-lapse features — the other two most risky lines in the U.S. market.

Manulife did make headlines in October, acquiring Pottruff & Smith Travel Insurance Brokers Inc. That deal represents “petty cash” for Manulife, says Byren Innes, vice president with NewLink Group Inc., an insurance consultancy in Toronto.

But with the acquisition, Manulife takes out a competitor in the travel insurance business in the eastern market, Innes says, and gains about 90 employees, many of them salespeople. The purchase dilutes the costs of operating the business over more insurance policies and provides some cross-selling opportunities, which Manulife Canada’s president and CEO, Paul Rooney, has noted as a focus. The greater the distribution points and customers — Manulife already has seven million — the greater the opportunity to introduce new products across insurance platforms.

Sun Life, for its part, is much better poised to make a blockbuster deal in the U.S., and it made its intent clear when it hired executives from Philadelphia-based insurer Lincoln National Corp., including former CEO Jon Boscia, to gain a better understanding of the market.

But Devine concurs with Stein-berg that most insurers in the U.S. are too risky, considering the economic conditions. Sun Life’s core is its group business, which usually involves shorter-term liabilities, so it might be comfortable dipping into that market. Says Devine: “It’s hard to see it doing anything else.”

Many analysts note that Great-West isn’t challenged by equities market exposure because it has never launched a variable annuities-type product. Unlike Manulife and Sun Life, it didn’t signal an imminent hit to reserves and its CEO has recently said that the firm is not considering a dividend cut or raising more capital.

“[Great-West has] few peers in the world in the life insurance business — they’re that good,” says Devine, who values the firms’s conservative management. “It is poised to do something significant; it’s big enough to do anything.”

Turning back to NBF’s coverage, the report notes that the best growth opportunity in the global life insurance market is in emerging markets, where the average life expectancy is on the rise and where the population is much younger than in the West — and also where market penetration by financial services is lower. IE