UBS Securities Canada Inc. initiated research coverage of the Canadian life insurance sector with a cautious stance on Thursday, indicating that, in the current climate, it prefers the banks.

In its report, UBS says that the big three Canadian life insurers “appear well positioned operating in an oligopoly”; and, noting that the economic recovery has driven higher revenues, capital, and asset quality.

“However, deflationary risks have continued to increase, resulting in much lower interest rates, equity returns, and growth. This has hurt investment yields, net income, and returns,” it says.

“We believe there could be more long-term upside due to higher interest rates, higher equity returns, improved business mix, higher pricing, and higher normalized [return on equity] and valuation. However, macro risks and their timing, and related capital implications, remain very uneven,” it says. “Furthermore, these risks could increase further, if interest rate and equity returns remain low.”

Additionally, the prospect of increased regulation and the move to new International Financial Reporting Standards also pose a risk, it says. And, large actuarial changes are expected in the third quarter, pushing the firm to hold a “negative sector outlook” on Canadian lifecos.

“We prefer Canadian banks over Canadian lifecos due to higher EPS growth, visibility, returns, and value, and lower macro, regulatory, and accounting risks,” it says.

And, within the sector, it favours Sun Life over Manulife, “due to lower macro risk and higher dividend yields,” it concludes.

IE