Canadian life insurers aren’t performing up to their current credit ratings, DBRS Ltd. says. While it’s giving them the benefit of the doubt for now, if profits don’t rebound soon, downgrades may be in order.
In a new report examining the Canadian life insurance industry released Monday, the rating agency says that, due to weak and volatile earnings, a couple of the big insurers
(Sun Life Financial Inc. and Manulife Financial Corp.) currently aren’t meeting the quantitative criteria for ratings. For now, it’s giving them a pass, and overweighting more qualitative factors, such as scale and diversification, “pending a return to normal markets and earnings”. Additionally, it suggests that it believes, “the worst of the market crisis is behind us and that Canadian accounting conventions are possibly understating their longer-term earnings potential.”
However, it cautions that financial dislocations and sources of economic disequilibrium “could easily perpetuate uncertain market conditions”. Chief among those risks is the U.S. Federal Reserve Board’s promise to maintain low interest rates at least until 2014.
The challenge of protecting against long-term interest rate risk “could effectively force the insurance companies to abandon certain traditional protection products associated with its business model by increasing prices to unattractive and unsustainable levels,” it suggests.
“To this degree, it would not be unfair to suggest that the North American economy is undergoing something similar to what was experienced in Japan during the 1990s. During that decade, it should be noted that the Japanese life insurance industry was transformed by bankruptcies and consolidation, largely as a result of falling interest rates and equity markets,” it says. “While the comparison is not completely appropriate for the current industry condition in Canada, DBRS nevertheless remains cautious on the outlook for the life insurance industry and stands poised to take negative rating actions should sustainable profitability at acceptable levels not be demonstrated in short order.”
Still, despite the challenges facing the industry, the report says it is clear that the industry, “still boasts very strong fundamentals and an established distribution infrastructure, which position it well to meet the savings and financial security needs of the large and soon-to-be-retired baby boom generation. In the meantime, DBRS waits patiently for a return to normal industry earnings unmarred by extreme market movements in both equities and interest rates.”