Over the past several weeks, executives of Toronto-based Manulife Financial Corp. have been communicating with concerned financial advisors about the beleaguered insurer’s latest quarterly results.

“We have around 40,000 advisor relationships across Canada nationally,” says Tom Nunn, Manulife’s senior vice president of external communications, “and we’re in contact with our field force nationally.”

The insurer has been clobbered by huge losses, amounting to $2.4 billion in the second quarter of 2010 vs a profit of $1.8 billion in the corresponding quarter last year. Manulife’s stock is trading at about $13 per share, a far cry from its $44 high-water mark set at the end of October 2007, and the firm’s financial ratings have been lowered or placed under review by several rating agencies — all after what Manulife CEO Don Guloien has called a “disappointing” quarter.

To help advisors deal with issues bought up by clients, Nunn says, a two-page Q&A document entitled “Common Customer Questions,” has been distributed to advisors.

The pamphlet emphasizes that the losses are “non-cash” and blames the company’s large U.S. business, including unhedged segregated funds and long-term contracts for those losses. The Q&A also stresses that the company uses Canadian “mark-to-market” accounting and that under U.S. accounting rules, it would have shown a small profit in Q2, further noting that rising interest rates and equities markets are likely to have a positive effect on profitability.

The Q&A also includes the question: “Does the volatility of Manulife’s stock price affect Manulife’s ability to pay life insurance policies?”

Naturally, Manulife’s answer to that question is: no.

The document reads: “The policy liabilities already provided for on our balance sheet reflect the amount which, together with estimated future premiums and net investment income, would be sufficient to pay estimated future benefits, policy-holder dividends, taxes and expenses on all our policies in force.”

The fact that Manulife finds it necessary to reassure advisors is a measure of the seriousness of the questions on their minds about the company’s prospects. But despite the firm’s difficulties, advi-sors are still generally willing to recommend Manulife’s insurance and financial products to their clients — even if those same clients may be reluctant to invest in the company’s sagging stock.

Bob Shumak, an advisor with HC Financial Inc. in Toronto, says it has been hardest to address the concerns of clients that had received Manulife shares in lieu of their ownership rights in the insurer when Manulife demutualized a little more than 11 years ago. “For some of my clients, it’s the only stock they own, and they’ve seen its value plummet,” says Shumak, a longtime Manulife supporter and a certified financial planner.

But, Shumak adds, Manulife is probably in no worse shape than other Canadian insurers. He discusses the company’s future with clients because he likes to take that topic off the table.

“If [Manulife doesn’t] survive, another global insurer will buy the assets and assume the policy obligations. I’m cynical, and I’ve been around long enough in the business that I remember Confederation Life,” he says, referring to the only instance in which a Canadian insurer was declared insolvent.

Tina Tehranchian, an advi-sor and certified financial planner with Assante Wealth Management (Canada) Ltd. in Richmond Hill, Ont., is positive about Manulife’s confidence in its ability to pay off on its policies and is happy to bring its products to the table with clients — even when fears of a double-dip recession in the U.S. further threaten Manulife’s balance sheet.

However, she says, she also has taken calls from clients as a result of Manulife’s slumping share price and the ensuing media coverage. Many clients ask if Manulife is in their portfolio, or if it makes up a significant portion of their mutual fund holdings.

“As a shareholder, you have to be concerned,” Tehranchian. “[The stock] is a lot more exposed to volatility in the stock market, to the interest rate environment. And it has a significant unhedged position in its seg funds business.”

Tehranchian is, of course, referring to Manulife’s variable annuities business, which is currently not profitable. The product had been popular with consumers because it guarantees capital safety while offering upside potential from investment in equities markets.
@page_break@But most of the sales of that product were made before the 2008 market crash.

Now, the company’s U.S. liabilities for this product (the capital and benefits it owes policyholders) exceed US$100 billion, and do not include the $6 billion in the Canadian version of the product.

Manulife says that it has hedged about US$45 billion — a bit less than half of the portfolio — limiting further downside risk. The company also has sharply reduced its sales of these products. The hedging has been costly and will also cut into future profitability, according to New Jersey-based rating agency A.M. Best Co. Inc.

So, as long as equities markets remain volatile and trade in a range below their 2008 levels, Manulife may be taking quarterly earnings and setting them aside for its future obligations to policyholders.

Apart from Manulife’s internal accounting, the Office of the Superintendent of Financial Institutions, the federal regulator in Ottawa, requires insurance companies to maintain a capital surplus of 150% over and above what is required to guarantee their policies. In the past, Manulife has had to employ more reserves to meet that requirement. Currently, Manulife’s reserves (the minimum continuing capital and surplus requirements) are 221% — among the highest for major Canadian insurers. Still, this is an issue that is likely to shadow the company for some time.

Although there was consensus among stock analysts that Manulife would lose money in the quarter, several admitted in notes to clients that they were surprised about the magnitude of the losses.

A report from Andre-Philippe Hardy, financial services analyst with RBC Dominion Securities Inc. in Toronto, described the results as “disappointing on many fronts,” echoing Guloien’s remarks on the day Manulife reported its quarterly figures.

The report blames a number of factors: the negative impacts of equities markets and interest rates were greater than expected; Manulife’s capital position had deteriorated more than expected; currency fluctuations had a greater than calculated negative affect; and the outlook for third-quarter earnings is “very poor,” with other one-time items likely to “cause the company to lose money.”

Hardy’s report notes that the insurer counts on income from part of its giant portfolio of fixed-income investments to cover a portion of claims and costs. Looking to 2011, if historically low interest rates continue, they could have further negative effects on Manulife’s income. In a worse-case scenario, the report notes: “A 1% decrease in government, swap and corporate rates would be expected to negatively impact net income by an industry highest $2.7 billion (up from $2.3 billion) [over the previous year].”

Other analysts are cautious as well. “Q3 is a critical pivot point,” says a report from Darko Mihelic of Cormark Securities Inc. in Toronto. “If markets co-operate, [Manulife] would not raise capital or cut its dividend again. If markets do not co-operate, the lifeco may still not raise capital, but we believe the fear of another raise would still push this stock lower.”

Both Hardy and Mihelic have continued to be negative about the share price. They have each lowered their 12-month price targets for the stock to somewhere between $16 and $18, down by about 10% from previous targets, on average.

Manulife’s woes have prompted ratings agencies either to lower Manulife on their financial strength scales or put is financial strength rating under review.

As of press time: Fitch Ratings Ltd. had dropped Manulife to AA- from AA; Standard & Poor’s Corp. had dropped its strength ratings on Manulife’s core and guaranteed insurance operating subsidiaries to AA from AA+; Moody’s Investors Service Inc. had placed Manulife under review for a possible downgrade of its Aa3 rating; and A.M. Best had placed the company’s A+ financial strength rating under review.

However, each agency also notes that Manulife’s ratings remain near the highest level possible. Tehranchian adds that only Great-West Lifeco Inc.’s rating is equal in Canada.

Richard McMillan, managing senior financial analyst with A.M. Best, says that while it is true Manulife would have shown a profit under U.S. accounting rules, over the long term, the difference in Canadian and U.S. accounting principles should theoretically even out. IE