Thursday, September 16, 2010

(No.113) Manulife & Sun Life: a safety parallel?

In the Globe and Mail's Report on Business (Sept.9) financial services reporter Tara Perkins wrote about her conversation with CIBC World Markets analyst Robert Sedran.

The premise of this "Tip Sheet" column was that while "the Street is concerned that Manulife Financial Corp might have to raise common equity capital yet again, ... Sedran sees a potential alternative: regulatory forbearance." Postulating his potential avenue of relief for Manulife Mr. Sedran pointed out that " Easing the regulations wouldn't be without precedent. In the early 1930s more than 40% of Sun Life's assets were common stocks. The insurer could have been in hot water were it not for a decision by regulators to allow a more generous interpretation of market values when marking assets to market, Mr. Sedran says. 'As a result the company survived a terrible environment throughout the Depression'."

Sun Life's financial situation following the Wall Street crash in 1929 was not just strained it was dire; in fact Sun Life was under water. Called upon in the Globe article as a parallel to Manulife's current financial challenge Sun's financial situation 80 years ago is, I suspect, one that Manulife's current CEO would not welcome.

Not incidentally both Sun and Manu have for most of their corporate lives operated as stock companies (except for a period of 40 years or so after they became mutual companies in order to avoid foreign takeover and then demutualized a decade ago).

At the time the Great Depression arrived in Canada Sun Life's czar was Thomas Bassett Macaulay who, since 1908 when his father handed him the reins of Sun Life, exhibited a self-confidence that makes the arrogance of some current and recent CEOs look almost reticent. The relevance here is to his conviction that, unlike other Canadian life companies, Sun was going to achieve major success based on highly risky investing of an ever greater proportion of its assets in the stock market. As I recall he ended up taking the proportion of Sun Life's assets invested in the stock market to well above 40%.

When the stock market crash occurred Sun Life did not go publicly to "regulators" in Ottawa in the modern fashion (as when Manulife's former CEO went publicly to Ottawa seeking regulatory relief on reserve requirements for the guarantees on its variable annuities). Sun Life quietly sought help from the key person -- the federal Superintendent of Insurance. The Sun Life episode occurred long before this senior and prestigious role was eliminated in the bureaucratic creation in 1987 of the Office of the Superintendent of Financial Institutions. Indeed the Superintendent of Insurance had long enjoyed deputy minister rank and reported to the Minister of Finance.

As former federal Supt. of Insurance K.R. MacGregor related the episode to me:
Sun Life's liabilities far exceeded its assets after the crash and it came quietly but desperately seeking the Superintendent's help (that was how regulatory problems were handled in those days). The other Canadian life insurance companies feared for their reputations with the Canadian public for safety and solidity and, while very angry about Macaulay's recklessness and the potential for collateral damage, wanted Sun rescued.

Out of the public eye the federal Supt. of Insurance had already rescued (and would again) smaller life insurance companies by quietly insisting that larger life companies take them over and assume their business. That method of preventing public insolvencies and losses to policyholders was a major reason why the industry could claim, pre-Confederation Life debacle, that no policyholder of a federally regulated life company had ever lost a dime. Sun Life was too big for that course of action.

What happened was that Ottawa shielded Sun Life from a public insolvency until Sun had time to recover its financial equilibrium. In fact this protective action went well beyond "easing capital requirements" and lasted until Sun had time to climb out of the financial hole Macaulay had dug for it in the stock market and reach a point at which its assets exceeded its liabilities.

Footnote: some years ago I was told by a reliable source that decades later Ottawa quietly assisted several life insurance 'brokerage' companies for a time on what had become their serious capital deficits in the level of reserving required for the billions of dollars of badly under-priced risk (and therefore under-reserved) 'first generation' lapse-supported Term-to- 100 business.

This is a subject I addressed occasionally during the years in which I published and edited The Canadian Journal Of Life Insurance. I also emphasized, as I do again now, that Sun's near death experience had a profound cultural influence down the years on Sun's senior management. In the post-crisis years it seemed that Sun Life could never have too much surplus. Sun Life's senior management style was very firmly on the side of conservative financial management. 'Safety first' became a part of Sun Life culture, one that has continued to this day.

Case in point: in contrast with Manulife whose former CEO, in the interests of jacking up company profits, ceased in 2004 to hedge its risk on the truckloads of guaranteed variable annuity business it was selling, Sun Life did not cease its hedging.

Another footnote -- on life company investments in Canada: the risk to the entire Canadian life insurance business in terms of public confidence by what Sun Life had brought down on itself ca. 1929 ff. and -- by inference -- on other Canadian life insurance companies was a major issue for the industry. The result was that the major companies went to the federal Supt. of Insurance (sotto voce, of course) and made clear that they wanted action taken that would prevent a Macaulay-like aberration occurring again. They requested a low limit be put in place severely capping the % of a life company's Canadian assets that could be placed in stocks. And it came to pass.

Many years later when I joined the industry I found it mildly amusing, as did K.R. MacGregor himself, that senior managements of federally regulated life insurance companies were by then pissing and moaning about the federal restriction on a company's stock market investments, a limitation the companies themselves had requested.

The reality of the life insurance industry's history was by then as much a blank page to the CEOs of that day as it is to most of their successors today.


Alastair Rickard