Sunday, July 24, 2011

(No.161) Manulife's retrocession: "like a dog turd in dung"?

In a column last April I said that Manulife was in the hunt for a buyer during 2011 of its life retrocession (reinsurance) business, Sun Life having already exited the retrocession business in Dec. of 2010. I also indicated that Manulife would not get as good a price as Sun had ("Sun & Manulife: bye bye retrocession", column No. 149, posted April 28,2011 on www. RickardsRead.com).

For readers unfamiliar with the retrocession niche of the life insurance business, here is a definition (of sorts) of 'reinsurance for reinsurers', i.e., retrocession:

an insurance company (the retrocessionaire) reinsures an amount of life insurance (retrocession) placed with it by an insurance company (the reinsurer) that has already reinsured some or most of this risk which, in turn, it has accepted from the life insurance company (the original insurer) that issued the life insurance policy for a specified amount of life insurance coverage on someone's life ( the risk).

Manulife finally found a buyer for its retrocession block -- Pacific Life based in California -- and announced with considerable 'spin' that its decision to exit the retrocession was made, as the Globe and Mail reported Manulife's spin (July 19, 2011), "in large part because Canadian insurers face tougher capital requirements than those in other countries." Sure. Perhaps those who reside in a parallel universe will find this credible, people like Manulife's board of directors who have a record of richly rewarding lousy senior executive performance (see "Manulife = another Elvis sighting", column No.143 posted March 29,2011 to RickardsRead.com).

The retrocession business has been in decline and increasingly a challenge financially for the two significant Canadian players -- Manulife and Sun Life. There are a variety of reasons for this several of which I listed in my April column. In fact, for those among the financial services paparazzi who are interested in an indication of how bad a place Manulife's retrocession business had reached, there are a couple of interesting numbers not included in Manulife's press release on which the Globe report so heavily relied.

1. Sun Life was never as large a player in the retrocession business as Manulife and indeed by 2009 had virtually disappeared from the annual company rankings of new assumed retrocession business. Sun Life sold its life retrocession business in Dec. 2010 to Berkshire Hathaway Life for a gain of $310 million after taxes. Even that sale excluded blocks of in force retrocession business that Berkshire wouldn't touch and that Sun had to retain.

2. Manulife's life insurance retrocession in force had been $97.3 billion in 2003 and stands, according to Manulife's recent media statement, at a net amount of risk in force of $106 billion (U.S.). It managed on its sale to Pacific Life to get an after tax gain of only $275 million for a much bigger in force block than Sun's. That is one indication of the Manulife retrocession block's real profitability and desirability. Moreover we don't know the dimensions of any life retro business in force that Manu couldn't sell and was forced to retain and will have to run off itself. The statement said nothing on that point but it's a good bet that Pacific Life (assuming it had genuinely expert advice about retrocession as part of its due diligence) left some of the retro blocks with Manulife, as Berkshire did in the Sun Life sale.

The Globe's July 19 article was headed "Capital rules prompt Manulife to sell division". A more informative headline would have read: 'Manulife finally gets out of a business it won't admit it should have left long since'.

I received an interesting email on the Manulife sale from an experienced senior life insurance industry executive. It is frank, informative and to the point. [My insertions are within square brackets and in italics.]

"Naive buyers are often the best buyer if you are a seller [of reinsurance retrocession], " he wrote. "The retrocession business (at least the blocks that have grown over two decades) can be like a dog turd buried in a quagmire of dung. Unless you know what you are doing and understand what you are looking for, you will end up smelling for years.

"Pacific Life is as close to a naive bidder as you could get. This [purchase] looks like a great way to fatten [ a company's] in force [of total insurance] and grow a top line and indeed, if priced right, it can be. ... I would guess that in the end Pacific Life is not as "experienced" [as Berkshire Hathaway] and thus my naive label.

"One can fall back," he concluded, "on the 'regulatory' label as a reason to sell since it is hard to challenge. The days of high flying retrocessionaires are over and the new [retrocession] business is priced way too thin or is of inferior quality and subject to more volatility. Manulife, like Sun, knew the end was here -- and not just near -- and the cash infusion helps them in other areas. [The Manulife sale is] a pure financial business decision cloaked in a regulatory guise that the press will accept and thus the story ends."

To my correspondent's comments I would add this:
Manulife's senior management took far too long to wake up to the fact that the retrocession business was turning into a problem. But this is part of a pattern; senior management's judgement ultimately brought Manulife to the edge of the financial precipice through the chasing of risky additional profits by abandoning in 2004 (as Sun Life never did) the hedging of the company's risk on the billions of variable but guaranteed annuity business that it was selling. It did so in a fashion reminiscent metaphorically of a drunk oblivious of the danger inherent in excessive consumption of alcohol.


by Alastair Rickard

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blog: www.RickardsRead.com

email: Alastair.Rickard@sympatico.ca