Wednesday, August 15, 2012

(No.211) Sun Life, Manulife & the Kabuki theatre of expectations


"Sun Life, Manulife and the Kabuki theatre of gerrymandered expectations"

by Alastair Rickard


It is time once again for the spin and response involving quarterly financial results for two publicly traded companies that particularly interest me: Sun Life Financial and Manufacturers Life, both of Toronto and constituting two of the three largest Canadian life insurance companies.

The New York Times, referring to reporting of corporate quarterly results, recently offered a warning "not to get swept away by the Kabuki theatre of gerrymandered expectations." It noted that these results are often "lathered up with the companies' spin, (making) the exercise more like a Rorschach test for reporters: what they see is what they think they see."

Some observers trace such problems with lack of clarity back to the dot-com boom when tech companies seemed to convince many analysts and financial reporters that 'net income' wasn't as important as their half-baked 'new metrics' of corporate performance.

I think this criticism has much to recommend it.

A recent Duke University survey of the chief financial officers of 169 publicly traded U.S. companies showed that the CFOs think about 20% of companies 'adjust' their earnings statements " to misrepresent economic performance". Indeed this survey reminds me of one to which I have referred in this column: the anonymous survey of life insurance actuaries in which a large majority thought much life insurance pricing is unsound.

This pattern in the reporting of earnings/results has set up a sort of quarterly dance involving journalists, one often joined (notes The Times) by analysts "who try to forecast quarterly results, and the companies which provide guidance to them." Some analysts will give pessimistic predictions of results and then "positive surprises follow when the actual results are announced. The press often collaborates in this exercise by couching the results as a win, even if the quarter was lousy."

This is where the Kabuki theatre analogy really comes into play. Indeed all of these dance steps were on display last week in the media reporting of quarterly results of Sun and Manulife and the concomitant 'expert' opinion of various analysts.

The Globe and Mail's Report on Business reported (Aug.9) that Sun Life's profit per share (9 cents) exceeded analysts' expectations (8 cents) but the Financial Post said (also Aug.9) that Sun had "missed analysts' expectations by a wide margin".

The media reports and their quoted experts once again maintained an overwhelming focus relating the companies' quarterly results to low interest rates and weak equity markets -- the usual suspects.  There were Sun's reduced earnings of $59 million net operating income down from $425 million in Q2 2011 while Manulife's Q2 loss of $300 million was, the Financial Post reported, "better than the shortfall ... expected by analysts."

Sounds familiar, as does this reference to Manu's $677 million charge to "revalue long term investment assumptions but the results beat analysts' expectations" apparently because the charge "was slightly smaller than expected". Why? Perhaps because Manulife's spin in advance of its Q2 results was that the charge would be in the $700 - $800 million range.

Oh and let's not overlook a commonplace in the coverage of Sun and Manulife: how they and their media partners in this symbiotic relationship return each quarter to portentous references to the companies' Asian operations as if these had somehow endowed the companies with the keys to the Royal Canadian Mint, senior management only awaiting receipt of le mot juste to unlock the vault door. But best to ignore the fact that the key doesn't always work (e.g., Sun Life's Q2 operating net income of $15 million from its Asian operations compared to Q2 Canadian operations of $186 million).  

One problem with this sort of quarterly Kabuki theatre performance is that it can leave investors (and policyholders) less than clear about a key company reality:  how effectively does it operate the actual business of a life insurance company in Canada and elsewhere ?

Now, we hear endlessly about the negative impact of low interest rates, equity markets etc on a company's earnings. What does not get rehearsed or even mentioned most of the time is why this magnitude of negative financial impact came to be felt by the company, about its connection to how the core business was operated: i.e., how the company went about 'selling stuff' and the pricing and soundness of what it sold and how it was sold.

Too bad the financial media and the industry analysts had not paid rather less attention previously to company spin and more to the implications of what Sun Life and especially Manulife were actually doing in their marketplaces in product terms when they followed:
(1)  a risky over-emphasis on pushing the sale of truckloads of variable policies, while
(2) increasing that risk exponentially by offering unrealistic guaranteed returns on this variable business, and
(3) in Manulife's case, the absolutely looney strategy (in wild pursuit of enhanced profits and greater senior executive compensation) of putting zillions of this doubly risky business on the books and leaving it unhedged from 2004.

One of my continuing themes in these columns and elsewhere has been the need for the life insurance industry's commentators (and yes, many of its senior executives too) to spend more time actually looking at and thinking about the actual business they are supposed to be operating. It is important, for instance, for commentators of all stripes to attach the appropriate significance and provide context to statements about, for example, the company's product design and pricing.

For example, this from Sun Life's Q2 2012 Financial Report in the section reporting on its Canadian operation (the most consistently important source of company profit for years post-acquisition of Mutual Life/Clarica Life): Sun "is making changes in the third quarter of 2012 to further de-risk [sic] its individual insurance and investments products, including price guarantee reductions ...."

Translation: Sun Life is continuing the long overdue process we began awhile ago to stop selling stuff some executives in the company unwisely thought made sense (when we were trying to impress the market with growth in the volume of topline sales rather than a smaller volume of sales which were actually profitable). It was product which was stupid to sell in the first place because of its under-pricing or trendy but ultimately unsound design or both. We will concentrate on selling more product that generates ROE margins that may not be as spectacular as we once expected would be the case with the 'guaranteed variable' stuff that's now eating even Sun's financially hedged lunch. As policies they need to be predictable and reliable, and can be when you have (as we do in Canada) your own quality, proprietary career agency distribution system on which you can rely to deliver sales.

Finally, midst all the spin to be seen during the quarterly performance of the Kubuki theatre, I was pleased to note the comment from an analyst who actually seems to have his eye on the right life insurance industry ball. John Kinsey, portfolio manager at Caldwell Securities, told the Toronto Star (Aug.10) that "I think for these [two life insurance] companies you have to use some common sense and look at their main business and how it did. How are they doing in Asia and with their core business? Is it competitive? Have costs gone up? Eventually the equity and interest rate factors will just settle out."

In other words: common sense tells one to look at the business these companies are in and how well they operate them.

To which I can only say 'amen'.

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email: Alastair.Rickard@sympatico.ca

blog: www.RickardsRead.com

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