Tuesday, September 30, 2014
(No.273) "Manulife's purchase of Standard Life of Canada: sensible or not?"
"Manulife buys Standard Life's Canadian operation:
some comments about obsequious insincerity and other matters"
by Alastair Rickard
I have written a number of RickardsRead.com columns with Manufacturers Life (Manulife), the Toronto-based Canadian life insurance company, as a subject. Going further back I wrote a good deal more about Manulife in issues of my Canadian Journal of Life Insurance [CJLI].
Therefore I was not surprised to receive a couple of requests to share my views about the purchase for $4 billion by Manulife of the Canadian subsidiary of Standard Life of Edinburgh. a transaction to be completed early in 2015.
I have never stood among those members of the media or life insurance industry who would cheer the supposed superior activity while ignoring the deficiencies of Manulife and its senior management. As editor of CJLI I once gave the then CEO of Manulife the Sir Mackenzie Bowell Award. It was an award I created specifically to recognize an absence of excellence by someone in the Canadian life insurance industry. I named it so because Bowell (an Orangeman from Belleville Ontario) is arguably the least distinguished prime minister (1894-96) in Canada's history.
Had I still been bestowing the award post-2008 when Manulife ended up in a financial ditch I would almost certainly have given it to the company's then CEO Dominic D'Alessandro.
As for Standard Life's Canadian operation long based in Montreal I formerly had a somewhat higher regard for it than I have in more recent years.
Standard, a mutual company long based in Scotland, had successfully resisted in 2000 and in 2003 attempts by two different carpet-baggers to force its demutualization. However that changed in 2006 when Standard in Edinburgh finally succumbed -- as the result of altered financial regulatory requirements combined with poor management and inferior performance -- to pressure to change from a mutual to a stock company.
The Canadian operation of Standard Life had already been changed by Edinburgh from a branch operation to a subsidiary. Even before that Edinburgh had tried unsuccessfully to 'patriate' a big chunk of the Canadian branch's surplus.
Standard's Canadian operation had much to recommend it at one time including some quality people in management. Also I confess to having a soft spot for Standard Life's Canadian operation if only because the real starting point of the life insurance business in Canada can be dated from the appointment by Standard Life in the 1830s of an agent in Quebec City.
Not so long ago Standard's Canadian operation gave up competing even for its declining share of the individual life insurance business in this country. Here Standard had long operated a career agency distribution system, then gave it up (like many other life companies) in favour of chasing individual life sales via brokerage. That was thought to require the offering of products carrying certain features with high up front commissions.
There was a significant distribution-related life insurance policy fraud on companies some years ago in Ontario, the investigation of which (dubbed Operation Lion as I recall) reached a certain point and was quietly shelved in order -- as far as I could determine at the time -- to avoid public embarrassment of both regulators and certain life insurance companies taken in by some unscrupulous sales people. They had taken advantage of policy designs and compensation ready made by companies to be taken advantage of.
Because of Standard's then product and high early commission system designed to attract brokerage sales, it was a company that would certainly have stood out as a leading example of victimization had there been any any real media coverage of Operation Lion.
In the modern era Standard's Canadian operation has long been more successful as an asset product/pensions/group player than as a player in the individual insurance business. Therefore, insofar as Manulife is seeking to bulk up its individual life business in Canada, the addition of Standard's Canadian subsidiary won't do much except for the addition of what's left of its declining block of in force individual life insurance policies.
Leaving to one side the price to be paid for the Standard business here it does make sense for Manulife to add substance to its operation in Canada (and especially in Quebec) where, given intelligent product pricing and distribution -- and in Manu's case that is hardly a given -- the company can add some real profits to supplement its excessive focus on chasing 'pie in the sky by and by' profits outside Canada.
For an excellent recent example of the potential financial benefit to a Canadian life insurance company's bottom line from an appropriate acquisition in Canada one need look no further than the reliably significant proportion of Sun Life's annual worldwide profits arising from its Canadian operation after it acquired Mutual Life/Clarica Life's Canadian operation in 2002 with its leading, national career agency system, an effective national distribution system for both insurance and asset products.
As both an industry 'insider' as well as an editorial critic of the life insurance business I have long been sceptical about the actual basis and degree of substance behind certain of the revenue/profit numbers from the foreign operations (especially in Asia) of North American life insurance companies. There is nothing quite so malleable as the actual and especially projected numbers involving product pricing and distribution and retention in some foreign markets put out by some life companies.
One example: I remember one senior Manulife executive confiding to me what a real mess a particular Asian operation of the company was while what I could read regularly in the financial press (as their 'reporting') was the Manulife spin of how great things were in that very operation. And of course there is always the possibility in a company's numbers of the inflation of profit figures through unrealistic product pricing, distribution costs and other self-serving assumptions. Of course some in a company's senior management inevitably respond that a life company's actuaries are entitled to make assumptions. Rather weak tea.
While the Manulife attempt to bulk up in Canada makes sense, the $4 billion price it is paying for Standard's Canadian operation seems excessive to me. In terms of real value going forward in the Canadian market there is no comparison with what Sun Life obtained to boost its market presence in Canada from its purchase of Clarica Life (the demutualized Mutual Life of Canada) in terms of size, quantity, quality, diversity, market position in every province and most significantly a very large national proprietary distribution system.
Of course there is precedent provided by Manulife itself for paying too much for an acquisition. Manu received the sort of uncritical media attention to which it became accustomed prior to its entry into the financial ditch ca 2008 when it bought John Hancock Life for $10.3 billion in stock in 2003. Hancock, formerly a mutual company, had demutualized in 2000.
At the time Manulife bought John Hancock I was far from being an industry loner in my view that Manulife overpaid for John Hancock. Indeed when Manulife bought the 141 year old Boston-based company there was a view held by more than a few within the industry that Manu had bought a company in decline.
Nor was I alone in being amused by Manu going round to American state insurance regulators within a a comparatively short period of time pleading its case for a 40% average raise in the premiums on its (i.e., Hancock's) in force Long Term Care policies (in some cases a 90% increase ws needed). The sale of LTC business was something Hancock pursued with the sort of vigour, poor judgement and questionable basis that Manulife itself later did involving the promotion and sale of that oxymoronic product: the guaranteed variable annuity.
It wasn't all that long before Hancock's enthusiastic leap into the LTC market was shown to be (to those who actually wanted to take notice) less than fortunate: its group LTC premiums had been increased by 25% in 2009, having already jumped 14% the previous year. For a sense of the magnitude of the Hancock LTC mess (amongst other facets of Hancock's operation) for which Manu had overpaid not long before the U.S. LTC market, pricing and claims really tanked, consider that by 2010 Hancock had 1.2 million LTC customers with seriously underpriced coverage and had already paid out more than $3 billion in LTC claims on just a small fraction of the coverage it had sold.
Boys and girls: can you write a sentence including the words "have you done your due diligence"?
One of the problems with much of the 'expert' analysis of life insurance companies and their operations is the often inadequate understanding of the realities of the business, including the failure to understand the importance to a company's mix of new and in force individual business of product design, pricing and distribution. Let me repeat for the umpteenth time in a RickardsRead column: active life insurance companies are in the business of selling stuff.
Manulife provides a case in point. Before Manu hit the financial ditch following the 2008 financial meltdown in the U.S. you would rarely see anything in the media or from 'experts' about Manulife that wasn't favourable. More often than not so-called analysis was laudatory, even after Manu stopped in 2004 hedging the huge risk associated with its sales tsunami of variable policies.
What is the real story behind Manulife's financial crisis?
The root cause was not the Wall Street-related financial meltdown. It was not even the fact that Manulife ceased hedging its variable annuity risk in order to increase company profits and hence senior management's already excessive compensation.
The Manulife financial problem's root cause was the absolute stupidity of senior management in proceeding to sell truckloads of variable rate product with contractually guaranteed rates of return (and moreover highly unrealistic rates over the longer terms involved in these policies). Many people experienced in the business and not willfully blinded by visions of corporate executives' sugar plums or easy commissions knew this and acknowledged the risks -- at least among themselves.
After the financial heifer dust hit the fan at Manulife it did not take long for the company's top management to go crying to Ottawa begging for regulatory relief to help provide a bit of traction with which to try to extricate the company from a financial mess of its own making. Manu's senior management got substantially less assistance than was wanted -- and rightly so.
This sort of corporate tale is only one example out of many of misguided management in financial services. The careers of too many CEOs contain far more financial compensation than achievement.
In my experience and observation some of the lousiest decisions made in the financial services business have been prompted by a couple of tendencies. Warren Buffet has remarked on one of them: people in the financial community would rather be wrong as a group than right on their own. This feeds the other tendency.
Career management considerations by executives are too often the first priority when offering opinion within the councils of a company. Indeed for too many executives the best personal tool to be relied upon is obsequious insincerity. It has certainly assisted some would be CEOs to clamber up the greasy pole.
Executive rank has been shown again and again to be no prophylactic against the allure of bad ideas. While every senior executive in a life insurance company has the right to be mediocre even stupid some have certainly abused the privilege.
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