AIG Failure Highlights Canadian Insurer Strength

While these numbers seem large, on a relative basis compared to the size of assets these companies have, the exposure is extremely small. For instance, Manulife’s exposure represents less than half of one percent of its total $164 billion in assets.

Nevertheless, with the world’s largest insurer being essentially liquidated by the U.S. Federal Reserve, there is a lot of uneasiness about the financial health of insurance companies, and this has been reflected in a run on their stock prices. The outlook for Canadian insurers remains safe, if not outright positive.

“I would say overall I’m finding Canadian insurer exposures are very manageable and are to the operating subsidiary level of AIG, which are relatively concrete assets that are financially sound, as opposed to assets of the AIG holding company, which are probably worthless at this point in time,” says Juliette John, manager of the $190 million Bissett Canadian Dividend Fund.

John says there will be some general industry spillover from AIG’s failure, which will result in tighter credit conditions, forcing insurers to increase their cash reserves to meet regulatory and credit standards.

Even so, she says the capitalization of Canadian insurers is strong enough that they shouldn’t experience any long-term impact on their operational performance.

Andre-Philippe Hardy, a financial services sector analyst with RBC Capital Markets, actually favours Canadian insurer stocks over Canadian bank stocks. In his latest research report he puts an “outperform” rating on Sun Life and Manulife for the 12-month target price of $40 a share.

In particular, Hardy outlines in the report that Manulife, which is now North America’s largest insurer by market capitalization, has the fiscal strength to actually go out and make acquisitions in this market. It is widely speculated that this may include some of AIG’s lucrative subsidiaries, like its U.S variable annuities business.

“The company remains well positioned to make acquisitions if attractive opportunities arise,” he notes. “AIG was the largest writer of U.S. variable annuities in 2007 (11.8% market share), while Manulife was second with 8.6%. Manulife is in a strong position to acquire these assets, in our view, given its existing expertise and scale in the market, and would likely be interested.”

Manulife is one of the stocks that Martin Hubbes, chief investment officer for AGF Funds, says he’s confident about holding onto.

“Overall I think the [Canadian insurers] are in good shape. Manulife has the opportunity to make acquisitions as more troubled companies have to shed good assets. It’s a good time to be in this type of market with a good balance sheet,” he says.

Hubbes is hesitant to recommend investors look at buying financial stocks. He says the intervention of the Fed to stabilize financial markets is a good sign, but he says a lack of transparency in financial markets, along with a considerably high spread on inter-bank lending, makes adding to financial stocks a risky proposition.

“I’m very nervous about calling a bottom. Things seem to have stabilized, because a lot of players were able to get short-term financing [from the Fed]. We still need financial institutions to lend to each other,” he says.

The TED spread, which is the difference between the three-month yield on a U.S. Treasury and London Interbank Offered Rate (LIBOR), was at its highest level on Wednesday since the stock market crash of 1987, according to some reports. Hubbes says the TED spread needs to come down before any clear sense of stability can return to the markets. He believes the best course of action for investors right now is to “stay the course” on their investments and avoid trying to time the market.

“We need to see those TED spreads decrease. We need to see the banks lending to each other and we need the banks to start lending to end consumers,” he says. “If you want to be buying financial stocks, you have to ask yourself how much risk you want to take. I don’t need to take that risk. My job [right now] is to find all the things that can go wrong with my clients’ investments. With my positions in companies like Manulife or the Bank of Nova Scotia, I’m very comfortable holding them long term.”

Probably the biggest vote of confidence about our insurers comes from the Office of the Superintendent of Financial Institutions (OSFI), primary regulator that monitors their risk and capitalization levels. OSFI says it’s “closely monitoring the federally-regulated financial institutions that are maintaining their required regulatory capital levels.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com.