Manulife paying price for lack of hedging

Manulife Financial Corp.’s pre-crisis decision to scrimp on hedging for its variable annuities book appears to be coming back to haunt the Canadian company. The lack of hedging forced the insurer to pony up cash in the fourth quarter in a bid to protect against rising interest rates and equity market volatility.
From Oct. 1 to Dec. 31, the insurer shorted about $5 billion of equity futures contracts to hedge against equity risk exposure to the company’s balance sheet. It also added $800 million of in-force variable annuity guaranteed value to bolster its dynamic VA hedging program. In addition, Manulife sold $200 million in on-balance-sheet public equities that are backing insurance liabilities.
The insurer also traded out of short-duration bonds into longer bonds and invested cash to reduce interest rate risk.
These recent moves stand in stark contrast to the actions of other carriers. Most took their lumps early on — specifically, in 2008 and 2009 — by raising reserves for their variable annuity obligations. Many had started years earlier to hedge against market volatility.
“Hedging for variable annuity risk is imperfect and expensive,” said Peter Routledge, director of equity research for banks and life insurers at National Bank Financial Inc. “[Manulife’s] appetite for equity market risk was not sensible, given that they didn’t hedge between 2004 and 2008 when other U.S life companies were writing and hedging.”
The insurer is in the middle of a four-year plan to lessen its exposure to market gyrations. The recent moves bring the carrier closer to its midpoint goal.
The maneuvers are not without a cost.
“Lowering sensitivity has a cost in the immediate quarter and lowers upside available to Manulife if rates rise,” Mr. Routledge added. “You’re taking away the upside right as the party is starting.”
The insurer aims to hedge about 60% of its exposure to equity market risk by the end of 2012. It plans to boost that protection to about 75% by 2014.
Manulife is aiming for a 25% reduction in interest rate exposure by the end of 2012, rising to 50% by 2014.
“The important thing,” said a company spokesperson, “is that investors are congratulating us for the work we’re doing here and giving a vote of confidence behind the work management is doing to fix the problem.”