No one knows better than insurers how hard it is to preserve capital in a low-rate, high-volatility environment. They must use multiple strategies to maintain the high capital requirements needed to cover claims.

Amid the retreat in average bond yields, Halina von dem Hagen, executive vice-president of treasury and capital management at Manulife, says the insurer maintains capital by hedging, repositioning or repricing products, and through proactive management, including asset acquisition.

Changes to products and pricing

Edward Gibson, senior vice-president and chief actuary of Empire Life, says, “Prices of longer-term products have been significantly affected over the last several years from the drop in bond yields, particularly at the long end of the yield curve.” T-100 and universal life level-cost-of-insurance premium rates have increased more than 30% since 2008, he explains, which “more than offsets the reduction in mortality rates over that time period.”

Von dem Hagen adds: “We don’t seek spreads [by] going down the [credit] curve; we wouldn’t compromise the […] creditworthiness of bonds and fixed income portfolios we hold.” Instead, she says, “we’ve curtailed [or] eliminated sales of products with long-term guarantees,” such as whole life products with secondary guarantees and variable and fixed deferred annuities.

On top of that, growth in assets has improved income. From Q4 2007 to Q4 2015, the average yield on the firm’s bond assets fell from 5.5% to 3.6%, but growth in assets helped investment income on bond assets to rise 42% over the Q4 2007 to Q4 2015 period, von dem Hagen says.

René Chabot, executive vice-president, CFO and chief actuary at IA Financial Group, says the company assumes rates will remain low. “You reshape your product line and promote [products with] the lowest guarantees in your portfolio,” he says.

The insurer has successfully promoted its cheaper, lower-guarantee segregated fund, which saw an increase in sales of 16.9% between 2014 and 2015, and an increase of 36.9% between 2013 and 2014. “There have been four rounds of [life insurance] price increases in Canada over the last five years or so,” adds Chabot. “The jury’s still out […] to what extent [IA] will react” to continuing low interest rates by raising premiums. (Canadian insurers are expected to increase prices as new tax rules for universal life products come into force in January).

Gibson is also taking a cautious approach. “Because we have longer-term products,” he explains, “we [in the insurance industry] wait and see” whether an economic development is temporary or permanent. Early movers tend to sell fewer insurance policies, he says.

Chabot says a consumer shift toward cheaper, term life insurance is positive for capital. “Term product is a pure mortality product rather than an interest rate product,” he says. Adds Gibson, “Improvement in mortality […] put[s] downward price pressure on term insurance products.” As people continue to live longer, fewer insurance claims are paid out in a given term.

Companies are also making customer service changes in an attempt to boost sales. Empire Life, for example, has a streamlined online application process, and Manulife developed an interactive telephone voice response system, allowing customers’ voices to be their passwords for authentication.

Capital management and asset allocations

Though low rates negatively affect capital on the insurance side, they present opportunities on the issuing side. Manulife recently boosted its capital position by issuing bonds in the U.S., Singapore and Taiwan. “We went long term to take advantage of current rates,” says von dem Hagen. The debt refinances maturing or callable instruments and supports business needs.

“Our recent issuances are an important part of our global strategy to diversify funding sources and expand our investor base,” says von dem Hagen.

For its part, IA acquired capital-light businesses; they pose little rate risk because there’s no guarantee required. In the last five to 10 years, for example, the company has acquired wealth management businesses. With mutual funds, “if the interest rate moves,” says Chabot, “all the risk is passed to the client, so there’s no impact on our balance sheet.”

Other capital-light businesses have also been acquired, such as vehicle financing in 2015 and a move into the U.S. final expense market, or insurance to cover funeral costs, in 2010. “More contribution from all your other segments on the capital-light side […] better calibrate[s] the overall equation of your company,” says Chabot.

MCCSR ratios as of Q2 2016

Company Ratio
Industrial Alliance 199% (guidance: 175%–200%)
Empire Life 213%
Manulife 236%

What hasn’t changed is insurers’ typical bond to equity asset allocation, with the heavier slice allocated in bonds. For some, the allocation is 70% to 30%, while others might use 85% to 15%. “Matching high-quality fixed income assets […] with a well-diversified portfolio of non-fixed income assets has been our strategy for quite some time now,” says von dem Hagen.

Gibson says, “Assets are chosen based on their cash flow profile and are matched to the expected cash outflows [of] our policy liabilities.” For Empire Life, that means mostly provincial government and corporate bonds with a relatively small position in mortgages (about 4%). Equity is largely Canadian common shares, with some U.S. exposure.

IA increased its corporate bonds—an area the company usually underweights. “We have historically been more conservative than our peers,” says Chabot. Now the company’s closer to the industry average, having reduced government bonds and mortgages, and diversified outside Quebec.

Long-term equities are meant to support long-term liabilities. Von dem Hagen says alternative long-duration assets are Manulife’s “unique competency.”

“We hold a well-diversified portfolio of these assets, such as real estate, oil and gas, agriculture [and] timber […] to offer an attractive return to our policyholders and shareholders,” she says.

IA also diversified its equities—typically about 20% common stock and 10% real estate—to avoid volatility. “We started in market indexes, holding, for example, the TSX,” says Chabot, but then moved to high-dividend stocks. The company also diversified into the U.S., then decided to split stock holdings among public equity (about half of stock holdings), private equity (about a quarter) and U.S. infrastructure (another quarter).

“Infrastructure investments generate long-tailed cash flows that more closely match the duration of policyholder liabilities and minimize reinvestment risk,” says Chabot. Further, “the infrastructure piece was very interesting because it’s a natural inverse relation to interest rates,” he says, explaining how a lower discount rate improves the value of infrastructure on the balance sheet.

The impacts on long-term equities of potential market downturns are assessed every quarter, says Gibson, through a sensitivity test.

IA has calculated, as of June 2016, that the stock market can drop 30%, or interest rates can incur a further drop of 30 bps, before reserve strengthening is needed. “This protection gives us time during the year to execute investment gains or asset management strategies that can be used, if necessary, for reserve strengthening at year-end,” says Chabot.


Manulife uses a combination of dynamic and macro hedging strategies to mitigate its public equity risk. For interest rate risk, interest rate swaps are used.

IA also uses dynamic hedging for its segregated fund. “Our hedging strategy is covering interest rate risk, equity risk and currency exposure,” says Chabot.

Empire Life aims to protect 10% to 20% of overall income and equity risk through hedging. “Our program is comprised of put options and short positions on equity indices, and it’s primarily Canadian, because that’s where most of our exposure is,” says Gibson.

Regulatory capital requirements for insurers

A high capital ratio indicates a long-term ability to pay insurance claims.

“When we manage capital, we look proactively at what’s ahead over the next few quarters,” says Halina von dem Hagen, executive vice-president of treasury and capital management at Manulife. “One has to consider calls or maturities that are in the pipeline.”

Balancing those are Manulife’s recent acquisitions of Standard Life’s Canadian operations, New York Life’s RPS business and the Hong Kong pension businesses from Standard Chartered Bank. It also reached a distribution deal with DBS, the largest bank in Singapore.

The capital ratio is set by the Office of the Superintendent of Financial Institutions (OSFI) and measured using the minimum continuing capital and surplus requirements (MCCSR) guideline. MCCSR must be at least 120%, with a target of at least 150%. (In Quebec, Autorité des marchés financiers sets capital guidelines.)