Fewer features, higher fees future for GMWBs: Manulife

While guaranteed minimum withdrawal benefit funds have been a huge hit in the Canadian marketplace, at least one company isn’t looking to gain shelf space anytime soon.

“We’re not excited about gaining market share until the product is more compatible with where we’re headed,” Manulife senior executive vice-present and chief financial officer Peter Rubenovitch told the 34th annual conference of the Association of Insurance and Financial Analysts in Scottsdale, Arizona, yesterday. “We are now clearly, as many others are, refining out product, ratcheting down our enthusiasm and certainly increasing our prices.”

GMWBs offered through segregated funds and variable annuities, which have much in common with Canadian-style segregated funds and which Manulife sells through John Hancock in the U.S., have to be refined so that there’s less volatility for the manufacturer as well as better pricing. That means some tinkering in the area of bonuses and rests, he suggests, as well as a focus on hedging risk.

“We started to put new-generation products on the shelf, much like our peers, and started offering withdrawal benefits around 2003. I think the 2004–2007 period is where we differentiated ourselves — in hindsight, unfavourably — by assuming more of the risk than most of our competitors. There were more features in these products — I think they probably weren’t charged adequate fees for the optionality embedded in them — and they were somewhat difficult to hedge, although we’ve had very limited hedging, virtually none in that period, as we have a diversified, large business and felt that the exposure was something that we could absorb.”

With dismal equity markets in 2008, Manulife had to put 10 times as much capital aside — more than $5 billion — at least temporarily, to fund the guarantees on its segregated fund and variable annuity lineup.

“In fact, in ’08 and ’09, as we saw, equity markets declined quite sharply; it’s had a marked impact on our reported earnings and our capital levels, certainly outside of the range of scenarios that we were anticipating when it came to risk,” he says.

As a result, the existing book of guaranteed products “is not, at the current time, particularly attractive or a big contributor to earnings,” Rubenovitch notes. It’s not a dead loss, but profits will be modest, or “break-even,” he adds. Still, “GMWBs with less features and rising fees are likely to continue to be attractive but will have to be re-priced by us and the industry.”

A key issue for Manulife is hedging against equity market risk. “Why were we surprised? If you look at the distribution of returns the S&P has provided since 1825, you can see that last year was only worse in one year in that entire time frame,” Rubenovitch explains.

“The scalar, if you will, of scenarios that we felt we could withstand didn’t include an event that was as extreme as last year and although we could withstand it, we couldn’t withstand it with the same impunity we were anticipating.”

Candidly, he admits, “We felt that retaining the risk would give us a little more volatility and a little more return. It gave us a lot more volatility and considerably less return.”

While Manulife began hedging in November 2007, some assets are hard to hedge, and customized option contracts are expensive. “We may pay for something and find we don’t get it. Options, for example, provide you with more coverage at a high cost but with a lot of counterparty credit risk. So we’re generally looking at exchange-traded contracts. We do have some other elements that we are considering. That’s our current program. It’s performing very, very well. On those elements that we’re seeking to hedge, we’re generally getting 85% efficiency in the worst markets.”

The GMWB market is still attractive, Rubenovitch says. But there will be higher fees. There will be fewer features, such as bonuses and rests in guaranteed payouts. There will be fewer pure equity plays and a shift to passively managed index funds that are easier to hedge.

“We’re continuing to set up a focus on setting up lower levels of equity components, higher proportions of bond funds and less step-ups and features so that we have a product that the customer still gets value from but we can still afford to protect and hedge,” he says.

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com