Wednesday, September 13, 2006

Manulife's Asia Investor Conference

BMO Capital Markets, 13 September 2006

Manulife remains Outperform-rated. One of the major reasons for our recommendation is the long-term earnings growth potential from Asia. The conference reinforced the long-term earnings potential of these operations. We believe investors should view Asia as a collection of very attractive companies at different stages of the growth cycle. Japan and Hong Kong represent the current growth stories and contribute roughly 18–-20% of consolidated earnings with above-average ROEs. The ASEAN region represents future growth opportunities, roughly 3–7 years from now and China represents a very long-term growth potential beyond 10 years. We have maintained, and continue to maintain, that Manulife's Asian footprint is second only to AIG among the global insurers.

Growing and maintaining an efficient tied agency system remains the key to developing a long-term competitive position in Asia. While the agency system remains critical, bancassurance has also emerged as an important, and fastest growing, distribution channel. The extreme case is Hong Kong where HSBC and other banks have gone from generating an immaterial amount of new life insurance sales to representing 40% of the new sales market in five years. Manulife has responded to these developments and has initiated a number of new relationships across the region and we expect to hear about more bank distribution arrangements in the future. The most successful example is the company's relationship with the Bank of Tokyo Mitsubishi UFJ in selling variable annuities in Japan.

In Asia, the company has a very successful expansion model. Since the company uses the same back office and support systems across the region (except Japan) and has well established product development skills that can be tailored to local customs, management in new territories is singularly focused on growing and staffing the agency field force. Hong Kong remains the “hub” of its Asian platform providing support functions and funding to the different regions. Moreover, the Asian and Japan division generates sufficient excess capital that is contributed to the head office for dividends, share buybacks, and acquisitions. Over the next 3 to 5 years, we would expect earnings from the Asia and Japan group to grow at much higher than average rates and increase its contribution to total consolidated earnings from roughly 20% in 2006 to 30% by 2010.

Returns and growth potential are high in Asia because there are significant risks, particularly political, currency and regulatory. It appears that with the entry of China and other Asian nations into the WTO over the last few years, that some of the political risks have diminished. However, political risks do not lurk far beneath the surface in Asia. With respect to the regulatory environment, Manulife indicated that across the region the regulatory framework continues to improve (or be less irrational). Increasingly, jurisdictions are looking at risk-based capital measures as the appropriate capital regime (similar to North American standards), a focus on consumer protection, and a more even playing field between the foreign operators and domestic competitors. We believe that these developments are positive for well-capitalized multinationals like Manulife.
Scotia Capital, 13 September 2006

• Japan has been a tremendous success story of late, with earnings up 60% (CAGR) since 2004 on a constant currency basis, after declining 6% (CAGR) from 2001 to 2003. Excluding the one-time benefit of some portfolio repositioning in 1H/06, earnings are still up 50% (CAGR) from 2004 and 70% in the first half of 2006. The growth has been fuelled by the combination of rapid growth in variable annuity assets (from nothing in 2003 to nearly US$7 billion at Q2/06), cost cutting and the re-engineering of the individual insurance business, expanding portfolio yields (JGB 10 year yields more than doubled to 1.7% over the last four years), improved agent productivity and favourable equity markets. Manulife is the #6 player in the Japanese VA market with a 9% market share. The top six players (Hartford, ING, Tokio Marine-Nichido, Sumitomo Life, Mitsui Sumitomo Met and Manulife) account for 82% of the industry market share in 2005. Industry sales growth, which was 70% in 2005 (Manulife's growth was 125%) has been spurred in part by the bank channel, which was allowed to distribute variable annuity products in late 2003. In an effort to free-up capital, Japanese domestic banks are more than happy to distribute these products, which allow them to receive a fee (via a sales commission) for "off-loading" capital intensive and low margin savings business to insurers. For a savings dominated market, still relatively risk averse, the variable annuity product is an attractive alternative to very low savings rates offered by banks. Manulife's partnership with MUFG, the world's largest bank, has clearly been a catalyst to its variable annuity growth story.

• Q3/06 VA sales will be weak, as a voluntary suspension of the company's GMWB (guaranteed minimum withdrawal benefit), due to tax reasons, will hurt growth. A replacement product will likely be released in late Q4/06. With domestic players entering the market foreigners have seen a decline in momentum. Hartford's sales were down 52% in Q2/06 and 38% in Q1/06, and Manulife's sales were up only 10% in Q2/06, after increasing 23% in Q1/06 and 125% in 2005. The product suspended, which represented about 30% of June, 2006 sales, was certainly disappointing. How quickly the company regains traction remains to be seen, but we get the impression the tax clarification process is taking longer than expected and that a re-launch of a new compliant product will be late Q4/06 as opposed to late Q3/06. Offsetting this to some extent are continued efforts to expand bank distribution beyond MUFG, with the company adding regional banks and securities dealers. The company now has 24 banks and securities dealers selling its VA product.

• Growing individual insurance sales and a productive career agency force remains Manulife's biggest challenge in Japan. Individual insurance sales have been flat at best, and are down recently (down 22% in Q2/06 and down 20% 1H/06, ex f/x), as the number of agents continues to decline, down 10% YOY in Q2/06 and down 1% QOQ. Shrinking career agency forces is an industry issue in Japan, and we note that companies that rely exclusively on this channel, like Prudential (U.S.) have had individual insurance sales decline 10% in Q2/06 and decline 13% in Q1/06. Despite Manulife's efforts to improve training, recruiting and retention rates, all in order to create a more professional sales force, we remain sceptical given the industry headwinds. That said, the company noted new recruit productivity improved in the first half of 2006 versus all of 2005 by 17%, and noted that the career sales force (3,684 agents at Q2/06) does help grow VA sales, accounting for 10% of Manulife's VA sales. Also, the fact that the company is looking to capitalize on a growing brokerage (albeit still small) channel in the industry with the recent launch of a corporate increasing term product, indicates to us the company has alternative channels through which to grow individual insurance sales.

• Big Opportunity - further deregulation in Japan will allow for the distribution of individual insurance products through banks. The strength of Manulife's MUFG relationship clearly allows for upside here. While the relationship is currently strictly on the VA side, we can safely assume Manulife is doing everything in its power to position itself as the primary carrier of individual life insurance for MUFG. In addition to the already excellent relationship, another Manulife advantage is its demonstrated strength and market share in the U.S. individual insurance market, where the company is #1 in the universal life (UL) market. It's strength and market share growth in the U.S. VA market has helped foster the relationship with MUFG in Japan, as MUFG clearly wants to partner with a company with a proven successful track record in the U.S. Manulife's UL dominance in the U.S. market becomes an excellent piece of advertising as it begins discussions with MUFG for individual insurance partnership. Clearly Manulife has much to gain from the coming deregulation, and with only 3,684 agents and little market share in the individual insurance sales through the career agency channel (#24) Manulife has little to lose.

• No significant new news from the Company's Asia division - traditionally the company's fastest growing (earnings up 20% CAGR since 2001) - we get the impression the trend will continue in the 15%-20% range going forward. The Asia division, where the company is the #2 foreign life insurer behind AIG, has an ROE "north of 20%" and continues to build critical mass in all territories. Asians are long term "savers", and life insurance, sold in the region as essentially a savings type product, clearly meets the need. Furthermore, with attractive GDP growth rates, large populations, and a very underpenetrated life insurance market, the industry is poised for success, assuming it has the all important market, political and cultural expertise. Going forward, management expects to continue to build its highly professional career agency force and leverage back office infrastructure, products and best practices across regions. We cannot argue with the success Manulife has had in executing this model in the past, based on its impressive results. With all regions now fully "in the black" we expect even more success in these under-penetrated markets, particularly those outside of Hong Kong, based on its long history in the region, its trong relationships with regulators, and its efficient cost infrastructure.

• Fast growth agency model continues to spur rapid growth in China. China is showing no signs of letting up, with the number of city licenses increases from 4 to 17 over the last two years, helped in part by the lifting of geographic restrictions by the WTO in December 2004 . Agent count has increased from 3,600 to 5,600 in one year. The company looks to breakeven in each city/territory it enters within three years, and notes that overall China is producing a profit, despite its rapid growth, helped by its industry leading 90% client persistency rate.

• Bancassurance will continue to increase but career agency remains the primary channel. Bancassurance has been a growing channel in the region, and in Hong Kong in particular it has grown faster than the career agency (in part due to HSBC's push into the Mandatory Provident Fund) such that it now accounts for 40% of industry sales in Hong Kong. We believe Manulife was somewhat reluctant to participate in this channel in the past, but is now beginning to develop the channel, not only because it's grown in importance, but also because the company inherited some banking relationships in the region from the John Hancock merger. Clearly the company sees participation in the channel as important, and over the next 3-4 years looks to increase its proportion of sales from the bank channel from 5% to 20% in Hong Kong and from 5% to 30% in Indonesia.