Long-term care exposure is a growing concern for investors of insurance and financial service provider Manulife Financial Corp. (MFC) - Get Report and insurance company Unum Group (UNM) - Get Report , both of which report earnings this week, as the liabilities pose a risk to profits. Due to stricter regulations in Canada, however, Toronto-based Manulife may be in better shape to handle LTC obligations, according to analysts.
"[Manulife] currently holds $34 billion in [long-term care] reserves, $11 billion of which are [provision for adverse deviations]," TD Securities analyst Mario Mendonca said this month. "[Canadian GAAP] reserves are 30% higher than U.S. statutory reserves and, importantly, statutory reserves are generally higher than U.S. GAAP reserves."
Manulife's reserves are more conservative than its U.S.-based peers because Canadian GAAP requires insurers to "build reserves sufficient to create a margin (PFADs) over best estimate assumptions while U.S. GAAP only requires that reserves eliminate negative margins," Mendonca said. A PFAD is a specific amount to make some provision for uncertainty in an asset or liability.
The Chattanooga, Tenn.-based Unum, meanwhile, "has implied that if interest rates increase, this may help them avoid a charge in 2018 and that if they do take a charge, it should be a non-cash GAAP only charge, with statutory reserves currently $1 billion larger than GAAP," Evercore ISI analyst Thomas Gallagher said in March. "Despite the increase in interest rates, we think pressure on claim durations still raises the risk of a charge this year for UNM."
Evercore lowered its price target from $58 to $48 in March.
Investors are monitoring insurers' long-term care, or LTC, business after Boston-based General Electric Co.
(GE) - Get Report took a $6.2 billion after-tax charge during the fourth quarter and committed to contributing $15 billion over the next six years to bolster its legacy insurance portfolio. LTC reserves are under pressure because of the extension of claim durations with cognitive impaired claimants living longer, Gallaher said. Still, the magnitude of GE's charge shocked not only GE investors but the broader LTC market.
Steven Finch, the chief actuary at Manulife, said in February that "the size of the charge GE announced I think was very notable to many in the market."
When compared to GE, Manulife's $11 billion in reserves designated for PFADs put the company "closer to adequacy," Evercore's Gallagher said in March.
The Toronto-based insurance company with a market capitalization of $37.8 billion merged in 2004 with John Hancock Financial Services, one of the largest long-term care insurance providers in the U.S. While 1.2 million outstanding long-term care policies remain in effect, John Hancock said in late 2016 that it would no longer sell any new policies.
Manulife followed suit in November 2017, announcing that it will cease selling new individual long-term care insurance policies in Canada as of Nov. 30.
The company conducts comprehensive LTC assumption reviews every three years, the last of which was in 2016, said TD Securities' Mendonca. That year, Manulife booked a $452 million charge related to its LTC business.
"Barring any material change in LTC experience (recent experience has been modest), we do not expect MFC to review LTC assumptions until 2019," Mendonca said.
Though Manulife's long-term care business is more stable than most insurers, Evercore's Gallagher said this month, the company reinsures two blocks, Time Insurance and Union Security, which have "showed year over year deterioration."
At Time Insurance, which has $1.5 billion of assumed statutory reserves, actual to expected claims experience increased from 190% to 216% this year and incurred claims increased 23%. Pertaining to Union Security, which has $1.8 billion of assumed reserves, actual to expected claims experience increased to 180%, compared to 145% a year ago, and incurred claims rose 21% year over year.
While investors will be scrutinizing Manulife's long-term care obligations in the upcoming earnings report, they will also be looking for possible updates on divesting the LTC business. At the June 2017 Investor Day meeting, Chief Executive Officer Roy Gori said all options, including divestitures, will be considered when it comes to unprofitable businesses. That being said, there is little interest in the LTC business given the steep obligations.
"Manulife Financial executives have said they are considering a sale of the long-term care insurance business, which had $40 billion in liabilities for its 1.2 million long-term care policies in 2015, the last year for which public figures are available," Capitol Forum, a Washington, D.C.-based research firm, said in a March 20 report. "But few companies with insurance experience would be interested in assuming the responsibility of paying out benefits on unprofitable policies for nursing-home and other assisted care, insurance and financial experts said."
Unum's CEO Richard McKenney also entertained the idea of selling off the company's LTC Closed Block but has yet to do so. The U.S.-based Unum, like Manulife, has stopped selling new group or individual LTC policies but remains committed to all current policyholders.
"Over the last 10 years, we've been looking about how we cannot be in this business," McKenney said at the Bank of America Merrill Lynch Insurance Conference in February. "But when it comes to buyers and sellers meeting, we just don't see that world today."
"Over the long-term care side, you just don't have buyers meeting sellers there at scale," he continued.
While there appears to be some interest in deals by potential buyers and reinsurers of LTC blocks, analysts at Evercore ISI noted in March, it is not a seller's market for the LTC business.
"Bid-ask spreads remain too wide as a result of morbidity improvement assumptions companies use in reserves and rate increase assumptions embedded in reserves," Evercore analyst Thomas Gallagher said following the annual Intercompany Long-Term Care Insurance Conference conference in March. "It is our sense that buyers are not willing to assume both of these items, and companies are not willing to make the required reserve increases to bridge the gap."
Unum executives tried to reassure analysts during Unum's February conference call discussing fourth quarter 2017 financial results that the company's large closed block of long-term insurance is nothing like GE's.
"We feel like we are in a very different place than GE is," Jack McGarry, Unum's chief financial officer, told analysts. "GE's block was a reinsured block, which removes them one step from the customer. Our block was direct written. So we directly control the underwriting and benefit guidelines in that block."
McGarry said that Unum has "aggressively and actively" managed the LTC insurance block and strengthened its reserves by $4 billion.
Despite McGarry's comments, analysts said that Unum may have to book an LTC-related charge this year or next.
"[Unum] did not take a charge in [the fourth quarter of 2017] because the company is still investing new money in assets backing LTC liabilities at yields in line with company assumptions set in 2014 (new money rates of 5% for the ensuing four to five years, then over the following five years, a grade back toward a long-term average of the 6.50% to 6.75%)," Wells Fargo analyst Sean Dargan said following the earnings release. "While the recent hike in long-term yields will help, unless rates move further from here it appears that UNM will have to take a charge at the end of 2018 or 2019."
Dargan also highlighted the LTC interest-adjusted loss ratio of 93.1%, which he said could reflect normal volatility or it could indicate claims experience is worsening.
Investors will get a clearer picture of how the long-term care obligations stand when Unum and Manulife report quarterly earnings on May 1 and May 2, respectively. Analysts surveyed by FactSet Research Systems Inc. expect Unum to report earnings of $1.25 per share on revenue of $2.88 billion. Manulife, meanwhile, is forecast to post earnings of 62 cents per share.