Manulife's bancassurance agreement with DBS Bank is credit negative: Moody's

LAST Wednesday, Manulife Financial Corporation (MFC, unrated), parent of Manufacturers Life Insurance Company (MLI, financial strength A1 stable), and DBS Bank Ltd (DBS, Aa1/Aa1 stable, aa3) announced that they had reached a 15-year regional distribution agreement covering four mutually significant markets: Singapore, Hong Kong, China and Indonesia.

MFC will pay an initial fee of $1.2 billion when the deal closes and make ongoing variable payments based on distribution volumes. The initial payment will be funded internally and reduce MLI's minimum continuing capital and surplus requirement (MCCSR) by 10 percentage points. MLI's MCCSR was 248 per cent at 31 December 2014.

This agreement is credit negative because Asian expansion is dilutive to MFC's core strength: its strong market presence in its home market of Canada. MFC's home market is highly concentrated and provides scale, recurring earnings power and considerable pricing power. This favourable industry structure promotes consistent profitability. An increase in MFC's international operations will weaken MFC's credit profile because of MFC's weaker market presence internationally and the more volatile operating environments of international operations.

Although many of these international operations have been in place for at least several years (in some cases more than a century), MFC has said that expanding international operations while maintaining balanced growth is a key strategic objective. As a result, we expect that MFC's reliance on earnings from international operations will increase, and will proportionately displace the stable and sustainable earnings from within Canada, which are growing at a slower rate. The DBS deal will accelerate this trend. DBS has particular strength in Singapore, one of the most stable operating environments in Asia.

MFC already has the largest commitment to Asian operations among Canadian life insurers, as reflected in the 28 per cent contribution to net income (C$1.2 billion) from the Asia division in 2014 (see exhibit). Many of the Asian countries have very low life insurance penetration and very favourable demographic trends, including large emerging middle classes.

The lack of state welfare schemes in many Asian countries is a key driver behind the growth opportunity for insurance and savings products. Key determinants of success include the ability to form effective distribution arrangements, often through brokers, agency and bancassurance.

As an Aa1-rated bank, DBS will be a very strong distribution partner. In most cases, the primary product offerings are simple insurance and wealth products that do not embody the type of policyholder-friendly features that have generated significant earnings and capital volatility in the US and Canada.