It is no secret that life insurance companies are hard to understand, beyond the basics of accepting premiums from customers. With their interests in increasingly complex investments along with head-scratching accounting assumptions, earnings are near impossible to project for most investors.
Even analysts are having trouble, judging from their recent track record of seeing actual quarterly earnings miss their expectations by a mile.
In the case of Manulife Financial Corp., the insurer's profit in the third quarter beat expectations by 28 per cent. In the quarter before that, its earnings missed expectations by an eye-popping 118 per cent. Sun Life Financial Inc. has also made a mockery of analysts' quarterly earnings forecasts in recent quarters.
In both cases, the variability in earnings has been translated into exceptionally volatile share prices. In particular, Manulife shares cratered 76 per cent during the 2008 financial crisis, then rebounded 180 per cent during the early stages of the economic rebound, then fell 55 per cent between July, 2009 and July, 2010.
It's enough to make your head spin, even if you're on the sidelines. No wonder many investors have dismissed Manulife as an impenetrable "black box" and steered clear.
"A life insurer's income statement measures how it performs in relation to its most recent predictions about the future," Peter Routledge, an analyst at National Bank Financial, said in a recent note. "Its balance sheet measures the present value of the company's assets, liabilities and equity under a certain set of assumptions about the future ... Thus, life insurance financial statements are inherently complex."
He believes that investors now place a high risk premium on the stock because of the apparent opacity of the company's financials and business model. As a result, the shares trade at a low valuation, relative to earnings and book value.
Of course, in the good days, insurance companies were also difficult to get a hold on, but it didn't matter much when the stock market was strong and insurance stocks were chugging higher and higher. Between 2003 and 2007, Manulife shares more than doubled, making the stock a star among Canadian financials.
Back then, during an unchallenged bull market and a sound economic backdrop, investing in a black box was by no means a bad thing, if you had faith that all was well inside that box. Now, investors want a greater level of certainty, and Manulife is having a tough time delivering.
For long-term investors who don't mind taking on some risk, Manulife might make a decent speculative investment because of its low valuation. For other investors, though, black boxes should be avoided.