Canada's CFO of the year tackles global issues: in an interview, Peter Rubenovitch, CFO of Manulife, the major insurance firm, talks about the acquisition of John Hancock, life insurance accounting, industry consolidation, product pricing and much more.

Peter Rubenovitch, Senior Executive Vice President and CFO of Manulife, and Canada's 2004 CFO of the Year, is confronting some of the most pressing issues on the minds of CFOs responsible for managing global companies.

Manulife provides individual life insurance, group life and health, group pension products and variable annuities in Canada, the U.S. and Asia. On April 28, Manulife merged with John Hancock Financial Services Inc., making the combined company one of the five largest life insurers in the world and the second largest in the U. S., based on market capitalization. Rubenovitch spoke recently with Ramona Dzinkowski, vice president and director of research for FEI Canada.

<Q> Manulife has been aggressively pursuing international growth. This past spring, it purchased John Hancock in the U.S. Can you describe some of the environmental risks in the U.S. at the moment and more generally, some of the risks for large multinationals operating in many different regulatory regimes and political environments?

RUBENOVITCH: The regulatory regime for the [insurance] industry has become more sophisticated. That's good for the better operators, because the rules make economic sense more frequently. The more sophisticated the regulator, the more likely the rules are to be appropriate to the business you offer. With respect to the political environment, there are some issues that affect the industry, whether it's the potential elimination of estate taxes or preferences on some savings plans in the U.S., or the framework in which you operate in some Asian markets.

In the Asian markets, if you can't determine what is acceptable practice and operate effectively in the market, you're going to be disadvantaged. That's a skill that the more effective multinationals develop. It gives them an advantage, particularly in the emerging markets where the regulatory environment may be evolving. We see that as an opportunity, more than anything else. If there's a change in the environment, you can often introduce new products and innovations that may not have been permissible in prior periods.

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<Q> What are some of the major changes you're seeing in terms of accounting standards and rules that will impact Manulife's operations around the globe?

RUBENOVITCH: Life insurance accounting is not intrinsically simple. You have a relationship for 30 or 40 years where someone is paying you a premium to insure against an event that could transpire well into the future. You have an inherently complex situation where quarterly, you're trying to determine how much richer or poorer the firm is as a result of an insurance contract that has a very long life.

There are different ways of reflecting those accounts. Canadian GAAP [generally accepted accounting principles] for insurance companies [is] materially different than U.S. GAAP, which is significantly different than the international accounting standards (IAS). I would be delighted if there was convergence--if there was a single effective model that closely reflected economic realities.

In fact, the most popular model for insurance accounting is U.S. GAAP, and it has some imperfections that clearly need to be addressed. The left side and the right side of the balance sheet are valued differently and are disassociated. Most insurers find that they can diffuse risk by balancing the right and left side, the assets and the liabilities. But if you're fair-valuing one side and not the other side, you clearly have a lot of noise turning up in the income statement.

There are some conventions, for example, in the treatment of capital gains that result in gains or losses being ignored by the investment community unless they are sustained and adverse. That has essentially caused insurance companies not to invest in equities. If you saw pension funds that had no equities, you'd consider this very peculiar. But long-tailed liabilities that should be paired with long-tailed assets don't show favorably on a U.S. GAAP basis. As a consequence, most U.S. firms have elected not to have equities in their portfolio mix. That doesn't make a lot of economic sense. In this case, the accounting is driving what I think are sub-optimal business decisions.

<Q> Do the IAS or Canadian GAAP have something better to offer in this case?

RUBENOVITCH: A good model that would be very attractive to us, and I think to investors generally, would be one where they can compare track records and performance with a common standard, [and] one that is economically sensitive. The IAS is seeking to converge with U.S. GAAP. However, I think the consensus is that the Canadian model might be technologically best, and the one that looks at things on the most economic basis.

In Canada, capital gains and losses, credit losses, are all included in our operating income, and our analyst community considers that as part of our total return. I think that's a better model, because investors are more interested in [whether] they are they richer or poorer, rather than how it's done. However, it's still important to remember that when you get into the details, there are all kinds of actuarial and accounting conventions that have to be determined.

Having said that, there are solutions to that problem, and eventually there will be a common standard. It will be partly an international accounting standards perspective, a lot of the fair value idea that is driving the U.S. model and a lot of the future-profits perspective that's included in Canadian insurance valuations today. The problem right now is not so much where we're going to end up--which will probably be the right place--but the three- to five-year transition process. Many of the decisions have to do with where you're starting from. The business of insurance is not greatly dissimilar in each [country]. The difference lies in how they've historically accounted for it.

<Q> Can you discuss how The Sarbanes-Oxley Act will impact Manulife, and the industry in general?

RUBENOVITCH: The [act's] intention is honorable, but it needs a little bit of polishing. The absence of the materiality threshold, some of the great detail, some of the documentation requests and some of the repetitiveness of the [compliance] cycle need to be cleaned up a little bit. We're lucky. We're one year behind the cycle, as a non-resident company. So we're going through it at the same pace, but we have the opportunity to look at how it works for everybody else and do our full filings one year later. It [does create] a bit of a tax burden on the regulated. The cost of compliance is probably higher than it needs to be to achieve the desired objectives.

<Q> We've noticed a trend in the insurance sector toward increasingly competitive pricing. What are the economics behind the pricing models today versus 10 to 20 years ago?

RUBENOVITCH: For the kind of company Manulife is, product pricing is most important on the mortality side. Generally, the cost of insurance has come down quite consistently over a period of years because people are living longer. The cost of providing life insurance has become cheaper, because you have a longer time until you have to pay out on a policy.

The market has also become quite competitive. We've seen some stabilization of that, partly because firms have recognized that they were getting too aggressive on their assumptions about mortality. So consumers are getting a better deal today than they got five or 10 years ago. What you have to do as a company to manage that is to make sure that you're manufacturing a product that's competitive but that still provides you with an attractive rate of return.

<Q> What are some of the implications of increased consolidation in the industry, and how will this effect your strategy going forward in terms of pricing or other competitive practices?

RUBENOVITCH: I think size matters. In some products, there's a tremendous amount of expenditure for technology and infrastructure. If you can amortize those costs over a large customer base, you're going to have an efficiency advantage, and you have more developed expertise, so you're likely to come up with more innovative products.

In Canada, we've had a fair amount of consolidation already in the life insurance business. The three largest players today are significantly bigger than the largest players were only five years ago. In the U.S., consolidation is at an earlier stage. A few large firms are likely to emerge, and in some categories, they will have a significant advantage.

These deals won't transpire because the CEO decides he or she wants to buy a competitor. The economics have to work, and what normally drives the economics are two things: the opportunity to cut costs and deliver the service more efficiently, or the ability to get revenue synergies. In the John Hancock case, both of these attributes were there. In fact, we had more synergies than some of these deals usually have, and moreover, a significant amount of cost savings.

Those elements make a purchase affordable and desirable in terms of servicing customers with a better price and a high level of service. Another benefit of consolidation is expertise: If you do similar things in many markets, you will have an ability to transfer knowledge between geographies.

<Q> If we're analyzing the risks diversified insurance companies face in the U.S. market today, the potential impacts of an interest rate increase come to mind first. How is the expected rise in interest rates likely to impact Manulife, and the insurance and financial sectors generally?

RUBENOVITCH: In general, insurance companies are often described as being interest rate-sensitive. I don't believe that to be the case any more. There are so many opportunities to hedge and cover interest rate exposure and manage interest rate risks. You can do well or poorly in rising or dropping rates on the basis of how you manage your affairs, not because of the nature of your business.

<Q> What is your competitive strategy going forward? Do you intend to increase your M & A activity in the U.S.?

RUBENOVITCH: We're certainly very keen to look at new opportunities in the U.S. They'll be selective opportunities over time. We had an interesting side issue with respect to our John Hancock transaction. John Hancock was listed in the S & P 500, but because we're a Canadian firm, we had to be removed from the index. We were concerned that this would cause index investors and "closet" index investors to sell their shares of Hancock and create a big supply of shares that may not have [had] buyers.

To take care of that, we put in place a $3 billion share buyback facility. In fact, what transpired was quite different. There were plenty of people to buy the shares, and on the merger date there was a shortage of shares available. We didn't end up buying virtually any shares back, so there was about $3 billion that was unspent. So Manulife, even after the merger, has too much capital. Isn't that a nice problem?

<Q> Where do you see the greatest opportunity?

RUBENOVITCH: We love the protection business. We like many of the wealth management businesses and would be happy to make them bigger. Distribution is also of interest to us. John Hancock and Manulife had different distribution channels, by and large, which were quite complementary, and we'd be happy to broaden our distribution capability again.