Interest Rates Hold Steady: Is This Bad News for Sun Life Financial Inc.?

The Bank of Canada is holding interest rates at a low 0.75%. What does this mean for Sun Life Financial Inc.? (TSX:SLF)(NYSE:SLF)

| More on:
The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The financial sector received some bad, albeit not entirely unexpected, news this week—the Bank of Canada is holding overnight interest rates at a historically low 0.75%.

The Bank of Canada estimates that the Canadian economy saw zero growth during the first quarter due to weak oil prices, and although GDP growth is expected to resume later in the year as non-energy exports increase, bolstered by a weak Canadian dollar, many are now predicting Canada will not see a 2015 interest rate hike—even if the U.S. moves to increase them this year as anticipated.

Insurance companies like Sun Life Financial Inc. (TSX:SLF)(NYSE:SLF) are extremely sensitive to interest rates due to their large exposure to fixed-income investments. Assets, liabilities, and earnings can be all adversely affected by a period of interest rate weakness.

Is Sun Life prepared for a continued period of interest rate weakness? To find out, let’s look at how interest rates affect insurance companies, and then at how Sun Life is exposed to these effects.

How insurance companies are affected by interest rates

Insurance companies largely have three sources of revenue– premiums, investment income, and fees. Insurance companies collect premiums in exchange for adopting various degrees of risk, and since claims on these premiums occur on an uncertain timetable, the companies will often invest the money in the interim in something known as the general fund.

This fund, in turn, generates income from interest and dividends, and this income is used in conjunction with premiums to generate an insurance company’s earnings. The two often work together, and in times of high interest rates, insurance companies often decrease premiums, sometimes even pricing policies at an underwriting loss with the expectation that strong investment income will more than offset the loss.

The opposite is true for periods of low interest rates, but since companies are often limited to the degree in which they can raise premiums, low interest rates can have a serious impact on earnings.

In addition, insurance companies also have exposure to variable annuity and segregated funds products, which provide various income and benefits guarantees to policyholders over the course of the policies life, which can often be 20-30 years.

These policies are risky, since interest rates can fluctuate wildly over these time frames. And because insurance companies often invest the premiums for these policies in interest-bearing assets, low interest rates can make it difficult for insurance companies to pay guarantees, which weighs on capital and reserves.

Sun Life has made moves to protect against these risks

Fortunately, Sun Life has some of the best risk management practices in the Canadian insurance business. First, the company has been in the midst of a steady move away from the “spread-based” businesses (where earnings are dependent on interest rates) towards more stable, fee-based businesses by expanding its asset management segment.

In 2014 Sun Life earned $4.4 billion in fee income, up from $3.7 billion in 2013, and this increase is largely from Sun Life’s MFS investment management firm, which represents the company’s global asset management business, and is responsible for managing assets for investors through mutual funds. Fees from this area now represent 19% of earnings, providing solid diversification in revenue.

Total assets under management for Sun Life’s asset management business were $511 billion in 2014, up 15% from 2013, and these assets collectively represent 69% of Sun Life’s total assets. This is compared with only 23% for Manulife Financial’s asset management segment, which demonstrates that Sun Life’s risk profile is lower because most of its assets are devoted to the less volatile, and less interest rate-sensitive asset management business.

Sun Life also made the recent move to sell its $1.35 billion U.S. annuity business, which significantly reduces Sun Life’s interest rate risk and frees the company from the type of risky guarantees to policyholders that can severely deplete capital, reserves, and earnings in weak capital market conditions.

The result? Sun Life now estimates a 0.5% decrease in interest rates (which would be extremely unlikely) would decrease net income by only 5%.

Should you invest $1,000 in Thomson Reuters right now?

Before you buy stock in Thomson Reuters, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Thomson Reuters wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $21,345.77!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 24 percentage points since 2013*.

See the Top Stocks * Returns as of 4/21/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

senior relaxes in hammock with e-book
Dividend Stocks

How I’d Invest $8,200 in Canadian Monthly Dividend Stocks to Pay for My Retirement Lifestyle

If you have some cash on hand, then these monthly dividend stocks can provide you with cash for life.

Read more »

protect, safe, trust
Investing

Protecting a $5,000 Investment: Why I’m Considering These 3 Defensive Stocks

These three top Canadian value stocks look well-positioned to provide portfolio stability and long-term upside for those navigating market turmoil.

Read more »

Canada national flag waving in wind on clear day
Investing

Where I’d Find Value in Canadian Stocks for My Long-Term Holdings

For investors seeking meaningful value (and long-term upside) from top Canadian stocks, here are two great examples to dive into…

Read more »

Circuit board with glowing lines
Tech Stocks

Got $1,500? How I’d Allocate it Between 2 Tech Stocks for Decades of Potential Growth

Are you looking to put $1,500 to work? These two Canadian tech stocks are a great place to start.

Read more »

man is enthralled with a movie in a theater
Investing

Is Now a Good Time to Buy Cineplex?

The decision of whether it's a good time to buy Cineplex has confounded investors since the pandemic, but It may…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Investing

Why I’d Consider These 3 TSX Stocks Under $100 for my $7,000 TFSA Contribution

Here are three top TSX stocks I think long-term investors would do well to own in their TFSAs during this…

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

Here’s Exactly How $20,000 in a TFSA Could Grow to $300,000

Can you grow $20,000 into $300,000 by holding the iShares S&P/TSX Index Fund (TSX:XIC) in a TFSA?

Read more »

Blocks conceptualizing the Registered Retirement Savings Plan
Retirement

Top Canadian Value Stocks I’d Buy for My RRSP and Hold Through Retirement

If you're looking for strength in your RRSP, then look for value in long-term holds.

Read more »