02/16/2012 09:38 EST | Updated 04/17/2012 05:12 EDT

Sun Life to further reduce earnings volatility as interest rate exposure rises

TORONTO - Sun Life Financial Inc. (TSX:SLF) is "charting a new course" to reduce volatility in its earnings after low interest rates and stock values contributed to a huge loss in its most recent quarter — but investors shouldn't expect change overnight.

"I think we're at a place where we do see some different options for reducing volatility," Dean Connor, who took over as president and CEO of Sun Life at the end of last year, said Thursday on a conference call.

But even though the insurance giant, which booked a half-billion dollar loss in the fourth-quarter, is working to reduce volatility as part of an overhaul of operations, it's a goal that will take some time, Connor said.

After closing shop on sales of individual insurance products in the United States, the company is also looking into changes to the way it manages its hedging programs, the use of reinsurance and restructuring some business units, he added.

"The decision in December to cease sales of variable annuities and life insurance was a dramatic change and I think surprised a lot of people both in the action and also in the speed which we took it," Connor said.

"(But) the kind of structural changes that we need to make will take time," he added.

The Toronto-based company reported late Wednesday it lost $525 million, or 90 cents per share in the latest quarter, reversing a net profit of $504 million or 84 cents a year earlier. Analysts, on average, had expected a loss of about 59 cents per share.

Connor said the quarter was "very unusual" because it included a $635-million non-cash charge associated with changes to reserves for its variable annuity and segregated fund insurance contracts liabilities.

However, Connor said that change will result in net benefits of between $10 million and $20 million per quarter and will begin to pay off in the second half of 2012.

"By essentially increasing our reserves it provides more on the balance sheet to come back into income over time," he said.

One of the attractions of variable annuity products to investors is that they offer a minimum rate of return guaranteed, which can cost the insurer when markets are under performing.

The combination of a market downturn with a substantial increase in the amount of capital required by regulators, has made variable annuities less attractive.

The company plans to unveil more details on its strategic review of operations during an investor day scheduled for March 8.

During the quarter, Sun Life booked a restructuring cost associated with shutting its individual products business in the U.S., which resulted in cutting some 800 jobs.

In its Canadian business, the company booked goodwill impairment charges related to the impact of persistently low interest rates, increased capital requirements and market volatility.

Stock and interest rate drops affect insurers because they tend to invest much of the money they make from policyholders into equity and bond markets.

Those losses were slightly offset by a tax gain from wrapping up a reorganization of its two insurance subsidiaries in the United Kingdom to make them more efficient.

But even as Sun Life expects it will continue to be hit by volatility for some time, it is also refusing to reduce its dividend payout to shareholders from the current 36 cents per quarter — at least for now.

Connor said the dividend level will be maintained as long as the company is comfortable with its run rate earnings — the current rate of annual earnings — and its capital position.

"But we live in volatile times and we're mindful that conditions could worsen at some point and if we did see that happening we would need to take action to preserve our strong capital position," he said.

But John Aiken, an analyst at Barclay's Capital said he wouldn't be surprised if the company cuts its dividend after this quarter.

"We had been anticipating a pretty bad quarter, but were surprised to see Sun Life's reported 90 cent per share loss come in below the low on the Street," he said.

Aiken also noted that Sun Life's sensitivity to interest rate changes increased by almost 50 per cent — due to the company's new hedging program that swapped out equity risk for interest rate exposure — and it is now much more sensitive to change than rival Manulife Financial Corp. (TSX:MFC).

Manulife has been working hard to drive down its interest rate and equity market exposure after coming under fire from shareholders for big losses in 2010.

Sun Life employs about 16,000 people, including 7,000 in Canada, and has insurance, wealth management and mutual fund operations around the world.

Shares in Sun Life added six cents to $20.95 in midday trading on the Toronto Stock Exchange.