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Morningstar | Sun Life Gets Vitamin D From Higher Group Sales and Margins, Offsetting Negative Market Effects

Higher annuity sales and lower expenses helped no-moat Sun Life hit the CAD 2.5 billion net income mark for fiscal 2018, a year-over-year increase of about 15%. Overall results for 2018 were strong, and earned premiums grew at a faster clip than we had expected. While equity market volatility in the fourth quarter posed a headwind for top-line numbers, with investment income down nearly CAD 6 billion, this was mitigated by insurance and investment liabilities declining by an equal amount. In general, premium revenue and net income growth tends to be relatively stable for life insurers such as Sun Life, though market volatility can cause material differences in total revenue and expenses quarter over quarter. The largest yearly sales increase came in the U.S. insurance segment, up 18%, and the largest decrease occurred in SLF Asia wealth management, down 23%. On an absolute basis, both SLF U.S. and SLF Asset Management had good results, led by higher Group Benefits margins and asset management fee income. We’re maintaining our fair value estimate of CAD 50 and reiterate our thesis that increasing scale within asset management and growth in the Asian market will drive top-line growth in the coming years.

We reaffirm our no-moat rating for Sun Life, though we continue to view MFS, Sunlife’s asset management arm, as a segment that could potentially be a source of competitive advantage. Overall AUM declined in the fourth quarter, primarily due to market challenges. We’re continuing to forecast mid- to high-single-digit growth for the asset management business through 2022. Compared with peers, MFS funds have done well and maintained inflows at a time when many active funds have been hurt by the shift to passive. At the same time, MFS has doubled down to focus and market the active management business model. We don’t foresee any immediate risks to the business, though we note that overall active fund flows have significantly trailed passive flows in recent years.

In the last few months, both of Sun Life’s primary competitors announced their full or partial exit from the U.S. annuity market. Great West sold its U.S. annuity business off, and Manulife reinsured over $8 billion of their U.S. portfolio. We believe annuity sales will likely struggle to build momentum in the long term as the sale of annuities often fails to meet the fiduciary standard. Given this, it appears Sun Life was ahead of the game strategically, as it sold off its U.S. annuity portfolio over six years ago. Interestingly, Sun Life seems to be putting a high focus on annuity sales in Canada, with annuity premiums more than doubling from the previous quarter. We view the disparity between selling the U.S. annuity business and strong Canadian annuity sales as a bit odd, and we would prefer Sun Life focus its efforts more on its moatier asset management business.

Sun Life’s return on equity ticked up slightly to 10.9% in the fourth quarter, increasing from 10.8% in the third quarter. For 2018, return on equity was 14.2%, up from 12.7% the year prior and modestly higher than our assigned cost of equity of 11%. Although ROE doesn’t accurately represent recurring earnings because of short-term market impacts, it can be a good tool for evaluating whether a firm is providing value to shareholders. Historically, Sun Life has struggled to consistently earn returns over its cost of equity. We don’t view annual 14% returns as sustainable given the difficulty for life insurers to have underwriting success in the long term and because of top-line exposure to market swings.