Muddy Waters Shorts Manulife on Risks in Hedge Fund Trial

(Bloomberg) -- Muddy Waters has found its latest target: Canadian insurer Manulife Financial Corp.

Short seller Carson Block, who runs Muddy Waters, announced a short position in the firm Thursday, and said its life-insurance subsidiary just concluded a trial with a hedge fund that could lead to billions in losses. Block expects a verdict this year. Manulife said in a statement that it disagrees with Block’s conclusions.

In a report, Muddy Waters said it believes investors aren’t aware of the material risks to Manulife posed by the trial. The insurer was taken to court by hedge fund Mosten Investment LP, which claims it should be allowed to deposit unlimited amounts of capital with Manulife and earn at least 4 percent in annual interest based on a 1997 universal life insurance policy it owns.

“This really looks to be more an issue of incompetence from the 1990s,” Block, Muddy Waters’ chief investment officer, said in an interview on Bloomberg Television. “This could effectively make this hedge fund, if it wins, the highest yielding money-market type product in the developed world.”

Toronto-based Manulife is one of the biggest life insurers in the world and operates in the U.S. as John Hancock. The lawsuit also involves a Bank of Montreal operation and iA Financial Group. Bank of Montreal declined to comment while a spokesman for iA Financial Group said it wouldn’t comment while the matter was still in litigation. Ronald Miller, a lawyer at McDougall Gauley who represents Mosten, declined to comment.

Manulife said it believes that Mosten’s position is “legally unfounded.”

“We firmly believe that the consumers purchasing universal life policies, and the insurers issuing these policies, never intended to have the policies function as deposit or securities contracts,” Manulife said in the statement. “We have a sound, highly rated global franchise. We expect we will prevail with respect to this matter and that it will not affect our business operations or our ability to meet obligations to our customers, vendors and other key stakeholders.”

Manulife dropped as much as 4.1 percent after Block’s comments to the lowest since 2016. The shares were down 2.9 percent at 1:18 p.m. in Toronto.

90’s Headaches

The Mosten case isn’t the first time policies written in the 1990s have come back to bite insurers. Products such as universal life insurance and long-term care policies sold decades ago were built under the assumption that interest rates would be higher. As those rates fell after the financial crisis, some companies, including Aegon NV’s Transamerica, boosted the cost of their products, prompting lawsuits from policyholders.

In a worst-case scenario, Manulife could face what Block called a “death spiral” if it loses the Mosten case at trial. The hedge fund could pile money into the policy and demand its guaranteed return, while the insurer is limited in its investment options to generate the needed funds.

If these issues hurt Manulife’s credit ratings, that could also prompt some customers to look elsewhere for coverage, Block said. It’s also hard to predict exactly how the trial will play out, but he said he believes there’s potential for Mosten to prevail on at least some of its claims.

“Nobody thought, hey, maybe somebody would try to stick billions of dollars in there in an environment in which interest rates are very low,” Block said in the interview.

Manulife has been seeking to trim risk at the company by winding down poorly performing books of business and appointing Naveed Irshad to lead that effort in North America.

Muddy Waters has previously built short positions in companies ranging from French retailer Casino Guichard-Perrachon SA to Chinese tutoring firm TAL Education Group.

--With assistance from Joshua Fineman, Natalie Wong and Doug Alexander.

To contact the reporters on this story: Erik Schatzker in New York at eschatzker@bloomberg.net;Katherine Chiglinsky in New York at kchiglinsky@bloomberg.net;Ivan Levingston in New York at ilevingston@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl

©2018 Bloomberg L.P.