* Profits to rise sharply on strong markets
* Shares may struggle to build on recent gains
* Manulife, Great-West to report on Thursday
By Cameron French
TORONTO, Feb 6 Canadian life insurers are expected to report higher profits on the back of stronger equity markets and recovering bond yields, but the results may give only a temporary bump to shares that have surged over the past three months.
The quarterly earnings will cap what has been a challenging year for the industry, particularly top insurer Manulife Financial (MFC.TO), which lost C$2.4 billion ($2.42 billion) and C$947 million in the last two quarters due to tepid markets.
"It was the perfect storm against them in the second quarter, and this is almost the perfect storm for them," said John Aiken, an analyst at Barclays Capital.
Weak markets -- particularly corporate bond yields that troughed in the third quarter -- force the insurers to hold more reserves to pay off future liabilities.
But Canadian stocks rose 9 percent during the fourth quarter, and bond yields have skyrocketed since October, so the insurers can now bring those reserves back into the earnings.
Manulife, the insurer most sensitive to markets, has also embarked on a hedging program to reduce its earnings volatility, a move that has helped draw investors back, even as it reduces the company's exposure to rebounding markets.
Robert Sedran, an analyst at CIBC World Markets, expects higher bond yields to add 38 Canadian cents a share to Manulife's bottom line, while higher equity markets should to add 28 Canadian cents a share.
For rival Sun Life Financial (SLF.TO), stock and bond movements are expected to add 36 Canadian cents a share to the bottom line. The impact on other insurers will be more muted.
Sedran notes that strong markets don't just help the insurers' balance sheets, and their wealth management components should see higher profits.
"Higher equity market levels lead to higher assets under management and corresponding fees," he said in a note.
Manulife and Great-West Lifeco (GWO.TO) report results on on Thursday. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
For Starmine chart: link.reuters.com/zah87r ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
Manulife, Sun Life and Great-West should all handily beat year-ago results, according to Thomson Reuters I/B/E/S, while profit at Industrial Alliance (IAG.TO) should fall slightly.
Analysts say the volatile market-driven profit has obscured reasonably strong core results. With market concerns receding, core profitability should get more attention.
"I think that bodes pretty well for a sector that in my view has seen valuations just be very depressed for quite some time now," said Edward Jones analyst Craig Fehr.
But while the stock prices were depressed for much of last year, recent market optimism has driven the shares sharply higher and reduced the potential boost to stocks from a strong quarterly result.
Manulife shares are up than 30 percent since the end of November, while Sun Life has risen just under 20 percent, and Great-West is up nearly 5 percent.
"Generally, what I think is going to happen is a fairly strong reaction to positive earnings," said Aiken. "But as we come out of earnings season, I think some of that excitement may deflate out of the valuation."
Analysts also say talk of higher dividends -- expected from Canada's banks this year -- could be premature for insurers.
Manulife investors, in particular, would welcome such talk. The company halved its payout in late 2009 to preserve capital during the financial crisis.
($1=$0.99 Canadian) (Additional reporting by Euan Rocha; editing by Janet Guttsman)