* Muddy Waters says legal case poses material risk to Manulife
* Manulife says case is 'legally unfounded' (Adds Manulife statement)
TORONTO, Oct 4 (Reuters) - Shares of Manulife Financial Corp fell as much as 4 percent on Thursday, hitting their lowest since November 2016, after research firm Muddy Waters Capital LLC said it had taken a short position on Canada's biggest life insurer.
Muddy Waters, which researches companies it thinks have fundamental problems not reflected in their stock price, cited a court case pending in the Canadian province of Saskatchewan which it believes could damage Manulife's financials.
The case, brought against Manulife by an Ontario-based businessman named Michael Hawkins, relates to universal life insurance policies which were underwritten in 1997 by Aetna Life Insurance Co, which was acquired by Manulife in 2004.
Manulife said in a statement on Thursday that it disagreed with the conclusions of the Muddy Waters report and that it believed the case against the company was legally unfounded.
Universal life insurance is a type of policy sold mostly in the United States where the insurer credits the customer every month when premiums exceed the actual cost of insurance, with interest, building up the cash value of the policy, usually at a contractually agreed minimum rate.
The policies were written when interest rates were much higher than now and the case is set to decide whether a holder of one of the policies can force Manulife to back up the policies with very high-yielding, short-term investment grade products.
Muddy Waters said a verdict is likely by the end of the year and that there were material risks to the financial health of Manulife that investors have failed to see and price into the stock.
Manulife disagreed. "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," the company said in its statement.
"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," it added.
Shares in Manulife were down 3.1 percent at C$22.44 at 1:40 p.m. in Toronto (1740 GMT), on track for their biggest daily fall since March 2017. (Reporting by Matt Scuffham in Toronto Additional reporting by Anthony Lin in New York Editing by Bill Rigby)