Manulife Financial Corp (MFC) 2003 Q2 法說會逐字稿

Good morning. Welcome to the John Hancock second quarter earnings conference call. All participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star zero on your touch-tone telephone. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Jean Peters, Senior Vice President of Investor Relations.

Good morning, everyone. Welcome to John Hancock's second quarter earnings conference call. Our press release and financial supplement were released last evening and are available on the website.

This morning, Tom Moloney, our Chief Financial Officer will take you through the results of the quarter. Also on hand are members of senior management including David D'Alessandro, Chairman and CEO; Mike Bell, Senior Executive VP for Retail; Jim Benson, Senior Executive VP for Retail Sales and Distribution; John DeCiccio, our Chief Investment Officer; and Deb McAneny, Senior Executive VP for Structured and Alternative Investments; Maureen Ford, President of John Hancock Funds; and Jeanne Livermore, Senior Vice President of Guaranteed and Structured Financial Products.

Before we begin, let me remind you of caveats regarding forward-looking statements. Before participants join this call by either phone or web, they were required to read and acknowledge cautionary language regarding forward-looking statements as well as the use of non-GAAP financial measures which will occur in this morning's discussion. If you did not review this cautionary language, do so now by referring to yesterday's earnings press release or our most recent 10 Q, 8 K or other SEC filings. As you are aware, forward-looking statements are subject to a variety of risks and uncertainties which may cause actual results to differ materially. Use of nonGAAP financial measures is done to enhance investors understanding of company performance and is not a substitute for GAAP income. A full reconciliation of income from operations to GAAP net incomes provided in our press release and on our website.

With that I now turn the call over to Tom Moloney.

Thank you and good morning, everyone.

I am pleased to report second quarter operating earnings for John Hancock of 82 cents per share. An increase of 14% over the prior year second quarter. As is the case with many of our peers, results benefited from the quarter's strong equity market performance. But it was Hancock's focus on maintaining a balanced earnings mix and discipline pricing that again paid off in delivering strong overall results from both fee based and spread based operations.

Through the first half of 2003, operating earnings per share of $1.56 are up 11.4% at the upper end of the range of our guidance for 203 of 7 to 11%. We are affirming our 203 guidance as noted in the press release since we do not currently expect the equity markets to continue to improve at the nearly 15% rate that they did in the second quarter.

We were staying with our assumption of 2% market appreciation for each of the next two quarters. We will be glad to be proven wrong on the upside on that score, but I don't think it's appropriate to make that leap of faith just yet. Total company's pretax operating earnings of $332.3 million for the quarter were up 12% from the prior year driven by strong results across retail core operations including non-trad life insurance up 20%, 26% growth from the asset gathering segment and 23% growth in Maritime Life.

Our product distribution and acquisition focus in each of these lines has paid off in providing a solid retail earnings engine so far this year. Institutional investment management was also a strong performer with results up 63% due to new business growth in the real estate finance group.

I will talk more about segment results in a moment. First, let me turn to investments, credit and the balance sheet overall. Net income for the quarter was $1 per share. Three times the 33 cent reported a year earlier. That bought net income for the 6 months to $1.88 per share, more than double a year ago period. As a result of this strong net income, book value per share is nearly 18% to $22.50 versus the prior June 30.

Including FAS 115 adjustments, book value per share was $27.71 at June 30. A very strong 35.7% increase over the prior year. We also saw tremendous improvement in net unrealized gains in our bond portfolio. Gross unrealized gains increased to $4 billion at June 30, versus $2.8 billion at the end of Q1. While gross unrealized losses dropped 34% to $774 million.

Excluding hedging adjustments which are temporary in nature, gross unrealized losses were $515 million at June 30. Less than 1% of the total portfolio. This is down 41% from March 31, 2003. Unrealized losses on bonds trading at less than 80% of book for six months or longer were $170 million down 40% from the first quarter. These unrealized losses dropped by more than half in most sectors including utilities and in our Venezuela and Argentina structured finance credits and remain flat for airline securities. On a realized basis, impairments in our bond and equity portfolio were $103 million in the second quarter, a 60% improvement versus $205 million of impairment in Q1. There were also $28 million in gross losses on sales versus $43 million in losses on sales in Q1. Note that these losses on sales were generally related to portfolio repositioning and most were not credit related.

We had substantial realized gains in the quarter as we managed our portfolio for tax authorization and ongoing portfolio positioning as well as from bond prepayments which we book from net income, not operating income like some of our competitors. I want to point out that we also realized $49 million in gains due to recoveries on bonds that had previously been impaired both from companies coming out of bankruptcy and from opportunistic asset sales where market pricing improved. While we do, of course, impair assets to public market levels when posts are available, the recoveries we were seeing demonstrate the market sometimes does misjudge the ultimate loss on a default.

Taken together, the substantial reduction in impairments as well as the recoveries and improvement in gross unrealized losses are all encouraging signs that the economy recovery is taking hold. However, we do not want to be overly optimistic a quick dropoff in losses as we get mixed signals daily from economic indicators regarding the strength of the recovery.

Still, we are cautiously optimistic that gross realized investment losses will come in at the lower end of our guidance we gave you in the first quarter conference call. More towards the $650 million level versus the $750 million which was the upper end of the range that was indicated. Clearly, the airlines industry remains our most risky sector at this time while both utilities and the oil and gas sector seem to be stable to improving. Gross mortgage losses are likely to be at the low end of the $45 to $50 million range we indicated and are included in the total estimate of gross losses.

I would also like to comment on our below investment grade holdings which declined slightly to 7.9% of invested assets of June 30, versus 8% last quarter.

The dollar amount of BIGS [ph] grew and that was entirely due to asset appreciation which offset some of the sales we made from portfolio repositioning and was a part of the migration to reduce percentage of BIGS [ph]overall.

However, there was a sizable increase in the NEIC Five [ph] or CAA category of bonds since the first quarter and I would like to address what is going on here. CAA bonds went from about $600 million at Q1 to about $1.2 billion at June 30.

About 27% of the increase was due to upgrades of CAT Six bonds and corresponding market appreciation. None of the public ratings on the remaining $413 million increase in CAT Five changed during the quarter, but these were split-rated bonds that the SVO previously carried at the higher rating and moved down to the lower level in the second quarter. There has been no recent credit deterioration in any of these bonds. As I said, the public ratings are unchanged. We are appealing about $250 million of these SVO changes and we expect to see upgrades in the coming quarter.

Now let's take a closer look at the key drivers of operating results among our business segment. Let's start with fee based products where equity market strength came in to play. Nontraditional life pretax earnings grew 20%.

Driven largely by separate account appreciation. Also earnings on a recently acquired Universal Life Block added about $3 million pretax to the quarter. Variable annuity results of $17 million pretax were nearly 4 times the prior year level, a separate account performance exceeded our cap meaning reverse assumption.

This resulted in dramatically slower DAC immunization for the quarter. Institutional investment management earnings grew 63%. Our real estate finance group completed two mortgage securitization in the quarter which added more than $7 million to pretax earnings results.

We discontinued our energy resource advisory company a few years back. However, there are a number of investment funds that are in runoff mode and one of them had about $4 million gain from a change in accounting from recent new accounting requirements.

These gains offset continued weak results of independent investment driven by lower fee revenue as the firm's asset mixes increasingly weighted to its fixed income versus equity fund. And also due to the cost associated with termination of its high net worth marketing initiative.

Turning to our spread based operations, we are pleased with the strong spreads in the quarter, especially in the fixed annuity line. Fixed annuity earnings grew 45% pretax to $40 million due to a 35% increase in average account balances and widest spreads which increased to 222 basis points versus 199 basis points a year ago and 205 basis points just last quarter.

Average crediting rates on total fixed annuities dropped 79 basis points from the prior year due to lower renewal rates and the introduction of a new product with lower guaranteed floors of 2%. This more than offset the 56 basis points decline in the portfolio yield.

Institutional spreads which were strong throughout 2002 declined to 144 basis points versus 157 in the year earlier quarter. Remember, that our pricing spread range is 120 to 145 basis points.

Now, turning to sales, we saw sales slow across many of our key businesses in the quarter compared to a year earlier. This reflects continued aggressive pricing from a number of competitors, the very low interest rate environment and consumer uncertainty about the stock market and estate tax laws.

Sequential results are more positive and let me remind you that we, like many companies, are responding to dramatic changes in the life market. As demand shifts from the variable life to the more secured universal life products. As you know, Hancock historically was a stronger, variable life player and we are still in the process of building a solid universal life platform that commands the attention of all of our distributors.

But that shift is occurring as we can -- as can be seen in the 17% sequential increase in total core life sales driven by a 24% increase in universal life sales and a 7% rise in variable life. From a year ago period, universal life sales grew 17% but did not offset the 66% drop in variable life sales. As a result, total whole life sales fell 30% from the prior year.

From a channel perspective, sequential and group sales were up 38% from Q1 and we are pleased to have maintained our number one sales position with the M-group. Direct brokerage sales grew 20% and signature was up 8%. Total life sales including Coli [ph] and Boli [ph] were down 23% from the year ago period but up 34% from Q1 reflecting solid increases in corporate owned life insurance sales in all channels.

While we are disappointed with core life sales in the first half, there is much underlying activity which we believe will start to get us back on track by later this year. We will introduce new and updated protection oriented versions of most of our life products earlier this fall tailored to the direct brokerage market.

We were making internal processes more flexible so we can bring products to market faster. Over the next several months we will reorganize wholesaling territories and accounts as well as double the number of life wholesalers. These efforts will be targeted to the direct brokerage and signature system.

We are changing our training emphasis of Signator [ph] to ensure that management -- managing general agents are focused on life sales and are not overly reliant on long term care. And we will insure that new product launches get full visibility and attention across all of our distribution channels.

Turning to the retail annuity lines, the sequential decline in sales was the result of discipline spread management. We were among the first to introduce 2% minimum products and by the end of the second quarter our first year crediting rates had fallen as low as 2.15% excluding the 1% first year bonus. We were among the first to have a 1 1/2% minimum product approved in New York and we plan to increase the number of states where we can offer a 1.5% minimum or an indexed minimum product by year end.

While many competitors still selling a 3% annuity during much of the quarter, we saw fixed annuity sales decline 11% from the year ago period and 35% from the first quarter. Our current average crediting rate on the annuity portfolio has 100 basis points of room before contract floors are reached. Thus, we still have spread flexibility if we were to need it.

Long-term care sales remain robust increasing 69% over last year and 5% sequentially. This is due to expanding distribution relationships and continued position-positive reception to the new products sweep introduced last year.

The institutional GIC and annuity markets continue to be weak. Funding agreement sales of $250 million were the weakest in years as we found pricing to be unattractive at virtually all maturities. GIC sales were down 28% from prior years. Both because of extremely low quote volume for traditional GICs and competitive pricing. We sold one large contract in the quarter based on our unique skills at structuring products to meet client needs but overall market demand is low as it has been all year.

Signature notes, our retail fixed rate product continues to have solid sales results at $193 million in the quarter. Despite the low rate environment, the notes represented a relatively attractive asset for many investors who want to have stable yield and secure principal.

John Hancock is no stranger to the sea of change we have seen in the life insurance landscape over the past two years. In fact, our ability to successfully adapt to such conditions is a hallmark of our on going success. With the steps I mentioned well under way, we are confident that life sales will improve nicely in the second half but not enough to get us to the level we provided as guidance coming into 2003.

Additionally, our disciplined pricing on spread based products will likely keep sales well below last year's level. As a result, our new guidance for core life products is the sales in the second half will be roughly flat with the second half of 2002 which will result in a decrease in total 2003 sales of 15% to 20%. This compares to the first half of the year where sales were down about 30%. Sales of total annuities are now expected to be down about 5% to 10% driven by our spread discipline in the highly competitive marketplace.

Long-term care sales should be higher than we previously forecast and we are raising guidance up to a positive 35% to 40%. In the current environment, we also do not see a return to our robust marketing for institutional spread based products any time soon. Although in recent weeks, we have seen a number of single premium annuity bids come to market. Overall we do not expect institutional spread base sales to be down from 2002. It is difficult to say by how much since demand is dependent on interest rates and buyer's expectations about the economy.

Despite the current slow sales environment, we believe our long-term earnings and balance sheet outlook is solidly improving and we are well positioned to take advantage of the economic recovery through our product distribution and expense focus.

Credit is stable to improving and we expect no net realized losses in 2003 as we should continue to generate some offsetting gains from sales of equity securities. Spreads remain strong in the retail and institutional lines. And as we have said repeatedly, we face very minimal interest rate risk due to our tight asset liability management processes. Expense management continues to be a priority and we expect most new initiatives to be funded by offsetting reduction in process improvements across businesses.

Our strong capital base and solid statutory earnings continue to give us flexibility to grow shareholder value through investments in our core operations. Statutory capital of June 30 grew to $4.9 billion, up 9.1% from prior years. And our risk based capital ratio is still solidly within the 300 to 325% range we manage within. Remember, we only measure excess capital above 325%.

Also, our stat to GAAP capital remains above 75%, one of the strongest in the industry. Capital strength continues to be a key ingredient to our financial strength ratings. As you know, Standard and Poors affirmed our life company's double-A rating with a stable outlook in July based -- and I quote S&P here: Very strong operating performance, good long term growth fundamentals and extremely strong capital strength as measured by S&P's capital adequacy ratio.

Now, before you jump to the phones to ask when share buy back will restart, let me remind you that our cautionary outlook on the economy still stands. I do not anticipate that we will engage in meaningful share purchases in the near term for the following reasons. None of which are new to you. Credit losses, while improving are still about historical average levels and the strength of the economic recovery is really still quite uncertain.

Business unit growth has been strong requiring more capital investment especially for spread based retail products. All the rating agencies are very focused on capital strength and we do not intend to disappoint them in their expectations. We expect to meet with our Board of Directors late in the fall to outline our 2004 business plan and which will include an assessment as to whether to increase the shareholder dividend. We will also be looking at new capital changes from the rating agencies in the NEIC, capital demands from our businesses and the performance of the economy. All of which would factor into any repurchase decisions.

I want to draw your attention to one more important metric for the quarter's success. Our 15% operating ROE for the quarter which we were able to deliver even on -- with solid growth in statutory shareholder equity. A strong earnings performance book value growth and a shift in earnings strength toward retail operations and away from institutional spread products marks fundamental sign posts of its success of our core strategies. Together these factors underpin the John Hancock franchise and offer a clear indication to all investors that we are among the best positioned companies in our industry to generate, sustain growth and solid returns.

Thank you I will now turn the call over to the operator to start the Q&A session.

Thank you. The floor is now open for questions. If you do have a question, please press the numbers 1, followed by 4 on your touch-tone telephone. If at any point your question has been answered, you may remove yourself from q-and-a by pressing the key.

Our first question is coming from Nigel Daley of Morgan Stanley.

Thank you. Interest rates are most significantly higher. How much further do they need to rise before we should be concerned about surrenders in the fixed annuity block? And second, for David, the press seems to be picking up a lot more comments from you regarding possible consolidation in the life industry. Can you recap how your view on consolidation in the industry have recently changed.

I will ask on the first question -- ask Michelle Van Leer to speak to that question.

Good morning Nigel. I think you are asking concerns about rising interest rate, what that might do in terms of laps rates and our fixed annuity block. Let me start out by saying we manage our business so that we can respond whether interest rates are going up or coming down.

In fact, if rates continue to go down we had purchased interest floors to help with the 3% business that we have and we invest in assets that don't carry prepayment risks and as Tom mentioned we introduced the lower minimum guaranteed products a little sooner I would say, maybe a lot sooner than a lot of our competition. We also feel that we are favorably positioned in our product, our investment strategy and our crediting rate strategy, sales mix, distribution, to be able effectively respond to an increase in interest rate. Of course, we would be more comfortable if the rise is gradual rather than sudden.

To give you just some quick bullets on the product. We recently lengthened our surrender charges to six years on most of our fixed annuity products and created a lot of flexibility through our proprietary products that when rates are rising, distributors have flexibility to trade compensation for rate and respond effectively to those changes. And we are also managing the whole block both new and renewal together to hit our target spread and historically in declining environments, as spreads might be stronger in renewal business and increasing rate environment, new business spreads will tend to come up to allow us to manage our renewal rates to follow the general trend in interest rates. Also, most of our fixed annuities are sold through banks where the contract holders might be less prone to be responsive to interest --to gradual interest rate swings and when there is an intermediary involved encouraging the movement of assets.

You should know that a lot of our business has been recent so that 76% of our fixed annuity business is still in the surrender charge period and 62% has a surrender charge of at least 5%. Our lapse rates have remained stable over the past year. They were 7.5% this quarter, about the same the last two quarters.

And just finally on the investment side, we have as Tom mentioned avoided any duration in our asset portfolio. I would say we probably have a shorter portfolio on average than many of our competitors and we believe will be able to turn it over more quickly to respond to interest rate swings.

And finally on some segment of that portfolio, we purchased some derivatives in the form of puts and caps that will pay off in high rate environments to help offset any losses we might have in asset sales funding unexpected liability payouts or adding to investment income to allow us to maintain a higher crediting rate.

Hi Nigel, this is David. I believe I only had one comment in recent months on consolidation but let me see if I can repeat it. That is that we see, as I have always seen, consolidation of the industry as inevitable but I think we see a considerable slowdown also. I think between the Europeans and between the fact that the large American companies as well as some of the mid-sized ones I think are all in the middle of a reassessment.

I think what we are more likely to see is the possibility of some companies deciding to shut some businesses which we are, of course, on the lookout for. One of the things people misinterpret about consolidation is that we are always considered a seller.

We consider ourselves a buyer as well and we indeed bought 6 or 7 companies or blocks of business. I think what we will be seeing in the coming year or so is some companies that have like businesses, annuity businesses, et cetera, will be shedding some of those businesses as I see them as noncore. And think that's what we will see more than anything else in the near future.

Can you comment on your how you view MOEs now?

I view MOEs as highly speculative. I don't think we will see a lot of activity until people are clear that we are passed the economic storm. As Tom said, we were not sure yet we are out of an economic storm and I think we won't see a lot of activity period until the economy is very clear to everybody.

Thanks, a lot.

Thank you. Our next question is coming from Michelle Juridano of J.P. Morgan.

David, just as a follow-up to that last question, when you see these annuity and life insurance policies becoming available, what are some of the things you will be looking for to fill in some of the holes you might have or strengthen what you already have. And then secondly on just the movements in interest rates, what kinds of things were you doing in the quarter when interest rates were coming down and now what are you doing now? Is there any change in the investment portfolio now that interest rates have gone up so much?

And then lastly on the sales, could you actually give us a some more details on what you are doing specifically. How many wholesalers are you rolling out? Give us a time frame and what are some of the specifics of the new products and the training that you will be doing. Maybe if Jim Benson or Mike Bell can focus on that, that would be helpful.

Let me take the first one right away. Things we are always looking for, as we did in the Allamerica purchase, is a block of business that's accretive -- to earnings as quickly as possible. We are interested in looking at blocks of businesses that will enhance the kinds of products we sell today that are easy to process for us.

We will be-- we continue to be interested in, of course, any blocks of business or companies that would add a distribution facet that we don't currently have. We were not interested in businesses that we consider non-core. We continue to have no interest in the disability businesses and the P&C businesses, et cetera. They can be someone else's headache and not ours. And I think the last thing I would add is we would be in really primarily -- interested in primarily domestic U.S. business and not foreign business. I would like to turn this over to John DeCiccio for your interest rate question and then to Jim Benson.

Good morning Michelle. In terms of the interest rate environment as you said, first we are looking at some real downward movements in rates and then we looked at upward movements in rates. I think we were very happy that in general the assets that we do have, have very little optionality in them in terms of prepayment activity or lengthening activity when rates go back up. That's a very positive thing and it's something we have always done and continue to do.

In terms of the activity of new investments, we have seen a very good deal flow in this entire period of time and even with the uptick in rates recently, we aren't seeing a drying up of interest in new investment activity because a lot of the players recognize that rates are still low and they are worried about continued possible increases in rates. We are seeing good deal flow. We also were seeing attractive deal flow in foreign private placement deals that we hasn't seen as much activity in and we have seen some attractive opportunities there. And in the mortgage side, we are seeing continued good pipeline and continued good opportunities as well.

So I think in general we found this to be a relatively good environment to the making of new investments and we haven't faced problems with our -- any optionality in our assets. One activity that we got into in the quarter that has an impact in terms of generating gains and also as a matter of fact improving income -- as you may remember last year, we talked about the amount of high quality AAA securities we were putting into the portfolio because we had a dirth of investment opportunities.

What happened during this quarter as we saw investment opportunities, we were able to recycle something close 800 million of those securities, basically generating gains and generating increased income which is something that by putting them into better longer term and higher spread kind of vehicles. So overall I think the quarter was very positive in terms of our investment activity.

Michelle, this is Jim Benson speaking for a moment. With regard to sales, it is our belief the key to sales growth is to become the life products manufacturer of choice. And so rather than concentrating just on distribution expansion, we have been working for the last several months to improve our ability to be perceived legitimately as the top life products manufacturer in the insurance business. And to do so, every product that we are offering today and will offer will be highly competitive in the brokerage marketplace which is the area as you know has greatest growth potential.

We are improving our ease of access and understanding of the products to the brokerage community and maybe most importantly we were improving our speed to market where it is typical in many companies to take 4, 6, maybe even 8 or 9 months to develop a product from beginning to when it's officially offered up for sale.

We are moving to a model where we do a number of processes simultaneously as opposed to sequentially and we are hope by the end of this year to be able to offer products from beginning to end in 75 days.

With that said, our goal is to be -- in addition having been the premier manufacturer of variable life over the last several years -- to be a premier manufacturer of universal life as well as variable life both single and survivorship modes.

In both the large case where we have been strong and the mid sized marketplace and to continue to be, I think, the only brand-name company that's competitive in the term marketplace. This fall we are offering a single life no lapse guarantee UL product, a new product. Survivorship UL with no lapse guarantee. An accumulation single life UL. A mid market Coli [ph] Universal Life. And then a refresh variable life single product. All of these coming out this fall. That suite of products will position us particularly well in the marketplace.

As far as distribution, we have slightly reorganized our new direct brokerage system. We are expanding our life wholesalers from 10 to 20 as well as supporting them appropriately with internal wholesalers. So the number of touches, the number of people on the ground working in this expanding marketplace is going to be significantly enhanced in the second half of the year.

In the agency system we have been successful here at Hancock recruiting new people in the industry to be long-term care specialists. Our eight new agent retention rates are among the best in the industry as a result of that. We are now shifting the emphasis not to exclude long-term care but to expand it so that our sales people will be more full-product and service planners looking at long term care, retirement plans and particularly life insurance.

So from a distribution stand-point, direct brokerage greatly expanded shifts to life insurance as opposed to highly concentrated efforts in long term care and then in M, the first half of the year was not strong. We remained I think in Tom's comments indicated, number one in the system but the system overall was down. We look forward to the second half of the year being stronger in M. We don't accept any major changes in our distribution.

Thank you.

This is David D'Alessandro. I want to add one comment. I'm sure there are a lot of people thinking that the sales issue is related primarily to just VL versus UL. There is another aspect that's worth mentioning and that is that we are a high end player as we always have been.

The first half the year the large brokers and large brokerage outfits for the most part are down on large cases. It's important to note the war is now behind us and maybe we were out of the economy problem, maybe we are not.

It's the large case market that is being driven down to some extent which is at the heart of some of our business. If the economy starts to come back, I believe that all of our plans and Jim Benson's careful planning and new organization will be right on top of the large case market. I think we shouldn't forget there is a size of case issue as well as type of product.

Our next question coming from Jason Zucker of Fox Pitt Kelton.

Good morning, thank you. I just have a question for you on institutional product sales and the question is this, just given that you are beginning to starting -- beginning to lower the risk profile in the investment portfolio, what I was wondering is whether or not you had left pricing power now on the market and perhaps because yield is coming down, you let's say can't be as competitive in the market today as you might have been a year ago?

It's Jeanne Livermore. In the marketplace we have seen a couple of things. First of all, weak demand which is part of the reason for our lower sales. But also, we are sticking to our pricing discipline, and as you mentioned, the repositioning of our -- okay, should I start again? Jason, did you hear that?

You broke up a little bit.

I will start again. The demand in the institutional markets is down which is part of the reason for our lower sales. But also we are repositioning the portfolio and we are sticking to our pricing discipline.

So what we are looking for is the spreads that we need to make a return. But as we reposition our portfolio, the other thing you have to remember is that the capital we assign to the portfolio is lower. So actually we need a slightly lower spread in order to make the returns that we need to make.

So although we have seen very tough competition, I think that the basic business models still work and we think with improvements in the economy, we will be returning to the sales levels that we have had historically.

So the conclusion is on the margin the fact that the risk profile comes down doesn't really mean you have less pricing power in the marketplace?

That's correct.

Thank you.

Thank you. Our next question is coming from Joan Zief from Goldman Sachs.

Thank you. Good morning. Tom, I wanted to ask you your opinion about the rating agency view of the industry still being quite negative. Do you think that with the credit issues subsiding and the companies having moved to sort of shore up capital and be more disciplined in that respect lowering high yield exposure, do you think we could see a shift in the rating agency view of the life insurance industry within the next 6 to 12 months? That's my first question. Then the second question is -- and if you said this I apologize, I missed it. Could you tell us how much of your gains were from prepayments? Also, could you just give us a review on your tax-driven investments?

Joan, I will take the first question, the rating agency questions and then we will have John talk to the gains from the prepayments and all. The question you are asking is one that we ask ourselves quite often.

And probably clearly would be best to ask the rating agencies but you are likely to get different views from each of the agencies as well as probably within those agencies. And the reason I say this is because the economy and the market really continues to send some truly confusing signals at this time and they are so far reading those signals the same way we are with a very cautious outlook.

But that never stops me from giving my opinion so let me try to run it through from my perspective. I think until there is a clear sign that the economy is changing and credit issues truly do subside, they will continue with their concerns and the negative out look on the industry.

I think rapid interest rate increases will concern them as Michelle pointed out earlier in her comments, and a number of companies really are exposed to lapses on interest sensitive products and some companies have been reaching out on the yield curve for a pricing purposes. And I think are exposed from that perspective and worry about that. That's one of the strengths they see with Hancock on the asset liability matching, that we have.

I think the lack of growth and the life insurance marketplace is a concern. Along with the issues of pricing and underwriting that we have seen and they see, companies out there buying business. The mix of businesses in some companies’ portfolios and the product features with associated unknown risks or other areas of concern or at lease raises questions in their mind.

Finally I believe some of the agencies are looking at the banking industry, which is rated Single-A and they are asking what are the differences between bank products and the insurance industry. That's why at this point the 6 to 12 month outlook of lifting the veil of negative I think is probably a long shot. I do think that you have to continue to take a lot of time and list in talking with the rating agencies as we do because we like to understand their thinking and everything else. But I think there is still a lot of question marks in their minds about where this industry is going and its long term strength and everything else.

This is John DeCiccio. On your question on the prepayment gains. There are $25 million of prepayments gains we had in Q2. I would want to point out because most of our investments are protected from prepayment losses.

They were made mostly at a T-Plus 50 make-hold period of time of the bond or the mortgage. There is a real economic gain to us here. It's not just simply an interest rate recompense -- economic gain that we get to reinvest and given our tax situation, we can invest the whole gain and take advantage of that in income and we are pleased that we do these as capital gains and not as an income item. That's a very positive thing.

In addition, there is the tax advantage investments during the quarter. We basically had not done any further level of the leverage to leases that we had done prior in the second quarter, but we were still -- we have opportunities there and there will be opportunities going forward but none in the second quarter.

Just a follow-up on the prepayments, are most of these commercial mortgages?

Most of the gains actually came out the bond portfolio, about $22 million of the $25 million of the bond portfolio and another 4 or so million out of the mortgages.

Thank you.

Our next question is coming from Andrew Klegerman (ph) of UBS Securities.

A few questions. First with regard to your mutual fund business. It looked like there was sizable outflow or redemptions rather, $1.7 billion versus 968 in the prior quarter and 1.2 in the year ago quarter. I would like to get some color on that.

Then with regard to your investment, I was reading in the press release that the largest impairments related to $20 million on a toll road project and $13.5 million on an Australian mining company. These investments to me seem somewhat exotic and I was wondering what type of expertise goes into selecting these type of investments.

And last question on distribution. I have heard on the call that there are a lot of new product initiatives under way. It sounds like there is some confidence in the group. But versus a year ago and I understand some of the environmental issues with regard to variable life and, versus a year ago quarter, you have $13 million in sales and this one versus $31 million the year ago quarter and 6 months over 6 months look similar. I'm wondering, are you losing share in the M group? Are new entrants like Lincoln National coming in and garnering share away from you? Was this sort of a blip and you will pick things up?

Hi, this is Maureen Ford. The $1.7 billion, a good portion of that, a little over $900 million, was in our institutional business where a number of our institutional clients rebalanced from fixed income to equity. We didn't lose any of clients. We were doing rebalancing.

I see.

Andrew, John DeCiccio. Some of the investments that you categorized as exotic investments, John Hancock has a significant staff involved in private placement activities. One of the areas we look at is project finance and toll roads are in the kind of project finance deals we do look at. We have done a number of them. And we had very good successes here. We had major gains taken out of the toll road portfolio. This particular deal did not work out very well. On the other hand, again, over the longer haul, we have done fairy well.

In terms of the Australian mining company, again, we have a deal focused on minerals and mining activity. And they do these deals across a various spectrum of companies both domestic and foreign companies.

And as I want to point out, we would hedge any currency risk. This is not a currency risk issue. We would have this all hedged back to U.S. dollars. This particular deal was something that we looked at very carefully and felt we were able to analyze the company. It did run into problems, as you know, metals have been in rough shape in the last few years.

Very helpful.

This is Jim Benson. Regarding M. M’s first half of the year was down for all carriers and we were along with that down proportionately. We were a little over 40% of their business the second quarter of '02 and about 35% of their business in '03. Lincoln National did come in. They are a quality performer carrier. We don't comment on other companies other than to recognize their significance in the marketplace.

We were significantly higher -- or M -- than Lincoln and virtually every other carrier with the exception of Pak Life in the second quarter and year to date. We think there are a number of very strong competitors. We think it makes M stronger and attract more distribution and as M's distribution grows so does our opportunity to grow within that channel.

Our next question is coming from Tom Gallagher of Credit Suisse First Boston.

Good morning, a couple of questions. The first is, Tom, you mentioned a few different times the aggressive pricing by competitors. From where I am sitting, I have been hearing about everybody talking about hunkering down and lowering crediting rates.

So at least you have the idea that companies are becoming less aggressive at least over the last few quarters. So can you talk about-put that in a little bit of better frame of reference in terms of which market? Are we talking universal life, fixed annuities? And are you seeing the competitive pressure ease there?

What I want to do is ask Jim Benson and Michelle to speak to the issue of the retail products and the aggressive pricing they are seeing there. Then I will ask Jeanne Livermore to speak to what she is seeing on the institutional business side as well where there are a number of cases that we were losing by a very wide margin overall.

Hi, this is Michelle Van Leer. I think you mentioned fixed annuity in UL. On the fixed annuity side second quarter for us and the industry was a little unique, in that we can compete and have -- we have been a big fixed annuity player for sometime in a competitive environment.

But second quarter was unique in that the drop in rates and going to a lower guarantee kind of caught some people a little short and they were stuck at 3%, didn't necessarily get out of the market and we were able to with a few other carriers go below.

So we were offering rates through the second quarter below 3% and in those states where we hadn't quite gone to 3% product, we had reduced compensation, eliminated bonus and so forth.

In the third quarter, we are seeing -- as rates are coming up a bit, we are seeing some more sense -- a comeback into the market. Although, there are still as there always will be, there will be some outliers. We think our opportunity is going forward -- we won't be in the same unique situation that we were in the second quarter.

We will maintain the discipline that we had all along but we have done that in prior years in a competitive environment and have done well on the sales side as well. UL as the market has shifted, as clients have shifted and as people have looked for UL in a guaranteed premium environment. It's certainly become quite a competitive environment. The regulation changed from last year to this year which I think also caused some turmoil among many carriers as people were adjusting their products to comply with A-XXX.

So there has been a lot of movement of product and that's why we are making -- coming out with a lot of new products right now. But there is 10 to 15 tough competitors in the UL market in that arena but we think with our name brand, with our abilities on the investment side, our ability to kind of design and create products to work here.

We offer on our no-lapse guarantee UL product the long-term care rider -- nobody else offers that -- and then with all of the distribution initiatives that are going on that we will be able to be a strong competitor in that arena.

Tom, it's Jeanne Livermore and I will comment on the GIC market and annuity market. So far this year in the traditional GIC market we have seen a decline in the quote volume. Of about 40%. So I think there is a smaller market and just as many competitors in that market. So far this year the deals we have lost we have lost by 35 basis points on average and that is a wide margin. And as a results of our pricing discipline, we have seen our market share fall in that marketplace.

And it's a similar story in the annuity marketplace, although in that market we have seen a fair number of quotes, but they haven't to my knowledge been any of the jumbo annuity deals actually placed.

So companies are coming in -- for quotes but when they see the results they aren't actually placing the business. But again, from the competitive information that we collect, it looks like we are off the best bids by that same sort of 35 basis point margin.

And when you lose by 35 basis points or so, is the only conclusion you can come to is that the companies are taking duration risk?

Some may be taking duration risks, some of them may be aiming at a lower ROE than we are aiming at. It's not entirely clear to me which of those things, but at least both of those things some of our competitors are doing.

Thanks. One quick follow-up. For Jim Benson. Just in terms of when I looked at another very strong long term care sales quarter, I guess one thing came to mind is that is this going to be a real problem in terms of transitioning your agent to begin selling life insurance again and is that the fact that they have sold a lot of the long-term care likely to really stall the process in terms of not reviving life insurance sales?

I certainly hope not. The good news is on long term care sale is the distribution is very diversified. It comes through our direct brokerage channel. We have a channel which we call our MGA long term care channel that's an outgrowth of our Fortis acquisition and we have at least half of our long-term care sales from people who are long term care specialists not in our agency system.

In the case of our agency system, our people were hired into a long-term care sales mode. It remains to be seen how many of them can be transitioned although our general agents are very eager to have them move into a broader product set specializing in life insurance. But we can see our sales growth as we revise -- revise guidance up 35% to 40%. That can continue without overdependence upon continued emphasis on long term care sales through our agency system.

Thanks.

Thank you. Our next question is coming from Bob Glasspiegel of Lane and McIlaney. I have one long term care question and one interest rate question.

On the long term care you talked about low lapse rates in the business. I assume that's a negative. CNA exited the business because they felt lapse running too low. Is that an issue of concern or not?

This is Barbara Luddy. We are seeing low lapse rates on long term care which most of industry is seeing and for our older blocks of business they are running much lower than had been priced in the business.

Over time as we recognize the phenomena we built that into our newer blocks of business and are pricing to extremely low lapse rates. Where we had a real benefit that perhaps not all of our competitors have is on the claims side where our claims experience had been significantly better than had been priced for on the older books of business and that's provided a buffer so that in total our experience is running very consistent with what we priced for and we were not seeing anything that would even begin to cause us to think about exiting the business. We thought this is a healthy business.

The low lapse rates do have additional benefits in terms lowering unit expenses. Then what we believe is that the aggregate claims experience on the book, which continues to be quite strong, could actually be benefiting from low lapse rates. One certainly sees that in life insurance business and some indication that it's true in long-term care as well where the more people that stay with you have a generally healthier population. We would expect that longer term, the good claims experience will persist and create the longer term gains on this business.

Thank you. If I could just follow-up on the interest rate question. I can understand, you having articulated less aggressive sales posture in the second quarter in light of low interest rates. But we had a pretty significant increase in interest rates.

I'm wondering why you are pulling in the horns today. You talked about competition, but perhaps are we reacting to the rearview mirror of the pain we had to go through in the low interest world and perhaps if interest rates stay where they are and credit starts to improve as it has, you will be better positioned for growth looking out a quarter or two.

In reference to the question here, I don't think we were looking at the rearview mirror, but what we were looking at and maybe it's our cautious outlook on where the markets are going both from an equity crediting marketplace as well as the interest rate view. What we do is from both of our interest sensitive products, both the GICs and funding agreements as well as on the fixed annuity markets is actually priced them daily and weekly and watching the interest rates and the movements of those interest rates. As we see them move, we will continue to adjust pricing and crediting rates accordingly.

And what we were cautious about is whether folks will continue with some discipline in moving up on their crediting rates or continuing to hold them. That's the issue we are worried about and watching.

When you miss some of your quotes in the GIC funding agreement marketplace and annuities by 35 basis points, it's hard for us to think that people will all of a sudden become really rational and move back in. We aren't looking back. We are looking forward and watch it on a daily bases.

There has been a significant change in the last three weeks and I want to make sure your commentary reflected where we are today as opposed to three weeks ago.

It's reflective as what we see today and what we have seen in the marketplace and how people apply it.

Thank you very much.

Our next question is coming from Vanessa Wilson of Deutsche Banc.

Thank you very much. Tom, with the ROE in this quarter at 15% and you are facing higher capital requirements from the agencies and also intentionally de-rifting your portfolio, what should we think about as a normalized ROE going out to -- 2 to 4 years from now.

We just actually undertaking our current plan process where we go out for and look at three years and looking at all of the business mix and the sales activities and all.

So it would be a little bit premature to say exactly where I see it moving to. Let me indicate when you look at the big portfolio that we have in place today, as I said before, a lot of this is not bigs [ph] that we went out and acquired with big spreads on them. They were created by downgrades. As we trade out of those positions over time and the ratings get improved and as we move to restructure the portfolio and replace some of the movement out of those downgrades over time, I think you will not see a quick dropoff in the ROE.

I still think that we will be a strong player in the 14% range. Let me point a number at this point. But that's something we will see as we work through. I'm not anticipating a quick dropoff in the overall ROEs of this company.

I guess in particular the increased capital requirements from the rating agencies. I guess some have fears that will drive 100 basis point drop in your ROE. That's very unrealistic, right?

Yes. Again, we are at the high end of our %300 to 325% capital requirements right now for NEIC and you see those returns. Even if you took out some of what folks have written about, as one-timers, you still have a good, strong, ROE. I still think that's not going to see a quick drop off.

And you had a nice increase in book value -- non [indiscernible] book value this quarter. It's up to $22.57. With this spike in interest rates we had this quarter, there is anything we should think about for the third quarter if we stopped interest rates where they are. Will your cash flow hedges reversed?

I don't believe so.

Okay. And then on the sales side, to the extent you are bulking up your sales infrastructure and there is a lower level of sales this year, how does that affect your DAC capitalization and allowables. Will you be expensing the level of that infrastructure buildup?

Most of the sales structure that we were bulking up on, as you put it, are our external wholesalers that are paid on a variable cost basis. The bulk will be deferable and not negatively impact us.

And my final question, in the compensation for senior executives, how heavy a weight will sales performance have this year?

This is David D'Alessandro. It has as I said at our previous conferences, it has no weight at all in the formulas that determine senior executives outside of -- except for the senior executives in sales below Jim Benson's level.

So Jim Benson would not be measured based on sales performance?

He is a member of the policy committee of the company and he is measured on as, all of us are, on operating income growth, and net income to some extent as well as EPS growth as we talked about in the past.

Thank you.

Thank you. Our final question is coming from Ed Speer of Merrill Lynch.

Good morning. I had one question to follow-up for Jeanne on the spread issue on new business. The question of with an indication that the quality of investments will maybe be a little bit higher at the margin or the portfolio restructure that you had to talk about.

The idea that the offset of lower capital requirements for a higher quality portfolio would allow for -- I think the implication was similar returns as historically has been the case. I guess the question is, why wouldn't there have always been the bent toward a higher quality portfolio? If there is no return benefit because the lower spread and the lower capital requirements work out to be the same, why have a higher risk portfolio to begin with? Thank you.

I think our business model was one that we sort of grew up with over the generations and our expertise was in private and still is in private placement where we saw a lot of value. I think as a public company, we want to diversify the asset strategy more than we had it diversified as a mutual company. And that means we were going to a slightly -- and it's a very slightly higher quality. It's not a big change in our investment strategy, but just a slightly higher quality.

Thank you.

I would like to turn the floor back over to management for any closing comments.

Thank you operator and thank you everyone for joining the call. For anyone's question who was not addressed we will follow up with you during the day and feel free to call us. Thank you.

This does conclude today's teleconference. You may disconnect at this time and have a great day.