Manulife Financial Corp (MFC) 2005 Q2 法說會逐字稿

Please be advised this conference is being recorded. Good afternoon. Welcome to the Manulife Financial second-quarter 2005 financial results conference call. Your host for today will be Craig Bromley. Mr. Bromley, please go ahead, sir.

Thank you and good afternoon. I would like to welcome everyone to Manulife Financial's earnings conference call to discuss our second quarter 2005 financial and operating performance. If anyone has not yet received our earnings announcement, statistical package supplied through this conference call and webcast, these are available in the Investor Relations section of our website at www.Manulife.com. As in prior quarters our executives will be making some introductory remarks. We will then follow with a question-and-answer session.

Before we begin I would like to remind everyone that during the course of this conference call we may discuss forward-looking information as defined in the U.S. Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those implied by such statements. Investors are directed to consider the risks and uncertainties in our business that they affect future performance and that are discussed in Manulife's most recent annual report on form 40 F, John Hancock's most recent annual report on form 10-K, and John Hancock's quarterly reports on form 10-Q each filed with the U.S. Securities and Exchange Commission.

Investors are cautioned not to place undue reliance on the Company's forward-looking statements. The Company does not undertake to update any forward-looking statements. Now I would like to turn the call over to Dominic D'Alessandro, our President and Chief Executive Officer.

Thank you very much, Craig, and good afternoon ladies and gentlemen. Thank you for joining us on this call. I am pleased to report there's been another strong quarter for Manulife. Earlier this morning we reported record shareholder's earnings of $839 million for $1.05 per share. Return on equity was also very strong at 14.3%.

We were very pleased with the performance of almost all of our operating divisions. Results in Canada increased sequentially for yet another quarter, and U.S. Protection recorded solid gains over the first quarter of the year. U.S. Wealth Management and Asia and Japan also continued to perform well. Only our reinsurance business had a quarter that I would categorize as disappointing.

Looking at our sales, as expected insurance sales were up solidly over the first quarter with the U.S., Canada and Asia and Japan all reporting an increase. However, the greatest improvement came from our U.S. Individual Insurance segment where sales increased almost 40% over the previous quarter. Wealth Management sales were also very strong. Variable annuity sales reached record levels in the U.S. and remain strong in Japan and Canada.

We also continue to expand our product offerings and distribution channels. In the U.S. we announced a sub advisory agreement with GMO, a well-respected Boston-based asset manager. We're very excited about the potential of this agreement as it will significantly increase the number of highly rated mutual funds we will be offering to our customers. As you know, investment performance is critical to driving sales in the fund industry, and we expect to benefit from the excellent track record provided by GMO. Transaction is expected to close in the fourth quarter of this year, pending required approvals.

I would also like to make a few brief comments on our operations in Asia having just returned from an extensive three-week visit to the region. We have a diverse range of operations in Asia and Japan, and each one is either contributing significantly to our bottom line or has the potential to do so. It is truly impressive. In China we have a rapidly expanding operation, which currently has licenses for 8 cities, and we expect this will expand to 10 by the end of the year.

In other areas we have established successful Wealth Management operations where there were none just a few years ago. We are also diversifying our distribution channels, most recent example being a new (indiscernible) agreement in Hong Kong. In Banda Aceh, Indonesia our employees are working hard to rebuild our business there. Their efforts are a testament to their resilience and to our commitment to the region. In fact we will soon have more than one million customers in Indonesia, and our company there is emerging as the clear leader in the life insurance industry.

I would like to conclude by noting that the second-quarter marked the one year anniversary of the John Hancock transactions, and over the last year we have accomplished a great deal. We have completed a large portion of the integration, have a very strong management team in place and they already realizing expected revenue and expense synergies. These accomplishments are more impressive when we consider that throughout this process we have successfully maintained our excellent service levels.

Looking forward I expect that we will see additional benefits as the businesses complete their integrations. With that, I would like to ask Peter to take us through the numbers in more detail. Following that, we will have our question-and-answer session. Peter.

Thank you, Dominic. The second-quarter and shareholders earnings of $839 million, an increase of 5% over the previous quarter and 28% above the results for one year ago. Factors contributing to quarter-over-quarter earnings growth included improved investment in credit experience, favorable claims results and other expenses. Partially offsetting these positive items were lower reinsurance earnings and unfavorable lapse results.

As Dominic noted our EPS increased to $1.05 in the second-quarter representing a year-over-year increase of 13%. Excluding the impact of foreign exchange movements EPS would have increased by 20%. As roughtly two-thirds of our earnings are U.S. dollar-denominated it is interesting to note that had we reported on a U.S. dollar basis growth in earnings per share would have been a very substantial 24% up over a year ago. The second-quarter earnings included very unusual items which taken in total reduced our results by $7 million on a post tax basis. The first item relates to the final adjustments to the John Hancock purchase equation, which resulted in a 26 million net reduction in earnings. These amendments are consistent with accounting guidelines that (technical difficulty) the finalization of our (technical difficulty) within one year of the transaction close.

In addition, integration costs, expensed during the second-quarter reduced earnings by $28 million post tax. The final item was a net gain of $47 million resulting from asset mix changes made to align investment policies of Maritime Life with Manulife's. On slide 9 you can see an aggregate the changes made to the purchase equation increased the goodwill associated with the John Hancock transaction by $407 million. The most significant item contributing to the increasing goodwill was the establishment of additional reserves for the John Hancock Accident and Health business, which is in runoff. The majority of this portfolio is being litigated or arbitrated we concluded following a detailed review that additional reserves were appropriate given the considerable uncertainties attached to some contracts in this portfolio.

As well there are also changes in policy liability valuation models, (technical difficulty) values and additional restructuring accruals. As this table indicates certain balance sheet items have been amended to reflect these adjustments which were largely offsetting. On slide 10 you can see we continued to make good progress on (technical difficulty) equity in the second-quarter we reported an ROE of 14.3%. This represents a very meaningful increase of 230 basis points over the third-quarter of '4, which was the first full quarter of combined operations with John Hancock.

I would also note that we are well ahead of our initial early expectations, and we continue to have significant excess capital per share buybacks. As we filed (indiscernible) in the past we continue to make progress on improving the overall quality of our invested assets. At the end of the second quarter we reduced our exposure to assets rated triple B and below to less than $37 billion. As a percentage of the invested assets this equates to 22%, down from 25% in the second quarter of last year.

We also continue to diversify invested assets in (indiscernible)expertise and investing in and managing alternative assets. Our recently announced deal to acquire Prudential Timber is consistent with that strategy. This transaction combined with the more recently announced deal to acquire Timberland assets from Harvard University will approximately double the size of our assets under management in the timber category to $5 billion U.S. In addition, we will now hold a portion of those long-term timber assets directly for our own investment accounts.

Some of you might have observed that our net impaired asset ratio has been increasing since the close of the John Hancock transaction. This trend reflects the fact that the acquired assets were fair valued upon close. As time passes and valuations fluctuate, impairments naturally occur. Adding to this trend is the fact that John Hancock has more credit intensive assets leading to a higher propensity for provisions compared to our premerger assets. I would note that this was considered in our initial purchase equations, and we have been very pleased with the performance of this portfolio since acquisition.

I would now like to turn to a review of our divisional performance. On slide 12 you will see that earnings in our U.S. Protection business increased by 15% over the first quarter to $107 million U.S. The earnings growth was driven by strong performance within the Individual Insurance segment where earnings increased by 30% over the first quarter to U.S. $109 million. A number of factors contributed to the income growth, including stronger equity markets, improved investment performance and good mortality results. In addition, the impact from new business was favorable compared to the previous quarter as higher sales volumes helped generate expense efficiencies.

Further, the positive impact of product cages (ph) implemented in the first quarter improved margins on a per unit basis. Within the long-term care segment results were down from the solid first quarter that included roughly 9 million of earnings previously identified as onetime in nature, but were up versus previous quarters. Driving this positive result were improved operational efficiencies and the move towards a more appropriate asset strategy that better reflects the long-term nature of the LTC business.

On slide 13 you will see the Individual Insurance segment reported sales of $142 million on a U.S. dollar basis. This represents an impressive increase of 37% over the first quarter. It is also a record second-quarter result based on the combined historical results of both companies. The strong increase in sales was driven by new sales initiatives implemented during the first quarter. Strong sales through the John Hancock financial network channel and increased momentum of U.S. sales, as well in July we introduced a new VUL product. Long term care sales declined marginally in the previous quarter as increased retail sales were offset by lower group sales. It is noteworthy the number of submitted applications appears to have stabilized and are showing some positive trends over recent months.

The slide 14 you can see that earnings in the U.S. growth Wealth Management division amounted to $108 U.S. This is down marginally from the division's record first quarter primarily due to weaker investment experience within the fixed annuity segment. Overall we remain very pleased with the performance of the division.

Slide 15 highlights the significant contribution for net sales in U.S. growth management, with the exception of fixed annuities where volumes have been restricted in low interest rates and tight spreads, all segments are contributing strongly to net sales. JH funds are well into positive territory, a result that is a good contrast to the premerger situation. This deal is a variable annuity segment have been consistently strong contributing to divisions overall growth in funds under management. Gross sales also remain strong. Variable annuity sales reached 1.7 billion U.S. outpacing the very strong first quarter by 17%. Success in this productline is evidenced across all distribution channels as a result of the principal plus rider and the launch of the principal plus for a life rider in May which resulted in June being our best sales month on record.

Sales of fixed annuities also increased over the first quarter particularly to the bank and John Hancock financial network channels. However overall sales levels remain constrained due to the interest rate environment. On slide 16 you will see Our GSFE segment reported earnings of $91 million U.S. The increase was driven by unusually strong investor results on hybrid assets and other investment related gains. While earnings on this $32.4 billion portfolio exhibits some volatility this level of earnings was extraordinary and is not considered to be sustainable.

Slide 17 shows earnings in the Canadian division increased again, reaching a record of $191 million. Our Canadian Individual Insurance segment earnings increased modestly as improved claims and investment results were largely offset by less favorable lapse experience. New business losses or stream (ph) was reduced reflecting the benefits of expense efficiencies and product restructuring as part of the Maritime integration. The slide (indiscernible) in Canada Individual insurance sales fell slightly from the first quarter. However, the business implemented a number of new product initiatives in June with the industry hitting our market position. Sales in the group benefits segment increased by 30% over the previous quarter, driven by large K (ph)sales. Retention sales increased by 30% as well over the previous quarter, sorry, first quarter of the year reflecting strong demand for both defined contribution and investment only products.

On slide 19 you will see that our individual Wealth Management segment in Canada continues to generate strong consistent net sales across the key product categories. Mutual fund businesses performed particularly well over the last year with good market share gains and a strong growth in funds under management. Gross sales also remained (technical difficulty) while this is down from the strong first quarter which includes the ROSP (ph) season it represents a solid 17% increase year-over-year.

As you will observe in Asia and Japan we are now reporting them as one division. However, as in the past, we continue to provide financial information on our Japanese operations. Earnings for the division are down for the first quarter, primarily due to the recognition of U.S. $16.7 million in net tax assets in the first quarter in Japan. Compared to the second quarter last year results increased by 15% to U.S. $107 million.

On slide 21 you will see that in Hong Kong sales from the new (indiscernible) agreement began to flow through in June and contributed to an increase in insurance sales over the first quarter. Japan also experienced a modest increase of insurance sales rising 2% on a local basis. Variable annuity sales remained very strong in Japan at U.S. $679 million. As expected, this result is down from a record first quarter in normal seasonality. Our key bank (indiscernible) channels continue to perform well, and while still modest, the (indiscernible) advisory channel is showing good growth following the launch of the manu prime product in the first quarter.

Looking forward there may be some (technical difficulty) volatility in sales levels as (indiscernible) Tokyo, Mitsubishi and UFJ show some of their focus to their pending merger. (ph)In other Asian territories Wealth Management sales were almost double that of the prior year, but declined in the previous quarter on somewhat reduced demand for mutual fund products. On slide 22 shows that the reinsurance division reported second-quarter earnings of $24 million U.S. The result is down from previous quarter due to life claims on the Manulife accident block that is in runoff. And the $10 million increase in claims charge is considered to be an unusual and unlikely to recur event. This follows the first quarter which is negatively impacted by also an unusual onetime claim loss in our P&C line. However, sales were considered particularly strong with levels reported on our life retro business up roughly four times about that reported in previous quarter.

Looking at the source of earnings on slide 23 we continue to show good growth on in force business with expected profit for in force of $650 million. The impact of new business (indiscernible) by $15 million to an origination loss of $80 million primarily due to the U.S. Individual Insurance segment, as strong sales offset fixed acquisition expenses and sales continued to shift to reprice products with improved margins. Experience gains were very strong at $243 million driven by good investment experience, improved claims results offset by worse than expected business persistency. This result is up from the first quarter when we experienced poor claims and less favorable investment results. As in the past, integration expenses and the impact of valuation basis changes have been included in the line management actions and changes in assumptions.

Also included in the slide are the unusual items referred to earlier in this presentation, mainly the purchase equation adjustments and a reserve impact of aligning investment policies in the Canadian business. In slide 24 you will see that on a U.S. GAAP basis, net income for the second quarter was $977 million, or 138 million above the results reported on a (technical difficulty) GAAP basis. Consistent with last quarter, the higher income is attributable to the impact of realized gains as such gains are taken directly (indiscernible) U.S. GAAP. Whereas under Canadian GAAP, they are amortized and largely offset by corresponding changes and liabilities. Excluding this realized gain impact, net income levels remain quite consistent.

In conclusion, we are quite pleased with results reported in the second-quarter. Shareholders earnings, earnings per share and return on equity all improved compared to the previous quarter as the second quarter from last year. The sales perspective demonstrated good growth in our wealth management insurance businesses with a record second-quarter sales result in the U.S. individual (indiscernible) segment. We also continue to repurchase shares into the second-quarter, bought back (technical difficulty) shares at a total cost of $339 million.

Despite this, capital levels remain very strong, and our NCCSR ratio increased to 224% in the second-quarter. We look forward to the remainder of 2005, particularly as we complete the last pieces of the John Hancock integration and capture the full benefits of expected revenue and expense (technical difficulty). Thank you very much.

Operator, we are now ready to begin the question-and-answer portion of our session today.

(OPERATOR INSTRUCTIONS) Steve Cawley.

A couple of questions for you. Dominic, while you were in Asia you had a presentation and in the presentation you were talking about excess capital, and you talked a lot about, from what I saw in the press and from what I saw elsewhere, that there was a preference for dividends and buybacks over acquisitions at this point in time because there wasn't any real acquisition targets out there. I was hoping you could expand on that a little bit.

I'm trying to collect my thoughts here as to what to tell you. I think that is generally a fair statement that I'm trying to communicate to people that because we have excess capital, we are not about to go and do anything rash on the acquisition front. That has been our posture consistently over the last 10 years or so. There is nothing now that would cause us to change that. Should an opportunity present itself, as always, we are very flexible on these matters.

So maybe just talk a little bit more about stock buybacks at this point in time. I know normally you don't really comment too much on it, but relative to previous quarters, do you have an increased propensity to go and buy back stock?

Again, we evaluate all of the different variables and make decisions accordingly. I think it is difficult for us to signal to you whether we're going to be in the market aggressively or less so. We will have to evaluate that as events unfold, Steve. I don't mean to disingenuous. But I don't know that I can answer your question more specifically than that.

It seemed like a bit of a different tone from the past where -- some urgency almost to have Hancock integrated and be ready for the next round of --.

I think that that's true. Obviously, we want to get the integration of Hancock behind us. I think we are largely there. While you've got that challenge on your plate, I don't think it would be very prudent to go out and undertake other significant expansion initiatives of the same type. But no, you shouldn't read anything into my comments beyond that we remain opportunistic and we are looking to do with our capital what is best for the shareholders.

Great. Second one for Peter. Peter, when I saw the change in the purchase equation, the immediate reaction in my mind was you've stacked reserves. You talked about bolstering the close block of business for the John Hancock accident health business. Can you give me some increased confidence that this isn't stacking reserves?

Well, it's quite flattering to think that I might have that discretion. I don't. What we've done is a detailed review of a very complex business. And it's difficult to determine what the right level of reserves are because there are so many litigated files both inbound and outbound. And we've established, we think now is an appropriate level. But it may not be adequate and it may be excessive because there is a lot of uncertainty when you have arbitration or litigation. But from our own experience, which is modest, our accident runoff block was quick simple and small compared to the Hancock one. It is difficult to know what is going to happen when you have an arbitrator or a litigation. So we've done what we think is appropriate. It has been reviewed by our external auditors. We've used whatever advice we could get access to. But we consider this to be an area that is very difficult to be certain as to the obligations.

Steve I would stress what has just been said. The reserves that are maintained represent our best estimate given the information that we have available. The division that came forward and requested the additional reserves did not so with a lot of glee. You can imagine we are not very happy to learn that the reserves had to be raised. So believing that, if you are thinking that we intentionally set out to overstate the level of reserves there, that is not the case. In the event they prove to be unnecessary we would highlight that to you, and when that eventuality happens. So we are not seeking to gain unreasonable advantage from creating a cookie jar.

(technical difficulty) I am tempted to give you some of my money to manage considering you are getting yield of 5.9, 2% I think it was in the quarter. I think I've asked you in each of the last two quarters whether or not this is sustainable and every time you tell me, oh this was a really really good one, well, this seems to be the best yet. So I guess this makes for a pretty easy question, but just wondering what's going on there and is it sustainable.

Well, we have a broad diversified mix of assets and that's what makes this sustainable, and we've had a terrific run on credit. I guess I'll repeat for everyone on the phone isn't likely to continue forever. And equity markets have been very favorable to us and we have a sizable position to equity, so I suspect everybody will not be so impressed when equity markets go down, there might be some complaints. We have also enjoyed huge revaluations in the value of our real estate portfolio. Of course the bulk of this under accounting regime gets deferred and amortized but that has had a very salutary impact on our invested asset yield. And as you commented, it is a very safe portfolio. So feel very good. Tom is reminding me we had some gains in hybrid assets which are basically mostly originate from the Hancock where they took back equity positions in line with either higher yield or mezzanine type debt transactions. And we had a very , very favorable quarter with respect to those. That is certainly not repeatable, and Peter identified it as such. So it was a good quarter. Sort of all the stars aligned for us, I wouldn't count on that every quarter.

(indiscernible) result that our forecast doesn't effect this level.

Jamie Keating.

I just got an update on the proportionate benefit of the integration savings in the quarter if we were running at what proportion of the ultimate savings? And Peter if at all possible, are we to realize basically 100% of those going into early '06? Are we still on track for getting most of that by the boards? By the end of '05?

Yes, we do expect to hedge 100% of our indicated target, starting the beginning of next year. It would be 375% on a run rate basis at this point in time. And so that is continuing to proceed quite nicely.

Thank you Peter and I hope I did not miss this, I had to hop off for a second. Some new products to be introduced in the second half in the U.S., you can skip that if it is already on the transcript, just curious what those are.

We were referring to some new products in our mutual fund area. I'll let John explain. John Depreu (ph) is with us and explain what that means; we're quite excited about this initiative.

We expect to introduce essentially a new family of mutual funds in the fourth quarter. The target date is November first. It really consists of two new initiatives. One is the transaction with GMO Grantham, Mayo, Van Otterloo institutional investment firm in Boston, where we are adopting 8 of their highest performing funds in the asset classes that are tracked substantial cash flows. We will also be doing an internal adoption with our own lifestyle funds where we are going to (technical difficulty) those shares from our variable product fund and make those available to (technical difficulty) mutual fund investors. Those five funds (technical difficulty) very dramatically in the last few years from about -- the last three years they have grown from 7 billion to about $24 billion in assets. They have proven very popular with the public, and we will now be able to make those -- and they have very high Morningstar ratings, four of them are rated four stars and one five star and will be able to make those available to our retail investors. So the upshot of those two initiatives are is we will end up having a fun family with a much broader array of highly rated funds across asset classes that generate most of the cash flows. And it amounts to almost the John Hancock funds as a more viable entity, and we look forward to that being one of the growth engines for us going forward.

We had some products as well -- in life insurance we have a brand-new VUL product that has just been launched this last month, and the money -- its many features -- I think the most attractive is the lifestyle funds that John refers to in the annuity and mutual fund families are going to be available for the first time in life insurance and that should be a real positive addition. We have a new UL product coming later on this summer to take into account some of the changes in the marketplace. And then in long-term care we have a corporate choice product that is designed for the executive benefit arena. As many of you know the coli (ph) business executive benefits funded by life insurance is dried up to a certain degree based on some legislative uncertainty and regulations that haven't been written yet. And we are introducing a new productline to go at our substantial array of brokers who have terrific contacts in the executive benefit arena for group long-term care or executive benefit long-term care.

In addition we have established relationships with a number of affinity organizations where we are putting out a specialized product in long-term care in the fourth quarter this year, which will not compete with our regular retail products but will give us another substantial opportunity in the marketplace. There is a lot of new product initiatives going on in the protection division as well. This is a little bit beyond what Peter was mentioning, but it might be worth noting.

You got a whole recitation there, Jamie.

While Jim has got the floor is that nonrecourse premium finance product still being a bit of an irritant to you?

A lot of irritation, because we don't think it is good for the industry in the U.S. We do not sell it. We were the first company to put out our application effective January first; the specific question on whether the premiums were going to be financed in any fashion. And depending upon the answer to that question and the remarks we would determine whether we would actually go ahead and underwrite that or not. That has proven to be am appropriate stance to take from an underwriting standpoint, some of our brokers do not care for it, because we really have weeded out virtually all of the nonrecourse premium financing arrangements, and there are very, very many iterations on this theme. But we just refuse this write the stuff; we think it is bad for the industry, and we don't think it is good for John Hancock and Manulife.

You offered an estimate as to how much business you might have passed by last quarter, was it sort of a similar amount this quarter -- do you know, any knowledge on that?

I really don't know but there is no reason to believe that the amount of business sold of this nature has gone down. So I would say that we probably passed by a similar amount (inaudible).

Thank you very much everyone.

Mario Mendonca.

Good afternoon, everyone. I have one really sort of straightforward question, and a couple of more irritating ones. First the straightforward one. The integration costs, 28 million or so this quarter. Peter, last quarter you said it would run about that level until the end of the year. And then go to 0 following year. Is that still fair to say?

Yes, I don't think we are going to spend all the money we have budgeted by year end. But I think we will stop isolating it because it will trickle off. So from our perspective it will just become part of our core run rate cost if you will. So that is substantially correct.

Okay, and we all know that reserves are part best estimate, part (indiscernible). The 407 million increase in goodwill or something like that went to reserves. Peter, is it a reasonable question to ask what portion of that is best estimate, what portion is (indiscernible)?

We probably aren't not going to be helpful there because there are quite a number of different items. But the accident stuff would be mostly expected. Some of the other items would be adjustments between the various categories. I know, Simon, if you can provide any more color on that.

I don't have all the details with me, but we did obviously look at that when we were going through the work. And I think it was pretty well split between the two. There was no bias to with lease and p-fab (ph) and strengthening the expected assumptions. I think the change really ended up being a bit of both.

So it is fair to say that of the 400 million or so strengthening of the reserves, 200 million or so went to p-fab?

As I said I don't want to put a number on it.

I don't think it was quite that large -- but we can get back to you on that.

Sure, because that portion eventually does come back to us, and the follow up question to that is what is the term of that product? Over what period would that say $150 million or $200 million come back at us?

It's anybody's guess but I would say it would be a period of years that the A&H litigation and arbitrations would wind down. We stopped in Manulife selling at -- in 1999? And we are still dealing with some files. So this is not a rapidly resolved item. Another reason to be prudent.

Some of these litigations tale two, three years. Some of them queue up in discovery (indiscernible) before they get litigated for three, four years. It is a slow and laborious process. Some of them are in very early stages.

I think you know where I am going with this, I am trying to see if that 150 to 200 million or so comes back to us over say ten years or maybe four or five years because kind of --.

We don't know any accident stuff that there will be a penny of earnings on this reserve strengthening. The reserve is because we are thinking there is enough uncertainty there it should be provided for. And it is like any other situation except more uncertain and a little time delayed because you can't measure this one. There is no probabilities that will help you.

And we have got to go with the actuaries on this and if the split is roughly 50-50 between p-fab and best estimate then you go with what the actuaries best estimate of the p-fab is.

Yes, and we will keep you posted as it develops, if we have win or a loss, that is substantial, we will keep you brief, but we are thinking this is an appropriate level of reserves for the risk we have inventoried.

Okay, and the other question. (indiscernible) speak to someone at (indiscernible) not long ago, we talked a little bit about moving C-1 risk reserves -- you can see that your C-1 risk reserves -- the credit risk essentially within actuarial reserves or asset default risk -- about 500 million was shifted to something else, maybe interest rate related reserves. Sort of a two-part question first, where did it go? Is it really interest rate risk that we are thinking about here? And the second part of the question is why now with Manulife's exposure to below investment-grade bonds? And we saw that this quarter because about 107 million or so in bonds were downgraded to below investment-grade. It just seems sort of contradictory. The C-1 risk reserves declining, credit risk maybe increasing, how do you feel about that Peter?

Let me make a few comments, the move to below investment-grade is dominated by the auto industry, and we previously indicated we really have no credit exposure or concerns on the auto industry. We are in very nice position. Our exposures are short, they are all secured, and they are mostly to finance companies. But we rate them according to their parent and as their parent was downgraded they show as non investment-grade and are published somewhere. So I would say there is no deterioration in our exposure there that is going to be economic.

Secondly, the risk reserve changed the C-1 number. It is still in the investments but as we have refined our investment strategies we have reflected in other than credit risk because we have total return assets in other investment strategies that we have exceeded on for the Hancock block. So that is really what you're seeing is a mechanical calculation.

Which risk factor are we talking about now? Interest rate risk or mismatch?

It would be interesting risk. It would be investment performance if your inequities or other total return assets would be other investment type reserves.

But C-1 actually captures the equity risk.

Simon, maybe you can help.

What we call C-1 Mario is really only the fixed interest credit risk, but let me just step back and answer your question, when we did the purchase equation review, one of the things we had to look at with the reserves was the asset mix and the investment yields that we used in all the reserving. And when we did that work we had to reflect the change, what we actually expected longer-term based on what we now know. And we did not change our credit loss assumptions at all. We are using the same unitized assumptions as to credit losses. It just so happens that when we recalculate the reserves reflecting a long-term equity mix and asset mix is that it just rebalanced where that reserve went. More of it went to interest mismatch and equity risk and less of it went to credit.

So your coverages and I use coverage in a different way not the bank way, but your coverages is about the same, then?

That is right. On the assets we expect to have we haven't reduced the credit loss assumptions.

Got it. Thank you.

John Reucassel.

Just a question for Peter. In the report to shareholders that I am seeing the one for this quarter, but you get one for Q1 that separated out the earnings from Manulife and what Hancock contributed. And if you looked at those numbers I think you earned about $0.98 last quarter. And if you looked at just the pro forma or the pre Manulife and used the old shares you got a number that was substantially higher. So people out there -- people have said the transaction has not been accretive. So could you maybe respond to that and say it has this deal been dilutive or accretive to shares or how we should look at those numbers when it comes out on the report to shareholders?

Yes, first I would comment that the split is increasingly less relevant because we run our operations on a co-mingle basis. And if you look at legal entity filings it will reflect a split, but it is not really what I would call an effective split because we may even incur costs in company A and put the business in B and vice versa, because the business is running on an integrated basis. The second thing is I would say despite the fact we've done much less share buybacks than the original pro forma numbers, we are modestly accretive according to our sort of rough calculations already. And that is because the results have been better than we were expecting. And then in terms of going forward and trying to track with and without Hancock I guess my observation is we've made soup here, it is mixed together and it really wouldn't be a simple measure. But I believe that the earnings growth that we have is at least as good as we otherwise would have had and our prospects are better.

I think John a transaction like this which is so transformational and strategic to look for -- to judge its merits as to whether in the very near term it has a dilutive or an accretive effect on the few pennies on earnings per share is maybe missing the point of it. I know we are all obsessed with that calculation, but I think the more important thing is to look at what has it done strategically for the prospects to be created at comic entity. And I would argue and I think you will agree with me that Manulife is extraordinarily well positioned as a result of this merger. I have been postulating for some time or putting forward the thesis that there is no better positioned financial institution anywhere then we are. We've got wonderful businesses in high-growth markets, and they are growing rapidly.

Okay, okay. All right. Maybe I will follow up with some of those later but, another question just on the individual life. In the U.S. and if I looked -- if I take the average margins after-tax margins, for the last four quarters my numbers come to about 6.5%. And prior to the deal I think Manulife is running just above 8%. Is this just an issue the margins is a lower margin business in the U.S. now with Hancock, or is this just an issue of getting all the synergies run through the business and more operating efficiencies?

I am not sure how you calculated the margins, I am not sure if we could be very helpful. (multiple speakers) ring a bell with you?

No. I think the products that we are pricing, particularly the new products that we have introduced this year as we addressed it, what we will call the Hancock strain issue at the end of last year, the new products have the same margins at least from our own internal calculations as we had before. Now what might come through in the first quarter or two may not seem the same, but I don't think even on that basis they are any different. I am not -- we are pricing to the same margin as before. In fact, the new products that we introduced in January, which was one of the reasons why we had a slight sales fall off in the first quarter is people got used to it. We are a higher margin products than were experienced on the Hancock side. So if anything they are at the premerger Manulife or maybe even a little bit higher.

If you got a calculation that you want to walk us through I would be happy to look at it off-line and see if I can comment more meaningfully.

Last just on the management actions and assumption changes of the 17 million in the quarter, I guess if you add up all the different segments that you have here, you are left with a residual, I guess they add up to 43 million in assumption changes. And then so the corporate has to be minus 26. Is that the purchase accounting adjustment? Is that what that is?

Yes, I think that's right. Simon, is that correct?

I think what you have got in the corporate segment is the integration expenses, which is 42 million pretax and the evaluation exchange, which is a plus 15.

Okay. And what was it in U.S. Wealth Management?

(multiple speakers) some small (indiscernible) impact in there, as well.

Okay, and what was in U.S. Wealth Management -- the U.S. 29 million in management actions and assumption changes?

That would be the peacock impact some of it got pushed out to the productlines and that was the amount that got pushed out to that line; that was a positive number in that line.

So what is it related to?

It is just the various catch-up on how the reserves would have moved after purchase if we had the same reserve (indiscernible)season and things like that.

Okay. Thank you.

Brad Smith.

Thank you very much. My first question, Peter, just on the credit side again I note that your gross impaired are up almost $100 million, and yet you slowed the rate at which you are building your allowance. I was wondering if you could comment on that and comment on how comfortable you are at a coverage ratio of about 28%.

I think you will be very comforted by the answer. The reason is we very conservatively took a look at a portfolio mortgages that are all current, current paying mortgages where the coverage ratios by our measure were deteriorating to a level where we thought we should take some minor provisions, reflecting the fact that if we were ever to take possession of these properties that we would have to incur some costs in getting rid of them. So we took very minor provisions on a fairly large volume of mortgages, an extremely conservative stance. I think most other financial institutions would not have regarded them as impaired in the first place given that they are current paying and that the loan to value ratios are less than 100%. But we took the provision on it. So as you can appreciate you would take a very small provision but that would inflate the gross. So there is no decrease in the conservatism of our provisioning methodology. In fact I think you would have to agree that that was a conservative move, if anything.

Don are you saying that you have the ability to take current pay investments and classify them as impaired?

Well, because of depreciation what we are doing is taking a look at the market values in certain regions in the United States and seeing a deterioration in vacancy rates. And then the value of the properties and being conservative on all our reserving we classified them as impaired. We reviewed that with Ernst & Young. They agreed with our assessment, and.

(multiple speakers) properties we were concerned there wasn't any question left that if we had to realize security it would be costs, and we essentially accrued for the cost of perfecting our security, which if you were at 99 or 100 cents on the dollar you would end up being at 95 and we accrued for that difference. So on a number of properties where the market is weak we want to be accrued to the level of what our realizable security is likely to be.

That's exactly what you would want us to do because when we make an assessment that the owner could just as easily hand us the keys as to continue to operate the property but do so for other reasons what we should look at is what we would realize at the end of that transaction. That is exactly what is reflected, Brad.

Okay, just about the level of provisioning in the quarter. I mean, you have been run rate sort of $50 million, and now you are 18 in this quarter. Is there a reason why you have slowed it in the quarter?

We've had never coverage, Brad, we have been derisking the portfolio we talked about monotonically since we did the John Hancock deal. And despite the fact that there is a nominal increase in below investment-grade as Peter described due to the situation with the car companies I give you my personal assurance there is less credit risk in the portfolio today than there was a quarter ago.

I thought we had like no credit losses one quarter.

We did, we had a net recovery. What Brad is observing is the net result of provisions being taken and recoveries on provisions that we've taken in prior periods and it is a low number. But is quite right. I think and is the third quarter last year weakening their recovery position.

You benchmark your allowance coverage on your gross to your peers? How do you stand? I take a look at the 270 to the 954, and I call that 28% coverage.

No, we look at our provisions, Brad, against the Moody's and the S&P impairment ratios. And that is how we establish provisions. And then we take less specifics against situations.

My last question is again with the credit default reserves, the $500 million drop, Simon did I hear you correctly that you just moved it out of credit defaults into other actuarial reserves that we can't see?

You can see them. They are all there. We just happened to have that one highlighted because we had discussions in the past about credit related reserves.

But it used to be a lot stronger number though than it is now at 1.8% of your total invested assets.

We think it is still a pretty strong number because it is the same ratio for asset quality bucket. As its always been.

Thank you.

Just remind you that we've extinguished something on the order of very close to $2 billion in Canadian dollars of below investment-grade debt since the time we did the deal. That would, I think suggest that all types of provisions, credit provisions relating to that ought to be reduced.

But I am just seeing the gross impairds going from 448 to $954 million over the last five quarters.

I guess, Brad, let me try to explain to you that because of the taking of some smallish reserves or provisions the accounting rules are that if you have a provision against something it is by definition classified as impaired. I don't know what more we can tell you other than we are very, very comfortable. That is not one of our worries is the credit portfolio.

So would that be to say then that you expect that number to start coming down, that gross impaired number next quarter?

(multiple speakers) no Brad because when we purchased the Hancock block and fair valued it it had no impairds at time zero, if your question is in the natural states. So we are going to run up for a period and then we will grade off, but it won't be because credit got any worse. It will just be because the stuff coming off that may have recoveries or whatever was not showing in our accounts as impaired because of the purchase (multiple speakers).

The purchase accounting that is mandated that you start off, you run into normally tens of billions of assets we added not a nickel of impaired. Just by definition they were fair valued. And therefore, as we go forward and the normal maturity happens to that block you would then expect that you would have urgent of some impairds. You can't be kept pristine. It was made -- it is mathematical and the Hancock has a net impaired ratio in excess of 1%, and its not going to go back there at least I hope. But obviously that impact is -- when you start at zero it is going to grade up.

So is that to say then that you're going to resume building your allowances that you trimmed this quarter -- well, you didn't trim.

They just occur naturally as we take (multiple speakers).

We publish all kinds of data and one of the most meaningful pieces of information we show you is our sources of earnings, and you can see that we have experienced gains going back -- I don't know thirty quarters, forty quarters whatever length of time we have shown you these things, which by deduction implies that our expected reserves are very, very high because the actual experience over time is positive. You know, you have very large experience gains at levels I think that very few companies can replicate. And that should give you some comfort if you're looking at the financial statements as to what the reserving practices overall are. We would certainly not go and take our credit reserves in an abnormal fashion and expose ourselves to fluctuations that would arise if that were the case.

Right. Thank you very much.

Timothy Lazarus.

I am looking at the second-quarter numbers in the GNSFP division. And I think the comment was that it was an unsustainable quarter. Could you comment on whether when you have a related gain in that division its actually booked directly into income and not amortized into income similar to how investments are treated? And what that amount was in the quarter so we can sort of get a normal quarter picture, if you will?

It would depend on the nature of the item and the hybrid asset gains I think the bulk of those were actually booked as incurred. So that was quite favorable. The other investment related items were also I think items that were reflected mostly in the current period. so it was an unusually strong investment result, and I would say if you look at the historical run rate for that business unit it would be more indicative in the current quarter of our expectations.

So Peter under sea (ph) GAAP just so I am clear, in this division you don't amortize gains like you do in the surplus?

No, it is depended on the nature of the investment. Some are accounted for in the equity method and others are treated just as the rest of our assets are. And that is what the difference is. It has to do with essentially ownership stake and the nature of the equity interest. It is not to do with the line of business. It just happens these investments that we had an extraordinarily positive result, were in the GSFNP segment.

Okay, but it is specific to this segment, Don, is all I am saying. If you had these steps in investments in your surplus --

No, those investments were in the long-term care accounts they would have shown up in same result in the long-term care. It is having to do with the nature of the investment that determines the accounting policy as opposed to the segment. They just happened to be in that segment.

Okay, if I could just follow up quickly -- I don't mean to beat this thing down, but Dominic when we did get the package from you when you purchased Hancock, there was a page which I am actually looking at that talked about earnings accretion and it was somewhere in the range of 7 to 8%. And if you actually look at your consolidated net income you guys are bang on in terms of the first six months, but it is the per-share number that is affected obviously by the fully diluted shares outstanding. Can you comment on whether you were just thinking perhaps that you were going to be able to buyback more stock at that time?

We certainly did, when we did those pro forma numbers that we showed you at the time of the Roadshow or the time that we announced the transaction, it was assumed you remember the environment at that time was that there was going to be a massive flow back of shares because we were issuing all this paper into the U.S. market. And so we would have assumed, I believe, I don't have the calculations in front of me but we would have assumed that there would've been -- much reduced number of shares outstanding today.

736 is the number I am looking at, so it is substantially a loss (multiple speakers)

(multiple speakers) been spending the $3 billion of excess capital, which a substantial portion is yet to be spent.

Tom MacKinnon.

Thank you very much, good afternoon, couple of questions. If I look at the source of earnings and the growth and the expected profit it is only been up about 4% over the last three quarters. I would've expected this to grow a lot faster, especially given the 20% flex growth in the value of new business that you had, as well as I assume some of the cost saves would have -- would be worked through this line as well. Assuming that they were expected. Can you comment on that? And I have got a follow-up as well.

Simon, can you take a stab at that one?

Why isn't the emergence of profits from the in force block faster, that is the question he is asking.

(indiscernible) I think currency has had an impact on that line. I think we are looking at it in Canadian dollars in a total company level and the fact that Canadian is (indiscernible) necessarily appreciating I think has had a material impact on that line. That would be my most immediate --.

You don't have a figure X the currency then?

We do know that the impact for the quarter of exchange vis-a-vis last year was like 57, 50 some odd million dollars. So some of it would've been on that expected line simply because the reserves are maintained in U.S. dollars and when they are released, they are worth less than they were some months ago.

Well sequentially it is 2%, I am not sure you've got that much of a change sequentially here, so the growth is only been 2%.

Another point the expense synergies that we are enjoying on an intra statement basis are not yet reflected in a change in reserves. We haven't capitalized them. So they don't turn up as an advantageous on result in profit on a new business. They are so still being reflected as experience gains to the extent their costs are lower. And the third thing is when you have a big run-up in new sales, which we've had in some of our lines, that would take some of the short-term profits out of that line because we have some strain. So I think there is a number of things that are combining there. But we are actually quite happy with the performance, and we think the SOE shows that the results are surprisingly consistent and good given what we've been taking the Company through during the integration period.

Did I hear you right Peter in saying the experience gains reflects the cost saves?

I think that is where we would be reflecting (multiple speakers

(multiple speakers) 75% of them through already so that is over 240 million U.S. dollars?

No, No. That is a run rate observation, not an actual. So we cut a cost, we save not a dollar, but (indiscernible) inventory as a run rate (indiscernible) and this has been back ended as you know because I have been advising you as you make progress.

Okay, I may have to follow up to find out exactly where this expense cost save has been sort of worked through. And then the other one is with respect Jim Benson (ph) you had mentioned you are going to be repricing, or you launching a UL product later this summer? (multiple speakers) taking into account some changes in the marketplace, maybe you can elaborate a little bit.

The UL marketplace is very fluid and we are looking at UL all the time. This is not related to AG 38 -- (multiple speakers)

Okay, that was my question.

This is just looking at the marketplace in general, and companies are repricing products every six months and we need to do that as well. So we are contemplating a reprice outside of the impact of AG 38, which is a different issue entirely.

Just one other follow-up is the 2004 annual report noted that the extent credit losses exceed those provided for in the actuarial reserves by 25% there would be a decrease in net income of $53 million. Now that you have taken 700 million on a shareholder basis, or nearly 700 million out of the provisions for asset default in the actuarial reserves, would this number essentially increase now, or how are we to look at that risk?

I assume, Tom, you're looking back at the MDNA disclosure at year end, all the economic sensitivities?

That is right.

I don't think that our exposure -- the way that number was calculated I don't think that our exposure to credit losses has increased. I don't think we would be -- if we were redoing that calculation right now I don't think we would be coming up with a materially bigger number.

So the provision is provided for related to the risk would be exactly the same?

Probably not dissimilar.

Thank you very much.

Helena (indiscernible)

My question is then (indiscernible) could you please (indiscernible) some qualitative discussion on the trends in (indiscernible) new business and (indiscernible) protection and Wealth Management side, and also geographically from different regions?

That's a pretty broad question you are asking us to give you some color around our revenue growth by region?

Value of new business, B and B.

Embedded value? I do not know, Simon, do you have that handy?

I can make some qualitative comments. Certainly versus the first quarter the number was up very modestly if you take out the seasonality from the P&C business. I think the new business embedded value numbers reflects what happened in the business. We saw growth in the insurance numbers reflecting the very strong insurance sales, and a slightly lower number on the Wealth Management reflecting the fact that we had the big seasonal sales in Canada in Q1. Year-over-year I think we are seeing strong growth consistent with what we are seeing in the earnings growth, would be my comment.

By different geographic regions, do you see coming from the U.S. or Japan or Canada?

I think it kind of just reflects the (indiscernible) but we tend to look at it by business. The insurance business, the U.S. businesses are growing in their sales and they are making very profitable products, so we saw strong growth quarter-over-quarter in the U.S. As I was saying I think that if you look at where the revenue growth and the sales growth is occurring, you're going to see that mirrored in the new business embedded value because we -- the margins and the products are all remaining strong.

Jukka Lipponen.

With respect to China can you give us an update sort of how you're seeing the competitive landscape? I think (indiscernible) called it like the Wild West at some point in time, and how do you view the group business opportunity that you are just getting into?

On the group opportunity we think that we've had some success in Hong Kong, and we think that as regulation and as the market evolves in China there will be opportunities in that business as well. I can't tell you how quickly that will materialize. Overall our business in China we are quite pleased with. As we have said, we've been busy trying to expand our footprint in the country. We've relocated our Executive Vice President to Shanghai with a view that he will focus all of his energies on the opportunity in that marketplace. We are very, very pleased with our market shares in those cities were we've been operating for a little while. Our analysis of the situation indicates that our retentions are much, much higher than industry averages. So our in force block as a percentage of the total is growing as a percentage of the industry. It is as you can imagine because of the rapid growth and because of the number of new entrants from other countries, and because of the dearth of experienced management, it is a challenge to (indiscernible) and hold on to general management ability in the country. So that was another reason for relocating Mark Sterling to Shanghai so he could be closer to the situation and. But overall Chinese are very smart people. They will learn the insurance business and the way we do insurance very quickly. And this is a problem that is part of the normal process in a very high-growth rapidly expanding, high potential market like China.

My second question is for Jim Benson with respect to AG 38 what are you seeing in the secondary guaranty euro market happening?

I think a couple things will happen. First of all, this is an interim rule and we are always an industry working -- at least the ones that write UL working with regulators and all to come up with principles based valuation methods as soon as possible. And so we believe that this is a two-year and at most two-and-a-half year problem. But it is a problem, and we believe that virtually all companies will look at product designs over the course of the next several months and probably change the design of the product to adhere to the new interim rule, in many cases -- I am not saying for us for sure -- but in many cases we are (technical difficulty) price increases of some sort. Some of that has already occurred from other companies that are publicly reported in the last week.

In addition to that all companies including ourselves will evaluate all the financing alternatives at their disposal to minimize the impact of this interim rule. Unfortunately here at Manulife we are well capitalized, highly rated and probably will be able to sustain the cost, the interim cost of this reserve adjustment less expensively than some of our competitors.

Thank you.

Worthwhile pointing out too that the reserve adjustment is prospective, it is not retroactive. So it will only apply to business written in the future.

Jamie Keating.

A quick recap on the Asian sales outlook, if you may. I am curious -- looks a little flat this quarter, but maybe you could just discuss seasonality and what other opportunities we see. Specifically interested in the bank assurance channel here in Hong Kong.

The reality is that because of the huge the very successful approach that we had, which was to distribute insurance through our captive sales force, we might have been a little later to embrace alternative channel distribution than maybe we should have been. And so we are just aggressively pursuing the bank channel now. Again, this was in the interest of candidness it may have been something we should've done a few years ago. But we didn't do it because we wanted to protect the franchise of our distributors, of our captive agents. We are generally, as I said, very, very positive about the prospects in Asia. We don't know anybody that is doing it much better than we are. We don't just look at new sales. One of the things that is important to us is the persistency of that new business and we would much rather sell less product that sticks on your books than more product that runs off. And all of the indicators we have suggests that our in force blocks are growing very, very nicely vis-a-vis anybody else in those markets. I just got back, as I said, from Hong Kong and Indonesia and Malaysia. We are very pleased with the business that we are growing there. One of the nice things about our company and is that we've got a large footprint in Asia, put the two divisions together earned well in excess of $500 million a year. And therefore we are not dependent on any one geography to generate a disproportionate growth to sustain the division. There is always something that is happening in one of those ten geographies that is positive that might offset a slowdown in some other territory. So overall we are well aware of the opportunities and the challenges, and we're dealing with all of them in the matter we think is appropriate.

Thank you very much, ladies and gentlemen, for your interest in the affairs of Manulife. And we think we've had a very good quarter and looking forward to reporting on our progress at future meetings. Thank you very much.

This concludes today's conference call. Please disconnect your lines, and have a great day.