Manulife Financial Corp (MFC) 2012 Q2 法說會逐字稿

Please be advised that this conference call is being recorded. Good afternoon and welcome to the Manulife Financial Q2 2012 financial results conference call for August 9, 2012. Your host for today will be Mr. Anthony Ostler. Mr. Ostler, please go ahead.

Thank you, Ann, and good afternoon. Welcome to Manulife's conference call to discuss our second-quarter 2012 financial and operating results.

Today's call will reference our earnings announcement, statistical package, and webcast slides, which are available in the Investor Relations section of our website at Manulife.com. As in prior quarters our executives will be making some introductory comments. We will then follow with a Q&A session. Available to answer questions in both their businesses are the heads of Asia, the US, Canada, Investments, and General Account Investments.

Today's speakers may make forward-looking statements within the meaning of securities legislation. Certain material factors or assumptions are applied in making forward-looking statements, and actual results may differ materially from those expressed or implied. For additional information about the material factors or assumptions applied and about the important factors that may cause actual results to differ from expectations, please consult the slide presentation for this conference call, including the slide entitled Caution Regarding Forward-looking Statements.

When we reach the question-and-answer portion of our conference call, we would ask each participant to adhere to a limit of one or two questions. If you have additional questions, please requeue, as we will do our best to respond to all questions.

With that, I would like to turn the call over to Donald Guloien, our President and Chief Executive Officer. Donald.?

Thank you, Anthony. Good afternoon, everyone, and thank you for joining us today.

We are joined on the call today by our CFO Steve Roder, as well as several members of our senior management team including our U.S. General Manager, Jim Boyle; our Canadian General Manager, Paul Rooney; our Asia General Manager, Bob Cook; Warren Thomson, our Chief Investment Officer; Scott Hartz, our Executive Vice President General Account Investments; Cindy Forbes, our Chief Actuary; and Rahim Hirji, our Chief Risk Officer.

This morning we announced our second-quarter 2012 financial results. While the volatility of equity markets and lower interest rates took their toll, I am pleased that we made substantive progress against our strategic priorities. We delivered excellent operating results and prudently managed our capital and financial position.

I would like to start off with a few comments on our substantial progress with our strategic priorities. We delivered record insurance sales in Asia, with many highlights, two of which are our entry into Cambodia and buildout of our distribution network with Bank Danamon in Indonesia.

We achieved record funds under management, all-time records under funds under management, despite the turbulence in markets. Solid growth by the Manulife Bank and our group pension businesses in North America.

Our balanced Canadian franchise continued its steady advance with strong sales across multiple lines, with desirable margins and risk profiles and cross-selling between the segments. We further improved our business mix in the United States and generated positive net flows in mutual funds and 401(k) despite the challenging markets.

In terms of operating performance, we significantly increased insurance sales as compared with the second quarter of 2011, with all-time record sales in Asia. We worked diligently to improve our product mix in line with our lower-risk product strategy. We strengthened our underlying earnings for the first quarter, and we were able to generate strong new business embedded value.

In terms of capital management and financial position, our variable annuity hedging program mitigated 88% of the effects of lower equity markets and interest rates, and was essentially fully effective over the first half of the year 2012. Our capital ratio stands at 213% as at the end of June. We significantly reduced our earnings sensitivity to interest rates in the quarter and remained ahead of our hedging timetable. And we decreased our leverage this quarter.

On the other hand, it is possible that third-quarter basis change could be up to CAD1 billion, which is related to businesses which do not make up a significant portion of our go-forward business plan. It is also apparent that the impact of continued macro-economic headwinds makes the achievement of our 2015 earnings objectives more of a stretch. Steve will talk in more detail about these items in a few minutes.

In summary, we are pleased that we made substantive progress against our strategic priorities, strengthened underlying earnings, and benefited from the positive impacts of our hedging programs. Without question, this quarter's results provide many reasons for optimism about our operational performance and capacity to grow. Our strategy is delivering results that will position Manulife for the future earnings growth and ROE expansion.

With that I turn it over to Steve Roder, who will highlight our financial results and then open the call to your questions. Thank you.

Thank you, Donald. Hello, everyone, and an honor and a pleasure to be here.

Let's start on slide 6, where we indicate the financial highlights for the second quarter of 2012. We reported a net loss attributable to shareholders of CAD300 million, which largely reflected the mark-to-market impact of falling equity markets on our reserves, and an update to our fixed-income ultimate reinvestment rate assumptions, or URR, which impacted earnings by CAD677 million.

Despite the loss, our underlying businesses continued to perform well, with a sequential improvement in underlying earnings. We reported new business embedded value, or NBEV, of CAD296 million, which is a strong result given the low interest rate environment. We ended the quarter with a MCCSR ratio of 213% and reduced our leverage.

If we turn to slide 7 you will see our total insurance and wealth sales. Insurance sales were just over CAD1 billion, up 55% over the prior year. This was primarily driven by record sales in Asia and record Group Benefit sales in Canada.

Wealth sales declined 7% versus a year ago as the challenging macro-economic conditions continued. I will provide more details for the Divisions in a moment.

On slide 8, you can see the total premiums and deposits of CAD17.5 billion, which were in line with the previous year. Insurance premiums and deposits for the second quarter increased 13%, driven by Asia and Canada. Wealth premiums and deposits declined 6%, as increases in Japan fixed annuities and John Hancock's 401(k) business were more than offset by the impact of lower mutual fund sales in North America.

Turning to slide 9 we see the total new business embedded value for Insurance and Wealth was in line with the prior year as a result of increased insurance sales, price increases, and changes in business mix which offset the impacts of the macro-economic environment. The increased insurance NBEV and decrease for wealth NBEV is consistent with the sales volumes that I previously discussed for insurance and wealth products, respectively.

On slide 10 you will see our Asia Division operating highlights for the second quarter. Asia Division net income of $283 million excluding notable items was driven by strong growth of in-force earnings and higher new business gains. The Asia Division delivered record insurance sales, which were 17% higher than the prior year.

Many of our territories recorded year-over-year double-digit growth, with Japan, Hong Kong, and Indonesia enjoying record sales. The increases in Japan and Hong Kong were helped by announced product and tax regime changes, so they are unlikely to be repeated in the third quarter.

Wealth sales in the region were 3% higher than the second quarter of the prior year, with strong sales in Japan being offset by declines in Hong Kong and China.

A couple of notable milestones in the second quarter. We commenced our exclusive partnership with Bank Danamon in Indonesia, and we started operations in Cambodia, marking our entrance into our 11th territory in Asia. We are very pleased with our overall performance in Asia as we continue to execute our strategy.

Moving on to slide 11 and our Canadian Division, which generated CAD201 million in net income excluding notable items in the second quarter. This reflects improved new business strain on individual insurance versus the first quarter, despite lower interest rates, and improvements in claims experience.

Canadian Division delivered record insurance sales, driven by a large case won by Group Benefits. Wealth sales declined 12% versus prior year, with mutual fund sales negatively impacted by market declines and the competitive environment, despite strong loan volumes in Manulife Bank, which increased 9%. We are happy with our growth this quarter in Canada.

On slide 12 are the highlights for the U.S. Division, which generated $245 million in net income excluding notable items. Insurance sales were down slightly, with the 17% increase in life sales being more than offset by the decrease in LTC, or long-term care, sales due to new business price increases relative to the prior year.

Despite strong sales from RPS, John Hancock's 401(k) business, Wealth sales declined 8% relative to the second quarter last year. However, we are pleased that net mutual fund flows on the wealth business have remained positive, whereas the industry as a whole experienced net redemptions.

Finally, we entered into a reinsurance agreement to coinsure 67% of a block of fixed deferred annuities. I will discuss this transaction in more detail later on. Overall, we continue to be pleased with John Hancock's performance.

Turning to slide 13, you will find that there were a number of notable items included in second-quarter net income. The direct impact of equity markets and interest rates in the second quarter resulted in a net charge of CAD727 million after-tax, which included CAD677 million charge related to the update of the fixed income ultimate reinvestment rate or URR assumptions.

The Variable Annuity block that is dynamically hedged generated a CAD269 million after-tax charge. This charge relates mostly to items not hedged, such as the provision for adverse deviation and certain interest rate risks.

In the second quarter we generated CAD83 million in investment-related gains, largely reflecting fixed-income trading gains. Appraisal gains on real estate and private equity offset appraisal losses on our oil and gas holdings.

Finally, we reported a net after-tax gain of CAD62 million in the quarter largely related to two reinsurance agreements. The recapture of a Canadian ceded insurance treaty generated a gain that was partially offset by charges related to the reinsurance of a U.S. fixed-annuity block of business. Net income excluding these notable items was CAD551 million.

It's clear that the analyst community is trying to derive a core earnings metric for us and that there are a number of different definitions of core on the Street. We agree that core is an appropriate metric to measure the underlying profitability of our business; and as such we plan to define and introduce core earnings for MFC, and we hope to have this in place for our third-quarter 2012 reporting.

On slide 14 is our source of earnings. Expected Profit on In-Force declined as a result of lower provisions for adverse deviation releases, of Pfad releases, in part due to the FDA reinsurance transaction, partly offset by higher fee income in the U.S. and Asian Wealth businesses.

The impact of new business benefited from improved mix and pricing and gains in Asia due to the higher volume of protection product sales ahead of tax and product changes, which more than offset the unfavorable impact of lower interest rates in the second quarter. Asia sales volumes are expected to moderate after the second quarter.

Experience losses reflect the unfavorable impact of equity markets on variable annuity guarantees, partly offset by favorable investment experience including gains on macro hedges.

Management actions and changes in assumptions resulted in a charge that reflects the update to our URR assumptions and expected macro hedging costs. These were partly offset by the impact of reinsurance activities and realized AFS bond gains. Earnings on surplus increased as a result of the non-recurrence of hedge accounting losses in the first quarter and more favorable credit experience.

Turning to slide 15, funds under management reached another all-time record, CAD514 billion, as at June 30, 2012. This increase was driven mainly by positive net policyholder cash flows, despite the volatile equity markets in the quarter.

Slide 16 demonstrates that our investment portfolio continues to be high quality and well diversified. And we continue to view this as a Group strength.

Slide 17 you can see that our credit losses remain negligible. We see our strong underwriting discipline and credit experience as a corporate strength.

Moving to slide 18, this slide summarizes our capital position for MLI. We ended the quarter with a capital ratio for our main operating company at 213%, reduced leverage, and made further progress on de-risking activities.

Turning to slide 19, we remain ahead of our 2014 goal for interest rate risk reduction, and we are near our 2014 goal for equity market risk reduction. We are very proud of our hedging programs and the positive impact they are having on our business, especially our earnings sensitivity to interest rates. We would note, however, that reserve additions or releases resulting from the third-quarter basis change could have a negative impact on our interest rate sensitivities.

Turning to slide 20, we have spoken to you in the past about the impact of so called lower-for-longer interest rates. And on slide 20, you will see some of the first- and second-order impacts of the lower-for-longer interest rate scenario. We are taking the necessary actions to prudently grow our business in this challenging economic environment.

We would like to remind investors that due to the unfavorable economic conditions, we increasingly view our goal of CAD4 billion in earnings in 2015 as a stretch target. We are reviewing the targets as part of our planning process, and we will update investors on this at our November Investor Day. We remain committed to focusing on the efficiency and effectiveness of our business and protecting margins.

I will now address three topics listed on slide 21, which may be on investors' minds. The first is the outlook for the third-quarter 2012 basis changes. As we've discussed previously, we will be completing our annual review of actuarial methods and assumptions in the third quarter of 2012.

The main drivers of the updated assumptions relate to businesses that are no longer our focus or that are not a substantial part of our go-forward new business plans. They are largely the result of revised standards with respect to equity calibration requirements issued by the Actuarial Standard Board in July 2012 and also the impact of the macro-economic environment on our assumptions.

While we cannot currently quantify the likely impact, the high end of the range of potential outcomes, based on our preliminary work, is currently in the order of CAD1 billion. The ultimate outcome will depend on market conditions at the end of the third quarter.

The second topic is reinsurance agreements entered into in the second quarter. We entered into a reinsurance agreement to coinsure 67% of our U.S. fixed deferred annuity business.

This transaction enabled us to transfer the risk of increasing lapses in a rising rate environment and minimum interest rate guarantees. It helped our MCCSR by 3 points and reduced earnings by CAD25 million in the quarter. On an ongoing basis, the reinsured block would have initially contributed around CAD5 million per quarter to earnings.

In Canada, we recaptured an existing ceded reinsurance contract in our Individual insurance business. It resulted in a sizable one-time benefit to second-quarter earnings, did not significantly change our risk profile, and improved the MCCSR by about 1 point.

Finally, the third topic is our updates to the fixed-income ultimate reinvestment rates. We will be moving to a quarterly calculation of the URR beginning in the first quarter of 2013.

We view this as a logical progression for us, as we have improved our ability to do this analysis on a quarterly basis, and after thoughtful consideration have decided to adopt this approach. This will reduce the volatility in our earnings.

For the full-year 2013, if interest rates stay at June 30, 2012, levels, we would expect to take a charge of around CAD400 million for the year as a whole in 2013, i.e., approximately CAD100 million per quarter. But movements in rates could create fluctuations.

So by way of summary, on slide 22, despite the unfavorable economic backdrop in the second quarter of 2012, Manulife delivered robust insurance sales growth, including all-time records in each of our three largest markets in Asia. We achieved another all-time record funds under management. We mitigated market impacts with the very effective performance of our hedging programs. We sequentially improved underlying earnings.

Prior to turning the call over to Q&A, I wanted to address a question that we anticipate in regards to M&A. As you know, we do not comment on specific M&A opportunities, but we thought it would be prudent today to restate our approach to M&A and let you know that we review all opportunities with the same conservative posture and approach towards M&A as Manulife has always taken.

While we continue to see Asia as a very attractive area to invest in, any deal must be positive for shareholders. And we don't need to do a transaction, as we are growing organically in Asia and elsewhere.

You would also note that we will not pursue a transaction for ego or size, especially as many M&A deals fail to create value. Any transaction would have to be highly strategic. It must contribute to stabilizing our core earnings and capital, provide diversification benefits, not add any significant risk exposures, be easily financed, and not be inappropriately dilutive.

In addition, in this environment we carefully review the risk/reward trade-off. And it would be unlikely for us to make any significant investments in areas that we do not have substantial expertise.

Small acquisitions from the past several years were executed with discipline and brought about positive results for shareholders. We will continue to focus on growing our Asian operations through expansion of our professional sales force and other forms of distribution and through expanding our product offerings and, in particular, growing our wealth business.

In line with our Asia growth strategy, I also wanted to take the opportunity to remind you all that we're hosting an Asia Investor Day on Friday, September 7, in Hong Kong. We'd love it if you could join us there, as it will give you an opportunity to hear directly from our key Asian Division executives about our Asia growth strategy and opportunities in the region.

This now concludes our prepared remarks. Operator, we will now open the call to questions.

(Operator Instructions) Peter Routledge, National Bank Financial.

Thank you. I had a question for Don. I think in the quarter's performance you see the progress that you have made renewing the distribution strength of the Company and protecting the balance sheet at least somewhat from the macro environment. You have also been quite admirably clear about the impact of the 2012 basis changes.

But the question I get from my clients is particularly on the basis changes and particularly for those related to policyholder behavior. When did they stop materially impacting earnings?

I mean 2012 is -- you have given us clarity and that is appreciated. But for 2013, 2014, can we put a pin in it and say -- this is it? Or is there still some risk?

Broad question. And then more specifically, the Long-Term Care premium increases have been going quite well. Do they offer some cover in 2013 and 2014?

Peter, thank you for the compliments and I would like nothing more to tell you that there will be no more basis changes of a negative nature in the third quarter and in future years. Of course, that would not be true. It is impossible for me to suggest that.

I guess I am comforted by a couple elements of these basis changes. The first is that they do relate to businesses that are not any significant part of our strategic plan going forward. You know, the first lesson of holes is to stop digging, and we have got that one down pat. We essentially cut back on these businesses three years ago in a very substantial way, and this just reaffirms that that was a correct decision.

The second thing is the basis changes, by and large, they come from a variety of sources, but these are reflecting new information emerging largely as a result of the macro-economic environment. I think Steve spoke to that already.

This isn't somebody made a mistake in pricing it, which is a different order of basis change. This sort of new and emerging data in one instance, and in the second instance is the changes in the actuarial standards, which of course we cannot predict with certainty when standards are going to change in the future, and we will always be subject to those.

So I think that should draw a lot of comfort if you think of really the three buckets can happen -- is you can make a mistake because you mispriced something; that isn't evident in these basis changes.

You can have standards change, which is far beyond our control. Some of them are attributable to that.

And the third one is, you have got new and emerging data coming as a result of the financial crisis for which there was no history when these products were created. And we are reflecting that history in the valuation.

Just in terms of the Long-Term Care as a cushion next year or in 2014, the premium increases, which as I understand have gone better than maybe you had expected a couple years ago.

Steve?

Yes, Peter, this Steve. I think where we are on Long-Term Care, we are pleased with the number of states that have -- where we have now got agreement for the price increases. We have managed to add three states recently, so the number has ticked up.

But some of the recent additions are relatively smaller. Some of the key states in terms of how we view the overall risk are still out there for us. So although the numbers ticked up, our overall view hasn't really changed at this point.

I don't think there is really any update to how we see Long-Term Care now from a quarter ago. I think it would be premature for us to say that.

It's going well, but you can't declare victory?

Yes, that's absolutely correct. We might have some champagne in the fridge somewhere, but nobody is drinking any.

Thank you very much.

Andre Hardy, RBC Capital Markets.

Thank you. I have a quick one and then a bigger-picture question. Quick one is agricultural holdings; how exposed are you to the lack of rain in the US Midwest? Is that an issue?

And the bigger-picture one probably for Donald. Your interest rate sensitivity is down to a degree that is so low that you might actually be negatively impacted by a recovery, at least initially, because probably corporate spreads would tighten more than the help you would get on Treasury rates going up. Is that a positioning that you expect to be permanent? Or do you agree with the statement I just made? Your comments around that would be appreciated.

So, Andre, we will allocate your first question to Scott Hartz, who is best placed to answer that question. Then we will follow up with the bigger-picture question.

Yes, thank you for the question, Andre. The drought is largely in the middle of the country, and we don't really do any lending against farms in the middle of the country.

All of our agri business lending is just that agri business on agri farm and it is not so affected. Then on the equity side where we do have agricultural holdings, in the states most affected, actually institutional institutions cannot hold farm properties. So like Iowa, we do not have any exposure.

Then in some of the peripheral states there, typically the farmer takes the crop risk. We just get paid a lease payment. And the farmers are actually holding up okay because of things like crop insurance and federal subsidies. So, we at this point do not see any impact to our investment portfolio.

Thank you.

On the second one, Andre. What we show in the part of the schedule that you're referring to, I'm going to refer this over to Steve Roder in a second. But what you are referring to is the income sensitivity in the quarter.

You are quite right, that has come down to a very low level. If that were to actually turn the opposite sign you might get worried.

But I must remind you that our overall economic sensitivity is far greater than the impact in the quarter. The most obvious part of that is, for instance, the URR, which is a weighted rolling average that is impacted. But there are a number of follow-on economic impacts such that we are not at all concerned with the fact that the interest sensitivity in the quarter has gone down to very low levels.

We want it to be there. There are other knock-on impacts of the economics that still have us substantially benefiting if interest rates were to go up. Steve, would you care to amplify?

Sorry, perhaps before Steve jumps in, I understand exactly what you are saying, Donald. But in terms of the direct impact, you don't anticipate it changing materially from where it's at now?

It could change in the third quarter. I am going to refer to Steve because he is far more expert.

I think it is important to remember that that interest rate sensitivity is based on a snapshot at a particular balance sheet date. When we look at that and we look at the trend line, our view is that that may not be representative quite of the way forward.

So again, we are not declaring a victory there prematurely. We think it might tick up in the next quarter, particularly some of the basis changes that Cindy may have under consideration could result in it ticking up. So, we think this might be a low and not one we should expect to continue on a flatline.

Okay, thank you.

Robert Sedran, CIBC World Markets.

Good afternoon. I just wanted to follow up, first, on one of Steve's comments about the acquisitions needing to be easily financed. Donald, in the past when discussing your acquisition appetite, you've talked about partners or innovative structures that can be used to fund them.

Do you still believe you have access to some of those different sources of capital? Or is it up to the Canadian market to fund your ambitions?

There is a broad array of capital available to fund acquisitions. They are highly attractive. And no, you are quite correct, it doesn't all have to be done in the Canadian capital markets.

Having said that, we have a very, very strong sense of protecting shareholder value. There's been speculation about extremely large deals, and we are very circumspect about dilution.

Okay, and just I guess to follow up on that one, the market has been using a 200% MCCSR ratio as a de facto minimum for some time. Would you be prepared to take the ratio down to that level -- or for that matter, below that level -- if you saw something attractive in a favored region?

I think there is a whole number of considerations there, including what our regulator would find attractive. I think it is pretty well known in both banking and insurance their stance has been that they'd like capital ratios to be approximately where they were after a deal as before. I can't speak for the regulator, but that is what I would anticipate.

You know, we are very comfortable with our capital level. That is a separate question.

We are very comfortable in fact with the amount of hedging that we have in place that is evident to anyone who looks at our financial statements. We are more comfortable than we have been in my history as CEO. But that doesn't necessarily imply that we would draw down on that strength in order to do an acquisition.

Thank you.

Tom MacKinnon, BMO Capital Markets.

Yes, thanks very much. Good afternoon, everyone. I just want to follow up on the question about the capital. If we look at some of the headwinds you've got, which are probably a little bit more regulatory-driven -- I mean first of all this capital metric is weird because it is applying constant factors to values that are marked-to-market and increasing. So the required capital keeps jumping up; but that is another point.

If you -- let's look at -- think about a 200% bogey. You used to talk about that years ago, but the sensitivity is a lot less now than it was then. How do you feel about if you were to breach that 200% bogey? Does it really apply anymore?

And what other levers would you have in terms of maybe HoldCo capital? Looks like you got some leverage room here, possible reinsurance deal. If you can you just speak to that, thanks.

Tom, part of me would like to get you to repeat the first part of your question, because I agree with you so vehemently. We have a pretty intelligent regulator, as you know. I think they are paying a lot of attention to that.

They are recognizing that the Canadian capital regime is a very tough one. The accounting regime is a tough one.

When you put the two in combination, as you expressed it, sort of multiplier effect. I think they're well aware of that.

I also would agree with you that with the amount of derisking that has taken place, our risk profile has changed enormously. And the third thing is, there's been changes to the capital formulas, as a result of the implementation of IFRS and so on, that have knocked something like say 40 points off our capital ratios. We are just measured using the same yardstick as used to exist some years ago.

Now some of these are self-inflicted, but we merged our two U.S. companies. As I recall, that brought our ratio down by 25 points, something on that order. But just measurement differences have brought the ratio down by about 40 points over that period of time.

So you know what we have is a very, very comfortable capital ratio. I can't say how far I would let it go down. But I would not lose any sleep if that capital ratio were to go lower.

That is certainly not our intention, but it wouldn't cause me any prudential concern. I mean, we look out for policyholders first; that has to be clear. But when we go through our sensitivities and Cindy applies the most draconian scenarios to both interest rates, equity markets, plagues, pestilence -- it is quite imaginative. At the end of the day there is always money to pay our policyholders, which makes me feel very, very confident.

Just a follow-up, Tom, just on the latter part of your question. You asked I think about what else we can do.

I think we have a continuing effort on finding ways in which we can get favorable impacts on our MCCSR ratio. So in the quarter, we talked about a couple of reinsurance transactions which were in part, but not entirely, driven by the fact that they had a favorable impact on our MCCSR ratio.

One of them gave us a 3-point pickup and one gave us a 1-point pickup. And if we look at the way forward, we have a list of small actions that will continue to chip away favorably at our MCCSR ratio. So there are things we can do, and we continue to keep focusing on those.

But I think to Donald's point, we have a very, very able and intelligent regulator, and they understand the pressures that are being put in place by this sort of safe-haven environment which we are living in. And they are aware that we don't get any explicit hedge credit.

I don't think -- I think at the end of the day the 200% is what it is, but we are living in a different world from the 200% of let's say two years ago.

Would you be -- would you think about taking the leverage ratio up to -- it went from 34 down to 32. That's when we take all debt and prefs and hybrids and everything together, how high would you take that?

No, we are not enthusiastic to do that. We think our leverage is about as high as we want it to be. We are certainly not looking to add meaningfully to that.

Okay, thanks.

Michael Goldberg, Desjardins Securities.

Thank you. Don, it's good to speak to you. On a US GAAP basis, your book value per share would be almost CAD10 higher than on IFRS. I know that there isn't a direct connection. But what do you think your RBC ratio would look like if it was measured?

And in presenting this comparison, is the point you want to make how tough IFRS accounting is, or how weak US GAAP is?

Well, Michael, I can't hazard a guess, suffice to say it would be satisfactory. We do know what our U.S. operation operates on, and it's a consistent basis. We check the ratios on both bases on it.

We haven't -- I couldn't hazard a guess how every business around the world would look on a US solvency basis. I think your point, though, is a very solid one.

A comparison that was sent to me by somebody recently was pointing out that a big US company headquartered in New York with Snoopy as a mascot reported earnings for the quarter, if I believe, about $2.3 billion on a US GAAP basis. We delivered US GAAP earnings of $2.2 billion for the same quarter. Their market cap is $36 billion; ours is under $20 billion.

That strikes me as a very interesting arbitrage opportunity if I was back in the investment game; but unfortunately, I am not. I am running a Company with a $20 billion market cap.

The same analysis could apply to the solvency ratios and so on. We have a very tough set of standards in Canada. That has served Canada very well, because we have a financial system that operates very capably throughout the crisis. And it's a great credit to our regulators, the Finance Minister, the Bank of Canada, and everyone right up to the Prime Minister.

But some of us sort of feel that enough is enough. And we are not feeling a particular amount of stress right now, but it is conceivable that others are. Again I think our regulator is a smart regulator and they are looking at these issues.

Okay, and a question for Steve. I was interested to hear your claim that OSFI is aware that Canadian LifeCos don't get any material hedge credit. Having said that, do you have any feeling that they are getting any closer to giving you any benefit for the hedges that you have?

No. I think there is a good dialog, very healthy dialog with our regulator, and as part of that dialog we obviously have flagged this issue up, as has the industry has a whole. But no, I don't have that feeling right now.

Okay, and last question. If the opportunity came up -- this is an investment question. Would you be interested in expanding timberland investments or any other infrastructure investments?

Michael, I'm going to refer that to Scott Hartz.

I'm sorry, would be interested in expanding our holdings? Yes, for sure. We think our alternative asset strategy is a great strength of the organization, and we plan to continue to grow that and develop that, which will include a variety of different asset classes including timberland, agriculture, infrastructure, oil and gas, private equity, commercial real estate, and so forth. So, absolutely.

Thank you.

Thanks, Michael. It's great to see you back on the job.

Thanks very much.

Gabriel Dechaine, Credit Suisse.

Hey, good afternoon. New what you may call it, risk factor you have got listed in here is the AG38 and potential for material adverse effect on the statutory capital position of John Hancock and therefore Manulife Financial Corporation. Listening to what some of the US companies talk about when they talk about AG38, they seem to downplay it, say it's for new sales and stuff like that.

I am just wondering what is different with Manulife. Do you use captives differently? Your interpretation of AG38 is different, or what?

And how would this look, let's say -- I'm just throwing a number out there -- but it's a CAD500 million capital requirement that is needed in the US, would that show up on the MCCSR, or would it just be HoldCo downstreaming it to your U.S. sub? Because they are all kind of connected now, aren't they?

Yes, Gabriel, the first thing I guess I would point out is that we are regulated principally on a Canadian-based MCCSR basis, and that includes all our businesses everywhere around the world, whether it is in a captive or not. It is all captured by the Canadian capital ratios.

And that is seen by regulators around the world as actually best practice, because you don't get these oddities where business can be moved offshore in captives with different outcomes. So it is all captured in the MCCSR.

And Steve or Jim, correct me. If this change were to take place, it wouldn't affect the MCCSR.

The second point is, why you would see some difference in our disclosure. We have a very strong commitment to continuous disclosure.

What has happened is on AG38, it looked more odious last year; it didn't seem to be going in a very positive direction because the NAIC had seemed to declare pretty strongly that this was not going to affect in-force business but just affect new business. Now some developments have taken place that look like that is not necessarily guaranteed.

So you are hearing real-time with us that that is an increased risk factor. We are still working with the rest of the industry. We feel this is the wrong thing.

It's a reinterpretation of valuations that have been done with the specific approval of state regulators on a case-by-case basis. This reinterpretation -- but no, it is not going to affect us any more than any other company that had comparable business in these structures.

It wouldn't affect your MCCSR, what would it affect if you are seeing material adverse effect on Manulife's capital position?

Well, it would mean that we -- if you took the view that whatever number came out there had to be funded, then that funding would come from the Parent Company and wouldn't affect our principal MCCSR ratio.

It would just shift the location of the capital, Gabriel.

So in theory you would have to raise some debt or whatever at the HoldCo?

No, no; we would move capital inside the enterprise.

Oh, okay, so -- well, good. The wording is a bit ominous, but it doesn't sound like it would be.

While theoretically -- we want to be clear to people. Theoretically, depending on the amount -- you throw out a number. If the number was a gigantic number if there wasn't the capital to move around, there could be an issue. But we don't anticipate that this is going to be a big problem, but we have no control over it.

Okay. All right. My next is pretty easy, I think.

Hey, Gabriel, I guess you -- sorry, I mentioned -- there is not a very long history of US regulators applying things retroactively, either in tax law or insurance regulation or in fact banking regulation. Usually it is done on a prospective basis.

So it's another reason why I tend to feel more comfortable. But we are alerting people that the risk has gone up from essentially very low risk to a little bit higher.

Okay. Yes, just so I have this crystal clear, if the capital requirement goes up in the US, there would be just some shifting within subsidiaries; but it would already be implied in the MCCSR, or -- ?

It's basically -- it will be a movement or a downstreaming of capital from the Parent Company down to the U.S. subsidiary.

Okay.

Right? So as long as the number is manageable, which we would expect to be, then the risk associated with this is manageable. And it is basically just moving funding, if you like, from parent down to subsidiary.

But because it is new information we have updated our risk disclosures with this information, and it will probably remain there for some while, whilst this issue is under resolution.

Okay. Can you -- now moving to the URR, your prescribed rate and the rate that is built into the reserves, what is the gap there and how does that trend over time? So if it is [3 6] now, and you are actually building a [3 5], I don't know the numbers exactly, but can you guide as to how it is moving from where you are now to that CAD400 million URR reserve increase next year? Is that another 20 basis points or what is that?

Okay, so the URR is based on a formulaic requirement, as you know. So the last year it was CAD677 million. That benefited somewhat from our decision to move to a quarterly regime from the first of January 2013. The go-forward on that would be around CAD100 million per quarter, although it won't be even, and it will -- we would expect it to fluctuate somewhat over time, depending on what happens in the markets. But I will ask Cindy if she would just like to elaborate on that.

Hey, Gabriel. It's Cindy. I don't have with me, but I am happy to answer off-line, what we project the URR to be based on the formula rates date at, say, end of June levels, for example.

But basically the CAD400 million that Steve just talked to for 2013 incorporates what we would project on that basis for -- with rates staying at June 30 levels, how much the financial impact would be of changes in the URR as a result of just the formulaic application of the URR.

Sure. Yes. And if you could tell me what kind of buffer you have below your maximum available rate too, that would be great. Thanks.

Okay.

Joanne Smith, Scotia Capital.

Yes, I just have a couple of questions with respect to -- the first one is associated with the hedge credit that was asked earlier. One of your Canadian peers reported earnings and they reported a new -- well, a credit to me anyway -- called market correlation. It's a very complicated concept, but I was just wondering if you could elaborate on whether you get any type of credit that is related to market correlation.

Joanne, it's Cindy. I think that what our competitor was talking about was matching up the shorter futures that they use for the hedging program against other positions. In this case I think they were talking about their indexed equities and their universal life products.

Yes.

We already do that. We have always done that. We have always matched our futures up against our long positions and against any offsets that we have.

So you do get that -- I think the maximum is 15% credit?

Yes, it would be the -- yes, it would be 15% if you were matching it up again a long position, because that is the required capital percentage on equities.

Okay. Okay. Then the other question I have is when we are looking at the basis charge in the third quarter, are there -- is there any potential for some other offsets, some positive offsets, that we might be looking forward to may be mitigate some of the impact of the potential maximum of CAD1 billion?

Well, I think we have tried to be as clear as we can be for you, Joanne, on -- I think it is on page 12 of the release where we have articulated to the best of our ability where we are. There are some pluses and minuses.

Cindy has moving parts, and I am not sure she is going to be able to say a lot more. And she is confirming that to me.

Okay. Then I guess my last question is just when you're looking at the basis charge or basis change associated with last rates and policyholder behavior, when you change that assumption, if in fact it is required to be changed, will you incorporate future changes to those policyholder behaviors?

I am just trying to understand if you're going to be getting ahead of the game or if you are just going to be catching up.

Well, first of all, I think I would just echo what Donald said, which is that we think the vast majority or certainly the majority of the basis changes at Q3 will be in the two buckets that don't constitute changes in policyholder behavior. I.e., they are something to do with changes in regulation or something to do with the economics rather than emerging experience. Let's say that at the outset; but then I will hand over to Cindy to elaborate.

Thanks, Steve. Joanne, we look at our experience as it emerges. We would -- we always are using judgment in interpreting experience, so we would consider what that tells us about the future.

But I wouldn't say that we are projecting forward, because I don't know what is going to happen in the future. So I can't really project my experience forward. But we do take into account the context for that experience to try to interpret it that way.

Okay, thank you.

Steve Theriault, Bank of America Merrill Lynch.

Thanks very much. A couple of questions. First for Steve or maybe for Cindy, I think I understand that strain will likely be higher in Q3 because of some nonrecurring impacts in Q2. First, is that correct?

Second, can you speak to your medium-term expectations on strain? Certainly it will bounce around. But now that your product repositioning is largely done, I am hoping you might be able to give some direction on some reasonable run rate on strain, ex sort of the quarterly macro factors that will come into play.

Yes, okay. Thanks for that. There is certainly -- we had some benefit in the quarter because of the sales on certain products in Japan. We mentioned some products that were related to tax changes, and there was good margin on those products. So that did benefit the strain in this quarter.

We think our trend on strain is in the right direction overall, but because of the special factors in this quarter we think it may tick up in Q3. On a longer-term basis we think there is probably some sort of floor to where strain will get to, because whilst we theoretically could deal fully with strain on the insurance side of our business, on the Wealth side of our business we expect that we will probably have to continue with a charge of around about CAD50 million per quarter on a go-forward basis, and it will be hard to eliminate that.

But I am just checking whether Cindy has anything to add, and she doesn't.

Okay, that's perfect. Actually good color. Thank you.

My other question was for Jim Boyle or for Cindy with respect to Long-Term Care. I have read about some actuarial studies that have suggested there could be issues with lapse assumptions in US Long-Term Care. Is there anything you are seeing in your business that highlights any concern?

Then specifically, could you share your lapse assumptions in US Long-Term Care currently? Have they migrated to any great extent over the last year or two?

Well, it's Steve here. I'll start off with this one. We do make a disclosure in our release concerning Long-Term Care in relation to one particular block of business; but I don't think there is a lot more to say on the topic other than that which we drew attention to. I am just looking at Jim.

Yes, Steve, part of the basis change in Canadian accounting is we refresh our assumptions periodically, where in the US you only do that when you get into a loss recognition mode. And obviously, the rate increase we went for was based on going and changing assumptions.

So as we look at back now and have some experience relative to those changed assumptions we have had, we are generally pretty confident that we got it right. There are a couple outliers that we may have to tweak over time; but as it relates to lapses, our lapse rates are very low, and we have seen no change really in lapse behavior since we did that basis change.

Steve, what you have heard though, somewhat of a little bit of history, gray hair, is in the early days of Long-Term Care I think that was one of the principal assumptions that companies got wrong -- was they assumed that people would buy the stuff and lapse. And I believe the lapse rate -- some were using as high as high single digits, which turned out to be totally unrealistic. And we don't have that problem for the reasons that you've specified.

The other thing is I'm going to go back and do something unusual here, go back on a question that Joanne asked about projecting. And I think there's two different interpretations of projecting.

When we make the observation that fewer people lapse a variable annuity contract when they have a guarantee that is substantially greater than their accumulated value, when we make that change we do project that out into the stochastic scenario. So any time that that re-occurs in the future, the assumption is that there will be a lower lapse rates.

So from that perspective, Joanne, we do project forward. What Cindy was referring to is we don't assume that if it is getting worse now that it will continue to get worse. And that if the lapse rate went from 2% down to 1% then it's going to go to 0.5% and then 0.25% or something like that.

But the stochastic scenario does assume that if there's fewer lapses in a condition, when people have a guarantee that's, say, twice the accumulated value in their contract, that they will not lapse as frequently. That is basically projected for in any part of the stochastic modeling that would have that condition take place.

That's correct, Don. Thanks.

Sumit Malhotra, Macquarie.

Good afternoon. A couple of questions, hopefully quick. I may have missed part of the answer relating to new business strain and specifically thinking about Asia. So I think you talked about some of the benefit that you've had the last two quarters will not be as material going forward.

Just so I am looking at this correctly, last two quarters you have had a pretty sizable benefit from impact of new business in Asia; and prior to that it was flattish. Could you quantify how much of a change you expect to see in the [interim] as some of the tax changes come through?

Well, I think the reference we made was the fact that the main benefit in the quarter was -- or the unusual benefit was to do with the Japan sales in relation to the tax-related product, where the tax changes were driving a pickup in sales. So that was the main issue in the quarter, and we wouldn't expect that to recur in the same fashion on a go-forward basis.

Could you just repeat your question? I apologize.

Did you give a magnitude as to how much that was impacting the strain line in Japan or in Asia?

We didn't give a magnitude.

Could you?

Roughly CAD30 million or so.

CAD30 million? Okay, and that reverses course next quarter, fair to say?

Yes.

Okay, and the second one was around IAS 19. I think we got an update from OSFI in the quarter and you updated your disclosure to say that that will be phased in over eight quarters with the 6 basis point impact on MCCSR.

Just from a shareholder's equity or book value perspective, does the -- I think the impact is in the range of CAD800 million to CAD1 billion roughly. Does that also get -- do they get phased in over the eight quarters or do we see that right on as an adjustment to shareholders equity on January 1?

Yes, it's a one-off adjustment to shareholders' equity on January 1, and our current estimate is in the area of CAD700 million post-tax.

CAD700 million? So it hits shareholders' equity right away, but the phase in on the capital side takes the eight quarters.

Correct.

Thanks for your time.

Darko Mihelic, Cormark Securities.

Hi, thank you. Two quick questions, just going back to strain. CAD30 million reverses in Q3. I understand that there was also some price increases in Canada that were put in late in the quarter.

So should we think of it as really looking at a CAD100 million run rate in strain? Or should we look for a pull forward effect? Or should we expect strain to reduce in Canada, somewhat offsetting the CAD30 million of reversal? Can you just give me some guidance on that, please?

We will look to Cindy on that one. I think we are getting into quite a bit of detail. But anyway, Cindy can help.

I think you should think of it as by the end of 2012 if interest rates stayed the same, for example, that strain on U.S. and Canadian Life businesses would be -- should be fairly nominal. And you'd have the run rate on the offsets (inaudible) that Steve was talking about.

In Q3 and Q4, getting there, you probably should think of the plus CAD30 million for Q3 and maybe somewhat smaller number for Q4.

Okay. That's helpful. Lastly with respect to -- I'm looking at your slide 14 where you discuss the source of earnings. Steve, I just want to make sure I understand it correctly.

When I look at the expected profit line, it declined quarter-over-quarter. And then somewhere in your remarks you mentioned that the reinsurance agreement cost you CAD25 million coming out of expected profit and will probably cost you about CAD5 million per quarter. Is that all in the EPIF line?

So the CAD25 million is the impact in the quarter and the CAD5 million per quarter going forward, and the CAD25 million is in management actions.

Okay. And on a go-forward basis the CAD5 million is coming out of EPIF; is that right?

Yes.

Okay, great. Thank you.

Thank you. We have no further questions registered at this time. I would like to return the meeting back over to Mr. Ostler.

Thank you very much, Ann. We will be available after the call if there are any follow-up questions, and don't forget that our Asia Investor Day is on September 7 in Hong Kong. Have a good afternoon, everyone.

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.