Manulife Financial Corp (MFC) 2013 Q1 法說會逐字稿

Please be advised that this conference call is being recorded. Good afternoon and welcome to the Manulife Financial first-quarter 2013 financial results conference call for Thursday, May 2, 2013. Your host for today will be Ms. Anique Asher. Please go ahead, Ms. Asher.

Thank you and good afternoon. Welcome to Manulife's conference call to discuss our first-quarter 2013 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 question-and-answer session. Available to answer questions about their businesses are the heads of our US, Canada, Asia, investments and general accounts 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, please consult the slide presentation for this conference call and webcast available on our website, as well as the securities filings referred to in 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 re-queue and we'll 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, Anique. Good afternoon, everyone, and thank you for joining us today. I'm joined on the call by our CFO, Steve Roder, as well as a number of members of our management team including our Asia General Manager, Bob Cook; Canadian GM, Marianne Harrison; our US General Manager, Craig Bromley; our Chief Operating Officer, Paul Rooney; our Chief Investment Officer, Warren Thomson; our Executive Vice President General Account Investments, Scott Hartz; Chief Actuary, Cindy Forbes; Chief Risk Officer, Rahim Hirji; and our Treasurer, Steve Moore.

I would like to start the call today with some highlights of the progress that we made on our growth strategies during the first quarter. We continued to develop our Asian opportunity to the fullest, and in the first quarter we achieved record wealth sales in Asia, which were more than double the first quarter of 2012. They were driven by strong contributions from all of our territories and in particular the continued success of recently launched funds in Japan and China, as well as continued momentum in the Mandatory Provident Fund business in Hong Kong.

Insurance sales in Asia, however, have declined. This was expected because of tax and product changes in Japan and Taiwan which dramatically pushed up sales in the same quarter in 2012. The decline was also based on pricing actions in some markets to protect margins in light of dramatically lower interest rates.

We also continued to grow our wealth and asset management business globally. We had record mutual fund sales in Asia, Canada and the United States, along with strong pension sales in the United States and in Hong Kong.

Our balanced Canadian franchise continued its steady progress and in the first quarter we more than doubled mutual fund sales, outpacing industry growth. We saw solid growth in Manulife Bank's lending assets despite a slowdown in the mortgage market. We maintained leading positions in our Group businesses.

We did however report a decline in insurance sales in Canada. The decline was due to two reasons -- one, the normal variability in the large case Group Benefits business relative to last year; and two, pricing actions taken to protect our margins in the low interest rate environment. As these pricing actions have not yet been instituted by our competitors, we expect to give up some market share initially.

In the United States we continue to grow our higher ROE, lower risk businesses. We achieved record sales, net flows and assets under management in our mutual fund business. We delivered strong 401(k) sales as well as solid growth in John Hancock Life, where newly launched products contributed to the sales success. And on a positive note, some of our competitors have recently followed our lead on pricing and product repositioning actions, which may result in an improvement in our overall market position in the United States.

This morning we announced our first quarter 2013 financial results. Let me share some of the highlights. We reported net income of CAD540 million, which was driven by strong core earnings of CAD619 million, an increase of CAD65 million over the fourth quarter.

On the top line we recorded wealth sales of CAD12.4 billion, up 43% over the first quarter of 2012. Strong wealth sales contributed to another consecutive quarter of record funds under management which, as you know, drives future fee income.

While we are very pleased with our performance in our wealth and asset management businesses this quarter, we were disappointed in the decline in insurance sales. Insurance sales of CAD619 million were down 23% from the first quarter of last year due to the items that I mentioned previously in Canada and Asia.

In summary, we are pleased with our solid start to 2013. Our first-quarter results reflect our continued progress on our growth strategy, strong core earnings, strong net income, decreased equity risk, and a very solid capital ratio.

While insurance sales fell short of our expectations, we generated record wealth sales with contributions from all of our major business units around the world producing all-time record funds under management.

We are confident that our growth strategies will continue to yield results for shareholders and position us to achieve our goal of delivering CAD4 billion of sustainable core earnings in 2016.

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

Thank you, Donald. Hello, everyone. Let's start on slide 6 where we indicate the financial highlights for the first quarter of 2013. In the first quarter we reported net income attributed to shareholders of CAD540 million, reflecting solid core earnings and strong investment gains partly offset by negative interest rate related impacts.

In terms of our operating performance, we delivered core earnings of CAD619 million, an increase of CAD65 million from the fourth quarter of 2012. We generated new business embedded value of CAD301 million, which was in line with the first quarter of the prior year despite a decline in insurance sales over the same period. We recorded a significant reduction in our equity exposures due to strong equity markets and increased macro hedging. And our capital ratio was further strengthened by 6 points and we ended the quarter with an MCCSR ratio of 217%.

Turning to slide 7 you will see our progress on core earnings. In the first quarter our core earnings were CAD619 million, an increase of CAD65 million for the fourth quarter of 2012. The increased profitability reflects lower new business strain, lower amortization of deferred acquisition costs and lower expenses, which was partially offset by unfavorable claims experience.

On slide 8 you can see that in the first quarter of 2013 improvements in core earnings in the US and Asia divisions were partly offset by declines in Canada and Corporate. In Asia the improvement in core earnings was primarily due to improved new business strain, higher net fee income and the higher fourth-quarter incentive, legal and systems costs that we highlighted as nonrecurring.

In Canada core earnings were negatively impacted by unfavorable claims experience and less favorable tax items, which more than offset improvements in strain.

In the US division the improvements in core earnings was due to improved new business strain, the release of tax provisions, favorable policyholder experience, improved expenses and lower DAC amortization. The decline in the corporate and other segment was related to the fourth-quarter release of Property and Casualty reinsurance provisions for the Japan earthquake and tsunami.

Turning to slide 9, in the first quarter our reported income benefited from CAD97 million of investment gains over and above the CAD50 million we include in core earnings. a CAD142 million gain related to the direct impact of equity markets; and a CAD101 million gain related to our hedged variable annuity guarantee.

These gains were offset by a CAD350 million charge from interest rate-related impacts primarily due to the negative impacts of swap spread widening and updates to our fixed income ultimate reinvestment rate or URR assumptions, and a CAD69 million charge attributed to actuarial model refinements.

These refinements are distinct from the annual review of actuarial methods and assumptions, which as you know is a rigorous process that spans many months and is reported in the third quarter.

We continue to make progress on our annual experience studies but have not yet completed our analysis, and while we expect there will be both positive and negative adjustments to the reserves, we cannot reasonably estimate the impact of this year's review.

On slide 10 is our source of earnings. Expected profit on in-force increased 7% on a constant currency basis largely reflecting higher fee income on increased funds under management and a reduction in deferred acquisition costs or DAC on our discontinued variable annuity business.

New business strain improved reflecting an enhanced new business mix and pricing increases in our insurance businesses, as well as improved expense performance in our wealth businesses.

This quarter's experience losses reflect unfavorable claims experience in Canada as well as the negative impact of wider swap spreads and the URR update, which more than offset favorable investment experience.

Management actions and changes in assumptions largely reflect expected macro hedging costs as well as actuarial model refinements. Earnings on surplus declined due to the release of tax-related interest provisions in the prior quarter partly offset by mark-to-market gains. Income taxes reflect non-taxable income, income earned in lower tax jurisdictions and the favorable resolution of tax items.

Turning to slide 11, you will see that our total insurance sales for the first quarter were CAD619 million, down 23% from the first quarter of 2012. Sales in Asia were 31% lower due to the expected decline in sales as a result of prior-year product and tax changes in Taiwan and Japan, as well as pricing action taken in light of dramatically lower interest rates. Excluding nonrecurring sales, Asia insurance sales increased by 2%.

Insurance sales in Canada were impacted by the variability of Group Benefits sales and pricing actions taken on individual insurance products to protect margins. And in the US, John Hancock Life sales increased on the success of newly launched products with more favorable risk characteristics, but were largely offset by lower sales of long-term care insurance.

Turning to slide 12 and wealth sales, in the first quarter we achieved record wealth sales of CAD12.4 billion, an increase of 43% from the first quarter of 2012. Driving the record sales were record results in Asia where wealth sales were more than double prior year levels, and record mutual fund sales in both Canada and the US.

On slide 13 you can see that strong growth of our in-force business was reflected in our premiums and deposits. For wealth products first-quarter premiums and deposits of CAD16.3 billion increased 42% over the first quarter of 2012, reflecting our strong mutual fund sales and continued growth in pension deposits. Insurance P&D increased 7% in the first quarter to CAD6 billion reflecting the growth of our in-force business.

Turning to slide 14, you will see that our new business embedded value was largely in line with the prior year at CAD301 million. Insurance NBEV reflected lower sales and interest rates in the quarter and lower property and casualty reinsurance renewals, partially offset by actions to improve profitability on insurance products. The increase in wealth NBEV reflected increases in mutual fund and pension sales, partly offset by lower bank lending volumes.

Turning our focus to the operating highlights of our divisions, beginning with the Asia division on slide 15. Core earnings for the Asia division improved from the fourth quarter of 2012 to $224 million as a result of improved new business strain, growth in net fee income and the non-recurrence of higher than normal expenses that we experienced in the fourth quarter.

First quarter wealth sales in Asia were more than double the prior year fueled by strong pension and mutual fund sales in Hong Kong that were more than double the first quarter of 2012; the continued success of the strategic income fund in Japan; and record mutual fund sales in China.

Insurance sales, on the other hand, declined 31% compared to the first quarter of 2012 as a result of the non-recurrence of significant sales in advance of product changes in Taiwan and tax changes in Japan. Additionally, sales slowed due to pricing actions stemming from the dramatically lower interest rates. Excluding nonrecurring sales, Asia insurance sales increased by 2%.

On slide 16 you will note that Asia division's total annualized premiums equivalent, or APE, and total weighted premium income, or TWPI, were up over the first quarter of 2012 by 12% and 19% respectively.

On slide 17 you will see our Canadian division operating highlights. Core earnings for the Canadian division declined 23% from the fourth quarter to CAD179 million. Core earnings were negatively impacted by poor claims experience and less favorable tax items, partially offset by improved new business strain.

Wealth sales in Canada were up 3% to CAD2.9 billion reflecting record mutual fund sales, outpacing industry growth, which more than offset a decline in new loan volumes at the bank.

Insurance sales of CAD243 million in the first quarter were 24% lower than in the prior year as a result of normal variability in the large case Group Benefits market and pricing actions taken in individual insurance to reduce risk and protect margins. We continue to drive the shift in product mix in Canada to those products with a more favorable risk and reward profile.

Moving on to slide 18 and the highlights for John Hancock, our US division. John Hancock reported very strong results in the first quarter. Core earnings in the US were CAD436 million, up 47% from the fourth quarter and reflected improved new business strain, the release of tax provisions, favorable policyholder experience, improved expenses and lower DAC amortization.

First quarter wealth sales of CAD7 billion represented an increase of 45% from the first quarter of 2012 driven by record mutual fund sales which were up 78% and contributed to our record funds under management. John Hancock Life sales increased 8% on the success of newly launched products with more favorable risk characteristics, but were partly offset by lower sales of long-term care insurance.

Turning to slide 19, funds under management reached another all-time record of CAD555 billion as at March 31, 2013 driven by positive net policy cash flows and strong investment experience.

Slide 20 demonstrates that our investment portfolio continues to be high quality and well diversified.

Slide 21 it speaks to the impact of net credit experience on first-quarter earnings. We had positive credit experience in the quarter, largely due to credit upgrades. We continue to see the quality of our investment portfolio and our expertise at extending credit as a group strength.

Slide 22 summarizes our equity market and interest rate risk sensitivities. In the first quarter we took advantage of favorable equity markets to further reduce our exposure to the TOPIX Index and have now achieved our risk reduction target for Japanese equities. However, we saw a small movement in our interest rate sensitivity in the first quarter. We are pleased that our sensitivities continue to be well within our risk targets.

Slide 23 summarizes our capital position for the Manufacturers Life Insurance Company. We ended the quarter with a further strengthened regulatory capital ratio of 217%, an improvement of 6 points over the fourth quarter of 2012. The improvement in our capital ratio reflects strong earnings and the favorable impact of changes in MCCSR guidelines, which was partly offset by net capital redemptions.

Before I conclude, I would like to address a topic which may be on the minds of our shareholders. And the topic is the decline in strain this quarter. We are pleased with the improvement in new business strain in our insurance and wealth businesses relative to the fourth quarter.

In regard to insurance strain, we saw the favorable impacts of business mix and pricing actions taken to protect our margins in the low interest rate environment. While we experienced reduced insurance strain in all divisions, I would highlight in particular the contribution from our US division.

Our wealth related strain also improved in the first quarter, largely related to efforts to reduce fixed acquisition costs in annuity lines, following the discontinuation of variable and fixed annuity sales in the US. On a go forward basis, as mutual fund sales continue to grow, we would expect an increase in new business strain as we cannot defer the non-direct acquisition expenses, some of which are, in fact, variable.

To summarize, in the first quarter of 2013 we continued to make substantive progress on our growth strategies; increased our core earnings; achieved new records for both wealth sales and funds under management; recorded a significant reduction in our equity exposures; and further strengthened our capital ratio.

Thank you.

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

(Operator Instructions). Tom MacKinnon, BMO Capital.

Good morning, pardon me, good afternoon. My question really is about the -- back to US division here with the core earnings. In 2012 they were up 8% and then in the first quarter here they are up over 70% year over year and 50% quarter over quarter. Now, Steve, you had made some comments as to expecting that strain to perhaps increase going forward with respect to the US division as some of the mutual fund's sales-related expenses would be non-deferrable.

How should we -- well, first of all, obviously everything aligned just as you would have expected and it was a super quarter in the US and the stars may not always align as such going forward. So any kind of help you can assist here in terms of what we should expect for core US earnings going forward, especially in light of some of the comments that you made about mutual fund stuff being non-deferrable.

I know in your plan it was really only for about 8% growth. So, obviously something going up 50% quarter over quarter isn't necessarily sustainable.

Thanks Tom. First of all, let's deal with the strain point. On our previous call, if I recall, we gave some guidance that maybe CAD100 million per quarter for strain was not a bad place to start. And I don't think our guidance would change; I think that is still good guidance. And that would include the United States.

Okay. But you don't have anything specifically for the US then?

No. But what I would draw your attention to is that in this quarter, as you say, everything sort of came up trumps in a sense and there were a couple of items in there that we mentioned. There was a favorable tax outcome and there was some good claims experience and each of those was in the CAD40 million region.

So if you were to take those and then apply them that wouldn't -- perhaps wouldn't be a bad way of looking at things. If I recall the run rate for the US core earnings prior to this quarter was close to 300 and clearly, as you say, I don't think we would want to declare this quarter as the ongoing run rate. But maybe that gives you sufficient guidance.

So the two items that were CAD40 million, the one was the tax and what was the other? Sorry.

We had some good claims experience in the quarter as well.

And these are both US, is that correct?

Correct. And that was a similar degree of magnitude for those two together were fairly substantial. But having said that it still remained a good quarter.

And each one was CAD40 million, is that correct?

In that order, yes.

Okay. But that wouldn't have shown up in the -- no, both of those would have been in the core then, is that correct?

Yes, that is correct.

Okay. And then maybe as a quick follow-up, just talk about the potential for core growth here in Asia. Certainly a lift up from quarter over quarter. But -- and I know the first quarter of last year was an exceptionally strong quarter, but how should we look at that going out?

Yeah. Well, as you see, this quarter has rebounded pretty well. We continue to face some headwinds in Asia, interest-rate headwinds, there has been some repricing. So we would expect Asia to improve somewhat. Having said that, we do have a bit of a headwind with the Japanese yen where it is and that is a little bit of a headwind for the year. So overall we would anticipate some modest improvement from here.

Okay, thank you.

[Operator Instructions] Mario Mendonca, Canaccord Genuity.

A question for Bob Cook. Bob, looking at the wealth sales in Asia over the last two quarters, numbers obviously pretty big. My question is, is there anything going on with those -- with that P&D that would be analogous to what happened with the insurance sales when they were very big last year, but then changes in product and taxes and regulation caused that prior year quarter to look unusually large?

Is there anything that would -- you could point us to that would suggest the high level of P&D we're seeing and Asian wealth could decline abruptly in the near-term?

No, I don't think there is anything I would particularly highlight there. I think that our expectation is that over the long term we will continue to see growth in the line from Asia. As you know, that is a core product diversification and a core part of our strategy in Asia. And we are seeing the results of that strategy over the last two or three quarters.

Last quarter Japan was one of the major contributors. This quarter China was a major contributor and I think we have several -- several wealth businesses going very strong now. And I would expect that to continue going forward.

Thank you. And then a question for Steve. The CAD40 million tax benefit in the quarter, presumably that is under your materiality threshold and that is why it wasn't specifically laid out.

That is correct, Mario.

Was there any other tax items that either benefited or pulled something out of earnings in the quarter?

Nothing material at all. That was the stand out item.

Thank you.

[Operator Instructions] Robert Sedran, CIBC.

Thanks, good afternoon. Just wanted to follow up quickly on the issue of strain and I guess, Steve, when you mention your guidance of about CAD100 million a quarter is still a reasonable level, is that because of the reason strain was so low this quarter had to do with depressed insurance sales? And if insurance sales come back to a level that you are expecting them to that will likely trend back towards that CAD100 million a little faster than otherwise would?

Because the items that you talked about, in terms of the reasons for the strain being low this quarter, feel sustainable in terms of keeping strain at that lower level. So are we just expecting better sales?

I think there are really two issues here. The first is you would expect -- as mutual fund sales increase you would expect strain to increase and that hasn't changed. This quarter a lot of the increase in wealth sales were in lines of business where the acquisition expenses were of a fixed nature and therefore rather bizarrely we experienced a very positive quarter in terms of sales, but at the same time it didn't bring strain with it. But we don't see that that necessarily will be a sustainable scenario. So those are the two things I would draw your attention to.

But didn't really have anything to do with the depressed insurance sales this quarter then?

Well, I think mix played a part. But as I say perhaps counter intuitively a lot of the wealth sales didn't bring with them those variable acquisition expenses.

Okay. And I'm not sure exactly how you can answer this question, but I hope you can. I am just wondering if someone can address the impact on the business, both in-force and in terms of growth of some of the fairly aggressive moves that are being taken by the Japanese Central Bank right now.

I mean we have had a -- Steve mentioned the yen, but we have had some big moves in the index, we've had some big moves in the yen. And I'm just wondering if you can kind of give us a sense of what that means for the business both today and going forward.

Don Guloien here. It is actually quite positive. I guess the first order impact is that it improves equity markets in Japan's serious risk on trade in Japan these days because the Japanese are getting a little bit more confident about the future and they recognize that if the Bank of Japan Governor keeps on with this practice they could see further devaluation of the yen. And if they keep their cash in a bank they are not going to make anything on it so they are moving it into other forms of assets.

We pick up on that in two ways. The first is it reduces the amount of variable annuity exposure we have, we just are sensitive to the equity market, helps actually some products that come to maturity and would pay out. So it is enormously beneficial from a risk management perspective. It helps in terms of a contribution to earnings, it contributes to sales, we have built up a big mutual fund operation in Japan and we are taking very substantial advantage of that.

The offset, which is pretty slight, is what it does to translation of earnings from Japan and obviously the yen depreciates if it does in fact further depreciate the translation of a given amount of earnings from Japan will be lower when translated into Canadian dollars. But most of our investors are buying Manulife because they like the international exposure and that is part and parcel with it. And we do not hedge currency translation risk. So overall it is a pretty positive picture in Japan.

Thanks, Don.

[Operator Instructions] Michael Goldberg, Desjardins Securities.

Thanks. First one for Don. You note in your highlights a significant reduction in equity exposure. And not that I don't believe you, but you didn't disclose this quarter the amount of your hedges so we could see your in the money guarantees net of hedges. So what is the comparable number for hedges to the 5086 at year end?

I'm going to refer this one to Rahim Hirji. But the reason we changed the presentation is more and more of our hedging is being done by macro hedging as opposed to just dynamics that schedule didn't really display the whole story. You can actually get it by looking at the different sheets and you will be pleased to know that the amount if you are to take off the dynamic hedging from not at risk it's going in the right direction. But I'll let Rahim answer more fully.

Thank you, Donald. Michael, when we started that disclosure we were not macro hedging, so we thought that disclosure at that point in time to show you the net amount at risk made sense to show you how much was covered up by our dynamic hedging program, how much is covered by external reinsurance.

We since then over the last three years have substantially increased our macro hedging and that was sort of the primary reason for changing the disclosure. If you actually look at the sensitivity disclosures, that clearly shows how much of our overall risk has been decreased by macro hedging.

And roughly right now our macro hedging is almost covering the similar amount of risk as our dynamic hedging program and that was the primary reason. But overall our equity risk, if you look at our schedule, has gone down quite materially quarter over quarter.

Okay, I will follow up with you. Also, Don, how are you thinking about the dividend? If in relation to core earnings what payout is appropriate? And if not in relation to core earnings then in relation to what? And how does uncertainty about capital rules still affect your thoughts about the dividend?

Well, first of all, I want to point out that any dividend decisions are made by the Board of Directors. But I don't mind speaking to what we would recommend to the Board. The first is I guess we'd look for stability in core earnings. I think you are quite right, we would reference the dividend payout in reference to core earnings. And as core earnings were to improve we would have to start thinking about it.

But we have also said before that we want to reduce the amount of leverage we have on our balance sheet and that is a priority. So you know I don't want to mislead anybody; I have said before I am going to be very conservative. It was very painful taking the dividend down. We are probably going to err on the conservative side talking about taking it up. But we would look for core earnings to expand, we would look for stability in core earnings. We would look to having a more conservative leverage ratio and then we could talk about dividend.

As it relates to the question that you asked about the capital situation, I guess I'd feel pretty comfortable with where the regulatory authorities are right now. I think generally they are pretty comfortable with capital levels in our industry.

When I look at international developments and so on I think on balance in the ASB discussion there is nothing that leaves me lying awake at night thinking that there is going to be a massive change to capital rules that are going to discourage in any way from doing the right thing for our shareholders. But the first thing before any of that would be to have core earnings actually stabilize to have them go up and to pay down some of our debt.

Is there a number you could give us though once you are at whatever level of core earnings as to what -- a range of what levels of what payouts on core earnings might be appropriate?

Well, if you were to take some annualization -- I don't want to give you a specific payout number. But going back a few years ago we made the difficult decision to cut the dividend. Remember, we talked to the Street about what our earnings expectations were at that time reflecting the new realities of having to put more hedges in place, having to cut back on certain products and so on.

And I think the number we were talking about at that time was roughly about CAD2.5 billion and we set our dividend payout relative to some number in rough terms like that. So that gives you an indication of something of a type of payout ratio that I might think is reasonable. But again, that is all subject to discussion based on how we feel about the variability, consistency of earnings, leverage and other factors.

Thank you.

[Operator Instructions] Joanne Smith, Scotia Capital.

Hi, good afternoon. I had a couple of questions. A couple of your competitors reported on their conference calls that because of the significant decline in the yen and the significant increase in the equity markets during the last couple of quarters they had seen some increased fixed annuity surrenders associated with non-yen denominated securities or investments. And I was wondering if -- and that caused a spike in fee income. And I was just wondering if you saw the same thing?

I will refer that to Bob Cook, Joanne.

Thanks, Donald.

No, we haven't seen any material increase in surrenders from that product line at this point in time. But obviously the shift has been one of the factors in the decline in sales from that product line and the shift more to the mutual fund sales.

Okay, thank you, Bob. And also with respect to the increase in the surrenders for the VAs, how should we think about that in terms of, number one, the net amount at risk; and number two, the Japan-related earnings?

Well, I think, Joanne, what I was saying is we have certain products -- this is kind of an unusual product in Japan that's called "Bikkuri Bako". What it means is when you -- a certain -- when we achieve a certain level in the stock market or the holdings in the person's account they get paid out like the thing matured, like an automatic surrender, if you will.

I see.

That causes a release of pads, a release of capital. If you are aware, many companies in the United States and elsewhere are searching for programs where they buy out policy holders, or try to, with a premium. This doesn't do that. This has a mature -- per the terms of their contract and it is a unique feature of these contracts.

And you know, when you are trying to reduce your equity risk profile or at least manage it within limits, I guess is a more accurate way of depicting it, it is actually a very conducive development for us. So it reduces capital, it does actually increase earnings. In the future you won't have earnings off that block of business but that is a trade-off we are quite happy to make.

Right, okay, great. Thanks, Donald.

[Operator Instructions] John Aiken, Barclays.

Good afternoon Steve, I just wanted to confirm that in your prepared commentary you talked about the hedging on the Japanese equity book and you said you have completed the program?

Yes, that is correct.

Okay. And then there was commentary in terms of your disclosure around the sensitivity assumptions and on a -- under your positive market shock scenario you are now including an assumed release of the macro hedging or a reduction of the macro hedging. Can we also assume that in an environment where the Japanese equities continue to spiral upwards that you may actually start to take some of the hedging off at this stage in the game?

I am going to refer that question to Rahim Hirji.

So I think you had two questions. The first one related just to our change in sensitivity. For a long time at the Company we have been focusing on reducing the level of risk that we had in our products and our overall equity position. And now we have actually turned around and we are actually focusing more on managing those sensitivities in our tolerances.

And when we revisited the assumptions that we were making on our disclosures, given the fact that our variable annuity portfolio really has asymmetric risk. So our risk decreases as markets go up and increases as markets go down and you can see that quite clearly in some of our sensitivities that disclose, that the upside sensitivities are less than what the downside sensitivities are on an absolute basis.

So from that perspective as markets go up we should be reducing the size of our hedges and that is exactly what we are now assuming under our disclosures, we think that the new disclosure more appropriately reflects the reality of how we would actually manage this risk.

Your second question was around how we would manage this risk on a go forward basis as the markets trended upwards and the TOPIX is up close to 10% during the quarter. And as per exactly what we have modeled in our disclosures, we actually are looking at reducing the amount of [noise notes] that we have backing our Japanese variable annuity liability and our hedging program there.

Great, thank you very much.

John, if I can just add one more thing is that volatility is come down which opens up other forms of hedging risk and we are pursuing those as well. So it's a very positive story overall.

[Operator Instructions] Doug Young, TD Securities.

Hi good afternoon. Just the first question, Cindy, is more around the long-term care insurance experience in the US. And I am wondering if you can give us an update what the claims experience in Q1 was and if you have made any more progress in terms of getting additional states on board for price increases. So that is the first question.

And then the second one is I guess, Craig, I am wondering -- this is a two-part question so I apologize, but the -- at what point or maybe your US mutual fund business is profitable or break even. I am just wondering at what point do you start to get to full margins on your US mutual fund business and if that's a future driver. And I guess at the same time I am trying to get a sense of how you are doing in terms of your mid-market 401(k) expansion and if you can quantify that for me. Thank you.

Thank you, Doug, this is Cindy. In terms of our claims experience on LTC this quarter we had a small loss of under CAD15 million on LTC this quarter. In terms of the progress that we are making on the state's approval, we are very happy with the progress that we are making. We continue to get approval from states. And so we are very pleased with the continued progress on that front.

Okay, I will answer your next questions, Doug. The mutual fund business is profitable and is increasingly profitable, it has been profitable for some time. It is not currently a huge contributor to the Company's overall income, but it is positive and growing.

And I guess with regards to the sort of -- I think what you are really asking is about how does this thing leverage up. There is a fair bit of operational leverage and it takes two forms, one is on AUM, so we are still a fairly modest sized player in terms of our AUM profile and that is what really dries out the profit. So we have a structure as the AUM grows there is a lot of leverage in terms of increasing the profitability and we are I think very well situated in that.

And the second is on sales. We have a fairly substantial sales force of wholesalers out in the field. We are not increasing that number and haven't for some time. As a matter fact we actually decreased a little bit. So as sales go up and the field force stays the same there is a fair bit of leverage on that as well. So things are looking very positive from a trend perspective in that business.

I guess your second question was about the mid-market product which we call enterprise. We're really just at the beginning stages of marketing that product, reception thus far has been quite good. The lead times in this market are a little bit different than in our core market of smaller cases, so we don't have financial results to discuss as yet. But the overall reception to the product, its features, some of its unique attributes has been very positive and we are in a lot of final situations.

If I can just come back, Craig, just on the mutual fund side. At what point do you -- at what asset level do you get to full margin?

Well, Doug, we are operating below margin right now. One of the reasons for that is we're continuing to invest in the infrastructure. That has worked out for us reasonably well. I mean Craig sold I think CAD5.5 billion of mutual funds over the first quarter this year.

I happen to think -- he is probably not going to agree with me -- he's operating way below capacity. I would like to see him maybe double that run rate over a reasonable period of time. And we are certainly investing with that in mind. We are going to build a world-class franchise there, we are well on our way and we will get there. As anybody knows who has been in that business, once you do that the profits flow in pretty rapidly.

Okay, thank you.

[Operator Instructions] Gabriel Dechaine, Credit Suisse.

Hi good afternoon. First question is -- well, we talked about the tailwinds you had in the US, but some pretty significant headwinds in Canada. Can you quantify the negative claims experience, I think it is over CAD100 million. And should I be worried about this? Is this the kind of -- is it one-off type of experience or something that could show up again in the Q3 assumption review? Just some clarification around that.

And then my second question on the DAC it looks like the run rate expense or the expense this quarter is down from your run rate by about CAD30 million. So as the USDA block matures a lot of that DAC amortization associated with that is disappearing effectively. Should we see even more downside to that expense over the next few quarters and years? And if you could put some numbers around that that would be fabulous.

So, Marianne has the first question.

Okay, so in terms of the claims experience it was about a CAD40 million claims impact that we had this quarter. And it is not unusual in the first quarter for us to see some poor claims experience. We do not believe that it is systemic and we actually expect that we will not see it recur in future quarters as well.

So that was group related I guess, Cindy?

Sorry I couldn't hear that?

Was that group related?

Primarily group related and a little bit in the individual insurance and a little bit in our affinity travel market as well.

Okay, thank you.

The second question on the DAC, yes, the DAC started to roll off in some of the old cohorts this quarter, so there was a relatively modest pickup from that in this quarter, something in the order of CAD20 million. And going forward, yes, we would expect that to increase. So by the time we get to 2016 we would have expected that to increase reasonably substantially as there is quite a lot of roll-off that is going to occur. And the order of magnitude of that would be something in the order of CAD200 million.

CAD200 million, like per year or -- so annual we are talking about CAD80 million this year and then by 2016 it should be CAD200 million?

That is correct.

And that is not part of the [E&E] by chance now?

No, it is part of one of many factors that will drive us towards our CAD4 billion earnings target.

All right, perfect. Thank you, sir.

Steve Theriault, Bank of America-Merrill Lynch.

A couple follow-ups really. First, Steve, you mentioned earlier that some of the Canadian pricing actions that you took were not followed by peers and in the past really I seem to recall that your competitors have followed pretty quickly. So any insights there, anything different this time around as to why?

I'll ask my second question to give Rahim maybe a minute to ponder it. It is really a follow-up to John Aiken's question. And you talked a bit about Japan, but most of the macro hedges are really in the US. And so the S&P 500 is now at record levels so that is good. But rates obviously haven't cooperated to the extent you would like.

And so, I am wondering are there any yardsticks you could help us with? So when I look at the charts for the US 10-year and US 30-year swap spreads, like if those get back to something like 50, which looks I think more normal, at that point do we start to see some movement out of the macro hedges? Anything you can help us sort of to think about that quantitatively would be appreciated.

Well, I will hand the first question rapidly to Marianne who will take that one.

In terms of the competitors, I can't very well speak to what the competitors' actions are going to do. But typically we do lead the market when it comes to rate changes, and they have typically followed. That's not to say whether they will or will not this time. But at this present time they haven't.

I think they have a strong conviction that rates are going to go up sometime in the medium-term. And, God bless them, they have a different forecast than anyone I have talked to. So we are not going to bet the shareholders' future on that.

Presumably then if it is coming through the P&L now these are rate increases that would have happened a few months ago? Is that fair?

The most recent one was in January.

Okay, thanks.

The second question, right.

So in terms of your second question, I think you had a two-parter there. I think the first question you had was around sort of the fact that we have a significant amount of S&P hedges and a lot of those S&P hedges actually hedged our Japanese block, not necessarily our US block.

And the reason for that is our Japanese variable annuity block has a lot of global equity investment, so it is not just Japanese equity related, it is also US equity related. And we are using some of the hedges in our macro program to hedge both the S&P exposure that comes from our Japanese variable annuity block as well as our US block and we will continue to do so going forward.

Your second question was around sort of levels where we would be maybe considering to move some of our hedges outside of our macro hedging program and into our dynamic hedging program. And I would say at this point in time compared to where rates have been we are probably looking at somewhere between 50 to 100 basis points of increase before we sort of look at that in any serious volume.

And the other aspect that I will give you is that our Japanese block also has significant maturities that come in three or four years and so our -- in terms of that the interest rate exposure would probably be over the -- not the 10-year point but probably the two- or three- or four-year point for our Japanese liabilities versus our living benefits liabilities that we have sold. And the rest is in North America which has much longer sort of durations associated with that.

Okay, that is very helpful. I admit I don't understand that it would be 50 to 100 basis points from here in the swaps but I am happy to follow up off-line.

I think the primary reason for that is that while rates are much lower than they were a year ago or three years ago, the equity markets coming back to where they are has been very beneficial from the actual amounts at risk perspective.

The other thing, Steve, the ball coming down is enormously beneficial from a whole variety of perspectives and it has come down very, very significantly more recently.

Okay, thanks. I appreciate the color.

[Operator Instructions] Darko Mihelic, Cormark.

Hi, thank you. A question for Steve. Seeing as we haven't seen any price increases from competitors in Canada, I'm just curious if you can go back to your discussion on why we should expect strain to go back up to CAD100 million per quarter from the current run rate. If you can just give a couple of ideas for us as to why that is happening. Is it because rates have moved lower against you or is it because it you expect to sell more product somewhere else?

Okay. I think the two reasons I gave earlier on were firstly, all other things being equal, as mutual fund sales increase we would expect strain to increase. But we did have an unusual feature this quarter which was that we were selling product surprisingly overweight, if you like, in areas where the acquisition expenses were of a fixed nature. So that didn't bring strain with it and we don't see that mix as being necessarily sustainable, we think the mix will change and that would tend to drag strain back up.

Okay, if I could just follow up on that a little bit. You are also inherently suggesting then that you shouldn't expect increased sales in Asia. Would that be fair?

No, I'm not sure I follow that.

I think I understand where you are going, Darko. There are a couple of moving things like a cost volume efficiency variance is all being combined. You have got strain being reduced in the United States very dramatically because we made price increases some time ago that reduced the strain.

And most of our strain results from when we price the product or a level of interest rates that we think is going to be obtained and then the rates suddenly drop, we can't change the prices so all of a sudden you throw off strain in the first period when you sell a product. And as you know then and all subsequent periods the profit is essentially as it should have been priced for in the first place. That throws up this notion of strain.

The strain will persist as long as you are selling that product or until such time as you re-price the product to more reflect what you can obtain in the capital markets. That problem has disappeared in the United States because we took pricing action very significantly. It has disappeared in large measure or almost entirely disappeared in Canada because we reflect the price changes.

Interest rates in Asia in some places, you know we just had an announcement when the call started about the Philippines now becoming investment grade, interest rates in Indonesia have come down enormously, interest rates in Hong Kong have come down enormously. So we will see some strain coming from products in Asia. And you are quite right that on those products in and of themselves, as we sell more at that price you will generate more strain.

Steve's comment is taking an estimate of all those factors combined and saying a reasonable guestimate would be that, but any one of them -- more sales in Asia where we haven't repriced, yes, we will produce more strain. More sales in the United States or Canada where we have repriced, where we have repriced will not throw off as much strain. Nor mutual fund sales will throw off strain, as Steve said. So his judgment is a summation of what is going on with a huge variety of different situations around the world.

Okay, fair enough. Thank you very much.

[Operator Instructions] Michael Goldberg, Desjardins Securities.

Thanks. Can you elaborate on how you might change the way you hedge equities as markets rise and volatility goes down? And what would be the impact?

Well, we don't want to talk in too much detail because we have some pretty interesting ideas. But suffice to say, when volatility goes down a lot of other option -- number one, you make more money or lose less on dynamic rebalancing, different things become possible with your macro hedges and then there are other instruments that could be used to complete your hedging. There is a whole variety of very positive things that go on, Michael.

Okay. And the mutual funds sales in the US, can you talk about how that is coming from -- either in terms of the existing producers that you have or adding new producers, just where is it coming from?

Yes, it is coming from, this is Craig, from all [quarters]. So all the different distribution channels are actually increasing their sales. We look at our channels being basically the planners, the wirehouses, the regionals -- what we call the regionals, and then we have the more institutional channels in DCIO.

All channels are up. The fastest growing though amongst those channels are the DCIO and the wirehouses. And the wirehouses -- both of those are actually areas that we targeted for growth in our plans last year and have been executing against. And so, we are very pleased to see that we are getting the growth that we have targeted there. So that is actually stripping the other channels. But it is across the board.

You said wirehouses and what?

Sorry -- defined contribution investment only. So basically selling into platforms -- other people's 401(k) platforms.

Thank you.

And, Michael, if I can, that is the story in the states. You take those exact words and change a couple of terms like DCIO and describe the story in Canada, change a couple words and exactly describe the story throughout Asia. My friend Steve Roder describes it as a conveyor belt of sales across wealth and asset management. It is also institutional and retail.

Thank you very much.

There are no further questions registered at this time. I would like to turn the meeting back over to Ms. Asher.

Thank you, operator. We will be available after the call if there are any follow-up questions. Have a good afternoon, everyone.

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