Manulife Financial Corp (MFC) 2013 Q2 法說會逐字稿

Please be advised this conference call is being recorded. Good afternoon and welcome to the Manulife Financial second-quarter 2013 financial results conference call for Thursday, August 8, 2013. Your host for today will be Ms. Anique Asher. Ms. Asher, please go ahead.

Thank you and good afternoon. Welcome to Manulife's conference call to discuss our second-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.

Today's speakers may make forward-looking statements within the meaning of securities legislation. Certain material factors or assumptions are implied 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. We have also included a "Note to Users" slide that sets out the performance and non-GAAP measures used in today's presentation.

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 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, Anique. Good afternoon, everyone, and thank you for joining us today. I am joined on the call by our Chief Financial Officer, Steve Roder, as well as several members of our senior management team including our Asian General Manager, Bob Cook; our Canadian General Manager, 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 Accountant Investments, Scott Hartz; our Chief Actuary, Cindy Forbes; our Chief Risk Officer, Rahim Hirji; and our Treasurer, Steven Moore.

This morning we announced our second-quarter 2013 financial results. And while our net income was not as strong as we would've liked due to a number of market-related items, I am encouraged by the substantive progress that we have made on our growth strategies, our solid core earnings, our record wealth sales, and the reduction in our run rate hedging costs. I would also like to start the call reviewing the progress on our growth strategies made during the second quarter.

We continue to develop our Asian opportunity to the fullest. Our wealth sales increased for the third consecutive quarter and were more than double those of a year ago. We increased our market share and achieved the leading position in net cash flows in the Mandatory Provident Fund business in Hong Kong. We also enhanced our distribution network with a new bancassurance agreement in Malaysia.

Insurance sales in Asia were below our expectations and only 6% higher than the second quarter of 2012, after adjusting for the run-up in last year's sales in advance of tax changes, as well as pricing actions to improve margins in that territory. We also continued to grow our wealth and asset management businesses. And in the second quarter we achieved record mutual fund sales in each one of Asia, Canada, and the United States, which contributed to another quarter of record funds under management, which as you know drives future fee income.

On a year-to-date basis, we have now achieved over CAD10 billion in net -- and I stress net -- mutual fund flows, reflecting our robust distribution partnerships, our strong product suite, strong performance, and improved market conditions.

Our balanced Canadian franchise continued its steady progress and in the second quarter mutual fund sales in Canada continued to outperform the market, with sales more than double those of a year ago. Manulife Bank's net lending assets increased and we saw a significant improvement in new loan volumes over the previous quarter. And despite the fact that our pricing actions have not been matched by some of our competitors, we saw an increase in individual insurance sales of 11% from the first quarter of 2013 with, needless to say, much improved margins.

In the United States we continued to grow our higher ROE, lower risk businesses, consistent with our strategic plan. Our mutual fund business achieved record sales, net flows, and assets under management, driven in part by funds added to the preferred list and selected for inclusion in model portfolios. Our 401(k) sales declined due to lower plan turnover in the market, but also our recently launched midmarket 401(k) and full-service group annuity products, which are now gaining traction.

While our US insurance sales overall were flat compared with a year ago, again, consistent with the strategic plan, we saw increased sales of life insurance products with more favorable risk attributes for our company. We also further strengthened our distribution capability with the announced acquisition of an independent broker-dealer to add to our already impressive distribution capability in the United States. We will continue to make investments to enhance our distribution networks globally.

In terms of our operating performance in the second quarter, we reported net income of CAD259 million. This was not what the market expected and occurs as a result of a number of items that are unusual in nature, but say very little about our earnings capability going forward. Steve will elaborate on these later in the call. I hope it is obvious that the volatility in our earnings is being constrained and our earnings in the second quarter were a significant improvement from the same quarter last year.

We also reported core earnings of CAD609 million and on the top line we achieved record wealth sales which increased 60% from a year ago. The performance of our Wealth and Asset Management businesses so far in 2013 has been outstanding. While our Insurance sales did not match the strong results of last year, we have much improved margins and are developing and launching new and innovative products that we expect to take traction in the second half of the year.

Finally, we also took advantage of favorable markets to reduce our quarterly run rate hedging costs by CAD30 million. In summary, our outlook is positive and we are confident that our strategies will continue to yield results for shareholders and position us to achieve our goal of delivering CAD4 billion of 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, and hello, everyone. Let's start on slide six, where we indicate the financial highlights for the second quarter of 2013.

We reported net income attributed to shareholders of CAD259 million, which was impacted by a charge of CAD291 million, CAD180 million of which is expected to reverse in future quarters. In terms of our performance, we generated core earnings of CAD609 million. We increased our MCCSR ratio by 5 points to 222%. We recorded new business embedded value of CAD307 million, and we achieved approximately CAD175 million pretax annual run rate savings from our efficiency and effectiveness initiative.

On slide seven, you will see our progress on core earnings. In the second quarter, our core earnings were CAD609 million, a decrease of CAD10 million from the first quarter of 2013. The decrease was primarily due to the non-recurrence of prior-quarter tax benefits in the US, which was partially offset by higher fee income on wealth businesses and lower expected macro hedging costs.

Unfavorable lapse experience was largely offset by improved claims experience this quarter.

Turning to slide eight, in the second quarter, as I previously mentioned, our reported net income was impacted by CAD291 million of charges, of which CAD180 million are expected to reverse in future quarters. Market-related items totaled CAD242 million and included approximately CAD100 million related to the impact on our policy liabilities arising from the increase in interest rates on balanced and bond funds supporting our non-dynamically hedged variable annuity business. We are in the process of updating our investment return assumptions as part of the third-quarter actuarial review, which may largely offset these charges.

Approximately CAD50 million in realized hedging costs in order to maintain our overall equity hedging position within our risks targets. Japanese equity markets were more than twice as volatile as the S&P 500 during the second quarter. Failing ongoing volatility, we also would not expect this charge to recur.

And finally, a CAD70 million charge related to the quarterly update to our ultimate reinvestment rate, or URR, assumptions. The beneficial impact of increasing interest rates helped reduce the URR charge from CAD97 million last quarter.

In addition, we reported a CAD49 million investment-related charge largely due to the impact on our policy liability investment assumptions arising from a significant purchase of Government of Canada bonds. This purchase triggered a charge of approximately CAD80 million, which we expect will reverse in future quarters as we reinvest these bonds into higher-yielding assets.

On slide nine you can see the total company core earnings in the second quarter of 2013 benefited from improvements in core earnings in Canada and lower hedging costs, which were offset by the expected decline in the U.S. Division's core earnings. In Asia, core earnings were in line with the prior quarter as growth of in-force earnings were offset by the currency translation of the depreciating Japanese yen. In Canada, the improvement in core earnings was primarily due to improvements in claims experience, and significantly lower new business strain on insurance products, partially offset by unfavorable lapse experience.

In the US, the decline in core earnings was mostly due to the non-recurrence of one-time tax benefits recognized in the prior quarter, and unfavorable policyholder experience, which was partially offset by higher net fee income. In addition, we took advantage of the favorable economic conditions to reduce our macro-hedging costs in the quarter by CAD20 million. I will elaborate on this later in my presentation.

On slide 10 is our source of earnings. Here are some of the highlights.

Expected profit on In-Force increased 2% on a constant currency basis, largely reflecting higher fee income from the increase in our funds under management. New business strain improved due to pricing actions, a more favorable new business mix, and higher interest rates, which was partially offset by higher wealth volumes.

This quarter's experience losses reflect a number of market-related items which I previously mentioned, as well as a lapse experience, partly offset by favorable interest rate movements and claims experience. Management actions and changes in assumptions largely reflect expected macro-hedging costs, AFS bond losses, and actuarial model refinements.

Earnings on surplus declined due to the impact of rising rates on mark-to-market assets held in surplus. However, core earnings on surplus was consistent with the prior quarter. And finally, income taxes reflect income earned in lower tax jurisdictions, tax reinvestment income, and the favorable impact of provincial tax rate changes in Canada.

Turning to slide 11, you will see that our total insurance sales for the second quarter were CAD929 million, down 3% from the second quarter of 2012. Sales in Asia declined 31% due to a run-up in sales in advance of tax changes and pricing actions to improve margins last year. Excluding non-recurring items, Asia insurance sales increased by 6%, although they do remain below our expectations.

In Canada, although individual insurance sales were lower than in the prior year, sales in Group Benefits drove a 19% increase. And in the US, while insurance sales were in line with the prior year, the underlying product mix reflected increased sales of products with a more favorable risk and return profile.

In addition, in the second quarter we saw a significant improvement in insurance new business strain in North America from a year ago, reflecting the improved product mix and pricing actions. This was, however, mostly offset by the non-recurrence of last year's substantial new business gains related to the run-up of sales in Japan and Hong Kong.

Turning to slide 12 and wealth sales, in the second quarter we achieved record wealth sales of CAD13.7 billion, an increase of 60% from the second quarter of 2012. Driving the strong sales were record results in Asia, where wealth sales were more than double the prior year with double-digit growth in all territories, and record mutual fund sales in each of Asia, Canada, and the US. We are particularly proud that our year-to-date net mutual fund flows surpassed CAD10 billion, representing a substantial increase from the same period last year.

On slide 13, you can see that strong growth of our wealth business was reflected in our premiums and deposits. For wealth products, second-quarter premiums and deposits were CAD17.4 billion, an increase of 54% from a year ago, reflecting significant sales in our mutual fund businesses. Insurance P&D increased 2% to CAD6.3 billion, reflecting the growth of our in-force business in Asia and Group Benefits in Canada.

Turning to slide 14, while our new business embedded value, or NBEV, was largely in line with the prior year at CAD307 million, it reflects a 41% increase in wealth NBEV largely as a result of the very strong mutual fund sales. Insurance NBEV was down 16%, reflecting lower sales in the quarter, partially offset by improved profitability. Insurance NBEV has increased consistently over the last three quarters to CAD177 million and is evidence of the improvements in our business mix and our re-pricing actions.

Turning our focus to the operating highlights of our divisions, we begin with the Asia Division on slide 15.

Core earnings for the Asia Division were in line with the prior quarter. Asia achieved record wealth sales that were more than double the prior year with growth in all territories, and insurance sales, while not yet where we would like them to be, increased 13% over the previous quarter.

On slide 16, you will note the Asia Division's total annualized premium equivalent, or APE, and total weighted premium income, or TWPI, were up over the second quarter of 2012 by 14% and 16%, respectively.

Turning to our a Canadian Division operating highlights on slide 17, core earnings for the Canadian Division improved 26% from the prior quarter to CAD225 million. Wealth sales in Canada were up 26% to CAD3.1 billion, reflecting record mutual fund sales and normal variability in Group Retirement Solutions. And while Manulife Bank's new loan volumes in the second quarter reflected a slowdown in the residential mortgage market last year, we saw a significant increase from the first quarter of 2013.

Insurance sales of CAD534 million in the second quarter were 19% higher than in the prior year, largely as a result of a single large case sale in Group Benefits. Although individual insurance sales were lower than the prior year, sales increased from the previous quarter and reflect higher margins.

Moving on to slide 18 and the highlights for the U.S. Division, core earnings in the US were $336 million. Second-quarter wealth sales of $7.4 billion were up 58% versus the prior year. Record mutual fund sales, driven by strong distribution partnerships and improved productivity, were partially offset by lower pension sales. Insurance sales of $130 million were in line with the second quarter of 2012, reflecting improved performance on our redesigned long-term care and life insurance products with more favorable risk and return profiles.

Turning to slide 19, funds under management reached another all-time record of CAD567 billion at the end of the second quarter. Slide 20 highlights our diversified and high-quality investment portfolio as of June 30, 2013.

Slide 21 summarizes the capital position for the Manufacturers Life Insurance Company. We ended the quarter with a further strengthened regulatory capital ratio of 222%, an improvement of 5 points over the first quarter of 2013. The improvement in our capital ratio reflects the favorable impact of higher rates on required capital and a CAD200 million preferred share insurance in the quarter.

Slide 22 summarizes our hedging activity in the quarter. During the second quarter we took advantage of favorable market conditions to improve the effectiveness of our hedging program by adding CAD2 billion in guaranteed value to our dynamic hedging program in Canada and an additional CAD800 million in the United States. We also began to hedge volatility and reduced Japanese yen exposure. And in addition, we unwound macro hedge positions to maintain our equity risk targets.

In the early part of the third quarter, we also added an additional CAD5.7 billion in guaranteed value to our dynamic hedging programs in the US and Japan. The reduction in hedge positions increased our second-quarter core earnings by approximately CAD20 million and we expect a further CAD10 million benefit in the third quarter if equity markets and interest rates remain at June 30 levels.

As you can see on slide 23, we have been active in the quarter and have deployed capital on opportunities which will further strengthen our distribution capabilities. In Malaysia, we commenced an exclusive 10-year bancassurance agreement with Alliance Bank, giving us access to their 1 million customers. We started in-branch sales under this new agreement in May.

In the United States, we agreed to acquire Symetra Investment Services to bolster the John Hancock Financial Network. This represents a 15% increase in advisors for the network. And subsequent to the end of the quarter, we announced our exit from the life insurance business in Taiwan. This transaction, subject to regulatory approval, is expected to close by the end of the year and result in a 3 point benefit to MCCSR on closing.

Before I conclude, I would like to address a couple of topics which may be on the minds of our shareholders. The first topic is the outlook for our 2013 review of actuarial methods and assumptions.

We will be completing our annual review of actuarial methods and assumptions in the third quarter of 2013. The scope of this year's review covers more than 150 methods and assumptions and includes morbidity, mortality, lapse and premium assumptions on long-term care; premium persistency on US universal life; lapse assumptions on certain blocks of business; annuitant mortality for some Canadian products; the modeling of ceded reinsurance and Guaranteed Investment Accounts in Canada; as well as the annual review of investment return assumptions.

While it is still early in the process, we expect that the third-quarter review of actuarial assumptions will result in a charge that is lower than in each of the last four years. We also expect a number of positive one-time items in the second half of the year. The net impact of all of these items, including the actuarial assumption review, is difficult to estimate with precision since the work is still ongoing, but our preliminary analysis suggests it will not be substantial in either direction.

The second topic I will address is an update on our 2016 objectives. As we set out in our press release, we continue to believe that our 2016 financial objectives, while bold, are achievable. The main growth drivers are expected to come from earnings growth in our wealth and insurance businesses, as well as a smaller contribution from our E&E initiative. Let me elaborate.

Firstly, core earnings from our wealth management business is expected to benefit as we have developed a scalable platform which we expect will result in improvements in the bottom line through operating efficiencies in our mutual fund businesses. Earnings are also expected to benefit from higher fee income fueled by net flows, and we expect to realize benefits from the run-off of deferred acquisition costs on our legacy variable annuity business.

We have already seen evidence of strong wealth sales in each of our divisions in 2013.

Secondly, our insurance business is expected to benefit from the growth of expected profit on in-force due to the higher release of margins as business matures, new business added to in-force, and reduced strain due to pricing actions. While our insurance sales in the first six months of 2013 did not match the strong results of last year, in part due to price increases, we have significantly improved our margins and continue to develop and launch new and innovative products. In addition, the new business embedded value that we have generated on our insurance businesses continued to increase and in the second quarter was CAD177 million, reflecting an improved business mix and our pricing actions.

Thirdly, our efficiency and effectiveness initiative, while important, is not the predominant driver to achieving our 2016 objectives. Since starting the initiative, we have identified and size over 200 E&E-related projects and have prioritized a number of quick wins for 2013, including projects related to operations, information services, procurement, workplace transformation, as well as organizational design. We are pleased with our progress and have already achieved approximately CAD175 million in pretax annual run rate savings to date.

However, we do not expect a material bottom-line impact in 2013 as we continue to make investments in this initiative, but we should see a meaningful net benefit in 2014 and further benefits in 2015 and beyond when the full-year impacts of our improvements are realized. In summary, our record wealth management sales, solid insurance sales with an improved business mix, and a strong start to our E&E initiative lead us to believe that our 2016 objectives, while bold, are achievable.

To summarize, in the second quarter of 2013, Manulife made substantive progress on its growth strategies, generated solid core earnings, achieved record wealth sales and funds under management, reduced run rate hedging costs, and further strengthened its capital ratio.

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

(Operator Instructions) Joanne Smith, Scotia Capital.

Good afternoon. I just have a question on the E&E initiatives and the CAD175 million in pretax savings that you've seen on a run rate basis. Steve, I was just wondering if you could kind of bring us through how much of that should drop to the bottom line, or if you could just kind of give us some type of a roadmap in terms of where we are going with this initiative, what the ultimate savings should be, and when we are supposed to start recognizing them or seeing them on the bottom line. Thanks.

Yes, thanks, Joanne, thanks for the question. We haven't given guidance on the total savings we expect to get out of this initiative, but we are pleased that we are able to give this update and particularly declare victory on approximately CAD175 million of gross savings. The way this is working is that some of these projects are prioritized ahead of others and so, whilst we generate savings on some projects, we will be investing into other projects.

So next year what we should have is the full annual impact of certain projects dropping through, but at the same time we would be investing in other projects. So I think what I have said previously, and it's consistent with the message I'm trying to give today, is that in 2014 the bottom line impact on the financials I think will be meaningful, whereas in 2015 and beyond it will be more substantial.

I think next -- I wouldn't be looking to see much on the bottom line in 2013. I think probably for 2014, based on the fact that the CAD175 million is pretax, it's probably not unreasonable to think of something in the region of CAD100 million for 2014 based on our plans. But there's a lot of work to be done.

Thank you very much, Steve.

Tom MacKinnon, BMO Capital Markets.

Thanks very much. Two questions here. One is on the actuarial assumption review. I think you talk about the charges will be lower than each of the last four years and that you're going to have some offsets from some positive one-time items in the second half.

What are the positive one-time items that will offset? And where are -- and in what areas are you thinking that you might have to take an actuarial assumption charge?

Thanks, Tom. Thanks for the question. I think we've tried to give some guidance on the prepared remarks in terms of the areas that we are focused on and it's too early to be specific about where we may take charges. I think long-term care has been long talked about and the review there is obviously very complex, but I think it's premature to say where we expect to take charges. We still have a range of outcomes if you look at the totality of the areas that Cindy and her team are looking at.

In reference to the offsets and the other items that we are referring to, a couple that I would highlight here. First of all, we are expecting in Q3 that we will be redeploying certain assets with attractive yields away from surplus and that's part of our liquidity management process, but we are expecting we will get gains associated with that.

At the same time, we have referred to the sale of Taiwan and there will be some gain in relation to the sale of Taiwan, which will be welcome, but is not sufficiently material that I have to disclose it in this quarter's release. So those two I would certainly flag up and there are one or two other bits and pieces going on, but those are the two I would concentrate on, Tom.

Now if I look at each of the reserve basis changes over the last four years, some are related to the macro environment and some are related to policyholder experience or expenses. Should we look at these things -- when you say they are going to be lower than they were in each of the last four years, are they -- should we look at them in terms of what they were in total or what they were just for policyholder-related or --?

You've significantly reduced a lot of the, I don't know, maybe some of the volatility associated with the macro environment, but I'm not really sure if that ends up showing up in terms of your reserve review. Is there any way you can focus to say that this would be policyholder-related and not necessarily related to things like any other kind of investment return assumption related or anything like that?

Tom, I would like to be helpful but I think we are looking at a large number of assumptions and processes and there are a lot of moving parts. The work is ongoing and I really find it difficult to be much more precise.

The guidance that we have tried to give is that the aggregate number we believe will be less than in any of the last four years, any of each of the last four years. In other words, you don't need to aggregate the last four years or take an average. It's less than any of the last four years.

Okay. Then a follow-up on the lapse. I think in the release you do -- you mentioned that the unfavorable lapse experienced in the second quarter, a large portion of that was due to specific events that are not expected to recur in future quarters. Can you elaborate on that? And does that suggest that we would not anticipate reserve strengthening associated with lapse?

Yes, there were one or two lapse issues in the quarter. One of them would be in Japan. We did have some lapsation on foreign fixed annuity products, primarily Australian dollar. That was in response to what happened to the Japanese yen/Aussie dollar exchange rate and Australian interest rates.

Basically that involves a switch into a yen product and we assume lapsation at that stage. So we wouldn't expect that to recur.

We had one other group case lapse, if I recall correctly. Those have been the main items.

So we wouldn't anticipate that the adverse experience you are seeing there is going to drive any kind of change in assumption then, right? So it's going to be unfavorable?

I will just ask Cindy if she wants to elaborate on that, Tom.

Tom, what I would say is that the estimates that we have given you in terms of less than each of the last four years basis changes would include any changes to any lapse assumptions as well.

Okay, thanks.

And to be clear, Tom, when Steve and Cindy have referred to basis changes less than URRs, I think a lot of you think it was a basis change. They are talking about basis changes excluding the URR, so less than the more behavior-related basis changes.

Okay, thank you.

Steve Theriault, Bank of America Merrill Lynch.

Thanks very much. Just first a couple quick follow-ups. Steve, you mentioned CAD100 million for 2014 as your maybe best guess at this point for on the expense side. Was that after tax?

Yes, that is after tax.

Thank you. You mentioned -- I just want to make sure I have this straight. You mentioned earlier that post quarter you added CAD5 billion of dynamic hedges. Was I correct in hearing that that would reduce the expected hedging costs by about another CAD10 million per quarter?

Well, yes, but the point to emphasize I think is that the reduction in hedging costs is really coming from the fact that markets are improving and, therefore, we can take hedges off to maintain our position in our target range. So it's not so much the switch from macro to dynamic that reduces the cost, it's more about the fact that as markets improve we can take hedges off.

And so there will be -- you can map that to a reduction in the macro hedges as well?

That's correct. So this quarter, if you see the benefit coming through on the expected cost of macro hedges, that's because we have been able to reduce the level of notionals that we are holding.

And so what I wanted to ask was -- again staying with you, Steve -- last quarter you stated that the very strong wealth sales didn't bring about as much strain as we should typically expect. So how did that track in Q2 in the context of another record quarter for wealth sales again in Q2? Would you change your mind at all on that front or how was the mix this quarter?

No, I think -- we try and give guidance on strain and there are many moving parts on strain. I think we think that in aggregate the kind of run rate that we are showing at the moment to strain and totality is reasonable assumption into the future for now. I wouldn't change that.

Okay, thanks very much.

Mario Mendonca, Canaccord Genuity.

Good afternoon. Quick question either for Steve or Cindy. In total, could you quantify what policyholder experience gains or losses, I suspect losses this quarter, were? Just policyholder-related, nothing to do with the macro environment.

I'm going to see if Cindy has that data point for you, Mario.

Yes, it would be around probably around CAD30 million, CAD25 million to CAD30 million.

Okay. And were there any really large ones there, like lapse, for example, offset by positive mortality? Was anything like that that you can point me to?

As we said, Mario, in our press release and MD&A, policyholder lapsation was negative this quarter offset partly by claims gains.

Okay. What I'm trying to get at is just an order of magnitude. Or can you give some flavor as to how big the positives and negatives were?

Not particularly, no.

Okay. Follow-up -- then a different question here. I'm not sure I understand -- on page two of your press release you refer to -- you say we are in the process of updating the annual update of investment return assumptions for our third-quarter review and assumptions which may largely offset these charges. That kind of confuses me a little bit.

Why would -- like if you are reviewing your -- you are updating your investment assumptions, why would that offset charges that happened in Q2? And that's my (multiple speakers) it sounds like you're saying you're going to offset Q2 charges, so that confused me.

Let me try and help with that one, Mario. This is -- we basically have a bit of an accounting mismatch here. If you look at the way we account for the unhedged variable annuity block, we are basically recognizing the change in the account value on a quarterly basis. So this quarter, as interest rates have increased, the value of the assets in certain of the funds, the balanced and bond portfolios, has decreased. And that half of the equation, we take that bad news, if you like, in this quarter.

On the other hand, at the same time as interest rates increase, we would expect our investment returns to improve, but the review of the investment returns is an annual event and part of our basis change review. So from an accounting point of view we have a mismatch. We would expect as part of the basis change review that we would probably be revising those investment return assumptions upwards in Q3.

So I do have it in mind that we will look at this and see if we might change our approach to this once we've got the Q3 basis change out of the way, although it's not entirely straightforward to do that.

And is the message you are sending that that change in assumption would be about the CAD100 million charge you took this quarter?

Yes, absolutely.

Thank you.

Robert Sedran, CIBC.

Good afternoon. I would like to ask a question about individual insurance sales in Canada. I believe -- unless I'm mistaken, I believe you are now in a positive strain position on those sales but negative sales performance year on year.

Donald, I think you mentioned that competitors didn't match the most recent price increase, and if the environment is indeed improving, maybe they just won't match that. So can you talk a little bit about what that does to your distribution channels, the competitive environment generally? Are you comfortable that such a discrepancy in pricing can persist over time? And are you comfortable ceding market share to protect the profitability of new sales?

It's a good question. We're watching it very closely. I guess there's two things. We don't manage the book and positive strain is only one aspect of the characteristic. The other is how much risk you are taking on the downside if rates were to drop again.

Rates right now look like they are trending up, but that's probably anything but a permanent phenomenon. We in the industry have suffered a great deal when rates fell below the pricing rate. In other parts of the world -- Taiwan, Japan -- it has put companies out of business, that very phenomenon. So there's an issue of how much strain that is possibly thrown up and it's also how much risk you take.

We are pretty comfortable with our position and as we mentioned in the opening, our sales are actually coming back pretty well. On the other hand, we are going to watch it very carefully. I guess none of us in the industry are returning outstanding returns just yet for our shareholders, and I would like to think that people are like-minded in sort of looking after the shareholders as well as the policyholders. That's the posture we are taking.

There has been a number of price increases over the past few years and it seems like pricing power was pretty strong. Does it feel like the most recent price increase maybe was not a bridge too far but maybe it's finally starting to have an impact on demand?

Yes, I think that is true. As you are observing and others, the industry sales have slowed down a bit, but that's not unusual when you have rapid adjustments like what we have had. We have seen a similar phenomenon in the United States where we sort of led the industry in price increases. It wasn't easy doing that and the market is actually getting quite a bit more hospitable now. So sometimes being a leader is not always a lot of fun.

Thank you.

Gabriel Dechaine, Credit Suisse.

Good afternoon. Just quickly on the macro hedge cost reduction, I believe when you initially implemented that program you were planning on having CAD5 billion of notional shorted or thereabouts. Are we heading back in that direction? Meaning are we potentially going to see even more of an earnings uplift from this reduction? Then I've got a follow-up.

The point is we've achieved our hedging target and we want to stay in the range. So now, whereas previously it has been a question of buying and holding and adding to our hedges as and when conditions allow us to do that, we now have to manage our position to stay in our chosen range. And as markets have improved that means that the cost of doing that is going to reduce for us.

The long-term care, I just wanted to -- like some of your US regulatory filings have some interesting information showing the actual claims to expect the claims costs. And it looks like it has been trending down since 2009, but you had a pickup in 2012. Just wondering how 2013 is shaping up and how we should see those filings.

Are they indicative of stuff you have already reflected in your big LTC review in 2010, or is there persistent issue here as far as the true-ups every year for LTC?

Gabriel, it's Cindy. The statutory filings in the US give a partial view on our LTC business; may not give the entire picture. We would have taken into account in our 2010 LTC review all of our experience up until the end of 2009. Then in this year's assumption review we will be updating our experience, our assumptions for experience up to 2012.

Okay. So is there any indication of how 2013 is shaping up relative to the prior few years?

Our experience has been quite consistent on LTC since we did the last assumption review.

Just, Steve, to throw another one in here. E&E, the CAD175 million you say you have achieved so far, I read into that that there's more to go. Is it a material amount, if so, of additional efficiency gains we can expect from Manulife?

Yes, sure. I think we have said out at the start that this was a multiyear project and we are only really about a year in right now, so there's still a long way to go.

We have been focusing on some of the quick wins we can achieve. Some of the other wins it may take a little bit more time to get out and need a bit more investment and just time to extract. So this will go on for some time and there is still some way to go for sure.

Thank you.

John Aiken, Barclays.

Good afternoon, Steve. When you talked about the hedging program, you mentioned that you reduced Japanese yen exposure. If I remember correctly, Manulife had just been hedging on the balance sheet exposure. Does this mean that you are actually now starting to hedge the earnings stream coming out of Japan?

No, we are not. We still maintain our policy of not managing or hedging the earnings translation risk.

Okay, thank you. Donald, in terms of the regulatory capital ratio moving up reasonably strongly, as well as the impact from the sale of the business, what is the outlook now for Manulife making acquisitions? And I know you don't talk about deals specifically, but can you talk to the attractiveness of the two major markets in Asia that you are really got in, namely India and Korea?

Yes, maybe got a little specific. I will try and take it high level. We haven't really felt constrained by the capital or access to capital in our acquisitions. I guess the biggest constraint is can you find deals that make economic sense?

I'm also not driven -- I think you know this -- I'm not driven by any it's got to be accretive in year two or three, any specific number like that. But you've got to feel that if you're laying it out with cash that it's a good return over the period considering synergies and everything else.

It's no surprise that there's a lot of interest in Asia and properties are getting bid up to fairly high levels. We always like -- we have the benefit of very strong organic growth and very strong franchises, generally speaking. I'm proud to say that we have not had to do any significant acquisitions in order to fill a hole that we perceive, so therefore we can be opportunistic and do them with a very strong sense of shareholder value.

You mentioned two places where opportunities were to emerge. I guess I will talk a little bit about India. I guess our attitude towards India is we want to be welcomed in any place that we do business and that the restrictions around the 26% ownership position, unless there was a clear line of sight to something different, is a very significant detractor.

As you know and others know, that is being debated right now in India and we might see some changes. I guess I would feel way more comfortable if we were to consider India to do so with a law that allows us to have more like a 50/50 ownership position. That doesn't imply if the law changes that we would go in.

Again, there's a whole series of other things that would have to be clearly in the shareholders' interest. Market conditions would have to be right on a whole number of other things beyond the ownership. But while the ownership restriction is stuck at 26%, I find it hard getting really, really excited about doing something in India.

And Korea, opportunities do emerge from time to time in Korea. We watch that market very closely. There's aspect about the market that concern us; there's aspect about the market that attract us. If we were to do anything in any market, it has to meet the test of financial sobriety that is it makes sense for the shareholders and is not driven by ego or flag planting. It has to be driven by real economic returns to shareholders.

Great. Thanks, Donald. That was actually more specifics than I was anticipating.

Happy to deliver more than you expected.

Peter Routledge, National Bank Financial.

Thanks. Turning back to slide 36, a follow-up on the hedging questions. Two years from today, if we assume basically your long-term annual return assumptions are correct -- I know it will be more volatile than that, but assuming that they are largely correct -- can you give us a range of how much smaller the macro hedge would likely be?

I think we don't feel comfortable to put a number on that one, Peter, at this stage.

Okay, but it will be materially smaller? That's not an invalid assumption [or anything]?

Correct. Depends on what you mean by material. Just seeing if Rahim wants to add something to that.

I think we would definitely expect our macro hedges to be smaller and our hedging book to be smaller, but I think our products are complicated and so we don't really give guidance around them.

Fair enough.

We have learned, Peter -- I think the hesitancy is the volatility, for instance, in the Japanese market experienced in the quarter alone creates gigantic changes in our hedging position. I think the general thrust of what you are getting at, though, is are hedging costs likely to be lower in 2016 than we would've predicted a few years ago. The answer is absolutely yes.

Then just in the US insurance business, just a technical question. A bit of a drop quarter over quarter in expected profit but impact of new business was strongly positive. Give us a little bit of background on what might be driving that and I guess the underlying question is that a new normal for that business?

Peter, is your question about the new business strain?

Well, it's both. Expected profit I noticed was down on a US dollar basis quarter over quarter quite considerably and then strain is strongly positive for a second consecutive quarter. I just wanted to know how sustainable those results are.

This is Cindy. On the earnings on in-force, we do see some noise in earnings on in-force each quarter, so I wouldn't say that necessarily this quarter is the new normal. It's probably somewhere in between. Q1 does tend to be a bit higher than -- for the US insurance business on earnings on in-force than the other three quarters, so that's how I would characterize it.

I would say in general the US life insurance in-force is pretty stable, so I wouldn't -- it will bounce around a little bit, but it's not in a secular decline or anything like that.

And the gains on new business? They are positive; you get a positive contribution in US insurance from the impact of new business?

Yes, and I think that's really -- we have done a lot of actions to improve the profitability of our business. I think we are largely at the limit of what we would expect to achieve in that area, but we do think that that is sustainable as long as we maintain the current product mix that we are selling.

So that level of contribution is bankable?

Bankable? Well, that's (multiple speakers).

I mean assuming that the market doesn't fall off and interest rates fall back down, yes. Okay.

That depends. Again, the answer is the same as when strain was a negative number. We priced the product -- we can change them month-to-month. We priced them for a long-term rate.

If interest rates end up being, in the first year, lower than what we expected, which was the more recent history, you would take strain at issue and it's a negative number. And as we have reminded people before though, it's not a total loss because in subsequent years the strain is -- sorry, the income is exactly what you would've expected at the time we priced the product, give or take a very small amount.

The same thing occurs if rates suddenly go up and you have priced it for a lower rate environment; they go up. You tend to take that up front in the accounting model that we have. Again, the second and third and fourth year numbers are pretty much as they were priced for. So the adjustment mechanism takes place at time zero, at point of issue.

So the biggest determinant of whether that is repeatable is really two things -- what rates are doing at the time the products are sold and the second one being how much we are selling. We feel pretty confident about the second one. The first one we can't predict with any certainty at all.

Fair enough, thanks.

Doug Young, TD Securities.

Thanks, good afternoon. Just on the E&E initiative, Steve, how much of that, your CAD175 million, is related to lower unit costs and is built into your reserves? What I'm trying to get at is -- and at what point -- I guess where I'm trying to go with this, at what point in time do you have to reflect that lower unit cost expectation into your reserves?

I'm going to guess you have to wait until you think it's sustainable and I'm going to assume that would be done as part of your Q3 assumption review. But I'm just trying to gauge at what point in time you could have a reserve release related to this item.

I think, Doug, we are focused on getting the run rate savings out and we haven't -- it's pretty dynamic and fluid situation. There's a long way to go and I don't think that is -- we would be looking to refine at that level of granularity yet. I don't know if Cindy wants to add to that.

No, I agree with you, Steve.

So this isn't something that's going to happen in the next few years in your Q3 annual review essentially?

No, you should not -- I think I know where you are going. You should not take that number and then capitalize it and assume that there will be a positive basis change associated with it.

Remember we have made huge shifts in our product mix. Some products we've taken and reduced the sales of them by very nearly 100% in some very significant lines. Other lines are growing and, of course, the unit costs are moving all over the place. When you cut sales of a product by 100% your unit costs kind of go right through the roof because you're still stuck with certain legacy costs that you can't get rid of. In other areas our unit costs are going down enormously.

So there is a whole bunch of different mix changes and volume changes occurring. I will take you right back to your management accounting days of standard cost; you've got volume, mix, and efficiency variances all occurring simultaneously. We will have to stabilize that and see where we sit. At this stage you can't predict whether it would be a release or charge.

Okay. Just in Asia just noted Other Asia was off meaningfully in terms of earnings year over year. I'm just wondering if there's a certain region, if there was something in particular that occurred in the quarter that you can kind of detail.

Just a second. We're just pulling up the data point on that one, Doug. I think what it was was it was high margin on cancer sales in 2012, so we had a high benchmark from last year. I think that was the main reason.

Other Asia, I'm sorry, Other Asia. Just a second to see if anyone else can answer that one.

I can follow-up if --.

I think we are sort of the bit in the weeds there. Can we get back to you offline on that one?

That's fine. Then just lastly hedging volatility. It sounds like you are hedging volatility on the equity side now. Is that meaning you are putting on put options and what does that do to your hedging costs?

Yes, we have started putting on some options. I don't know if Rahim just wants to give you a little bit of color on that.

We have started using options to hedge our book and I think what we would expect is more stable hedging costs into the future and higher efficiencies, but I wouldn't expect this to have a material impact in our sort of core earnings going forward. It would be more a stabilization of our earnings.

So volatility has come down where the puts become far more economic for us and we can put them up. In other words, hedge more Greeks at not significantly greater cost, which is a very positive outcome, as you readily appreciate.

Great, thank you.

Darko Mihelic, Cormark Securities.

Thank you, I have a couple of questions. The first question, Donald, you mentioned in your remarks the net income to shareholders CAD259 million, I guess, or CAD227 million after dividends. I guess not as good as you would've liked.

If I add back the CAD291 million of charges, and let's just for argument's sake call that CAD550 million; it still seems somewhat short of what I would have thought you could have earned given all the good stuff that's happened in Q2 relative to Q1. In Q1 you had CAD540 million. So a CAD10 million rise quarter over quarter doesn't seem like a lot to me, again, given all the positive movements in equity markets and interest rates.

Then I draw your attention to the slide -- I guess it's the slide, sorry -- with your sensitivities in slide 32, and your interest rate sensitivity is far below the 2014 goal. Your equity market sensitivity is well ahead of where you wanted to be.

I guess my question is, have we gone too far in the hedging? And are we now in a situation where almost anything can happen with markets, and we won't see a positive outcome?

Yes, just want to, for the people on the call, it's Darko Mihelic. That's a "ch" at the end of the last name. Actually, your two questions sort of concantenate into the same answer, and that is it's a disappointment. You guys spend a lot of time doing modeling, and some of the things that occurred this quarter would be unable to model it. They are clearly a disappointment.

So I guess at the end of the day, I don't care whether people like me or dislike me. I want people to trust me. And if it's a disappointment to us, it's a disappointment to you and we want to be honest about that. So it is a disappoint.

I think your analysis is exactly right. If you add back for those factors you get a number closer to core and -- which is again why we responded to requests from the Street and from investors to have a core earnings measure. It gives you a better indication of the earnings capacity.

The third aspect of your question, which is it feels in many ways like a better quarter, I would agree with you 100%. The underlying dynamics of the business, as we have indicated, are very positive. Some of those, as Steve has indicated, don't show up until subsequent quarters. The fact that URR is dropping and a whole bunch of other things; we need less hedges in place in order to manage our outcomes, a narrower fan of outcomes as we promised investors.

Your comment specifically as it relates to interest rate sensitivity; we have said this one before that the interest rate sensitivity depicted by the in-quarter sensitivity to interest rates is only a part of the factor. There's a whole bunch of things that change in a very positive way. And while this is an accurate depiction as best as we can calculate it of what will happen with the next quarter's earnings for a move in interest rates, it is not a depiction of the economic exposure of this enterprise to interest rate movements.

That is difficult to quantify because it depends on what you include and what time period and so on, but I give you my assurance, 100% assurance that our sensitivity is far greater, economic sensitivity, than what is depicted by what happens in the next quarter, which is all that is depicted here. While we have dramatically reduced the interest sensitivity of our company, we have not reduced it entirely, and in my humble opinion, haven't gone too far in reducing it.

Of course, if interest rates go up to 6.5%, I think a lot of people will say, well, you shouldn't have put those hedges on. But if they were to drop again because something untoward happens in Asia or in Europe, the answer will be we put on insufficient number of hedges. But we have considerable positive exposure to upward interest rates left and it is not depicted by this -- by what happens in the next quarter.

Okay, fair enough. I appreciate that. It's just a difficult thing to work on this side of the Street with the limited tools we have.

I guess a follow-up question, Donald, is with respect to the MCCSR now creeping up, could you order for us in the order of importance -- is the next move more likely to be more deleveraging of the balance sheet with any, quote-unquote, excess capital? Are you happy with the level of leverage that you have? And if -- and maybe you can outline where you'd like to take that to.

Then the follow-up question to that is at what stage or what would it take for a dividend increase to occur? Again, I apologize for asking this because I know you were asked this last quarter. But, again, if we look at just core and look at the payout ratio on core, would that be something that you would consider raising the dividend based on core after you've reached a certain leverage goal?

Darko, I got to be straight with you, I much prefer questions about when are you going to raise the dividend to questions we used to get, which is do you think you're going to have to do a down round equity financing.

Okay, fair enough.

It's much more pleasant getting the former question.

Our order of priority is before we would contemplate raising the dividend -- I suspect both of your questions go at that core thing -- we would have to see earnings grow. They would have to stabilize and we would have to be comfortable with our leverage ratio and obviously comfortable with the overall level of capital.

At [222%] we feel very comfortable, but I will be clear that our regulator here in Canada is a conservative one. I think they increasingly look at the top three companies in Canada as whether we are global SIFIs. They sort of treat them as they've got to act as if they were global SIFIs, which means capital not only to withstand the unthinkable crises, economic crises, and have enough to pay the policyholder at the end of the day, but basically be able to continue to operate and be -- function pretty much as normal, even after the unthinkable occurs. And that is a very high standard.

That is, as you will recognize, the standard that's applied to the largest banks in the world as a result of the FSB's work. I think that is more and more the way our regulator looks at it, so the definition of how much capital is enough is changing all the time.

You know, you have identified the deleveraging and we have too. We carry a little bit more leverage than we would like to have. We would like to bring that down over time, so before I could contemplate recommending to our Board any dividend increase three things have to occur.

Number one, earnings would have to grow and stabilize. They're going in the right direction. I'm very comfortable that that will occur within a reasonable period of time.

That we will have deleveraged somewhat. That is a commitment that we have made and want to complete. And then we would have to convince our regulator that we have sufficient hedges in place. After all, we've got something like 85% of our VA risk and, I don't know, a similar portion of our interest risk hedged now, plus a very high capital ratio.

I sleep really easy at night, but, of course, they are refining their standards all the time. And we would have to satisfy them that we are in a very comfortable position.

Thanks very much for the answers, Don. I appreciate it.

Operator, it's Steve here. Just before we go to the next question, we managed to find the answer to Doug's question on Other Asia. It was actually -- we've dug out the data point here and it was actually due to the US dollar and NT dollar exchange rate. So in Taiwan we actually have some US dollar assets backing the PfADs on some of the Taiwanese business and that appears to be the main constituent of the point you highlighted, Doug.

So I think we can go to the next question, operator. Thank you.

Ohad Lederer, Veritas.

Thank you, good afternoon. I just want to go back to the CAD100 million charge related to the higher interest rates and non-dynamically hedged variable annuity business. In response to Mario's question, Steve, you noted that the higher rates caused the balanced and bond funds to decline in value.

Just for clarity, we are talking client money in seg funds, not Manulife's general fund assets backing reserves, is that correct?

Yes, that's correct.

So out of Manulife's total CAD104 billion of notional subject to seg fund guarantees, how much is in bond funds and related to fixed income? Has there been a -- clearly in the retail asset management world, there has been a big shift, big customer preference for fixed income over the last 24 months. Has there been a big shift within Manulife? I know your book hasn't changed in size, but within your CAD100 billion or so portfolio has there been a big shift?

I'm going to direct that towards Rahim Hirji, Chief Risk Officer.

In general, about 40% of our seg fund assets are in bond funds and that hasn't really changed over the last two to three years. We tracked this fairly well and closely as part of our hedging book. It doesn't really move by more than 0.5%.

So this quarter the commentary is that there's a timing mismatch and some or most, or perhaps even all, of the CAD100 million charge is going to come back in the third quarter as part of the annual review? Could there be instances where a backup in rates is -- where you can't get it back? Are there guarantees on I guess bond funds at what may prove to be peak prices?

I think Cindy is going to answer your related question on reserves.

Right. So the timing difference we are talking about is the difference between how frequently we update the interest -- the mean interest assumption in our determination of policyholder reserves on these products. We typically update that interest assumption an annual basis, so there is just a timing difference, so we would expect to get back the CAD100 million.

Okay. So in general, whatever you give up on the -- whatever the amount the reserves need to go up on you think you will be able to get back on investment return assumptions, whether it's one quarter later or three quarters later?

Right, so that's correct. We would expect the reserves to change by an offsetting amount in the next quarter when we do our basis change to recover the CAD100 million.

Thank you.

Tom MacKinnon, BMO Capital Markets.

Thanks, I wanted to follow on that. When you give a sensitivity of changes in earnings to 100 basis point moves in interest rates do you take into account the fact that seg funds are in bond funds? Is that reflected in that sensitivity? Because it certainly is -- when you talk about changes in equity markets, we certainly are taking in changes in reserves for VA guarantees associated with equity funds.

When we do the interest rate sensitivity are you taking into account the changes in any of the guarantees and any of this discount rate change on those reserve guarantees for bond funds?

Tom, it's Cindy. We have not taken into account the sensitivity of the bond funds. It's because you are only seeing this sensitivity because of the timing difference between when we are updating our liability assumptions and when we are reflecting the change in the market value of the underlying funds. So we would always expect to come back to a neutral position and it's just timing, so we haven't reflected it in the sensitivity.

So the one is the change in the net amount at risk and the other is the change in the discount rate you use for that net amount at risk?

It's not a change in the discount rate, it's a change in the expected future return on the bond funds. It would be like if you held a bond and you have already bought a bond when yields were 3% and then they went up to 3.5% and you intended to hold it to maturity you would still have the same returns.

So it's really just to -- the future returns on the bond fund, the market value of the bond goes down but the future expected return on the bond fund moves to the current market return. So they offset each other for liabilities that are sufficiently long in duration.

Okay. Well, I guess that makes sense. I would assume you would have just done that in tandem to avoid the noise.

(multiple speakers) We are going to take a look at that. You raised a good point. It's accounting noise and we would rather have less accounting noise. So we will take a look at it.

It's a bit like you bought a bond and the start -- to me, my simple mind, you bought a bond at the start of the year and it's going to accrete to 100 at the end of the year. Interest rate move; you take a loss in the first quarter because -- but then it creeps up to the value so you get a higher return in the subsequent three quarters. Net-net you get exactly what you bargained for but you have had some very odd in-period movements.

Understood, thanks.

Gabriel Dechaine, Credit Suisse.

Okay, just a clarification on the lapse. You mentioned that was Group insurance and something in Japan. Is nothing there -- the negative lapse experience from VA in the US or UL in the US or UL in Canada?

I'm sorry, I think it was COLI in Japan and the other lapse was a form of fixed annuities in Japan, but I think Craig is going to answer that one.

This is Craig Bromley. There was a large COLI case that lapsed in the quarter and that is -- was a big cause of the core lapse experience. That happens from time to time. COLI is a bit volatile. We've experienced lapse gains on that in the past as well.

(multiple speakers) In the United States. Sorry, I think I said Japan in error.

Okay. I just want to make sure it was not the things that I was asking about. So it's not VA, not UL?

No.

Perfect, thanks.

Joanne Smith, Scotia Capital.

I just had a follow-up on the interest rate sensitivity question, the non-disclosed impacts from a rise in interest rates. If I look at the required capital in the MCCSR calculation, the interest rate risk required capital, I would expect that over time, if rates continue to go up, that that would come down and that some of that capital to be released.

As well, the last rate in Japan as a result of the strong equity markets and the way that I understood how some of that triggers automatic lapses on certain VA policies. As those policies lapse, I would expect that the capital backing those guarantees would also be released. So how should we think about a gradual rise in interest rates over the next two years and what that means to your capital levels? And any other type of undisclosed impacts from interest rates going up? Thanks.

Joanne, your question is a good one. Rise in interest rates, as you have suggested, is very positive in a whole number of ways. The trouble we have -- I guess I'm having a little trouble with that term undisclosed. All we can do -- all we think we can do humanly possible is tell you what can occur in the next quarter and even that is difficult enough.

I guess I was just saying non-quantified, Don.

Non-quantified, that is -- I know where you're getting at and I take no offense. It's just it will appear over a period of time and we can't predict, depending on what the impact is and how the curve goes and so on, what quarter it shows up in is going to be next to impossible to predict. For us to give you.

And I think you know this, that the economic impact is very, very beneficial. It reduces capital; it reduces required reserves indicative of a more robust economy. So the top line is growing. A whole bunch of positive things happen that this company will be benefiting from in innumerable ways, but all we can really quantify with any rigor is sort of the next quarter's impact and even that is an imperfect science.

I guess the question that I get most often is when you will be able to take down some of the required capital or the reserves. Obviously, we are not looking at the next quarter or even the next two quarters, but if trends continue going in the right direction we are looking at a situation where maybe a year from now we are looking at a much different risk charge related to interest rates. Would that be a safe assumption to make?

Joanne, you're right. One of the things that Cindy does when she does her annual dynamic capital adequacy testing is she tests for various scenarios -- deflation scenarios, inflation scenarios. Sort of the one that some of you on the end of the phone might imagine is highly likely is, with the turnaround in the US economy, is inflation coming back and higher rates and so on.

Without getting too specific, when we look at those over a large number of years they end up producing levels of capital that are to describe them as comfortable would be an understatement of the year. I won't tell you what kind of handle they have on them, but these are big levels of capital sufficiency. If it leads you to the conclusion that there's a lot of pro-cyclicality in the capital calculations, you would be drawing the correct assumption.

So our balance sheet is bolstered for really, really tough conditions. And if conditions turn out to be not anywhere near that tough, and in fact, quite robust, we are going to have some very happy choices about what to do with excess capital.

Great. Thanks very much, Donald.

Michael Goldberg, Desjardins Securities.

I have a couple of questions. First one, and maybe this is a curiosity, but to have that CAD80 million loss in the quarter just as a result of the parking of cash, must have been a lot of cash that got parked. Could you give us some idea of how much that was and what gave rise to it?

It's Warren Thomson here. We actually had just over CAD500 million in Canada that was parked in long treasuries. We had over CAD850 million in cash flows in the quarter. We got about CAD350 million invested as we would expect and CAD500 million was just temporarily parked in treasuries. And we would anticipate we would invest that over the course of Q3 and Q4.

So where would that have come from and why wouldn't it have been deployed sooner?

It actually comes from reserve adjustments that occurred in the quarter and it basically -- it was just basically cash flows in excess of what we anticipated. So actually in the ordinary course we would have anticipated cash flows in Canada, let's say, in the CAD300 million to CAD400 million range and we had an incremental amount to invest that was greater than our normal run rate investing activity would cover.

So, Michael, in the normal course it would have been invested in the quarter. We don't force the people. We try and manage to the economics so they get it invested when they see the right opportunities. In the meantime, they park it in long treasuries sort of to lock in the yield.

There's this unanticipated inflow that wasn't invested, but unfortunately it makes some noise in the results. But you can guess they are getting it invested now and that's why we can say with some comfort that that reverses. We have had this before. We have had this very phenomenon. Sometimes we get ahead, sometimes we invest behind; this one it was behind.

So just to clarify, would the reversal of this, or the deployment of that cash and perhaps the reversal of that CAD80 million loss, would that be in addition to the other CAD100 million that you are talking about?

Yes, it would be, Michael.

Okay, and that could potentially happen sometime in the remainder of the year?

Yes. (multiple speakers)

My second question, if you took your asset management businesses together, are they profitable on a stand-alone basis? And if not, what level of funds under management would you need to breakeven?

They are profitable on a stand-alone basis. It's not as profitable as if we had been in the business 100 years because we are growing it at a very rapid rate. Those of you who witnessed the rate of growth here, that becomes the result of investments that we are making in the business.

So it's not as profitable as if it'd been around for a long time, because we are creating this business almost from nothing, but it is profitable. We see the day when we would expose that to you as a separate line of business and you could look at it in that way. We might be able to calculate EBITDA.

You might be able to put a multiple on it. You can do whatever you want with it, but we will, at the appropriate time, disclose that as a separate line of business.

Let's put it this way, what do you figure your earnings go up by for a CAD1 billion increase in funds under management?

I can't give you that right now, Michael, and I think one of the reasons for that is we have it in different segments, right? You've got the product manufacturing segment; you've got the asset management segment. So one of the things we want to do, and I'm talking very openly, we want to pull together all the financial reporting on this business so that we can see the totality on a single sheet. That's obviously a necessary thing for us to be able to depict it to you as a separate business line.

And you know, it is a global business, so it shows up in different P&L's all over the place. It depends on what the business is. If it's institutional business, we can give you a ready answer. It's pretty nearly what the fees are because it all flows to the bottom line, as you well know, because the costs are more or less fixed.

If it's sold through a wirehouse in the United States, it's a little bit more complicated because there's different elements that would influence the contribution margin.

But we are taking steps to improve the margins on this business by a bunch of appropriate measures to make sure we are spending in all the right places, as well as to grow the assets under management. We are making progress on both scores and I hope you will be impressed when we start to depict it at some point in the future as a separate business line.

Okay. And just one last question on this. What number would you use as the current funds under management for this business on an aggregate basis?

We have CAD260 billion in the Manulife Asset Management entity as assets under management, but that isn't full comprehensive because you also have assets that are in the wealth businesses where they would have it with other third-party managers. So the aggregate number would be probably closer to CAD400 million, taking what's within the liability businesses as well as the asset management business. It would be in the CAD300 billion to CAD400 billion range.

I'm really thinking of just the fee-generating assets under management.

That's what he's talking about. What Warren is explaining is that a portion is managed by Manulife Asset Management, but a portion is managed by other managers. As you might guess, the margin is not quite as high on that but we make product margins on it. That's the higher numbers towards the CAD400 billion -- CAD300 billion to CAD400 billion and it's CAD260 billion from what we manage ourselves for third parties.

And that is a combination of retail product; it's sold through mutual funds. Some of that is in variable annuities, which is more or less a run-off block, but not running off very quickly as you well know. And increasingly there's a whole bunch of institutional business that is being sold.

The nice thing about it is it's being -- our success is not just in one territory and it's not just in one product line. It's not just in equities or not just bonds. It's across bonds, fixed income, alternatives, and it's in all the geographies that we do business.

We've got some of our largest sales in Asia, for instance. You know the US mutual fund numbers are just staggering, and in Canada, both the group pension products, the mutual fund products, and other wealth products in institutional are also selling quite nicely. So it's starting to be a decent business.

So just again to clarify, CAD260 billion roughly under management for third parties, so CAD140 billion unfunds?

No, there is CAD260 billion would be what's within Manulife Asset Management, that's what we manage. Over and above that there is an incremental piece, which I don't have a crisp number on that, but it's more than CAD50 billion and it's less than CAD150 billion. So that's what -- it's in the CAD300 billion to CAD400 billion range if you aggregate it, the piece that is run with third parties.

Okay, great. Thank you.

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

Thank you, operator. We will be available for further questions after the call.

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