Sun Life Financial Inc (SLF) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Sun Life Financial second quarter 2004 earnings conference call. After the speaker’s presentation we will conduct a question and answer session. If anyone has any difficulties during the conference, please press star zero for operator assistance at time. I would like to remind everyone that this call is being recorded on Thursday, July 29, 2004, at 4:00 p.m. Eastern time.

I will now turn the conference over to Mr. Tom Reed, Vice President Investor Relations. Please go ahead, sir.

Thank you, operator and good afternoon everyone. I’d like to start by introducing the members of the management team present for today’s call. Hosting the call we have Don Stewart, Chief Executive Officer of Sun Life Financial; Jim Prieur, President and Chief Operating Officer of Sun Life Financial; and Paul Derksen, Executive Vice President and Chief Financial Officer. Also available to answer questions are Bob Astley, President Sun Life Financial Canada; Bob Salipante, President Sun Life Financial US; and Bob Pozen, Chairman of MFS.

The slides to which the speakers will be referring, are available on the Sun Life Financial website. Turning to slide two, I would draw your attention to the cautionary language regarding forward-looking statements, which form part of this afternoon’s remarks. This slide reviews the reasons why forward-looking statements could be rendered inaccurate by subsequent events.

And with that, I’ll now turn things over to Don.

Thank you, Tom, and good afternoon. Second quarter results reflect a solid performance for Sun Life Financial. Operating earnings of $438m and earnings per share of $0.73 are both records and reflect the benefits of a strong operational focus throughout the company.

Return on equity at 12% is up 170 basis points from the second quarter of 2003, as we continue to make steady progress in improving this financial metric.

In the United States, earnings in US dollars were up 82% from Q2 of 2003, with the annuities business reflecting the benefit of stronger equity markets and steadily improving fixed annuity spreads. In addition, the results in our US individual life business rebounded this quarter, in part due to the impact of implementing an enhancement to our interest rate risk management program.

Results in Canada also improved from Q2 of last year, despite a significant investment in the quarter in customer services enhancements in the group benefits business, with retail operations in Canada particularly strong in the quarter.

At MFS we experienced significant outflows over the quarter, as well lower fees, higher legal expenses and a higher cost of paying directly for third party research, have held the contribution of MFS at the same level as a year ago, despite the higher level of assets under management. The management team at MFS is very focused on taking the necessary steps to improve investment performance, a key factor in improving the sales performance across the complex.

We continue to be pleased by the progress shown in our Asian businesses. The sales in India, for example, tripled the level of the same quarter a year ago. Across the company credit concerns have receded significantly, with credit losses reduced to an unusually low $3m for the quarter, down from 38m a year ago.

Sun Life Financial continues to generate health amounts of capital and in the month of June we repurchased 1.6m shares. I’m also pleased to report that the Board of Directors has approved an increase in the dividend, from $0.21 to $0.22 per share. This represents the second increase in 2004, bringing the total increase this year to 29%, reflecting our commitment to re-deploy our growing capital base to enhance shareholder value.

Finally, as previously announced, Bob Astley will be retiring from Sun Life Financial before our next quarterly call. This gives me the chance to publicly acknowledge and recognize Bob’s fine leadership of the very large and highly successful Clarica Integration Project and to thank Bob for his many contributions. I know that Kevin Dougherty is ready to pick up the challenge and is extremely well qualified to move Sun Life Financial Canada forward from its strong base.

I’ll now hand over to Paul Derksen, our Chief Financial Officer. Paul?

Thank you, Don. As Don mentioned, we had very good earnings this quarter. Earnings per share were $0.73, up 22% relative to the $0.60 we earned in the second quarter of ’03 and up $0.02 from the first quarter. This is despite the fact that equity markets were down this quarter, with the daily average S&P 500 at 1,123, down 9 points from the first quarter. And despite the fact that MFS earnings were somewhat lower than expected. This is testimony to the strength that the protection business of Sun Life Financial.

On slide five you can see our positive earnings trend. Earnings are up 20% over last year. Similarly, return on equity has been increasing significantly. We have committed to a return on equity increase of 75 to 100 basis points per year. We have exceeded this target measurably, with an increase of 170 basis points, to 12% this quarter. That is despite the fact that return on equity was negatively affected by the movement of the currency, excluding which, return on equity would have increased to 12.2%.

On slide six then, turning to the business groups, Canada had a very good quarter with earnings at $230m, up 6% from a year ago, and up 18% year to date. Items driving the earnings increase includes the benefits of the Clarica integration, improved credit performance and increases in CI earnings. Group benefit earnings were lower than the first quarter, because morbidity was worse and [indecipherable] estimates were made to further enhance customer service. Group benefit earnings are expected to recover in the ensuing quarters.

On slide seven, retail sales were strong, with wealth management sales at $511m, up 31% from last year, down somewhat from the first quarter for seasonal reasons, in particular, the RSP season. Individual life and health sales were up 5% from a year ago, as the ICA channel continues to perform well.

Slide eight, defined contribution assets have grown significantly and are up 19% from a year ago. Earnings are up 23%, as GRS continues to be the number one provider of defined benefit contribution plans in Canada. This business continues to enjoy a significant competitive advantage in technology and customer service, and this quarter’s results are a testimony to that.

Slide nine, group life and health sales were up slightly from 2003, but down from the first quarter when we experienced exceptionally strong growth. Business in-force is up 6% from a year ago, which is an important driver of profitability.

On slide 10 then, turning to the United States, the US also had very strong earnings growth, up 82% compared to a year ago, when spread compression of fixed annuities had a negative impact. Return on equity almost doubled. The increase in earnings is primarily due to improved equity markets, higher interest rates and lower investment provisions and tax rates.

Earnings of all business groups were up significantly from last year, with individual life earnings benefiting from the implementation of an interest rate hedging program. Annuity earnings were negatively affected by reserve strengthening and some short term volatility in theGMDB hedge.

Slide 11, annuity sales were the same as last year, with net sales of $56m. Strong sales of the index annuity product offset reduced, fixed and variable annuity sales, reflecting customer preferences. Our product is now the third largest seller of index annuities in the industry.

Slide 12, group life and health had an excellent quarter. Sales were up 35% from last year’s level. Business in-force was up 13%, to $772m. US individual life sales were off somewhat. The main regions are the high net worth and offshore products, the sales of which are typically volatile. We do expect improvements in the third quarter.

Slide 13, MFS earnings were unchanged from last year, while the daily S&P 500 increased by 20%. Compared to the previous quarters, earnings were off $5m, as the average S&P dropped 9 points. This reductions in earnings is caused by lower assets under management, fee reductions and higher legal and compliance expenses. As a result, margins were off somewhat this quarter. We expect expenses and particularly legal costs, to gradually be reduced over time as matters are settled.

Slide 14, turning then to assets under management. At US, 137b, assets were up 7% from a year ago, with increases in all categories. Assets were lower in the second quarter relative to the first quarter and the following slide, slide 15, gives a little bit more detail on the specifics of the flows. On slide 15 you can see that the outflows for the quarter were $5.3b, with managed funds accounting for $2.4b and mutual funds $2.9b. The redemption rate in domestic mutual funds increased to 31%, from just about 28% in the first quarter.

These redemptions were particularly high this quarter for specific reasons. We had over $2b in institutional outflows related to a portfolio manager who retired as had previously planned. He had $700m of a public account, which left, which was previously announced in the first quarter and actually moved in the second quarter. So we do expect significant improvements in the flows in the third quarter. On the right hand side of the page you can see our market movements added 0.5b this quarter.

Slide 16, having noted all this, let me put the MFS position in perspective. MFS is essentially tied for the ninth place amongst all mutual fund complexes in the United States. By comparison at the time for IPO in the year 2000, MFS occupied the number 11 position. In terms of mutual fund sales, it ranked as number four and five in international and domestic equity sales respectively. It ranked number seven and eight in taxable and tax-free fixed income fund sales. So MFS continues to be a strong competitor in the United States and an important contributor to Sun Life Financial.

Slide 17, Asia had a very good quarter with revenues up 17% in local currency and earnings up 83% in local currency. Even if you include the currency movements, it was a strong quarter, with revenues up 10% and earnings up 67%. Operationally we’re making good progress, which is partially offset by the strength of the Canadian dollar relative to local currencies.

Slide 18, annualized premiums in Asia are up 85% from a year ago in local currency and up 74% in Canadian dollars. This is driven by strong growth in Hong Kong and in India. Sales were below the first quarter because of seasonal reasons, primarily in India.

Slide 19, United Kingdom had another predictable quarter with earnings of 17m pounds and return on equity of 19%. Persistency is around 98%. They recently repatriated 125m pounds, or over $300m, which had a small impact on the earnings of the UK. In future quarters it will have the effect of moving some earnings from the UK to elsewhere in the organization, thereby perhaps reducing UK earnings, but return on equity should be stable. There should be no effect on the overall business.

Slide 20, turning then to productivity. Non-MFS operating expenses were down $11m from a year ago, partially due to currency, which amounted to 4m, expense ratio of 19.6%, slightly higher than a year ago, primarily due to business mix. On the right hand side you see MFS expenses, which are up significantly from 2003, but $6m below the first quarter of ’04. The reasons I’ve mentioned before, include higher legal and compliance expenses, as well as the impact of the elimination of certain soft dollar transactions.

Turning then to slide 21 and our asset quality. The quality of our asset portfolio continues to strengthen. Our net impaired ratio is now only 19 basis points. Gross impaired assets were reduced by $288m from the second quarter and by 41m from the first quarter. 24m of impaired bonds were sold in the United States and 16m was restructures in Canada. As a result, provisions for credit losses decreased accordingly, and amounted to $3m for the quarter.

Slide 22, as you know, we’ve had significant amount of activity in the capital area. In 2003 we returned over 70% of our earnings to shareholders through dividends and buybacks. In the first quarter we increased our dividends by 24%. Reflecting the strong confidence we have in the continued profitability of the business, this quarter we increased our target payout range from between 20 and 30%, to between 25 and 35%.

Secondly, we increased our dividends by a further 5% for a total increase of 29% over the third quarter of last year. At the same time, we decided to review our dividends twice per year. We also bought back 1.6m shares for $60m. Despite that, our MCCSR continues to increase to 245% and our debt ratio declined to 20.6%.

Just within the last half hour, a press release, I believe, has been issued and Standard & Poor’s has recognized this very strong capital position as well as the favorable earnings trend at Sun Life Financial and today affirmed the company’s AA+ financial strength rating and raised the outlook to stable.

That leads us into the last chart that I have, resources of earnings. You can see the expected profit is off by $13m from last year. That is entirely due to currency. On a constant dollar basis the expected earnings are up at least 10% from last year. We see the new business train of $61m is less than last year. That also is due to currency on a constant basis. The new business train is the same as last year.

Experience gains and losses were somewhat higher this year, reflecting the hedging programs we’ve put in place. Assumption changes were roughly the same as last year. Earnings on surplus was higher, because of the buyback of deb, as well as the investment performance of the portfolio. Taxes were – the tax rate was slightly lower this quarter. Leading then to the earnings of $438m, as we discussed previously.

This concludes my presentation, but before I hand it back to Tom to start the question and answer period, I’m pleased to announce that Sun Life Financial will be hosting an investor day in Toronto, on November the 15th of this year. Email notification of this will be going out and further detail will be provided shortly. Tom?

Thanks, Paul. Operator, we’re now ready to start with the Q&A portion of our call. And I’d ask that you please poll the callers for their questions.

Thank you, sir. One moment please for your first question. Your first question comes from James Keating, from RBC Capital. Please go ahead.

Hello, gentlemen. I guess I have a couple of questions, if I may. One is, the capital that was re-deployed or freed up out of the UK, interesting development, I was wondering if you could just discuss the triggers available there and how we might predict that may happen again?

And secondly, I wonder if we could discuss the tax rate a bit? It looks like it’s quite favorable here. Reinsurance may have played a bit of a part, but I wonder if we can get a rounded view on that?

And one last one, specifically on the legal costs for MFS, I think Paul alluded to the point that the cost may start rolling off at some point. I wonder if you could just quantify how much there is currently in the numbers or whatever other costs related to that may be there that could see roll off going forward?

James, in terms of the UK Capital repatriation of 125m pounds, as I mentioned in previous meetings, we had the overall MCCSR targets and then some capital is sort of stuck in particular jurisdiction, because of higher local requirements. And that’s what you see here.

The reduction is the result of the negotiations to the improvement in the business, the sale of the group business that we had last year and discussion with the local regulator. It would be very hard for you to predict what the next amount of capital returning would be in the absence of being part of those negotiations. We continue to work at that. It's an important target for us to repatriate some of that capital and we’ll keep you posted as we make progress on those matters.

In terms of the tax rate, the tax rate is 18% this quarter, which compares to a, what we believe is a longer term sustainable tax rate in the low 20s, 22, 23%. As you know, actually what happened is we had some settlements in Canada and the United States. We typically accrue taxes on a very conservative basis and then we then are assessed. We often have a very positive impact on the bottom line and that’s what you saw this quarter. And there will be more of that over time. This is not the last positive impact that you’ll see, because as I mentioned, typically we are more conservatively reserved for that.

Your final question on MFS with regards to the legal and other costs, it’s hard to predict precisely what the costs will be. If we look at the detail, we think we still have some expenses this quarter associated with some of the settlements and the people cost associated with it, so we expect some reductions. But I’d hesitate at this point to give you a clear forecast exactly where these expenses are going. They lowered in the last quarter. How much lower it will be next quarter I can’t tell you at this stage.

Your next question comes from Brad Smith, from Merrill Lynch. Please go ahead.

Thank you very much. Paul, I was wondering, I believe in the US and the discussion in the MDNA there was some talk about the negative impact of your GMDB hedge and then some reference to some reserve strengthening. So I was wondering if you could quantify those elements for me?

And my second question relates to the Asian operations, where I’m just curious, is what we’re seeing in the quarter, 10% up on the top line, 67% up on the bottom line, is that the inherent operating leverage in those businesses, or is there something else contributing to that appearance of operating leverage in the quarter? Thank you.

With regard to the United States, in terms of the GMBD hedge, as you know, the accounting rules changed, effective January 1, ’04, whereas previously we simply valued the hedge at intrinsic value, we now basically mark them to market. And the value of the markets of these hedges is very dependent on not only where the equity markets are, but also what happens to interest rates and the [vol] rates in the market. And for this particular hedge, it gives us a little bit more volatility in the short term. But in the longer term when the larger market moves, it’s a very effective protection – down side protection against equity moves.

They have not quantified – in terms of the reserves strengthening, I think that’s basically a result of the quarterly review of the variety of reserves that we have. There’s nothing particularly special about this that I can mention. I would say notionally, if you look at it in the aggregate, the $0.73 that we reported this quarter represents the recurring earnings for [all] the franchise, [central] so either way, as we try to portray every other quarter, with the lower tax rate that I referred to earlier largely offsetting some of the negatives that we saw on the annuity book and some other parts of the business. So I’d say that all in all, once you add it all up, the $0.73 is a reflection of what we believe is the sustainable run rate.

We do need, obviously, improvements in the equity markets going forward. We don't like the S&P 500 being below 1,100. In order for us to keep up this very significant earnings increase we’ve been showing quarter over quarter, we need some help from the equity markets.

The final point on Asia, the operating leverage comes from the fact that we have significant fixed expenditures, if you like, in terms of setting up the India and Chinese operations. And so, what you see is India, for instance, we are forecasting that next year, if you look at the insurance operations and the wealth management operations combined, will actually be very close to breakeven, might actually breakeven next year. And so the earnings impact, as you start cutting through your fixed cost base and then at the same clip start creating profitability, your earnings elasticity is quite significant. And that’s what you see, some of that this quarter.

Thanks, Paul. Just one other question. The sequential move in the annuity block profitability in the US, coming up a lot from last year, but coming down quite a bit from the previous quarter, is there anything you can tell us about that and make that a little bit clearer to us? I think it went from 82 to 46 or something?

Yes, I would say it was a little high in the first quarter, a little lower in the second quarter. And so year to date I think it’s more or less indicative.

Your next question comes from Jim Bantis, from CSFB. Please go ahead.

Hi, good afternoon. A couple of quick questions. The credit losses as you pointed out, were unusually low at 3m, but are we at a point where actually we can see that go negative in terms of recoveries, because of the strong asset quality that you’ve got on the books?

Second question, if we can maybe get a little bit more color on the shortfall on earnings coming under the Canadian group insurance business? I think experience was an issue, but also in the context of investments and customer service. Is that a systems issue, or if you can elaborate on that, that would be helpful. Thank you.

In terms of the credit losses, the high quality of our portfolio is a reflection of our investment policies partially and it’s partially the markets. I would say that before we reverse some of the provisions we’d probably strengthen them. So I’m not sure that we’re going to see continued [indecipherable] end up with negative credit losses in quarters, that’s a possibility. I don't want to eliminate it. But I think we continue to be well reserved for what may happen in the near future and are going to continue to maintain that.

In terms of Canadian group, I actually pointed out there was a combination of mortality and beefing up some of her call centers a little bit. We’ve got very high customer service standards. We want to maintain those. And that had some impact on earnings. We believe actually that given the improvements we’ve seen in the early parts of this quarter, that we’ll see improvements in earnings in the third quarter for group benefits.

Paul, could you quantify the costs required to beef up the call centers?

I don’t have those. We can’t really go into that. I don’t have that detail with us. But as a result of that the expenses were slightly higher.

Just maybe a last question. You talked about the positioning of MFS and I think you were saying it was tied for ninth. But can you talk about its relative market share though, not in terms of its sizing in the positioning, but its market share within the marketplace and how’s that impacting sales in the context of your wholesalers?

Well as you know, in the US it’s the top three organizations that are graining significant market share, the top three on the list. And all others are stable to – as a group are not necessarily maintaining that. But you can see in terms of – I’ve also shown the positioning for each in the domestic equity international and so on there, which gives you a bit of an indication as to the ranking on the individual sales categories.

I think that what basically the case is, the market share of MFS is remaining relatively stable and slightly declining. But I think just to get perspective, we lost in mutual funds a little over 3%, but if you look at Janus lost over 111%, Putnam lost close to 10%, AAM lost over 10%. And then if you look at the houses that were very fixed income oriented, again, you see Black Rock losing 10%, and Federated losing 7%. So you basically have three bit winners here and everybody else is declining. But I think we’re holding our own relative to the people in the second tier.

Your next question comes from Tom MacKinnon, from Scotia Capital. Please go ahead.

Yes, thanks very much. The question has to do with the US annuities. When you bought Keyport a couple of years ago, you moved into a targeted top ten position in both fixed annuities and variable annuities and I think you dropped considerably down in [inaudible]. VARDS has you about number 19 in variable annuities sales now, 15 in assets and I’m thinking fixed annuities has got to be 15 or 16. Anyway, you’re not in the top 10 position anymore. And there’s generally been a focus towards the equity index annuity [line] as well, away from fixed and variable.

Is there a focus now to somewhat de-emphasize the fixed and the variable annuity businesses? Is it the company’s position to – or does the company want to be back in top 10 position in these lines of businesses and if so, what are its plans?

And a follow up on that would be, do you feel that you are becoming somewhat – is fixed annuity a core line for you? Do you think you are becoming somewhat marginalized in that line, feel you have to increase scale in that line of business?

Okay, Bob Salipante here, Tom. With respect to fixed annuities and EIA, if I could take those together, as I indicated on the last call, we made the strategic shift last year to emphasize EIA. It works better for us under Canadian accounting. It has a higher ROE. And I think we made a successful transition there and leverages the same manufacturing platform from Keyport.

In variable annuities we very much intend to move back up the list. And we’re taking the steps to do so. We’ve improved profitability of the product. We’ve re-branded. We’re hiring wholesalers. We have a new product release coming on September 7, so when the brokers return from holiday we will be there, we think, with a very very competitive offering. So, VA business is a good business for us and we expect to move back up the list.

With respects to fixed, are we marginalized or scale? Again, I look at EIA and fixed as a bundle. And clearly we’ve grown our EIA position nicely and leveraged our Keyport scale in that fashion.

Okay and one follow up there. What percentage of the fixed books at contractual minimum rates now?

It's moved just under 30% this quarter, just a touch under 30.

Your next question comes from John Reucassel, from BMO Nesbitt Burns. Please go ahead.

Thank you. Just a couple of questions. First for Bob as well. You were looking at hiring someone for the annuities business to head that up. Where does that process stand? And if you hired someone, just maybe give us some background and if not, an update on the timing.

And then maybe on the individual life business in the US, I guess there’s been reduction of reserve requirements and what not. Can you just give an idea of what the – it looks like sustainable earnings were in the mid-20s. If you could just update us where that stands?

And maybe Paul, if you could let us know if you bought back any stock in July?

Okay. We announced a few weeks ago that an individual by the name of Mary [Fay], who has a strong base of experience in the annuity business was joining us. Mary has a strong career in the annuity business in the product manufacturing side, with firms including Hartford and GE. She comes on board at the end of August. We’re very excited about that. What’s been gratifying to me is we’ve really had a shot at, I think, the best in the business with these openings.

With respect to the individual life line and earnings, I guess I look at the first two quarters together as more indicative. What we had in the first quarter is we had to strengthen reserves, to take into account the potential for extended period of low interest rates in the second quarter.

Essentially in that business we sell a floor and so, in the second quarter we put in a hedge that essentially is buying a floor, and we were able to release about two-thirds of the reserve we set up in the first quarter.

And Bob, just on Mary Fay, is her background sales or production?

It's product. She’s on the product side, but she has a marketing orientation as well, which is just what we were looking for.

John, in terms of the buybacks in July, our internal standards are such that when we are aware of the numbers for the quarter, we stay out of the market, as we think that’s a high standard to abide by. So we haven’t been in the market in the month of July up to now. But we fully intend to be in the market in this quarter, given the right opportunities.

Your next question comes from Mario Mendonca, from CIBC World Markets. Please go ahead.

Good afternoon. Paul, more of a conceptual question. As I look at the company we’ve got MFS struggling right now, assets declining for a variety of reasons. And that’s in the context of a pretty healthy equity market over the last year or so. The variable annuities, net redemption; fixed annuities, net redemptions. In Canada, the ICA channel [indecipherable] sale at 5% on individual life [side]. So really, you’re looking at Asia, these equity indexed annuities, that just doesn’t seem enough to really grow earnings long term.

In the past you’d given sort of a sense of what you thought earnings could grow at. And consensus right now reflects about 14% earnings growth ’05 versus ’04. Where do you sort of see this long term earnings growth for Sun Life?

Well, let me just point out some of the times that you’re seeing in the – as I pointed out, in the US and in Canada. We’ve sidestepped unprofitable markets. And so, had be participated in some of these annuity businesses that were sold last year, we would have had a negative impact on earnings, particularly where markets are now. So, I would say not participating in those markets, is going to increase our earnings relative to what they would have been had we participated in those. As you know, and it goes for some of the markets in Canada as well.

I would say that MFS struggling – I’d say MFS is a very strong competitor in the United States. Indeed it’s going through a rough time, but it has an extraordinary run for the last 10 years and we have full confidence in the management team that they will turn this around and show improvements. It's not going to be tomorrow afternoon. But in the short to medium term we’ll see some significant improvements in MFS. So I would say that the franchise and its ability to generate earnings is very much in tact.

We’ve always said that we’re aiming to get around 10% increase in our earnings on an organic basis and then go beyond there by way of acquisitions or strong market improvements or what have you, that includes say around the mid-single digit, 7% roughly, market improvement, that 10%. And I think we very much are able to do that with this franchise.

On top of that, what you’re ignoring is their tremendous capital strength, the place is generating, as I have told you before, close to $1b worth of capital. You have over $1b of capital sitting there. They’re looking at further restructuring of capital, giving us all kinds of opportunity to further enhance the earnings of the operation. So I’d say that we have actually a very strong base to create shareholder value.

So the 10% still seems like a reasonable number for you then?

Yes, sir.

In terms of acquisitions, that was something you brought up and perhaps this is something more for Don. It seems like there’s a good amount of evidence, at least from my perspective – maybe anecdotal evidence that suggests Sun Life is preparing for a good size acquisition. And some of the evidence would be things like repatriating the 300m from the UK, the dividend increase – although impressive on a year over year basis, maybe not so much – like it’s just a penny this quarter. The buybacks perhaps slowing down a little bit. The change in [RC] standards. A lot of things sort of support the notion that Sun Life could be interested in doing a deal. Don, am I making too much of all this sort of build up of information?

I think our position on US acquisitions is consistent with what we’ve said previously, Mario. We’re looking for a value added deal with the right fit, the right price, the right time. Specifically, what we said previously, is that our focus is on acquisitions around the 500m US market and that our capital position would allow us to go higher than that. I think anything beyond that would not be consistent with our [value] position, which is where we’re at. We’re very much driven by value. Then that means we will continue to be in the market. We’ll continue to look at deals and we’ll only move if the right deal comes along. So I wouldn’t endorse the speculation that you allude to.

Okay. And then maybe just one detail question again, maybe for Paul. On the annuity side, you make reference to higher interest rates and the positive impact that could have on individual – or probably the fixed annuity business. Could you describe the mechanism by which the higher interest rates would be beneficial to your fixed annuity business?

I’m going to ask Bob Salipante, perhaps, to speak to that point in terms of interest rates and the impact on fixed annuity business.

I think, Mario, the key there is for the rates to move up modestly. And if rates move up modestly then we enjoy the benefit of improved spread. I think that’s the essence of it.

Right, but if you’re asset liability matched then I’m not sure I really follow that. And if you’re not at your contract minimums – maybe I just don’t understand the mechanism that causes the spreads to improve.

Essentially Mario, it’s the 30% that we talked about before that is already at the minimum, that is very short. And therefore, you get an opportunity as rates rise, to be able to earn a higher rate on that. So you no longer have that eating away at your margins.

Right. I just, it seems to me that the only way that would really – you’d be able to generate better spreads is if right now the company wasn’t asset liability matched. Do I have that wrong?

Yes, essentially you do, in the sense that there’s a lot of very short stuff, which is below the minimum guarantee, so we’re paying the minimum guarantee. If you’re perfectly matched, it’s invested very very short, it’s not earning the minimum guarantee, much less the minimum guarantee plus the spread. So that’s a real strain on the profit of the business.

Okay, perhaps I’ll follow up on this one later on. Thanks.

Your next question comes from Michael Levy, from Lehman Investors. Please go ahead.

Actually it’s Eric Berg calling in. Two questions. First, maybe we could just go over one more time, if you wouldn’t mind, Paul, your response to Mario’s question. I was sort of in his camp, thinking that right now with the negative cash flow in several areas, that results need to improve. So if you were to sort of, one more time, if you wouldn’t mind, listing the areas of the business that you would say are doing well right now?

Well, the point that I made, was that many of the annuities sold a year or so ago with the embedded options at the time, in the marketplace, are not profitable right now. All you have to do – what you need to do perhaps is take an example as to what they were sold at a year – go through the map and with current market rates and the guarantee levels they provided a year ago, those are under water, right? And I think you’ve probably seen that yourself.

Are you talking about – I was aware of that. Were you talking about the income benefits, the death benefits and just the living benefits in general?

Yes. So the point is not selling those is better than selling those, in that at least you don’t have negative profitability on our books. So Mario’s question was done in the context of lower sales in those particular areas and since those sales have negative margins, it’s a good thing not to have made those, right?

I follow you.

That’s my point one. Point two is that the business is generating a significant amount of profitability just by managing the book. And while it’s very important to have sales, the most important contributor to profitability at MFS is what the markets do. A dollar of sales in MFS, will yield, after paying all the expenses, will yield no profit in year one.

So this business’ profitability is much more responsive to the way that its book is being managed as opposed to putting on sales, necessarily, on an incremental basis. And that’s why we can sustain a profitability level and profit growth when we sidestep some of these low margin products. Canada has a significant amount of embedded profitability that is expected to increase at a 10 plus percent rate. The United States is recovering actually from a low level of profitability, if you look last year where we were and the progress we’ve made, that it’s providing some significant momentum.

When you say how you manage the book at MFS, would another way of saying that be just maintaining profitability on the existing assets?

On the in-force block, if you like.

Okay. The other question I had was a follow up to – and I appreciate your reviewing that with me. That was helpful. I got it the second time around. So thank you for that. My second question and my final question is to Bob in the United States, Bob Salipante, you indicated – and I’m hoping we can just develop this a little bit more in your response to an earlier question that you had a, let’s see, a reserve addition in the first quarter and that the introduction of a hedge allowed you to release that reserve into earnings or lessen the reserve. Do I have that right and can you explain why the hedge allowed you to do what you did?

Okay, Bob Wilson is going to answer. We have a surfeit of Bobs around the table.

The Canadian Actuarial rules require that you set your reserves based upon the worst of a set of scenarios. And with the interest rates at the end of March being as low as they were, one of the scenarios that you have to run is that the interest rates actually get even worse. And the universal life block in the US which has guarantees which are between 3 and 4%, depending upon when the policy was issued, under very low interest scenarios, you would get into a position where you had negative spread. And with very low interest, as well as some of the secondary guarantees that are in the contract, that is quite costly.

So what we did in the second quarter, was we invested in a couple of derivative instruments, one being the floors that Bob mentioned, the other one being a swap. Which effectively kick in when interest rates are low. We took advantage of the very steep yield curve to buy. The floors were actually very inexpensive, because the yield curve had an imbedded provision in it that interest rates are going to go up. When we did the cash flow testing to do the Canadian reserves at the end of June, in the low interest scenarios, the floors kick in a sizable amount of money to us. And as a result, we basically reversed about two-thirds of the extra we’d had to add in the first quarter.

I understand. I guess just a final and quick follow up. I thought under the Canadian Actuarial Liability method it is not the worst outcome, but management’s best estimates plus the provision for adverse deviation that is the basis for the life insurance reserves.

No, that’s true for everything except the interest scenarios. The Canadian approach is very punitive to [ALM] strategies, if you don’t have one. It encourages you to be matched. If you aren’t it is quite punitive, unlike US cap. And in this particular instance you actually do have seven prescribed scenarios and you must take the worst.

Your next question comes from Michael Goldberg, from Desjardins Securities. Please go ahead.

Thanks. I have a couple of questions. First of all, I know this is a hypothetical question, but if MFS had held its market share from a year ago, can you give us some idea how much higher than the $41m earnings might have been this quarter? In other words, what was the opportunity cost of all of those redemptions that took place? Why don't you start with that one and then I’ll get onto my next question.

Michael, I don’t obviously have the precise market share they had last year and this year with me and do the math on it. But given the fact that the expense base is relatively fixed, you can just imagine that much of the fees, that a significant portion of the fees that we would have earned on those fees, on those assets, would have flown through to the bottom line. We can help you with a little model on that if you’d like, offline. I just don't have all the data related to last year’s market share and this year’s market share at my fingertips. But we can help you with that after the call if you’d like, give you the details.

Okay. My next question, and I hate to sound like a broken record, but could you give me some idea quantitatively and qualitatively, as to what happened with VNB growth in the second quarter and year to date?

As you know, we don't disclose VNB growth on a quarterly basis, but directionally, we had actually in the protection business, regional for the first six-months, good VNB growth, which was slightly offset by lower sales at MFS.

Okay. And finally, you show in your segmented capital now, corporate equity or equity related to that residual corporate sector, about $2.5b. How much surplus capital would you say that you have now?

In terms of – I think what I said earlier, we have a little over $1b of liquid surplus capital in the business. I think I mentioned that earlier in the call.

Your next question comes from Timothy Lazaris, from GNP Securities. Please go ahead.

Hi, thanks. I have two questions. The first question has to do with the last slide about sources of earnings. And I guess I ask this one every quarter, but the assumption changes that contributed $14m in the quarter, could you break that down in terms of what type of assumption changes they are? Are they related to pads and/or [SEG fund] release reserves or anything of that nature?

And then secondly, my question has to do with CI funds. What was once I guess a small contributor to your earnings is now contributing close to the levels or approaching the levels of MFS. And I’m wondering how comfortable you are with your investment in that company and/or your intentions to increase that investment?

Okay. In terms of the assumption changes, this is the result of a lengthy review of all kinds of actuarial reserves and is a whole lot of little numbers go in there. There’s nothing really that jumps out that would be of significance to you. Now you look at the number you see it’s the same as last year. And so, it’s more or less the same as last year. It's a fairly recurring number that is basically the result of fine tuning the system on an ongoing basis.

And as you know, we intend to show those assumption changes quite clearly for all our investors to see. We report those in the individual business units as well. So we see some volatility in these business units. But at the same time I think that gives more disclosure to you, so that you have a better understanding of what drives the business. But it was nothing significant in there this quarter that is really worth reporting.

With regards to CI, as you know, we’ve continued to be very supportive of CI, the team. We’ve put a lot of money into CI. We funded – we supported all the acquisitions, three. The result is that the earnings are up. The standstill with CI expires at the end of next year. We haven’t changed our position at all and what we said is that we’re very supportive of the management team. We can’t imagine owning 100% of that organization. It's a fine, actively entrepreneurially managed organization and its best position is on its own. And that position hasn’t changed, Tim, from the last call.

Okay. If I could just follow up on that. So if the July of ’05 period expires and you maintain your 34% ownership, I suspect that there’s some things that CI management can do to dilute you. Is it your intention to at least maintain 34%?

Well, we have a partnership with CI that goes well beyond the 34%. As you know, 30% of the first quarter sales of CI were produced by the Clarica sales force, the ITA sales force, and in the second quarter I can’t remember the number, but it’s a substantial amount. And so the partnership goes beyond an ownership and we view the partnership more broader than a 34% ownership. And over time we’ll work with the management to make sure that this partnership continues to focus on generating value for its shareholders and the moment that we have – and so we believe that we’ve done that well over the last year. We’ve worked very well with the management. We have a great deal of confidence in them and we’ll continue to do that in ’04 and ’05.

Okay Paul, the only reason I emphasize the 34% is because I guess it’s been referred to as blocking control. And I guess if you didn’t maintain that, ultimately CI could go into the hands of another insurer, I mean a minority shareholder in something that may not be as strategic.

Tim, there are many many ways to look at this. There’s many alternatives, many courses of action. And as soon as there’s anything to announce, if there is anything to announce, we’ll let you know.

Your next question comes from Steve Cawley, from TD Newcrest. Please go ahead.

Paul did I hear correctly, can you [indecipherable] financial model as well? First question, the Clarica, is there anything left to come from expense synergies? Like I know you’ve hit your targets and what not. Can we expect any further synergies what so ever on the expense front or are they exhausted?

I think, Steve, the better way to – Don Stewart speaking, he better way to look at the operation is that the integration is done. It was a success. We closed the chapter and management going forward, is focused on running an efficient business that can grow in the Canadian market and be very operationally effective. So if management is successful in delivering benefits from that, they will come from current operations. I really do think you have to draw a line on history and move on and that’s what we’ve done.

Sure. So Don, how about I say it this way. When some of the companies de-mutualized we were talking expense gaps. When you take – rather than looking at it that way, because I’m sure that’s not the way to look at it now. Do you take a look at your organization in Canada and do you say to yourselves that there are considerable expense cutting available or not?

Well, as you put it, let me put it back how we see it in management. And that is, in the environment we’re doing business in, there’s ongoing pressure and ongoing ability to raise efficiency. We’re in a changing business and we’re bringing in technology, we’re always looking at ways of improving our business process. It's an ongoing journey. It doesn’t end. So we would prefer to see it as raising productivity and efficiency, which in some cases will mean expense management reductions. In other cases will mean growth and productivity increases. But it’s the composite and it’s the efficiency drive that we have and will continue to have.

Okay, well any time you want to share some numbers along those lines that’d be great. Secondly, on MFS, you’ve taken the tact now that you want to be – it appears, to be a leader on the compliance side. Do you think that that’s hurting some of your relations with the wire houses? Do you think that you might be losing support because of some of these initiatives or is it a question strictly of performance right now?

This is Bob Pozen. We’ve had very constructive discussions with all the wire houses. We’ve talked to them about how in some sense they’re benefiting from some of the positions that we’ve taken, because they don't have to step out as much. And we’ve worked out positive relationships. Not only haven’t we been dropped from any programs, we continue to have good relations.

And I think quite frankly, all the wire houses know that when it comes to the brokerage area and soft dollars, life is changing. And so we’re working in a very constructive and positive way to figure out what the new paradigms are going to look like. There just isn’t a definitive answer. We have to wait until the SEC moves, et cetera. But I think people – and I’ve met with all the wire houses, they’re all very appreciative of the approach we’ve taken. People are having very candid discussions and I think people view it as mutually beneficial.

Do you see more of your competitors soon following in your footsteps or is this going to be a drawn out process? Because I wonder if that puts you at a competitive disadvantage?

I think the SEC will close down pretty soon, soft dollars for promotional fund to sales and it’s sort of the market is closing it down slowly. I believe I’m on the NASD taskforce, that the use of soft dollars for Reuters, Bloombergs, market data, is also very vulnerable to an SEC change in interpretation. I think that soft dollars for research will continue to stay.

We’ve seen some people say that the third party research, which is the only part that we’ve dealt with, that they’re going to pay cash for. So that would be probably, if I had to predict a year from now there’ll be some people who will be paying for third party research in cash, other people using soft dollars. But remember, MFS continues to get proprietary research along with the brokerage commission, so we’re not that far out on that issue.

How are your retention levels, like right now, amongst your portfolio managers, has there been much turnover?

There’s only been one portfolio manager who’s left who we didn’t sort of ask to leave because of performance issues. And that’s a portfolio manager who had taken a sabbatical two years ago and has small children and that did hurt us. It hurt us a lot, because she was a very good portfolio manager. But everyone else has held in and we’ve been able to hire new analysts. And we don’t hire portfolio managers from the outside on the equity side, but we did hire somebody from Wellington, as a portfolio manager on the fixed income side to give us a little more help.

Has there been any elimination of positions? You mentioned that you didn’t want to go. Have there been any firings?

There have been people who have been – analysts who have been let go and there have been demotions and changes in the growth in core equity areas where we were not satisfied with our performance.

One request for Paul. Paul, in following the Key in banks, they make it relatively easy by taking a look at PCL rates and what not, to give us a sense of where provisions for credit losses should be. It doesn’t seem like there’s a comparable metric on the life insurance front. Have you put any thought towards putting something together that will allow the market to get a better sense of following provision for credit losses?

I think, Steve, that is a good suggestion. Let us take that back and take a look and see what we can do to help the communication on that. This is the last question though.

Yeah, yeah. Don, you’ve been pretty adamant against [cross tiller] mergers. Are you seeing any changes there what so ever and in regards to the Bank Act, do you see any changes materializing there that could have a negative impact on you, like sales of insurance through branches?

I think, given the new government has come in, all matters relating to legislation and the prospect of change there is very early days. And the configuration that we’re working under will evolve over the next three to six months we’ll have possibly something more definitive to say on that. But our position in all of this we think is one of reason as opposed to one of extremity. And you need to look at our submission, Steve, when you characterize my remarks the way you do. I’d be happy to share a copy of that with you.

Operator, I think we have time for just one more question.

Thank you, sir. Your last question is a question from James Keating, from RBC Capital. Please go ahead.

Oh thanks. I just wanted to revisit the ICA channel on domestic sales. It seems to be volatile, which strikes me as unusual, given the career force would presumably be fairly focused. We discussed the wealth management distraction last quarter. But I wonder if you could just address if there’s anything else that we should be thinking about here in terms of the sales lumpiness here from the force? And I guess I should also note, it looks like your numbers went back up a bit this quarter after having dipped, just in terms of number of advisors. Can you just let us know if that looks like it’s a trend or if there’s anything unusual about that?

It's Bob Astley speaking, Jamie. First of all, the seasonal pattern by quarter has been a feature of our experience for many many years. It does reflect such things as the [RSP] season, sales campaigns, the personal patterns of producers. And so you’ll see that we have the strongest quarters for insurance sales in the second quarter and the fourth quarter. So the quarter, year over year comparisons are the best indicator.

I would say that on a productivity basis, the average premium per active advisor in the second quarter was about 8% higher than it was a year earlier. We were very pleased with that. And you’re right, we did show a small gain in the sales power in the second quarter and we’re optimistic that we have a good track to follow for the third and fourth quarters.

Mr. Reed, I’d like to turn it back to you for final comments.

Okay, thanks very much, operator. And I’d like to thank all of our participants on the call today. If there are any additional questions we’ll be available after the call. And should you wish to listen to our re-broadcast, it will be available from our website shortly after 6:00 p.m. With that I’ll say thank you and goodnight.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.