Sun Life Financial Inc (SLF) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Sun Life Financial Q2 2009 results conference call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (Operator Instructions)

I would like to remind everyone that this conference call is being recorded on Thursday, August 6, 2009, at 9 a.m. Eastern time. I will now turn the conference over to Paul Petrelli, Vice President of Investor Relations. Please go ahead, sir.

Thank you, John, and good morning, everyone. I would like to start by introducing the members of the management team present for today's call. Providing you with some preliminary prepared remarks we have Don Stewart, Chief Executive Officer of Sun Life Financial; Jon Boscia, President, Sun Life Financial; Dean Connor, President Sun Life Financial Canada; and Colm Freyne, Senior Vice President and Acting Chief Financial Officer.

Also available to answer questions are Bob Salipante, President, Sun Life Financial International; Kevin Dougherty, President, Sun Life Global Investments; Rob Manning, President and CEO of MFS; Mike Stramaglia, Executive Vice President and Chief Risk Officer; and Bob Wilson, Senior Vice President and Chief Actuary.

As many of you know, while the primary purpose of our call today is to update equity analysts and investors on our results and answer their questions, our audience also includes media, industry peers, rating agencies, our regulators, our employees, and our distributors, and we welcome them. The slides to which the speakers will be referring are available on the Sun Life Financial website.

Turning to slide two I draw your attention to the cautionary language regarding use of non-GAAP financial measures and forward-looking statements which form part of this morning's remarks. This slide reviews the reasons why forward-looking statements could be rendered inaccurate by subsequent events. And with that I will now turn things over to Don.

Thank you, Paul, and good morning, everyone. Earlier today Sun Life reported earnings for the second quarter of 2009. As has been the case for several quarters, earnings continued to be heavily influenced by external economic factors. Colm Freyne will address the impact of economic factors in more detail later in the call.

It's important to note that despite these economic challenges our underlying results remain solid reflecting our balanced portfolio of diversified businesses and strong risk management practices. I am pleased to report that our businesses are performing well and continue to demonstrate positive momentum despite the challenging environment. Dean Connor and Jon Boscia will walk through the operational results in more detail later in the call.

We continue to invest in disciplined growth around the globe. In the second quarter we announced the acquisition of the UK operations of Lincoln Financial, which will increase Sun Life UK's assets under management nearly 60%. The acquisition is expected to close later this year.

In Asia we have received regulatory approval for our joint venture with Commerce International Bankers Group, which will enable Sun Life products to be sold through the 600 branches of PT Bank CIMB Niaga in Indonesia. Last week we announced a restructuring of our joint venture with China Everbright Group to capture a larger market share of China's growing financial services sector.

Turning to slide four you can see that our business delivered solid top-line growth in the second quarter. Total premiums and deposits grew by 22% over the prior year or 11% on a constant current basis. While industry sales continued to be affected by market turmoil, we are benefiting from a flight to quality, strong distribution, and superior fund performance at MFS. Wealth deposits increased 7% on positive retail flows at MFS and strong US annuity sales. Managed fund sales, which represent institutional sales at MFS and McLean Budden, were robust growing by 33% over the same period last year.

The value of new business continues to be pressured by higher hedging costs. We are taking steps with both our US variable annuity and Canadian segregated fund products to enhance profitability, which Dean and Jon will discuss in more detail. We are focused on the profitability of these products over the longer term. We continue to see good value of new business growth in our group wealth and in group and individual insurance lines.

Turning to the slide five, you can see that the fund performance at MFS continues to be outstanding with 92%, 95%, and 89% of fund assets ranked in the top half of the Lippert Category Average over three, five, and 10 years, respectively, as of June 30, 2009. This preeminent performance translated into strong positive net flows of almost $5 billion in the quarter despite the difficult environment. The total flows included positive retail flows of over $1 billion.

We continue to invest in growth at MFS where we recently announced an investment in the expansion of MFS's Global Investment Research and Distribution platforms.

Now turning to earnings on slide six. Our net operating income for the quarter is CAD591 million or CAD1.05 per share. Although economic uncertainty continues to persist, the rebound in equity markets and rising risk-free interest rates during the quarter provided a positive contribution to earnings consistent with the sensitivities described in our Q1 disclosure.

Credit conditions continue to present challenges as downgrades by rating agencies in the second quarter continued at an elevated pace resulting in reserve strengthening. We also recorded higher asset impairments as detailed on the following slides.

The reserve impacts outlined on slide seven were significant contributors to results this quarter. The rebound in equity markets in the second quarter resulted in reserve releases of CAD432 million net of hedging. The impact of rising interest rates provided an additional CAD104 million. Both of these impacts are in line with our Q1 2009 sensitivity disclosures.

Narrowing credit spreads, particularly on assets supporting our US fixed annuity business, contributed CAD117 million to earnings this quarter. Downgrades in the Company's investment portfolio in the quarter resulted in the need to book an additional CAD217 million of reserves for potential asset defaults in the future.

This quarter we took additional steps to further strengthen reserves on both our CMBS and direct commercial mortgage portfolios in anticipation of negative commercial mortgage experience over the course of 2010. This resulted in a reduction in after-tax earnings of CAD97 million.

With property values continuing to decline and US unemployment approaching 10% we expect credit conditions in the commercial mortgage sector to be a challenge over the near term. Although we expect our diversified and seasoned portfolio will perform comparatively well through the cycle, we are not immune to fallout in this sector. Our commercial mortgage portfolio is well diversified with over 4,000 loans and an average loan size of under CAD4 million and weighted average loan to value of 59% based on our 2008 evaluations. We estimate that the loan to value would be in the low to mid 60% ranges if all of the properties were revalued today.

Ours CMBS portfolio is well seasoned with 84% originating in 2005 and prior. Further details on our invested assets can be found in the appendix.

Slide eight details the significant credit impacts on earnings in the quarter. Credit impairments were CAD121 million or CAD0.22 per share in Q2. The loss reflects the amount by which credit write-downs exceeded the amount expected in Q2 in the reserves. The impairments were experienced across a number of our asset classes, such as US securitized assets, corporate credit, and includes a CAD68 million charge related to bond holdings in CIT.

Slide nine highlights our sources of our earnings. The expected profit on in-force business is up CAD54 million over the same period last year, primarily due to the impact of business growth in Canada and the United States, as well as currency. As for the impact of new business, results this quarter were in line with normal levels.

Our experienced gains and losses show the impact of the improvements in market conditions experienced in the quarter as just discussed.

Management actions and changes in assumptions in the quarter reflect the impact of actions mentioned previously. That is further strengthening of our credit risk reserves on our CMBS and direct mortgage portfolios as well as a number of other items. Earnings in surplus were impacted by impairment charges on assets backing capital.

The effective tax rate for the quarter of 26% is higher than our normalized range of 18% to 22%, largely due to higher US earnings which is a higher tax jurisdiction.

Moving on to Business Group performance on slide 10. SLF Canada reported net income for the second quarter of CAD217 million, down from CAD296 million a year ago. The decrease in earnings was attributable to increased reserves for mortgage defaults, interest rate-related hedging costs, lower morbidity gains, and increased income tax provisions. As noted in the first quarter, the earnings contribution from the Company's ownership stake in CI Financial is no longer included in the results.

In the United States we reported income of CAD422 million for the quarter, up from the CAD83 million reported a year ago. The earnings benefited primarily from stronger equity markets and narrowing credit spreads in fixed annuities.

Earnings from MFS were down CAD24 million over the same period last year and consistent with the corresponding decline in asset levels and the resulting impact on fee income. MFS margins were 23%, up from the 21% reported in Q1 2009.

Earnings from our Asian operations are up CAD8 million over the same period last year. The corporate segment reported a loss of CAD100 million in the second quarter resulting from downgrades in the Sun Life UK business and credit impairments taken on the Company's holdings in CIT just mentioned. Note that these impairments were taken subsequent to the end of the quarter and have not yet been allocated to the corresponding business groups.

I will now turn the call over to Dean Connor. Dean?

Thanks, Don. Our Canadian operations delivered a solid quarter with CAD217 million of net income and sales that continued the momentum established in previous quarters.

Taking you to slide 12, sales of individual fixed interest products -- and that is GICs, accumulation annuities, structured settlements, and payout annuities -- more than doubled to CAD248 million extending the growth we saw in the first quarter. The sale of market-based products declined, including segregated fund sales which declined by 18% to CAD540 million, which is in line with the change in the overall Canadian market. Year-to-date our segregated fund sales were level with the prior year at CAD1.2 billion, which places our growth ahead of the overall market.

Individual insurance sales were down 5% year-over-year reflecting a decline in universal life level cost of insurance sales, offset partly by strong growth in critical illness sales fueled by the launch of our industry-leading new product in Q1. These results are a reflection of the Canadian economy, both in terms of customer preference for fixed income products and in terms of softness around higher premium life insurance sales.

Taking you to slide 13, group benefits continued its strong sales momentum with sales up 68% versus prior year. After six months, Sun Life leads the Canadian market in group benefit sales. In line with our strategy to increase our share of small to medium-sized business, we signed a national distribution agreement with the Canadian Federation for Independent Business to distribute benefit plans to CFIB members, and those sales are off to a strong start.

Business in-force grew 6.6% to CAD6.8 billion in annual premium and premium equivalents aided by strong sales and client retention rates which continue to be among the best in the Canadian industry. The incidence of new disabilities has not increased, but we are beginning to see some decline in the rate of return to work in part because there are fewer jobs to return to in the economy. And this is an area that we will continue to manage closely.

Group retirement sales came in just under CAD1 billion for the quarter, a strong result by any definition, but down from the CAD1.5 billion in the same quarter prior year which included one large client win at CAD934 million. That CAD1 billion of sales includes group payout annuities sales which increased 48% to a record CAD170 million for the quarter. Rollover sales increased by 4% to CAD193 million tying our best-ever retention rate at 46%.

In view of expected higher ongoing hedge costs, we announced price increases and risk reduction changes to our segregated fund lineup in May. In collaboration with our partners at CI, our segregated funds have performed well and as expected through these volatile markets providing enormous piece of mind to our clients and to the advisers who recommended them. They changes that we announced in May will place these products on an even more sustainable footing for the future, while we continue to design the next generation of products.

We continue to set the pace for innovation in the Canadian market. Earlier this year we launched a fresh new approach for group benefit members who are laid off or reassigned or retire making it easy to convert their life and health insurance benefits to a personal policy. This suite of products, branded My Life CHOICES, has received an enthusiastic response from employers and employees alike, particularly so given the economy. And sales to date are running well ahead of expectations.

In another example of innovation, our defined-benefit solutions business launched the first product of its kind in the Canadian market called [pensurance], which is a form of pension annuity for defined benefit plan sponsors who seek to derisk their pension plans in a methodical way. We completed our first pensurance sale in the second quarter.

We continue to invest in our career salesforce, both in terms of the number of advisers and the tools we use to support their success. Q2 marked the seventh consecutive quarter of growth in sales power with a net gain of 27 in the quarter and 44 year-to-date. Expenses declined 4% in the quarter and 6% year-to-date, reflecting in part a continued focus on tight expense management and investments in technology and process that are driving gains in productivity.

So to summarize with CAD217 million of net income and strong overall sales momentum Canada had a very solid second quarter and we are well positioned for growth and for the future. I will now turn it over to Jon Boscia.

Thanks, Dean. I have said on prior occasions that achieving sustainable organic growth is the number one priority for Sun Life US. We are pleased with the second quarter results for the US as we continue to strengthen our organic growth capabilities across all business lines.

As Don noted, improving market conditions positively impacted earnings which were partially offset by the impact of credit rating downgrades on actuarial reserves and the impact of asset impairments. The combination of financial strength, balanced product offerings, and a focused salesforce are attractive to customers looking for reassurance and guidance during these challenging times.

Total sales are an encouraging sign of progress. Excluding the offshore market, sales are up more than 47% versus the prior year's period. Digging deeper total annuity sales increased more than 60% and even more importantly, net cash flows have improved by $1.2 billion when compared with the second quarter 2008 as seen on slide 15.

While industry variable annuities sales have been dampened by the recession, Sun Life has been the beneficiary of the market place's flight to quality. For the second quarter domestic variable annuities sales were $833 million, up 43% sequentially and 63% from a year ago. This not only represents a testament to Sun Life's financial strength, but importantly it is a testament to the progress made on our distribution front.

Deliberate management actions have reduced the wholesaler count versus year-end 2008, while at the same time adding some of the industry's best wholesalers from numerous competitors. This combination has resulted in an impressive 48% increase in individual wholesaler productivity versus the first half of 2008.

Further, in markets where we have brought on new wholesaling talent, monthly sales have increased by an average of nearly 130%. Our rankings within key distribution partners have improved significantly and we have begun become one of the top sellers inside of important firms such as Merrill Lynch and Smith Barney.

Fixed annuities sales continue to benefit from the volatile equity markets as consumers search for safe havens. However, we are not gathering assets at any cost. We continuously monitor market conditions and are only pursuing this business on an opportunistic basis. Overall, we remain focused on the profitability of all annuity products over the longer term and will be executing actions in the third quarter to further improve the value of new business.

In the Employee Benefits Group we recorded $126 million in sales, up 115% sequentially and 3% from prior period 2008 as seen on slide 16. Both prospect activity and lapse rates compare favorably to last year. We are continuing with initiatives focused on key distribution alliances where we are experiencing a 150% increase in sales compared with the first half of 2008.

We see higher stop-loss sales this year versus the first half of 2008, but we are maintaining a disciplined approach to pricing across the board in this very competitive marketplace.

Similar to first-quarter results we did not see signs of increased disability claims, claim notices, or deterioration of recovery patterns in the second quarter. As we have said before, we are watching leading indicators since we would expect to see at least some impact from the current recessionary climate given our prior experiences.

Within the Employee Benefits Group we began to roll out a new quoting and policy administration system. The system integrates quoting, proposal generation, and contract issuance into one system that dramatically improves the way we manage and deliver cases. As a web-based system it will create efficiencies that reduce operating costs, thereby giving us a competitive advantage in this highly competitive sector.

Turning to our individual insurance, we recorded target premium sales of $60 million, up 82% sequentially, but down 39% from a year ago due to two large case BOLI sales in the second quarter 2008. However, our core sales, or sales that exclude large case BOLI and COLI, are up 54% over the second quarter 2008.

We are continuing to shift our focus away from the no lapse guarantee universal life products and we are achieving particular success with our Sun Executive product aimed at the small business market. In the first half of 2009 life insurance products other than no lapse guarantee products accounted for nearly 50% of our core sales compared to only 5% in 2007.

Across the US we are focused on infusing the organization with top talent. Since the fourth quarter of 2008 we have added more than 80 senior professionals to the Company. They have joined Sun Life from more than a dozen competitors and are strengthening us in sales, finance, marketing, product management, and actuarial.

Finally, our newly centralized marketing organization allows us to leverage Sun Life's enterprise-wide marketing strength while aligning nicely with our centralized US distribution organization. We are embarking on a branding campaign that will launch in Q4 and our distribution partners have emphasized that they expect additional lift as Sun Life's name becomes better known in the US.

While market performance positively affected results for the quarter, it is rewarding to see the impact of actions we have taken previously following the completion of our strategic business review. The second-quarter results showcase the importance of aligning markets, products, distribution, and service capabilities.

With that I would like to turn it over to Colm.

Thank you, John. Turning to slide 18 you can see Sun Life remains strongly capitalized with a minimum continuing capital surplus requirement ratio for Sun Life Assurance Company of Canada of 231%. We continued to build on our capital position successfully raising a further CAD250 million of preferred shares in May. This remains at the holding company level and is not included in the capital ratio for Sun Life Assurance.

We remain focused on maintaining conservative reserves and a deep capital base, and will review our capital plan in the normal course at year-end. At that time we will update you on our return on equity targets.

We continue to hold a higher than normal liquidity position with over CAD11 billion in cash, cash equivalents, and short-term securities. By this result from the drag on earnings we believe it continues to be a prudent position, although we expect to see this cash position decrease as we return to a more stable credit environment.

Finally, the Board of Directors of Sun Life Financial has approved a quarterly shareholder dividend of CAD0.36 per common share, maintaining the same level as the prior quarter.

Slide 19 highlights the future impact of certain perspective actuarial assumption changes. As a result of the pronounced market volatility over the past year and in accordance with professional guidance we are reserving in capital, we intend to update the equity and interest rate-related assumptions used to value certain liabilities in the third quarter of 2009. As a result of these updates, we estimate that there will be an unfavorable impact to net income in the range of CAD450 million to CAD550 million after-tax.

These changes to assumptions have an unusually large impact this year due to the previously mentioned volatility and the calibration criteria for interest rates in the low rate environment. The majority of the earnings impact from these changes is expected to be released into income over time should long-term economic conditions be consistent with management's best estimates. These changes will reduce our capital ratios. However, we expect to remain strongly capitalized after these updates are in effect. We have provided more information about these changes in our second-quarter Management's Discussion and Analysis.

Moving to slide 20. In addition to the updated earning sensitivities provided in the appendix to the slides, we would like to provide you with some additional directional guidance on sustainable earnings. Prior to the start of this severe economic downturn the Company generated annual earnings in the range of CAD1.9 billion to CAD2.3 billion from 2005 to 2007. Earnings at these levels reflected the corresponding asset and account values in existence at that time.

This period was characterized by relatively stable interest rates, rising equity markets, and very good credit conditions. Going forward sustainable earning levels are expected to reflect today's lower asset levels and account values.

Today's environment also reflects higher risk management costs, currency volatility, the potential for higher levels of capital required by regulators, and likely higher tax rates as governments around the world look to address deficit spending.

In addition we will take advantage of opportunities afforded by the recent market dislocation. We will continue to accelerate our organic growth in our major markets by further investing in distribution and in marketing and branding initiatives. We are in the process of reviewing our 2010 financial plans and will have additional information on our core earnings later in the year.

And now back to Don for closing comments.

So in conclusion our financial strength and sound business model provided a solid foundation as we continue building momentum in each of our markets. Going forward we will continue to focus on disciplined growth while maintaining conservative reserves and a deep capital base. Protecting customers and delivering sustainable value to our shareholders remain our first priorities.

Okay, thanks, Don. Before we open the call to questions I would ask each of our participants to limit him or herself to one or two concise questions and then to re-queue with any additional or follow-up questions. We will make every effort to take all your questions during the allotted time this morning. With that I will now ask John to please pull the participants for questions.

(Operator Instructions) John Reucassel, BMO Capital Markets.

Thank you. I guess, Colm or John, I will dig into normalized earnings. Is your target ROE -- you mentioned a couple quarters ago or so you are still targeting 13% to 15%. Is that still a target or not?

Yes, John, it's Colm here. The targeted ROE of 13% to 15% was the target we established at the end of 2008 and reported on in our annual report. It had been at 15%.

I would say that the continuing challenges and comments I made in my remarks around capital levels would suggest that we will need to revisit this target level at the end of the year. And we will provide further guidance at that time.

Okay. And just want to make sure -- my follow-up question and then I will stop. You talked about normalized earnings from '05 to '07 of CAD1.9 billion to CAD2.3 billion and then went to talk about all these issues why -- I don't think you said anything was higher or lower -- everything was lower or more expensive. So the only thing I can take from that is it's going to be tough to get back to the level of earnings of '05 and '07 in the next year or so. Would that be a fair interpretation?

I believe that would be a fair representation. The headwinds and the challenges outweigh some of the positives. Clearly, we have seen some market rebound in the last couple of months, the last quarter in particular reflected that. But we certainly see against the backdrop of continuing high unemployment in the US, consumer sentiment in the US quite negative, we see plenty of challenges. So to predict a return to the benign environment in 2007, we certainly are not at that point at this stage.

Okay, I will re-queue. Thank you.

Michael Goldberg, Desjardins Securities.

Thank you. Good morning. To what extent is the planned reserve strengthening and assumption changes in the third quarter aimed at getting more of future earnings coming from experience gains and less from expected profit from in-force in your source of earnings and how much will the third-quarter strengthening reduce your MCCSR? Could you give us a range at least? And I have got another question.

Michael, I will take the second part of that and then I will ask Bob Wilson to comment on the first piece. With respect to the MCCSR, at this point I would say based on our rough estimates -- and I stress, these are rough estimates because we are projecting what will transpire in Q3. And we have further work to do before we have finalized the amounts and the adjustments to CTE levels that will accompany those final determinations. But I would say at this stage approximately 12% would be a rough estimate of the impact on MCCSR.

Michael, it's Bob Wilson. We update our ESGs, or economic scenario generators, every year in Q3 based on data through the end of June. It's just that the extreme market volatility and the fact that the markets are down 30% still from where they were at June of last year. When you add that in to the last 55 years of data it has an unusual effect on the reserve, so it's not that we are doing anything different than we normally do with regards to generators.

Okay. So there is no true basis change just in terms of the expected mix of your sources of earnings?

What has happened is that the tales have become fatter. Therefore, most of what is going up in reserves we expect over time to come back, because reserves are set at a conservative level to cover primarily the tale of the distribution.

Okay. I will follow-up with you after the meeting, Bob.

Sure.

I have one other question. Can you discuss the impact of your China joint venture restructuring on your ownership of that business?

It's Don Stewart speaking, Michael. Basically we see that the broader arrangement and the change in ownership that we have recently announced with China Everbright Group will position us in a stronger fashion in the Chinese rapidly expanding financial services market. You probably noted that the domestic companies are expanding much faster in China than perhaps is the case in other jurisdictions like India. And, therefore, this would give us a tighter arrangement with our partner, increased localization, and we think we will be in a position to grow considerably faster than before.

So your ownership will be 20%, correct?

Correct.

And that is down from --?

50%.

Okay. Thank you.

Tom MacKinnon, Scotia Capital.

Good morning. Thank you very much. Question with respect to the interest rate reserve releases you had in the quarter; I am curious as to what they related to and why not -- and why did you do those this quarter? Why wouldn't you just wait until the third quarter and then fold them in with your changes as a result of the changes in your economic scenario generator?

Tom, it's Bob. The effective interest rates on our reserves is purely just a matter of what our current interest rate. So during the past year we have reported consistently that we have had losses from credit spread widening on fixed annuities. Credit spreads came in quite a bit in Q2, therefore, we had gains on credit spreads in the United State fixed annuity.

We also had reported losses from interest rates dropping. On UL, for example, in Canada interest rates came up quite considerably. US interest rates at the ten-year point were up 90 basis points.

UL pieces of business like no lapse guarantee and level COI are extremely long; you can't match them. So we do have interest-rate sensitivities that we publish and these changes in income were consistent with what we publish as interest rate sensitivities.

The CAD104 million made in this quarter that has nothing to do -- if you didn't do it this quarter and the environment was exactly the same at the third quarter versus the second quarter, you would have still had that CAD104 million interest rate reserve release. In addition you are going to be taking out whatever, CAD500 million, CAD600 million economic scenario generator interest rate reserve hit. Am I coining that correctly?

We will be taking a hit in Q3 from both equity generators and interest generators which we haven't fully quantified at this point. The interest rate generator is largely due to the education note that the CIA has not yet published, but which is currently before the Practices Council for approval as an education note.

I am still unclear as to what the CAD104 million impact -- was that just as a result of interest rates rising?

Yes, just a result. These interest rates rose by 90 points in the US and something similar to that in Canada.

Okay. Thank you very much.

Eric Berg, Barclays Capital.

Thank you and good morning. Actually just to clarify, first on Tom, is it the result of -- is the benefit from interest rates the result of interest rates rising or of credit spreads narrowing or both?

There are two effects that are going on -- interest rates rose and credit spreads narrowed. The credit spread number is on a pretax basis in the US, roughly 150 million to 160 million.

Okay. A couple of just a couple of real quick ones then. John, you mentioned that you have been continuing the movement away from the no lapse guarantee business or the guaranteed UL. Help us understand why. What is it about the way that product is being priced that is leading you to steer clear of it?

Finally, I believe there was a mention of how higher capital requirement or higher expected capital requirements are going to affect earnings prospectively. I would think that they would depress returns, but it's not to clear to me how higher capital requirements -- if in fact we have them, which that seems to be the case -- would depress earnings. I would think that having higher capital in the business would lead to higher earnings.

So two questions -- one on universal life and one on the effect on earnings that you see from having to hold higher capital in your businesses. Thank you.

Okay, Eric. I am going to take the first part of that question and Colm is going to answer the second part of the question.

On the first one, what is unattractive about the high-end no lapse guarantee product -- two aspects really. One is that it is a pure commodity type of business; it is spreadsheet. It's not the type of business that affords any type of relationship building or sustainability associated with it. It's one that, candidly, if you begin to get a lot of you suspect you probably have a pricing error in one of your sales and distribution may be picking you off.

Second, it's the end of the market. It still lends itself to IOLI and SOLI types of businesses. And while we do have very high screens and we are confident that those screens have worked and continue to work for us, why play in an area that you are questioning every piece of business that is coming in. So as a result we like good, old-fashioned core life insurance.

And, Eric, with respect to the comment on the higher capital requirements, if you recall in my comments around the period 2005 through 2007 this was a period where we and others in our industry were in the process of repurchasing shares due to the generation of income and the capital that we were able to maintain. We have suspended share buybacks, as you know, and generally the industry is not in a share repurchase mode at the moment and that contributes to the reduction in the earnings per share that we see.

John, I didn't hear the last, just the last two words of your statement. You prefer good old-fashioned; did you say whole life or --?

No, good old-fashioned core life insurance, not whole life.

So core would be, for example, non-guaranteed universal life insurance.

It's not non-guaranteed; it's no lapse guaranteed. We would have current assumption universal life; we would have variable universal life; we would have the small case business insurance areas. So some very attractive sectors out there.

I understand now. Thank you. I am all set.

Mario Mendonca, Genuity Capital Markets.

A question for Bob Wilson, and I will admit right off the bat that I am probably a little out of my comfort zone in going through this sort of thing. But I want to challenge or at least try to understand the notion that the increase in interest rate reserves next quarter that those are [PFADs], because what I would like to do is just -- I understand that a PFAD from an interest-rate reserve perspective is really the difference between the reserves that were required under the base scenario relative to the actual reserves you are holding.

First of all, am I characterizing the PFAD correctly by saying it's the difference between the base and the sort of the reserves you are holding now?

That is the correct definition of PFAD for the CIA, yes.

Okay. So when you say that you are strengthening the PFAD you are saying that you are putting up reserves beyond the base assumption. And the base assumption, of course, in that case then becomes the best estimate; that is essentially the best estimate assumption using the definition we are going to. So the question I have is what is -- if you can boil it down to one number or a couple of numbers if you have to do it by region -- what would the long-term or analogous to your URR, let's say, what would that be right now under your base or best estimate of assumption?

Well, the best estimate assumption defined by the CIA as the base scenario is the implied forward yield curve, so that depends on whatever the implied forward yield curve is at the present time. It's also defined in CIA as assuming the credit spreads remain the same.

Right. And that is for the first 20 years.

No, that is actually -- the base scenario as defined by the CIA is credit bridge remaining the same forever.

Oh, I follow that. But --

And the implied forward yield curve is the implied forward yield curve, which does technically go out 30 years.

Now there is a uniform transition from, I thought, year 20 to year 40. And what I would like to understand is, number one, what is the transition you use from say 20 to 40? That would be helpful I think, and the --

That is a number I don't actually have with me at the present time, and obviously it varies by country.

What is the methodology though? Does it happen in 20 years or does it happen in five years?

There is a -- you go from 20 to 40 and the 40th is based upon a long-term average of interest rates.

Is there anything -- I guess what I am getting at --

To a certain degree 40 years out is like, who cares, in terms of its effect on anything.

Okay. What I am trying to get at is if the difference between the base and what you are holding now is the PFAD, so the base is the best estimate, I guess I want to believe that the best estimate is sufficiently conservative so that what is on top of that truly is the PFAD. How can we be convinced or how can you convince me that the base is conservative?

The base isn't intended to be conservative. The base is intended to be a best estimate. And it's market consistent at least for the first 20 years that you are using the implied forward yield curve straight off of the government yield curve.

Plus credit spreads?

Plus credit spreads, yes.

And the reason then to add more to the PFAD is why?

The CIA is coming out with a guidance on use of stochastic interest rate models which produces results that are based upon government bond rates in the long-term being considerably below the URR.

Below --?

The URR if you were using the nine prescribed scenarios.

And is that because rates are very low right now?

No. It will always be that way because of the way that the education note defines what you have -- the calibration criteria you have to meet.

And does that only apply to stochastic or does that apply to --?

It only applies to -- this change is a set of calibration criteria for stochastic interest rate models. It is not affecting the nine scenarios.

Okay. Thank you very much.

Andre Hardy, RBC Capital Markets.

Thank you. Just one request for information and one question. The question relates to expected increases in capital requirements next quarter on the equity side. So it sounds like that is determined by your own models. In your press release you talked about potentially higher regulatory capital requirements, which sounds like a different issue.

Is that because of the changes that US regulators want to put in place or those changes don't really have an impact on your VA business since a lot of it is booked in your [AUS-fee] regulated entity?

Yes, I will take that question, Andre. The first part of the question related to the impact of the actuarial assumption changes and the impact on our MCCSR. The impact there is really made up of the earnings impact so we have signaled that the impact on earnings will be in the CAD450 million to CAD550 million range. So that will impact retained earnings and will impact the MCCSR.

The second part of your --

Just to be clear, Colm -- sorry to interrupt -- but that is your models driving that new number, it's not a change in regulatory?

That is not a change in regulatory, correct. And then the second point you raised around future changes, the regulatory environment continues to examine the appropriate levels for segregated fund reserves in Canada. So we are not aware of any specific direction at this time but we know that this is an area that is under review. I think the piece you mentioned regarding the US is perhaps referencing changes to the statutory reserve requirements in the US, and we do not expect that would have a major impact on our statutory reserve requirements in our US business.

Okay. I have a request for a few numbers and you can post them on your website after and get back to us. But what would be interesting to see is the rating on the bonds that are in an unrealized loss position and also how much of your bonds have traded at less than 80% of par for over six months. And, again, what the rating is in those bonds. If you don't have the numbers off hand, a follow-up would be great.

Yes, I don't have the numbers to hand.

We will come back to you, Andre, on that.

That is great. Thank you.

Colin Devine, Citigroup.

Tom McKinnon, Scotia Capital.

Yes, one of my questions has been answered. Really I think the key thing was the change in terms of the reserving. It really only applies -- it wouldn't apply if you have done deterministic versus stochastic generation. That is definitely the case then is that right, Bob?

With regards to the interest rate generator that is definitely the case.

And maybe just secondly there has been an uptick I see in terms of the capital securities that are below investment grade from CAD37 million at the end of the first quarter to CAD144 million at the end of the second quarter. Has part of that been reflected in terms of any increase in your default provisions in the quarter?

Tom, yes, the actuarial liabilities have been changed to reflect the ratings as of the end of June. And then in the case of CI the ratings when we took the write-downs in the middle of July.

Okay, thanks.

Michael Goldberg, Desjardins Securities.

Thanks. I wonder if we can get an update of the information that was provided in the first quarter on your seg funds -- the reserves, fund value, and amount at risk.

Michael, that material is included in Management Discussion and Analysis. I believe it's close to the back of the package. We are just checking the page reference.

Michael, it's Paul speaking. It is on pages 16 of our press release this morning.

Okay, thank you.

Doug Young, TD Newcrest.

I guess in terms of my first question on the investment side, I guess on the CIT can you tell us has that been 100% written down? And I guess the second part to that question is on the commercial mortgage side. Can you talk maybe a little bit more about what you are seeing in that market place? We are hearing about commercial mortgages dropping in value by 30% to 35%, but your loan to value ratio hasn't really dropped by a similar amount and I suspect there is a reasons for that. I am just curious as to some additional points on that.

And then, Jon, in the US -- my second question. There has been a number of initiatives that have been going on. Can you talk about where your expenses are versus where they need to be? Are they there yet? And can you talk about the pricing environment as well in the US marketplace? Thank you.

Okay. Doug, I will take both of those questions. CIT has not been written down fully. The price that we are carrying it at at this point in time is below what we actually believe the recovery value would be if CIT were to go into bankruptcy.

That does take into consideration the new CAD3 billion bond offering that they have that is going to be super senior to everything else. But even with that consideration, our best estimate of recovery value are higher than what our current carrying value are.

With regard to mortgages and what has taken place and what we see in the mortgage market, our mortgages have held up very well, particularly relative to what we hear is happening to other companies. The reason for that goes back to the original underwriting criteria that we utilized which has been a very conservative level of underwriting. You will remember that in Don Stewart's comment in addition to the absolute number of commercial mortgage loans that we have, he also commented on an average size of less than CAD4 million.

That is important because that is an area of production that many of our peers do not actively participate in, and that has been a long-standing process that we have followed in the investment area of Sun Life. It has allowed us to be able to undertake loans with loan-to-value ratios and debt service coverage that are not available when you get into the larger jumbo loans and the more competitive properties. And as such, the portfolio was well underwritten and continues to perform quite well.

With regard to US, the expenses have been aggressively managed. We have, unfortunately, had to job eliminate nearly 200 jobs in the US thus far, but the expenses still are not where they need to be. You may recall that we have said that we have a couple of businesses that are not yet at scale, and one of the consequences of not being at scale is that we do carry a higher expense level than we ultimately will need to carry. But we need to have that expense level while we grow to scale levels.

Pricing has been a mixed situation; depends on which of the areas that we are talking about. In response to an earlier question I indicated that we are continuing to move away from the high-end no lapse guaranteed product because that is very competitively priced. It's not where we want to put underwriting, not disciplines at risk in the group business.

We are starting to see some continuation, I should say, of trends that are not attractive where employers are looking for multi-year guarantees. And we are avoiding those as best we can and concentrating in other areas of the market instead. So it is a mixed situation, but we are trying to have very good discipline. Not competing on pricing, but competing on the financial strength of Sun Life and the quality of distribution relationships.

Eric Berg, Barclays Capital.

Thanks very much. Jon, I am hoping you can build on your earlier response on the loan-to-value question. I think the question was not how you are avoiding losses and how you do it, but it was sort of a very straightforward arithmetic one which was -- if I understood the question -- how could it be that property prices are falling sharply by your estimate but loan-to-value ratios haven't risen by anywhere near the same percentage?

I think it's just a matter of arithmetic and arithmetically inescapable that if you have a 30% drop in prices, if your loan-to-value ratio starts out below 100%, I think it's mathematically inescapable that you are going to have a very, very large increase in loan-to-value ratios. So, again, the question how could it be that property prices are falling sharply but loan-to-value ratios -- once you tell me that property prices are down whatever, 30% or 35%, that is all I need to know to calculate a revised loan-to-value ratio. Doesn't that necessarily mean a much larger loan-to-value ratio increase than you have been reporting? What am I missing here?

Two comments in there, Eric. One, the 30% property value reduction that you see are industry-type property value reductions. Property values are directly correlated and dependent upon the rent roles and the amount of income that is coming in to it. And if you keep your properties full and you continue to have rents that are current and you continue to have attractive lease rollover patterns then your properties are going to perform better and not experience that type of decline versus other properties. So that is in fact much of what we are seeing in the US.

One [caveat] is that we are seeing a little bit higher incidence in the retail sector where we are seeing some smaller shopping centers have vacancies associated with it. We are watching those properties very, very closely. In some of those situations, Eric, we might have a loan-to-value that is 150% or higher on an individual property basis. The good news is we have very, very few of those properties.

We also have to remember that half of our commercial real estate loans are in Canada, and Canadian property market has not experienced anything similar to what the US property market is. Up here there is much, much more discipline in the way properties are underwritten, constructed, and financed. And that speaks to the real benefit of being a global company instead of a single geography company.

That is a very helpful addition. Thank you, Jon.

Colin Devine, Citigroup.

We have no further questions at this time. Please continue.

Okay. Thank you very much, John. I would like to thank all of our participants on the call today. If there are any additional questions, we will be available after the call. And should you wish to listen to our rebroadcast, it will be available from our website later this afternoon.

With that I will say thank you and good day.

Ladies and gentlemen, that does conclude our conference call for today. Thank you for participating. You may now disconnect your lines.