Sun Life Financial Inc (SLF) 2012 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Sun Life Financial's first quarter 2012 earnings conference call. At this time, all lines are in a listen-only mode. Later we will conduct a question-and-answer session for analysts.

(Operator Instructions)

I would like to remind everyone this conference is being recorded today, Thursday, May 10, 2012, at 2.00 PM eastern time. And I would now like to turn the conference over to Mr. Phil Malek, VP Investor Relations. Please go ahead, sir.

Thank you, Luke, and good afternoon, everyone. Welcome to Sun Life Financial's earnings conference call for the first quarter of 2012. Our earnings release and the slides for today's call are available on the Investor Relations section of our website at SunLife.com. We will begin today's presentation with an overview of our first quarter results by Dean Connor, President and Chief Executive Officer of Sun Life Financial. Following those remarks, Colm Freyne, Executive Vice President and Chief Financial Officer, will present the first quarter's financial results. Following the prepared remarks, we will have a question-and-answer session. Other members of Management are also available to answer your questions on today's call. Turning to our first slide, I draw your attention to the cautionary language regarding the use of forward-looking statements and non-IFRS financial measures, which form part of today's remarks. As noted in the slides, forward-looking statements may be rendered inaccurate by subsequent events. With that, I'll now turn things over to Dean.

Thanks, Phil. And good afternoon, everyone. Earlier today, Sun Life reported positive results for the first quarter of 2012, with operating income of CAD727 million, or CAD1.22 per share on a fully diluted basis. Operating results this quarter reflect the improvement in equity markets, rising interest rates, and strong business momentum. As promised during our call with investors in December, this quarter we've begun reporting our operating income, excluding the net impact of market factors and that was a solid CAD357 million of earnings for the quarter. Colm Freyne will provide more information about this measure later on today's call.

Top line results were strong in the first quarter, with a record level of premiums and deposits. Adjusted premiums and deposits grew 28% over year to reach CAD25.7 billion. We're hitting the milestones we set for ourselves in each of the four pillars targeted for growth, and there were a number of notable achievements I would like to share with you this afternoon. MFS reported another exceptional quarter, with record gross sales of $19.5 billion. MFS also reported one of the strongest net sales results in the Company's history, with total net flows of $5.9 billion, driven by retail flows, which were up 22%, and institutional flows, which were up 71%. Fund performance continues to be outstanding, with 87% and 94% of fund assets ranked in the top half of their LIPPER categories, based on 5 and 10-year performance. Assets under management rose to $285 billion, driven by the strong fund performance, strong flows, and rising equity markets. As part of its continued global expansion, MFS recently announced plans to expand its presence in Australia, by establishing a sales and service capability alongside a local investment team.

In Asia, individual life sales grew 27% over prior year. China was up 131%, Philippines up 60%, Hong Kong up 13%, Indonesia up 10%, and India, while down slightly in Canadian dollars, was up 5% in local currency. After several quarters of decline following the 2010 regulatory reforms in India, we're pleased to see the beginnings of a return to growth. Our integration of the Grepa Life acquisition in the Philippines is going well and it will accelerate our growth as we retool the products and build bank assurance distribution. Here in Canada, we experienced strong sales in our Group Retirement Services business of CAD1.1 billion, an increase of 133% year-over-year. Sun Life Global Investments had a strong RRSP season with CAD54 million of retail sales, and CAD388 million of institutional sales and it continues to increase its penetration in our Career Sales Force, growing to 11% of mutual fund sales in the quarter. Individual life insurance sales grew 9% excluding universal life, where sales were down as expected following the most recent round of price increases in January. Group Benefit sales at CAD136 million were down slightly from prior year, reflecting in part the lumpiness of sales in the large case market. We are pleased to have been named the Most Trusted Insurance Company in Canada for the third consecutive year by Reader's Digest.

In our US business, sales of our group and voluntary products were up 15% year-over-year, and we are hitting all our milestones as we build out our voluntary benefits business. In Q1, we hired 14 experienced sales reps from top competitors in the market, and as well, created a dedicated sales desk to support this new sales force. These colleagues will work closely with our employee benefit reps in our 34 sales offices across the US to generate voluntary benefit sales. We are on track to launch our first three products customized for the voluntary market this summer, with further launches planned later this year. During the quarter, we completed the additional hedging activities we described at our recent investor day, by increasing our interest rate hedging to 100% on our segregated fund and VA businesses, we have lowered our published earning sensitivities to decreases in interest rates by approximately 20%. And this is, of course, in line with our goal of reducing the volatility of our results and ultimately reducing our cost of capital. Sun Life continues to be a strong and well capitalized company, with a minimum continuing capital and surplus requirements ratio of 213% at SLA as of March 31, remaining well in excess of regulatory requirements. I'm pleased to announce that the Board of Directors of Sun Life Financial has approved quarterly shareholder dividend of CAD0.36 per common share, maintaining the same level as the previous quarter. We're off to a solid start to 2012 and confident that we are taking the right actions to meet our financial objectives and execute on our growth strategy. And with that, I'll ask our CFO, Colm Freyne, to walk you through the financial results in more detail and then we'll open up the call to your questions.

Thank you, Dean, and good afternoon, everyone. Turning to slide 5, earlier today the Company reported operating earnings of CAD727 million. This amounts to CAD1.22 per share on a diluted basis, or CAD1.24 per share after adjusting for the dilution caused by our remaining hybrid capital instruments, known as SLEECS. On a reported basis, income for the quarter was CAD686 million. Results in the quarter benefited from strong equity markets and higher interest rates, as I will explain in more detail on the next slide.

Also on this slide, you can see that our capital position remains strong. We ended the second quarter with a minimum continuing capital and surplus requirements ratio of 213% at Sun Life Assurance, which is up from the 211% reported in Q4, but down year-over-year. The increase in equity markets and interest rates during the quarter improved the ratio by approximately 5 percentage points, consistent with our published capital sensitivities. This was partially offset by net capital usage by the business as a result of two items that we expect to impact capital over the remainder of 2012. The first item is the impact of the IFRS conversion phase-in that used approximately 1 percentage point in Q1 and will use a further 2 percentage points of MCCSR by the end of the year.

The second item relates to segregated fund capital usage caused by the aging of the in-force block that used approximately 2 points this quarter and is expected to use a further 5 percentage points by the end of the year. By the end of 2012, the IFRS phase-in will be complete and the segregated fund capital usage will be significantly reduced, resulting in improved capital generation at Sun Life Assurance Company of Canada. During the quarter, we issued subordinated debt in the amount of CAD800 million at the SLF holding company level. We expect to inject these proceeds into the operating company in the second quarter. Today, we announced our intention to redeem CAD800 million of Sun Life Assurance subordinated debt on June 30. As a result, the redemption will have no impact on the MCCSR ratio of Sun Life Assurance. As of the end of the first quarter, we continue to have a strong level of cash resources of Sun Life Financial to fund our dividend payments and other corporate obligations. We continue to manage our business to ensure that we maintain a strong level of capital in a challenging macroeconomic environment.

Turning to Slide 6, this quarter, we are introducing an additional net income measure, which removes the impact of certain market-related factors that fluctuate from quarter to quarter under our accounting regime. Operating net income excluding the impact of changes in interest rates, equity markets, and the fair value of real estate properties in the quarter was CAD357 million. We believe this new measure will be helpful to shareholders in viewing the underlying earnings of the Company, absence changes in these market factors. In arriving at this measure, we will also adjust for changes in actuarial assumptions driven by capital market movements, such as changes in the ultimate reinvestment rate and calibration changes in our economic scenario generator. There were no such changes to actuarial assumptions in the first quarter.

As you can see, positive equity market performance contributed CAD253 million to earnings this quarter. The contribution from equity markets was higher than expected due to a number of factors, which I will describe in more detail on the following slide. With respect to interest rates, the net impact of rising rates was partially offset by the movement of credit and swap spreads in the quarter, resulting in a net positive impact of CAD95 million. Income in the quarter included after-tax net gains of CAD22 million from increases in the fair value of real estate classified as investment property. The changes in market value in the first quarter were driven by a combination of lower capitalization rates and improved occupancy and rental rates.

Slide 7 breaks out the impact of certain notable items on the interest and equity market performance in the quarter on an after-tax basis. Net positive interest rate experience of CAD95 million was impacted by several factors, as shown on this slide. The narrowing of credit spreads in the quarter had a negative impact of CAD19 million and changes in swap spreads had a negative impact of CAD46 million. The additional interest rate, or Rho hedge position established in the quarter reduced the positive impact of interest rates by CAD32 million. Updates to prior quarters' estimates of policy holder liabilities contributed to CAD33 million to net income in the quarter and a nonparallel shift in the yield curve contributed a further CAD15 million. The higher than expected equity market impact was driven by a number of factors.

Results on the quarter benefited by CAD73 million from positive basis risk, primarily the outperformance of underlying variable annuity investments versus the relevant hedging instruments in our US and Canadian variable annuity and segregated fund businesses. As the result of a systems transition at the start of the quarter, we had a greater unhedged position throughout the period than planned, which resulted in a gain of CAD48 million. This position was identified and closed before the end of the quarter, as part of the normal operation of our internal control processes. We have conducted a thorough review of the matter and have taken steps to improve testing controls in the area. Volatility decreased significantly during the first quarter, as equity markets improved. The lower level of volatility compared to our long-term best estimate assumptions resulted in a gain of CAD15 million.

Turning to Slide 8, we have broken out other notable impacts to the quarter's results. As in recent periods, credit impacts were not a significant factor, with a net gain of CAD8 million relative to best estimates. Net unfavorable mortality and morbidity experience of CAD20 million was driven by unfavorable morbidity in our Canadian Group Benefits business, related to long-term disability. We did not experience adverse morbidity in our US Group business in the quarter. Higher project expenses resulted in CAD8 million impact to earnings. These were largely related to solvency II initiatives in the United Kingdom, as we finalize our preparation for the new capital regime for life insurers in the European union. As you can see, lapse and other policy holder experience was not a material factor to the results this quarter. Management actions and changes in assumptions of CAD32 million were made up primarily of a CAD17 million benefit from reduced unit costs from a new outsourcing contract for policy administration in our UK business, and a CAD13 million reserve release from the increased interest rate hedging position established in the quarter.

Moving to Slide 9, we provide details on our source of earnings for operating income. Expected profit of CAD456 million represents a net increase of CAD21 million from a year ago. This increase was primarily due to the reserve hedging methodology change implemented at the end of 2011. New business drain of CAD56 million, down from the CAD62 million reported in Q1 of 2011, and CAD81 million in the prior quarter. The actions taken in recent quarters have had a positive impact on both of these lines in the source of earnings. The experience gains of CAD472 million, primarily reflect the positive impact from equity markets and interest rates described previously. Assumption changes and Management actions described previously resulted in reserve releases totalling CAD44 million on a pretax basis. Earnings on surplus of CAD77 million were CAD18 million lower than the first quarter of 2011, due primarily to lower levels of securities gains, lower impact from real estate appreciation, and partially offset by lower interest costs given the repayment of certain capital instruments at the end of 2011.

Turning to slide 10 and the results by business group, SLF Canada reported operating earnings of CAD239 million, down slightly from the CAD245 million reported a year ago, mainly due to the impact of the negative morbidity experience in the Group Benefits business. US Operations reported operating income of CAD434 million compared to income of CAD180 million a year ago. Results include the favorable impact of equity market gains and higher interest rates in the quarter, as previously described. Operating earnings from MFS were CAD69 million, up from the CAD67 million reported a year ago. This increase was driven by higher average net assets, partially offset by higher expenses in the quarter, due to expansion activities in Australia, integration costs with McLean Budden in Canada, and the transition to new offices in Boston.

Operating income from our Asian operations was CAD29 million, down from the CAD44 million reported in the first quarter of 2011. Higher new business strain due to the rapid growth of sales in China during the first quarter contributed to the year-over-year decline. Additionally, we experienced unusually high investment gains in our Philippines business in Q1 of 2011, contributing to the decrease from the prior year period. Our UK operations reported operating income of CAD26 million, down from income of CAD43 million in Q1 of 2011. Expenses in the UK business remain elevated due to higher regulatory and project costs related to solvency II. The benefit from higher interest rates was more than offset by swap spread movements in the quarter, contributing to the decrease in earnings from the prior period. Corporate support included under the corporate segment reported an operating loss of CAD70 million compared to a loss of CAD107 million a year ago due to lower expenses in the first quarter of 2012 and one-time expenses in the prior period, including foreign exchange losses.

On Slide 11, you can see our sensitivities to interest rates and equity market movements as of March 31. As Dean mentioned earlier in the call, we have lowered our sensitivity to changes in interest rates due to the additional interest rate hedging put in place in the first quarter. Turning to Slide 12, we are now providing you with sensitivities to changes in credit spreads and swap spreads in order to provide you with additional measures to better understand the impact of capital market movements on our results. As you can see, these sensitivities are relatively small. The sensitivities are net amounts based on partly offsetting impacts from different blocks of business with different profiles. Accordingly, impacts in any one business group may appear disproportionate from the total Company net impact in a given reporting period. Note that the credit spread sensitivity includes impacts from changes in both corporate spreads and provincial spreads in approximately an equal weight. Providing these additional measures is another step in our ongoing efforts to assist investors to better understand the impact of capital markets on our results. I will now turn the call back over to Phil.

Thank you, Colm. We would like to ensure that all of our participants have an opportunity to ask questions on today's call. I would ask each of you to please limit yourselves to one or two questions and then to requeue with any additional questions. With that, I'll now ask Luke to please poll the participants for their questions.

(Operator Instructions)

Steve Theriault, Bank of America Merrill Lynch.

First question for Colm or Dean, the temporarily unhedged position, was that unknown until the end of the quarter? How much of the hedging program was affected, if that makes sense? And is this something the regulator would take issue with and be a talking point as you negotiate for hedging credit at some point?

Steve, it's Colm here. Let me explain a little bit around this. So in terms of the impact on the quarter, it was both implemented -- the new hedge system was implemented in the quarter and the impact of this was detected approximately two months into the quarter and detective controls picked it up and we resolved the issue, we put the additional hedges in place. In terms of the impact overall, I think one has to recall that we were changing our profile here as we changed with respect to the reserves, the treatment of hedges in the reserves, so we've been changing our profile. So this is not a problem that has been in place for a prior period. This was all related to the changes that we put in place in the quarter. So while we're disappointed that the testing controls that we had in place on the new software and the technology we were using failed to detect the flaw in the monitoring process, we did correct it in the quarter. So we have spoken to the regulators, as you would imagine, on the quarter's results and they are aware of this issue. But they have not raised any points with us around this. And we don't see this as being a financial reporting issue. But I think your broader point around the credit to be given to hedges in the capital structure is a point that we take seriously and the regulator is obviously serious about as well and controls over hedging systems are a key part of the process that would be at which credit as permitted.

And one more, if I could for Wes, please. Wes, at the investor day, you talked about a strain declining from around CAD160 million last year to somewhere between CAD80 million and CAD90 million for this year. If I look at the first quarter strain, it annualizes to something in the range of CAD130 million. So I guess the question for you is, are you still confident that you'll get the decline that you had anticipated and we'll see strain coming down pretty aggressively over the next three quarters or has something changed there with respect to your outlook?

Yes, so this is Wes. If you think about our Group business, there are really two key impacts in the strain. One is that we do expense the acquisition and distribution costs up front in Group, due to the short-term nature of those contracts. So these costs are, and do come through a strain. So in the quarter, we did have an increased result in sales. So 16% increase in sales versus Q1 '11, which is reflected in that increased strain. And then secondly, which is I think more to the point that you're making, is that the investment in voluntary was quite significant in the quarter, with the bringing on of distribution talent and we'll see that revenue trailing a bit through the course of this year and then picking up. So at some point, those two will converge and we would expect a more normalized view of strain for the Group business.

Strain could be higher just based on higher sales?

Both higher sales and while we make the additional investment in distribution for voluntary.

And so Dean mentioned 14 sales reps hired. We should -- from what I'm hearing, we should start to see the benefit pretty quickly. Can you tell us, do you have a sense on -- I know you often think in terms of years worth of experience. Are they relatively seasoned people that you hired away?

So the 14 voluntary benefit reps, and in fact in the second quarter, we've already added several more to that. Our target was by the time that we launch our voluntary capabilities in June, that we would have a cadre of about 20 representatives, 17 actually in the field, in the market place, with an internal sales desk supporting that group. The capabilities that we're rolling out in June will dramatically increase what we've had historically, both in product, enrollment capabilities, and other areas and they will be working closely with our existing Group representatives across the 34 offices in the United States. So we're very optimistic and excited about this rollout and more to come.

Steve, it's Dean. I would say they are experienced, for the most part, they are experienced, capable people who have been in the business, not just the benefits business, but in particular, the voluntary business in the United States.

Okay. Thanks very much for that.

Peter Routledge, National Bank Financial.

Hi. Just two questions on Canada. One, can you explain or give some more color on the spike in expected profit in that line of business? And, two, and maybe it's related. Wealth sales in Canada were strong, particularly the sales of your proprietary funds, the SLGI, so I mean, those were big increases. I understand it's off a low base, but can you give us more color of what's happening?

Sure, Peter. It's Kevin Dougherty speaking. So we saw an uptick in incidence in LTD and LTD incidence rates in Q1. I think that's pretty well we've seen right across the industry. There was sort of a slow rise that we detected over the last few quarters, but a bit of an uptick in Q1. Beyond that, I would say the recovery rates have been quite strong and so that's kind of the other side of it. We started to introduce some price increases for economic conditions at the beginning of last year and they will start to flow through our results this year. And also, some price increases in our manual rate tables in March of this year. So we see those as sort of the appropriate response and we're focused on pricing and underwriting at this time.

Is that just LTD or across your products?

It's just LTD.

And so that's behind the increase in expected profit?

I'm sorry.

I can perhaps take the question on the expected profit, Peter.

All right.

So when you look at our expected profit overall, at the total Company level, and I'll come back to Canada. Year-over-year, we're up CAD21 million. And that's really a mixed story across the business groups and in the source of earnings by business group that you have you'll see that Canada, as you quite rightly point out, is up CAD29 million. That's really the benefit from the hedges in the reserves methodology that's coming through in Canada. And in the case of the United States, you might say, well, why are we not seeing the same level come through in the US? In fact, you're seeing a decrease in expected profit in the US. We had a change in methodology with respect to expected profit on the Employee Benefits Group, whereby we updated our expected loss ratios to reflect recent trends. So that resulted in a shift in geography on the source of earnings, so we see a decrease in expected profit and a better result and experience related to morbidity, mortality. And we've also had some exchange related movement on the expected profit line on the US. So really it's two different factors that are driving that, the expected profit in Canada is really around the change in the methodology.

And just, Kevin, on the sales growth of SLGI in Canada?

Yes, we've continued to see good takeup from our Career Sales Force in Canada and we recall in Q4 I think we were around 8.6% of flows, moved to about 11.4% in RSP season, which is great. You know, this reflects really just -- we continue to broaden the product shelf and so that's part of the story there. And we're having good success in bringing advisors into, into the SLGI product mix and so we're well over half of the advisors in our career channel are using SLGI products now and we see this continuing through the year.

Okay. Thanks very much.

Gabriel Dechaine. Credit Suisse.

Good afternoon. Couple things here. Where do I start? Can you give me some sense of what the charge could be or MCCSR impact could be from the seg fund calibration requirements in Q3? Also, one of your peers reported last week a substantial charge related to the US VA lapse assumptions. I understand your businesses are quite different in the US, but they are not that different. And I know you haven't strengthened your VA lapse assumptions, at least going back to 2007. I'm wondering what you're observing in the experience, if there's any reason to believe why you could face a similar charge, maybe not of that magnitude, but something anyway, later this year.

Thanks, Gabriel. It's Colm here. I think you're commenting on some actions that were taken by another Canadian Lifeco last week. And I think perhaps not so much taken as perhaps discussed as potentially arising. On the seg fund ESG change, we don't have anything to advise or update on that front, nor do we have anything to update or revise on VA lapses. And our practice has been, as you know, to advise if we are far enough in the process, to have an amount to quantify. We do tell investors about those. So that's really the backdrop. And I think every company's situation is different, so it's a little difficult to take a direct analogy from one to another. In terms of the VA lapse assumption, clearly as we have more experience with that book of business, we're looking at it closely and I'll ask Keith maybe to say a couple of words around our current process.

Sure. We do review the experience in great detail on an annual basis. I would say that at this stage, I'm not seeing any particular change in the experience based on our data that would think we have a significant adjustment. What I would add, though, is we don't have the largest block of business. We do look outside. We get peer review input each year on our assumptions. We frequently ask consultants to give us guidance to let us know what others are seeing and what others are thinking so we're in that process. We don't have anything to report, but we will make this part of our Q3 assumption review process.

And Gabriel, it's Colm here again. Just to clarify, the fact that I'm not commenting on seg fund ESG dollar impacts in Q3 is simply that we don't anticipate any at this point and my point was that if we had anything to advise you of, we would be doing so.

So you don't anticipate any for that one. And then just Keith, while you're on the phone, just the fact you haven't taken any VA lapse assumption strengthening over the past five years including this one potentially, is there anything, other than the size of the book? I know you didn't sell as much VA as pre-2007. Was there anything on the pricing side that stands out? You guys had more conservative lapse assumptions perhaps? I don't know if you can put some perspective on that. But that could also explain why you're not as concerned as some other companies. Because it's not just the one that reported last week, it's several others, European ones that have done similar things.

Well, I don't think our block is that different, or our distribution channels. So I really can't comment on other companies either. We have a good amount of data. We think we have pretty good assumptions. We do review them very thoroughly each year. And as you know, we've taken hits on other behavior assumptions over the last five years. So I don't really have a lot of depth to talk about other companies and how we compare.

And you are reviewing your scenario generator next year as well, for the URR type assumption in the US?

So on the scenario generator, on the equity side this year, just to maybe give you a bit more color there, I think the CIA requirements are quite old. I think they were previously published maybe 10 years ago. And have now been updated. Our practice has been to use the same methodology and update our scenario generator annually. So we kind of keep it current and we'll have a couple of small areas where we need to make adjustments. We're thinking that might be a CAD30 million type of adverse impact that we would implement in Q3. But -- so we don't see a significant divergence there because we keep the scenario generator up to date. Similarly, on the interest rate side, even though we don't quite know where that will end up with the final guidance, we feel pretty good that we try to keep it up to date and so we don't expect a significant issue there either.

Thank you.

Andre Hardy, RBC Capital Markets.

Thank you. Two hopefully quick ones. Can you help us understand, please, how much capital you expect to create organically, so how many MCCSR points would you expect to create organically? And the reason I'm asking is you flagged some negative items that will hit the next three quarters. And then of course capital markets haven't been very kind so far in Q2. I'm trying to understand the offset that we should expect from internal generation.

Yes, so Andre, it's Colm here. Exactly flagging for you the fact that, not withstanding a strong market in the first quarter, we saw a more modest increase overall and that's because we've got some headwinds, as I pointed out. And those do fortunately come to an end at the end of this year, or in large part. And then we will improve the organic growth at SLA. And of course we have organic growth at MFS, which also provides strong dividend capacity for the organization and dividends up to Sun Life Financial. And at Sun Life US, we did not put any money into the, into Sun Life US in the quarter, nor did we take a dividend. But again, as that business runs off and it will take obviously time, we would expect to see further dividends from Sun Life US. So I think it's really a mixed story at Sun Life Assurance of Canada, which is the largest engine of dividend capacity. We're seeing that over the course of the year, that the organic growth will be impacted by the need to put up additional capital on the in-force seg fund business, and that's a result of the complex requirements around capital on seg funds on the in-force business as a result of the aging of the block and some of the big capital move, capital market movements we saw last quarter, last year, I should say.

I guess what I'm trying to understand, Colm, is if you ignore capital markets, you have a minus 7 that you flag on your MCCSR. That's before organic capital creation. And I'm trying to understand how much of an offset you might have from that.

Yes, so the regular earnings, of course, would provide us with organic capital and so the impact is that we then dividend capital up to the parent company and that generally allows us to grow capital at Sun Life Assurance. What I'm signaling is that we're not in the balance of this year growing that capital because of these other impacts that I've noted.

Okay. Might it shrink?

Well, I think it will really depend on the absolute level of capital markets. At this point in time, as we know, with markets down significantly in Q2 to date, we would be below the 213% that we landed at March 31. But of course, capital has got other -- there are other measures around capital and we're constantly looking at ways to be the most efficient we can be on the capital front.

Thank you. And the second one was around earnings on surplus. Obviously, there's always going to be volatility around the timing of real estate gains or securities gains. But what do you think is a good, normal range for the company?

Yes, so I think on earnings on surplus, you know, it is a -- it does bounce around a bit and there are a number of factors that impact it. There's clearly the level of AFS gains and indeed in some periods AFS losses. There are tax recoveries that flow through. There's real estate gains, levels of debt financing, cash levels, how much cash we have deployed and how much to deploy, the overall level of interest rates, of course, is a big factor. And I would say the overarching factor is the impact of the lower rate environment on our surplus assets, whether it's bonds or mortgages. So I think the challenge for us is to continue in the surplus account, to overcome that headwind from the low rate environment, to be judicious around taking security gains where appropriate, and maybe I would ask Steve Peacher to say a few words around how he's approaching maximizing value in surplus in a low rate environment.

Yes, Andre, it's Steve. I would just say that we're -- in order to combat the low interest rate environment, looking at all options, things such as at the margin, increased allocations to areas like private placements, where we've historically been able to garner extra spread for a given level of credit risk that's been successful for us. We're looking at our cash balances, can those be lowered because holding cash is quite expensive. We're looking at asset allocation within surplus to see if there is a more efficient and profitable asset allocation. So we are looking at a number of things to try to increase earnings across the asset base, including surplus.

Thank you.

Tom MacKinnon, BMO Capital Markets.

Thanks very much. Good afternoon, everyone. I've got a question here on UK annuities, the guaranteed annuity option product, which I presume is in runoff. The release notes the impact of net favorable movements in interest rates and equity markets hurt this product in the quarter. I assume that was an experience loss, but if you can quantify what that was, maybe you can shed a little bit of color with respect to what are some of the annuity rate guarantees in this product, what would be the impact, like if rates fell 20 basis points, 30 basis points on the product?

Yes, Tom, it's Colm here. Just to start at the beginning why rising equity markets would hurt this product, it is an annuity option, so to the extent that the underlying equity funds rise, that gives a greater option value to the holder, if they choose to annuitize. So that results in a reserve strengthening. On the specifics of the rates, we did have a negative impact from closing out a swap spread lock that we had in the US as part of our hedging strategy and that contributed around CAD10 million. This is not a new issue to us. I should point that out. We've been managing the UK business in a runoff mode for many, many years. And we continue to manage that business with a complex set of hedging paradigms to ensure that we cover off all the various risks over there.

Historically, this reserve continues to increase. Do you believe, is that because rates have gone down, or like if it's sort of in a runoff, when would we expect this reserve to start declining? What percentage of the group is in payout mode? Any other, any other light you would shed with respect to that?

Tom, this is speaking-- with respect to the GAO, the reserve has been increasing over the last number of years, principally because of the decline in interest rates for the same reason that Colm was mentioning, rising values of the underlying funds, whether they are driven by lower interest rates or rising equity markets, give rise to more underlying fund value, to be annuitized at a guaranteed rate. And that drives the amount of the reserve up. The book is in runoff. And in the fullness of time, it will run off. But the book still has a number of years left to run before it declines significantly.

Is there any idea as to what the, what percent the, Sun Life's interest rate sensitivity is related to this product? Is it small, or is it less than 25%?

Yes, Tom, it's Colm here. I don't have that number to hand, but my guess is it would be less than 25%. But if it's not, we'll certainly, we'll certainly follow up on a future call with more specific details around that.

Okay, thanks.

Doug Young, TD Securities.

Hi, just on the first one, on the UK, obviously there's been some expenses. Wondering if that's something that's ongoing, or is that, is that something that's going to fall off related I guess to the solvency II and can you quantify that? And just the second part of that question, obviously it's, with solvency II, the capital requirements in the UK are going up. Does that mean you're going to have to put more capital into the UK business and if that's the case, can you quantify? And then I got a follow-up.

Yes, so Doug, it's Colm here. On the UK expenses, they have been running at an elevated level for some time now and we have commented on them. As you'll recall previously, and it has been largely around solvency II, although in previous quarters, we also had costs related to the reorganization that we put in place at the end of the year, known as the part 7 reorganization. We do expect these expenses related to solvency II to come down significantly. There was a very large project and we're not alone in having incurred substantial costs around solvency II. I think it's a feature in Europe. But they will be coming down and obviously they need to come down because we're moving to the point where we'll be implementing it in a go-live situation in the not too distant future. So that will tail off. On the issue of capital, we're not expecting that solvency II will result in an increase in our capital. It is a more complex and a more fine tuned and risk-based capital regime, but it won't result in additional capital and we're very appropriately and adequately capitalized in the UK and indeed would expect that capital releases should be available from the UK over time.

And can you quantify the amount that you expect the expenses to come off, once you've implemented?

Well, I think the CAD7 million that you're seeing this quarter that was attributed to that, I would expect that to come down, to be eliminated.

Okay, and then the second part is, your equity market sensitivity, and even if you back out the notable items that you gave, the sensitivity, the earnings impact from equity markets in-quarter was a lot bigger than what we had expected. Again, even backing out those notable items. And I would imagine some of that is going to be as a result of the markets that we're using to gauge, using your sensitivity to gauge the impact. What were some of the issues or items that drove that greater sensitivity than the guidance that you've given us?

Yes, no, I think I fully anticipate and understand the question. And just a small point of clarification, Doug. I would say that we don't give guidance. We provide sensitivities with a lot of caveats, because this is a pretty complex area. Lot of modeling involved here and there's operational risk and indeed, we've highlighted ourselves this quarter that sometimes even with the best of intentions, some aspect of the hedge monitoring and programming around that may in fact come under some pressure. But there were a number of factors behind it. We explained the large ones, but perhaps I could ask Claude Accum to say a few words around some of the other factors that have contributed.

Yes, Doug, when we look at our equity sensitivities, a lot of these sensitivities relate to the variable annuity hedging programs. We tend to invest in eight different hedgable indices, TSX, S&P 500, Russell 2000. If you looked at the weighting of the two largest principal components to those indices in the quarter, it's probably around 30% Canadian, TSX, about 50% US, so it's a combination of S&P and Russell 2000, and about 20% other factors, other indices. If you were to take a weighted mix of the returns on those indices and take off 2%, you would get to an excess return of 7.2% in the quarter. We've indicated our sensitivity's about CAD100 million per 10-point rise in equity markets. So you multiply those two together, you get CAD72 million. It's probably about another CAD10 million just from rounding. You'll observe when we publish our sensitivities, it's quoted at around CAD100 million per 10%.

We actually rounding to the nearest CAD50 million. So that number, if you use the exact unrounded number, you might get another CAD10 million, CAD12 million. Then if you look at that other 20%, it's not all long positions in indices. Some of it's actually short positions, for example, in the FTSE which had a lower return, which actually added value in this quarter. And so that might add about another CAD10 million, so you would get up to around CAD90 million of expected, if you add the other notable items, I think you'd get to the published number. And these numbers that I'm quoting, how they manifested in the quarter, these things do swing around from quarter to quarter as the hedge programs dynamically adjust.

Just a point of clarification, can you -- the shorting of the FTSE, what's that related to?

Not all the businesses have a long position, so some of our exposure in the UK on some of the hedging programs there are short positions. Net short.

Okay, okay. Thank you.

Mario Mendonca, Canaccord Genuity.

Good afternoon. Colm, could you help me think through the increase in expected profit in Canada? I understand your explanation that it related to the benefits of booking the cost of hedges in the reserves. That increase, 147 to 184, would you say that's entirely related to that explanation?

Yes, Mario, it was related to that. But I think we would caution that, again, this is the complex change in reserving methodology that we implemented at the start of the quarter, at the start of the year, and as I think we've cautioned in our investor day recently in March, and Keith, you might want to jump in here. But we said we would really need a couple of quarters to see how the, how this new reserving methodology was coming through, both on expected and experience and indeed in terms of the new business strain. So it is, it is attributed to the hedges of the reserves methodology, but I wouldn't draw a lot of conclusions at the aggregate, at the granular level this quarter from the number. I would say, though, at the total Company level, being up around CAD20 million on expected profit is a position and a level that we're comfortable with, being in the round of CAD450 million, CAD460 million level, relative to an average last year of around CAD440 million. So directionally, we're comfortable, but we would like to see a little bit more experience on this particular item before we would be definitive. Keith, maybe you wanted to add to that?

I think you covered it, Colm.

So that was essentially my follow-up question to that point, was do you feel comfortable, and maybe it's not appropriate to ask on a segment basis, but on a total Company basis, you are comfortable with the level of expected profit you saw this quarter?

Yes, I think that's a fair representation at this point.

Okay, and then a second question, on MFS, the sales numbers looking back to the detail I have, I don't see a better quarter than this in terms of sales, or net sales. Was there anything in there besides just your typical sales? Were there any transfers in from other businesses?

Mario, we've got Amrit Kanwal, the CFO of MFS on the line. We'll ask Amrit to answer that question for you.

Thank you.

Hi Mario, this is Amrit. The short answer really is there was nothing spectacularly noteworthy as far as flows go. They were quite diversified by client and by geography, and frankly, by investment style as well.

So how do you get an increase in net flows from 1.7 billion to 5.8 billion from one quarter to the next? That's just, that's just the market was better, or -- I'm looking for anything that would help explain such a move.

Yes, the -- a lot of clients tend to take a look at their portfolio allocations in the first quarter and we do see greater velocity of money moving in Q1. That might be part of it. Our flows do come in chunks. We had several intakes, if you will, in sort of CAD1 billion range and that -- so our flows can fluctuate by several billion quarter to quarter.

Thank you.

Darko Mihelic, Cormark Securities.

Hi, thank you. I just wanted to circle back on the VA book. It's my understanding that this book is closed and in runoff. And I thought that the mere action of doing that would increase the lapse or surrender rate of that book. And furthermore, I would have thought that you would like to see a higher surrender rate of that book to free up capital over time. So are you, Keith, when you discuss that you're not seeing any trends, do you mean that you're not seeing any trends specifically to dynamic lapse assumptions, or do you mean the overall book of VAs you just don't see any change in surrender rates?

Yes, I think what I'm saying is the actual experience is pretty close to our assumptions, bearing in mind that we only have in the US 250,000 policies. So it's not the largest block of business from which to draw definitive conclusions. And then secondly, I would say that with regard to the specific announcement of closing the block to new sales, we did not see a significant change in the behavior yet. There was a little spike-up in some of the large case business and we did see a little bit higher lapse there for policies that were in the money, so there was a release of reserves related to that. But it wasn't very substantial and we'll have to track this over time. But so far, we haven't seen a notable change.

Okay. So just to be clear, the reason why I asked this, one of the other companies that has closed a block of VA business in the US has seen lapse rates as high as 20%, and 40% to 50% of those lapses were actually in the money contracts. You're not seeing anything like that?

That's correct. We're not.

Okay, and is there anything you could do to help spur the surrender rate along? Or is it something you wouldn't want? So maybe -- sorry to belabor this point, but it seems almost as though one of the companies in the US has significant amount of reserves set aside and would be more than happy to see high surrender rates over time in that book. Is that kind of your position?

We have to be very cautious when we think about those issues. I would think we have to start with the customer and understand the customer value proposition and why these surrenders might or might not help the customer. Having said that, there are ideas and alternatives being explored in the industry, as well as within our team, to look at alternative product offerings and other solutions that can address the customer need, but free up the capital by making an internal transfer. Those are still ideas that are being evaluated and we'll have to consider them over time.

Okay. Thanks very much.

Joanne Smith, Scotia Capital.

Yes, I have a couple of questions for Wes. I was surprised at the size of the restructuring charge in the quarter, Wes. I thought it was going to be larger. Does that mean that it's just a timing issue and we'll see more charges coming throughout the year? And second, you talked about the expected profit declining in the US because of the group life and health. Did you take some rate actions on that book of business recently? I know that you said you did last year, but what about in this year?

Okay. Thanks, Joanne. I'll start with the first question, restructuring. So we did announce late last year that the majority of the restructuring charges related to the closing of the domestic individual life and annuity business would occur in Q4, and it did. It was about CAD65 million pretax, which would have translated to about CAD40 million plus after-tax. And so the balance of that is what you saw in Q1, about CAD11 million pretax, CAD9 million after-tax coming through. So we do expect that the majority of that is now behind us. There are some expenses associated with transition, where we have employees who are transitioning out, but that's going through our normal expense process and would not, therefore, be part of our run rate expenses going into 2013. So we feel good about the numbers that we published. We're on track, and achieving those targets through Q1.

With respects to your second question, we did take rate actions late last year in the Q3 on both our life and STD, and I'm pleased to say that we, across the board in Q1 with Q1 renewals, we did see an average of sort of mid single-digit rate increases on those renewals with really no effect on our persistency. So we continue to enjoy the same level of persistency that we have seen, which quite frankly, has improved over the last couple of years during the economic downturn. So, the beauty of the Group business is that we don't offer long-term rate guarantees. And so the majority of our business comes up for renewal each year or up to two or three years at the most, for the most part. And so we have that opportunity on an individual basis to really look at the value of that business to us and price accordingly.

How much of the book renews annually versus two to three year guarantees, Wes?

Yes, in our LTD -- excuse me, in our disability business overall, about 50% of it is within that first, within a two-year period, guarantee period and the balance of it is, some of it can go up to three. But the majority, over 50% of it is in a two-year period.

Okay, thank you. And I'm not sure if Kevin Strain is on the phone. I have a question about Asia.

Yes, I'm on the phone today. Thank you.

Okay. I've been hearing a lot of companies talk about how excited they are about growth in Asia and it seems like everybody wants to be there and there are a number of properties on the market for sale, et cetera. I'm just wondering if you could just explain to us a little bit more, and I know that we went into this at investor day, but just a little bit more what you're doing to differentiate yourself in that market. And because you're so reliant on distribution partners, mostly banks, could you talk about the economics and how the negotiations of the economics of those relationships works out. I know that there's been a couple of relationships where your economic interest has declined over the last few years. So I would just like to get a little bit more color on what exactly you're doing to differentiate your business model there.

We have a multi-distribution model in all of our countries. So we have an agency, Career Sales Force in each country of various sizes, but all of them have strong growth objectives. And as Dean talked about, we saw growth in each of our agency sales force during the quarter. We have bank assurance relationships in every country, except for Hong Kong at this point in time. And we have some very strong bank partners. New partner in Indonesia, CIMB Bank. We have a relationship in the Philippines, a new joint venture with Grepa Life. We have relationships, obviously, in China with Everbright Bank, and multiple relationships in India.

We're also looking at other distribution methods, particularly in Indonesia, we have a telemarketing focus. And these are areas we see the chance to really broaden this, leveraging our expertise on agency, leveraging our relationships on the bank side. We're seen as being very good partners there. One of the reputations we have with the investment bankers is that of a good partner. I will say that Canadian companies have a great brand recognition in the region and so we, as Dean said in the past, we're in the deal flow. We see all the relationships, partnerships that come up and have a pretty good look at those. So I think for us, it's a multi-channel distribution, understanding, strong understanding of products. We've been seen as a product leader in many of the countries. And a good focus on risk management and profitability and also being recognized as a good partner. But we're in the process of really sort of re-looking at our strategy as I enter over there, and focusing on growth in the region.

Thanks very much.

John Aiken, Barclays.

Good afternoon, I guess just piggybacking off of Joanne's question, I know it's unfair to extrapolate from one quarter against your 2015 objectives, but given the experience that we saw in Asia, most notably the new business strain, can you actually grow earnings while maintaining market share in the various geographies? And more specifically, how can that actually be achieved?

John, it's Dean Connor. We, as we talked about at investor day, if you go back to the Asian material, I think in total, there are 21 different things we identified across the five markets in terms of growing the business and creating value. In part, what you have been seeing is the rapid expansion in China, where we're now selling in over 100 cities. And the build out of that has been expensive. Same in India. We've had a very rapid build out in the last few years and we're well over I think 650 branches in China -- excuse me, in India.

So I would say that one aspect as we look ahead is to -- now that we've built that platform out and rapidly expanded it to grow the sales into the expense base, if you know what I mean, in other words, to push the sales to catch up with the expenses, and I think that as we modeled out to 2015 for investor day, that was clearly one aspect of it. But I'm not -- for this call, I won't take you through all 21 steps. They are all laid out for you in the material from investor day. I think Kevin said it well. These are markets for the most part that have -- that themselves are growing at quite a clip, and we see lots of room, lots of runway for us to earn our fair share of sales in those markets and do so profitably.

Great. Thanks for the color.

Mr. Malek, there are no further questions at this time. Please continue.

Thank you, Luke. I would like to thank all of our participants on today's call. If there are any additional questions, we will be available after the call and a rebroadcast of the call will be available on our website. With that, I'll say thank you and good day.

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and you may now disconnect your lines.