Sun Life Financial Inc (SLF) 2016 Q3 法說會逐字稿

Good morning, my name is Sean, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sun Life Financial third-quarter 2016 financial results conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator instructions)

I would now like to turn the conference over to Greg Dilworth, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Sean, and good morning, everyone. Welcome to Sun Life Financial's earnings conference call for the third quarter of 2016. 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 third-quarter results by Dean Connor, President and Chief Executive Officer of Sun Life Financial. Following Dean's remarks, Colm Freyne, Executive Vice President and Chief Financial Officer, will present the third-quarter financial results

After the prepared remarks we will move to the question-and-answer portion of the call Other members of Management will also be available to answer your questions on today's call.

Turning to slide 2, I draw your attention to the cautionary language regarding the use of forward-looking statements and non-IFRS financial measures, which form part of this morning's remarks. As noted in the slide, forward-looking statements may be rendered inaccurate by subsequent events. And with that, I will now turn things over to Dean.

Thanks, Greg, and good morning, everyone. Turning to slide 4, the Company reported strong results for the quarter, with underlying net income of CAD639 million, up 21 % from CAD528 million in the same period last year.

Our underlying return on equity was 13.4%. For the first nine months of 2016, we've earned CAD1.8 billion in underlying earnings, and generated an underlying ROE of 12.5%, which is in our target range of 12% to 14%.

I am also pleased to report a CAD0.015 increase in our common share dividend, bringing our quarterly dividend to CAD0.42 per share. This, together with the increase announced in the first quarter, represents a total increase of 8% in the common share dividend this year. This increase reflects our business momentum, commitment to returning capital to shareholders, and confidence in the execution of our four-pillar strategy.

The strategy is that characterized by our balanced and diversified business model, and the benefits of it were on full display this quarter. Underlying earnings were up across all of our businesses over the prior year, expected profit was up 11%, with a healthy mix of both organic growth as well as lift from our recent acquisitions.

Top line growth was also strong, with insurance sales of 25% and wealth sales higher by 28% over the same period last year. Total assets under management ended the quarter at CAD908 billion.

Turning to slide 5, I will cover a few key highlights for the quarter. Sun Life Canada delivered a strong third quarter, both top line and bottom line. Individual insurance sales grew to over CAD100 million of new annual premium.

In Canadian individual wealth, sales of Sun Life manufactured wealth products were up 17% year over year for the quarter, and up 36% for the first nine months of 2016, from strong momentum in Sun Life global investment mutual funds and Sun Life guaranteed investment funds, segregated funds. Sun Life global investments continues to outpace the industry growth rate for Canadian mutual funds, with CAD537 million of retail fund sales in the quarter, up 51% over prior year. Performance has been particularly strong in our managed solution suite, with 100% of the granite managed solution funds and granite target date funds exceeding their benchmarks for the four and five-year periods to September 30.

Both of our group businesses delivered sales on par with Q2, but down from a strong Q3 of last year. Our defined-benefit solutions business, which provided de-risking solutions to DB plans had strong sales in the third quarter, including a CAD300 million annuity buyout transaction.

Turning to asset management, MFS ended the quarter with assets under management of US $441 billion, and a pretax operating margin of 38%. Net outflows at MFS for the quarter were US $900 million, driven by a institutional outflows. MFS generated positive net inflows in retail, and year to date, MFS has grown its market share, capturing 15% of the US mutual fund industry's long-term net inflows.

At a time when active managers are increasingly required to demonstrate value for clients, MFS fund performance has remained very strong, with 71%, 86% and 97% of fund assets ranked in the top half of deliver categories for three, five, and 10-year performance, respectively. This strong performance was recognized this quarter as MFS was named Equity Manager of the Year by Financial News of London.

I was particularly pleased with comments from the judges, who noted MFS's client centricity, and I quote, MFS have consistently provided clients with exceptional investment returns over a long period of time, they have always put performance and clients first. It seems that this client-first philosophy extends to their efforts and client service, as well.

This is exactly the kind of feedback we are striving for in all of our businesses, as we build great client relationships that stand the test of time. Client relationships where people stay longer, do more business with us, and refer their family and friends.

At Sun Life Investment Management, which includes the results of Bentall Kennedy, Prime Advisors, Ryan labs and Sun Life Institutional Investments, we generated positive net flows of CAD1.3 billion, and ended the quarter at CAD51 billion in assets under management.

We continue to see good momentum in this business, and during the quarter, Bentall Kennedy won new mandates from a large Australian superannuation fund and from CalPERS. At Sun Life Institutional Investors in Canada, we launched a new CAD550 million short-term private fixed-income fund, which filled quickly, and in fact, was oversubscribed.

As you would have heard at our recent Investor Day on October 20, we think that Sun Life Investment Management is really well-positioned to serve the growing need for alternative investments and liability-driven investing, and we are optimistic about the opportunities ahead of us.

Turning next to the US, underlying earnings improved, due to the pricing, expense and claims management actions in the legacy Sun Life Group business, as well as the contribution from the Assurant employee benefits acquisition. Sales in group benefits were up almost CAD80 million over the prior year, reflecting strong contributions from the acquisition. We're now eight months into our integration efforts, and we are tracking very well to plan, including the financial targets established at the time of the acquisition.

After combining the Sun Life and Assurant sales organizations in the second quarter, we made progress on product and technology integration in the third quarter. These initiatives will enable us to launch our full suite of group products in the US on Sun Life paper and buildout systems platforms that will help us grow the business in the future. In international, sales of life insurance almost doubled over last year and continued to show momentum over the first two quarters of 2016.

Moving to Asia, we had another strong quarter of top and bottom-line growth. Underlying net income was up 19%, while individual insurance and wealth sales were up 42% and 53%, respectively. Year to date, insurance sales in Asia are up by 26% over last year, driven by growth in our advisor force, by sales productivity increases in both agency and bank channels, by greater health and accident sales, and by the contribution from recent buyouts in Asia, including India, where we increased our stake in the JV from 26% to 49% earlier this year.

We continue to invest in ways to make it easier to do business with us and deliver personalized and relevant solutions for clients. So, in the Philippines, we launched the first of its kind mobile app that allows clients to easily transact and conduct self-serve financial needs analysis, and it has been well-received.

So, to conclude, we delivered strong results this quarter, and I am pleased with our progress for the first nine months of 2016. Year-to-date underlying earnings are up 7% off a strong 2015, our 12.5% ROE is on target. We are executing well on both organic growth and on our acquisitions.

Sun Life has a preferred risk posture and a strong capital position, and we are carefully allocating that capital to generate value for shareholders, drive new business, invest in innovation, and create great new client experiences. And with that, I will turn it call over to Colm.

Thank you, Dean, and good morning, everyone. Turning to slide 7, we take a look at some of the financial results for the third quarter of 2016. Our operating net income for the quarter was up CAD750 million, up from CAD478 million in the third quarter a year ago.

Underlying net income, which excludes the net impact of market factors and assumption changes amounted to CAD639 million. Our underlying return on equity was 13.4%. Third-quarter adjusted premiums and deposits were CAD41 billion and assets under management ended the quarter at CAD908 billion.

We maintained a strong capital position, ending the quarter with a minimum continuing capital and surplus requirements ratio for Sun Life Insurance Company of Canada of 221%. The MCCSR ratio for the holding company, Sun Life Financial, Inc., was also strong at 247%. A higher ratio at the SLF level largely reflects the excess cash level of CAD1.8 billion held by SLF, Inc.

Our leverage ratio of 25.6% increased from 23.5% in the prior quarter, driven primarily from CAD1 billion of subordinated debt issued by SLF, Inc. in the quarter. Proceeds from the subordinated debt issuance may include investments in subsidiaries and the repayment of existing indebtedness. During the third quarter, the office of the superintendent of financial institutions released its final capital guideline for Life Insurance Capital Adequacy Test that will replace the current MCCSR framework, beginning in 2018.

We are currently evaluating the new guideline and assessing the impact across our businesses. As a reminder, as we have noted, that the LICAP is not expected to increase the amount of capital in the industry compared to the current framework, but rather to better align risk exposures of various businesses with capital requirements. We will provide more detail on these changes and their impact on Sun Life in 2017.

Turning to slide 8, we provide details on underlying earnings for the quarter, where earnings were higher across all of our business groups. In SLF Canada, underlying earnings reflected favorable investment activity and good morbidity experience in group benefits. We had unfavorable mortality impacts on our wealth and annuity products, and we saw adverse expense experience due to lower sales of non-SLGI mutual funds.

In SLF US, we had a strong result, reflecting the impact of higher sales, pricing actions, expense management, investments and claims, management and the contribution of the acquired business. Underlying earnings also benefited from favorable investing activity and good credit experience, offset by unfavorable morbidity results in our stop-loss business.

In SLF Asset Management, underlying results were up from the prior year at MFS and Sun Life Investment Management. At MFS, net outflows amounted to US $0.9 billion, operating margins were 38% on higher average net assets relative to the prior period, but results also reflect higher operating costs.

Sun Life Investment Management net inflows of CAD1.3 billion were up substantially from the prior year, from strong sales across all business lines. In Asia, we maintained good momentum, as underlying earnings grew over last year, reflecting business growth across a number of markets and lower levels of new business strain.

Turning next to slide 9, we provide details on our sources of earnings presentation. Expected profit of CAD738 million increased by CAD73 million from the same period a year ago. Excluding the impact of currency and the results of SLF Asset Management, expected profit was up CAD74 million, driven by business growth in Asia, Canada, and the US, and the benefit of acquisitions, such as our purchase of Assurant employee benefits business in the US, and our increased ownership level in India.

New business strain was CAD47 million for the quarter, an improvement of CAD16 million over the same period a year ago. The lower level of strain was primarily driven by higher sales and a more favorable mix of business in Asia and in international. Experience gains of $100 million for the quarter effect favorable market movements and the positive net impact of notable items. Non-market-related experience items this quarter, included a favorable credit, strong investing activity and other experience, which consists of a number of smaller items spread across our business groups.

The strong level of investing activity this quarter reflects tactical trading and ongoing portfolio repositioning. We also took action to reduce inflation risks related to annuity payments in the United Kingdom by purchasing inflation-linked bonds, which had a favorable impact on our investing experience this quarter, up approximately CAD29 million after tax.

We experienced unfavorable mortality, including impacts in Canada, as previously mentioned. Our adverse expense results were driven by lower non-SLGI mutual fund sales in Canada, our continued investments in our businesses, and compensation costs related to long-term incentive accruals from strong relative share performance of Sun Life Financial.

The net impact of our Q3 2016 review of actuarial methods and assumptions contributed CAD20 million pretax to net income. This quarter's review included the assessment of many assumptions, across a large number of products, businesses and geographies. Investment assumptions had the largest positive contribution from updated credit and swap spread return assumptions, and changes in the provisions for investment risk.

Mortality and morbidity assumption updates also had a favorable impact in the quarter. We strengthened reserve assumptions in the areas of expenses in policyholder behavior. In both cases, the majority of the assumption changes in these areas were related to closed blocks of business in SLF US. Management actions and model refinements had a modest net unfavorable impact, primarily related to future reinsurance premiums.

As we noted last quarter, we expect that the Actuarial Standards Board will revisit the ultimate reinvestment rate assumption in 2017. Based on our current estimates, the 10 basis-point decline in the ultimate reinvestment rate would result in a one-time impact to net income of approximately CAD75 million. Kevin Morrissey, our Chief Actuary, is here with us this morning, and will be available to answer questions on our assumption review during the Q&A portion of the call.

Earnings on surplus of CAD126 million were CAD38 million higher than the third quarter last year, and benefited from higher investment income, gains on available-for-sale securities, and the impact of mark-to-market on real estate. Income taxes at CAD150 million represents an effective tax rate of 16% on operating net income. On an underlying net income basis, however, the tax rate for the quarter was 22.2%, and on a year-to-date basis the effective tax rate on underlying net income is also 22.2%, which is in line with the high end of our expected range of 18% to 22%.

Slide 10 shows sales results across all our insurance and wealth businesses. Total insurance sales were up 25% with increases across our US and Asian insurance businesses, our sales this quarter also reflect the contributions of recent acquisitions, including the Assurant employee benefits business, and increased ownership level in India. Excluding these benefits from these acquisitions, insurance sales were up 12%, demonstrating a good balance between organic growth and contributions from the businesses we've acquired.

Total wealth sales of CAD35.2 billion were higher by 28% over the prior year. The higher sales were driven by continued momentum at MFS, the benefit of acquisitions at Sun Life Investment Management, and strong sales performance in our wealth businesses in Asia.

Turning next to slide 11, we present the changes in our year-to-date operating expenses over the prior year. Overall, operating expenses for the nine months to September 30 were CAD4.3 billion, up CAD668 million over the year-ago period.

The increase in expenses was driven primarily by currency movements and the inclusion of expenses of recently-acquired businesses. When we adjust for these items, our controllable expense growth amounted to 4%, as our investments in growth have been partially funded through productivity gains generated through our Brighter Way program.

To wrap it up, we achieved strong results for the quarter. We continue to see the benefits of investments in organic growth in acquisitions, and we are benefiting from strong top and bottom-line performance. And with that, I will turn the call over to Greg for the Q&A portion of the call.

Thank you, Colm. To help 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 yourself to one or two questions, and then to re-queue with any additional questions. With that, I will now ask Sean to please pull the participants for questions.

(Operator Instructions)

Your best -- your first question comes from the line of John Aiken with Barclays. Your line is now open.

Good morning, Colm, thank you very much for the disclosure on the impact of the URR. When we take a look at the reserve release we got on the investment assumptions this quarter, it was a very strong release.

Yet from my standpoint, it would've made a lot of sense to take a charge against the URR. Is the fact that you didn't take a charge this quarter mean that you think there is not necessarily a strong possibility that there is going to be a change in the ruling, or the fact of the matter is, you do think there's a high probability that you don't know how to quantify it?

Yes, I think there is a strong possibility of the change in 2017. But when we deal with these types of changes, it is an interactive process with the standards board, so the industry works with the board and we make sure that all factors and considerations are brought to bear. We saw that when the ultimate reinvestment grade net methodology was revised a couple of years ago.

So, we would rather participate in that and be proactive in that. I think our disclosure gives you a very good sense of the amount that would arise should a 10 basis-point decline be the result that prevails. I think there is some evidence that it might be at around that level, but there's more work to be done. But maybe to give a little more context, I'd ask asked Kevin Morrissey if he has anything to add to that.

Good morning, this is Kevin Morrissey. I just want to highlight that the ESP has not probably made changes to the URR. We see this, really, as an event next year in 2017.

Also, the size of the impact, as Colm mentioned, at CAD75 million or a 10 basis-point decline, is not particularly [baked into our] balance sheet. We understand that we will get plenty of notice when ESP does make changes. And if any are required next year we'll make them at that time.

Thanks for the color, guys.

Your next question comes from the line of Gabriel Dechaine from Canaccord. Your line is now open.

Good morning. You talked about the yield enhancement in the UK and quantified that a bit from the positioning in some inflation-protected bonds.

It looks like you had a similar type of enhancement gain in the US offshore business, but you only disclosed the operating profits there, so I can't really tell what the underlying was in that business. Is there an element of frothing this number that you can quantify?

Yes, Gabriel, it's Colm here. I think the way we think about this is that the investing gains number is quite large this quarter. And CAD29 million of that CAD56 million after tax, related to a very specific scenario in the UK business, where we acquired some inflation-linked [guilts] to offset an adverse scenario on the liability side where there was some exposure to inflation.

Or we said, well, that's really not a very normal part of our investing game line, so if we break that out, and of course the UK is a run-off business for us and we want to ensure that you have a good sense of sustainability around that business, the earnings in the UK, the run rate hasn't changed as a result of this transaction. So, when you take that out, you're left with CAD27 million.

That is at the high end of the range we've talked about for investing gains previously, where we have said, think of a number in the CAD10 million to CAD20 million level. In fairness, we have done well against investing gains over some period of time now, and we continue to, every quarter we look at this quite closely to say how do we feel about that going forward?

And we would continue to offer that kind of an indication that CAD10 million to CAD20 million is a number we feel we can continue to generate in the current environment. So, that's a bit of a long-winded answer, but if I take the CAD27 million that is left over after I adjusted for the UK piece, I would say that breaks out between, mainly between Canada and the US, and the impacts on international is not a big portion of the portion that relates to the US, so, that's not a driver of the international results this quarter.

Where was that? If there was a yield enhancement, I only see the operating number, but the offshore business looks like a big --

The international business is noisy this quarter, when you look at it on an operating basis, because of the assumption changes and management actions that took place this quarter. If you strip out all of those, and as Kevin has mentioned or as we have mentioned, the net to CAD54 million after taxes was spread across a number of items that the underlying results of the international business were solid in the quarter. We had some reduced new business strain that was a contributor, but otherwise, there is not a big change in the underlying business there.

Okay. Maybe I'll follow up. I actually want to ask you about MFS.

The tax rate on MFS is around 35% or 36% on your financials. There is no adjustment in the corporate or anything like that that would lower it when you roll it all in at a consolidated level, that's what you are actually paying in taxes at MFS, correct?

That's right, there's no offsetting amounts in corporate.

Are you fairly excited about a possible corporate tax reduction following this Trump win, going to 15% could be huge. Sorry, I couldn't resist.

Well, I will comment generally on tax rates. Clearly, US tax rates, corporate tax rates are high relative to international tax rates. Tax rates internationally, including the other major jurisdictions we operate in. So, a reduced tax rate clearly would be beneficial, and we will await developments.

Okay, great, thanks.

And your next question comes from the line of Meny Grauman, Cormark. Your line is now open.

Hi, good morning. Just had a question on the net interest impact going from a pretax loss of CAD6 million to a gain of CAD18 million after tax, I'm just wondering if you could explain what's driving that swing to the positive after tax.

So, Meny, when we show these numbers pre and post tax, because we operate in different jurisdictions where you can have a loss in a high tax jurisdiction and a gain in a low tax jurisdiction, when you consolidate numbers you can often, and we often see that in our presentations, that the numbers flip from a pre-tax loss to a post-tax gain. So, it is nothing other than the operation of the pre-and post-tax numbers in different jurisdictions, where there are offsetting amounts.

And then if I could just ask a question about the goodwill impairment testing, you flag it for Q4, but I don't think you provide much by the way of any indication of which way it's going to land. I'm wondering if there's more you can add beyond what appears in the press release.

You're right, we do flag it every third quarter, because it is an annual test that is performed in the fourth quarter each year. We flag it simply as a matter of practice, just to provide that. But there is nothing, and you can see from our business results, there are none of our businesses that are under pressure, so the fact of flagging it is not giving you some kind of a heads up that there's some particular challenge there, it's just simply not a good practice.

Thank you very much

Your next question comes from the line of Steve Theriault with Dundee Capital Markets, your line is now open.

Hi, thanks. Good morning, everyone.

Maybe I will start just with a couple of clarification question on the assumption changes, if I could. So, the first one, on the investment-related assumption of credit spreads and swap spreads, do I understand that right that what I interpret that as you are assuming that through the cycle of corporate spreads are wider and swap spreads are lower?

And the other component was the assumption on -- assumption change on the reduction of provisions for investment risk of that. Is that related to the C1 risk in required capital, as I understand it? Maybe a little color on that one, as well.

This is Kevin Morrissey. On the first one, on the credit spreads you have that direction right. We are assuming that credit spreads are marginally wider for reinvestment, so, that's favorable.

And on swap spreads, we are net sellers of swaps in the future, so, the narrowing of spreads actually benefits us in evaluation, and you're right in the direction of that, it is a positive as well. Related to the investment provision, that was related to review of the power risks, and as a result of the deneutralization structure, on the par flows account, which we've reviewed the interest provision this quarter, we did some testing for the strength of that, and we released a bit of the results of that deneutralization structure that income goes to the shareholders.

Okay. I may follow up on the latter. And then for Kevin, strain on Asia profitability, the ROE has been somewhere between range bound and a little bit higher the last couple of years, and I guess as I look at it, a little bit higher.

What geographies have been helping on profitability? And then maybe more importantly, what does the next leg higher look like to get to double-digit ROE within that division? Is it contingent on that a particular country that needs to be kicking harder?

Is it sales, generally, is it something else? Just a bit of an outlook and guidance to the extent you can on that would be helpful.

Hi, Steve. I think there is a couple of factors here. We have been investing in the business and those investments have been driving growth.

Overall, our goal is to achieve scale in all seven of the markets. Five of the seven are profitable, and clearly the profitable ones are the ones that are driving the ROE.

In the case of the -- for example, Vietnam. Vietnam is a new business for us. It is a Greenfield business. It throws out losses in the early stages.

So, those types of businesses over time as we achieve scale will start to drive profit and will start to drive ROE. So, the goal is to continue to focus on profitable new business, on BMD, on growing the expected profit. We saw expected profit grow by 16% in the quarter.

We dropped our new business strain by CAD7 million, and over time, that growth in earnings from profitable sales growth from going the BMD will drive the our ROE up. We are looking at the capital we have in each of the countries, and making sure we understand where that's at and how do we get dividends back up into Canada, which will also help the ROE over the longer term.

That helps. But if we think out to 2017, and as you get closer as you are working through your next-year plan, is it more likely that ROE stays pretty stable and there is continued investment?

Or is there some gearing in some of those geographies that take it higher? Appreciating it's going to go higher in the long term, but can you give us a little bit of extra visibility just on the near term?

Yes. I think you're going to see the kind of growth you've seen in the last few years, where the earnings will grow a little faster than the ROE, because we are making the investments. But we will be driving towards, over the medium-term, heading towards the double-digit number for ROE.

That's helpful. Thanks so much.

Your next question comes from the line of Sumit Malhotra, Scotiabank. Your line is now open.

Thanks, good morning. First question is likely for Colm, and it is looking at your experience line under your underlying earnings. I know you've taken out the market-related factors here, but we have seen this line quite consistently positive over the last year, and it seems to almost exclusively be driven by your investment experience.

My question is on geography of earnings. At what stage or what -- how do you think through the process of we have had consistent gains in this regard relative to what assumptions have been.

What has to happen for this to become something that is included more in the expected profit line? Do you have enough of a history that that can occur, or is there more to it than the way I am phrasing it here?

No. I think it's a very fair question, and it is something we look at. To the extent that we would have significant ongoing investing gains from a very reliable source. We would certainly consider moving a portion of that into the expected profit, and indeed, we have done so in the past, so we would never rule that out.

You know, the investment gain line does really cover quite a bit that comes through in that line. And given the management of the balance sheet and a low interest rate environment, where we had some over the past year or two, some unusual fluctuations that have allowed us to capture some benefits, there can be real economic benefits we've floated through this investing game line.

But I think as we work forward, we certainly will keep looking at that very closely to see if there is any other portion that might be adjusted for. But at this exact moment, we are not considering a methodology change of the type you're talking about. I'm looking at Kevin Morrissey to see if he has any additional comments.

Yes, to answer that, the investment activity comes from a number of sources, a number related to trading activity where Sun Life has particular expertise, especially in non-marketable fixed income securities. We also endeavor to try and find value by revising and improving ALM and investment strategies, and this type of tactical market opportunity is going to fluctuate quite a bit as market opportunities arise from quarter to quarter, but we are going to continue to try and add value every quarter.

Just to be clear, you give us this slide, this other notable items and experience. The investment activity, I'm looking back at my numbers here, and it has been consistently positive or consistently a gain going back to 2013.

Am I right to think about this that you have a base level of gains that is included in your expected profit assumption, and this line is essentially telling us how much better or worse you did relative to that expectation? Is that simplistically the right way to think about it?

Yes, I think that's right. Maybe I will come back to what Colm mentioned earlier about this quarter, we did have about half of that related to the UK, which we consider more of a one-time, where we took some action to hedge the inflation risk there.

So, if you back that piece out, it is more in the 30 neighborhood, and that is more in line with what we have seen historically. But yes, it has been running hot for quite a while.

Okay. Last question is going to be on the US, and it is for Dean. Expected profit line took a solid jump up in Q3, and it wasn't exactly clear to me whether it was the ongoing benefits or the integration of the Assurant acquisition that is driving that.

My question specifically for that business is where you think margins can go. You've given us some pretty specific numbers on what the accretion from this deal could be, but when it comes to tracking progress of margins, where is this business right now on a margins basis? Where do you think you think it can go, and is it an expense-only story or is there some leverage you think you have on the top line the get this margin improvement story moving?

The Assurant business came over to us in good condition, and it's so far performing at or better than our expectations, so you are seeing some of the impact of that incrementally this year and in the most recent quarter. The way we think about margins for the group business in the aggregate is that the future potential for this business, you should think about as a 5% after-tax margin. We have different parts of the business performing in different places at the moment.

As you know, we are still in the process of performance improvement for the legacy Sun Life, group life, and disability business, making progress there. The Assurant business is in good condition, as I said. So, I think when we put all of these pieces together, that is a reasonable way of thinking about the future margin.

And 5% after-tax is the total group objective, and I will calculate this myself, but if you could help me, where do you think -- where are you right now on your measure?

We are below that at the moment, primarily because of the performance improvement that we are implementing in the legacy Sun Life group business.

All right. I will follow up with you later. Thanks for your time.

Your next question comes from the line of Tom MacKinnon with BMO Capital. Your line is now open.

Thanks very much. Question with respect to MFS and the margins here at 38%, and up nicely, quarter over quarter. If we had equity markets go up 8% annually going forward, where do you think these margins could play out?

Good morning, this is Mike Roberge. Clearly, if you were to get a significant market lift, you're going to see that fall to the bottom line. But I think our view, as you look across the industry, and in a more normal environment, where you have more normal equity returns, there will continue to be pressure, I think you're going continue to see pressure from passive, both in terms of flow, but relative to relative pricing in the industry.

We're going to be dealing with the DOL fiduciary issue, which I think will have some negative impact on industry margins. I think industry margins are going to be somewhat challenged over the next couple of years until we end up in a more normal environment. So, as we think about the industry, we do not think there's significant uplift in margins in the industry, net of some big consistent move up in the marketplace.

You had an uplift in the margins quarter over quarter, was there anything yet that was driving that? -- 4%, but what would have been more particular in terms of driving those margins?

We had ANA -- average net assets up, we held expenses relatively flat in the quarter, so you got some operating leverage. But again, expenses quarter to quarter can fluctuate some. And I think it is within a tolerance of what we would expect that you could see quarter to quarter.

Again, should we be looking at something that is probably in this range for next year or perhaps slightly lower? In the range that you had in the third quarter or perhaps slightly lower.

Over the last couple of quarters that we thought there was going to be some pressure. And again, I do this relative to industry. We're seeing margins in the industry compress, it's due to a lot of the pressure we've talked about de-risking the move to passive, pricing, now we are being faced with some additional regulatory pressures. I think you're going to see margins in the industry continue to be somewhat pressured. And I think you should expect that same, those same pressures to have some impact on us, as well.

Okay. Thanks for that.

One other question with respect to policyholder experience losses. Traditionally, these things have been, were good positives in 2015 and the first quarter of 2016.

We saw them hurting earnings by $0.03 in the second quarter and $0.04 in this quarter, and once again, we had some -- you can point to US group and Canadian group and US stop-loss now for the second quarter. Is there anything we should read into this, and what are you trying to do to improve this stuff going forward? Any color there would be great.

Tom, it's Colm here. So, I think by policyholder, you mean the aggregation of mortality, morbidity, lapse, others. What we think of when we think of --

Mortality, morbidity and lapse. I'm not working expense into that thing.

On the mortality side, we had a negative this quarter, CAD23 million. Nothing in particular to be concerned about there from our perspective.

It was spread across Canada, the US, UK, international. We've had some strong performance in international, and we've talked about that previously. We said it's unlikely to continue at that level.

And, indeed, we had some claims this quarter, so it did not continue at the previous level. So, nothing in particular there. Morbidity was a net one, so, it was really a non-event.

We did have some in the other category, which was a positive this quarter. So, really, positives, negatives, we didn't really see anything that we were concerned about from a sustainability perspective. And frankly, as we go through to our Q3 assumption changes, we've had a pretty good look at all of these areas as part of that exercise, so I wouldn't read anything unduly into the quarter, other than the fact that these items can be random quarter to quarter.

What is that other category?

Other category is where we can't neatly fit it into any of the other categories. That sounds a little self-evident.

Either they die or disabled or the lapse.

It is often a refinement of a model. It can be something that we look at it in the quarter and say, well, maybe in some cases it may not be -- it may not actually relate as much to the current quarter. And of that CAD23 million, there's about CAD10 million of it that I would say was really a true-up in respect of the international business, that bonused the quarter, but, really, we would say that was not so much part of the current quarter.

And the other 13 was a model refinement?

Various. It's a number of items, Tom, it's a big complex valuation world, and there's lots of pieces that fall into this. Nothing of major significance in there.

Understood. One last quick one, the tax rate has been running at the top and year to date. Why is that, and how should we be looking at the tax rate versus your 18% to 22% range?

Yes, the tax rate tends to run at the high end when we have strong earnings, particularly in the United States and MFS, and higher tax jurisdiction than our Canadian tax jurisdiction. We have seen that particularly this quarter and year to date. So, we feel fairly good about where we're at on the tax front.

We continue to work through various tax items. We don't see any particular concerns with us being at the top end of that range, and we're holding to that range as being a good indicator of what we should be able to manage to.

So, if synergies from Assurant and growth in MFS were drivers of -- the predominant drivers of earnings growth going forward, is it safe to say that the tax rate would move more towards the top end of that, going forward?

Yes, I think we would hope to hold it within that top end, but, yes, you could see it being at that top end.

Okay. Thanks very much.

Paul Holden, CIBC.

Thank you, good morning. First question is related to MFS and change in asset mix over time, and specifically referring to mutual fund mix versus the managed product mix.

How should we think about profitability on the mutual fund AUM versus the managed product AUM. Is it sort of two to one for the same amount of AUM?

No, I think when you look at it in profitability terms, the fees, if you look at the all-in fee that you charge in retail is a little bit higher, but the costs associated with that, there's more infrastructure associated with that. So, on a net basis, when we look across US retail or non-US retail business in our institutional business, the profitability on that is actually very similar across all three of those channels.

Okay. Got it. And then question specific to US group, and I guess the legacy Sun Life business in particular, maybe an update on expected re-pricing to be done Jan. 1, 2017, still confident you will get the expected re-pricing complete?

Where we are on that, as you know, we have been going through the re-pricing process and the performance improvement plan for about two years now. And as of this point, we have re-priced approximately 75% of the business and we would expect to re-price the remainder of it, partly on January 1, then drop the balance of 2017.

So, we have been making good progress on that. We have generally been getting the rates that we have been seeking.

We have also continued to have the phenomenon of the business that chooses to lapse, it's business that is performing at significantly higher loss ratios than the business that we have been retaining, so that's contributing to the improvement as well. We've also been achieving some gains as planned, through expense management and through investments and better claims management.

Okay. That's all the questions I had, thank you.

Your next question comes from the line of Doug Young, Desjardins Capital Markets. Your line is now open.

Good morning. While I got you, Dan, US stop-loss had unfavorable experience again this quarter. I was wondering if you can quantify what the impact was this quarter relative to what the impact was last quarter.

And can you remind me just in terms of actions, and I think it is related to the same items that happened last quarter, but maybe you can update me. And then just talk a bit about some of the actions that you're doing to try to rectify this.

Sure, Doug. And I can give you some directional information on that. Our stop-loss morbidity results in the third quarter were improved versus the second quarter, but still below our long-term expectations for that business, although recall, we had a very strong first quarter, as well.

We're seeing the same underlying trends as we talked about last quarter. No significant difference there, and we really break it into two categories. There's clearly an element of volatility for the prior two years, 2014, 2015, we saw our experience actually run better than our targeted pricing loss ratio by about one standard deviation.

And so far this year, we're seeing that loss ratio run about one standard deviation higher than the targeted loss ratio. So, we believe some of that is clearly just the natural ebb and flow of volatility in the business. But there are some underlying factors.

There are some business cohorts that were performing poorly and we've seen a significant increase this year in pharmacy expenses, particularly specialty pharmacy expense. So, we did take some pricing action to reflect those two elements. We began to implement those pricing actions with August 1 effective date business, and because the entire block of business renews annually, we will be able to complete that re-pricing relatively quickly.

For example, as of January 1, we estimate that we will have re-priced about 78% of the business to these new levels, and we just started that in August. So, a fairly rapid cycle there where we are able to adjust.

Have you quantified what the drain was? Or what the hit to earnings was from the unfavorable?

Yes. I mean, it's varying quarter by quarter, we're obviously year to date below what our expectations were for that. But I'm not sure we're ready to give that level of detail specifically on stop-loss.

That's fair. And then just I guess with the election, there is a view that maybe the Obamacare gets repealed or what happens. Is there any implications for your business, positive or negative, from changes that could transpire?

Yes. We have been watching that very closely. We think the impact on our business would be fairly minor.

The Affordable Care Act or Obamacare does not directly affect our business. Because the product that we offer are not offered through the public exchanges.

But obviously, as it impacts the overall healthcare system in the US, it has indirect impacts on our business. So, there could be some downstream disruption there. I would point out that any action requires the agreement of Congress, and without a 60-vote supermajority in the Senate, action is likely to take quite a bit of time and require some bipartisan consensus.

I would also point out that the direction that Congress and the president-elect are indicating, combined with -- there was a referendum in Colorado on single-payer or a so-called Canadian-style healthcare that was rejected. Overall, the theme is that the current private system of benefits in the United States is being supported, and we expect will continue to be a robust system.

Okay, great. And if I could sneak one other in, just on the notable items column. The CAD24 million expense overrun.

I go back the last 15 quarters, and I think it's been around CAD24 million. I know you've called it out as a notable item, but I guess why would you think it's a notable item, if it has been recurring? Just some color on that would be helpful.

I think it is an area that we obviously spent a lot of time on in managing our overall expenses. And again, the alternative is to, of course, reflect all of these types of items in the expected profit, and we would do so to the extent that we saw this as being part of our sustainable run rate expense experience. So, when we look at that CAD24 million, there's clearly a couple of items that we see as being somewhat one-off in nature.

There is a component of that that relates to the outperformance of the Sun Life share price relative to peers, and that's part of our long-term incentive plan, so that's something that can happen, and we would hope it happens regularly, I guess, in terms of our performance. But it's not something that we would say that's part of an expected profit item, so it appears in the expense experience. We have also got some lower allowables in respect of the wealth sales in Canada and our SLGI-related sales are doing very well, but some of the non-SLGI non-(inaudible) fund sales are lower, and so there's an expense item in respect to that.

If it were to persist and continue on for longer periods, Doug, we would consider moving some of that to expected profit, and that's what we've done in the past. But we feel comfortable that these are items that are either somewhat one-off or will reverse in a reasonable timeframe, and that's why they're not reflected in the expected profit.

Okay. Thank you very much.

Your next question comes from the line of Peter Routledge, National Bank Financial. Your line is now open.

Hi there, thanks. The question on your -- the change in the NFI or non-fixed income asset assumption. I just wondered, you took a charge to change the assumption, so I just wondered, if you could give us more color on what you did.

Sure, this is Kevin. So, setting the non-fixed income forward-looking assumption is, as I'm sure you can appreciate, is a very challenging task. It's an area where there's a particularly high degree of judgment in setting the actuarial assumptions.

So, when we started, we looked at the historical experience, and there's a lot of that on both equity and the real estate side, and that history sets a cap, based on where we may set our assumptions. Then we also took a look at forward-looking expectations both from internally from our investment teams and externally. And we are looking at, again, very long-term assumptions set in here.

So, in the context of a very low growth economic environment and low interest rates, we decided that some strengthening was needed. We are not disclosing the details of where we landed on specific assumptions. We do have now more daylight between kind of where that cap is, and where we set our assumptions, and we feel quite good about where we are now.

I was looking for it last night, do you guys disclose sensitivity on changes in those assumptions? What does unit of change mean in terms of earnings?

We have additional disclosure in our annual report. I don't have that at my fingertips.

(Multiple speakers)

I will go find it, don't worry. Thanks.

The question I had just as a followup was, you had a gain on the credit and swap spreads, and then a charge on the non-fixed income assets, and that led basically to roughly 130 gain. How big were the gross changes? Were those two big gross changes that got you to 133 or are they pretty mild?

I think you want to think about them as both pretty big but not enormous, right. So, the strengthening that we took on the non-fixed income was big, but would be high-double digits in the millions, not over 100 million. So, it was significant, but not enormous.

Dan, you're a popular person today. I wondered, if you could just, I have noticed strain in the United States is quite low. And has generally been falling over the last four quarters, both absolutely in relation to volume sales. Can you talk about what is driving that, and how sustainable it is?

In the most recent quarter, the biggest contributor was actually in our international life business. And specifically, we had a single very large sale that had good characteristics and new business gain. So, that's really what's driving that there.

Overall, obviously, as we factor in some of the newer products and the mix of products that we are selling, for example stop-loss, and now dental with the Assurant transaction, over time, that's also helping that metric as well.

Are we -- I don't want to ask you for guidance, but if your US -- sorry, pardon me, your international wealth sales, if they stay strong, will they continue to be at a level that blunts your strain in that business?

And I'm guessing you're referring to the international life. We stopped selling the international wealth business last December. Overall, we've got the international life business priced such that it creates new business gains.

And we have also made some adjustments to our product portfolio. We continue to expand that product portfolio to improve that metric as well going forward. So yes, we are optimistic that will be a positive.

Thanks. That's everything.

And your next question comes from the line of Mario Mendonca, TD Securities. Your line is now open.

Good morning. Probably for Colm or whomever.

It's been a while since I've been thinking about the behavioral impacts of rising rates, but that's clearly what people are thinking about these days. Could you just maybe search your memory for what, if any, could play out in terms of policyholder behavior, reserving generally, if we see a bit of a shock to long-term rates, not a gradual increase but a more blunt one?

So, I think it's a good question, and certainly, as we forget rates and some of the volatility we've seen, I think people will be focusing on rates a little more closely. I'm going to ask Kevin Morrissey to say a word on that.

I think for the topic that comes to mind immediately would be products where we have guarantees that guarantee the book value of investment type products when rates are going up. So, the policyholders could be incentivized to take their money when the value is diminishing of the assets in our books. And we have in place very robust dynamic hedging programs to mitigate that risk.

And presumably have the reserves in place, as well?

That's right.

And so, can we assume that if we do get a spike in rates that this has been appropriately accounted for through reserving [in hedging], or is that really just to -- is that wishful thinking at this point?

Yes, I think we want to be careful around what the specific scenario is and how it play out. I would say we do have good provisions. We have strong hedging programs, and we are confident that we don't have (inaudible).

How about on new business. Is there anything you would point to in new business that just sales of insurance or wealth products that you think would be impacted, positively or negatively?

Mario, it's Dean. I'll just comment that it has been a long time since we talked about this scenario. But I think generally speaking, we are well positioned. US, there's both defense and offense, I think we are really well positioned for the offense side of that trade.

So, think about defined benefit buyouts as lots of pension plans that would desperately love to get rid of this big liability off of their balance sheet. So we would see more demand. We would see more demand for life annuities.

We would see some of the life insurance products, like UL and other products, see more demand growth for those. I think you would see as well in our asset management businesses, I think MFS has done a great job, for example, talking to brokers and clients about the positioning and fixed-income assets as rates go back up, because there has been such a persistent mindset that rates can only go down.

So, I think MFS has done a great job and is well positioned with fantastic equity exposure, and strong fixed-income products to serve clients in that market. So, I think we're actually well positioned to benefit from a rising rate environment.

And then just one final related question. The disclosure is pretty good, and we're all familiar with the end-quarter effects of changes in rates.

But it is a lot harder to think about what the longer-term effect on core earnings would be. Colm, perhaps could you refresh our memories on where we would be, where that would actually play out, and if you could take us through that from a source of earnings perspective.

I think vis-a-vis, the disclosure with respect to this (inaudible) with increases and decreases is much more a valuation of the liabilities. And then if you think about the impacts going forward that's not captured in that, would be impacts on new business strain, and Dean mentioned certain products will illustrate a lot better with slightly higher rates. They don't need to be a lot higher, and we've seen that.

So, we could see improved business strain, particularly in Canada. We could see higher earnings on surplus as we reinvest assets in our surplus account, we're going to see higher returns there. And I think another area that has a big impact can be on our required capital.

So, as rates rise, we have a benefit there, as you know, the system in Canada is quite pro-cyclical, so that frees up additional capital, and that capital can be deployed. This is why we generally would like to see a gently rising rate environment, because it's quite conducive to our industry to a certain point, and we think we're well positioned (inaudible).

The earnings on surplus impact you referred to. Can you give us a sense about the duration of that book, so we know when we might actually see the higher-yielding securities make it into the earnings and surplus?

I think it would come through on a gradual basis. We have Randy Brown here, and maybe he'd like to say a word on that, our chief investment officer.

The duration on surplus is about five years. Rising rate environment you would assume it's not all in fixed income, but you would assume, based on the asset mix, probably a 4% decrease per 100 basis points.

Sort of 4% decrease what?

Per 100 basis-point rise in rates.

But a 4% decrease on what, though?

In surplus to mark-to-market value.

I see. But then some benefit later from the reinvesting in higher-yielding securities?

Yes, maybe just, I think Randy was answering a slightly different question. So, in terms of the run rate impact, we would see it, but it's because of the duration, as Randy says, it's not going to be a big impact, but it's really more the aggregation of a lot of impacts across the book that's beneficial to us.

Okay. Thanks for the time.

There are no further questions at this time. I will turn the conference back to Greg Dilworth for closing remarks.

Thanks, Sean. I would like to thank all of our participants today, and if there are any additional questions we will be available after the call.

Should you wish to listen to the rebroadcast, it will be available on our website later this afternoon. Thank you, and have a good day.

This concludes today's conference. You may now disconnect.