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Executives

Amir Gorgi - Head of IR

Donald Guloien- President and CEO

Peter Rubenovitch - Senior EVP and CFO

John DesPrez - COO

Simon Curtis - EVP

Beverly Margolian - EVP and Chief Risk Officer

Warren Thomson - EVP - US Investments and Global Investment Management

Scott Hand - Independent Director

Analysts

John Reucassel - BMO Capital Markets

Tom MacKinnon - Scotia Capital

Michael Goldberg - Desjardins Securities

Doug Young - TD Newcrest

Mario Mendonca - Genuity

Jim Bantis - Credit Suisse

Darko Mihelic - CIBC

Manulife Financial Corporation (MFC) Q1 2009 Earnings Call May 7, 2009 2:00 PM ET

Operator

Good afternoon, and welcome to the Manulife Financial Q1 2009 financial results conference call for May 7, 2009. Your host for today will be Amir Gorgi. Mr. Gorgi, please go ahead.

Amir Gorgi

Thank you, and good afternoon. I would like to welcome everyone to Manulife Financial's Earnings Call to discuss our first-quarter 2009 financial and operating results. If anyone has not yet received our earnings announcement, statistical package and slides for this conference call and webcast, these are available in the Investor Relations section of our website at www.manulife.com.

As in prior quarters, our executives will be making some introductory comments. We will then follow with a question-and-answer session.

The speakers who follow may make forward-looking statements within the meaning of securities legislation. Certain material factors or assumptions are applied in making forward-looking statements and actual results may differ materially from those expressed or implied in these statements. For additional information about the material factors or assumptions applied, and about the material factors that may cause actual results to differ, please consult the slides for this presentation for this call available on our website as well as the securities filings referred to in the slide entitled "Caution Regarding Forward-Looking Statement."

When we reach the question-and-answer portion of the conference call, we would ask each participant to adhere to a limit of one or two questions. If you have additional questions, please re-queue and we will do our best to respond to all questions.

With that, I would like to turn the call over to Donald Guloien, our new President and Chief Executive Officer. Donald?

Donald Guloien

Thank you, Amir. Good afternoon, ladies and gentlemen. Thank you for joining us on this call. In terms of today's agenda, I am going to open with a few remarks, and then pass it over to Peter Rubenovitch, who is going to talk about the quarter in more detail and given the topical interest in investments, particularly private placements and mortgages; we've expanded our disclosure this quarter, which Peter will also speak to.

Finally, John DesPrez, our new Chief Operating Officer, is going to speak to you about risk management and growth initiatives. In terms of the quarter, earlier today, we reported a net loss of C$1.068 billion. The quarter's net loss was primarily driven by continued declines across all equity markets, particularly in the United States, and to a much lesser extent, fair value adjustments and provisions for credit impairments and downgrades.

Peter will take you through the numbers in some detail in a few moments, so I won't roll on them here. As we look forward, knowing that there is risk of turmoil in capital, markets our focus is going to be on balancing our business mix, reducing risk and strengthening our capital levels. While I tend to have an optimistic view of equity markets going forward, we can't bank on that, and therefore we must consider more pessimistic scenarios in our capital planning.

I would now like to spend a moment discussing the leadership transition between Dominic and myself. First, some things that won't change; Manulife will remain committed to those core values that we've identified on previous calls; professionalism, real value to the consumer, integrity, demonstrated financial strength and employer of choice. These values have guided Manulife well through prosperity and challenging times, and are as relevant today as they were when we drafted them 15 years ago.

Second, Manulife will continue to be hard driven, ambitious and aggressive. They are great attributes. These will be married with a strong risk management culture that is also part of our DNA, but needs to be continuously and vigorously reinforced.

Third, we will be equally demanding of our people. Manulife is a meritocracy with a strong performance culture. We expect the best, and we are very proud of that. Fourth, we will continue to pursue a healthy balance of organic and strategic growth.

Our first priority in these unsettled times is to ensure that our financial position continues to be strong. But we will also have an unparalleled opportunity to be the consolidator, taking advantage of the current disorder amongst financial institutions worldwide. Unchanged will be the high degree of discipline and precision in execution that we have brought to every merger in our history.

So what are the differences, and first, let me clarify, these differences have less to do with differences in style or vision between Dominic and me and more to do with today's different circumstances. When Dominic joined the Company 15 years ago, we were a high-quality company, but smaller and not particularly well known. He drove us to far greater standing, and, needless to say, produced a shareholder return over the last 10 years above 12% per annum; we are very proud of that.

As we've grown our capabilities and our reach, we have different challenges, we also have different ambitions. Dom and I would like to see the Company diversify our product offerings in areas where we have shown great capability. The goal is to balance the business mix, as we have balanced our investment portfolio. It doesn't matter whether you look at it from a risk management perspective or a marketing management perspective; balance is highly important.

We do a great job of designing and managing insurance products, but we are also great providers of bank services in Canada, 401(k) products in the United States, Mandatory Provident funds in Hong Kong, fixed interest products, mutual funds and institutional investment management services in many countries around the world. We offer reinsurance solutions, manage real estate, timber, oil and gas, private equity and other assets as capably as anyone. I would like to see us expand these offerings in both breadth and depth.

We also expect sometime over the next five years to have the opportunity to broaden our geographic reach, whether that is through acquisitions or aggressive new market entry strategies that give us access to Europe, India or Korea or other parts of the world.

To be clear, right now, we have more organic and strategic opportunities in North America and Asia than we ever thought possible. So, for the near- and mid-term future, those will remain our focus. But we believe our mindset and preparation must deal with the inevitability that Manulife might indeed have the opportunity to outgrow its current geographies.

Finally, we would like to build our brand, to be better known everywhere where we do business. When people hear the name Manulife, we want them to think reliable, strong and trustworthy. We want them to instinctively think that Manulife and John Hancock are the best places to entrust with the biggest financial decisions of their lives.

Other institutions can dominate in credit cards, stockbrokerage and transactional banking, but saving for retirement, planning for estate transition, providing income for life; these are the needs that we can address better than anyone else. So with that, I'd like to ask Peter to take us through the numbers in more detail. Peter?

Peter Rubenovitch

Thank you, Donald. As indicated, we reported a first quarter loss of C$1.068 billion. Continued declines in global equity markets in the quarter resulted in charges of C$1.4 billion, largely in relation to segregated fund guarantees. Accruals for credit downgrades and credit impairments totaled C$193 million in the quarter, and declines in the appraisal value of our commercial real estate and to a lesser extent of our private equity portfolios resulted in reserve strengthening charges of C$277 million.

The cash provided by operating activities in the first quarter was C$2.5 billion, confirming the non-cash nature of these accounting charges. Excluding these items, this quarter's earnings would have been C$803 million.

Slide 9 outlines in more detail the impact of equity markets on our results. As noted, the biggest market declines were in the US at 12% and Japan at 9%, while markets in Canada and Hong Kong were down some 3% to 6%. Of the C$1.4 billion of equity related charges, C$1.150 billion related to the increased reserve accruals for segregated fund guarantees. The remaining C$255 million in equity-related charges included a C$142 million of primarily OTTI impairments accrued on equity positions in the corporate and other segment, C$63 million related to declines in equity values in our liability segments, with other items totaling C$50 million.

Turning to slide 10, post-tax charges for credit downgrades and credit impairments totaled C$193 million in the quarter. As discussed in prior quarters, our actuarial practices require us to strengthen our reserves upon credit downgrades, and therefore, we took a charge of C$72 million in the current quarter for reserve impact of credit downgrades.

Net credit impairments were C$121 million, of which over C$100 million related to impairments on our residential mortgage-backed securities holdings. These RMBS charges reflect an increase in the anticipated loss on these exposures based on actual recent experience, and is similar to results being reported by others in this area. In light of the macroeconomic environment, we continue to be satisfied with the credit performance of our investment portfolio.

Looking to slide 11, real estate and other investments had book fair value adjustments of C$277 million post tax. Of this, over C$200 million is a relation to lower appraisal values on our commercial real estate portfolio, backing our long-duration policy liabilities. Although, real estate is carried at an adjusted cost base for accounting, which reflects a gradual move to market on our balance sheet, our actuarial liability calculations reflect current period market value changes, despite the very long-term nature of these holdings.

Appraisals are generally done on an annual basis staggered throughout the year, because of the downturn in the economic environment, and the results of the actual Q1 appraisals, we've extrapolated the declines in the estimated fair values across the majority of this portfolio.

Lower real estate valuations are being driven by rising capitalization rates, which reduce current valuations, even though our rent renewal roll for this year is below 5%, and vacancies for this portfolio have not changed.

Turning now to source of earnings, the impact of investment markets in the first-quarter results stands out very clearly. Expected profit on in-force, while up noticeably, is only up 2% on a constant currency basis. The impact of new business was consistent with prior periods. The entire experience loss is driven by the three key items I've just discussed, the equity markets, lower valuations for real estate and credit-related charges. On a pre-tax basis, these items amounted to C$2.5 billion.

Equity markets also impacted the earnings on surplus, where impairment charges for OTTI on equities and other market-related effects led to a pre-tax loss of C$146 million. There were two related items which largely offset each other in the quarter, but which are reported on different lines.

Management actions and changes in assumptions reflect an actuarial charge of C$271 million, which was mostly offset by a tax related gain of C$208 million. Both of these items were largely in respect to segregated funds in our Japanese operations. Excluding this tax item, income taxes for the quarter reflect a recovery in light of this quarter's loss.

Looking at slide 13, we have an updated cash flow graph for our overall segregated fund guarantees. We have shown two levels of cash flows for these guarantees, with different lines, each reflecting different CTE or confidence levels for the underlying cash flows. The orange line represents CTE0, or the expected level, and the blue line represents CTE70, which is the midpoint or the permissible range for establishing reserves, and is the level that our reserves were at, on March 31st.

The cash flows shown are the level of payments we would pay under these guarantees, less the component of fee income associated with these guarantees, because these are shown as net liability cash flows, negative cash flows represent inflows to the firm, while positive cash flows represent outflows from the firm.

As you can see in the first years, we expect revenues that we will collect, will exceed the guaranteed benefits that are payable. Under the orange line, which is the expected level or CTE0, there are cash inflows for the first eight years, followed by cash outflows, for which the maximum in any one year is estimated at C$300 million. Benefit payments do not occur, until the customers' segregated fund assets have been depleted. In fact, under the expected scenario, on a present value basis, fully reflecting where markets were at March 31st, the fees charged for these guarantees is only estimated to fall short of the expected cost of the guarantees by some C$600 million. While we also include the net revenues on the base contracts, we would expect to make a modest profit.

The blue lines represent the cash flows at CTE70, the midpoint of our target reserve level, and the level of our quarter-end reserves. As a reminder, CTE70 can be thought of as being equivalent to assuming average market returns of less than 2% per annum for the next decade. The blue line shows that we expect cash inflows for the first six years, followed by annual cash outflows that have been fully reserved for, with a peak maximum of C$1 billion.

Even after extreme declines in global equity markets, the annual expected income from the non-variable annuity businesses, are anticipated to be well in excess of the worse single-year cash outflows that we are estimating for the variable annuity business, under this conservative scenario.

The key message is that even after fully reflecting the latest quarter-end markets, these obligations are extremely long-dated, and at conservative confidence levels, the costs associated with these cash flows are expected to be quite manageable.

Turning now to slide 14, we show a breakdown of our total reported seg funds under management. As shown in this chart, our reported seg fund balance includes some C$82 billion of wealth, group and insurance products that do not have variable annuity style guarantees.

Finally, adjusting for reinsurance and other items, this slide provides a reconciliation to the guaranteed segregated fund value that is disclosed in our SIP, and that I will discuss on the next slide.

Slide 15 shows a summary of the details of our reserves and capital in relation to segregated fund guarantees. I'd point out that this quarter, we have expanded our supplementary information package disclosures on our segregated fund guarantees.

Due to continued declines in global equity markets in the first quarter, the reported amount at risk has increased to some C$30 billion, up from C$27 billion last quarter. The actuarial liability of C$7.7 billion is over 25% of the undiscounted amount at risk, and total liabilities plus 200% of required capital for these guarantees, totals some C$13.4 billion, which amounts to over 44% of the undiscounted at-risk exposures. Virtually, all of the actuarial liability remains a margin for adverse deviation, as the expected pre-tax cost is less than C$700 million.

During the quarter, we successfully implemented CALM for our segregated fund guarantee reserves. This included segmenting assets to support these liabilities, and using the corresponding cash flows from these assets in the liability valuation.

At quarter end, our segregated fund reserves were at the CTE70 level, and it included C$323 million pre-tax increase, recorded as changes in actuarial methods and assumptions related to implementing CALM and valuing reserves at the CTE70 level.

During the quarter, as summarized on slide 16, we further bolstered our regulatory capital by raising C$450 million through a new preferred share issue, and by entering into a reinsurance agreement to cede certain Canadian Group Benefits related exposures. The newly issued preferred shares are non-cumulative five-year rate resets, with an initial yield of 6.6%. Upon future resets, these will be priced at five-year Government of Canada's plus 4.56%, or can convert to floating-rate preferreds, which will be priced quarterly, based on three-month Government of Canada Treasury Bills plus 4.56%.

We have ceded the risk of material adverse deviations in mortality and morbidity experience from our Canadian group life and health business on a modified coinsurance basis. The agreement allows us to retain considerable upside on the business, while reinsuring the risk of losses. The reinsurance allows us to reduce the capital we hold for these exposures by approximately C$300 million.

In response to suggestions from our shareholders, commencing this quarter, we've enhanced our Canadian dividend reinvestment program, and introduced a new dividend reinvestment program for US shareholders that replace our US investor services program. Under these programs, investors may elect to use dividends to acquire additional MFC shares at a discount, without paying commission. Manulife may issue such shares from Treasury. Similar programs have been recently introduced by several major financial institutions, and feedback from investors on these programs has been very positive.

On slide 18, you will note that our capital position remains strong and above historical average levels, despite the drop in equity markets during the quarter. MLI's first-quarter MCCSR ratio was 228%, up from 198% at Q1 '08, but down modestly from the 234 recorded last quarter. This quarter's small drop from year-end reflects the impact of declines in global equity markets, partially offset by the previously mentioned preferred share issue and reinsurance agreement.

The ratio is consistent with management's current objective of targeting a capital ratio that has a cushion above 200%, the upper end of our historic MCCSR target range, for as long as equity markets remain unusually volatile and turbulent.

Slide 19 provides an updated estimate of capital and earnings sensitivities going forward. MLI's reported MCCSR ratio at quarter-end was 228%. A 10% equity market correction from quarter-end levels is estimated to result in a decline of approximately 25 points in our MCCSR.

From a consolidated earnings perspective, we estimate a one-time equity market correction of 10%, followed by normal market growth at assumed levels, would reduce reported earnings by about C$1.9 billion. The increase in sensitivity is partly due to increase in the (inaudible) of these exposures, and, to a greater extent, represents the lower present value we now ascribe to assumed tax deductions on these items.

Turning to slide 20, you will see that premiums and deposits decreased by 1% to C$19.3 billion versus the prior year. This, however, represents a decline of 16% on a constant currency basis. The increased premiums arising from higher sales of fixed wealth product and in-force insurance business growth, were more than offset by the decline in variable wealth product deposits in light of continued market volatility.

On slide 21, new business embedded value totaled C$543 million in the first quarter, down from prior period levels. Consistent with historical practices, the prior period values have been updated to reflect current discount and currency rates, in order to provide an apples-to-apples comparison. New business embedded value in the first quarter of '09 was still strong at C$543 million, but was down significantly from the prior year, partly due to declining sales, in light of the challenging macro environment, but also due to the current period of new business hedging costs for our variable annuities.

Turning to slide 22, total funds under management at quarter end were C$405.3 billion, an increase of 1% over the prior year. The impact of capital markets is quite evident in this result, as strong positive net policyholder cash flows of C$22 billion and favorable currency movements of C$57 billion were reduced by C$74 billion of net negative investment income due to market value declines.

Turning to slide 23, the continued decline in capital markets adversely affected the first quarter's results for all divisions. Because the divisional results were substantially affected by the same items I just inventoried at the total Company level, I've excluded the market and investment-related variances in this table in order to isolate operational items. As you can see, all divisions had earnings after adjustments for the unusual market impacts that were not (inaudible) to the result on a similar basis in the prior year, with foreign exchange, the last line in that table, being the largest source of differential.

Turning to slide 24, insurance sales for the quarter were up 3% from prior-year levels, but down 11% on a constant currency basis, reflecting industry-wide impact of unsettled markets. There were some positives, as the new product offerings in Japan produced good growth and sales in Canadian Group Benefits were very strong.

US market share results were recently published, and John Hancock ranked number one in individual insurance sales over the last three years and ranked number one in long-term care sales for the second consecutive year. US Life sales declined significantly versus the first very strong quarter of 2008, but are in line with the first quarter of '07 sales levels. Lower universal life and retail long-term care sales were the result of consumers delaying financial planning decisions in light of the economic downturn. Overall premiums were consistent with prior-year levels, reflecting in-force business growth.

In Canada, total insurance sales were up 14%. Group sales increased by 27% due to increases in large-case market and expanded distribution initiatives in the small-case market. Declines in individual life sales were for reasons similar to that in the US. In Asia, overall insurance sales were 14% higher than last year, as strong sales growth in Japan more than offset lower sales in Hong Kong. Japan sales in the quarter were up 45% versus the prior year due to the continued success of its new insurance offerings.

Slide 25 shows that wealth sales for the quarter were down by 4%, or down 17% on a constant currency basis. Sales of fixed products grew 91% in the US and 277% in Canada, and declines in the variable products across all geographies were consistent with industry trends. In the US, fixed product sales rose by $364 million over the first quarter of '08, as equity market volatility and credit concerns prompted investors to exit equity markets and seek fixed return products from top-rated firms.

In Canada, individual wealth sales were up from the prior-year levels as increases in fixed product sales more than offset declines in both segregated fund and mutual fund sales. Group Pension sales increased by over 300% due to higher volumes of large-case defined contribution business. Bank loan volumes rose by 7% over the first quarter of '08.

In Asia, overall wealth sales were 27% lower than a year ago, as volumes in Hong Kong and Japan more than offset increases in the other Asian territories. Despite the continued market turmoil, product innovation and distribution expansion initiatives continued, and new funds were launched in Indonesia and additional products were sold through our partner bank relationships in Japan.

I'd now like to take a moment to provide a brief update on our investment portfolio, which continues to perform strongly. In response to requests from the investment community, we have expanded our SIP disclosures to provide more detail on our investment holdings, including details on our private placements, alternative investments and unrealized losses.

I've also included over 20 slides in this investment deck. In the interest of time, I will now attempt to cover the highlights of these slides. Slide 26 indicates that we continue to have a liability driven investment philosophy, based on conservative evaluation protocols. Slide 27 confirms that we continue to benefit from a high-quality, diversified asset mix, which is defensively positioned for this challenging environment.

We have limited exposure to today's more topical-in-the-news investment items. Specifically, as outlined on slide 28, we have limited exposure to European Bank Hybrid securities, with a cost representing one half of 1% of our total investment portfolio. Slide 29 shows that our fixed income securities portfolio, our below investment grade holdings only total 5.7% of fixed income assets, and that 70% of these are rated BB, which compares very favorably with the overall high-yield marketplace.

Slide 30 indicates that both our public bonds and private placements are highly diversified by industry. Slide 31 shows you that public bonds and private placements are well-rated and balanced by geography. No single non-government position represents more than 1% of our invested assets.

On slide 32, our private placements benefit from covenants and collateral which provide for better recoveries on default and better protection from credit deterioration. Most importantly, they are a great source of diversification by name, industry and geography, often offering investment opportunities that are not available in the public market. The slide 33 shows that our fixed income financial holdings are diversified by sector and geography, with over 80% rated A or higher. Majority of our bank exposure is in the Senior US Debt side, as noted on slide 34, and the majority of our insurance exposure is in Senior Debt of the operating companies, as shown on slide 35.

Moving on to our securitized assets, our RMBS holdings are described on slides 36 and 37, and are limited to one-half of 1% of invested assets, with originations concentrated in years 2005 and prior. You will recall the majority of our impairment charges this quarter related to our RMBS holdings. These charges reflect an increase in the anticipated loss severities. The second chart on this slide reflects our prudent internal credit ratings for RMBS holdings, which are significantly more conservative than their current external ratings, and are reflected in both our reserves and our capital calculations.

Our ABS holdings described on slide 38 are highly diversified, highly rated, with over 95% rated AA and above. On slide 39, you can see our CMBS holdings which are of exceptional quality with over 90% rated AAA, virtually all of which is in the Super Senior tranches and well seasoned with 90% originated in 2005 and prior.

Moving out to our mortgage portfolio, we provided significant details on various holdings on the next two slides. Our commercial mortgages, as depicted on slides 41 and 42, have been conservatively underwritten and continue to have low loan-to-values and high debt service coverage ratios. The values reflected in our commercial mortgages' loan-to-value ratios, our conservative internal appraisals that are based on long-term sustainable values, and in recent years, these have generally been 10% to 15% lower than the external appraisals we receive.

Canadian residential mortgages on slide 43, includes high-quality residential mortgages issued by Manulife Bank in Canada, the majority of which are insured by CMHC, a federal government agency. Of the exposures not [uninsured], the average loan-to-value was only 30%, and all residential mortgages are Canadian exposures.

The final component of our mortgage portfolio, are agricultural loans, and as shown on slide 44, these loans are well diversified by business type and geography. Slide 45 shows our commercial real estate portfolio that mostly consists of unlevered, high-quality urban office towers, concentrated in cities with highly diverse economies. The real estate portfolio continues to benefit from high occupancy rates, with less than 5% of leases subject to renewal in '09.

You will recall that lower real estate valuations driven by rising capitalization rates resulted in a significant charge in the quarter. This is despite the fact that the cash flows of this portfolio remain undiminished, and it is our intent to hold these properties for the long term.

As summarized on slide 46, our alternative assets are largely composed of private equities, power and infrastructure, oil and gas, timber and agriculture. These have provided strong historic returns and diversification from traditional equity markets. Though limited in size, this well-diversified portfolio is a good fit for long-duration liabilities and surplus.

We also provided on slides 47 and 48 a detailed update on gross unrealized losses on our fixed income securities, as well as the progression over the last three quarters. Gross unrealized losses are essentially unchanged from year-end at roughly C$9 billion, and still represent a relatively modest 8% of our total fixed income portfolio. Although overall spreads in our corporate holdings narrowed marginally during the quarter, this was fully offset by increases in Treasury yields over the period. As previously indicated, we have the ability to hold these securities until maturity, and have provided for expected levels of defaults in our actuarial reserves.

Fixed income securities trading down 20% or more for at least six months increased to C$1.5 billion this quarter. Although up from a C$1 billion in the prior quarter, due to the further aging of financial un-securitized holdings, exposure to this category remains at a modest level, given the size of our portfolio. In terms of unrealized losses on equities that are designated as available-for-sale securities, due to declining equity markets, gross unrealized losses in this portfolio have increased modestly from C$828 million to some C$877 million, which represents 27% of the original value of this portfolio.

AFS equity securities trading down 20% or more for at least six months totaled $269 million, again, a very modest amount given the size of the portfolio.

With that, I'd like to pass this call over to John DesPrez, our new Chief Operating Officer, who is going to talk about our plans for managing equity risk exposure, and growth opportunities in the future. Thank you.

John DesPrez

Going forward, as Donald indicated, the company will focus on rebalancing its product portfolio, to diversify its sources of income and its risk positions. The next few slides speak to what we are doing to reduce our risks, related to segregated fund guarantees, as well as to one of my first initiatives in my new capacity as Chief Operating Officer, which will be an analysis of growth opportunities for our company.

There are a number of fronts on which to manage our equity exposure, but in summary, they involve, eliminating VA expansion to new markets, hedging all new business and opportunistic hedging of the in-force block in established markets, reducing the risks on the in-force block, and changing product features and margins on new products to ensure business is profitable after hedging costs.

As you will see on slide 51, we've made significant progress on hedging our new business. In the US, all new business has been hedged since November 2008. In Canada, we leveraged off our US infrastructure and hedging strategies, and effective April 1st, all new GMWB business is being hedged, and we are targeting to hedge other products starting in October 2009.

As well, given recent market levels, we took the opportunity to hedge C$1.6 billion of in-force Canadian business written between November 2008 and March 2009. In Japan, we intend to start hedging new business by the end of the year. All told, we are now hedging approximately C$10 billion of guaranteed value at quarter-end. We have a fully dedicated hedge program team of over 20 people, plus a number of dedicated resources in each of our VA seg fund businesses.

In light of continued equity market volatility and sensitivity, the company has conducted a strategic review of its segregated fund product portfolio, including both fund offerings and product features, and started implementing changes in the last two quarters. Features vary somewhat by geographic markets, but as outlined on slide 52, our goal with respect to fund offerings is to improve hedge effectiveness, by reducing the equity component, increasing the index component, and eliminating components that are difficult to hedge. This affects both the in-force and new business.

With respect to product features, we want to reduce those that cannot be hedged or where the fees and risks are not aligned. As such, in the quarter, maturity benefit products were withdrawn in Canada and Japan, and the US has withdrawn three of its four core VA products.

In our largest market, the United States, we reduced our bonus level from 7% to 5% on May 1st, our resets are now annual instead of quarterly, and we have increased fees, all of which significantly reduce the risk profile of our current VA offering.

In addition, in June, we intend to introduce a new product in the United States, low-cost, based on one index fund, low optionality and fewer resets, an effort to redefine the category in a more appropriate place on the risk-reward spectrum.

Time of transition is also a time to reflect on the growth direction, so it is important to review the markets we are in, and the markets we are not in, but should be in. Slide 53 shows the markets and geographies where we currently operate. As you know, our philosophy has been not to dabble in markets, but to compete where we are, and can become a major player. Having said that, there is a lot of white space on this map, both in terms of geography, and the scope of our business operations.

Consequently, we are conducting a strategic review of our business mix, with an eye to presenting a plan to our board in December of this year, outlining Manulife's go-forward growth strategy.

As outlined on slide 54, the areas we are focusing on are how we can accelerate growth in our core businesses, whether we want to move into adjacent markets and whether we should move into new markets and geographies.

Our review is in its very early stages, but we do believe that our core values and competencies will enable us to pursue a healthy balance of organic and strategic growth.

With that, I will turn it back to Donald, who has some closing remarks.

Donald Guloien

In conclusion, continued decline in equity markets have reduced this quarter's reported earnings substantially. The broader economic slowdown has affected our sales volumes. Our core earnings continue to perform well, exclusive of these market-related items, and our diversified product offerings continue to meet the changing needs of consumers.

We also continue to have strong capital levels, despite volatile equity markets, and we continue to enjoy access to capital markets. Our investment portfolio continues to be well-positioned for the challenging credit cycle, with limited exposure to noteworthy items, and finally, our global franchises remain strong despite unprecedented market conditions, which we expect will provide new expansion and diversification opportunities that we are well-positioned to consider.

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from John Reucassel from BMO Capital Markets.

John Reucassel - BMO Capital Markets

First, thanks for the additional disclosure on the asset portfolio and the seg funds. A lot of information here, so I guess I'm limited to two questions. But let me start, Don, with you, and maybe John. When you talk about a more balanced business mix, I assume you're talking about more protection and less wealth management. Is that where you are leading?

Donald Guloien

No, John, you might have some of the direction. We are very proud of the guaranteed products, the VAs. They are a good product. They serve a real need, but there is obviously some risk associated with them. So what we want to do is have a balance of basically those products with all other products. We would like to expand wealth management products. We would like to expand insurance and things like group life and health, 401(k) business, other forms of pension business, institutional retail investment management, a whole range of businesses that we would like to see expand to produce a better balance.

John Reucassel - BMO Capital Markets

Don, I know you've only been in the chair half an hour, but in the past, Manulife has talked about a medium-term target of 15% EPS growth. I guess, the dust has to settle out there, but is that too ambitious a goal for the new Manulife, or is that something you are still trying to aim towards?

Donald Guloien

Well first of all John, you promoted me to the chair. I just made presence this morning, and Dr. Cook-Bennett might be a little upset to think I am vying for her job already. On the comment about the ROE goals, our earnings growth goals, we’ll have to assess that

I think in the short term obviously, this could be some challenge from the sales, the new business activity in terms of what it’s adding to the bottom line, in terms of the cost of hedging, which will be reflected going forward on a new business basis. I also believe that regulators around the world are going to take a look at capital standards, once things stabilize, and, you know, if you had the gas, they’re probably not going to have and go down in the future, they’ll probably go up. I have no inside information there, but being a betting man, I’d go in that direction.

So I think we’re going to take a good part of the rest of the year deposit, reflect on things, and then we’ll talk to you maybe about new ROE goals and earnings growth goals going forward.

John Reucassel - BMO Capital Markets

Last question. On the private placement portfolio, I know it’s been five years since the Hancock deal. What portion of that private placement portfolio is legacy from the Hancock deal, or is most of that run off?

Scott Hand

This is Scott Hand. It’s probably about half and half. We have a private placement shop in Canada, which was also putting new deals on the books, but it’s probably a seven to 10-year average life portfolio, so you kind of do the math and I would guess it’s about 50-50.

John Reucassel - BMO Capital Markets

Okay, thank you.

Donald Guloien

John, I want to pick up a scrub on that one; run off would be the wrong term to use for probably that business. The Hancock was a wonderful deal. We were actually trying to get into the private placement business in Canada and the United States, Manulife on its own prior to the merger. So we had a chance to merge with the Hancock that already had fantastic experience and resources there. That was a highly desirable commodity. We see huge advantage to private placements in enabling us to diversify our fixed income investment risk.

So that is an asset; that is not something that’s in run off mode. I think if you would ask the CIOs of any of the other Canadian companies, they would tell you the same. They feel better because some of the covenants and provisions associated with privates, and the lower loss given default rates, that privates are a prized possession, and we have one of the best originations capabilities now, in Canada and in United States.

Operator

Thank you. The next question is from Tom MacKinnon from Scotia Capital.

Tom MacKinnon - Scotia Capital

Two quick questions then maybe a follow-up from that. Just the new reinsurance deal, it just struck, what was the impact on the MCCSR? Do you have that handy?

Simon Curtis

Yes, Tom. It's Simon here. It's about C$300 million reduction in required capital. So that would be about six points to eight points on MCCSR ratio.

Tom MacKinnon - Scotia Capital

The other quick one would be implications for Hartford's decision to pull out of the variable annuity market in Japan. Has that opened up any opportunities there or, can you comment just with respect to the landscape there?

John DesPrez

It's John DesPrez. Certainly, it open ups the competition a little bit. Hartford had developed a very significant business in Japan, which may afford us some additional opportunities in that market.

Tom MacKinnon - Scotia Capital

The real question or the one I am thinking about here is, if I kind of even look at the underlying earnings growth here and strip out all the stuff that kind of happened and even with respect to some of the tax stuff, it might be around $0.52, $0.53. I mean that's not much more than the 13% ROE. Now, you do have a 16%, hurdle. Is there a certain level that we have to get equity markets back up to before you can really kind of hit that 16% hurdle, or is this something that we might have kind of readjust or thinking of going forward?

Peter Rubenovitch

Tom, I think your reckoning is approximately right, but I think that thing that's awkward in that kind of calculation is, we have done a lot of investments that typically show off investment gains, which we are not enjoying. In fact, it's quite the opposite, and so that wouldn't be embedded in our calculation. Our sales are bit softer than we are used to seeing, and we have a quite a bit more cash than we normally hold and we are giving up a fair amount of spread on that liquidity, and the liquidity is there partly because the ability to get new long term assets of quality is taking a little more time than we like.

There has been a period with very limited issuance, and so scarcity of quality assets and it will take us three to six months to get even to where we think is the appropriate level, as markets give us more investment opportunities.

So the combination of those things doesn't fundamentally change what you could earn. In a normal market, we haven't seen one of those for a little while.

Tom MacKinnon - Scotia Capital

You get the impression that there is a bit of a pause and reflect on things here and a strategic review really of your risk profile. I guess the danger is here, that you take your eye off the ball with respect to external opportunities that you kind of rejig internally here. How can you reassure us that that's not the case?

Donald Guloien

Well, it wouldn't make the economic sense for our shareholders to that and that's why we have John leading this growth task force to find growth opportunities. I mean, we want to de-tune risk and one element of what we do. Now it's a significant element, we are not going to lie to anybody about that. We want to [retool] growth in a variety of other places, and we have some very good ideas on how to do that.

Operator

The next question is from Michael Goldberg from Desjardins Securities.

Michael Goldberg - Desjardins Securities

First, can you give us some idea where you plan to set your DRIP stop purchase plan discount, and what kind of participation rate you’re aiming for?

Peter Rubenovitch

We are initially setting discount at 3%, which is consistent with what some others are doing in this marketplace, and the shareholders will determine the amount of participation. We are going to make sure people are aware of the opportunity, and typically there is fair interest in these plans, but we will be responsive to whatever demand there is.

Michael Goldberg - Desjardins Securities

That will be the same in Canada and the US?

Peter Rubenovitch

That’s correct. Programs are slightly different, but the economics would be the same.

Michael Goldberg - Desjardins Securities

Turning to your out risk in the money guarantees, could you give us some idea of how these actually move with equities specifically? How much would markets have to increase, in order to reduce the $30 billion in the money guarantees by, say 50% all other things being equal?

Simon Curtis

Indirectly, the way I often look at this myself is, that if you take that notional amount of guarantee value, which is about C$100 billion today, it applies sort of 60%, for 60% being in equities, and then you can take whatever market movement you want to and multiply it by that Michael. So if you got (inaudible) money and markets move 10% and take 60% to that, that shouldn’t really take that amount down by C$6 billion.

Michael Goldberg - Desjardins Securities

I’m sorry I missed that. Somebody coughed or something.

Simon Curtis

Basically since all the guarantees are in the money today, that C$100 billion exposure is mostly for contract in the money. So, if you had a 10% market movement on the 100 billion of guarantee value, you’d have sort of a C$10 billion movement in that notional amount, and you could take sort of 60% of that to get you how much the guarantee value should go down, because 60% is in equities and 40% is in the mix of other investments.

Operator

The next question is from Doug Young from TD Newcrest. Please go ahead

Doug Young - TD Newcrest

Hi, good afternoon. Just first on slide 15, talking about your reserves and capital as a percent of your amount of risk, I think you said 44%. One of your Canadian competitors came out with disclosure today and shows that there is 70%. Is there something I’m missing, or is that the wrong way to look at or is that not comparable? I guess that’s the first question.

Second, if you were to let CTE go up to 80, and then afterwards, reserves would have be released? How much do markets have to go up before you hit the CTE80 level?

Simon Curtis

I think, I heard that comment this morning about the coverage in the money amount relative to reserves plus required capital, in our case, it being 44%. The problem with directly comparing it between companies is, you really need to understand the underlying mix of the types of guarantees, and when they maybe coming due. So, our guarantees are generally quite long dated, which is going to reduce the accrual you would make today, both for discounting, and future fee income offset, and for some likelihood of the markets recovering.

As an example, if had a C$10 billion of notional in the money guarantees today, if they were maturity guarantee one year from now, you'd expect heavy reserves and capital covering virtually all of that. If it was against the debt benefit guarantee 40, 50 years out, you would have a much lower amount set aside, because of both discount in operating fee income and chances of markets recovering.

So, without really being able to sort of bisect the two different books, it's very hard to get a good feel for what that different coverage means.

Your second question I believe, was related to our level of reserve versus what a CTE reserve would be?

Michael Goldberg - Desjardins Securities

At what point in time do you release reserves? How much of the market increase would have to happen, and I'm assuming that you would let your CTE go to 80. What point do you start releasing reserves?

Simon Curtis

Well, we've generally been trying to keep our reserve debt around CTE70 level, so it's not a certainty that it would necessarily go up to CTE80. CTE80 reserve today would be about C$2 million more than the 7.7 billion reserve we're booking, and that is fairly close to the reserve change you see for a 10% market movement.

I would emphasize that we would not necessarily change the reserve for the CTE level as the markets move.

Michael Goldberg - Desjardins Securities

Just one follow-up, in terms of your redemption rate in US VAs, they seem to be down, obviously higher lapses would be more positive. How is this comparing or uncomparing to your expectations that you've built in terms of lapse assumptions and product that you are reserving?

Simon Curtis

I'm going to start and then Hugh McHaffie may make a few more comments. We do use a dynamic lapse formula in our pricing evaluations, so we do expect a lapse rate to come in to more contracts or in the money. The lapse rates have trended down consistent with what we had expected of our models, but they are running lower than our current expectations.

Unidentified Company Representative

The lapse rates have come down. Fourth quarter the full lapse was 5.4 and the first quarter is 4.3. So they are down as we would anticipate to go down as they are more in the money and are just slightly lower than our expectations, but within a range.

Michael Goldberg - Desjardins Securities

If you to were to have to adjust that, what type of financial impact would there be or is that really not in consideration at this point?

Simon Curtis

I wouldn't have a number at this point. Relative to some of the impacts of the market movements you've seen, it wouldn't be adopting a number.

Operator

The next question is from Mario Mendonca from Genuity. Please go ahead.

Mario Mendonca - Genuity

A question about slide 47. There are C$9.2 billion of gross unrealized losses and the AFS equities, of course, the unrealized loss being about C$900 million. There are also a fair bit of equities that are supporting also the liabilities or HFT equities. Presumably there is a good amount of those that would be some big unrealized losses there as well. Could you help me think through that, how big a number would that be?

Donald Guloien

Mario, Warren Thomson is going to answer that one.

Warren Thomson

The equities that we hold in respect of our liability segments actually are mark to fair market value on a quarter-by-quarter basis. From an earnings point of view, the general fund equities are at market value

Mario Mendonca - Genuity

I'm familiar with that. I figured though there would be some level of reserve adjustment to offset that. I guess, maybe what you're suggesting here is Manulife doesn't really do it that way. The reserves are adjusted every quarter anyway. The reserves are not adjusted for changes in HFT equities.

Warren Thomson

To the extent, we have public equities backing our policy liabilities in the general account, they are held for trading. The full impact of the mark-to-market effectively would go through each quarter unless it was a pass-through product.

Mario Mendonca - Genuity

It would go through earnings?

Warren Thomson

Go through earnings.

Mario Mendonca - Genuity

That's what I'm getting at. So there is no reserve adjustment to offset the effects of lower HFT equities?

Warren Thomson

No.

Mario Mendonca - Genuity

That's what I'm getting at. That's helpful.

Donald Guloien

Just to clarify to the other people on the call, in other words when we talk about equity sensitivity and how earnings were affected by equity markets, it includes that already because that has been taken through the income statement.

Mario Mendonca - Genuity

I suspected that, so I just wanted to be very clear on my own mind that that was the case.

Donald Guloien

No, I'm glad that you're pointing it out because not everybody would have your understanding.

Mario Mendonca - Genuity

A related topic then. It seems like there are a lot of these assets now that are well below what you paid for them and several of these are supporting policyholder liabilities. It seems clearly there were some charges this quarter about C$200 million impairments plus there was a little bit on the equity side.

What I'm trying to understand is this, if in fact we're not due for a sharp V recovery here and maybe we just sort of meander along at these levels for a while, is there some formulaic approach to recognizing impairments that you could help us out with in thinking? As we go through over the next few quarters, is C$200 million in impairments about right on a quarterly basis if we don't have a pretty sharp recovery?

Unidentified Company Representative

As you see on that slide, it is about 8% of the portfolio. That's really just reflecting the general level of corporate spreads. In fact, if you looked at the investment grade corporate bond market, it's got an average dollar price of about 90, implying if you had bought those at new issue, you would have a 10% gross unrealized loss on your profit.

So, it's just reflecting the current market conditions. There's no doubt we expect impairments in the future, given the current market. We will hold those until they recover. They are instruments that will mature. So, unless we have real defaults, I do not expect to take charges on those.

Donald Guloien

200 points to the extent they are downgraded. We take stronger provisions. Secondly, we look at every credit. If there's any expectation of impairment, we take specifics. So, I think we can hold them fairly conservatively.

Mario Mendonca - Genuity

You can't provide us any guidance here on what the level of impairments might be from a formulaic perspective going forward. It really is just quarter-by-quarter. You'd got to look at the securities and make a determination then. Is that fair?

Unidentified Company Representative

We do exactly that.

Donald Guloien

That's exactly right. The generalized spread widening, we would not expect anything with those characteristics to result in impairments. It is a tougher economy, there's no question. There's more stuff going bump in the night. We would expect more impairments I think in the next 12 months than we've historically had last couple of years that's for sure.

Operator

The next question is from Jim Bantis from Credit Suisse. Please go ahead.

Jim Bantis - Credit Suisse

A question on slide 15, I think this was John's slide with respect to managing equity risk. You spent quite a bit of time talking about the changes you're making to VA products going forward and managing that risk in terms of hedging it. There were a couple of bullets with respect to opportunistically hedge in-force block and reduce risk on the in-force block. I'm wondering if you can elaborate on those points for me.

John DesPrez

I will talk about what we've done on the underlying investments to reduce the risk on the in-force block. Then I can ask Beverly to talk about the position that we opportunistically took out Canada just recently and how that might be an example of what we want to do going forward.

We are contractually limited for doing very much with respect to the in-force block in terms of mitigating the Yangtze. The one thing we can we do have the right to change is the nature and kind of the underlying investment. As you know, we use asset allocation funds as a general proposition underlying our guarantees, which give us a range in the equity component in those funds.

As a general proposition, what we've done is reduced the equity components of those asset allocation funds to the lower end of the ranges. So the 80/20 fund could move down to close to 70/30, we've done that. The 60/40 could move more like 50/50, we've done that. So that's one area.

The second thing we've done is we've introduced more index funds into the asset allocation portfolios, those indexes being perfectly hedgeable, if you will, than some of the actively managed funds. The third thing we've done, sort of counterpart of where we got the money to move in the index funds is we've removed a bunch of funds from those models in the specialty areas that are particularly difficult to hedge. So, that's what we've done on the funding side.

Beverly, if you want to talk about what we did in Canada and what we might do in terms of hedging blocks of in-force business?

Beverly Margolian

Sure. As you know, we started hedging our new business in Canada on the end of March. What we're doing is we're taking a look at blocks that we have in-forced and seeing where it make sense from an economic standpoint to hedge that, depending on where the market levels are and what happens and where interest rate are.

So we did hedge about C$1.6 billion of in-force business in Canada at that same time. Just recently, we've hedged another C$350 million in Canada. We're looking at our blocks that we have in in-force and real opportunistically put on hedges as it makes sense.

Jim Bantis - Credit Suisse

Got it. The type of hedges you're using are just forward contractors on the equity markets?

Beverly Margolian

Yes. We're using equity futures contracts, sorting them, as well we are using some interest rate lengthening swap.

Operator

The next question is from Darko Mihelic from CIBC. Please go ahead.

Darko Mihelic - CIBC

Question for Simon and I apologize for the linear nature of it, but I want to dig away at the question that [Doug] was asking earlier about page 15 and your reserves plus required capital. It seems as though it's almost consistent in terms of your reserves and capital as a percentage of your amounted risk. The quarter before it was around 40% and now it's around 44%.

The reason why I'm asking this question, I want to dig at it a little bit more, is because if I look at markets today, I calculate your amounted risk will only be about C$19 billion or so, which means you'd be at 70%. So I guess the question is, are we looking at, knock on wood, market sort of been where they are now for the quarter, could we see like C$2.5 billion reserve release?

Simon Curtis

Turning to the page and looking at those numbers, the way I would look at this is we've disclosed what the 10% equity markets going down, the impact of that would be C$1.9 billion. That's very largely driven by equity market, impact on segregated fund guarantees. If equity markets recover and go the other way, you're going to see the segregated fund reserves reversing in exactly the same pattern.

So with equity markets up between 10% and 15%, you would see a similar type of reversal in those types of guarantees, which could be C$2.5 billion to C$3 billion. Of course, there's 60 more days to go in the quarter to get to the final impact, but certainly if you're just putting the pen in right now, that's what you would see.

Donald Guloien

Darko, don't go in here, you ruined it for me. I was hoping that was going to happen. I was going to take credit for it as the new CEO and say it's a much improved situation over the last guy. You nailed me to public that it's all due to the equity market.

Darko Mihelic - CIBC

I apologize for that. Thanks a lot, gentlemen.

Operator

Thank you. There are no further questions registered at this time, I'd like to turn the meeting back over to Mr. Gorgi.

Amir Gorgi

Thank you, operator. We will be available after the call if there are any follow-up questions. With that, I'd like to thank everyone for joining us on this call today.

Donald Guloien

Thank you.

Operator

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

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Source: Manulife Financial Corporation Q1 2009 Earnings Call
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