Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Amir Gorgi – IR

Donald Guloien – President and CEO

Michael Bell – Senior EVP and CFO

Jim Boyle – President, John Hancock Financial Services

Bev Margolian – EVP and Chief Risk Officer

Simon Curtis – EVP and Chief Actuary

Scott Hartz – EVP, General Account Investments

Analysts

Steve Theriault – Bank of America-Merrill Lynch

Colin Devine – Citi

Andre-Philippe Hardy – RBC Capital Markets

Tom Mackinnon – BMO Capital Markets

Mario Mendonca – Genuity Capital Markets

Darko Mihelic – Cormark Securities

Doug Young – TD Newcrest

Michael Goldberg – Desjardins Securities

Eric Berg – Barclays Capital

Manulife Financial Corporation (MFC) Q1 2010 Earnings Conference Call May 6, 2010 2:00 PM ET

Operator

Good afternoon and welcome to the Manulife Financial Q1 2010 financial results conference call for May 5, 2010. Your host for today will be Mr. Amir Gorgi. Mr. Gorgi, please go ahead.

Amir Gorgi

Thank you and good afternoon. Welcome to Manulife’s conference call to discuss our first quarter 2010 financial and operating results. Today’s call will reference our earnings announcement, statistical package, and webcast slides, which are available on the investor relations section of our website at Manulife.com.

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

For additional information about the material factors or assumptions apply, and about the material factors that may cause actual results to differ, please consult the slide presentation for this conference call and webcast available on our website as well as the Securities filings referred to in the slide entitled “Caution Regarding Forward-Looking Statements.”

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 requeue 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 President and Chief Executive Officer. Donald?

Donald Guloien

Thank you, Amir and good afternoon ladies and gentlemen. At our annual meeting this morning, Michael Bell and I talked about efforts to strengthen ROE and generate long-term value for our shareholders by balancing business the allocating capital, earnings solid margins, innovating, extending our product reach, and making disciplined acquisitions. We also spoke from the perspective of a strong successful Canadian company concerning global financial reform and the leadership that Canada has been showing on these ongoing developments.

I also want to mention a few of the personnel changes we announced in our press release this morning. You all have noted that we have decided to eliminate the Chief Operating Officer role. We felt the time is right to have leaders of our divisions report directly to me, the CEO and I will provide direct support to these divisions as we grow the businesses.

Most of you know John DesPrez very well. He accomplished a great deal in his Chief Operating Officer role and was incredibly helpful to me in my first year as CEO and indeed through his entire career at Manulife. John is a talented leader and will now move on to new career challenges with our thanks and appreciation.

We also know that Simon Curtis, who is with us today on the call, has decided he wants to return to corporate development, which is an improvement area for Manulife’s next stages of growth. Our CFO for Asia Cindy Forbes will (inaudible) Simon in the role of Chief Actuary. I think this reflects a great talent and bench strength that we have at Manulife. Cindy will work very closely with Simon over the transition period and Simon will be deployed in some very exciting activities in the future.

This afternoon we are pleased to take you through our first quarter results in more detail. I will make a few openings remarks before turning it over to Michael to discuss our financials.

This morning we reported a high satisfactory first quarter. We delivered sales growth in our targeted business lines, managed expenses effectively, maintained strong capital, reduced risk, and achieved strong earnings and ROE for our shareholders.

Net income for the first quarter rose significantly from a year before to CAD$1.14 billion or CAD$0.64 per share and we generated a solid return on shareholders’ equity, 16.8%. Our capital remained strong with an MCCSR ratio at Manulife Insurance of 250%. In our investments, credit experience was positive relative to market conditions. We also made significant progress hedging our variable annuity position at opportune times during the quarter.

While we are keeping an eye on the long game, I don’t like to focus too much on any single quarter. It was pleasing to report our sales in new business embedded value results for the first quarter. We demonstrated solid growth in our targeted business line. Our strong brands and distribution networks enabled us to expand our sales of quality products, good margins.

This quarter our insurance sales were up 35% in Asia with China and Taiwan leading the way with a strong collective increase of 45% in those countries. Our U.S. retirement plan services grew by 66% and our mutual fund sales increased 105% in the United States and over 260% in Canada. That’s close to CAD$3 billion in mutual fund sales in the first quarter of this year.

New business embedded value increased 22%. Notably we reduced our reliance on variable annuity products where sales were in fact down 39%. But the corresponding new business embedded value increased 37%. So overall a good quarter. We remain focused on executing against our plans and we are cautiously optimistic about future economic trends.

With that, let me turn it over to our CFO Michael Bell to provide you with more details. Michael?

Michael Bell

Thank you, Donald. Hello everybody. Today we reported first quarter shareholders’ net income of CAD$1.14 billion, which equates to CAD$0.64 a share on a fully diluted basis. Our results in the first quarter included strong topline and net income results. Net income included solid underline earnings and the benefits of the positive equity market performance and the favorable impact that this quarter’s investing activities had on the valuation of policy liabilities. These benefits were partially offset by additional tax related provisions on leveraged lease investments, changes in currency rates and unfavorable policy holder experience.

Slide eight provides a summary breakdown of the notable items included in this quarter’s after tax earnings. As noted on the slide, the quarter’s equity market performance resulted in a net gain of approximately CAD$350 million. We also experienced a CAD$195 million in net gains related to investing activities and other investment related items. The majority of these net gains related to our fixed income investing activities which had a favorable impact on the valuation of our policy liabilities. Specifically while our valuation model makes certain assumptions about our expected investment of positive cash flow, recent actual investment activity was favorable relative to those assumptions.

The remaining investment amounts related to net mark to market gain of CAD$83 million on our oil and gas and private equity investments mostly offset by a mark to market loss on our real estate timber and ag properties of CAD$67 million. Net credit charges of CAD$17 million and downgrades of CAD$15 million were only slightly higher than the long-term expected assumptions built into our valuation of our policy liabilities. In addition, as noted in our 2009 annual report, we increased our tax related provisions on leverage lease investments by CAD$99 million and this was partially offset by a release of CAD$24 million of other tax provisions. Net policyholder experience resulted in a charge of CAD$31 million after tax. This largely was due to the unfavorable U.S. long-term care morbidity experience and the unfavorable lapse experienced in U.S. life.

The strengthening of the Canadian dollar relative with June 30th, 2009 levels reduced earnings by CAD$42 million. As you recall, the June 30th, 2009 rates are used in our definition of adjusted earnings from operations. So adjusting for these items are adjusted earnings from operations for the first quarter totaled CAD$742 million after tax which was within the range of our expectations.

Slide nine details the impact of equity markets on our results in the first quarter. As noted, the S&P TSX, the S&P 500 and TOPIX increased during the quarter by 2.5%, 4.8% and 7.8% respectively. We estimate that the positive equity market performance resulted in a net gain of approximately CAD$350 million.

On slide 10, we have provided summary metrics relative to our efforts to reduce equity exposure. Our actions to reduce equity exposures combined with the impact of the improvement in global equity markets have resulted in a significant reduction in our amounted risk or in the money amounts, net of reinsurance and hedging. At the end of first quarter, the amount in the money net of reinsurance and hedging was $8.1 billion and down by over $20 billion from year ago.

We continue to increase the amount of in-force business hedged as we hedged an additional CAD$15.2 billion of guaranteed value of in-force business in the first quarter and increased the total percentage of gross guarantee value hedged to reinsure to 51%, up from 23% a year ago.

Since June 30th of 2009, we have hedged over $22 billion of the amount of in-force at that time. We estimate that this will reduce the expected average run rate of quarterly earnings in the future associated with this block by approximately CAD$30 million after tax per quarter if markets perform consistently with our long-term expected assumptions.

Now while this is our current estimate, we will likely continue to refine and periodically update this estimate in the future as we consider the potential expansion and enhancements to our hedge and as additional data emerges. These results are in line with our concerted efforts to reduce our overall equity sensitivity and we are very pleased with the progress we have made during this quarter in this regard.

Turning to slide 11, under Canadian GAAP changes in interest rates impact the actuarial valuation of imports policies by changing the future returns assumed on the investment of net future cash flows. During the quarter, the corporate rates and credit spreads used in our valuation of our liabilities increased slightly and had a minimal impact on reported earnings. Now the interest rates we use differ modestly from the overall Bloomberg indices primarily since our valuation rates consider our projected investment purchases in the future taking into account our expected investable universe. Specifically our methodology for projecting our investable universe has not changed and excludes the outlier spreads, both the wides and the narrows.

Turning to slide 12, our fixed income portfolio continue to perform very well relative to overall market conditions with net credit impairments of CAD$17 million while actuarial charges related to credit downgrades were CAD$15 million. This experience was mostly offset by our long-term expected assumptions built into the valuation of our policy liabilities.

Turning to our source of earnings on slide 13, expected profit on imports was CAD$810 million in the first quarter, down by 9% compared to the prior year. Importantly excluding the impact of currency, expected profit on in-force was up approximately 3% with growth in our Asia and Canadian divisions offsetting the reduction in our U.S. division. The expected costs associated with the variable annuity hedging program are included in this line and these costs have increased as we have expanded hedging over the time period.

The impact of new business of CAD$142 million was more pronounced than the prior year primarily as a result of our interest rates. The next experience gain of CAD$555 million reflects the pretax impacts of equity market gains, gains from fixed income activities on policy liability valuation partially offset by the leverage lease provisions and net unfavorable policyholder experience.

With respect to overall investment in market related experience, equity performance and fixed income investing activities were favorable in the first quarter of 2010, which credit and non-fixed income experience was approximately inline with our long-term assumptions.

Earnings on surplus funds were CAD$151 million pretax versus a significant loss a year ago. And the large swing is primarily due to the improvement in the equity portfolio results. In the first quarter of 2009, we incurred impairment charges and then in the first quarter of 2010, we realized after tax gains of approximately CAD$44 million.

Our effective tax rate in the quarter benefited from gains in jurisdictions with lower tax rates.

I will now flip to slide 14, slide 14 summarizes our regulatory position. At March 31st, MLI’s consolidated MCCSR 250%, up 10 points from yearend 2009. The 10-point increase was driven by our strong retained earnings in the quarter as well as the improvements in the equity market, which reduced the required capital for variable annuities.

During the quarter we filed our yearend JHU.S.A statutory statements and the RBC ratio ended the year well above our 300% target.

Slide 15 provides an updated estimate of earnings and capital sensitivities going forward. From a consolidated earnings perspective, we estimate that a onetime immediate equity market decline of 10% followed by normal market growth assumed levels. We now reduced reported earnings by approximately CAD$1.1 billion after tax. Similarly a onetime immediate equity market decline of 30% followed by normal market growth at assumed levels, we have now reduced reported earnings by approximately CAD$3.9 billion after tax versus the CAD$4.6 billion after tax at December 31, 2009. The observed decrease in sensitivity versus the prior year end is largely due to the lower in the moneyness of these exposures and increased hedging activity.

Our earnings sensitivity to interest rates has not changed materially since last quarter. In an addition as noted on the slide from a regulatory capital perspective, a onetime immediate 10% equity market decline from year end levels is estimated to result in a decline of approximately 10 points in MLI’s MCCSR.

Turning now to our topline results beginning on slide 16. Total insurance sales in the first quarter grew by 20% over the prior year on a constant current basis. Improving economic conditions fueled sales growth across all of our divisions, led by Asia, which grew by 35% on a constant currency basis.

The next several slides detail our insurance sales by division. Slide 17 show the U.S. insurance sales were up 17% over the prior year on U.S. dollar basis. John Hancock Life experienced a 6% increase over the prior year reflecting a gradual economic recovery tempered by management actions to increase profit margins.

Long-term care sales grew by 50% driven primarily by increased long-term care sales for the federal employee program were John Hancock is now the sole carrier.

Only slide 18, insurance sales in Canada increased by 9% from 2009 levels. Improved customer confidence contributed to a 9% rise in the individual insurance sales reflecting strong growth in permanent life products and a return to a larger case size. Group benefits had a good start to the year with strong results in large case segment up 13% from year ago.

So let’s turn to Asia now on slide 19. First quarter insurance sales grew by 35% over the prior year Asia on a constant currency basis, (inaudible) by increases in Hong Kong and Japan, which were up 64% and 37% respectively. In Hong Kong, the growth in sales resulted from a combination of a new product launch and increase in Asian count and an improvement in Asian productivity.

In Japan, increasing in term sales doubled relative to prior year levels. Corporate owned life insurance and medical sales also continued their strong momentum and a new whole life product was launched in the quarter. In the other Asia segment, sales grew 16% on a constant currency basis led by China and Taiwan, which we were 45% collectively on the same basis.

Taiwan sales were double prior year level driven by strong whole life sales while growth in China was fueled by an increase in the number of Asians as well as a new product launched in March.

During the quarter, new products were also launched in Singapore, the Philippines, and Indonesia.

In the first quarter, Manulife- Sinochem received two new licenses, it is now licensed in 42 cities which are home to more than 300 million individuals.

Turning to slide 20, total company wealth sales excluding variable annuities increased by 21% over the prior year on a constant currency basis. Sales of retail variable products and group retirement savings grew by 51% (inaudible) basis as a result of stronger equity markets and effective marketing and distribution efforts. Results were partially offset by a decline in the demand for fixed products.

The next several slides detail wealth management sales by division. So turning to the U.S. on slide 21, first quarter wealth sales excluding variable annuities increased by 523% on a U.S. dollar basis. The overall increase was due to growth in the John Hancock mutual funds and retirement plan services, which were up over the prior year by 105% and 66% respectively. The significant advances in these product lines were attributable to the equity market recovery, competitive fund performance on a broader offering of mutual funds and the strong distribution relationships built over the last few years.

The strong results in mutual funds and retirement plan services also drove increased net sales, up by CAD$1.2 billion compared to the prior year. Strong results in these businesses more than offset 45% decline in fixed products, which decreased in light of reduced demand and management’s focus on higher margin products.

On side 22 in Canada, first quarter wealth sales excluding variable annuities were 1% higher than in the prior year. Annualized mutual funds enjoyed one of its best quarters in our history, its good execution in combination with favorable markets led to an almost four-fold increase in gross sales.

Our group savings and retirement solutions businesses increased our sales by 10% in part due to successfully leveraging our group benefits customer relationships. Fixed rate product sales were down 38% from the record levels in 2009. Manulife bank loan volumes were down 10% reflecting real estate market declines as well as competitive pressures. During the quarter, Manulife continued to expand its distribution and relationship with Edward Jones allowing their advisors to integrate our innovative debt management and banking solutions into their clients financial plans.

On slide 23 in Asia, overall first quarter wealth sales excluding variable annuities experienced a 51% decline over the prior year on a constant currency basis. Wealth sales in Hong Kong were down relative to a strong prior year quarter and in the first quarter of 2009, it’s important to note that sales included a onetime top up of pension funds by the Hong Kong government, which was now repeated this quarter.

In Taiwan, wealth sales were impacted by a significant decline in money market mutual fund sales from prior year levels. And during the quarter, new wealth products were launched in Japan, Malaysia, Indonesia and Taiwan.

Now turning to slide 24, first quarter variable annuity sales decreased by 39% versus the prior year on a constant currency basis, and this is largely as a result of management’s ongoing initiative to better balance our risk profile across all geographies. Sales decline in Canada and the U.S. were partially offset by an increase in variable annuity sales in Japan, where sales increased in advance of April 1, 2010 tax changes.

Turning to slide 25, total company premiums and deposits increased 1% versus the prior year on a constant currency basis. Insurance premiums and deposits were 5.2% dollars for the first quarter representing a 7% increase on a constant currency basis reflecting growth of in-force business. Premiums and deposits for the wealth businesses excluding variable annuities amounted to CAD$9.7 billion for the quarter, representing an increase of 13% on a constant currency basis. The stronger equity markets contributed to deposit growth in mutual funds and retirement savings, which was partially offset by the lower fixed product sales in both the U.S. and Canada as I mentioned earlier.

Variable annuity premiums and deposits were CAD$2.2 billion in the first quarter, a decrease of 40% from the prior year on a constant currency basis and this is consistent with the decline in sales as a result of ongoing risk management initiatives.

On slide 26, overall new business embedded value was up 22% from the prior year. And as a reminder, our new business embedded value calculation is based primarily upon anticipated profit margins during the annual new business planning review and then use throughout the year. New business embedded value for the insurance businesses increased by 21% in the first quarter of 2010 relative to the prior year and the increase was driven by higher sales as well as actions taken to improve product margins.

New business embedded value for the wealth management businesses excluding variable annuities increased by 17% over the same quarter last year consistent with the overall increase in sales. And importantly, new business embedded value for the variable annuity business increased by 37% in the first quarter over the prior year and the increase is attributable to product and business mix changes as well as more favorable variable annuity hedging costs from higher swap interest rates.

Now as shown on slide 27, total funds under management at the end of first quarter were CAD$446 billion, representing an increase of 4% over the year in 2009 on a constant currency basis. This increase was attributable to policyholder cash inflows in excess of outflows of CAD$5 billion and investment income of CAD$11 billion which more than offset unfavorable currency movements of CAD$10 billion over the period.

Now turning to our investment portfolio, which is summarized on slide 28. Our holdings continue to be of high quality and well diversified. 95% of our bonds are investment grade and our invested assets are highly diversified by geography and sector. Most notably we have no exposure to (group) sovereign debt in only CAD$70 million of exposure to sovereign debt issued by the combination of Italy, Spain, Portugal and Ireland.

Those are provided on slide 29, a detailed update on gross unrealized losses on our fix income securities. We also show the progression over the last four quarters which illustrates continued significant improvement. Due to general spread narrowing, gross unrealized losses declined by 26% sequentially since the prior quarter to CAD$1.8 billion and by approximately 89% since the first quarter of 2009. At quarter end, gross unrealized losses represented a relatively modest 1.6% of our total fixed income portfolio. In addition, unrealized losses for our fixed income portfolio creating at less than 80% of cost for over six months declined by 26% since the fourth quarter of 2009 to approximately CAD$800 million.

So by way of summary we’re pleased with our results this quarter, which improved significantly from one year ago. Both our topline and bottom line results were strong and we’ve made considerable progress in further reducing our equity market exposure and we’re well positioned to execute on our top priorities.

And with that I’ll turn it back to Donald.

Donald Guloien

Thank you, Michael. So let me sum up then. We are quite satisfied with the results and the returns for shareholders for the quarter. Capital remains strong as that of our investments and credit performance. Q1 we made significant progress in reducing risk, overall the very hard work of our team in 2009 is benefiting us as we move into 2010.

I’m particularly pleased to point to some of the underlying results. Sales strong and (inaudible) business lines and very positive growth in new business embedded value trends show that we are achieving solid margins and building value for the future.

Our team is focused on the long term to execute on a range of initiatives, which will grow both our top and bottom line. Our attitude is if we focus on the right long-term strategies to building earnings and ROE, the quarters will fall into place.

With that we will be pleased to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Steve Theriault from Bank of America-Merrill Lynch. Please go ahead.

Steve Theriault – Bank of America-Merrill Lynch

First question probably for Simon. Simon, you did some lapse assumption tightening last year. I noticed in the recent quarters some of your U.S. peers have reported a continuing worsening in lapse rates, particularly in the VA business. Should we be worried at all that we could get additional strengthening of lapse reserves later this year or do you still feel pretty comfortable with the steps you took in 2009?

Simon Curtis

Thanks, it’s Simon speaking. No, we’re certainly comfortable with the steps we took in 2009. We have seen some poor lapse experience in our insurance lines but it’s primarily early duration lapses, which maybe an impact from the economic sort of meltdown that we had last year in the economy, and that would not be something that you would anticipate taking material reserve actions for. And our variable annuity lapses at the moment are quite in line with our valuation assumptions.

Steve Theriault – Bank of America-Merrill Lynch

Another question surrounding long-term care. Is there any thoughts, I’m not sure who would address this, any thoughts surrounding the impact of the new U.S. healthcare legislation on your long-term care business? Is there any potential for reserve strengthening or noise of some sort on the back of the new healthcare reality in the U.S.?

Michael Bell

Steve, it’s Mike. I think it’s really early to tell what the long-term impact is going to be of the healthcare reform in the U.S. and in particular the possibility of the federal government in effect introducing their own kind of long-term care program. I think it’s way too early before we see what the underlying regs are going to look like to draw any conclusions there. But that’s certainly something that we are paying close attention to and I would expect we will give additional updates in the future.

Steve Theriault – Bank of America-Merrill Lynch

And just finally, any hedging undertaken in April you could or would highlight for us?

Donald Guloien

No, none in April. Remember what we do is a function of equity market levels as well as swap rates. And swap rates have been down and equity markets haven’t been that favorable. So no, we haven’t executed any hedging in April.

For any in-force hedging, we of course do the new business as we write it.

Operator

Thank you. Our next question is from Colin Devine from Citi. Please go ahead.

Colin Devine – Citi

A couple of questions. First with respect to what’s hedged or not hedged at this point, it would seem to me that the real problem part of the portfolio is the U.S. variable annuities for ‘05, ‘06 and ‘07 are the most troublesome vintages. Perhaps you could give us some idea of where you stand with hedging those specifically because clearly, the ‘08 or ‘09 vintages wherever you wrote them really aren’t the issue.

Then secondly, with respect to the capitalization of Manulife in the U.S., I know that Sun had made a capital injection into its U.S. business at the end of last year. Has there been any capital injection from Manulife down into its U.S. operations?

And then finally for Michael, Rich Carbone on the Pru call today started talking about international accounting standards and some of the changes that may be coming. Obviously, they are coming to Canada faster than they are coming here. Perhaps you might give us an update as to what that may or may not mean for Manulife.

Michael Bell

Sure Colin, it’s Mike. I’ll start and Bell will then add some detail on the hedging. First on the capitalization of the U.S. business, we did not have any net capital investments into the U.S. subsidiaries here in first quarter. We’re comfortable with our RBC ratio, is actually well above the 300% long-term target that we pay close attention to in the U.S. So again, at this point I would not expect to make net capital investments into the U.S. subs over the course of 2010 as long as again, markets cooperate the way we expect them to.

Colin Devine – Citi

How much did you put in in 2009?

Michael Bell

Let’s see, there were several ins and outs, I don’t have the specific number. And again, it was muddy because of the U.S. legal entity merger as well. So I can’t give you a clean net number. But again we’ll work with the (mirror) to see what we can follow up with you on.

On Rich’s comments on the coming attractions here with IASB and IFRS. I think it’s really definitely too early to tell definitively what the timing of those changes will look like, what the impact will be, how they might possibly be implemented in Canada and/or the U.S. Obviously, it’s something that we’re paying close attention to because as you know we have a significant block of long duration business and therefore the discount rate is a particularly important issue to us. And again we expect to see an exposure draft come out in June that we’ll certainly pay close attention to on. And then there’s also the issue of whether acquisition expenses get expensed or capitalized, what the rules are there. So again I think it’s early to tell how that’s going to shake out as well.

So again, I didn’t actually listen to Rich’s comments but to me it’s way too early to draw any conclusions. Bev, you want to add anything on hedging?

Bev Margolian

Sure. Certainly we look at trying to hedge the businesses as we said when it’s appropriate and when we think we’ll have gotten some value for our shareholders. So we’re watching the markets and we’re watching the interest rates. And as various blocks become economical to hedge those we do. We have hedged a fair chunk of our Canadian businesses and the markets in Canada relative – it was a little bit earlier than U.S. And we have hedged also U.S., some of the more recent blocks but also some of our older blocks, and we look at each one of them in a very detailed cohort level so that we can optimize what we’re doing.

Colin Devine – Citi

The problem is the ‘05 to ‘07. I mean the inference I am clearly taking from your comments, okay, because the Canadian business you charge off about 100 points or more, the features are a fraction of what they are here in the States, that is not the issue. On the ‘05 to ‘07, the inference I’m taking from you, unless you want to correct it on this call, is that, in fact, that is – for the ‘05 there’s some blocks that are hedged less than the overall average and I think Mike said 51%. Is that fair?

Donald Guloien

Yes, Colin let’s back up a bit. Our philosophy is to hedge the cohorts when we feel that’s most advantageous to the shareholder. We don’t want to rush into hedging too quickly. We deliberately didn’t do that. We raised equity, cut the dividend in order to fortify our balance sheet so that we could withstand a downtrend in the markets with the hope that that would not be necessary and that we would hedge as the market recovers, and that is in fact what we’re doing.

I think you’d be correct to infer that business that was written earlier more buoyant equity markets would be the most out of the money. And if they were written more recently would be closer to the money. I guess the other point I’d point out is that the early business, the very early business was effectively reinsured.

Colin Devine – Citi

It’s the ‘05 to ‘07, to be fair it was that waiting that let you build a CAD$100 billion unhedged position. I’m sorry, now you may feel that’s a cheap shot but I’m hearing the same story we’ve had for the last few years.

Donald Guloien

I think we’ve acknowledged pretty openly that we had an unhedged position. We also promised our shareholders that we’d be judicious about hedging the position. Some shareholders would have liked us to hedge it back in March; others would prefer us not to take it at all and have the benefit accrue a 100% to the shareholders. We’re taking a moderate view that is we built up workers capital to withstand down markets but are gradually hedging it away as the market provides us the opportunity to do so. Jim Boyle’s got a few remarks he’d like to add.

Jim Boyle

Colin, Jim Boyle, I can give you a little more color on the U.S. block. I don’t have it by the exact cohorts you mentioned but to give you some sense, 61% of the U.S. variable annuity business is hedged or reinsured. So in total greater percent in the U.S. than the overall block and the net amount of risk in the entire U.S. variable annuity block at the end of the first quarter was CAD$4.2 billion. So we have made headway in all cohorts and all segments and U.S. has represented at least as much if not more than the rest of the company.

Donald Guloien

And (inaudible) point out is that the net amount of risk is decreased by approximately 70% as a result of market appreciation and the hedging activity and I can’t give you the breakdown cohort by cohort on that.

Operator

Thank you. Our next question is from Andre-Philippe Hardy from RBC Capital Markets. Please go ahead.

Andre-Philippe Hardy – RBC Capital Markets

I want to go back to long-term care in the commentary and the annual report and again, this quarter that there is likely to be reserve strengthening if current experience is maintained. You were helpful enough in your annual report to provide sensitivities on different morbidity changes. Just how much has experience been worse than projected? And can we infer the type of reserve change that we might see from that based on the sensitivities that you have given?

Michael Bell

Andre, it’s Mike, I’ll start. Specifically in the quarter, if you just look at first quarter, morbidity was worse in our reserve assumptions, our long-term reserve assumptions by approximately CAD$30 million after tax. Now, there are several reasons that I would suggest that you exercise caution here in trying to extrapolate off of that. First of all, first quarter from a seasonal perspective tends to be seasonally higher than the other quarters during the calendar year. So if it was CAD$30 million in first quarter and nothing else changed, we would expect it would prove in second quarter, whether it does or not we’ll see, but that would be the normal seasonal pattern.

We also think that a good chunk of the recent adverse experience has been a function of the weak macroeconomic environment because again the more recent experience has been worse and we believe that a component of that has been the poor economy and not necessarily therefore a predictor of the future run rate. And then maybe most importantly two other facts. A lot of the poor experience appears to be isolated in specific sub blocks of the book of business as opposed to being pervasive across the entire block.

So for example, when we look at the business that was written premerger with the Hancock, that block is running substantially worse than the business that’s been underwritten and sold in more recent years. We also note that the richer benefit plans, which were predominant before the merger with Hancock also the ones with the bad experience. So it’s not reasonable to assume that that same level of bad morbidity is going to exist in the business that we’re writing today or the business that we’ve written more recently. Obviously, remember (inaudible) proposed post merger. And then the final component which is extraordinarily important to factor in here is our ability to get additional in-force rate increases to offset the higher morbidity.

Again, we’ve had some reasonable success in prior rate filings, we’ve got some more rate filings that are being considered as we speak. We do expect that the States will be opened to good arguments on additional in-force rate increases. So as a result, we’re looking at all of those things. We have morbidity study underway as we speak, we’ll be looking at opportunities for in force our rate increases. And I’d expect that we will give another update at second quarter and that perhaps the only way the impact would be looked at is part of the third quarter basis change.

Andre-Philippe Hardy – RBC Capital Markets

Is it too early – your annual report suggests very, very large sensitivity, 4% or 5% change in morbidity.

Michael Bell

Yes.

Andre-Philippe Hardy – RBC Capital Markets

Is there any way the change could be that large based on what you’ve seen so far?

Michael Bell

Yes, I wouldn’t try to size it for all the reasons that I just described in terms of all the moving parts. I really wouldn’t try to give a range on it. I just don’t think that would be prudent. But I think it’s fair to say that the negative morbidity if we thought this was the new run rate that reserve impact if we capitalized at all in a single reserve hit, that could be material.

On the other hand, the projected value of additional in-force rate increases would also be a material offset. So what you’re asking me to do is kind of try to comment or report some kind of arbitrary range on two numbers that are moving around and could potentially be materially offsetting. So I’d rather not try to give you something but we’re not really on solid ground yet.

Andre-Philippe Hardy – RBC Capital Markets

Just a really quick one on currency. You’ve tried to give us in the last two quarters the impact of currency versus your normalized earnings estimate. And I was surprised that the impact was down in Q1 versus Q4 when the Canadian dollar went up against just about every currency. Can you explain that one please?

Michael Bell

Sure, a couple of different moving parts here going on. First of all, what I think you want to look at is the income statement changes as opposed to the balance sheet change because we’re talking about the income earned over the quarter. And most importantly it’s really the earnings mix that’s important here. So it’s not just how the currency changed but where we had the earnings and how those currencies changed. It’s not just the U.S. dollar, it’s also, for example, the Japanese Yen.

So again, there are a number of moving parts here. It’s not a material, we’re really talking about a few million dollars but it’s not quite as easy as just looking at the Canadian dollar versus the U.S. dollar and then drawing those conclusions. Again, the earnings mix is the pivotal piece.

Andre-Philippe Hardy – RBC Capital Markets

That would make sense because even on an average basis the Canadian dollar was up against everything. Thank you for that.

Operator

Thank you. Our next question is from Tom Mackinnon from BMO Capital Markets. Please go ahead.

Tom Mackinnon – BMO Capital Markets

A question on the interest rates on slide 11. I guess the change in your actuarial valuation rates is sort of difference in the observable market indices, there was a change in the observable market indices rates. And I assume that’s just because you might be heavier weighted in one group financials perhaps than what would be in the underlying indices. Is that a correct statement?

Michael Bell

It’s related to that but not precisely that. The issue here is that what we try to do in the reserve model, what we try to do in the call model is project future investments and reinvestments. And so what we’re trying to do is look at the investable universe that we will be investing that future cash flow in. So, for example, when we look at the corporate A universe, we throw out the ultra widespreads and ultra narrow spreads. And the reason is their history would suggest we don’t invest in the ultra wides because generally there is a story there and we don’t tend to like the risk profile, and we don’t tend to invest in the ultra narrows because again, we’re not getting paid for the overall risk.

So what it’s attempting to do is model our investable universe that is projected in for those cash flows. It throws out the two extremes. Normally it doesn’t really change a lot differently than the Bloomberg indices, for example, but in this particular quarter, the wides that are in the Bloomberg index came in rather dramatically and therefore the Bloomberg spreads declined but our (inaudible) investible universe was relatively unchanged widened just a shade.

Tom Mackinnon – BMO Capital Markets

Do you have any idea as to what this would look like since March 31st? I mean we have certainly those indices down 20, 25 points and the spreads down probably 6 or 7. So would that be a proxy to use as what would be the change in your actuarial valuation rate? So, I’m just trying to figure out if we should just take those observable market indices since the quarter.

Simon Curtis

It’s Simon here. I don’t have it in front of us. I think we directionally are the same as what you’re seeing in the market, but whether it’s exactly the same magnitude, I don’t know.

Michael Bell

It’s Mike. I think the key here is it is hard to use a single index and then try to extrapolate that what that earnings are going to be for the full quarter. Remember at the end of the day, it’ll be whatever the rates are at that magic date June 30th, in the case of second quarter this is going to really drive the second quarter item as opposed to where we are here in May.

Tom Mackinnon – BMO Capital Markets

And a follow-up just I guess, if we’re looking at slide 15, I mean markets are down considerably here, well, today and more importantly, I guess since March 31st. So if we are off 7%, say from March 31st, and we want to use this EPS sensitivity that you show for equity markets; if the markets went up 2%, you wouldn’t get up in a quarter, you wouldn’t get any of this gain. So if we are going to fall down 7%, do we take nine tenths of this loss?

Michael Bell

Yes again, there are a lot of moving parts but that’s not a bad rule of thumb in terms of modeling. Again, there are so many different factors that go into it. But you are absolutely right, it would be the 7 points relative to the 2 points expected at markets if the quarter ended. Again, all other things being equal, which is a broad caveat.

Tom Mackinnon – BMO Capital Markets

And then finally, the tax rate at 15% seemed a little low in the quarter. What should we be modeling to here?

Michael Bell

Because of our geographic scope, we have earnings and losses in various quarters, in various jurisdictions, some with high tax rates, some with low tax rates. So our effective tax rate is one of those, it is very difficult to model without the supporting detail. I think it’s fair to say if you’re going to ask me over a 10-year period what would I expect our effective tax rate to be for the enterprise, if our earnings were in line with what we’d expect over a 10-year kind of period, our effective tax rate would likely be in the 20s given our mix of business and given the various tax structures that we have.

Tom Mackinnon – BMO Capital Markets

What’s in the adjusted earnings from operations? What’s the assumption on taxes for that?

Michael Bell

Well again, it would essentially be what I just said, something in the mid 20s but again, I cannot emphasize enough. That number is going to bounce around a lot quarter to quarter, so I wouldn’t get overly –

Tom Mackinnon – BMO Capital Markets

Mid 20, you mean closer to 25?

Michael Bell

Yes 24, 25.

Operator

Thank you. Our next question is from Mario Mendonca from Genuity Capital Markets. Please go ahead.

Mario Mendonca – Genuity Capital Markets

Good afternoon. There was a reference on the call, I think it was you, Michael, made reference to the CAD$30 million after tax effect of hedging. If you could just clarify that for me, you are referring to, on a go-forward basis, the expected profit, say of CAD$810 million this quarter. Going forward would be the pretax amount of that CAD$30 million? It would be lower by the CAD$30 million pretax?

Michael Bell

The short answer is no, that’s not what I was trying to communicate. So let me back up and I’ll try to, I’ll hit the reset button here. What I was attempting to do was to respond to a question that many of you have asked me and many of you have asked Donald, and that is help us understand the risk return tradeoffs in terms of hedging. And we’ve said, “Look, we believe in the hedging program, we believe that it is reduced risk, it’s not a panacea. All you have to do is look at the risk factors in our disclosures to note that we don’t think it’s a panacea” but the point is we do believe that over the long haul, it does reduce risk.

It does, however, though have an impact on ongoing earnings. And so, what we went back and looked at is to look at the roughly $22.5 billion of guaranteed value of in-force that we’ve hedged since June 30th of 2009, June 30th being the date where we were looking at our expectations for 2009 and 2010 for adjusted earnings from operations. And we’ve said basically the hedging of the $22.5 billion of in-force in that nine-month period, we estimate has roughly created an earnings headwind of approximately CAD$30 million a quarter as we look forward April 1st and beyond. So round numbers and again, it’s got different blocks of business but for round numbers that would equate to approximately 50 basis points after tax for the amount of that in-force that we’ve hedged.

Now again, that number is going to bounce all over the place in the future as we hedge additional business because the hedging cost depends upon a number of factors that depends upon where swap rates are when we enter the hedges, it depends upon what volatility is going to be, it depends upon how in the money the products are, depends upon the product structure.

So the 50 basis points is a factoid to help you think about the headwind for second quarter 2010, for example, from that in-force business already hedged and we’ll look to give you additional updates in the future.

Mario Mendonca – Genuity Capital Markets

Sort of related question. The hedging now, we’re up to 51%. And I heard you loud and clear when you said hedging was not a panacea and I suppose what you might be getting at is that the sensitivity of the equity markets for a 10% decline has stayed stubbornly high at $1.1 billion in the quarter, down only $100 million from last quarter. Is there a level in the S&P where the amounts at risk start to decline more precipitously and the sensitivity starts to decline more abruptly? Can you help us think through that? Because the sensitivity is not declining at the pace I might have expected.

Michael Bell

Sure. I mean a couple of things to it to think about there. Number one to state the very obvious point, it does not have a linear impact. I know you have figured that out but just for others, it’s not a linear impact. Second, you’re absolutely right that one of the most powerful drivers to that sensitivity is how much in the money are those policyholders. So as an example, if we look at certain blocks in the U.S. and Asia in particular where they are pretty significantly in the money, that’s going to be a relatively stubborn to use your word block to try to move materially the sensitivity.

I would also point out as you’ll see in our disclosures here at first quarter, we were very transparent in laying out how we model hedging imperfections. Now those are modeling assumptions, they are not necessarily be perfectly accurate. But as a result of assuming that we are going to have some hedging ineffectiveness, it also means that our modeling assumes even for blocks that are completely hedged that there is still some negative impact. Now again, how that proves out to be we’ll see as we get more experience.

Mario Mendonca – Genuity Capital Markets

Just sort of related then, at what level on the S&P does the shape of the curve start to change, such that the sensitivity of the equity markets declines more abruptly with each increase in equity markets? Anybody can make the guess, but it was like am I right in saying it’s in the 1300, 1400 in the S&P when that sensitivity collapses?

Michael Bell

I think I wouldn’t say collapses but I think it’s fair to say that the – by the time you get up to the 1400, 1500 levels, you get back in the high water marks on some of the reset products that would help. Simon, anything you want to add?

Simon Curtis

No, I think that’s a fair comment. We don’t have an exact answer but I think Mike and I were both thinking that 1300 to 1400 range is probably the right range to use. I’d also add that it’s not just the S&P, it also Japan and Canada; we need all three markets to get back to those levels before you probably see the sensitivity get that dramatic drop that you’re thinking of.

Mario Mendonca – Genuity Capital Markets

Okay, and I’ll try to go a little quicker here now. The interest rate sensitivity obviously hasn’t changed. I’m a little surprised given that it seems like you did certain things to improve the matching of your investments with the policy reserves. You took that, again, presumably you extended the duration of the assets and matched them a little better with the liabilities. Why then would the interest rate sensitivity not have changed?

Michael Bell

Two things and then others can add. One is that we did not materially change the duration of the asset portfolio. It modestly linked in but it was not material. It was mainly walking in additional credit duration or by taking advantage of some long bonds with attractive spreads and locking those in. So what that meant is that we in effect reduced our reinvestment risk and locked in that higher spread relative to what the (calm) model would have otherwise projected.

Second, let’s also remember that this book of business is continuing to grow. So if nothing else changed we would expect to see growth in the sensitivity with the growth in the book.

Mario Mendonca – Genuity Capital Markets

So to be perfectly clear, did you extend duration or did you take greater credit risk? I struggled with what your explanation, Mike.

Michael Bell

So two things yes, we modestly linked in the portfolio but for the most part, it’s not that we took additional credit risk, these are high quality programs, for example, the Build America Bonds program in the U.S., we took advantage of also some very attractive spreads from the Quebec pension plan so again we feel very good about the risk profile, but the point is we locked in long-term spreads that were higher in the reserve assumptions.

Donald Guloien

Yes longer credit duration Mario as opposed to the duration in the absolute sense.

Mario Mendonca – Genuity Capital Markets

Okay, and then finally is there – Don and this is a discussion you and I had late in 2006, is there anything you can see on the horizon IFRS or otherwise maybe even OSFI that would cause you to question the extent to which Manulife uses non-fixed income assets to support reserves?

Donald Guloien

Well I can’t answer in the absolute but remember, yes 30, 55 year asking that asking that question and we found a way to keep doing it with despite 30, 55. I can’t promise whatever situation but we love our asset mix, principally because it keeps us out of the risk end of the fixed income spectrum. It’s actually a risk mitigation strategy as opposed to a yield enhancement strategy. I think that lost on a lot of people that set a very important success factor for Manulife. IFRS is going in all kinds of different directions in depending on where it lands. Could that create some challenges, I can’t promise you that it wouldn’t but I don’t see any issue there right now.

In terms of OSFI and in terms of capital standards, I don’t see any issue there either.

Mario Mendonca – Genuity Capital Markets

That’s helpful. Thank you.

Operator

Thank you. The next question is from Darko Mihelic from Cormark Securities. Please go ahead.

Darko Mihelic – Cormark Securities

It’s a question for Don, I just actually want to understand where your mind is at with respect to the hedging. So if I take Michael’s cost of hedging of being about $30 million after tax per quarter, and if you could get that for the rest of the book, would you hedge?

Donald Guloien

As a general approximation what we try and do and see if that one is jumping here but the who is our master of hedging. We basically try and lock in a profit margin close to 50 basis points from the point of issue that is looked after the entire contract. There is something like 50 basis points we feel good. Now that’s not every quarter, sometimes it’s more sometimes it’s less.

We also look at the go forward spread that we would earn and like it to be a positive number and as close as possible that number on a go forward basis as well. We reflect a little bit of our view of markets, if not just I have to stress this, I trust equity market levels with the technique that we use in a lot of companies use in this business is basically shorting futures and the benefit of that is they’re exchange traded, we don’t enter into counterparty risk there, but associated with that you execute a swap transaction. So the yield on swaps is very fundamental for the economics of when to hedge as well as equity market levels.

What we’re trying to do is a balanced approach. I know if you guys know on the call but few moments ago the S&P was down 8% and the Dow was 9%. We took a lot of criticism for equity raised last year. Its days like this when you feel very comfortable that that kind of movement in equity markets doesn’t cause us to have any great amount of fear. We’re fortified for that and we have the benefit of being able to hedge this out over time.

If we were to hedge this earlier, we would crystallize the loss, that would have an impact on our capital accounts, we’d have to restore that capital somehow. So what we’ve elected is a very moderate view fortify the company so that we can withstand to our mind any reasonable scenario, not all scenarios but any reasonable scenario. On the other hand we have the luxury of time being able to hedge out the in-force risk at a time most can do to our shareholders.

Darko Mihelic – Cormark Securities

And I appreciate that, I just – in my mind, I think to myself even another $50 billion to go in terms of hedging and that would be another $60 million per quarter in lost earnings or else equal. Would you entertain doing that?

Donald Guloien

No I think you’re making the assumption that this goes back, I almost Colin’s question. We try and hedge when the code works of business get to close to being at the money, not necessary exactly at the money but approximately at the money, right Bev? And so that gives us that cost. If we were to hedge some business that is 30% out of the money, the cost would be much more significant than that.

Bev Margolian

I think that, it’s that when Don talked about the profit margins, that we were trying to sort of achieve, you’re estimate about what we’ve gotten in the past and cost of hedging and we’re around 50 basis points. So be consistent with what we’ve expected to have on the future blocks that we did decide hedge and get those margins.

Darko Mihelic – Cormark Securities

I am basically asking if you could get that same cost locked in for the next $50 billion would you do it.

Bev Margolian

Well, we would probably do a fair chunk of this but maybe not all of it, because we will have a tolerance to have some equity sensitivity that’s certainly much lower than we have today.

Darko Mihelic – Cormark Securities

So you don’t have an explicit target in mind with how much you want to hedged?

Donald Guloien

Well we have a target but we want to reserve the right to change that target as we see how the experience develops. We will never get 200%. There are certain parts of it that because of the funds selections or whatever, we don’t want to create basis risk here by hedging using an S&P 500 let’s say and having a fund that operates differently that. So we would never effectively get 200%, but we would like to close up more in the position that we have today, but we’re going to not talk about our targets.

Darko Mihelic – Cormark Securities

Okay, fair enough. Thank you very much and one last question if I may, when I look at your balance sheet, it strikes me as similar to that of Sun Life in the sense that you’re carrying a lot of extra cash, if I look historically back at your balance sheet, you’d carry somewhere around 6%, you’re carrying just over 8% today. Do you have in your mind the idea that you would as things quote, unquote normalize reduce the excess liquidity position on your balance sheet and would that also help your earnings to the same extent that it would more or less help Sun Life?

Michael Bell

Darko, its Mike. The short answer is yes. In a second though, I wouldn’t get overly hung-up with the raw calculation that you just did, again it’s very important to understand what the liquidity needs are for the various operating companies and so in some sense all cash is not created equally on the consolidated balance sheet, but you’re absolutely right with your conclusion that we have additional or which I should say we have higher levels of cash supporting the surplus segment in particular today, then what our long-term target would be. We are looking to deploy that, again we never report a number on it but certainly something that we’re working with Warren to come up with some very concrete plans on.

Operator

Thank you. Our next question is from Doug Young from TD Newcrest. Please go ahead.

Doug Young – TD Newcrest

Hi just two quick questions. On slide 12, the net credit experience, I guess this is more of a clarification, the $32 million post-tax, the – is that net of the $28 million of reserve for your assumption within your valuation – within your reserves for credit or is that a gross number?

Michael Bell

Doug, that’s a gross number.

Doug Young – TD Newcrest

That is gross, okay. So net its $4 million credit impact in quarter; is that the way to look at it?

Michael Bell

Yes, that’s correct.

Doug Young – TD Newcrest

Okay, and the second with regards to your exposure to European banks, $571 million is the cost and then for the PIGS $70 million cost. Can you tell us what the carrying value would be and what types of provisions you would have on those?

Donald Guloien

Doug, Don here. What was the first question about the banks?

Doug Young – TD Newcrest

Just the European hybrid banks, the 571 I think is the cost million. Just wondering what their carrying value is, and the same question for the PIGS exposure of $70 million. What the carrying value was for both of those, and then I guess the second part of the question is in terms of provisions that you have or impairment provisions that you already hold back those exposures?

Donald Guloien

Well, we’re going to reflect that to Scott Hartz.

Scott Hartz

Excuse me. Yes the European hybrids, we did take some provisions as we discussed in the fourth quarter, when we had some ceasing of dividends at RBS and a few others. Currently the market value is about $50 million or so on the European hybrids below our amortized cost and on the sovereign debt, which is Italy and Spain, that $70 million is at Italy and Spain, it’s not significantly different than the market value from the amortized cost.

Doug Young – TD Newcrest

I’m sorry, can you just repeat the first part? You said about that it’s the market value is below cost?

Scott Hartz

Market value would be below cost on the European hybrids by about $50 million.

Doug Young – TD Newcrest

About $50 million, and did you – sorry, you didn’t mention the amount of provisions that you have?

Scott Hartz

I don’t have the amount of provisions at my finger tips but we did provision some of the RBS and others in the fourth quarter.

Doug Young – TD Newcrest

So it was, I mean market value would be pretty close to the carrying value, give or take…

Scott Hartz

Yes, I mean there is $550 odd million of the European hybrids and the market values maybe $50 million, below that on the European markets.

Michael Bell

And our carrying value is somewhere in between.

Scott Hartz

Well, our carrying value is actually the market value. There is roughly $50 million of gross unrealized loss on that block which we expect those positions to recover or we would have provision for them.

Operator

Thank you. Our next question is from Michael Goldberg from Desjardins Securities. Please go ahead.

Michael Goldberg – Desjardins Securities

Can I go back to that hedge question and just to clarify, is the $30 million cost of hedging built into the $700 million to $800 million per quarter of normalized profit that you’ve indicated?

Michael Bell

So Michael, its Mike. That was the point of picking the June 30 number, is that hedging has been done, since June 30 of 2009. And so, again one of the reasons that we have a wide range there is to reflect things like the hedging, but it is $30 million of headwind relative to what we were thinking when we developed the additional range. Now in fairness, there is also things going the other way, I mean our equity position for our surplus equities are now well above water and therefore represent opportunities for gains that we were not in that position in June 30 of 2009. So the 30 wasn’t explicitly in the original range, so it’s a new headwind but we’re sticking with the range, we didn’t update the range this quarter. And so therefore it’s again with an eye towards things like our surplus equities.

Donald Guloien

We’re also writing more new business and some of that business creates strain, even things like the mutual fund business creates strain because the right half of the acquisition cost in the first year. So lot of things would influence that number.

Michael Goldberg – Desjardins Securities

Okay and you have previously provided this expectation for your adjusted earnings from operations, that exclude experienced gains among other items yet you had over $500 million of experienced gains this quarter and in total over a $1 billion over the past two quarters. So your advice should investors ignore experience gains, treat them as if they’re an extraordinary item or should they view them as an integral but unpredictable component of earnings, or to put it another way, if you were looking to buy an insurance company that regularly had experienced gains, would you pay something for those gains?

Donald Guloien

Yes, Michael you ask great questions and but it’s not one day answer, I think some portion of those is our business, but I can’t tell you how much and it’s not because I won’t tell, I honestly don’t know, when we had the wind at our back on investment gains and years gone by, I think most of you remember that I said, hey we did well here, we’re very proud of it, it wasn’t exactly like that, but a lot of things went our way. This is not necessarily going to continue forever. We had a lot of positive results in this quarter. I would not want people to take the $1.1 billion that we earn this quarter and sort of straight line it and see that the expectation.

We try to provide that adjusted earnings to give people a sense that as a result of hedging new VA business, writing less of some businesses and so on that the run rate that we’d experience in the past are not likely repeatable in the short term and we tried to give a sense there that the expectation should be adjusted downward and that’s why we gave that guidance back in July.

We’re going to stop giving that guidance at the end of the year. We feel obligate to continue it until the end of the year, but I think as lot of these questions have indicated, it becomes less and less relevant as time goes on. We were trying to be straight with investors and say, hey you know the days when you get close your eyes and expect that we could pump out say $1 billion of earnings a quarter. That’s not likely going to happen because of the current economic environment because of the changes we’ve made in the way we do business and so on.

It’s our lower expectation going forward and we did our best to come up with a way of looking at that that was very best we could put together. As each quarter goes by, we write more new business, we hedge some more, things change, that guides becomes less and less relevant as time goes on. Michael, your point the experience gains, I mean we try and be conservative.

Now every time we have to do a basis change, that’s just of a negative type, that’s just we didn’t – we weren’t as considerably need to be. But we tried to be conservative here and you’d hope that we would generate on average positive results from experience but I can’t give you a level to expect and so on. Warren’s guys do a pretty good job generating gains, but it’s not predictable – we can’t predict which segments it will appear in, we can’t predict when it will appear.

But on average we think that they should do better than the expectations built into the valuation.

Michael Goldberg – Desjardins Securities

This is why I asked the question. Doesn’t the mix between your experienced gains and your expected earnings from in-force ultimately depend on where you set the dial in terms of assumptions?

Donald Guloien

100% correct.

Michael Bell

That’s true.

Operator

Thank you. Our next question is from Eric Berg from Barclays Capital. Please go ahead.

Eric Berg – Barclays Capital

Mike, I want to return to the discussion that you had earlier regarding the sensitivity of the earnings to a decline in the stock market.

Michael Bell

Yes.

Eric Berg – Barclays Capital

I listened very attentively to every words but I also know that there was approximately a 25% reduction in the amount of guarantee value that was hedged out in the quarter versus at the end of December. I don’t have the particular slide in front of me but earlier in this call, I did the calculation, it looks like there has been a 25% reduction in the March quarter from the December quarter in the amount of guarantee value that was hedged. So my question is again, why isn’t this relationship between the amount of – guarantee amount that is hedged, why doesn’t the sensitivity come down linearly? Why isn’t this relationship linear and why isn’t that earnings sensitivity moving far more than we saw in the quarter? And I have a couple of follow-ups. Thank you.

Michael Bell

Okay. Eric, its Mike. I’ll start and see if Simon want to add. But first of all, we would estimate that the decline in our equity market sensitivity from yearend 2009, to the end of first quarter 2010 was in that 10% to 20%. Yes it rounds if you just look at the 10% scenario on the slide, it looks like it rounds to about 10% or 9% or something like that, but un-rounded it would be in the teens and if you go back to my prepared remarks and look at the impact of the 30% decline, again it’d be more in the kind of mid-teens, would be the dropping sensitivity.

Now to your question on why is it not linear, it’s really the two points that I mentioned earlier and that is, what’s really important here is how in the money are these policies and the deeper they get in the money, the more sensitivity there is. And because the business that we’ve more recently hedged has tended to be closer to the money and not deep in the money, we don’t get that same bang for the buck in terms of a big drop in equity market sensitivity.

So that’s one factor. The other factor is remember we’re hedging essentially all of the new business and even when we hedge the in-force business, we’re building in some projected hedge inefficiency. Now again that’s a guess, if you will, we don’t really know what the hedge inefficiency will be, the next time we have a big market correction. So it is an educated guess. We – I think we disclosed in a very transparent way how we model that, but the point is we’re not trying to say the equity market sensitivity goes to zero when we hedge this business or that the new business equity markets sensitivity is zero.

It’s a reduced level but not down to a zero. Let me see if see Simon wants to add.

Simon Curtis

No, I mean I think one of your comments Mike about the rounding is important. The number at the end that we try and give round numbers because these are only estimates and we don’t want to give a false sense of accuracy, but at the end of the year the number rounds it down and now the number is rounding up. So it makes the actual decrease look considerably lower than the actual number if we did it exactly to four decimal points.

Eric Berg – Barclays Capital

Donald, you’ve been incredibly consistent in sort of your articulation of why you have taken the path that you did, but that you have fortifying the balance sheet and hedging on your terms as opposed to sort of doing it all at once. But you’ve also acknowledged in this call that you yourself have said that this strategy has been well controversial with some of your shareholders applauding it, and others being critical of it. My question is why not take the whole issue off the table by buying deeply out of the money put options on the S&P 500 that would make this a part of Manulife’s history, it would not deny anybody any upside since when you buy a put, you get all of the upside on a stock. Why not take that tack and put this whole ugly matter behind that?

Donald Guloien

I asked the very same question and I became convinced because it sounds likes a good strategy. I became convinced that the tracking error of that, it would be not be as effective as it sounds, I mean I think it’s a great idea and it occurred to me and I’ve asked the question a number of times and I’m quiet convinced the answer is right, that the best thing to do is wait from the enclosure to the money and follow. There is a whole variety of reasons to that that explain, that goes beyond the scope of this call. But I’d be granting you it’s certainly not a bad idea. We’d love to put it behind us, but we’re going to do what’s in the interest of shareholders.

Now when I often about say its controversial, those who wants us to hedge back in March, April, May, they’re seeing that we have a little bit of wisdom, some of them say hey you’ve been lucky, but they kind of see some of the wisdom of what we’ve done. This phased approached, if the market were to drop 50% to more you can be darn sure all the people that want us to hedge it out are going to say, you should have listened to me.

On the other hand, if the market goes up 250%, those who said, why did you go so fast are going to have that view. We’re not trying to run a popularity contest, we’re trying to do the right thing for the shareholders at least on how we see things. And I guess the most important thing as we fortified ourselves for the downside risk, so that if we don’t get the change to hedge us out for another couple of years, it’s not the end of the world.

Eric Berg – Barclays Capital

Last question is of a similar nature but of a narrow nature and that has to do with long- term care. For as long as I can remember and maybe you’ll disagree long-term care has had its ups and downs at Hancock. For as long as I can remember, there have been issues, maybe not every quarter, maybe not for many quarters but it has never been consistently a winner for you guys. Why are you sticking with it if it just doesn’t seem like over the course of time Manulife or Hancock has been able to get it consistently right?

Donald Guloien

Sometimes when markets are like that and people lose a lot of money and I’m not talking about us, I’m talking about the industry. And activity has just about when it starts to get good.

And those of you who are followers of the hog pricing cycle knows it works that way in a lot of things do in markets and we think there is some different approaches that could be taken to the long-term care business. It’s a real consumer need. And if everything, if ever even a growing need and we would like to find a way to address it that has a better balance between the consumer and the shareholders.

In the meantime, we’re raising our prices both on in-force business and on new business. We don’t have a crystal ball and no one does in the business, you can’t predict what morbidity rates are going to be long-term, but where there higher, we’ll appeal for rate increases just like regulated utilities do and just like people in the health insurance business in United States do and we’ve had some success, we’ve had considerable success in doing that. It’s not with others controversy, it’s not the first thing that insurance commissioners want to do is approve rate increases especially in this economic environment, but we are having success doing that.

But I think ultimately we’ll look to some different product formulations how to address this need and mitigate our shareholders risk, but still meet the consumer need and we have some ideas how to do that. We have a significant position in the market and we raised our prices obviously, other companies are free to do whatever they thing is in the best interest of their shareholders, but given the experience in the industry and I don’t know if you’ve seen an A.M. Best report that talks about the experience of long-term care, it’s a wonderful read.

I think regulators and companies everywhere have to think, are we in this business to do public service or in this business to make a profit, and we are in the business to make a profit.

Eric Berg – Barclays Capital

Thanks Don, I’m going to – I’ll work with Amir. I would like to get a copy of that A.M. Best report, so I’ll work through him. Thank you so much.

Donald Guloien

Okay. You’re welcome.

Operator

Thank you. We have a follow-up question from Colin Devine from Citi. Please go ahead.

Colin Devine from Citi

Yes one quick question. On the US variable annuities, the older ones, was there an annual step up on those or not and I am just curious to in-the-moneyness going to continue to rise if markets even are flat?

Jim Boyle

Hi Colin, Jim Boyle again. Like most companies we had multiple product designs but in the main, most of those products did in fact have the annual step ups for themselves. I think the question you’re driving at directionally is yes, they do.

Colin Devine – Citi

So they would be stepping up from if they were reset in 2007 at a rate of 5 or 6% compounding from that?

Jim Boyle

Yes.

Colin Devine – Citi

Thank you.

Donald Guloien

Its linear I think best point out, but Colin that’s reflected in our overall exposure data, right?

Bev Margolian

Yes.

Colin Devine – Citi

I appreciate Don, but the point of this has been the problem blocks, right, that are the deep in the money are actually getting deeper in the money because they’re compounding at 5 or 6 or whatever the step up rate is on blocks that were essentially high watermarked to the S&P in ‘07.

Donald Guloien

Colin, I know you’ll know it but there are sales of these products are dramatically reduced and the --

Colin Devine – Citi

Don, if you were selling them in ‘08, it’s not a problem, Don. It is in ‘07 ones, it’s the ‘05, ‘06 and ‘07s, but -

Donald Guloien

You got to look forward and we’re addressing the issues.

Colin Devine – Citi

No, I appreciate that. I’m just trying to understand what’s been hedged in terms of the actual risk here and what’s not. Thanks.

Operator

Thank you.

Amir Gorgi

Operator, are there any more calls?

Operator

There are no further questions registered at this time.

Amir Gorgi

Great, thank you. So with that we are available for any follow-up calls and have a good afternoon everyone.

Donald Guloien

Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Manulife Financial Corporation Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts