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Manulife Financial (NYSE:MFC)

Q2 2011 Earnings Call

August 11, 2011 2:00 pm ET

Executives

James Boyle - Senior Executive Vice President of U S Division and President of John Hancock Financial Services

Michael Bell - Chief Financial Officer, Senior Executive Vice President and Member of Risk Disclosure Committee

Donald Guloien - Chief Executive Officer, President, Director and Member of Risk Disclosure Committee

Craig Bromley -

Anthony Ostler - Senior Vice President of Investor Relations

Cindy Forbes - Chief Actuary, Executive Vice President and Member of Risk Disclosure Committee

Beverly Margolian - Chief Risk Officer, Executive Vice President and Member of Risk Disclosure Committee

Analysts

Joanne Smith - Scotia Capital Inc.

Doug Young - TD Newcrest Capital Inc.

Michael Goldberg - Desjardins Securities Inc.

Tom MacKinnon - BMO Capital Markets Canada

Mario Mendonca - Canaccord Genuity

Darko Mihelic - Cormark Securities Inc.

Robert Sedran - CIBC World Markets Inc.

Sumit Malhotra

Gabriel Dechaine - Crédit Suisse AG

Steve Theriault - BofA Merrill Lynch

Unknown Analyst -

Peter Routledge - National Bank Financial, Inc.

Andre-Philippe Hardy - RBC Capital Markets, LLC

Operator

Please be advised that this conference call is being recorded. Good afternoon and welcome to the Manulife Financial Q2 2011 Financial Results Conference Call for August 11, 2011. Your host for today will be Mr. Anthony Ostler. Mr. Ostler, please go ahead.

Anthony Ostler

Thank you, Jenny, and good afternoon. Welcome to Manulife's conference call to discuss our second quarter 2011 financial and operating results.

Today's call will reference our earnings announcement, statistical package and webcast slides, which are available in 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. Available to answer these questions about their businesses are the Heads of Asia, Japan, the U.S., Canada and general account investments.

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 applied and about the important 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.

[Operator Instructions]

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

Donald Guloien

Thank you, Anthony. Good afternoon, everyone, and thank you for joining us today. Joined on this call by our CFO, Michael Bell, as well as several members of our senior management team including our United States General Manager, Jim Boyle; our Canadian General Manager, Paul Rooney; our Asian General Manager, Bob Cook; our Japan General Manager, Craig Bromley, it's great to have you here, Craig; Scott Hartz for General Account and Investments; Bev Margolian, our former Chief Risk Officer and our new Chief Strategy Officer; Cindy Forbes, our Chief Actuary; and Rahim Hirji, our new Chief Risk Officer.

Our second quarter 2011 financial results were announced this morning. We are making excellent progress on a number of fronts. We delivered strong underlying sales growth, including record sales, in a number of our businesses. We expanded our distribution in Asia through both agency and bank channels. And we produced excellent investment results. I'm very pleased with the progress we have made in executing our strategy.

Given the volatility of markets around the world both during the quarter and particularly over the last 2 weeks, I am very pleased that both the amount and the effectiveness of our hedging to date, which is significantly dampening the impact of the decline in equity markets and interest rates on earnings and capital ratios. Hedging does have a cost, but at times like these, it is clearly beneficial. It also allows investors to focus more and more on our core business, which is developing very positively.

In the second quarter, we had quarterly earnings of $490 million, which is after the $370 million charge for changes in our fixed income ultimate reinvestment rate assumptions that in the past normally occurred in the third quarter.

In terms of net income attributable to shareholders, excluding the direct impact of equity markets and interest rates, we delivered $929 million, over double that of last year. And in fact, our U.S. GAAP numbers are similar to those. Our progress in the second quarter aligns perfectly with our strategic priorities, namely sales of wealth and insurance products targeted for growth were up 27% and 28%, respectively.

We expanded and diversified our distribution in Asia with several new important bank distribution agreements. In Canada, we generated record mutual fund sales while in the U.S., we delivered a 50% increase in Mutual Fund deposits, $3.5 billion for the quarter, a nontrivial number. We achieved a record $481 billion in funds under management, despite movements in currency and stock markets. Our hedging program successfully dampened the impact of the second quarter's low equity markets and interest rates.

We reduced to $1.2 billion the sensitivity

to 100 basis-point drop in interest rates, $600 million if you include 100% of the available-for-sale bond offset. This surpasses our 2012 year end target and brings us 90% of our year end 2014 target of $1.1 billion. The Manulife's MCCSR ratio at 241%, our capital level continued to be strong. We've also reduced our capital sensitivity to changes in interest rates. And finally, we continue to offer a high-quality proposition to clients with 27 new or enhanced products launched to the market. This includes an offshore renminbi bond fund in Asia, synergy in Canada, income plus for life with auto portfolio rebalancing feature in the United States.

In summary, our capital remained strong, our asset quality is superior. We're seeing strong underlying sales growth. And we delivered $929 million of net income attributable to shareholders, excluding the direct impacts of equity markets and interest rates. I hope you agree that our strategy of delivering results that will position Manulife extremely well for future earnings growth and ROE expansion.

With that, I'll turn over to Michael Bell, who will highlight the financial results and then open the call to your questions. Thank you.

Michael Bell

Thank you, Donald. Hello, everyone. Our second quarter results demonstrated strong execution of our strategic priorities, as we grew our targeted businesses and benefited from our reduced risk profile. We continue to be ahead of our original timetable on reducing both interest rate and equity market sensitivities. And we took additional actions to further reduce our interest rate exposure in the second quarter.

Overall, we delivered net income of $490 million in the quarter despite underperforming equity markets and a low interest rate environment. And these results reflect our improved ability to mitigate much of the impact of the unfavorable financial markets.

MLI ended second quarter with a strong capital position, with an MCCSR ratio of 241%, which provides a substantial cushion against the risk of adverse market conditions, particularly in light of the expanded hedging. In the second quarter, we also completed our annual update to our fixed income ultimate reinvestment rate assumptions, referred to as the URR. This resulted in a $370 million charge to earnings, which I'll discuss further in a few minutes. And I'd also note that we announced the sale of our life retro business, which is expected to release capital in the third quarter 2011.

So turning to Slide 7, you'll note that there were a number of notable items impacting the second quarter after-tax earnings. There was a $69 million net loss due to the direct impact of equity markets and interest rates declining in the quarter. And this excludes the $370 million charge for the annual URR update caused by the current interest rate environment. The direct impact of equity markets resulted in a loss of $148 million, as we benefited substantially from the expanded hedging program relative to a year ago. The direct impact of changes in interest rates in the quarter generated a $79 million gain, as we benefited from favorable changes in both bond and swap spreads, as well as realized capital gains on the sale of our AFS bonds and the favorable impact of additional de-risking actions taken in 2011.

Importantly, our second quarter results benefited from our expanded hedging for both equity markets and interest rates. As I mentioned, we took a $370 million charge in the second quarter for our annual update to the fixed income URR. Our process to update URR assumptions is formulaic, and uses the 5- and 10-year rolling average government bond rates based upon the assumption that June 30, 2011, rates will be in place through June 30, 2012. Since rates have declined, this update represents a charge to earnings. While the calculation of the reserve impact is complicated, process improvements that we've made over the last 12 months enabled us to estimate the impact of this annual update at this time rather than waiting to include it in the annual basis changes scheduled for third quarter.

In addition, there was a $52 million loss in the VA liabilities that were dynamically hedged. We also noted that the expected cost of our current macro equity hedging program based on long-term valuation assumptions was approximately $104 million for the quarter. We also recorded a gain of $123 million from the impact on policy liabilities related to activities to reduce our interest rate exposure. Additional investment-related gains amounted to $217 million from fixed income trading activity, non-fixed income investment performance and a favorable change in our asset mix.

So overall, we're pleased with the benefit we've received in the second quarter results from the de-risking actions that we've taken.

I now move to Slide 8, which is our source of earnings. Expected profit on in-force increased primarily as a result of increased fee income on higher assets under management. Experienced gains were primarily driven by the impact of investment gains; partially offset by the impact of falling equity markets and lower interest rates; and a $25 million charge for unclaimed property in John Hancock Life. Management actions include the URR charge and the expected cost of the macro equity hedging program. These were partially offset by the realized capital gains on our AFS surplus bonds.

I'd now like to walk through the demonstrable progress that we've made against our 5 strategic priorities. So in Slide 10, I'll start with our good results driving profitable growth with strong insurance sales. Sales of our targeted insurance products grew by 28% over second quarter of 2010 on a constant currency basis. Our Asia Division delivered strong sales growth with second quarter sales up 42%. And this was driven by a 35% increase in the ASEAN region and a 67% increase in Japan. In the ASEAN region, record sales in Vietnam and the Philippines were driven by strong growth in our agency sales forces. Japan sales were strong in the second quarter, but are expected to slow in the third quarter as we've repriced our whole Life Insurance product.

In Canada, insurance sales were up 7%, primarily driven by the Group Benefits and Affinity businesses. In the U.S., we're pleased with our 21% sales growth for the targeted Life Insurance products, as we've replaced the majority of the no-lapse guarantee UL sales with products with less interest rate risk. So overall, we did a very good job growing sales of the insurance products that we've targeted for growth.

Turning to Slide 11. Sales of our targeted wealth products for the quarter grew by 27% over a year ago. We generated strong growth across all 3 of our geographic divisions. In Asia, sales increased 59% compared to the same period in the prior year. In Canada, Individual Wealth Management sales increased 22% driven by record Mutual Fund sales, which more than doubled, and strong growth in both the investment plus product and the Manulife Bank.

In the U.S., John Hancock Mutual Funds had another strong quarter for sales with a 50% increase over the second quarter of 2010. While 401(k) sales were down in the second quarter, we have a record level of proposal activity, which is an encouraging sign for the second half of 2011.

So overall, we are pleased with our substantial increase in non-guaranteed wealth sales.

Improving ROE is another one of our strategic priorities. And as shown on Slide 12, we continue to change our business mix in order to improve our long-term ROE outlook and risk profile. Parts that we've targeted for growth have increased in double-digit rates compared to second quarter 2010 while the premiums and deposits for the products not targeted for growth are down relative to a year ago. And as we discussed in our 2010 Investor Day, changing the mix of our business is an important priority. And we are pleased with our progress to date.

Moving to risk management. You can see on Slide 13 that we are still ahead of our original timetable for reducing equity market sensitivity with 60% to 66% of underlying earnings sensitivity now hedged. As of June 30, our estimated earnings sensitivity to a 10% equity market decline was $490 million to $590 million.

On Slide 14, you'll see that we also continued to be ahead of our original timetable to reduce our interest rate sensitivity. We continued our de-risking activities in the second quarter. We executed additional forward-starting swaps. And we purchased long-duration bonds to increase the duration of our assets backing policy liabilities. We've decreased our estimated sensitivity to 100 basis point decline to $1.2 billion, surpassing our year end 2012 target and bringing us to within 10% of our year end 2014 target of $1.1 billion. Including the 100% of the AFS bond offset, our estimated sensitivity is now at June 30, $600 million.

Moving to Slide 15, as I noted earlier, interest rate changes in the second quarter resulted in a net gain of $79 million. In second quarter, favorable changes in spreads contributed to earnings. Specifically, corporate spreads increased based on our own investable universe while swap spreads declined further. And both of these spread changes increased second quarter earnings.

In addition, we realized a gain of $107 million on the sale of AFS bonds. As we've discussed, we intend to use AFS gains to offset some of the impact of lower treasury rates. While we realized most of these gains late in the quarter, most of them were realized before rates increased during the last week of June, so we also benefited from the timing of these sales. Our de-risking activities in 2011 also reduced our sensitivity to the decline in treasury rates. So overall, we feel good that the impact of the interest rate change in the quarter was much more favorable than it would have been a year ago before the additional de-risking.

Slide 16 demonstrates that our investment portfolio continues to be high-quality and well diversified. Our invested assets are highly diversified by geography and sector, with limited exposure to the high-risk areas dotted on the slide. We continue to view our investment management as a significant competitive advantage.

The next slide demonstrates the success of our continued investment discipline. You can see that second quarter credit charges were in line with the long-term assumptions even with the turbulent financial market conditions. And we view this as a good result.

Moving now to Slide 18, this slide summarizes our capital position for MLI. As of June 30, MLI reported an MCCSR ratio of 241%. Combined with the actions that we've taken to reduce our market exposures, our strong capital position represents a substantial buffer. Our completion of a third-party reinsurance agreement for our Canadian business increased our ratio by 6 points in the second quarter. A decrease of 4 points resulted from the continuing phase-in of the adoption of IFRS and the change for the MCCSR guidelines for affiliate reinsurance.

Now subsequent to quarter end, we announced the sale of our Life retro business to Pacific Life, who's based on the United States. Although the Life Retro business is profitable, it does not have a growth profile that's acceptable to us. And I'd also note that as a result of more restrictive Canadian regulatory requirements for this business, a non-Canadian buyer such as Pac Life could operate this business with less capital. We expect this transaction to close in the third quarter 2011 and generate an after-tax gain of approximately $275 million, and increase the MCCSR ratio for MLI by approximately 6 points.

And finally, we continue to offer a high-quality value proposition to our clients. Slide 19 highlights a number of new product and service enhancements and the awards that we received in the second quarter.

So now turning to Slide 20, I'll now answer 4 questions that may be on investors' minds. And the first is, what's the status of the long-term care in-force price increases? Well, while it's still early in the cycle, we continue to feel positive about our progress so far with the states, and their review and approval processes of our in-force rate increases. Rate increases are progressing well, and we now have approvals from 20 states for our retail business. And the retail business represents the majority of the financial impact of the total long-term care business.

As a result, while it's still early in the cycle, we continue to feel comfortable with our estimates and timetable that we developed when we calculated the reserve strengthening at the third quarter of 2010. And we're pleased with the progress that we're making.

Second question is why did we update our fixed income ultimate reinvestment rate assumptions in the second quarter rather than in the third quarter as part of the annual basis changes? First, as I discussed earlier, we made our annual update to the URR assumptions in the second quarter. And it resulted in the $370 million after-tax charge. Our process to update the fixed income URR assumptions is formulaic, and uses the 5- and 10-year rolling average government bond rates. And we assume that the June 30, 2011 rates will remain in place for the next 4 quarters.

So while the calculation of the reserve impact is complicated, process improvements that we've made over the last 12 months enabled us to estimate the impact of this annual update at this time rather than waiting and including the update based upon June 30 interest rates at the third quarter.

The third question relates to the annual review of the actuarial methods and assumptions that'll take place in third quarter 2011. As noted, we expect to complete our annual review of all actuarial methods and assumptions in the third quarter. And I'd ask you to note that we are reviewing $162 billion of actuarial liabilities, many of which have very long durations. As we've discussed before, there is a lot of judgment required in this process.

While we're not done with our analysis, and cannot currently reasonably estimate the aggregate impact of the additional basis changes in the third quarter, early works suggest our U.S. mortality table updates, when completed, may result in a charge which would have a material impact on third quarter 2011 earnings. Preliminary indications are that this charge could be up to $700 million after-tax.

While we generally experienced mortality gains in our recent earnings in the U.S., including this quarter, some of the emerging trends are subtle, as we are seeing different experiences depending upon the block of business. For example, a large portion of the potential mortality reserve strengthening is for the acquired John Hancock Permanent Life business. Losses on this bloc started to emerge recently. And we are updating the underlying mortality tables to reflect this submerging, older age, older duration experience.

On other U.S. Life business, we're seeing different experience depending upon the duration of that business. So, for example, in the early policy durations, claims experience has been, and continues to be, more favorable than what we priced for. And this has been generating mortality experience gains. However, we are seeing losses on later duration business and at older attained ages, and the potential reserve strengthening reflects these results.

The result of potential updates to the mortality tables is that the total lifetime claim cost from issue are not changing materially. So as such, we don't expect the updates to cause material changes in the prices that we charge in the market. In aggregate, we expect the basis change impact for U.S. mortality to be negative to earnings in the third quarter.

Now beyond mortality, work is continuing on the review of other actuarial assumptions. And we would expect the other impacts to include both positive and negative adjustments. Work is expected to be completed in the third quarter, and the actual impact could differ from these early indications.

Our fourth question is around the market movement since June 30. Obviously, a considerable amount of financial market volatility has occurred since the end of second quarter. The lower equity markets and interest rates will obviously have an impact if they remain at those levels through September 30. But due to our considerable hedging progress in the past year, we are much better-positioned. Nevertheless, without additional hedging actions, a decline in equity markets and interest rates would likely increase our earnings sensitivities in the third quarter.

I would also note that the volatility in the reported results should remind all of us that mark-to-market accounting regimes are often not the most suitable for long-term illiquid businesses like insurance. Given what has happened in the past 2 months, we're particularly pleased that we accelerated our hedging over the past year.

So in summary, we're pleased with our progress as we continue to execute our strategic plan to grow targeted businesses while we reduce our risk profile. We achieved record funds under management in the second quarter and delivered record sales in a number of key businesses. We took further actions to reduce our equity market and interest rate sensitivities that remain ahead of our original timetable. This progress enabled us to mitigate the impact of the underperforming equity markets and low interest rates in the second quarter. Our strong capital levels, combined with the actions that we've taken to reduce our market exposures, represent a substantial cushion relative to financial market volatility.

We accrued the impact of the change in the fixed income URR assumptions this quarter, which is mostly offset by investment gains. And we delivered $929 million of earnings, excluding the direct impact of equity markets and interest rates. Our life retro sales is expected to close in the third quarter, and is expected to contribute $275 million after-tax in third quarter earnings and 6 points to MLI's MCCSR ratio. We also expect to complete our annual basis changes in the third quarter and to take a charge for the changes in our U.S. mortality assumptions. So overall, and encouraged by our progress against our strategic plan and the momentum that we're gathering.

This now concludes our prepared remarks. And operator, we'll now open the call to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Mario Mendonca from Canaccord Genuity.

Mario Mendonca - Canaccord Genuity

A question first on the URR, Michael. It was applied at June 30, so that Canadian long-term bond, the benchmark, the prescribed rate that OSFI has the life insurance companies use. At the end of June, it was something like 3.5%, if not more. Right now, it stands at about 3%. So it's moved down pretty significantly since you did your URR work. Are you going to update that in Q3 2010 to take into account the drop? And if you are, or if you had waited until Q3, how big would the URR charge have been relative to that $370 million that you actually took?

Michael Bell

Mario, it's Mike. I'll start and see if Cindy wants to add. I'd first point out that our standard practice now for the last several years has been to use the June 30 rate. So there's not a change -- we've pegged this URR update off of the June 30 rates now for, again, certainly since I've been in the job. And in addition, we continue the practice of assuming that, that June 30 rate is in place for the next 12 months. So through June 30, 2012, when we'd expect to update it again. As a result, I would not expect that we would have to update the URR again later in 2011. And therefore, I would expect that the next update will be 2012. Now obviously, as you correctly point out, rates have dropped since June 30. And even more importantly, because the URR is based on a 10-year weighted average with the last 5 years being double weighted, and the fact that higher interest rate years are falling out of that rolling average and now being replaced by lower interest rates, I would expect if rates stay where they are, that we would have another charge that would likely be bigger than $370 million at June 30, 2012. But to answer your question, I would not expect another adjustment here at 2011.

Mario Mendonca - Canaccord Genuity

My second question, and that was, thank you -- that was very clear for me. The second question relates to another important assumption. You saw -- the market performance assumptions used in the U.S., Canada, they're different from what's in Asia. And presumably, or Japan specifically, the 6% in Japan versus the 10% and 9% in Canada, in the U.S. and Canada, respectively. First, why would Japan's be so much lower? And I think I know the reason for this is because that's what history has shown us. And I guess, the related question is how much more weak S&P performance, and it seems like we're looking at the same S&P level now that we have since over the last decade. How much weaker does it have to be before you determine that, that 10% in the U.S. and 9% in Canada isn't an approximate long-term assumption anymore?

Michael Bell

Again, Mario, I'll start. See if Cindy wants to add. First, you're absolutely right. We do have a very standard process in terms of looking at historical equity market recurrence by geography. And you're absolutely right that historically, the returns in Japan have been lower than North America. And I would also note that interest rate environment during that period is also tended to be lower in Japan as well during that period. In terms of looking at it, we look at it every year. And also, I'm aware that the Canadian Institute of Actuaries is also looking at how those parameters are set. At what point, if markets were negative, would that have to be updated? Again, certainly, we would not expect it to be a 2011 item. I don't know Cindy, if you want to add anything?

Cindy Forbes

I agree, I wouldn't expect it to be 2011. And we review the assumption every year, and we do follow the guidance and theory in determining that assumption.

Mario Mendonca - Canaccord Genuity

SO just how many years of data really go into it then? Is it like 40 years then?

Cindy Forbes

Since 1956, generally.

Operator

The following question is from Andre Hardy from RBC Capital Markets.

Andre-Philippe Hardy - RBC Capital Markets, LLC

Michael, in your prepared remarks, you talked about the sensitivity to movements in rates and equities, probably rising in the face of further declines in rates and equities since Q3 started. Do you have a rough estimate of the magnitude of the change if the quarter ended today?

Michael Bell

Sure, Andre. Well, first of all, I would point out that there are a bunch of different moving parts here. So almost by definition, anything I give you needs to be viewed directionally, not precisely. But round numbers, the sensitivity could increase by round numbers perhaps 20% given the drop in equity markets and in interest rates. And by the way, that's one of the reasons that we wanted to get ahead of our targets, so that we don't then feel compelled to rush out, and hedge a lot more at the bottom to make sure that we hit the year end 2012 and ultimately, the year end 2014 targets. But I want to repeat my caution, Andre. The bases changes, for example, could change those sensitivities because we do things like update lapsed assumptions that can change the sensitivities. And also, obviously, management actions could further reduce those sensitivities. So please view the 20% as a directional number.

Andre-Philippe Hardy - RBC Capital Markets, LLC

Just to be clear, you're talking about 20% for rates and for equities?

Michael Bell

Yes. That's approximately right. I don't know, Bev, if you'd -- Bev's nodding. Yes, about 20%.

Beverly Margolian

It's an indicative number only.

Operator

Following question is from Robert Sedran from CIBC.

Robert Sedran - CIBC World Markets Inc.

I just want to follow-up on the issue of interest rates and I'm thinking more from the perspective of what the current rate environment means to a core number. In other words, not so much what it means the reserves quarter in, quarter out, but how does this affect the sources of earnings? Like does it -- how much of a weight, how much of a headwind is it on earnings on surplus, on expected profit, on strain? I mean is there any risk to the actual core number facing some headwinds here in the next year if rates do stay as low as they look like they're going to stay?

Michael Bell

Robert, it's Mike. Certainly, it would be a negative headwind on both interest on surplus as well as new business strain, with the caveat that obviously, if interest rates stayed down for a material period of time, we would expect to increase new business prices. So ideally, that new business strain would be somewhat temporary. But in a short period of time, since there's always a time lag in terms of implementing price increases, it would increase strain and decrease interest on surplus. I don't think at this point, I would try to get into quantifying a number. I mean the markets have been moving so much week-to-week. There's something we could look at, some additional disclosure on it at third quarter. But I'd rather not try to speculate on the size of that.

Donald Guloien

I want to emphasize what Mike said about pricing action. I think, certainly, the outlook in the United States leaves me a little bit more optimistic that other companies will follow the lead that we have in raising the prices for intrasensitive products that have guarantees. I mean the more it looks like this is going to be a longer-term phenomena forces people to realize that they have to come to grips with it. With the mark-to-market that we have under Canadian accounting regime, we've been penalized early and more heavily than many of our U.S. peers. And I think the more it looks like this is not a permanent state but a semipermanent state that's going to force people to take more pricing action.

Robert Sedran - CIBC World Markets Inc.

And just Michael, a quick numbers follow-up. How big was the benefit from alternative investments in the earnings on surplus in this quarter?

Michael Bell

Wait, it wasn't huge. The NFI [ph] impacting IOS in the quarter, I'd say, Robert, less than $20 million.

Operator

The following question is from Tom MacKinnon from BMO Capital Markets.

Tom MacKinnon - BMO Capital Markets Canada

I got 2 questions. The first is back in the fall of 2010, when you gave your 2015 objective, I think it was somewhere around $4 billion by 2015 and a 13% ROE. Sort of translated more like a 8% CAGR growth in earnings. You said that was essentially based on interest rates being generally flat from September 30, 2010, levels and equity markets up 8% annually, I guess 10% with dividends from where they were in September 30, 2010. So you're now we're about nearly a year through this process here. And I'd say the interest rates haven't really moved that much. In fact, I think when you did this thing, the U.S. 10-year was 2.15%, it's about 2.30% now. And the U.S., 30 years, it's 3.70% and it's not that much different from that right now. And the S&P 500 is up 3% and you thought it'd be up 8% pre-dividend. So I'm wondering, we're not quite a year through this process when you laid out these objectives, and do you have anything to say that your forecast has changed? You've hedged it a lot faster, but how are we to look at that forecast given what's kind of happened over the last 10 months or so?

Michael Bell

Sure. Tom, as always, appreciate your thoughtful questions. So first, let me state the obvious. You're absolutely right, that with the lower interest rates and the equity markets since the investor day under-performing our long-term assumption, those do both represent mild headwinds to that 2015 outlook...

Tom MacKinnon - BMO Capital Markets Canada

But the 10 years' only about 20 points lower than what it was when you did that forecast.

Michael Bell

That's right. That's why I said mild headwind. And actually, just for completeness, I'll add a couple of other headwinds that you didn't mention. We now obviously have had these 2 reinsurance transactions, the reinsurance transaction in Canada, which we did in second quarter, which increased our MCCSR but has a cost to it. And we also have now sold our life retro business, which also increases the MCCSR in third quarter, but again has a lost earnings impact to it. And then the basis change for third quarter 2011 also represents a headwind, given that, that will mean lower interest on surplus because we'd counted on those earnings accumulating for surplus. I think a couple good news elements, Tom, that lead me to conclude that it'd be too early to, certainly to materially change those assumptions. Number 1 is, as I said at the Investor Day, we did consciously build in contingency into the 2015 outlook for exactly these kinds of things that, for God's sake, if you're going to project 5 years out, there are going to be some things that go the other way. And that's why we had a contingency. And I'm confident at this point that we've certainly not absorbed that full contingency even though these things, as you said, are headwinds. The other point, really more importantly, in terms of long-term shareholder value, is that the changes that we've been making in terms of the mix of business and really our business fundamentals, I would suggest all in, are modestly better than we had anticipated at the Investor Day. The change in the mix, in particular, has happened faster than we had anticipated. And the growth in the targeted products has been very positive. And then last but certainly not least, is long-term care. Again, it's early. But certainly, if you'd asked me at the investor day what our record would be in terms of getting price increases, I wouldn't have answered, but in my head, I would have certainly guessed something less optimistic than the 20s. So I think there are some reasons to be positive as well.

Tom MacKinnon - BMO Capital Markets Canada

And just a follow-up question with respect to the reserves hit for -- related to U.S. mortality and upcoming in the third quarter. I guess the Canadian Institute of Actuaries looking at allowing mortality improvement into the reserves. Are you going to allow any mortality improvement into your reserves and to what extent? I assume that would have to be some sort of benefit with respect to the Individual Life business? And has that been -- is that one of basis changes you'll look at in the third quarter or...

Michael Bell

Tom, it will certainly be part of the basis changes that we'll be looking at for third quarter. It actually has a mix of positive and negative impacts, depending upon the specific product lines. So as an example, mortality improvement would be a negative for Long-Term Care. On the other hand, obviously, morbidity improvement would be a positive, a favorable for Long-Term Care. As you noted, it'd be a favorable for the U.S. Life business, the Canadian Life business. Again, that will all be part of the third quarter basis change.

Operator

The following question is from Michael Goldberg from Desjardins Securities.

Michael Goldberg - Desjardins Securities Inc.

I had a couple of questions also. So I'll start with a number question. You've previously provided the amount of available for sale equities-backing surplus that you have. Can you tell me what it is now?

Michael Bell

Michael, it's approximately $2 billion.

Michael Goldberg - Desjardins Securities Inc.

So it's down from about $2.2 billion?

Michael Bell

Yes. Round numbers, yes.

Michael Goldberg - Desjardins Securities Inc.

Okay. And also on the mortality assumption change that's coming in the United States, could you give us a little bit of color as to what you'd think may be behind the weaker-than-expected experience there? Could there have been any anti-selection?

Michael Bell

Michael, it's Mike. I don't think it is a result of any selection. Again, it's a complicated issue but it is isolated at this point to the U.S. bloc. Maybe to step back and give you some more context here, we are reporting mortality gains in the U.S. Life bloc. For example, this quarter, I think it was approximately $30 million pretax of mortality gains. The subtlety though is looking at the results by duration, the early duration life insurance business. So the business, it's still clearly in the select period, from an underwriting standpoint, has been very favorable, which suggests that we've had very good underwriting discipline that the mortality has been running better than the pricing and the reserving assumptions. So we would view that as a good thing and really the opposite of any selection. Unfortunately, what we're seeing is as the select period wears off, and as the insured block gets to older attained ages and older durations, that mortality experience is running worse. And obviously, this is a series of actuarial judgments. We're not yet done but I felt like it was important to disclose that this is an emerging issue. We don't have it calculated down to the number yet. But it is an emerging issue, and therefore, we felt like it was important to disclose.

Operator

Following question is from Peter Routledge from National Bank Financial.

Peter Routledge - National Bank Financial, Inc.

Just a question on your capitalization. Given where equity markets and interest rates are, we can conclude your MCCSR will be a fair bit lower next quarter. And then you do have this reserve increase for mortality risk. And I'm wondering how do your stakeholders look at your capitalization in light of this, both OSFI and rating agencies. Is there any reason to think they might look a little differently at your MCCSR in light of now really your third year of reserve increases for policyholder behavior?

Michael Bell

Well, Peter, first of all, a couple of comments here. Obviously we feel very good about our capital position at June 3. At 241%, that's a very strong level. To date -- it's obviously early in the quarter, but to date, our current view is that the coming bad news from the basis change, coupled with the impact on financial markets thus far in third quarter should be manageable. Now obviously, if financial markets got worse or if there was other bad news, we might have to revisit that. But to date, we feel like the situation is manageable. Now obviously, if the market continued to have negative performance in terms of interest rates and equity markets, it could cause us to rethink, for example, the pace at which we reduce our financial leverage. We've been letting debt mature as opposed to refinancing it. We just had $550 million of sub-debt mature in February. So we could rethink some of those options. At this point, I don't feel any particular pressure from outside stakeholders to take action but again, it's something obviously we always work on contingency plans around.

Donald Guloien

Donald here. I want to interject a little bit also, just for some perspective. Everything Mike said was very good. I'll just add that 241% now is different than 241% years ago. We didn't have that level of MCCSR because we have a huge chunk hedged, both interest rates and equities. I mean, let me remind you. On equity hedging, we're at 90% now of our 2014 targets. And the hedging is working extremely well. It's been tested. I get daily reports through the financial crisis the last couple of weeks. The hedging is working not perfectly but, relative to my expectations, close to flawlessly. So 241%, which is a really high ratio if you're totally unhedged, 241% and hedged is a very comfortable position. In fact, you've heard us say it before. It's a little bit abstract, but if the S&P went to 0 and the TSX went to 0 and the Nikkei went to 0, we'd still have no problem paying off our claims. That is an amazing statement. Now obviously other things would happen but that is an amazing statement of the quality of reserves and capital and hedging that this company has in place. So all of that has to be -- and you can probably hear a little bit in my voice. We actually get no explicit credit for hedging right now. So again, the 241% on the MCCSR, that has a huge dampening impact on the earnings and obviously the risk that our policy holders would have and that has to be recognized by regulators and rating agencies.

Peter Routledge - National Bank Financial, Inc.

And just, Michael, I'm gathering from your statements, the long-term repricing, long-term care repricing is going well. Would you revise your assumptions about repricing this year or is that something you need to wait a little longer for?

Michael Bell

Peter, I think it's highly unlikely that we would revise those assumptions this year. Never say never, and obviously we'll make all of those decisions at third quarter, but we're in this for the long haul. And I would anticipate that it would likely not be until at least next year, before we'd be able to make those kinds of updates.

Operator

The following question is from Steve Theriault from Bank of America Merrill Lynch.

Steve Theriault - BofA Merrill Lynch

A couple of questions. First, a question on new business embedded value generation versus sales where I think I must be missing something. So if I look at the slide deck, sales of insurance and wealth and targeted businesses for growth is up 27%, 28%. But when I look at Page 4 of the supplemental, new business embedded value generation is down 22% for insurance and up just 6% for wealth. So does this have to do with the fact that maybe a lot of the growth is in Asia and somehow that makes a difference, the nature of the products sold? I imagine maybe currency could potentially be part of that. Could you help me understand the linkage or the lack of linkage there?

Michael Bell

Sure. And Steve, it's Mike. It's somewhat of an apples to oranges comparison because we have had some changes in the formula that we use to calculate new business embedded values specially we're now using spot interest rates at the end of the quarter. In prior years, we had used the prior year planning assumption. We've updated other assumptions so I don't think the new business embedded value is really apples-to-apples versus prior years. I do think that if you compared, say, to first quarter or -- at least let me say it this way. Maybe going forward, I would expect it to establish a more reasonable baseline. But by, in particular, changing it to the spot interest rates, it's not really very useful to compare it to historical numbers.

Donald Guloien

There's a variety of different practices of calculating new business embedded value. And I guess the one that's most prominent and the one we use historically was the to assume that interest rates revert back to the pricing assumptions, given that everything else that we do is using more current interest rate projections. We're doing that with our new business embedded value as well. It's in this day and age, a more conservative way of looking at it, but we think more appropriate, more consistent with the way we do other financial reporting.

Cindy Forbes

And if you were looking quarter-over-quarter, one of the things that distorts the comparison in sales versus business embedded value is the fact that many of P&C retrocessionaire [ph] business is renewed in the first quarter. But this doesn't show up in our sales numbers, so that's one of the reasons why you're seeing an impact in the relationship quarter-over-quarter. That doesn't look -- isn't what you might expect. And then also in Japan, we saw a lot of sales growth in Japan but now that we update our interest rates and spreads every quarter, interests rates were down and spreads were down and that offset the impact of the increased sales in Japan.

Steve Theriault - BofA Merrill Lynch

One more, I think, quick one. I think I noticed -- probably for Mike as well. I think I noticed in the slide deck, I know that you unwound $100 million of Canadian hedges in the quarter. I guess I'm surprised by that, given that the market was pretty choppy except maybe in the first week or so of the quarter. So can you talk a little bit about what led to that unwinding? Was there an associated rotation into the dynamic hedging program as a result? And I guess, is there opportunity to do more of this or is that door fairly closed given what we've seen quarter to date?

Donald Guloien

I'll answer that one, Don here. The TSX was way up. We don't want to get in a position over-hedge, where if a market goes up, it costs us earnings. That would be rather hard to explain to investors. So we will be rebalancing. The intention is to increase the overall hedge. Again, we're getting very close. We're at about 90% of our 2014 targets. But that's what it was all about. We certainly don't ever want to get into a position where, in a legal entity and we run these across a variety of legal entities, or respective of a specific index that we get over-hedged. And you actually did put your finger right on it and that is, we also look at the interaction of our dynamic hedges and our macro hedges. And at the time, there was some serious consideration of a new cohort going into the dynamic hedging programs. So that was also taken into account. I mean, it was a pretty small adjustment, actually $100 million. We have, I think, as of today, something like $14 billion of hedges in place, $100 million against that is a rather immaterial number.

Operator

Following question is from Doug Young from TD Newcrest.

Doug Young - TD Newcrest Capital Inc.

Just first question on the U.S. mortality charge for Q3, Michael. What product was that related to? Is that the no last guarantee? Is that the whole life product?

Michael Bell

Sure, Doug. It's Mike. First of all, over half of the preliminary estimate is the legacy acquired John Hancock permanent business. So again, this is business that we acquired back 7 years ago, when we bought that business. Again, what we're seeing is that the late age mortality on that old bloc is running higher than the late age assumptions. So that is the majority at this point of the preliminary estimate that we're talking about here. Having said that, and again Cindy can add here. The phenomenon that I described earlier, Doug, where the early duration mortality is running better than the pricing assumptions, better than the reserving assumptions and likely reflects even better underwriting discipline that we had assumed. That is tended to be across the bulk of the Life Insurance business that we've written since the Hancock acquisition in 2004. And again, the flip side is, the emerging late mortality is the positive selection impact wears off, is in fact reasonably broad-based.

Doug Young - TD Newcrest Capital Inc.

Okay. And the second one, just related to the U.S. 401(k) business, Jim, I guess, I know you've been pushing into the mid-market. I know Q1 sales had been weak, Q2 sales had been weak. And listening to competitors, it's obviously a very popular market that people are moving into. Can you talk a little bit about the competitive trends? And I know you've talked about sales growth of 20% in that, is that a realistic assumption from where you stand?

James Boyle

The first half of the year, our sales were off our expectations. We did see a heightened competitive universe for sure. Many of our competitors, as you mentioned, find this an attractive space. I would tell you that the latest numbers we're seeing as we closed the quarter, and as we look forward for the second half of the year are quite positive. Our assets under management are at record levels. The proposals that we have currently in the pipeline at the end of the quarter are at record levels for us. The conversion of those proposals in the months of July and so far in August have been quite positive. And our sales are trending favorably. So short story, very competitive market in the first half. Our fundamentals are really good as we ended the quarter and we're feeling much better about the second half.

Doug Young - TD Newcrest Capital Inc.

Do you think you can hit 20% sales growth?

James Boyle

There's a lot of factors involved there, particularly the economy, growth in jobs, development of new businesses and new plans. And I think if you'd asked me that before the market 3 weeks ago, I would've had a different answer than I have today. We need some help from the economy as well.

Operator

Following question is from Darko Mihelic from Cormark Securities.

Darko Mihelic - Cormark Securities Inc.

My first question is for Michael. And I just want to go back to the question that Mario asked about assumptions regarding equity markets and such. I just want to cover off all the bases with respect to the upcoming basis changes. In effect, I'm just wondering about stuff like market volatility parameters. I think it was last year that you increased the volatility assumptions that you use for your variable annuities. And also as well, perhaps non-fixed income assets. What about stuff like oil and gas and so on, and assumptions regarding those returns?

Michael Bell

Darko, it's Mike. I'll start. First, in terms of the basis changes, I really want to emphasize we're not done yet. So we do have a significant amount of work still to do over the next 60 days or so to review those assumptions with outside auditors, with a peer review, et cetera. So we do have a lot of work. And therefore, I can't be just super definitive on all these comments. At this point, I think it's unlikely that we would have a material change to either the VA volatility assumption that we've updated the last couple of years or the non-fixed income return assumptions. Again, I am cognizant of the fact though that the Canadian Institute of Actuaries is looking at the volatility parameter along with the other VA assumptions. So again, Cindy is probably closer to it. And I'm sure she's closer to it than I am in terms of the timing of all that. So that's something out on the horizon but I think unlikely to be an impact this year. On the NFI, I'll just remind that, first, NFI has been a great part of our portfolio. It's a great diversifier for us. We believe that having that kind of diversification with NFI plus the bonds actually reduces our overall risk profile. At the same time, it helps our long-term returns. It also truly is a core competency for our organization and a competitive advantage. I'd also point out, as we talked about at the Investor Day, that if you look at the last 5 years or you look at the last 10 years, we've actually outperformed our long-term assumptions. And therefore, again, this would seem to be a funny time to reduce those. So again, at this point, I don't think that those will be coming out. But again, we'll obviously make our final decisions at third quarter.

Donald Guloien

And most of our experience gains over the past 5 years have come from outperforming those assumptions. It will be kind of hard to justify making them lower. But, anyway...

Darko Mihelic - Cormark Securities Inc.

As an aside, I would say that in your annual report, for the last 2 years, it seems that we've underperformed, but fair enough...

Donald Guloien

That's a bit tough.

Darko Mihelic - Cormark Securities Inc.

Fair enough. My other question is for Don Guloien. Your hedging is far ahead of schedule, and you speak rather glowingly of its effectiveness, which is good. But at the end of the day, I guess my question is, even if you hit your targets, that still leaves an awful lot of risk appetite on the table. And I'm wondering if you may be perhaps going into Q3 or going into Q4, you actually consider increasing the amount that you'll be willing to hedge.

Donald Guloien

Darko, that's an excellent question. And there's -- I would be willing to hedge more. I'm afraid I'm going to get into a little bit of technicality, but it's necessary. We've never aimed to go to 100%. I don't think anybody who is sort of rational would, because there's certain things that will create volatility that you wouldn't want us to hedge if you're a rational investor. And what I mean to say there is for instance, provisions for adverse deviation or the PfADs you talked about. When actuaries take their best guess of when people are going to die or cash out or do whatever it is to claim their benefits down the road, they come up with a best estimate. And then, as you know, we test them against a market service set assumptions and gives rise to a thing called PfAD. You would not want us to hedge to the PfADs because that is not what we expect. That is a provision for adverse deviation. That is saying things could go wrong. You wouldn't want us to hedge to that, right? I think I can convince anybody that, that would be economically wrong to hedge to a padded result. You would hedge to what you reasonably think is going to happen. If you don't hedge to the padded result, even when markets go down, you have to add to your pads and the pads aren't covered by the equity market movement, that will give rise to an accounting loss. But it would be really, really scary and I think improper to have us take hedging to eliminate that accounting loss when it's not a real economic exposure. I've try to say that, it's a pretty complicated concept. So you wouldn't want us to go to 100%. And I think the real mistake that we ever announced to you that we've hedged so much that regardless of whether markets go up or down, our earnings won't, or capital, won't move. The targets we set were reasonable, because they seem like very challenging targets at the time we set them. That's an indication that took us -- it would probably take us 4, 5 years to get there. The good news is, with the way the market rallied last year and then the early part of this year, we took advantage of that. And we hedged another bunch in Japan just before this market fall. That approach has served us well. But there's no religious belief here that suggests that once we get to the target, we will stop. We will relook at it then, but we're not going to go so far as to hedge 100% of it. And we're certainly not going to hedge pads, which would be not our best guess of what the real liability is, if that makes any sense.

Operator

The following question is from Gabriel Dechaine from Crédit Suisse.

Gabriel Dechaine - Crédit Suisse AG

Just on the long-term care repricing initiatives. Let's just say you were stopped here and no other states out of the 30 remaining would approve any rate increases. What would be the approximate size of the reserve increase that would be required? And my second question is on management actions in the current quarter. You talked about the changes and sensitivity to interest rates going up and all that and not ignoring potential management actions. Is this an environment where you can still go out on the curve, and then get the benefit of tighter ALM matching or it does not make sense to be doing that right now?

Michael Bell

Sure. So first, Gabriel, on your hypothetical negative scenario, I don't think it'd be a real good idea to precisely answer that question. I mean, suffice to say, it would be over $1 billion, but I'd rather not go into more detail than the math on what that impact would be. I see no evidence that, that outcome is going to take place. We've had good discussions with nearly all of the states. I think your hypothetical is overly negative. And so let me just leave it at that.

Donald Guloien

And Gabriel, maybe we haven't made this one clear, but we're getting some very big influential states. If anything, this should snowball in our favor. Now we're not trying to set up unrealistic expectation. We're just going to tell you the facts. But the fact is when you get very pivotal states, with very influential commissioners saying we reviewed this thing, it's more they have to explain why they haven't approved it than why they have.

Gabriel Dechaine - Crédit Suisse AG

It was kind of a back door way to ask if any big states, out of the 20 have approved.

Donald Guloien

We have, yes, we've got some very significant states.

Michael Bell

And then, on your question, are there additional management actions that we could take to further lengthen the duration of the assets? Could we do more equity hedging? The answer to both of those is yes. Of course, we could do that. Again, there's a little bit of an element here of sort of locking in at the bottom. And I don't know, I guess based on the last experience over the last 2 years, I'm not sure anybody knows what the bottom means. So those are available to us. And again, it is something that we'll consider. But I will repeat the comment from earlier. One reason is that we got ahead of our original timetable, is that in anticipation of a quarter like this, that we wouldn't feel obligated to run out and potentially hedge more at the bottom.

Gabriel Dechaine - Crédit Suisse AG

No, that was more of a -- I know you can. I was more asking about have you, post-quarter, sold some AFS bonds or...

Michael Bell

A very small amount. But the -- again, at this point, that would still be -- doing something material would be more of a decision that we'd make over the next 45 days.

Donald Guloien

It's funny people say that we're talking about the quarter like it's over in terms of -- I mean, I think we've come through a stunning time but I tend to be kind of resolute. I think this is -- I'm talking macro here, nothing new to Manulife. But the market reaction to what's going on in the United States is a gross overreaction. The challenges in Europe are real, but the budgetary crisis and the debt ceiling in the United States is overblown for political reality TV. And it's going to resolve itself 1 way or another. I mean you can write that down. And people were asking Mike on the call here. And it's a reasonable question to ask is where would you be in terms of your sensitivities to market disruptions, based on where the market is today. Well, it depends when we gave his answer. He gave a conservative answer. The market's up about 5% today. It's a different answer than what he would've given today already. I can guarantee 1 thing, the market is not going to close where it is today. At the end of the quarter, it'll be higher or it'll be lower. I could have a bias and I'm the one who's pushing all the hedging, right? We're getting the hedging done so that we don't have to talk about this as much. But if it's not totally obvious yet, we're sleeping pretty easy at night with the amount that we've got hedged and with the volatility that we have.

Gabriel Dechaine - Crédit Suisse AG

I'm just jaded, Don.

Donald Guloien

It's hard not to be jaded with some of the silliness that's going on around the world.

Operator

The following question is from Heather Takahashi [ph] from Fortress Investment.

Unknown Analyst -

Just a quick question. Sweeping on the call, there was a headline over the wire about a magnitude 6 earthquake in Japan. So I'm just wondering, given your experience with the March earthquake or maybe your own stress testing, if you have any sense of the materiality of the...

Donald Guloien

That's actually, I hate to say it, but by Japanese standards, it's pretty modest.

Craig Bromley

This is Craig Bromley. We tend to have those every couple of weeks, but I will certainly look at it when I leave this meeting. But in general, I've been probably in 50 earthquakes in my time in Japan. And in the next time in Japan, it will probably be another 50. It's a regular occurrence, and it's something that the Japanese deal with stoically.

Unknown Analyst -

And then my other question was on the mortality table charge. I'm just wondering if you have a sense of whether there are any multiplicative effects with that. For example, will it make you any more or less sensitive for example to changes in interest rate assumptions?

Michael Bell

Heather, those second order impacts are work that we still have to do here over the next 60 days. So the short answer is, there are impacts on any number of other reserve factors, which is again why it makes it as complicated as it does to finalize the calculation. Again, what we did when we put out the comments, not expected to exceed $700 million. It was trying to estimate those other second order impacts as well. But I don't -- again, that work is complicated, and ends up having several nuances in its own right.

Operator

Following question is from Joanne Smith from Scotia Capital.

Joanne Smith - Scotia Capital Inc.

I can't believe there are actually questions left, but I do have a couple. The change in the URR, I believe when you changed it back in the third quarter of 2010, the new assumption was about 4% in Canada and 3.7% in the U.S. Can you tell me what the new URR is now?

Michael Bell

Cindy, do you happen to know that? I don't have that memorized. The new URR assumptions in Canada and U.S.?

Cindy Forbes

They're 3.70% in Canada, 3.90% the U.S. at the long end.

Joanne Smith - Scotia Capital Inc.

Okay, and second question is, when I look at your results, I see it there. But obviously, a favorable tax impact. And so, if we were to normalize the effective tax rate, it's quite difficult from the outside, because of all the noise from 2010. And we've only got 1 quarter behind us prior to this one. So when I look at the normalized effective tax rate, what kind of guidance could you give us?

Michael Bell

Joanne, we've looked at that several times. In fact, if you go back a couple of years, we did talk about that on some analyst calls. You're exactly right. It bounces around quarter-to-quarter, and it bounces around for a number of different reasons. For example, the geography where we have earnings versus we have hits, I'll place havoc with it. Round numbers, when we've looked at this, we tend to get to a long-term effective tax rate in the, call it, 22% to 25% kind of range. But you're absolutely right. In any given quarter, it can bounce in strange directions. I believe, Linda can correct me here, but I believe that if you back out, for example, the URR impact, I believe the effective tax rate would be something like 21% because the effective tax rate on the basis changes in the mid-30s is up, on that URR, is in the mid-30s. And if you back that out, you get to about 21%.

Joanne Smith - Scotia Capital Inc.

When I'm looking at your U.S. operations and the earnings, especially the U.S. Insurance earnings, they were really good. Looking at the source at the volumes table and taking out the non-core items. Since you don't disclose the source of the variance on a business line basis, could you tell us where have you saw the most improvement in the quarter?

Michael Bell

Yes. Again, we probably could go off-line to talk about some of the specific details, Joanne. But broadly speaking, we're benefiting from the higher assets under management. So the higher fee income, and that's certainly true in the U.S. It fell. We've also been benefiting from the new business strain improvement from the higher prices on the insurance products in the U.S. Let me see if Jim Boyle or Cindy want to add here.

James Boyle

Right. The way we show source of earnings, as you know, includes both life and long-term care. We've made great progress year-over-year. As you can see, the impact of new business, that's a reflection of the price increases coming through. And our managing expenses well relative to the sales volume. This quarter, in particular, if you look at experienced gains, there was $240 million of experienced gains. Those were primarily investment-related. Some of those were realized gains predictive on [ph] sales of certain fixed income investments that we shifted over to the non-fixed income investments. So the core earnings continue to do well. We're doing a nice job on new business strain. And this quarter, in particular, we had some nice investment gains on the experienced side.

Operator

The following question is from Sumit Malhotra of Macquarie Capital Markets.

Sumit Malhotra

For Michael Bell on Long-Term Care. Last quarter, you told us the approvals you had received were from 15 states. This quarter it's up to 20. So just to go about it the other way, have there been any states in which your request to increase the pricing have been turned down?

Michael Bell

At this point, there is no state where the file is closed. So at this point, we all still have an opportunity in those other 30 states.

Sumit Malhotra

And there was a mention here -- this is my second question on the same topic. There was a mention that some of the states are quite sizable. So of the 20 states in which you've been approved -- in which the pricing has been approved, would you be able to tell us what proportion of your in-force that represents? And where do you think, it doesn't sound like it's going to be a Q3 2011 issue, but where do you think that number has to get to before you can start thinking about releasing some of the reserves that you added for that business?

Michael Bell

I'd really prefer not to go into that, quite that level of detail. Again, Don was absolutely right. There've been some material states out there that are in the 20 that we got. There are some very large estates that are in the 30 that we don't have yet. So I really not, rather not get into the percentages at this point. And in terms of the timing, again, I'm sure this is something that we'll look at on an ongoing basis. Again, at this point, barring some major change, I think it'd be unlikely that we would see any impact in the long-term assumptions until at the very earliest third quarter 2012. But it's something again, I will report on this I'm sure every quarter. I'm sure we'll get 7 more questions every quarter on this topic. And the most important thing to note is that we're really pleased with our progress. We're doing well and a real credit to Marianne Harrison and her team.

Sumit Malhotra

And so to the extent, you're going to update us on the number of states. It seems like you've done that in the first 2 quarters of this year. Perhaps the next up is the magnitude of your business and maybe we got an idea whether this is going to be a benefit to you for 2012?

Michael Bell

At some point, I'm sure we will provide some additional detail on that.

Operator

The following question is from Michael Goldberg from Desjardins Securities.

Michael Goldberg - Desjardins Securities Inc.

Don, can you elaborate on the big picture for Manulife on the challenges that you described? For example, in Europe, and I know you have no operations there, but the challenge in Europe, as you also described as real. And also, your comment that U.S. companies haven't really fully reacted to the low level of interest rate. How does this ultimately impact Manulife in terms of competitive position and opportunities that they develop for the company?

Donald Guloien

Well, I think, I'm actually very optimistic. I like to think long term in sort of 5-year cycles. And I think we've got the capital, we've got the hedging in place. We're keeping our powder dry. And as we said before, rates stay where they are, we're pretty much provided for where things are. I mean, Michael talked about the URR headwind but it's pretty minor relative to what other people would go through, right? And for those of you on the call who don't know what we're talking about, is U.S. GAAP people basically lock in their pricing assumption until they go into loss recognition status and have to update it. And Canadian GAAP forces people to sort of market-to-market on a quarterly basis. The latter has been very painful with low interest rates. And last year at this time, we took a $2 billion charge for low interest rates. But is leaves us in good stead for dealing with the future. I think Europe is going to go on sale, and it's one of the reasons why I'm not anxious to spend anything right now, is to get into a position to take advantage of the opportunities that present themselves down the road. It doesn't necessarily mean that we would enter Europe. But it possibly means that European companies would be forced to sell some of their subsidiaries elsewhere in the world. So we have very conservatively provided for reasonable expectations of what can happen and the worst that could happen, and I think from here, it's likely to get better for us. Meanwhile, in our operating plan, strategic plan is unfolding exactly as it should, with minor hiccups here and there. We talked about those very openly. But as [indiscernible] question indicated, we laid out a 5-year plan. We feel very confident that we will achieve the 5-year plan. If anything, maybe a little earlier than our original expectations Our ability to hedge is way better than what we imagined at that time. So what's going to happen, we're delivering the operating earnings or the normalized earnings, whatever you want to call them. We're delivering the core earnings for the enterprise. And at the same time, we're reducing the capital market's volatility. It causes variance from those. We're building some very good businesses based on a nice, balanced mix of business, right? Not just 1 product driving it but a whole variety of products. And we pulled back very significantly on products that give rise to excessive risks of any nature, including most recently in some of the Japanese products. So we got a very nice healthy balance mix. We're growing very nicely across the board, hedging in place, a really nice earnings progression. I'm feeling very good, and tumult emerges in the world, I hate to be a harbinger of sort of bad news anywhere. But I think we're going to be in a position to take advantage of it. That's not the next 6 months. I think I made a mistake in a couple of calls where people asked about excess capital, we said we had some. And then sort of that created some expectation that we're going to buy something in the next 6 weeks. That's wholly unrealistic. We're aware of a number of opportunities, but the biggest confidence that we have is will they be cheaper somewhere down the road. And in some cases, they will be. And Manulife will be progressively stronger. So I'm feeling pretty good.

Operator

The following question is from Joanne Smith from Scotia Capital.

Joanne Smith - Scotia Capital Inc.

Just 1 follow-up, and this is for Don and, I guess, Jim. When the Fed made a statement the other day about long-term interest rates staying -- or interest rate staying very, very low at least until midyear 2013, that implied obviously a very weak economic environment in the U.S. And I remember, when we went through the last recession and what happened to sales for life insurance products. And it wasn't very good. So can you tell me how this is different, if you think it is at all, or how you would expect that, that type of a scenario would play out on, number one, your sales expectations in the U.S.; and then the grander plans of the 5-year goal.

Donald Guloien

Well, our experience was not too bad in that period and in terms of what we're selling and it's not to say it won't effect by the economy. But Joanne, I think the biggest parameter is -- that affects our sales quite frankly, I hope Jim would agree with me, is where we choose to cut back based on this profile. We're not having any problems selling product right now. We can sell unlimited amounts if we are willing to take the risk that other companies seem to be doing. So it's not a matter that we're worried about chasing sales. On the macro picture of the economy, I think the Fed is reacting appropriately. The bickering in Congress, the immature bickering between the extremes of both parties caused a huge amount of unease and caused people to question whether the U.S. government can get it together to come on a plan that would deal with some of the challenges. The challenges are imminently solvable through a number of initiatives. And I think the Fed did the right thing. But the Fed left itself also the window to get out of the way. And I think, given the United States government is funded short, the last thing they want is inflation to get out of control because if it's afraid to take off and grow up too rapidly, that will hurt the U.S. Treasury a great deal. So I think the Fed clearly acted appropriately to put some salve on the panic that was taking place. But this is a solvable problem. The United States has the capacity to solve this issue. Canada went through it 20 years ago and we did novel things like tax people through value-added tax and cut back on spending and with all the obvious things. And guess what, our economy is in pretty good shape today, due to the foresight of some of those people. And United States, if you talk of people that are part of the gang of 6, so-called gang of 6, a bipartisan group, or Allan Simpson [ph], they've all got recipes for how this thing can be done in a bipartisan way. And at the end of the day, the United States will do the right things and solve the problem. So I think this is a very, very considerable overreaction. But probably, one that was necessary to get people look in the mirror and do what they need to do.

Joanne Smith - Scotia Capital Inc.

Don, I'm talking more broadly about the economy. Every economic indicator that has been reported over the last month has been worse than expected. And I'm saying beyond the bickering that's going on in that ridiculous place called Washington, I'm talking about, we have had a real slowdown in the U.S., and people are worried.

Donald Guloien

People are worried but one of the reasons for the slowdown is really good news. The last thing you want to have happen -- I mean if you talk to central bankers anywhere, the real risk of cheap money is that people go back to their old ways of doing things and God bless the American people, they're deleveraging. That means those of you, and I'm not saying you are, Joanne, but those who are looking for a sugar high have the thing bounce back and everybody show up in Best Buy stores cramming the doors trying to buy as many TV sets as they can because they can borrow money at no cost. That's the thing that would really scare the living daylights out of me. What has happened in the United States is that, from the consumer rights with businesses that they have taken a very prudent approach and are deleveraging, they're paying down their credit card debt because, yes, they are really scared. That means that the recovery is going to be a little bit longer in coming. But I think it's exactly what we want to have happen, and I'm not alone in that view. If you talk to Mark Carney, I think he'll tell you the exact same thing. That's why I described it as -- the ideal is like the profile of the contact lens. The people who are disappointed are largely disappointed because their expectations were too high. When housing starts come out and people say, "My God, housing isn't coming back." That's the last thing you want to have happen right now. What you want to do is clear the inventory. You don't want new houses built. You want people in the construction industry realize that they're not going to be building 7,000 square foot homes in Arizona and make a really good living and moving on to other parts of the economy. That's going to be really tough for them. And I feel for them as individuals. But that's what needs to happen. You need to clear the inventory of the existing housing stock before housing price will go up. And the best sign is to see housing inventory reducing not again a sugar high of housing starts going up. So I know I sound a bit like a central banker because I listen to those guys and this is exactly -- the other thing that people seem to be losing a picture of, when they look at the U.S. economy, is the health of the balance sheets of American corporations, which have never been stronger. I mean Scott Hartz will be calling up everybody twice a day saying, "Will you please borrow more money from us?" You got Apple computer, a computer company sitting on $90 billion of cash. That's maybe an extreme example but there's a lot of very healthy companies out there. So when people get upset about the U.S. economy, recognize that the consumer is doing the right thing in deleveraging. Businesses have massively deleveraged. All they need is some sign of confidence that the leadership in Washington will do the right thing and not do something silly. And people will actually start building plants again and getting back to business. Jim, do you disagree with that?

James Boyle

Joanne, I would approach it from more of a tactical perspective than Don's strategic answer. To give you some comfort, tactically, we've been dealing with a very difficult economy here since 2007 in the United States. We've been able to reposition and reprice our products. And we've demonstrated positive momentum on virtually every measure across all of our businesses. And we don't have wild expectations for growth in the United States. We sure hope that they're going to come, but we have, I think, demonstrated the ability to manage and pivot to the environment, particularly in a negative environment. So our customers out there, obviously, are feeling the effects. And there's some fear in the marketplace. Some of our products tend to be attractive to people who are in a fearful state of mind. So I feel confident that we've done a good job managing in a difficult environment. And we will be able to continue to manage and hold share and execute well relative to our peers even if a difficult environment continues.

Donald Guloien

Joanne, if I stood up with Jim at our Investor Day and said, "We predict a very turbulent stock market interest rates, a fight over the debt ceiling and everything else that's going on the last little while, but notwithstanding that, we're going to sell $7 billion of mutual funds for the first half 2011 in the United States," you guys would have laughed us off the stage. That's exactly what we did. So we're very proud of it.

Operator

There are no further questions registered. I'd now like to turn the meeting back to Mr. Ostler.

Anthony Ostler

Thank you, Jenny. We will be available after the call if there are any follow-up questions. Have a good afternoon, everyone.

Operator

Thank you. This concludes today's conference call. Please disconnect your lines, and thank you for your participation.

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