Manulife Financial's (MFC) CEO Donald Guloien on Q2 2016 Results - Earnings Call Transcript

| About: Manulife Financial (MFC)

Manulife Financial Corp. (NYSE:MFC)

Q2 2016 Earnings Conference Call

August 4, 2016 2:00 PM ET

Executives

Robert Veloso - Investor Relations

Donald Guloien - President & Chief Executive Officer

Stephen Roder - Chief Financial Officer

Steve Finch - EVP & Chief Actuary

Roy Gori - General Manager, Asia

Scott Hartz - EVP, General Account Investments

Craig Bromley - General Manager US

Kai Sotorp - EVP, Global Head of Wealth and Asset Management

Analysts

John Aiken - Barclays

Meny Grauman - Cormark Securities

Gabriel Dechaine - Canaccord Genuity

Robert Sedran - CIBC

Linda Mattison - Bernstein

Tom MacKinnon - BMO Capital Markets

Sumit Malhotra - Scotia Capital

Mario Mendonca - TD Securities

Humphrey Lee - Dowling & Partners

Peter Routledge - National Bank Financial

Doug Young - Desjardins

Darko Mihelic - RBC Capital Markets

Operator

Good afternoon and welcome to the Manulife Financial Second Quarter 2016 Financial Results Conference Call for Thursday, August 4, 2016.

Your host for today will be Mr. Robert Veloso. Please go ahead, sir.

Robert Veloso

Thank you and good afternoon. Welcome to Manulife's Conference Call to discuss our second quarter 2016 financial and operating results. Today's call will reference our earnings announcement, statistical package and webcast slides, which are all available in the Investor Relations section of our website at manulife.com. As in prior quarters, our executives will be making some remarks and 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 applied and about the important factors that may cause actual results to differ, please consult the webcast slides for this conference call, as well as securities filings referred to in the slide entitled, caution regarding forward-looking statements.

We have also included a note to user slide that sets out our performance and non-GAAP measures used in today's presentation.

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

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

Donald Guloien

Thank you, Robert. Good afternoon, everyone and thank you for joining us today. This morning, we announced our results for the second quarter of 2016. The quarter as you know presented a very challenging operating environment. The volatility in equity markets remain highly elevated. In many markets, interest rate hit all-time lows. Most notably in long U.S. bond yields which dropped roughly 30 basis points during the quarter and 90 basis points over the past year. These and other factors contributed disappointing quarter earnings and net income.

Despite the challenging environment, our underlying business remained resilient and our key drivers of growth continued to perform very well. We generated 11% increase in insurance sales driven by record results in Asia. We achieved a 34% increase in new business value, which speaks the quality of sales and margin that we generated this quarter.

We once again delivered positive net flows across our wealth and asset management businesses globally, one of the few firms that is able to make that claim. We reported 25% decline in gross flows, but you will recall that last year's record flows include an $8 billion institutional mandate and exceptionally strong flows coming from Mainland China. We're also making a very strong regulatory capital ratio of 236%, up 3 percentage points from the previous quarter.

Turning to slide six, where we review our key highlights during the quarter. In Asia, we delivered record annualized premium equivalent or APE sales up 34% and growth in new business value up 47%. We continue to experience strong momentum in the DBS partnership with Singapore, Hong Kong, Indonesia and Mainland China, all reporting record growth versus last quarter. We launched our single highest - second highest wealth and asset management gross flows on record driven by the launch of the first U.S. property real estate investment trust in Singapore and strong mutual fund sales in Mainland China, and we continue to enhance our customer facing technology.

In Mainland China, we began to handle claims via WeChat. In Hong Kong, we introduced the second generation of our electronic point-to-sale tool, which features increased financial-needs analysis capabilities. In Canada, we delivered strong gross flows in our wealth and asset management businesses, up 7% compared to the prior year despite challenging market conditions. We delivered retail insurance sales, which were in line with the prior year and we continued to make it easier for our customers to do business with us, by extending life insurance eligibility to Canadians with HIV and simplifying our medical underwriting process for lower coverage amounts.

In the United States, we delivered solid gross flows in our pension business, an increase of 23% versus the second quarter of 2015 with success originating from both the small and mid-market segments of that business. We completed the integration of the pension business we acquired from New York Life and exceeded our targets for sales and retention in the first 12 months post-acquisition. We expanded the Vitality program by adding two term insurance options; one offering lower fees and the other offering a streamlined customer application process. However, overall, we recorded lower insurance sales and modest mutual fund net outflows in the United States.

In terms of our global wealth and asset management businesses, we delivered our 26th consecutive quarter of positive net flows. We reported core EBITDA of C$288 million and continued to strategically invest in expanding distribution reach and operational infrastructure. And we achieved C$503 billion in assets under management and administration, lifting our total company figure to C$934 billion.

So in summary, while core earnings were disappointing, it would be overly simplistic to project full-year earnings by simply multiplying our year-to-date results by 2.

Our underlying businesses remained resilient, our key drivers of growth performed very well and we are taking number of steps to improve earnings in the second half of the year. We are very much focused on achieving or exceeding our C$4 billion core earnings goal this year, but for the C$400 million investment-related component, which as you know is largely enhanced the markets.

With that, I'll turn it over to Steve Roder, who'll review our financial results and then open the call to your questions. Thank you.

Stephen Roder

Thank you, Donald. Good afternoon, everyone.

Let's start on slide eight where we summarize our financial performance for the second quarter of 2016.

As Donald mentioned, we were disappointed with our profitability metrics in the second quarter. Core earnings and net income were lower than we would have liked and additionally core ROE was impacted by higher equity. We are focused on ensuring that the second quarter is not representative of the balance of the year and our key growth drivers continue to perform very well. In the following slides, I would discuss the key drivers of our financial and business performance.

Turning to slide nine. Core earnings decreased C$69 million or 8%, compared to the second quarter in 2015. This reflects the absence of core investment gains versus C$51 million included in the prior year. Higher expected macro hedging costs and lower earnings on surplus access partly - partially offset by the favorable impact of foreign currency.

Turning to slide 10. Net income in the second quarter was negatively impacted by the challenging environment, including falling interest rates and volatile equity markets, which led to a C$170 million market related charge. This more than offset investment related experience gains of C$60 million, which included very strong credit experience and modest gains on alternative long duration assets.

On slide 11, is our source of earnings, expected profit on in-force increased 3% from the prior year on a constant currency basis, primarily due to lower amortization of deferrable acquisition costs in our variable annuity businesses, partially offset by lower earnings from our wealth and asset management businesses. The impact of new business improved versus the prior year, largely reflecting higher insurance sales volumes in Asia, partially offset by a higher non-deferrable acquisition expenses in our wealth and asset management businesses.

Experience losses this quarter reflect charges of direct market impacts and unfavorable policyholder experience, partially offset by favorable investment related experience gains. This quarter, we incurred a charge of C$106 million pre-tax of C$63 million post-tax, the policyholder experience, as adverse experience in the U.S. and Canada was only partially offset by continued favorable experience in Asia. Management actions and changes and assumptions this quarter, primarily reflects the expected cost of our macro hedging program and integration costs, partially offset by a realized gains on available for sale bonds. And earnings on surplus decreased primarily due to lower available for sale equity gains and higher debt financing costs due to new issuances.

Turning to slide 12, and insurance sales. Insurance sales in the second quarter increased 11% from a year ago, reflecting record sales in Asia, up 30% versus the prior year, and driven by double-digit growth in most territories and strong momentum from the DBS partnership partially offset by inherent variability in group benefit sales in Canada and lower U.S. insurance sales amid heightened competition. Excluding group benefits, total company insurance sales were up 19% from the prior year.

On slide 13, you can see that both net flows and gross flows remained resilient, and all our divisions reported positive net inflows. As Donald mentioned, this was our 26th consecutive quarter of positive net flows in our WAM businesses. We're pleased with our net flows of $4.8 billion, especially given the challenging market conditions. While net flows were down from the prior year, you will recall that last year's record flows included an $8 billion institutional mandate and very strong flows in Mainland China as a sharp rise in local equity markets drove significant mutual fund inflows.

Gross flows declined 25% from the prior year to $26.6 billion, reflecting lower institutional gross flows due to the non-recurrence of the substantial mandate I previously mentioned, which more than offset strong gross flows in the U.S. and Canada.

Moving to slide 14. Other wealth sales were up 6% in the second quarter compared to the prior year, reflecting strong double-digit sales growth in Asia driven by the continued success of recent product launches in Japan and Singapore, partly offset by declining sales in Canada which were impacted by challenging market conditions and product changes.

On slide 15, is our new business value. We had a strong quarter with the new business value increasing 34% from a year ago. The growth was driven by Asia which increased 47% partially offset by weaker results in North America, which were impacted by the lower interest rate environment. New business value margins in Asia increased to 29.7% up 2.3 percentage points from the prior year, this was most notable in our Asia other segments, were higher volumes and in part due to contributions from the DBS partnership, led to margin expansion of over 8 percentage points to 25.4%. We also benefited from improved product margins, which more than offset the impact of lower interest rates.

Turning to slide 16. Our assets under management and administration or AUMA at the end of the second quarter, was $934 billion, up $51 billion from the prior year, the increase was largely driven by net custom inflows, strong investment performance, as well as foreign currency movements.

On slide 17, you can see our capital position and leverage. We continued our part of diversifying our funding sources globally and successfully completed a US$1billion senior debt offering in the Taiwan and a S$500 million, subordinated debt offering in Singapore, these transactions mark our first century, into the Asian debt markets, which has a large fixed income investor base, and where we have a significant business presence and builds on our first quarter U.S. bond offering. The offerings were the primary drivers of the strength and capital ratio and higher leverage ratio in the quarter.

Turning our focus to the operating highlights of our divisions. We begin with the Asian division on slide 19. Asia core earnings increased 12% on a constant currency basis, driven by higher sales volumes partly offset by lower interest rates. We achieved record annualized premium equivalent or APE sales of US$627 million, up 34% from the prior year, reflecting double digit growth in those markets and strong sales in Singapore, Hong Kong, Indonesia and Mainland China, as we continued to experience strong momentum from the DBS partnership.

We delivered strong gross flows into our wealth and asset management businesses of US$3.5 billion in the quarter, albeit down from record results from the prior year, which benefited from strong equity markets in Mainland China.

Turning to our Canadian division operating highlights on slide 20. Core earnings increased 10% over the prior year, driven by improved policyholder experience and group benefits and higher fee income from the wealth and asset management businesses partly offset by the non-recurrence of gains from reinsurance treaty recapture.

Insurance sales of C$120 million declined 28% versus the prior year, reflecting inherent variability in large case group benefit sales. Wealth and asset management gross flows of C$4.2 billion increased 7%, compared to the prior year largely due to strong mutual fund flows despite challenging market conditions.

Moving on to slide 21 and the highlights of the U.S. division. Core earnings were US$280 million, down 11% from the prior year, reflecting more unfavorable policyholder experience in Long Term Care relative to the prior year, a number of smaller policy-related items in the second quarter of 2015, which did not recur. The impact of lower insurance sales and the timing of market spent and the impact of market volatility on fee income, and shift in business mix on our wealth and asset management businesses. In short, sales in the quarter were US$107 million down 9% from the second quarter of 2015 due to lower life insurance sales, the expansion of the Vitality program, the momentum in recently re-priced term insurance was more than offset by competitive pressures.

Wealth and asset management gross flows of US$11.7 billion increased 5% versus the prior year, reflecting robust mid-market pension sales, which were partially offset by lower mutual fund flows due to challenging market conditions and weaker fund performance. However, it's important to note that despite these headwinds, mutual fund gross flows continued to outperform the industry.

Turning to slide 22, and the overview of our wealth and asset management businesses around the world. Core earnings of C$152 million decreased 5% compared to the prior year, due to the impact of market volatility on fee income, shifts in business mix and strategic investments to expand our distribution reach in Europe and Asia and to modernize our operational infrastructure.

Assets under management and administration of C$503 billion, were up more than C$28 billion from the prior year, reflecting positive net flows and the benefits of the strong investment return. We are very pleased we achieved positive net flows of C$4.8 billion in the quarter amid very challenging market conditions.

Despite these headwinds, positive net flows were delivered across all our divisions and with the mutual funds pensions and institutional asset management. We also successfully launched the first U.S. property real estate investment trust in Singapore.

Moving to slide 23, as of June 30, 2016 the annual net pre-tax savings from our E&E initiative reached C$450 million, exceeding our 2016 target of C$400 million. While 2016 beneficiary mark the end of our E&E program, the program has resulted in a new way of life at Manulife, and we will continue to identify and execute on additional opportunities to make our operations more efficient and effective.

In the third quarter of 2016, we will complete our annual review of actuarial methods and assumptions. This year's review will cover over 100 assumptions including policyholder experience assumptions related to our Long Term Care and U.S. Variable Annuity business and reinvestment assumptions used in the valuation of our policy liabilities. While the review is not complete and the impact is difficult to estimate the position, preliminary indications or that the impact could be adjusted net income attributed to shareholders up to C$500 million post-tax. This figure includes an allowance for a potential update to our ultimate reinvestment rate assumption for risk-free rates.

So in conclusion, while net income and core earnings this quarter were disappointing, we are pleased with how resilient our underlying business remained, our key drivers of growth are continuing to perform well, and we are focused on improving earnings in the second half of the year. This concludes our prepared remarks.

Operator, we'll now open the call to questions.

Question-and-Answer Session

Operator

Thank you. We'll now take questions from the telephone lines. [Operator Instructions] The first question is from John Aiken from Barclays. Please go ahead.

John Aiken

Good afternoon. Steve, with the Efficiency & Effectiveness initiative, the C$450 million run rate is very difficult for those or some of the outside to ascertain. Can you let us know in rough ballpark figures, how much that amount to-date has been reinvested in new projects and how much of that has been soft up with just general business growth or factors like the growth of the Asia platform that you mentioned in your remarks?

Stephen Roder

Yeah. Thanks, John. Thanks for the question. The way we look at it is, that the run rate say, of what is now C$450 million to a very large extent that has been offset, if you like by strategic project spend and that project spend has a wide spectrum of types of project. So on the one hand it would include a lot of activity around customer facing digital initiatives, on the other hand it would also include projects that relate to the improving infrastructure of the company, project such as the - which we've talked about before the valuation systems transformation project and dealing with how we go about valuing our liabilities each quarter and that the infrastructure of the investment division another very large project called the GO project.

So, until now a lot of that is not being seen net if you like in the bottom line. As we move forward, and we're trying to give more guidance on this as we get through our planning process to and probably in Q4, we would like to think that as we forward we'll start to see more of this coming through into the bottom-line.

In reality, what happened is we just continued on with a lot of project activity, and many of these projects you have to spend to save, and that's still going on. In terms of, I'll take the opportunity to talk about the growth in expenses in the year as well, because you have to be a little careful when you look at the expense growth in the year, and if you like the baseline number, you have to be careful to adjust it for things like currency and also the timing of on-boarding new life and DBS. So, what I can say is if you - once you normalize the baseline, the growth and expenses for the year is actually about 6% which is lower than the number you get on the headline basis. And of that, at least - well over a half of that is actually to do with sales related expenses in Asia that - that ranks a deferral. So overall, we've got to keep very focused on expenses, we'd certainly be doing that on the second half of this year and as we go forward, and we'll try and give more clarity on E&E towards the end of the year.

John Aiken

But Steve, just not to nail you down to particular numbers, but looking forward to 2017 and 2018, could we expect to see some more tangible results falling through on the expense line, not necessarily in absolute numbers but at least on relative growth at least to what we are seeing on premiums and sales?

Stephen Roder

Right. So, we are going through updating our planning process right now, and we'll have to see how these projects roll forward and to what extent. They will fall through to the bottom line, does it say, we'd like to think that as we continue on to succeed in the Efficiency and Effectiveness project that started net-net turning to bottom line, because I still believe to some extent there is only so much you can spend on projects each year. I mean, I've given the example, the VFC project, for example, that's the valuation project on the liability side of the balance sheet. The total project spend on that is not far short of a C$100 million and it will ultimately give a run rate save of about C$20 million a year, but as of now, it's still costing us. So that would be a great example and the go projects on the asset side of the balance sheet if you like that's actually a bigger project. The cost of that is over C$100 million and it will so produce run rate savings, but it's going to take some time to get that.

John Aiken

Thank you. Appreciate it. I'll re-queue.

Stephen Roder

Thank you.

Operator

Thank you. The next question is from Meny Grauman from Cormark Securities. Please go ahead.

Meny Grauman

Hi. Good afternoon. Just a question on the C$500 million indication for actuarial methods and assumptions. Did I catch it correctly that you said there was an allowance there for a potential URR decline, is that correct?

Stephen Roder

Yeah. That's correct. So, our view is that when we get into Q3 and we'll have to take into account the facts and circumstances prevailing at the time, but there is a lot of talk [indiscernible] around the revision of the URR and it may be that a Q3 we choose to take a charge in relation to changing our URR assumption, so we haven't finalized that yet but included within that C$500 million number that we've given you guidance on today. There is a fairly significant amount in relation to potential URR charge.

Meny Grauman

Would you be able to give some breakdown there in terms of what that is and then what the potential charge for the long-term care would be?

Stephen Roder

No I can't get too specific. If I could be very specific, I'd be booking the charge right now. But we did give some guidance in our documentation that suggested that a 10 bps charge would cost us in the order of C$300 million. So maybe that's gives you, at least some help in getting to how the charge might breakdown, but I can't be specific.

Meny Grauman

Okay. Thanks. And then if I could just ask another question on the potential disposition of low ROE businesses. Do you have any update on how that is progressing? Anything you can tell us on that.

Stephen Roder

Well it's still early days in the project its - these kinds of dispositions are not straight forward. We don't have to enter any transaction, we won't do anything that's not in the benefit - to shareholders benefit. So I don't have anything more detail to report on that right now.

Meny Grauman

Okay. Thank you.

Operator

Thank you. The next question is from Gabriel Dechaine from Canaccord Genuity. Please go ahead.

Gabriel Dechaine

Good afternoon. Yeah just a follow up on the reserve charge. So let's take that C$500 million and if it is C$300 million for URR and maybe it's less than, I don't know. But that would mean C$200 million of reserve charge for long-term care and BA, that seems kind of low, I mean it’s good, but that seems kind of low and only thing that because over the past four quarters, we've had well in excess of C$200 million of negative policyholders experience in LTC specifically. So I'm just wondering, am I missing something there, are you planning another reprising of LTC that the 2013 process go better than expected, if you can help clarify please?

Stephen Roder

Yeah, sure. So just as the headline, I mean there's a huge number of assumptions being reviewed Gabriel and some are positive - some are likely positive, some are likely negative. We've obviously spend a lot of time focusing on long-term care which is negative. Maybe we don't speak so much about some of the positives and they're not so well reviewed.

Gabriel Dechaine

Okay.

Stephen Roder

Let's ask Steve Finch to give you a bit more color.

Steve Finch

Sure, Gabriel, it's Steve here. We in this assumption review as Steve mentioned, we're reviewing a lot of different assumptions and so on and what we highlighted in the material was that some of the material areas that we're reviewing on big blocks of business, you know the long-term care, on long-term care, it's a very comprehensive review. It includes reflecting all the recent experiences that you also noted as well as looking at our margins and it will also include looking at our expectations on our success in getting future rate increases. So it will take all of those factors into account and definitely reflect a more recent experience as well. On variable annuities, I think you assumed it, it will be a charge, but we're actually finding some favorable aspects of policyholder experience that we're reviewing there. So that's....

Gabriel Dechaine

Okay.

Steve Finch

A few comments as I said there are also other items that will be both positives and negatives, but as of right now, the guidance on up to 500 is our best indication.

Gabriel Dechaine

Okay, that was very helpful response. Then on the leverage ratio, you are at around 30% right now, do you want to get back to 25% or in the ballpark, I know there is about a C$1.1 billion of debt redemptions at the end of the year, I'm just wondering how eager you are to regain some of that financial flexibility, because we've always like that because of the uncertain macro and if anything or even more of an uncertain macro.

Steve Finch

Yeah.

Gabriel Dechaine

And Donald, but before I forget this one. You said, don't take the first half earnings and double them and get to an annualize figure because you are implying that this stuff you can do to improve your profitability in the second half, what are you planning on there, I'd love to dive into that a bit as well.

Stephen Roder

So Gabriel, I will take the first part on the leverage and capital and then Donald can answer the second question. So yeah, we have taken the leverage ratio up, we took a view that we had some fabulous capital raising opportunities in the first half of the year. We are very, very pleased with what we are able to achieve in - particularly in Taiwan we were able to 30 year money. On very, very good terms, we think the pricing was very good and so we took the view we should just take it and because who knows what's going to happen in have in volatile markets as you say.

So we've driven up the leverage ratio in the short term and you're absolutely correct, assuming we follow through C$1.1 billion of costs in the fourth quarter then the leverage ratio will come down by something in the order of 150 bps, I would expect so. So we're probably be back down 28, 28.5 kind of range, I would think at that time and that's fine, we're quite comfortable there, ultimately we - one day we would like to be back at 25, but I think even 28 we still have a fair bit of financial flexibility. So very comfortable there and to be honest, if we can continue to raise money, 30 year money on very favorable terms.

We are inclined to what is favorably on that sort of opportunity, and I do think that diversification has been a great thing because it reduced the risk profile and it also served to bring in outspreads in general. So, we count as a success and maybe I'll pass over to Donald and he can answer the question on the second half.

Donald Lindsay

Good morning, Gabriel. Thank you for taking us there. We feel a lot of confidence about the second half being better than the first for a variety of factors, some in our control and others not. Some of the big ones are macro hedging costs. We've taken a look at it and we think we maybe set the colors a little bit too tight. It's been great that we've been largely immune to equity market movements, significantly immune. But perhaps we kept the colors a bit too tight and that cost us in terms of core earnings.

There is a number of, as Steve has discussed extensively, we're getting these enormous savings for any project that we're pawing into forward facing investments. One of the beauty of these forward facing investments is necessary they are to do to keep the health of an enterprise going forward is that, you've got a lot of discretion about how fast they're implemented and so on. And well, I've said over and over again that I will not stop something that is truly strategic for Manulife just to make a quarterly earnings result, we do have the ability to change the pace of those, and in fact we're running well under plan on expenses right now, that's our internal measure. Everybody is doing the typical thing expecting that they're going to catch up over the next half of the year and we won't necessarily let people do that. There is a pace to these things that we can manage. There is also other things that we've implemented yearly savings and some of our acquisitions where we will be harvesting actually greater gains going forward than we've to date.

Last but not least, there is all the new business we're adding, some of it, most of it costing one way and others. Steve talked about non-deferrable acquisition cost associated with various businesses that are growing rapidly like in the investment management business and in Asia. That produces a stream of earnings going forward, both of those businesses and all of them in fact produce a very positive stream of earnings going forward. It is really interesting again that we are growing fastest in the businesses that have the highest margins and highest ROE, and actually where we have got disappointments, in terms of sales growth, it is in areas that actually tend to have deficient ROE and lower than average margins across our enterprise.

So the business mix is shifting in very favorable. That's not entirely by accident, we are allocating resources, strategic capital, everything else towards the businesses that have the higher margins for our investors. So, there are other reasons that - but I don't want to speak too long and I guess you'd probably let me speak for half an hour on this one, there is a number of things...

Stephen Roder

I would.

Donald Lindsay

…even I - yeah, well, we feel a lot of confidence...

Stephen Roder

More numbers though too.

Donald Lindsay

Yeah, borrowing, borrowing, extraordinary factors. We've said it before, we are very targeted as an organization in making C$4 billion of core earnings, includes the C$400 million of investment related component. Earlier in the year I said, the C$400 million, given oil and gas prices looks like it's going to be unobtainable, but we have never backed off the other element of it which is the element that we can control. Our entire compensation system is targeted on achieving the result with the C$400 million in there, and so on, and we as a management team are very committed to producing that result.

Gabriel Dechaine

Well, I appreciate the response, I'd love to dive into it some more, but I know others have some questions as well, so I don't want to hog the floor. Have a good remainder of the summer.

Donald Lindsay

Thank you.

Operator

Thank you. The next question is from Robert Sedran from CIBC. Please go ahead.

Robert Sedran

Hi. Good afternoon. This issue has come up from time-to-time on conference calls, and I want to ask about interest rates and specifically what the interest rate mean to core earnings. You probably can't quantify for me how much of a headwind, they are to core earnings today. If you can, it would be great, but part of what I'm getting at is the linearity of that exposure. In another words, is the decline from 3% to 250% the same impact roughly as the decline from say 150% to 1% if we were ever to go there. Is there, does it become a more significant as rates go lower, I know that it does in some cases on the headline. I'm thinking more in terms of the some of the core earnings that, that are being held back by the lower interest rate.

Stephen Roder

Okay. Hi Rob, its Steve here. I'll take a bit of crack at that, and then pass - maybe pass to Steve Finch. So, no, I don't think you can take that view, that it's kind of linear. I think the reality is that the interest rate declines may force management actions. And so, for example, in this quarter we take management actions in Japan to the re-price product. And we even withdrew a particular Japanese yen product. It'll be a product that we largely sell in foreign currency. So, I think it's a bit more nuance than that. Having said that and you're right it's very hard to quantify, the overall impact on core earnings of declining interest rates. But let me pass to Steve, because I think he does have a bit of an overall view on what interest rate did to us this quarter.

Steve Finch

Yeah and I think it's been explained in previous calls that the - when interest rates go down, there is some knock-on impact to our go forward core earnings because our pads become lower, and there is less to release in the future. It's not a huge number and I think, in general that's fairly linear, we've probably bump into some minimum crediting rates which make it not quite linear, but reasonably linear. The other place you see it come through which Steve was talking about, Steve Roder is in our new business gains, and if you look at the trend from Q1 2016 to Q2 2016, some of that decline is from lower new business gains, which then the business can react to by modifying products and so on, so it's - it is hard to put out the figure on it, but that's where you would see it coming through.

Robert Sedran

Okay. Thank you. And just, I guess the point of clarification on something that Donald mentioned in his answers to Gabe. Would you talk about the colors on some of the equity exposure? I might understand that, that equity exposure might be going up or just a nature of the equity exposure might be changing. I just - I look at the S&P and as much as we talk about market volatility, the S&P 500 is, are reasonably healthy levels, I guess, and I'm wondering what the view is on changing the way you look at those exposures at this point?

Donald Guloien

Yeah, what we're talking about is more intraday movements a little bit greater, so we would be taking a little bit greater risk on intraday movements, and theoretically, yep, markets went really, really bad. There would be a little margin at the - there would be a little increase in equity risk, but basically we think the price of hedging to narrowly has exceeds the benefit to the shareholder by a pretty good margin.

Robert Sedran

So, the philosophy is not changing, the implementation is changing a little bit?

Donald Guloien

Yeah, would you, I'm want to be straight, it will increase our equity exposure marginally, not something you had probably noticed. If equity markets were down 30%, it's not going to be a meaningful difference, but the, what we are doing is hedging on an intraday basis and that is costing us, especially when you have markets going up and down like a seesaw, based on election events or somebody is [indiscernible] or terrorist event in some part of the world, that's costing us very dearly, trying to keep it very tight. So, we are going to open it up just a little bit.

Robert Sedran

Understood. Thank you.

Operator

Thank you. The next question is from Linda Sun-Mattison from Bernstein. Please go ahead.

Linda Mattison

Hello. Sorry, you might hear noise at my background, so - because I am travelling. I have two questions to ask. The first question is regarding the insurance sales in Hong Kong and Asia. I can see that Hong Kong is growing very nicely. I'm just wondering how much this growth is coming from Mainland China, Japan Hong Kong, therefore vulnerable to further capital control measures that China may take.

And the second question is the URR, the ultimate reinvestment rate. This quarter it has dampened your earnings and just wondering why are you adjusting down the URR this specific quarter. Are we going to see more work and figure more downward revision and what kind of drawback - sorry, what's on the geography this URR actually impacts you the most, so whether it's U.S., Canada, or Asia? Thank you.

Donald Guloien

Hey, Linda. We'll ask Roy Gori to take the Asia question first.

Linda Mattison

Thank you.

Roy Gori

Thanks. Thank you, Linda. Linda, in terms of your first question on Mainland China business and its impact on Hong Kong. It's actually a relatively modest contributor to our overall Asia sales, approximately 6% of our total sales come from Mainland China and in Hong Kong it represents less than 30%. So while it does contribute to sales, it's a relatively modest contribution and our Hong Kong business is primarily focused on the local domestic market and there is where we have a very strong business. In addition to a strong agency, we have expanded our distribution and banca is now a much more significant contributor to our business in Hong Kong, that's obviously off the back of the DBS partnership, but also the furthering of our banca assets. So that's just probably a top line financial summary to answer your question.

Linda Mattison

Yeah. Thank you.

Donald Guloien

Okay. And then the URR question and I think this is technicality around, how reserving is, to be carried out. So Steve will just explain what's going on there.

Steve Finch

Yeah. Hi, Linda. So the URR change that we're anticipating would come due through in Q3 to be clear and this is a rate that's prescribed by the Canadian Actuarial Standards Board in terms of what reinvestment assumptions are allowed in the valuation that was last set in 2014 and our expectation is that the Standards Board will reflect - will update their guidance in 2017 taking into account the fact that rates have been lower over the last few years. It is a very, very long period that the Standards Board looks out. They go back all the way to 1935 in terms of calibrating this rate.

Donald Guloien

So, Linda. Just to answer that, so there is, I'd say on balance of probabilities the industry is expecting that guidance or requirements arising from the Canadian Actuarial Standards Board will change. And…

Linda Mattison

Yes.

...in that situation, if we believe that the facts and circumstances suggest that it’s prudent to do so. Then we're giving some guidance that we would expect to take a charge in relation to that as part of our Q3 basis change.

Linda Mattison

Okay. So just to clarify, so basically industry is expecting the guidance to change and you're - basically giving a guidance, what the impact would be for you if that is going to happen about?

Donald Guloien

Yeah, we take the view that, we'd rather be in precisely right and precisely wrong, so take some charge now and then we'll true it up, when the actual guidance appears rather than wait necessarily for the guidance to arrive.

Linda Mattison

In this regard, is it completely prescriptive, and forgive my ignorance, is it completely prescriptive or is there discretion that to specific company management deal and actuarial review?

Donald Guloien

It's prescriptive in Canada, but then we have to apply consistently in our other operations or there is some judgment there.

Linda Mattison

Okay, great. Thank you.

Operator

Thank you. The next question is from Tom MacKinnon from BMO Capital Markets. Please go ahead.

Tom MacKinnon

Yeah, thanks very much. Question on the interest rate charge that was taken in the quarter. Your sensitivity again shows really no impact on earnings from parallel changes in interest rates relative to rates you assume in your valuation policy liability. So, fact will be the only thing that can [indiscernible] would be the corporate spreads and swap spreads, which kind of a marginal, and I didn't think they were going to impact it as much as what happened in the quarter. It seems as well that a lot of the interest rate headwind came from this is on the reported number, came from the Asia operation. So was there something with respect to interest rates in Asia or perhaps in Japan that hurt you more specifically in the quarter than what your guidance generally explains?

Donald Guloien

So, Scott is going to take that question. Scott has to take that one, Tom.

Scott Hartz

Yeah, hi. And so, yes, our disclosure is that for a parallel shift does not affect us much, but you know that assumes parallel shift is the same amount in all countries, all geographies and of course rates don't shift in a parallel fashion, we do have some exposure to non-parallel and it just gets very complicated to try to disclose all the nuances, but I think you're right that it's - the driver this quarter was really corporate spreads. And we have an exposure to corporate spreads, they were tighter. What's most important to us are sort of long corporate A spreads and that's really the big driver.

There were a few tos and fros. And I think you're right, swap spreads didn't have much of an impact. There have been other quarter where that's been a bigger deal, but that was not much this quarter. So really it was corporate spreads. The big drop in Japan was not helpful, but not a big deal. Again, really it was the corporate spreads only.

Tom MacKinnon

And what was driving the decision not really to take much in terms of AFS gains in the quarter despite the drop in treasury yields?

Donald Guloien

You know we've kind of moved away from quarter-by-quarter taking gains or losses in AFS. Unless we see a really big move that we think is going to be sustained and then we will typically do that, and so we did some of that in the first quarter, but this quarter it wasn't that big a move and we didn't feel it was the right time to do so.

Tom MacKinnon

Okay. And then a final question on long-term care. Assuming you sort of get it right with your reserve review and your basis change for long-term care in the third quarter, what does that mean for - presumably that means we shouldn't be having any sort of policyholder experience losses with respect to long-term care going forward, at least for some time until you perhaps experience deteriorates again. Help me - help us walk through that then.

Donald Guloien

So, correct. So, if we take - if we were to take charge in Q3 than that could be beneficial in terms of core earnings to the second half. So Steve can talk a bit about that.

Stephen Roder

Yeah. Hi Tom. I think your inclination here - your view here is correct. We're definitely reflecting in our assumption review the impact of recent experience which has been negative, and we're definitely looking at the overall review with the bias to making sure we get the short-term as well as the long-term rate. So I think we'll be provide more information when we get to Q3, but directionally you're correct.

Tom MacKinnon

Okay. Thanks.

Operator

Thank you. The next question is from Sumit Malhotra from Scotia Capital. Please go ahead.

Sumit Malhotra

Thanks. Good afternoon. Just wanted to come to back to URR one more time. Steve correct me, if I'm wrong, in previous conversations around this issue, you had indicated that, this was more likely to be an event that the company would have to deal with in 2017. If that's correct, the change today is that reflection of what you're being asked to show the numbers from the regulators or is this just a view that maybe other items in the actuarial process aren't going to be that sizable, so it's better to be ahead of the process if you can?

Stephen Roder

Well, thanks Sumit. I'd say first thing, nothing to do with the regulators at all. And facts and circumstances change and our understanding of those facts and circumstances change, so that would drive our accounting as I say, my advice has always been precisely right rather than precisely wrong. So that drives my thinking, but I'll pass to Steve, he can give you a bit more color.

Donald Guloien

The only thing I'd add is, it's become also a lot more clear that the prescribed guidance is going to come into - in 2017, which I would say was uncertain earlier.

Sumit Malhotra

Sorry, meaning that the official change or the mandatory change will occur in 2017, but you are of the view that there is enough information that you can - you can make the change now to, for the lack of the better term, get ahead of it?

Donald Guloien

Correct.

Sumit Malhotra

All right. Then, to go to the earnings for a second, if I think about the core EPS this quarter, C$0.40 and just look back to three months ago, something your line items don't look that different, but the one that is always, at least from seat, the biggest mystery to figure out is the experience gains, and you show us a, a larger number there, in your MD&A you talk about the C$106 million in LTC pre-tax of unfavorable policyholder experience. If you can, if you leave the market impacts out of it, and looking purely at the insurance policyholder experience, are there other areas outside of U.S. long-term care that are having a detrimental impact on the slide?

Stephen Roder

Yeah. Hi, the number that you coded that's the total policyholder experience charge, and long-term care was just under two-thirds of that. In general, I would say, that's been a fairly consistent result over the last number of quarters. It has bounced around a bit. The- we are seeing consistent gains coming out of Asia claims results, and then we are seeing some, some lapse losses coming out of different product lines in both the U.S. and Canada mix up the rest of the experience.

Sumit Malhotra

But nothing that you would, you would call, unusually large this quarter, because at least on the way I've looked at it, that seems to be the area that was chiefly responsible for earnings coming in a little later this time around. Is that fair or am I not looking at...

Stephen Roder

There's nothing - there are a couple of isolated things and we're not sure that there are meaningful trends there because the experience did deteriorate a little bit from Q1 to Q2 of this year. The biggest driver was LTC and then it was a number of smaller items that don't generally look like trends.

Sumit Malhotra

Okay. Last one is for Donald. You're obviously sitting in a strong capital position. Steve touched on the fact that you were able to bolster that with issuances in a new geography and there was lots of demand, and you're giving us as you usually do a pretty positive outlook for the company and why things should be better in the second half. So, with all that said, the stocks trading, I don't know 85% of book value per share. With the capital being where it is, it certainly seems like one of the best proceeds - use of proceeds for shareholders right now could be to buy some of that stock. Why have you, especially since the acquisitions, have been quieter for Manulife of late? Why doesn't it make sense with the stock where it is for the company to be first in line to buy shares back?

Donald Guloien

Yeah. It's a fair question. I think we've said before that we're giving consideration and discussing that with our board of directors that we've always preferred to invest in the business, but when the stock price gets as low as it is, stock buybacks could make sense. And so, there are active discussions I can say that. But the other thing is, we're going to air on the conservative side with respect to the amount of capital that we hold for a number of reasons. None of us would have predicted rates would go as low as they are and it's having an impact on other asset classes. These are unusual times, there is more volatility in markets than there has ever been before for a whole variety of reasons.

And the third thing is, we are in the midst of a regulatory capital change here in Canada and while we have no reason to believe that there is anything difficult coming from there, when we are adjusting capital ratios, small changes equate to billions of dollars, so we are inclined to be on the conservative side there, again that's not for telling any issues, we really don't know where that's going to end up, but it's better to have more that you have to think about different ways of deploying than have less and have to do it down around equity financing and...

Sumit Malhotra

Yeah.

Donald Guloien

I want to protect shareholders from that.

Sumit Malhotra

That's basically, I'll leave - I'll wrap it up here, this is basically the gist of my question, I mean, I always thought it would make sense for you at least file the paper work on NCIBs. So that if you have days or periods of time in which your stock is under pressure, it gives you the option to at least be a - be a buyer of the stock at those levels, there is nothing like from an [indiscernible] perspective that is preventing you from, as I say, filing paper work for NCIB, this is a Manulife decision, not something you've been asked to refrain from.

Donald Guloien

Well, I can't talk about the regulator but, I'm frankly not aware of any barrier whatsoever to us doing that if we choose to do it, it's a matter of Board deciding and our bias has been quite clearly to use capital in other ways that are more productive, but again we never anticipated our stock price to be down in C$17 and change, maybe that changes our thinking and, some words that you have used in describing it is very similar words I have heard elsewhere, shall we say. So it's clearly under consideration.

Sumit Malhotra

Thanks for your time.

Stephen Roder

Sumit, just one - I just one add-on to your question about Q1 to Q2, where you kind of get under the reason for the declining core earnings. One thing I should not be overlooked is the impact of foreign currency. So, the decline in, the weakness in the U.S. dollar between Q1 and Q2 probably cost us quite close to C$40 million. So, quite a big piece of that decline in core earnings is pure foreign currency related.

Sumit Malhotra

Okay.

Operator

Thank you. The next question is from Mario Mendonca from TD Securities. Please go ahead.

Mario Mendonca

Good afternoon. Stephen and Donald, because of the improved disclosure around pre-tax experience items and items of note, it has become easier to drill down on those items, and one area in particular that I'm focusing on is trying to back into the unallocated expenses. And I think I've come fairly close to understanding what that's all about. Could you help me understand did the unallocated expenses, have they increased say quarter-to-quarter or over the last year or so?

Steve Finch

Hi, Mario its Steve. No, the answer is no, they haven't. I think most of the organizations have a level of unallocated expenses, and our business has usual trends in unallocated expenses. I'm pretty happy with, there has some strategic spend in the center that is not allocated as well. Most of it is associated with the build out of the investment division infrastructure. So, earlier on when I talked about the true normalized growth if you like in expenses, it's around 6%. And I mentioned that over half of that was associated with sales in Asia. Well, around a culture of it - quarter of it, is related to the build-out of the investment divisions, infrastructure and that relates to the build-out out of the European initiative to further our ability to distribute product across European institutions. It includes some private market build-out and it includes the expenditure in relation to the GO project, so those would be in there and that takes care of most of the increase in expenses. It doesn't related to that Asian sales related expense growth.

Stephen Roder

And Mario, if I can jump in. Remember, we're building that business the hard way that is organically by constant investment but as you would really appreciate it is much cheaper doing it that way. It's now a C$500 billion business. If you went out and bought a C$500 billion asset management company, I think you'd know what that would cost, and it's a lot less. It's multiples - multiples, higher, easier to do to buy somebody else's finished business than to grow it organically piece by piece, and we're going to continue. That's where you talk about - where people talk about where the savings of E&E going, that's one of the places going, the other place is obviously Asia that we're continuing to invest in and that is all being reflected through run rate expenses.

Mario Mendonca

Sure, I get it. Building doesn't - doesn't create goodwill, so materially right, I follow that.

Stephen Roder

You got it. I would like ask you to repeat that, but that would be unfair.

Mario Mendonca

Right. No, no. I get it. The other thing I wanted to quickly touch on is, if we were to - sort of related topic if - we were looking at a year out from now, would the corporate segment and I've observed that the corporate segment generates a loss equal to your - roughly equal to the [indiscernible] that's material segment. Would you think a year from now that corporate loss would be materially lower than where it is today?

Donald Guloien

Mario I think the answer to that would depend on, where we go on strategic spend, because there is strategic spend in there.

These expenses are basically entity sustaining expenses. So there are expenses quite rightly belong in unallocated. It depends where we go in our planning process and the sequencing and placing and phasing of our projects...

Mario Mendonca

That's fair.

Donald Guloien

.... next year. So I can't really give you a crisp answer from that, but I will tell you that in the first half of the year that investment division build-out is probably worth something in the order of C$60 million.

Mario Mendonca

I get it. Okay.

Donald Guloien

The other thing. Mario, Donald again is, we don't want to underestimate this or not speak to it and I am embarrassed to talk about it is. We've had phenomenal growth in risk - expenses around risk and compliance, now every FI has, but if you look at the rate of growth in those areas, it's simply sell mining and it's stuff we have to do - all the regulatory stuff, that's not unique to us, but it's phenomenal. Now it's not growing the same rate forward, but that has been a big increase and that could fall into that line as well.

Mario Mendonca

Okay. Then a question for Steve Finch then. You referred to the decline in interest rates and the impact that can have on core earnings, you specifically referred to the release of keypads and how that causes expected profit to go down going forward. The question I have is, did that phenomena play out this quarter specifically the release of [indiscernible]?

Steve Finch

Yeah. It was not a huge number roughly C$10 million pre-tax.

Mario Mendonca

Okay. So the impact on expected profit going forward is inconsequential then?

Steve Finch

Yeah. It's really the new business stream, right so [indiscernible] for the benefit of everybody, we have hedging programs in place that once we've written a piece of business, we by and large forward hedge it than we should be relatively protected from movements in interest rate within reasonable bound. But the new business that we price, we priced it at the prior quarter, interest rates dropped by 60 basis points that's going to be underwater until it has been re-priced.

The vast majority of that impact shows up in the quarter was written, and reduce in new business gain or theoretically a new business loss. And then it will tend to go closer to long-term expect as Steve said very minor adjustment after that, but yet it basically all present valued. And you're putting it on a lower rate than you priced in the product you take a hit at the time. So that is what we experienced with the big decreases. You don't notice it so much in North America, a little significant, but in Asia particularly in Japan, the decreases were very, very significant and that the impact was felt.

The other impact that's felt on the Canadian MCCSR basis is the required capital goes up, so what are your booking say, you raised some capital, and we would expect the MCCSR to be higher, but the impact of interest rates on required capital is actually very profound and the Canadian system is a little bit pro-cyclical. I think the regulators are taking a good look at whether or not this makes sense, that the rates go down actually the margin for error it goes up, that more required capital is held, then if interest rates go up, it gets linear. It's sort of counter intuitive frankly as rates go down and you think there'll be less margin required and rates go up when more margin required, but the system is the way it is and as the balance sheet expands we have to have more required capital. So, it has that impact on us as well, which is another reason we are holding more capital.

Mario Mendonca

Let me be sensitive about time here now, and I'll be quick, but Steve Roder now. You do spend a good amount of time emphasizing the improvement in embedded better value margins in the Asian business. And I feel like when you do that, I should pay a lot of attention and I should pay a lot of attention and I should care about that. But help me understand why that matters from a near-term perspective or medium-term perspective on earnings and the emergence of earnings for this company? Thanks. [Indiscernible] the answer it doesn't. Maybe it doesn't...

Steve Finch

No, it depends on what do you mean by near-term. I mean the earnings were emerged over a period of time and the emergence curve depends on the product, the shape of the emergence curve et cetera. So, I mean what we've seen as a result of the growth in new business value is that we have had consistent quarters of growth in Asian core earnings. Now, this quarter was 12%, that's on the low side, compared with the last several quarters, but - because policyholder experience was still positive in Asia, but not as positive as it has been in the previous quarter. So, that new business value growth is driving Asian core earnings growth. So, I think that's why - I think it is important from that perspective and will continue to be and the other interesting feature is that if you look at our embedded value, I think compared with some of our peers, the earnings emerge faster than some of our major peers in the region. So, that's also a positive but does it - is it going to affect, does it have a have a major impact on the next quarter? No, not necessarily. So, it depends on how you value that future income stream - stream and how much you ascribe to that future growth profile.

Mario Mendonca

So, your outlook is five years, but mine is five minutes. That's the difference.

Steve Finch

It was and [indiscernible]. I mean it is a strong comparison. If you talk to investors in different parts of the world, they have entirely different view and I can tell you I get a lot more questions about, the new business value, embedded value in those parts of world, which tend to take a longer term view, that's for sure.

Mario Mendonca

Yeah, I'm just surprised why they are not buying the stock on a day like today, then?

Steve Finch

Well actually that, they are buying the stocks, if you look at the underlying investor base, we have seen quiet of significant expansion in the number of shares held outside of Canada.

Mario Mendonca

Thank you for endorsing - indulging me. Thanks. I appreciate it.

Operator

Thank you. The next question is from Humphrey Fai Lee from Dowling & Partners. Please go ahead.

Humphrey Lee

Good afternoon. Thank you for taking my questions. Just I want to follow up on the assumption review, especially Doug mentioned the positive side, it sounds like VA is getting a little bit positive experience, was it more kind of the utilization being more favorable or like any color that you can share would be helpful?

Donald Guloien

Yeah I think, at this stage in our review, we probably don't want to get into that level of detail, we will be happy to share all the details, when we report our Q3 results, I think we'll leave it at that for the variable annuity right now.

Humphrey Lee

But what about kind of the - in recent years, in terms of the surrender or lapse experience, how were they compared to your current assumptions?

Donald Guloien

Well, if - if you'll recall, we did take some material charges roughly four years ago, related to policyholder experience and the trends, since that time have been, have been quite acceptable.

Humphrey Lee

Okay. Got it. And then maybe moving onto, onto - in the U.S. especially for John Hancock Investments, you talked about the gross flows were positive, but net flows were outflows, and then you are citing [indiscernible] and some fund performance, specifically I guess maybe I'm just a little bit curious especially given your fund lineup in the U.S. There seems to be more target date funds of asset allocation, those that seems to be more of the bread and butter for John Hancock Investments. So that's why I'm a little bit surprised the market conditions being - having a big impact on your flows in the U.S. So maybe you can elaborate a little bit on what you're seeing there?

Craig Bromley

Sure Humphrey, it's Craig Bromley, I'll just talk a little bit about that and maybe if I'll want to add something or maybe not. So I guess first of all we still have a pretty good experience in terms of our gross and net flows versus the industry. We continue to take market share, so it's not a dire story by any means.

In terms of the product mix that we're selling, our - a big portion of our assets under management are target date funds, particularly in support of our 401(k) RPS business where that product is quite a popular option. However, most of our sales in John Hancock Investments are not target date funds. They are actually a mix of various types of products, both fixed income and equity and absolute return. So it isn't one of the bigger sellers, actually target date is - it is one of the bigger assets under management. And you know it's great to have a dispersion of different types of funds to weather different market conditions and that's been a real benefit for us. But we are experiencing some performance challenges in a couple of those funds, not target date funds, but actually a couple of other high-selling funds for the last two years. We expect that to turnaround and we are getting still great sales out of those products, but we have seen some significant redemptions, and redemptions are actually quite lumpy in this business. Surprisingly you think of retail mutual funds as not being particularly lumpy, but there is a fairly big sort of semi-institutional component of the sales, which are really platform and model sales and those do redeem and sell in big chunks. So, the second quarter was disappointing in terms of redemptions, but we have no reason to believe that that's a continuing trend.

So, we have pretty good expectations for the John Hancock Investments, platform has been a great story for a number of years, 18 consecutive quarters of net inflows. We sincerely expect to be back in that situation going forward. Is that helpful?

Humphrey Lee

Yeah. That's helpful.

Kai Sotorp

So this is Kai Sotorp. Just to add to that, one of the big dimensions in the U.S. that played out was related to the volatility markets and the Department of Labor rulings. There was a big shift in flows out of active and into passive. So, most of the wirehouses which make up a big chunk of every mutual fund company sales, actually the redemptions we saw were not out of us versus another active manager; they were out of active into passive. And of the top 10 franchises, there were only two active manager franchises that had net positive flows last quarter.

Humphrey Lee

Got it. Thank you for the color.

Operator

Thank you. The next question is from Peter Routledge from National Bank Financial. Please go ahead.

Peter Routledge

Hi. Thanks. A question related to your wealth and asset management business. And on page 12 of the sub pack you've laid out of source of earnings overall and excluding wealth and asset management, which means you can sort of back into, source of earnings for wealth and asset management and what strikes me there, first of all and I would like to get your comment on it is, there is a very high level of strain on new business relative to expected profit and that it's rising as a percent, what's driving that strain?

Kai Sotorp

So this is Kai Sotorp. So the strain that we have is - a fair chunk of that is on the retirement and retail side.

Peter Routledge

Okay. Why is it high [indiscernible]...

Kai Sotorp

Deferred acquisition cost is pretty high related to intermediary sales. There is none of that really in the institutional business. So I think as our mix shifts more towards institutional and out of the intermediary channel driven retail, we should have less strain, but the two biggest impacts actually in terms of margin have been the following. About 56% of the decline was due to compression effects in the retirement business. So change of business mix as we shifted from the from the small to midsize market and fee compression from shift from equity to fixed income.

On other - the remainder is really due to the strategic initiative spending, so that's the increase in agency force, the infrastructure spend behind the investment division and the distribution expense inclusive of Europe, so the strain is not as obvious as - or as great as you would see because it's actually, there is a variety of factors driving the decline of margin and the decline of earnings.

Peter Routledge

Right. And part of the strain is, you're getting pretty healthy sales in this business. So that's probably driving as well.

Kai Sotorp

Yes. I mean...

Peter Routledge

...go ahead.

Kai Sotorp

...if you actually - sorry if you look at the - if you look at WAM flows, gross flows...

Donald Guloien

It's pretty good

Kai Sotorp

.. Last quarter versus the prior year, same quarter. And you exclude the large mandate win, we're virtually on the money in terms of the gross flows, but in a dramatically different environment which is I think a frolic effort, by the teams around the world in terms of getting the retail, institutional and retirement business moving.

Donald Guloien

That's one of the reasons Peter, Donald here, that's one of the reasons why we talk about EBITDA in that business, is that's the way a mutual fund company looks at it, right, because I mean, they don't have a concept to screen and you're quite right, when you look at the source of earnings that's in a life insurance approach apply to a business that doesn't have that, but you look at the Fidelity, T. Rowe Price, CI whatever, they don't talk about screen. They know they have a cost of originating business. It tends to be upfront or a big portion of it is upfront, and that's what they look at EBITDA is what they can really expect to the emergence to be in and that's what we measured on that basis, but being a life insurance company we're forced to actually reflect also in the source of earnings which gives to a notion of screen.

Peter Routledge

Yeah, and I'll ask one more question, just on expected profit, and it made - I did made it to life insurance centric question, but the expected profit in this line is flat line for the last several quarters. So and it's really to another question. When do we start to see expected profit grow in line with your sales, because like that's what I am surprises about, that I get to say the strain is higher but I don't get. Why don't we get more profit out - expect to profit out of this pretty strong asset growth?

Stephen Roder

Yeah, so there is another number of factors. One is the integration of two fairly significant platforms and retirement last year which was New York Life and Standard Life, that's translating through into Q1 and Q2. Secondly the business mix that came on board with New York Life and Craig Bromley can speak some more about this. That book has a higher proportion of large case to medium case, which while it has a bigger quantum, the actual fees charge a small amount of basis point - basis. So, you - it looks as if you're having kind of an opposite effect on that side, but when you strip out the integration cost, when you strip out the strategic initiatives and the compression effect from the mix of segments, we've actually had an increase of about 50 bps in terms of margin expansion and the other businesses; retail and institutional. So, I think we're already starting to see some of the margin expansion benefits coming through.

Peter Routledge

And does that factor into your optimism for Q2 - or second half of this year overall for Manulife.

Stephen Roder

I think that the factors that Donald detailed earlier on are probably the bigger drivers for how the second half may look different.

Peter Routledge

So, I should think that more...

Stephen Roder

It's the areas we're concentrating on. I think some of the strategic spend that Kai is dealing with, that's going to continue on in the second half for example, that's not a flash in the pan, that's heavy lifting.

Peter Routledge

So, this is more of a 2017 lift.

Stephen Roder

Yeah. Yeah.

Peter Routledge

Okay. Thanks for indulging.

Stephen Roder

Sure.

Operator

Thank you. The next question is from Doug Young from Desjardins. Please go ahead.

Doug Young

Hi, good afternoon. I'll keep this relatively quick and I guess this is probably a question for Roy. [Indiscernible] margins in Asia and the improvement in margins, it sounds like a lot of that is being driven from other Asia. And it sounds like a lot of that could be coming from DBS. And I'm just trying to get a sense if that's correct, and then just thinking about it does that mean the DBS margins are better than the existing business or is it - this just a volume game where you're under-scale in certain regions and the scale has given you a pickup in the margin? Thank you.

Donald Guloien

Yeah. Thanks. Thanks Doug. I think you're right in growth terms, the improvement in margin across Asia, well actually the NBV total improvement for our year-on-year is about 47%, year-to-date we're about 57% up. And our margin lift has been about 2.3 percentage points.

Geographically, other Asia is contributing much more significantly. Our APE growth in other Asia is about 92% and we've got NBV growth in other Asia of about 201%. DBS is obviously a significant contributor to that. And we're - I guess the first comment I'd make is that we're delighted with our progress with DBS. We kicked off our partnership in Q1 of this year and again that was something that's been nine months in progress with significant work on technology integration as well as new product launches.

Q2 for us with DBS, so it's not any continuation of that momentum, but actually an improvement. Our growth in sales was 14% up on Q1. So, we're really delighted with that partnership. We've got a strong alignment of interest through the commercial construct that we've created with DBS, but also just hopefully there's a real strong alignment.

In addition to DBS, we've really had strong growth across the other geographies in other Asia. So, Vietnam, Malaysia, Cambodia, China have all contributed significantly to other Asia growth. So it's not just a DBS story. And other Asia is now becoming a much more significant contributor to our total growth. And then again from a distribution perspective, we've talked about the fact that not only are we focused on banc assurance and our banca sales have grown by 200% year-on-year. DBS is effective there, but again we got seven exclusive bank partnerships across Asia, and they are all growing very significantly.

Agency growth also being very strong, and while we grow our total agency count by about 8%, our agency sales grew almost 20%, so we've been really focused on getting much greater productivity out of our agency and the focus around quality as opposed to absolute quantity of agency has been a huge area of attention.

So, so, yeah, in summary, other Asia is now a much more significant contributor, DBS and Singapore is a significant component of that, but there are other geographies within other Asia that are now really deciding to come into their own and contributing more significantly, but the focus more generally around channel diversification through bank as well as getting greater productivity as agencies is also coming through, they are all contributing factors as well.

Doug Young

So, my view that the DBS margins are higher, it maybe not the case, there is other drivers is that the way to think of it?

Donald Guloien

See, where we are sort of disclosed margins on any of that partnership has been, and DBS is clearly one that we are not going to sort of get into that detail, but I would say that, all of the key factors that we're measuring success against the DBS have been nearly achieved, but we've exceeded our targets.

Stephen Roder

Doug, its Steve here, I could add to that. I think, if you look at it on a first order basis, and typically you'd probably say that you would achieve high margins through the agency channel in Asia than you were through the bank channel, and I'm making a general comment, and not specific to Steve, yes. On the other hand, you can achieve much higher volumes through the bank channel, and much faster, and you can I think argue that the bank channel sales are more efficient. And so - so that's very, very important and if you go back to Investor Day 2015 at that time, other Asia margin was something we highlighted as I think the way we're going to use it opportunity there, because the margin at the time was coming out at 14%. And it's now in a mid-20. So, scale is clearly a big piece of that. And as Roy explained that's quite widely based across the other Asian region.

Doug Young

Great. Thank you very much.

Operator

Thank you. The next question is from Darko Mihelic from RBC Capital Markets. Please go ahead.

Darko Mihelic

Hi. Thank you. Good afternoon. I realize the call is getting long, so I'll try and be very brief. My questions is also on Asia, and it's actually twofold and I'm just - I just want to make sure that we're not - there is no potential for a negative surprise here. And so what I'm looking at is page 13, of your supplemental. My question is twofold; when I look at this page, I see the direct impact of equity markets and interest rates and the variable annuity guarantees is quite negative, it's been that way actually - hasn't been very good for -having had very good experience from last five quarters frankly. So, your reported earnings are not looking that great here in Asia. And so the question is twofold, the first is, does this sort of set us up for a potential revision to assumptions in Asia in the future in 2017, let's say? And then secondly, I think Donald at Investor Day you suggested that the variable annuities in Japan are largely - start to wind down a really run-off in 2017 and beyond. Does this potentially - given where the topics is, given what's happened in Japan, does this potentially change that narrative?

Donald Guloien

I can answer that one easily, and I'll deal with the latter part first, then the other guys will deal with the other. But no they are running off now actually and that is actually contributing to some of the net income disappearing in Japan as some of those blocks of business go away, as market hit certain levels as those things reach a time limit, they - those products expire. So those are coming up the books now, releasing capital and earnings but of course don't contribute going forward.

Darko Mihelic

All right. And second part Stephen I wanted to just to talk about those assumptions.

Stephen Roder

Yeah I think the majority of the impact that we're seeing here is from interest rates which have dropped so dramatically and those are then reflected in our reserves going forward.

Darko Mihelic

Okay and with respect to - so if I were to look at [indiscernible] believe the point. But if I look at page 3 of your supplemental pack and I look at the significant amount of liabilities held, for your variable annuities. The fact that they have been rising as they have been in connection with the drop in some of these markets. And there is about C$11.3 billion of these of policy liabilities held or variable annuity guarantees. Is it fair to assume that a big chunk of this is in Japan?

Stephen Roder

We're seeing a big rise actually in the U.S. as well as swap rates have come down, we're seeing our liabilities increase, but we're also seeing that the hedging programs are operating very effectively and we are seeing an offset in the hedge assets that they we are holding. So but it's primarily the swap rates that are driving up the reserves and I think as well there has been some FX impact as this is reported in Canadian dollars.

Darko Mihelic

Thank you

Stephen Roder

..and again to be clear the assets, they're all in the U.S. - in the U.S. its U.S. liabilities and assets. So it's not hitting our earnings, but that's what driving some of the reported increase in liabilities.

Operator

Thank you. This concludes today's question-and-answer session. I would like to turn meeting backward to Mr. Veloso.

Robert Veloso

Thank you, operator. We'll be available after the call if there is any follow-up questions. Thanks everyone and have a good afternoon.

Operator

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

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