C O N F E R E N C E C A L L P A R T I C I P A N T S
Steve Theriault BofA Merrill Lynch - Analyst
Peter Routledge National Bank Financial - Analyst
John Aiken Barclays Capital - Analyst
Robert Sedran CIBC World Markets - Analyst
Tom MacKinnon BMO Capital Markets - Analyst
Mario Mendonca TD Newcrest - Analyst
Gabriel Dechaine Credit Suisse - Analyst
Joanne Smith Scotia Capital - Analyst
Sumit Malhotra Macquarie - Analyst
Michael Goldberg Desjardins Securities - Analyst
P R E S E N T A T I O N
Operator
Please be advised that this call is being recorded. Good afternoon and welcome to the Manulife Financial third-quarter 2013 financial resultsconference call for Thursday, November 7, 2013. Your host for today will be Ms. Anique Asher. Ms. Asher, please go ahead.
Anique Asher - Manulife Financial Corporation - IR
Thank you and good afternoon. Welcome to Manulife's conference call to discuss our third-quarter 2013 financial and operating results. Today'scall will reference our earnings announcement, statistical package and webcast slides which are available in the Investor Relations section of ourwebsite at Manulife.com.
As in prior quarters, our executives will be making some remarks; 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 areimplied 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 todiffer, please consult the slide presentation for this conference call and webcast available on our website as well as the securities filings referredto in the slide entitled Caution Regarding Forward-Looking statements.
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We have also included a note to users slide that sets out the performance and non-GAAP measures used in today's presentation. When we reachthe question-and-answer portion of our conference call we would ask each participant to adhere to a limit of one or two questions. If you haveadditional questions please re-queue and we will do our best to respond to all questions. With that I would like to turn the call over to DonaldGuloien, our President and Chief Executive Officer. Donald.
Donald Guloien - Manulife Financial Corporation - President & CEO
Thank you, Anique. Good afternoon, everyone, it is indeed a good day and thank you for joining us. I'm joined on the call this afternoon by ourChief Financial Officer, Steve Roder, as well as several members of our senior management team including our Asian General Manager, Bob Cook;our Canadian General Manager, Marianne Harrison; our US General Manager, Craig Bromley; our Chief Investment Officer, Warren Thomson; ourExecutive Vice President General Account Investments, Scott Hartz; our Chief Actuary, Cindy Forbes; our Chief Risk Officer, Rahim Hirji; and ourTreasurer, [Steven Moore].
This morning we announced our third-quarter 2013 financial results. I am very pleased to see our strategy unfolding into strong operating results.We are making real tangible progress against our longer-term objectives.
This quarter we had strong wealth sales driven by growth in our mutual fund businesses worldwide. We reported strong core earnings and, as wepredicted last quarter, a number of items with unusual timing reversed themselves this quarter contributing to the increase in net income. Investmentperformance also made a very significant contribution. As a result we ended the quarter with a very solid capital ratio and we again delivered recordfunds under management.
Let me start by reviewing the progress we made on our growth strategies in the third quarter. We continued to develop our Asian opportunity tothe fullest, generating strong growth in our wealth sales compared to a year ago with double-digit growth in most of our territories. We maintainedour leadership position in net cash flows in the mandatory Provident business in Hong Kong. And, while insurance sales were below the samequarter last year, we've seen good momentum building in both Hong Kong and Japan in September and expect this to carry forward into the thirdquarter.
We also continued to grow our wealth and asset management businesses. In the third quarter we had strong positive net wealth flows whichcontributed to the 20th consecutive quarter of record funds under management, which as you know, drives future fee income.
On a year-to-date basis we have now achieved over $13 billion in net -- and I stress net -- mutual fund flows, exceeding our full-year 2012 results,reflecting our robust distribution partnerships, a strong product suite as well as improved market conditions.
Our institutional advisory business continues to deliver with assets under management up 30% since September of last year.
Our balanced Canadian franchise continued its steady progress and in the third quarter mutual fund sales continued to outperform the marketand we ended the quarter with mutual fund assets under management up almost 30% compared with same period last year.
Manulife Bank's net lending assets increased and we saw significant improvement in new loan volumes over the previous year. And our Canadianbusiness continued to build its diversified platform. This quarter we announced the launch of RetirementPlus, a new segregated fund product.Manulife became the first Company in Canada licensed to offer the new Pooled Retirement Pension Plans and we expanded our travel insurancebusiness through a transaction with RBC Insurance.
In the United States we continued to grow our higher ROE, lower risk businesses. Our mutual fund sales were almost double the prior year periodand nearly 5 times greater -- 5 times greater -- than the industry increase for the intermediary sold channel. Our 401(k) sales declined due to lowerplan turnover in the market, but our recently launched midmarket 401(k) product continues to gain traction with additional commitments fromsponsors.
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And while our US insurance sales were relatively flat compared to the same period last year, we saw increased sales of life products with muchmore favorable shareholder friendly attributes.
In terms of our operating performance in the third quarter, we reported net income of CAD1 billion and core earnings of CAD704 million, bothrepresenting an increase over the prior year and the prior quarter. On the top-line we achieved solid growth in our wealth businesses. The performanceof our wealth and asset management business so far in 2013 has been simply outstanding.
While our increase in insurance sales increased modestly from last year, we have much improved margins and are seeing encouraging signs fromthe initial sales of some of the new products that have been recently launched.
So in summary, our growth strategies continue to generate positive results and we are making measurable progress towards our longer-termfinancial goals. With that I will turn it over to Steve Roder who will highlight our financial results and then open the call to your questions. Thankyou.
Thank you, Donald, and hello everyone. Let's start on slide six where we highlight our financial and operating results for the third quarter of 2013.We reported net income attributed to shareholders of CAD1 billion, reflecting strong investment-related experience of CAD543 million, partlyoffset by a charge related to the annual review of actuarial assumptions.
In terms of our operating performance, we generated core earnings of CAD704 million, we strengthened our MCCSR ratio by 7 points to 229%,and we generated new business embedded value of CAD278 million.
Turning to slide 7, you can see that we are demonstrating solid progress on growing core earnings. In the third quarter our core earnings wereCAD704 million, an increase of CAD95 million from the prior quarter. The increase was primarily due to more favorable policy holder experience,the release of tax provisions in Canada from closing prior years' tax filings, and lower net hedging costs partly offset by lower investment incomein the surplus segment.
Turning to slide 8, third-quarter total Company core earnings reflect improvements in each of our territories and lower hedging costs. In Asia coreearnings improved due to improved lapse experience and new business strain in Japan, partly offset by the negative impacts of currency andhigher dynamic hedging costs. Excluding the impact of currency and additional dynamic hedging costs, core earnings in Asia improved 14% fromthe prior quarter.
In Canada the improvement in core earnings was primarily due to the release of prior year tax provisions of approximately CAD40 million and lowerexpenses. In the US, core earnings growth was due to improvements in policyholder experience and new business strain in the life business, partlyoffset by higher dynamic hedging costs. Corporate & Other core earnings declined largely due to lower investment income on equities and oil andgas assets in the surplus segment. And expected macro hedging costs declined due to the favorable market environment and a shift towards moredynamic hedging.
Turning to slide 9, as we predicted last quarter, a number of items with unusual timing reversed themselves this quarter contributing to the increasein net income. In the third quarter our reported net income benefited from strong investment-related experience of CAD543 million, CAD52 millionof which was included in core earnings. The favorable experience included CAD284 million primarily related to favorable returns from our timber,agriculture and private equity assets, gains from the redeployment of government securities into higher yielding assets and continued excellentcredit experience.
In addition, we reported net gains of CAD259 million related to planned asset allocation activities that enhanced surplus liquidity and resulted inbetter asset liability matching in the respective liability segments. You may recall last quarter we referenced this as a positive onetime benefitexpected in the second half of 2013.
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Market-related factors, including gains on variable annuity liabilities that are dynamically hedged, also contributed CAD94 million to net income.Partly offsetting these gains was a net charge of CAD252 million related to the annual review of actuarial methods and assumptions.
Moving on to slide 10, in the third quarter we completed our annual actuarial review which covered more than 150 methods and assumptions thisyear. The review included updates to our lapse and policyholder assumptions that resulted in a CAD530 million after-tax charge to earnings drivenby premium persistency on universal life products in the United States where we reviewed policyholder premium funding patterns and prudentlyadjusted our assumptions; lapse experience for certain insurance lines in Canada and Japan to reflect that in the current low rate environmentcertain guarantees on our products are valuable to policyholders which results in fewer lapses; and lapse assumptions on certain variable annuitieswere updated to reflect recent experience including reducing base lapse rates in Japan as contracts get closer to maturity.
The triennial review of our long-term care assumptions resulted in a net charge of CAD12 million. I will discuss the long-term care assumptionreview in more detail later in the call. These charges were partly offset by reserve releases related to updates to our segregated fund stochasticvaluation parameters and other method and assumption changes which had a combined CAD290 million benefit.
You may recall that in the second quarter we took a charge related to the impacts of interest rates on bond and balance funds in variable annuityproducts. This has largely reversed as we updated our bond parameters to reflect higher prevailing rates in the third-quarter actuarial review.
On slide 11 is our source of earnings. Here are some of the highlights. Expected profit on in-force declined largely due to an increase in dynamichedging costs and lower PfAD releases on our variable annuity business as a result of improved markets, partly offset by currency benefits andhigher fee income. New business strain improved, particularly in the US and Japan, as a result of product repricing, favorable new business mixand higher interest rates.
The third-quarter's experience gains reflect strong investment-related experience, favorable equity markets and improved policyholder experience,partly offset by URR charges and the impact of wider swap spreads. Management actions and changes in assumptions largely reflect the impactof the annual actuarial review, expected macro hedging costs, and realized losses on our AFS bond portfolio.
Earnings on surplus increased largely due to lower non-core losses on surplus which reflect the impact of interest rates on mark-to-market assets.And finally, income taxes reflect income earned in lower tax jurisdictions and the favorable release of prior year tax provisions.
Turning to slide 12, you will see that our total insurance sales for the third quarter was CAD605 million, up 4% from the third quarter of 2012. Salesin Asia declined 4% as higher sales in Hong Kong and Other Asia were more than offset by lower corporate product sales in Japan. In Canada salesincreased 27% reflecting normal variability in Group Benefits. And in the US sales were largely in line with the prior year and reflected an improvedproduct mix.
On slide 13 you can see new business strain arising from insurance sales improved to CAD66 million from a year ago with improvements in allgeographies particularly in the US. Driving the improvement was product repricing, favorable new business mix and higher interest rates.
Turning to slide 14 and wealth sales, in the third quarter we achieved wealth sales of CAD11.3 billion, an increase of 34% over the prior year period.In Asia wealth sales were up 21% with double-digit growth in most territories. Canadian wealth sales were up 32% reflecting strong mutual funddeposits and higher new loan volumes. And US wealth sales increased 37% driven by continued strong mutual fund sales partly offset by lower401(k) sales. Wealth new business strain of CAD82 million was largely in line with the prior year period.
Turning to slide 15 and premiums and deposits. Continued growth of our wealth business was reflected in strong wealth P&D, up 27% to CAD14.6billion. Insurance P&D increased 9% to CAD6.1 billion reflecting broad-based growth particularly in US life.
Turning to slide 16. New business embedded value, or NBEV, of CAD278 million rose 56% over the prior year period. Wealth NBEV nearly doubledas a result of strong mutual fund sales and improved fixed expense coverage. Insurance NBEV was up 38% reflecting higher margins due to productrepricing and an improved new business mix.
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Turning our focus to the operating highlights of our divisions, we begin with the Asian division on slide 17. Asia division core earnings of $233million were up 6% from the second quarter, or 14% when normalized for currency and additional dynamic hedge costs. Asia wealth sales increased21% over the prior year period driven by double-digit growth in most territories, and strong pension sales and Hong Kong. Insurance sales weredown 4% versus the prior year largely due to lower corporate product sales in Japan.
While insurance sales were below the same quarter last year, in September we saw good momentum building in both Hong Kong and Japan andexpect this to carry forward into the fourth quarter. Total annualized premium equivalents grew 8% over the prior year due to strong growth inHong Kong and Other Asia, partly offset by lower corporate product sales in Japan. Total weighted premium income increased 6% driven by solidin-force growth across Asia and strong wealth sales, partly offset by lower corporate product sales in Japan.
Turning to our Canadian division operating highlights on slide 18. Core earnings for the Canadian division improved 19% from the prior quarterto CAD268 million. Wealth sales in Canada were up 32% to CAD3.1 billion reflecting strong mutual fund sales which outpaced industry growth andstrong growth in new loan volumes at Manulife Bank. Group retirement solutions also contributed with a 23% increase in sales.
Although individual insurance annualized premium sales were 8% lower than the prior year, sales in Group Benefits drove an increase of 27% intotal insurance sales compared with third quarter 2012.
Moving on to slide 19 and the highlights for the US division. Core earnings in the US were $348 million, up 4% from the prior quarter. As you cansee in the chart, core earnings for our US operations continued on a positive trend. In the third quarter wealth sales grew 37% over the prior yearto $6.7 billion driven by continued strong mutual fund sales.
This more than offset lower 401(k) sales which were impacted by lower plan turnover in the industry and competitive pressures. Insurance salesof $154 million were in line with the third quarter of 2012. We continue to record strong sales in our re-priced, lower risk insurance products.Additionally, sales of our redesigned long-term care products were up 15% reflecting a more rational competitive environment.
Turning to slide 20, funds under management at the end of the third quarter were 550 -- sorry, CAD575 billion, representing our 20th consecutivequarter of all-time record funds under management.
Slide 21 highlights our diversified and high-quality investment portfolio as at September 30, 2013.
Slide 22 summarizes the capital position for that Manufacturers Life Insurance Company. We ended the quarter with a further strengthenedregulatory capital ratio of 229%, an improvement of 7 points over the second quarter of 2013. The improvement in our capital ratio reflects lowerrequired capital on segregated funds as a result of both higher equity markets and changes to the assumptions used in the required capitalcalculation consistent with the third-quarter changes in actuarial assumptions, and strong reported earnings.
Before I conclude I would like to address a couple of topics which may be on the minds of our investors. The first topic that I want to discuss is theUS long-term care triennial review. This year's review included an update of our long-term care morbidity, mortality and lapse assumptions fromour last review in 2010. Since then we have seen an increase in expected claim costs due to longer lengths of stay on average for our customers,higher incidence rates and lower mortality.
While we strengthened our morbidity and mortality assumptions in line with this emerging experience, the impact was largely offset by our estimateof future rate increases as we will be filing for additional premium increases that average 25% on approximately 50% of our in-force business; amethodology requirement to tax cash flows; as well as better-than-expected experience on our 2010 in-force price increase approval.
It's important to recognize that our long-term care product is adjustable and we expect over time to get the appropriate rate increase approvalsto offset the increase in expected claims costs. As you know, we have had significant experience in the state approval process having receivedapprovals from 47 states so far on our retail long-term care business on our 2010 rate increases.
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The second topic I will address is with regards to the impacts of a rising interest rate environment on Manulife. Despite the hedging of ourmark-to-market accounting sensitivities, Manulife has retained positive exposure to a rising interest rate environment as well as follow-on benefitsin an improving economic environment.
Since the end of April interest rates have risen nearly 100 basis points leaving many investors to ask, how will Manulife benefit in a rising rateenvironment? The answer is rising interest rates will have a favorable impact on our net income, core earnings and capital position.
We have already seen the impact on our core earnings as a result of improvements to new business strain. We've seen a reduction in the interestrate charges related to changes in the ultimate reinvestment rate on our in-force business. And we're starting to see the pro-cyclical impact oflower interest rates on our MCCSR ratio now starting to reverse as interest rates rise.
For illustration let's assume we had a 50 basis point rise in interest rates including swap and corporate rates and they remained at this level for ayear. In terms of the first order impacts, we would expect a one-time positive impact to net income of approximately CAD150 million due to theimpact of the rise in rates on our policyholder liabilities, and a reduction in our URR charges of approximately CAD100 million over the next year.
In regard to our capital, all else being equal, we would expect approximately a 10 point benefit to MLI's already strong MCCSR ratio. Additionally,over the median term we would expect further benefits from second or third order impacts. Higher interest rates would imply an improved operatingenvironment and customer sentiment, which typically results in reduced new business strain, subject of course to any pricing changes, higherearnings on surplus over time as cash flows are reinvested into higher yielding bonds - initially this however will be more than offset by losses onthe sale of AFS assets and surplus, an improved environment for generating positive investment experience and an opportunity to reduce ourleverage ratio which also improves core earnings. Unfortunately, while these benefits are easy to identify they are very difficult to quantify.
Conversely, if rates were to stay low, under the Canadian actuarial standards we have already largely reserved for the current rate environmentand as such we would not expect any material impacts.
To summarize, in the third quarter of 2013 we made substantial progress on our growth strategies, we reported strong core earnings and netincome, we generated favorable investment-related experience and we further strengthened our capital ratio. This concludes our prepared remarks.Operator, we will now open the call to questions.
Q U E S T I O N S A N D A N S W E R S
Operator
(Operator Instructions). Steve Theriault, Bank of America-Merrill Lynch.
Steve Theriault - BofA Merrill Lynch - Analyst
So, I have a couple questions on hedging, probably for Steve or for Cindy. We are seeing today that you have unwound a pretty sizable portion ofthe notional macro hedge, so a couple related questions.
First, if equity markets reverse course, do you feel like -- will you need to begin ramping the macro hedge -- hedges to the same extent as before?Or are the actions that you are taking on the dynamic side, would those actions preclude a required ramp in the macro hedge at least to someextent?
And the second part was, I was surprised to see the decline in the expected macro hedge cost be fairly large this quarter or larger than expected.Can you help us understand at all how quickly the remaining macro hedges could run off? If markets rally another 10%, what is the sensitivity? Iknow that is hard to quantify but anything you can give us would be helpful.
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I will start off and then I will ask Warren to comment. The first part of your question the answer is, no, we wouldn't necessarily have to reverse that.And what we have done on the dynamic side would prevail in a sense. So you shouldn't assume that we would have to go into reverse on that atall.
On the macro hedge side, yes, the costs have come down. I think to date we have around a run rate saving of CAD35 million, we were at CAD20million and we have increased that to CAD35 million. But I will just pass to Warren and see if he wants to add.
Warren Thomson - Manulife Financial Corporation - Senior EVP & CIO, Chairman & CEO of Manulife Asset Management
Sure. I think, Steve, the important point is when things do move from the macro to the dynamic program it is a permanent change. So it's anythingthat, once it ceased being subject to hedging under the macro program it won't revert to the macro program, market moves are just addressedby the changes within the dynamic program. So as markets move we adjust the dynamic hedges.
So I think -- and it's, as the name suggests, the macro program is more of a static program and until things move from the macro to the dynamic,you don't really make much in the way of changes there. But once it is in the dynamic program, it does not revert back.
Steve Theriault - BofA Merrill Lynch - Analyst
Okay. And if I -- just before I let you go, can you tell us based on Q3 rates what -- just refresh us on what your URR expectations are looking out thenext one or two years before any potential guideline changes?
On the URR you have seen the quarterly run rate has come down. Our expectation would be that it would continue to come down based on themechanical process that we effectively have to follow through. So we would expect an improvement to that.
And to a large extent that would be maintainable, although it is, as you know, a mechanical function of movements in interest rates over the lastseveral quarters. So it wouldn't necessarily be without the odd tick back up again, but by and large we're going to see a lower continuing run rateper quarter.
Steve Theriault - BofA Merrill Lynch - Analyst
So a little bit lower than the 63 we are seeing this quarter?
Peter Routledge - National Bank Financial - Analyst
Just a couple of thoughts on the lapse and I'm on page 28. Just to clarify first, the benefit is CAD1 billion. I just want to make sure I read it right. Youadded CAD500 million this quarter, there was already CAD500 sitting there from your prior quarter. Is that fair? I'm talking about the benefit forpremium increases.
CAD500 million is due to the 2013 premium increases we will file for in the next quarter. And the other CAD500 million is from the 2010 -- theremainder of the 2010. It is not exactly what is left over because we did prudently reserve for premium increases in 2010. And so, we had someexperience gains on that, which we know that we had better experience than we expected on the 2010.
And now we are reflecting those additional remaining premium increases related to 2010 that would have been part of the margin before, butnow are being included in the reserve. But they are again properly and prudently margined as conservatively as we margined the premium increasesin 2010.
Peter Routledge - National Bank Financial - Analyst
Thanks. Just -- you may not disclose it, I'm not going to press for it but you have a gross increase in expected claims costs. What is that number or,if you can't give the direct disclosure, the concern when I read that I had was that could be a big number because there are a lot of offsets in there.And does it foreshadow more of these charges down the line?
It is Cindy again. We have updated our experience. We certainly -- with being in the LTC business for 20 years, we have quite a credible amount ofexperience. And each time we update our assumptions we have even more credible experience. Really can't speak to what the future trends mightbe. But as you note, the increase in the gross claims costs, they are not a large percentage but they are -- the dollar amount would be in excess ofthe CAD1 billion that you see in future premium increases that are included in the reserves.
Peter Routledge - National Bank Financial - Analyst
Okay. Just final one and perhaps for Don. You have done a great job in terms of getting your premium increases and you are managing a toughbusiness pretty well. I don't mean to be confrontational. But looking at more charges on this business, the question naturally comes up, why notjust get out, why go for the extra premium increases, why not just pull out?
Donald Guloien - Manulife Financial Corporation - President & CEO
Well, pulling out would do nothing to reduce the exposures that you are observing, that is largely on or all on the in-force. The products that weare selling now will have a very, very handsome margin built in even for profit and also for the potential for worsening results down the road. Andif anything is going to be profitable it is the new business we are writing.
We are also writing very small amounts of new business and, as we said in other venues, part of the leverage we get in going for rate increases isbeing in the business because I guess the ultimate threat for regulators is if everybody pulls out of the long-term care business because they can'tget rate increases, there will be no long-term care available to consumers.
So we are managing the new business very, very prudently. I don't think you are going to have to worry about big swings with respect to the newbusiness. What the future holds for the in-force business is something that we can't determine with any specificity, but we feel we are getting ontop of it.
Peter Routledge - National Bank Financial - Analyst
Thanks very much.
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Wanted to circle back on the hedging just for a moment. Steve, can you refresh my memory? In terms of the dynamic hedging, is there any accountingfor volatility in terms of the hedges that are put in place?
Sorry, let me just pass it to Warren. I think Warren can give you a fuller answer on that one.
Warren Thomson - Manulife Financial Corporation - Senior EVP & CIO, Chairman & CEO of Manulife Asset Management
The actual dynamic hedging program doesn't actually cover the cost of volatility per se; that actually is one of the byproducts of the program,actually when we have a modest cost of hedging that emerges that is what we are including when we talk about our realized hedging costs. The-- I lost my train of thought.
John Aiken - Barclays Capital - Analyst
Warren, that answers my question. The follow on that I had then is, with the switch with reporting the dynamic hedging and the expected profit,any sense of -- I mean volatility right now in the marketplace is actually quite low. Any impact on whether increased volatility would be a materialheadwind to expected profit growth going forward?
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Warren Thomson - Manulife Financial Corporation - Senior EVP & CIO, Chairman & CEO of Manulife Asset Management
You helped me out by buying me some extra time there. The conversion to options is the piece I was trying to get to. We have in fact been addingoptions into our program and options do address the cost of volatility. So again, once the cost of volatility has dropped in the current environmentwe've actually been adding to our option base program.
So prospectively, I think if you know the markets remain -- if markets remain benign, you would expect us to do more option based hedging andthat will cover the cost of volatility. The current dynamic program, it is a bit of a byproduct of the volatility comes out as a cost. When volatility risesthe cost of our hedging will be higher in the current dynamic program. But we do hope over time to have a meaningful portion of the businesscovered by options.
John Aiken - Barclays Capital - Analyst
Great, thanks, Warren. That does answer my question.
Operator
Robert Sedran, CIBC.
Robert Sedran - CIBC World Markets - Analyst
I want to start with Asia insurance sales, please. The strong momentum we are seeing in September that you mentioned, Steve, is that the resultof the product launch or is there a feeling that perhaps insurance sales in Asia are starting to turn and maybe we will get into a double-digit rangegoing forward? And if you do, is there a negative offset through earnings because of strain or some other expenses that might come?
Well, let me just start off and then I will pass over to Bob Cook. There are various factors to take into consideration when we look at what has beenhappening in September and heading into Q4. So, first of all, we did have a new product launch in Japan, which is starting to get some traction.That is our [SSLT] product which is what we are referring it as.
And that was (technical difficulty) so we are expecting Japan to improve into Q4. At the same time we have had a campaign running in Hong Kongand it has had a lot of momentum in September and into October, so Hong Kong has come back. And Indonesia went through a bit of a lull in Q2,perhaps partly because of the weakness of the rupiah. But Indonesia has also come back. So our three largest jurisdictions, if you like, have all hada positive September and into October. But let me then pass over to Bob for a bit more color.
Bob Cook - Manulife Financial Corporation - Senior EVP & General Manager, Asia
I guess the only thing I would add, Robert, is throughout the third quarter across our 11 countries in Asia we actually launched 40 new or repricedinsurance products, so we do expect those to have an impact in the fourth quarter and more particular, to give us momentum going into 2014.
Robert Sedran - CIBC World Markets - Analyst
Thanks, Bob. And, Steve, would there be than a strain impact that we should be watchful for going forward or should it be negligible?
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Well, I guess you have to look at both sides of that. We have insurance strain and wealth strain. Insurance strain has improved because of improvementin interest rates. Wealth strain is a volume gain. So I think we said before it is incredibly difficult to predict strain because there are so many movingparts.
I think previously we gave some guidance that CAD100 million was a reasonable number for us an overall strain number per quarter. Our feelingis that that has probably come down. And I think if we had to call the number now for the spreadsheet, if you like, I would probably say CAD70million is a better number.
Robert Sedran - CIBC World Markets - Analyst
Okay, and can I just ask you for one point of clarification on this triennial review. You mentioned that a lot of the products are adjustable and you'realso going for price increases. Are they -- I mean are you making the adjustments plus the price increases or is there some interplay between thosetwo variables or can you just perhaps clarify that for me?
Yes, I mean Cindy can add to this, but we've basically made assumptions about our ability to get price increases. As Cindy said before, we've got alot of experience now from what happened in 2010. And bear in mind in 2010 we were perhaps a bit of a trailblazer. We were one of the firstcompanies to go out there for price increases, that is not the case now.
The various states are well used to companies seeking to get these price increases, to which they are entitled. And we're certainly not alone anymore.Our early outreach program in relation to these new increases, I think the mood is, well, nobody is surprised. So it's a lot more certain of anenvironment, if you like, than it probably was three years ago. But let's just see if Cindy wants to add anything to that.
Sure. So, Rob, the price increases or the adjustable products I was referring to is LTC in particular and that is related to the annual review of actuarialassumptions and what we are assuming for the future increases, which is separate from the discussion around our new business and the impactof more new business on strain and the repricing of new products.
So the repricing of products that we have done over the last number of years, but when you are looking at year-over-year or quarter-over-quarternumbers, the repricing that we have done has reduced our strain on the insurance side because we have reflected the current rate environment.So there is separate and distinct.
And overall I think increased sales in insurance sales in Asia wouldn't really have a negative impact on strain. In other words, the CAD70 millionthat Steve was referencing would be, I think, stand up even with higher sales and insurance sales in Asia.
Robert Sedran - CIBC World Markets - Analyst
Okay, I think I have got it. Thank you.
Operator
Tom MacKinnon, BMO Capital Markets.
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Just wondering if I can get two questions. The first is an E&E update. I think you talked about the initiative at CAD175 million at the -- Steve, at thesecond-quarter call. And talked about CAD100 million in 2014 benefits from the E&E initiative. Is there any update on these numbers?
Hi, Tom, Steve here. So, you are correct. On the second-quarter call we made two references, one was to the fact that we had already achievedannualized run rate savings of about CAD175 million and the second was to the fact that we expected an accounting benefit, if you like, in 2014of around CAD100 million. And bear in mind that the accounting would take into account investment in certain projects that would have benefitsin the future.
So the phasing of the accounting and the phasing of the achievement of run rate savings is not the same. That is why the numbers are somewhatdifferent. And we are not -- we haven't provided an update at this quarter. We are going to provide an update on E&E in Q4. All I would say, Tom,at the moment is there is no significant changes to what we've indicated previously. So there is nothing material that I would highlight right now.
Tom MacKinnon - BMO Capital Markets - Analyst
Okay. And then the follow-up is perhaps for Donald.
Sorry, Tom. I would just like to say I am reminded to say that was pretax numbers, which I omitted to say.
Tom MacKinnon - BMO Capital Markets - Analyst
That's right, okay. The follow-up for Donald with the MCCSR now really poised to I guess, given the fact that the duration of I guess your VA businesscontinues to shrink here and you get some required capital relief there, it really stands to gain significantly if equity markets were to run up andinterest rates were to run up. And you are already sitting at a 229% now. So is there a way you can think about returning some of that capital toshareholders? Can you repatriate some reinsurance contracts? What should we -- what can we look at you doing?
Donald Guloien - Manulife Financial Corporation - President & CEO
Well, you know --.
Tom MacKinnon - BMO Capital Markets - Analyst
Or recapture reinsurance, I should say, pardon me.
Donald Guloien - Manulife Financial Corporation - President & CEO
Sure. I guess our order of priority is first to reduce the leverage ratio. Two, as we see acquisitions more and more we are funding them internally,doesn't mean we can fund very huge deals internally but it is nice to be able to do them internally. Third is I guess we would look for some -- weare looking at reinsurance contracts as they come up and seeing whether it makes sense to recapture them or to keep them in place, and actuallyin different situations we have taken different responses. It all depends on the circumstances. The next thing is we want to see some -- I guess have
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greater insight into where capital rules and accounting rules are going long-term. And then ultimately we would like to talk to our Board aboutdividends. But that would be roughly the sequence.
Tom MacKinnon - BMO Capital Markets - Analyst
All right, if you have like some sort of internal metric for the MCCSR, is -- I mean would you be able to share with us anything related to that? Likedo you need enough to withstand a certain correction in the market and maintain that over a certain percentage? Is there anything that you havewhere you would figure an optimum level would be?
Donald Guloien - Manulife Financial Corporation - President & CEO
Yes, I don't know. Optimal level is not necessarily the answer, but we have certainly a minimum that -- and we are well above that, we have a veryhandsome cushion in there and the minimum is calculated with reference to extremely high probability of safety for not only in customers butalso debt holders and everyone else in the chain.
And we are in a very, very satisfactory capital position. But we do have our own calculation of economic capital that is different than the way OSFIlooks at it and we are at a very comfortable level regardless of which measure you use.
Tom MacKinnon - BMO Capital Markets - Analyst
Well, maybe I will try to ask it a different way. If you are going to price a product, presumably you have some sort of target surplus level that mightbe a function of the MCCSR. If it is, can you share with us what that MCCSR metric you would use when you price a product to try to get a specifichurdle?
Donald Guloien - Manulife Financial Corporation - President & CEO
Yes, I would rather not get into the specific target right now. But, yes, we do have a target that would be less than the amount of capital we areholding at the present time. But, Tom, you also have to take into account that when we price a product we look at not only the MCCSR capital butthe local capital because that can also be a constraint. In some cases local capital rules are more conservative, in other cases they are more liberal.
Tom MacKinnon - BMO Capital Markets - Analyst
Okay, thanks for that.
Donald Guloien - Manulife Financial Corporation - President & CEO
Tom, one other thing maybe to add is, we also have to be concerned about the external environment and what is going on in the externalenvironment. So there are a couple of things out there at the moment that we have to monitor. As you know, there is the Actuarial Standards Boardreview here in Canada and that piece of work has been going on for some time but it is not complete yet. And how that will play out, we are notentirely clear.
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And the other is, as you are aware, we have to contend with the IASB, the International Accounting Standards Board and their exposure draft andwhat does that turn into in terms of an accounting standard? And how does that flow through into capital rules. So those sorts of issues are alsothings that we have to consider when we sort of judge how comfortable we feel about our MCCSR ratio.
Tom MacKinnon - BMO Capital Markets - Analyst
Okay, thanks.
Operator
Mario Mendonca, TD Securities.
Mario Mendonca - TD Newcrest - Analyst
If we could just go back to the long-term care for a moment. It would be helpful to understand how leveraged these assumptions are to gettingthe price increases across the board. What I'm getting at here is, is there a particular block of business where if the pricing increases didn't stick,the reserve hit could be more significant? Or is this -- would you characterize it as sort of broad based everything is equally important?
Mario, it is Cindy. I would not say that there is a particular block that we are overly leveraged to. I mean I would point to the disclosure on page 28where we say we have CAD1 billion of premium increases embedded in the reserves and every dollar of those are equal. I would not -- I mean thereare some blocks that would have higher percentage increases obviously. But I would not say that we are overly leveraged to any one particularblock.
Mario Mendonca - TD Newcrest - Analyst
Thank you.
Operator
Gabriel Dechaine, Credit Suisse.
Gabriel Dechaine - Credit Suisse - Analyst
My first question is for Donald or Steve. Just the macro hedge cost reduction, revisit that one there. If I look at your 2016 earnings objectives I don'tbelieve it anticipated any increase to that program. I am just wondering if that is correct and if it is, how should we look at this reduction in cost?Is it additive to your target or are there any parts of the business that maybe aren't progressing as well as you had anticipated, macro factorsperhaps, like the yen weakening, that this is really somewhat of an offset to those issues?
Donald Guloien - Manulife Financial Corporation - President & CEO
Well, Gabriel, I will take a start at it. I mean looked at in isolation I think you have got the answer there. It is a positive. I mean, the more we havebuoyant equity markets faster than the roughly 8% growth that we factor in, that is going to enable us to reduce macro hedges, shift into dynamicprograms and on average there will be less hedging taking place and less hedging necessary, so it will cost us less.
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So that is definitely a tailwind. As you pointed out though there is other headwinds -- the earnings that are coming from Japan, they translate at alower currency translation rate we are at currently. I mean that may not be the case for the next four or five years but it certainly is in the currentperiod is a bit of a drag and there is a grab bag of things that go forward and go against us. I think on balance though we feel pretty good aboutnot only the quarter but the next quarter and how things are shaping up against our long-term plan.
There is one thing on hedging I guess I would want to point out and then you asked -- there have been a few questions asked about that shift frommacro to dynamic. That creates some interesting geography issues, particularly as it relates to Asia. We show macro (inaudible) and this is fairlyprescribed, this presentation.
The cost of dynamic hedging programs get reflected in the operating divisions, but the macro hedges show up in the corporate accounts. So whenyou have a shift from macro hedging to dynamic, that shows as a benefit to corporate but a cost in the operating --.
Gabriel Dechaine - Credit Suisse - Analyst
To the segment, yes.
Donald Guloien - Manulife Financial Corporation - President & CEO
-- In the segment. So that has had the impact of depressing Asian earnings. You've identified the other one is the yen, particularly given that wemake a lot of money in Japan, that has had an impact on Asian earnings. If you adjust for those you get a different picture of what Asian earningsare. But those are important things to adjust for.
Gabriel Dechaine - Credit Suisse - Analyst
And just so I am clear, Steve, you mentioned the -- it was 35 million a quarter is the run rate and that is net of the macro shifting into dynamic Iguess?
That is the year to date run rate savings per quarter. We flagged CAD20 million previously and it has now increased to CAD35 million.
Gabriel Dechaine - Credit Suisse - Analyst
Okay. Then my next question is a quick one on the long-term care. Would you -- when you went to your first round of pricing increases, had youleft the door open with the regulators that maybe will be coming back for more? And then how does your pricing increases compare to the industry?
And then I will just throw this one in while I am talking. The lapse rate assumption increase in Japan on the VAs, does that in any way affect theoutlook for capital free up from runoff of that book if people annuitizing instead of just surrendering?
Yes. But I think -- actually there were some comments from some regulators who said, if you need to come back again please come back againfairly quickly. We would rather you came frequently for smaller amounts than kind of coming less often for a larger amount. So that is good. Andwe are following that advice I guess you could say. So that is the first part of the question. The second part of your question on Japan. I think Cindyis going to have a go at that.
Yes, Gabriel, could I ask you to repeat it? Sorry.
Gabriel Dechaine - Credit Suisse - Analyst
Also the magnitude of pricing increases, how that compares to the industry. But the Japan element is because the lapse assumption -- I guesspeople aren't lapsing enough in the Japan VA book. Does that change the outlook for the capital liberation that you are expecting to ramp up nextyear and into the later parts of this decade?
No, I wouldn't say so. We have seen somewhat higher lapses on Japan's VA book, particularly one product line that has -- or one product that hasa target hit feature. And obviously as we have higher lapses that does release us from liability and capital. As -- but I wouldn't characterize it theway you did.
Gabriel Dechaine - Credit Suisse - Analyst
Okay.
Donald Guloien - Manulife Financial Corporation - President & CEO
Most of the lapses that are being reflected are things like when markets are down, fewer people lapse at the bottom because it is not in theireconomic interest to do so. And while some of that was anticipated, not the full reality of what we are experiencing today. So, no, that does notaffect at all the run off of the Japanese block.
Gabriel Dechaine - Credit Suisse - Analyst
I didn't think so, I was just confirming.
Donald Guloien - Manulife Financial Corporation - President & CEO
Yes, Gabriel, you asked a question there on the long-term care that -- the second part of it which was how do the price increases compare with thecompetition. And I think that is a good thing. Number one is when the price increases that have been reflected in Cindy's valuation are lower thanthe ones we asked for last time and they tend to be lower than what a lot of the competition has asked for more recently because some of themdelayed and are catching up. So not to say that any regulator is happy to see us coming in for a rate increase, but what we are looking for is, shallwe say in the scheme of things, rather reasonable.
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I just wanted to touch on a couple of things. One is the changes that you are making to your variable annuity sub accounts and that I guess is partof the reason that the basis review is not complete for the third quarter. And I just would like to understand from either Steve or Cindy how thatcould possibly reduce the volatility in earnings and also would possibly reduce your hedging costs.
Right. Okay, so, in our release, you will see we talk about the future tax reserve work that is being -- that is going on and is yet to be completed andthat is -- that work is in some way dependent on the outcome of the change we are making in relation to the investment strategy on the segregatedfunds within the VA product.
And these changes are being made for the benefit of policyholders. And we need to see how that -- those changes that are being proposed topolicyholders, how that progresses so that the work can be completed. So that is the linkage there. Does that answer your question, Joanne?
Joanne Smith - Scotia Capital - Analyst
I am talking specifically about once the policy holders approve the shift of their funds from let's just say an S&P 500 index fund to one of thesemanaged volatility funds, obviously it is to the benefit of the customer because they're going to have less volatility, a lot of your peers have donethis. They will have less volatility in the fund returns.
But it should also result in less volatility to your earnings as well. And I would also expect that it would result in lower hedging costs because if youare embedding some of the hedging at the product level now through these managed volatility funds, that is one less hedge that you have to puton.
Donald Guloien - Manulife Financial Corporation - President & CEO
We expect it will have all those benefits you ascribe, but we expect them in total to be modest. And of course it depends so heavily on what thepath of outcomes is going forward we wouldn't want to put out a number; it really depends on what happens. The markets go up and then godown or if they go down and then go up the whole direction, how much volatility is experienced and how much gets moved, it is impossible topredict.
But we expect, as a result of these changes, if they are passed by the policyholders -- and one of the things that we have tried to do is be very, veryclear of the benefits and the costs to our policyholders -- that if they pass it that it will reduce volatility for them and also for us.
Joanne Smith - Scotia Capital - Analyst
Okay, all right, that helps a lot. Second question is on the retirement plan services division. Is Craig on the phone?
Okay. So what I wanted to know is I believe that you've had a lot of success in the midmarket and you have a lot of momentum there. But it appearsthat the small case market has increased in competitiveness. And I'm wondering if you could just flesh that out a little bit for us?
Yes. So I mean as you know we are a leader in the small case market, we consider that our -- has been our core market. We have the number onemarket share and we have reasonably good margins because we have a high service model for small customers. We are under some attack; thatposition is an attractive one and there are a number of competitors who would like to displace us, and so we are getting some pricing pressure.
The way we have reacted to that, we knew this was going to be coming, it is a competitive market. We are going on the attack and going into themidmarket, taking some of the abilities that we have from the core market into the midmarket which was really like launching almost a whole otherCompany but based on the core of our service model.
And that is doing very well in terms of commitments, but you won't see it in terms of recorded sales probably until 2014 because these things havea long lead time; as sponsors move the plan, it takes some time. So that is going very well. Now that is sort of one part of responding to thecompetitive pressures and the other is both working on our expenses and on our pricing for our core market to vigorously defend that. So we areadding features all the time and, from an economic perspective, we are making sure that we are competitive because that is a very importantsegment to us.
Joanne Smith - Scotia Capital - Analyst
Okay and I guess just on -- one of your competitors -- not maybe direct competitors in this market, but a peer in an earlier conference call todaysuggested that they have been seeing a lot more RSP activity in the full-service retirement plan market because of a shift in focus from healthcareto now retirement plans. And that is just an anecdote that I got from a competitor's conference call earlier. And I am just wondering if you cancomment on what you are seeing there?
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Donald Guloien - Manulife Financial Corporation - President & CEO
Well, in our segment of the market we saw an awful lot of RSP activity last year and actually the year before. And it is actually -- we see it having toslow down this year. It may pick up going forward but we haven't seen that.
Joanne Smith - Scotia Capital - Analyst
Okay, all right. Thank you very much.
Operator
Sumit Malhotra, Macquarie Capital Markets.
Sumit Malhotra - Macquarie - Analyst
My first question is for Bob Cook and it relates to Wealth Management sales in Asia. Your year-over-year results here have obviously been verystrong over the past number of quarters. Just looking at this sequentially, it did seem to be a material step down and I know there was somecommentary in the documents about the fact that a number of new products were launched late in 2012.
Is there anything more at play here than just seasonality? Or is there a situation where you think there is a slowing trend because those launchesfrom last year are starting to slow in terms of sales?
Bob Cook - Manulife Financial Corporation - Senior EVP & General Manager, Asia
No, I wouldn't characterize it as seasonality at all and I'm still very bullish on the long-term trajectory of our wealth businesses in Asia. I just thinkyou have to look at them over longer periods of time than just quarter to quarter. So I think if you look at full year next year versus full year thisyear you should see and expect good progress on our part.
The reason why I say this is that in most of the countries in which we operate in Asia, the mutual fund business operates more on what I would callan IPO model rather than a regular contribution model that you would be used to in North America. So, our sales tend to be very lumpy dependingon when we have new fund launches, and this year it just happened that our product calendar concentrated the bulk of our fund launches in thefirst two quarters of the year and that is where our sales were concentrated.
So I don't -- we don't have a firm calendar for next year, so I can't really predict what the pattern of sales will be next year. But again over the courseof the entire year I would expect -- I believe our strategy is still working extremely well and I think the long-term trajectory is positive.
Sumit Malhotra - Macquarie - Analyst
So, don't read too much into the step down in this quarter's results?
Bob Cook - Manulife Financial Corporation - Senior EVP & General Manager, Asia
Correct.
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And second question, final question is probably for Steve. You have talked about the expectation of an extra CAD100 million pretax from the E&Einitiative in 2014 and then a larger benefit in 2015. Are you in a position to talk about what, if any, which geographies of the Company are set tobenefit more from this? Or do you still -- do you see it as being relatively widespread?
Okay, yes, I think the way to look at this is probably to say that there are four work streams, if you like, that contain the most dollars. That would beinformation services, operations, workplace or workplace transformation and procurement. And then you would probably say that there is moreopportunity for those in North America than there is in Asia because Asia is a bit of a growth story, if you will.
But then I would also say that from an Asian perspective it is more about making sure that we continue to get our unit costs down. So rather thana save it will be -- if you like a save of future cost increase, if I could characterize it that way.
Sumit Malhotra - Macquarie - Analyst
So just to make sure I get you clearly here. So from the E&E initiative itself the benefits are more likely to accrue in the North American business?
The immediate benefits, that is correct. But I think at the same time some of these initiatives will benefit us in terms of preventing cost increasesin Asia and in terms of getting unit costs, if you like, down over time in Asia.
Sumit Malhotra - Macquarie - Analyst
Thanks for your time.
Operator
Michael Goldberg, Desjardins Securities.
Michael Goldberg - Desjardins Securities - Analyst
A couple questions. You have given some color on insurance sales and Asian wealth sales. And I guess that it was slower sales this quarter sequentiallythat contributed to the slower VNB levels sequentially also, is that a fair way to look at it? And also that being the case, can you give us some ideaof what kind of VNB growth you think is achievable over the remainder of the year and into 2014?
Yes, no, I understand. But there is some seasonality to that. So, yes, you are correct in the sense that the insurance sales in Q3 in Asia in particularwere not as strong. That would impact new business embedded value. On the other hand, we have been successful in getting some pricing actionsimplemented, particularly in Asia and in Canada. So that will benefit us going forward.
In terms of the new business embedded value growth going forward, we are optimistic about that, it is a focus to continue to make sure that weare getting our pricing actions passed and implemented and we would expect that to stay on an upward trajectory.
Donald Guloien - Manulife Financial Corporation - President & CEO
Why don't we have Bob fill in on Asia specifically?
Bob Cook - Manulife Financial Corporation - Senior EVP & General Manager, Asia
Well, I guess I think you will see -- although we don't give you the granular breakdown, is we are expecting that our value of new business will growat a somewhat faster rate than our sales growth because most of the product activity that we have been engaged in for the last year has been inthe direction of reducing risk and widening margin.
Michael Goldberg - Desjardins Securities - Analyst
Okay, I have another question also. Looking at the potential impact of higher interest rates, is it reasonable for me to think that you would offsetsome of the benefit of rising rates by strengthening other reserves? Would this in effect backend load the benefit of higher rates on earningsemergence? And whatever you do to shape the pattern of earnings emergence over time, is it fair to say that there is no change overall to yourpresent value of future profit?
Michael, it is Steve here. I think the answer to your question is no. I think when Cindy and her team go about their reserving exercise they want tosort of play it straight down the middle rather than vary their stance on conservatism or otherwise. So I would say the answer to that is no.
Yes, that is correct, Steve. We would not be changing our earnings emergence or -back-adjusting reserves to offset the impact of rising rates. Wehave an approach to setting our reserves that is defined and disciplined and we follow the same approach every quarter. We are not, for example,holding back changes in reserves and then reflecting maybe the impact of interest rates at the end of the year. Some companies do that and maybethat is what you are thinking about, Michael. So for us we really -- the impact of interest rates flows through in the current quarter.
Michael Goldberg - Desjardins Securities - Analyst
No, I am not really thinking about it on a quarter-by-quarter basis, I am thinking on more of a longer-term basis.
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Well, once again, I wouldn't expect us to necessarily strengthen our reserve base to hold back the impact of higher rates. If we -- but if we didanything at all to change the earnings emergence pattern, in general the PV wouldn't change very much. But obviously you're discounting, so timevalue is money. There might be some difference somewhat in the PV, I wouldn't expect it to be material.
Michael Goldberg - Desjardins Securities - Analyst
Okay, thank you.
Operator
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Ms. Asher.
Anique Asher - Manulife Financial Corporation - IR
Thank you, operator. We will be available after the call if there are any follow-up questions. Thank you.
Operator
Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.
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