Manulife Financial Corporation (MFC) Q4 2011 Earnings Report, Transcript and Summary

Please be advised that this conference call is being recorded. Good afternoon, and welcome to the Manulife Financial Q4 2011 Financial Results Conference Call for February 9, 2012. Your host for today will be Mr. Anthony Ostler. Mr. Ostler, please go ahead.

Thank you, Anne, and good afternoon. Welcome to Manulife's conference call to discuss our fourth year 2011 and full year 2011 financial and operating results. Today's call will reference our earnings announcement, statistical package and webcast slides, which are available in the Investor Relations section of our website at manulife.com. As in prior quarters, our executives will be making some introductory comments. We will then follow with a question-and-answer session. Available to answer questions about their businesses are the Heads of Japan, the U.S., Canada, Investments and General Account Investments. Today's speakers may make forward-looking statements within the meaning of securities legislation. Certain material factors or assumptions are applied in making forward-looking statements, and actual results may differ materially from those expressed or implied. For additional information about the material factors or assumptions applied and about the important factors that may cause actual results to differ, please consult the slide presentation for this conference call and webcast available on our website, as well as the securities filings referred to in the slide entitled Caution Regarding Forward-Looking Statements. [Operator Instructions]. With that, I'd like to turn the call over to Mr. Donald Guloien, our President and Chief Executive Officer. Donald?

Thank you, Donald. Hello, everyone. First of all, I'd like to thank you, Donald, for those very kind words and support. It has been a tremendous pleasure and privilege to work with the great people at Manulife and to live here in Canada. We've made tremendous progress as a company in the last 3 years under Donald's leadership and I am confident that we'll have even more success in the future. Since my transition timetable is open-ended, it just reinforced that I'll be fully engaged for as long as I'm here and will likely have plenty of time for goodbyes at a later date. So in terms of our full year results, we are net income of $129 million in 2011, and that compares to a $1.66 billion loss in 2010. Included in the 2011 results are the impact of unfavorable interest rates and equity markets, the charges related to our actuarial basis changes and a goodwill impairment charge that we had discussed last quarter. Due to these notable items, I'd like to stress that our 2011 reported earnings are not indicative of our view of our expected run rate earnings going forward. We ended the year with MLI's MCCSR at 216% and we view this level as comfortable, particularly in light of our expanded hedging programs. Our earnings and capital in 2011 benefited materially from the significant hedging actions over the last 5 quarters. As of yearend 2011, we've exceeded our 2014 goal for reduced interest rate sensitivity, and we continue to be ahead of our timeline for reducing sensitivity to equity markets. We are pleased to have benefited significantly in 2011 from our decisions and actions in this area. And turning to Slide 8, you'll note that there were a number of notable items impacting the fourth quarter…

[Operator Instructions] Our first question is from Tom MacKinnon of BMO Capital Markets.

Question really here about how we're going to get to the core earnings kind of growing going forward. I guess there's some debate as to what they are. But if we want to look at earnings excluding some notable items and define that kind of as a core number, we should -- as you shift this business into more of these targeted for growth areas, which I understand will be more profitable and presumably will have less strain, when would we start to see the core number kind of pick up here going forward? And when would that happen? I understand you probably have some price increases to -- price hikes to come through in your book of business as well. So if you can comment on that, I'd appreciate it.

Sure, Tom. It's Mike. As you know, many people define core earnings a little bit differently. So we've obviously discontinued the use of the defined term "adjusted earnings" from operations. But if I think about your question and I think about the underlying earnings power of the book, there are a number of reasons why we would expect, certainly over the fullness of 2012, that our underlying earnings run rate would be stronger, for example, than what we saw in Q4. And there are 3 or 4 items that I would highlight there. First of all, if you look at the new business strain, you saw that new business strain increased sequentially, approximately $40 million after tax Q4 to Q3. It was a little less than that, but the round number's about $40 million after tax. As we've been increasing prices and more of those price increases kick in here in 2012, I would anticipate that new business strain would improve. Now obviously, if interest rates declined further, that would lead to another series of price changes. But again, borrowing a major change in interest rates, I would expect new business strain to improve as a result of the price increases. Importantly as well, assets under management are higher here for January 1, 2012, than they were for October 1, 2011. And so as a result of that higher starting point, I would expect that we would have higher fee income in first quarter than we had in fourth quarter. And again, as long as the markets didn't materially reverse, I would expect that to persist here in 2012. And then...

Would you be able to quantify that difference in the fee income?

Well, round numbers, it was about $35 million lower after tax in Q4 versus Q3. So again, obviously, there are mix changes and you got some books growing, others declining. But again, that was the magnitude Q4 to Q3. And again, precisely what it'll be for 2012 is anybody's guess. But it'll be that kind of magnitude, which when you annualize that number, it's obviously a big number. And then, lastly, Tom, it's important to note that we did have a number of one-off items in the quarter. I think these were identified on Page 13 of the press release. We had a number of tax and operating expense items, for example, severance. We had a number of those items in Q4 that we would not expect to recur. We also have an approximately $40 million reversal of an after-tax gain that was incorrectly booked in Q3 that then became a minus $40 million in Q4. So those kind of one-off items are another $100 million of after-tax headwind in Q4 that I would not expect to be a recurring item in 2012.

I mean, you addressed a little bit of -- just in terms of that assets under management, I guess that would show up in the in-force, expected profits on in-force and then the price hikes, which show up in terms of less strain. Is there anything else other than, “okay, we're going to reprice some of our business going forward and that's the way we're going to develop our core earnings”? I mean, what's the sort of natural roll-off of the expected profit on the business in-force assuming everything is consistent with the underlying actuarial assumptions with those big, fat PfADs? Presumably, there's got to be some juice there.

Well, there's certainly juice, Tom, and just the fact that our overall business is growing. I mean, with the kind of top line growth that we've had in the fee-based, less risky business, we do expect that to be juice for earnings growth. And certainly, we're counting on that in the trajectory to the $4 billion earnings objective for 2015. So again, I would expect that to be a natural tailwind as we go throughout 2012.

And how do we see this core earnings progress? Would it be more in the second half of the year? Or assuming everything rolls out in the macro environment as anticipated?

Again, I think there are a couple of different pieces here. First, the one-off things that I mentioned in Q4, I would expect it to not recur here in the first quarter. So again, I think we're going to get just some natural uptick in Q1 because of the nonrecurrence of those items. I would expect that new business strain will likely really improve in Q2, as the price increases that we put in effect for 1/1/2012, to really be essentially fully in effect. And then, in terms of the assets under management, again, it will depend upon market conditions, of course. But I would expect that to be more of a gradual increase. Let me see if Cindy or if any of the GMs want to add here.

It's Paul Rooney here. The only thing I'd say is that since we've done our last round of price increases to reduce our strain, we have seen interest rates come down further. And so should we need to make some adjustments, those might -- they would -- any these increase in strain would be less than we've seen in the past and we could moderate that in the second half of the year.

Our next question is from Michael Goldberg of Desjardins Securities.

I'd like to just follow up on Tom's question and maybe we can put some numbers -- aggregate some numbers. So I understand that there were a number of items that negatively impacted your fourth quarter earnings. Aside from the items noted on Page 13 of the press release and Slide 8 of the presentation, overall, can you quantify what the effect of these other onetime items would be in total?

Michael, it's Mike. First of all, we're really trying to move away from this notion of sort of adjusted earnings from operations. We certainly flagged in the notable items, those that are major items that are worth highlighting. Again, beyond that, as I mentioned earlier, the sum total of these -- the combination of the tax and operating expenses and the reversal of the gain that was incorrectly reported in Q3 that we didn't have to reverse in Q4, those were worth $100 million after tax. So we didn't highlight that in the notable items, but that would be the quantification of that. You can see that the new business strain, as I mentioned earlier, was worth nearly $40 million after tax. And the drop in the assets -- excuse me, in the fee income from the decline in the assets under management because of market conditions was approximately $35 million after tax sequentially. So those items together would be approximately $175 million. Now again, you obviously got to -- maybe use your own judgment on how you want to model that going forward into 2012, but that would be the quantification beyond the notable items that I would flag.

Okay, that's great. And secondly, you note also in your disclosure that the net impact of 100 basis point rate decline on MCCSR would be about 13 percentage points. Presumably, there's convexity if rates were to decline even more. And so what I'd like to do is to try and think of, let's call it a break-even level, where I think of 180% MCCSR as being breakeven, analogous to a mining company with a price of commodities that it produces. How much would rates have to drop in order to get to 180% MCCSR?

Michael, it's Cindy. That's a complicated question, and there really isn't a clear cut answer. We haven't done the analysis or sell that way, although I would note that some of the instruments we put on to hedge our interest rate risk such as those swaps actually moderate some of that convexity, so we don't necessarily end up in a position where we break through the barrier that you articulated of 180% MCCSR. So -- but things change, they change quite a lot quarter-to-quarter, so it's also an answer to when that would change over time. But at this point in time, I'm not sure that we would have such a thing as a break-even interest rate. The other thing maybe to note with respect to the 13 percentage points, and as noted in the opening remarks where only fee income impact or the impact on available capital of a decline of 100 basis points is only $200 million per quarter after AFS bond offset. Most of the interest rate sensitivity is actually coming from increases in required capital due to interest rate decline.

Okay. I only mentioned it because given how low rates are right now, it would appear that rates could pretty much drop to 0.

Yes, that could well be the case. And as I was saying, you may never get to the point. But things change over time, so that's sort of a bold statement to make. But you certainly would have a lot of protection against having interest rates take you down to 180%.

Michael, it's Mike. The other piece I would add, I mean one of the reasons we feel some trepidation to try and to give you that precise of an answer to your hypothetical question is that by the time you get to a scenario where interest rates are truly close to 0, not only number one, is that relatively unlikely in the near term, but in the second-order impacts that are laid out on the slide, likely tick in, in one way, shape or form. So we're not trying to evade your question, but I just think that it ends up being very hypothetical because the world probably looks very different if the -- if truly rates have dropped to something like 0. Chances are, there are other bad things going on in the world.

Our next question is from Doug Young of TD Securities.

I guess first question is probably for Cindy. I know that you -- on Page 26 of the release, I know you highlighted this in Q3, but thought I'd ask it now. The CIA is reviewing some of the calibration parameters used when setting up reserves for different products and so forth. And I'm just wondering, can you give us more insight in terms of what's being reviewed and what the potential impact could be here and how material this could be?

Well, the CIA is reviewing the calibration criteria for seg funds, for reserves. And that would have the impact of, in likelihood, reducing returns or in fact probably making the tail of the distribution wider, so that would mean higher reserves and higher required capital. But we really can't answer the question as to the impact because the -- they're still working on it. And so it hasn't been exposed to the members of the CIA to know exactly what the changes might be. But you know, they're bringing -- they're incorporating experience up to 2010 -- market experience up to 2010, which is a more volatile period and probably we will have sort of a moderate impact as it deals on the calibration of factors.

And when you say -- I mean, is this essentially -- you're assuming every year a return of, I'm just going to use the number, 5% to 7% depending upon the market that you're in. Is that what they're tweaking or they're potentially going to tweak?

It would be the combination of the return and also the volatility. So you have not -- you would have an impact on the number of scenarios of the returns and the tails of the scenario and the number does basically reduce the returns and the tails of the distribution, I should say, that would increase reserves.

I mean, for Manulife, if you had to assume up to 2010 market environment, I mean, where would your -- because we know what your assumed return assumptions are. I mean, where would those return assumptions go to? Can you give us a sense on that trend?

It's not directly applicable because when we look at our returns for general account funds, we're looking at the bean where we're just also looking at the volatility. You can't do direct translation from one to the other. So as I was saying, we're not expecting it to be -- we would say it would be a moderate impact on the -- on our seg funds. But we really can't give you a range because we're not -- we haven't -- the CIA has not exposed their research paper.

This is the last on this one, but would you expect that to be phased in? Like, is that -- has been discussed as well?

Sorry, could you repeat that?

Would you expect the impact to be phased in over a period of time like we've seen with other changes?

No, I would not expect that. I would expect it to apply for reporting periods after October 15, 2012.

Okay. And then just second rate on the interest rate. Michael, you mentioned, obviously, the URR impact and you also mentioned the impact of changing your scenarios. And just on the URR, I guess we should be expecting that impact to be coming through in Q2 similar to your normal process. And then, on the change of scenarios, have you bumped into new scenarios in any different geographies? I think you have. And if you had to bump into the new scenarios in all your geographies, can you tell us where that interest rate -- or give us a sense of where that interest rate sensitivity might go to?

Sure, Doug. First, on the URR question, you are right, our standard practice would be to update that annually effective on June 30. So I would anticipate that being a Q2 item, if nothing else change. In terms of the reserve scenarios, we have not, at this point, had to change to the alternative scenario. You'll recall that -- we talked about this last quarter, that if rates fell further in Canada, in Japan, there would be the likelihood that in both of those geographies, we would move from the current reserving scenario that grades the current rates to the URR. We would move from that scenario potentially to the scenario that says take rates that are in place today and assume those forever without change. Because again, if rates drop further in Canada, in Japan, that would be a more conservative scenario than the current URR scenario. We have tried to estimate that in our hedging program and also in the interest rate sensitivities that we've given you to 100 basis point parallel change in interest rates. Now that -- I also don't want to give you a sense of false precision, I mean, that's a very complicated calculation with a lot of moving parts, but we've done our best job in estimating that. Let me see if Cindy wants to add further. Sounds like that's it, Doug.

Our next question is from Peter Routledge of National Bank Financial.

Just a question on Page 29 of the shareholder report. Just looking at the amount at risk for GMWB and it jumps about $3.5 billion. And most of that looks to me to be an increase in the guarantee value. So I guess the first question is, is that -- or how much of that is just the automatic step ups in the U.S. or Japanese variable annuity blocks?

This is Cindy. I mean, I think that maybe we'd have to get back to you on the question, but I suspect that a lot of the change in guaranteed value quarter-over-quarter is driven by currency change, not by fundamental.

By currency, okay. How vulnerable -- I know a lot of this business is written in the mid-2000s, so when get into the mid-teens presumably, it will be in the money at the expiry date. How much policy holder behavior risk do you have? Like, could that net amount at risk blow out by more than your hedging might compensate?

Well, I mean, we definitely are exposed to policyholder behavior on these products, in terms of how many people lapse, how long people starts to draw income, what percentage of their allowable benefits they draw. So there is certainly exposure to policyholder behavior. But I actually -- I don't think it would have a large impact on the net amount at risk, but more would have an impact on the reserves. It could have an impact on the hedge effectiveness to the extent that actual policyholder behavior is different than what we assumed in the hedging program.

As we approach the middle part of the decade, or at least to date, have you seen any material changes and how policyholders are behaving?

Well, I would say that if you look back on the -- on our basis changes over the last couple years, and certainly have had basis changes related to strengthening policyholder behavior. Now it's a project that -- these products are relatively new, so some of that may just be the -- are estimates of how they would behave [indiscernible] the products were not needed to be corrected, you could say, versus changes in behavior. But it's hard to separate those 2 aspects, but we have seen changes in policyholder behavior over time.

But no step change?

No, not that I would say. No, no step change.

Our next question is from John Aiken of Barclays Capital.

I'm surprised this has taken this long to get addressed but Michael, since you're staying on, did you get any sort of guarantee from Don the search process will take less than, say, 5 years? Actually my real question is for Jim. On the Long-Term Care, in really 2 parts. One, is there any impact from Unum stepping away from the business? And second, can you address the profitably that we've been seeing over the last couple of quarters? And what magnitude is driven by the pricing increases that have been approved by the states?

Okay, John. As to Unum, that was announced earlier. I don't think that really has any impact on us whatsoever as we look at the Long-Term Care industry. Today, we have about 11% market share and there's 10 really solid competitors there, some new entrants, some of the big neutrals are there. So we like where we're positioned and I don't think the Unum announcement will affect us much. From a profitability perspective, obviously, last year, we had a significant basis change. We went through our mortality and morbidity and had to update our assumptions. As we sit here today, we've repriced the product over the course of the year to deal with those assumption changes, as well as the reduction in interest rates. We're happy to report here in the fourth quarter, we actually had an experience gain of $18 million in the Long-Term Care. And the profitability of the new business we're putting on the books exceeds the company's hurdle rate. So we're comfortable with the returns and the assumptions we have there. And obviously, the demographics on that segment are quite good.

Our next question is from Darko Mihelic of Cormark Securities.

A couple of questions. Michael, with respect to cost of hedging, your expected cost of hedging, you've made no -- or you haven't discussed the possibility that the macro hedge cost comes down. So should we assume correctly -- or should we correct -- is it correct to assume that on a go-forward basis, we should continue to see a macro cost of hedging somewhere in the neighborhood of $100 million per quarter?

Darko, it's Mike. First, I would not expect that the cost of the macro hedging program to come down anytime soon. And in fact, as we steadily expand the macro hedging program, particularly in Japan, I would anticipate that the cost of the macro hedging program would increase. Now over the long term, over the long term, we would expect to replace those macro hedges with the dynamic hedging program. And -- but as we've talked about before, we need really a combination of higher interest rates, higher swap rates in particular, as well as higher market levels to make that economic. So for the -- over the near term, I would not anticipate a decline in impact, again with a steady addition of TOPIX hedges, I would expect an increase.

How much of an increase -- you mean as a material yet or...

Again, as you know, we make our hedging decisions -- we've got a combination of judgment and time-based triggers and market-based triggers. So it's, again, a multifaceted judgment process each quarter. So at this point, I wouldn't try to give you a specific projection. But again, I think you only anticipate an increase over the course of 2012.

And perhaps just an earlier question, with respect to Long-Term Care, perhaps you can provide an update on premium rate increases on -- in terms of which -- how many states have now approved for pre -- prior blocks? And I guess where I'm leading with that question, maybe more generalized question is, when I look at your slide, your Slide 19, we discussed all the future impacts of declining sustainable interest rate environment. And generally, whenever we hear discussions regarding future earnings prospects, we typically hear about our earnings' headwinds. But some of your competitors actually talk about possible offsets like, “we have plenty of mortality reserves to help us offset interest rate declines” and so on, and yet we never hear that kind of discussion from Manulife. Can you perhaps provide a little bit of context around where it is or -- I mean, you've kind of alluded to PfADs, but why is it that Manulife never actually discusses any possible tailwinds or any possible offsets to this very difficult interest rate environment? And again, whether you want to discuss the actual amount of reserves that could be released from Long-Term Care and what have you, is there anything out there that I'm missing? Or is it plain and simple that all Manulife faces are headwinds and not a lot of reserves are left over to help offset?

Okay. Well, Darko, I'll start and I'll see if Cindy wants to add. In the case of the Long-Term Care price increases, we've now secured rate increases on the retail block from 29 of the states. We feel great about that progress. We're still in active discussion with the remaining states. So at this point, again, I'm certainly not ready to upgrade any reserve assumptions but at this point, we feel very good about how that work is going. In terms of the impact and the management actions related to the drop in interest rates, it's certainly the case that we have been increasing prices a lot faster than most of our insurance company competitors. And we feel good about that, and that's certainly a conscious strategy is to stay leading edge in terms of price increases to offset the impact from the drop in interest rates. As we've talked about consistently over the last 3 years, we've also been steadily changing our mix of business to emphasize insurance products that have less interest rate risk than what we've had in the past. And so therefore, that's obviously less of an impact. And as Cindy reinforced in one of her questions, between the combination of the surplus bonds that we've gone long on, with particularly long treasuries and all the forward-starting swaps that we've put in place, we really materially reduced our interest rate risk. It's not 0. But as we noted on the slide, it's now $200 million after tax per 100 basis point decline, which is materially lower than it's been in the prior years. So we've really been in risk mitigation mode. In terms of your question on how come there aren't reserve releases to offset that? Again, first I've tried to stay away from exactly what other companies do, but I think some of the impact is different for us because of the Canadian GAAP -- excuse me, the Canadian actuarial standards that require us to relook at all actuarial assumptions each year. And we've certainly had mortality releases in the last several years in several of the businesses. But I would say at this point, we feel like our assumptions are reasonably current, so there's not an obvious source of gold out there to release if other things go poorly. Cindy, would you like to add anything?

Yes, that's a good answer, Mike. And I would add, just -- as Mike just said to reiterate that, we do review our assumptions every year. We have had the leases from mortality in the past with the exception of mortality improvement in the reserves, so the impact of future mortality improvements will be less. If we otherwise would, then that will impact all companies in Canada. So I think that, that's just the nature of our block of business. And as some other companies in Canada may have -- may manage theirs somewhat differently with embedding in margins to cover a change in interest rates. But we can't really comment on other companies' approaches.

Our next question is from Robert Sedran of CIBC.

I'd like to return to the issue of interest rates and I guess I'll take the role I don't normally take, which is that of the optimist. And let's say rates do back up 100 basis points and it doesn't seem crazy given that the yields have already started to drift a little bit higher here. A couple of questions. First of all, the AFS to offset, how committed are you to recognizing AFS losses in an environment where you're actually releasing reserves later to interest rates? And then, Michael, if you're able, and I know you're probably not able to pin it down to a very close number, but what might be the impact on the URR charge or the impact even on strain in terms of order of magnitude if we did close the year at 2.75% or 3%?

Okay. Well first on the AFS piece, Robert, I would anticipate in normal quarters reaping the AFS realized capital losses on a reasonably symmetrical basis with how we reap AFS gains in a declining interest rate environment. I mean, we have to manage it both ways if it's truly going to be a mitigant, because we have to keep that in balance to keep the changes for the subsequent quarter as available powder. Now having said that, obviously we reserve the right to not make that formulaic. We'll use judgment depending upon what else is going on in the environment, what else is going on in the company. So it's not going to be a rigorous formula. But certainly, I would anticipate in most normal quarters. If you see interest rates go up, the benefit of that would be at least partially mitigated by realized capital losses on AFS bonds. On the question on URR and strain, unfortunately, Robert, there are just so many different factors that go into that. I don't know that I'd necessarily try to give you a rule of thumb because any rule of thumb I'd give you would be wrong, because they're just -- it's so multifaceted in terms of what sales volumes are, what the mix of business is. So I -- again, let me see if Cindy wants to add. But I'd avoid trying to give you a very specific formula at this point.

Is it fair to say that 2012 URR charge is probably not going to be that affected by whatever happens to interest rates this year?

Well, I think that's fair, because again it's a rolling average and so a lot of that is baked. So we only have between now and June 30, so I would not anticipate it to move materially. On the other hand, stranger things have happened.

And just to follow up on one comment you made and I'm not sure I understood it correctly so I want to double check. I think you said we no longer have a buffer for unfavorable -- for additional unfavorable market conditions to our 2015 targets. Does that suggest that if we were to stay in the environment we're in the 2015 numbers, our targets may still be achievable? Did I understand that correctly?

Sure. What I was trying to get at, Robert, is that consciously at the November 2010 Investor Day, consciously, we had built contingency into the 2015 objectives. We did that very thoughtfully and we acknowledged that at the Investor Day November 2010. Unfortunately, the combination of equity markets underperforming in that period means things like fee income is down below the trajectory that we had originally projected, so that's an obvious headwind. The drop in interest rates means that the projected interest on surplus is less now for 2015 than we had anticipated. We now have built into 2015 a URR hit, because if interest rates stay low, we're going to have a steady diet of URR hits over the next several years. So there are now a number of headwinds for 2015 that were not evident at the November 2010 Investor Day. The good news is we had built in contingency for the items that have happened subsequent to November 2010. The issue, however, is that there is not any more cushion left in our current outlook relative to those objectives. Now your question if things stay exactly the same, could we still achieve those targets? Yes. If I did not think those targets were achievable, we would have said that. But the problem is now, it would not take much in terms of a new negative to be forced to have to adjust that number. And as an example, if we went out and took significant action to bolster our capital ratio, most of those actions do come with a price tag. And so that would be the kind of example that could conceivably push us off the $4 billion. But for now, we remain with the $4 billion objective.

Our next question is from Mario Mendonca of Canaccord Genuity.

First, Michael, could you help me think through how much leverage capacity you feel Manulife has, if the need was there to boost the MCCSR and your feeling why you didn't want to do with it through common equity?

Sure, Mario. Well, first, our leverage -- our long-term leverage target has remained unchanged at 25%. We do believe that, that's the appropriate long-term target, and we do anticipate managing our affairs to that long-term target, again over the long term. It's not lost on us that our average ratio at year end was approximately 33%. It's not lost on us that the earnings coverage ratio -- again, depending upon exactly what your outlook is for 2012 would be reasonably close to 6x. So again depending upon what you view as run rate versus one-off items that really shouldn't be counted in an earnings coverage ratio. And so I would anticipate that we've got a little bit of headroom left in the leverage ratio and a little bit of headroom left in the earnings coverage ratio, but not a substantial amount before we would start to see some ratings pressure. And again, I think that ratings pressure, if it was something that was evident for the entire industry, would not be that big of a deal. But we're very serious about our ratings because our ratings are indicative of our core financial strength. And financial strength is really the basis of our brand, the Manulife brand and the John Hancock brand. So one way to answer your question, I think there's some room, not a huge amount of room, not $5 billion of room, but the -- but I'd rather not be more precise than that.

I think the rating agencies down here, Mario. I think the rating agencies are starting to really recognize the amount of de-risking that we have implemented, both in terms of the product mix and in terms of the hedging activities and how we've attenuated the volatility of earnings and have given real credit for that despite the fact that we get no credit for that or no direct credit for that in our MCCSR calculation. So not all MCCSRs are created equal. And Manulife had an MCCSR 200% with no hedging in place and 216% with so much hedging in place. And then Cindy and Mike are always reminding people approximately 30 points, sort of, for that ratio to disappear due to absolute changes in the measurement criteria. It's hard to compare them. It's pretty solid ratio, and I think that is being recognized by the rating agencies.

I was wondering if you can offer to help me think through whether you would accept the downgrade before having your shareholders say, eat another capital risk, common equity risk?

And my second question relates to Japan. We saw the macro hedging increase by $300 million this quarter, $600 million to $900 million. Is that -- this is a tough one, I think. But is that a normal pace of increase? Or was this particularly a strong increase?

It was a little faster than what we normally do. Warren, do you want to speak to that?

Sure. We actually have a [indiscernible] crisis at a measured pace that we put in place and that would be a faster pace than we would normally expect. But again, we will look at this. And as I think Mike mentioned earlier, it's a combination of looking through our time-based requirements to actually put in place hedging, as well as looking opportunistically at how the market's performing. So it's a mixed call. We're pretty bullish on Japan actually. But the -- when there's issues in Europe, Japan sometimes acts like a beat of 2 against the rest of the world. It had so many challenges. I mean, my view is it's one of the most undervalued markets in the world. But at some stage, you got to -- we do have a commitment to get to those targets. We take them very seriously, so we will be doing a regular amount of reporting regardless of what markets do. But when market opportunities provide, we will increase the amount of our hedging.

Our next question is from Steve Theriault of Bank of America Merrill Lynch.

Just to follow on the macro hedging for a second. Mike, you talked about adding more TOPIX and that maybe -- you may add some more -- well, it certainly sounds like we'll add some more over time. With the S&P 500 up, I think, 11% in the quarter, you didn't add anything to the U.S. Am I safe to conclude here that you're where you want to be in the U.S.? And while you might not be rolling any of that off anytime soon, that we shouldn't see more increased hedging cost from bigger macro hedges out of the U.S.?

We're largely done on most of the global markets in terms of things performing in a normal manner. I think we can still reserve the right for management judgment. If we thought the markets have rallied extraordinarily, we might want to put a small amount in place to mitigate sort of a retreat from those new levels. But I think for most global indexes, the only index that we're actually following a time-based program at this time is the TOPIX.

Okay. And then going back to -- Michael, you were discussing about capacity to issue debt and prefers. And at the end of your commentary there, you said you're not sure if you could do $5 billion. When I looked at the debt to total capital, a couple of billion would get you to a debt to capital, by my calculations, of about 37%. Is that the sort of level you think the rating agencies would continue to be comfortable with? Like can you push it up closer to 40%? Or is it more modest than that, the capacity at the current ratings?

Steve, it's Mike. I don't think there's a bright line on the part of the rating agencies. Again, I just don't think it's that precise. I don't think it's -- 37% is okay and 38% is a problem or 36% is okay, but 37% is a problem. I think it's a multifaceted judgment that the rating agencies have. Having said that, 37% would be higher than any of our material benchmark competitors, and therefore, that would be higher than what I would anticipate being comfortable. So I mean never say never, because who knows what the world is going to look like, but I would not anticipate going to that kind of level under a normal environment.

And if I can wrap up with one quick one on sales. The targeted for growth sales in wealth were down a fair bit. Canada and the U.S. looked fine, but there was a pretty big decline from the Asia division. And so maybe for Bob Cook, can you talk a bit about the nature and the sustainability of the decline there?

That's fairly broad based, not specific to any particular geography?

Our next question is from Ohad Lederer of Veritas Investment.

I'm looking at Page 38 of the press release. I'm just wondering about the sensitivity to assumption changes, thinking ahead to the third quarter. Looking at non-fixed income, I guess 2 questions about the sensitivities that are listed on this page. Between 0 and 100 basis points, is that essentially linear? And then the second question would be, as we get further into kind of a QE world where more and more assets go into non-fixed income, prices go up. I assume the returns will eventually -- possibly come down. Is there something -- what kind of things should we be looking for to say that those return assumptions may have to come down the way we've seen unsatisfactory equity returns in the past?

Okay, I'll start with your second question and see if Cindy wants to answer the first question on linearity. On your second question, I certainly don't anticipate a material change in the near future like 2012. And the reason for that is that if you look at over the last 5 years or look at over the last 10 years, our NFI has actually outperformed our best estimate assumptions. And between that and the fact that NFI is not really a single asset class, it's really a collection of asset classes. That basket, if you will, of different investments has really performed very admirably and has not, over a long period of time, not been correlated heavily to the interest rates. So I would not draw the conclusion that, by necessity, that would decline. And between that and the fact that our 5-year experience has been positive, our 10-year experience been positive, I think that's unlikely to change in the near term. Now obviously, it's something that we monitor all time. Obviously, it's something that we look at on an ongoing basis. But at the current time, I would not anticipate a material change anytime soon. Let me see if Cindy wants to talk about the linearity.

We haven't really looked at linearity so I'm going to pass on that question. I would say that the sensitivity is -- largely, the sensitivity is very much related to where interest rates are and not current, say, risk-free and corporate spreads are -- and corporate rates are -- and not only the NFI returns. So it's very much signified the gap between risk-free rates and the falling industry rates as it has been what's driving up the sensitivity.

Can I just take one more in on IAS 19? The company has talked, I think there's some commentary in the MD&A about a potential hit to capital. Is that just a straight take the $1 billion unrecognized actuarial loss and put that against your available capital, that's about 7 points? Is that the way to think about it?

It's not quite that clear-cut. First of all, this would be majored at 1/1/2013. So really at year end, I wouldn't take the stale number that you're describing. You also want to tax affect that as well. So it wouldn't be the pretax number that you're citing you'd would want to tax affect that. I do think it appears that OSFI -- we do expect at this point that OSFI may make us take this as a hit to the MCCSR. I would anticipate if OSFI followed prior rules that this would be transitioned in, perhaps in 2013 and 2014. So again, I don't think it's as clear-cut as what you're describing. Incidentally, just to add an editorial comment, we don't think that makes a lot of economic sense. I mean, this is an accounting change, not an economic change. We've had this pension plan for several decades now. There's no change in our risk profile. There's no change in funding requirements for the pension plan. We think this is sort of silly, but it does appear to be a risk factor, and that's why we strengthened the disclosure on that at year end.

I understand that it's a year out and the number's stale. But I guess that would be procyclical, right? If rates continue to go down and equity markets go down, that billion will grow and vice versa should markets do better?

Yes, you're right. And again, I mean, how silly is that? Because it's not synced up with the actual funding requirements of the pension plan, it's just a new accounting measure that, again, I think I've said what I want to say.

Our next question is from Gabriel Dechaine of Crédit Suisse. Gabriel Dechaine - Crédit Suisse AG, Research Division: Just a quick one on the hedge. Can you tell me the switchover from macro to dynamic? What do we need to see specifically? What should I be focusing on as far as which bond yields, which segments of the curve and what levels would we need to get before we start thinking of an increased shift over there from macro to dynamic? And then on the strain, it looks to me like the pickup, it was mostly driven by the low rate environment rather than the spike in older products, sales of other products. And like you're suggesting in Q2 that could start to see more of an improvement, is that because you've got sales of those products that are going to be closing in the first quarter, and then you're hitting the 100% sales of new products by Q2? Is that how it's going to work?

Gabriel, I'll start on the second question and then Jim Boyle can answer that and then we'll give to Warren on the VA hedging. On the new business strain, what I was referencing there is that we did put in place another material price increase for the U.S. Life Insurance business that was put in place at the end of 2011. And I would anticipate that by the time we get to Q2, we'd see the bulk of the benefit, maybe not every single penny, but we'd see the bulk of the benefit in Q2 as the business being sold would then be sold at the higher rates and therefore have less strain. So that's what I was referencing there. In addition, again, over the last 2 years, Paul Rooney and company have done a great job of really leading the market on price increases for Life Insurance in Canada. Again, I would anticipate if rates continue to stay low, that we would -- that, that would be another area that we would look at as well. Let's see if Jim wants to add anything there?

Yes, just to add to the U.S. a little bit. We did make good progress 2010 to '11 were drew out strain from $315 million down to $156 million in the first 2 quarters of '11. The strain was pretty negligible, about $16 million a quarter. But you can only reprice so fast that rates kept dropping and whatnot. So we will see some improvement in Q1 and more improvement in Q2. I'll give you 2 quick examples. We discontinued the sales of our group LTC product because we couldn't get new pricing file at that time and we knew the older prices were out of date. Contractually, we had to sell some of that business in the fourth quarter. We sold $7 million of group LTC that had $23 million of strain associated with it. We've made a lot of strides on the no-lapse guarantee business. Our product, if you look in the U.S., because we raised prices so much it's probably clearly in the fourth quartile from a competitive perspective. And it was less than 12% of our sales in the fourth quarter. Having said that, we still sold $17 million of NLG in the fourth quarter, which had $36 million of strain. So between the 2 of those items, $59 million, we've made the decision on group products and a little bit trickled into Q4 and we might see a little bit more in Q1. On the NLG, we announced January 1 that we are raising prices another 12%, so that's going to kick in -- there is some timing there with applications of the underwriting cycle. But we've done a good job keeping up with it, but this environment requires us to continue to keep up. And I think we've done what we need to do and we will see improvement throughout the course of the year.

Maybe moving on the -- moving from macro hedging program to the VA hedging program. Obviously, it's both a function of where equity markets are and interest rates with particularly long swap rate. We would need to see a meaningful rise in both equity markets and the long swap rate to move into a hedgeable territory. The primary exposure that we have open, which is the only one that we're talking about due to time-based hedging is the TOPIX. We're pretty satisfied on an overall basis where we sit vis-a-vis our hedging from both the macro and VA program. And most of the other markets in Canada is in very good shape. And like I said, the S&P -- on the U.S. context and TOPIX, we would have ultimately some VA hedgeable blocks, but it would be very material rises on both the long rate and the equity markets to move from macro to dynamic in those markets. Gabriel Dechaine - Crédit Suisse AG, Research Division: And it's mostly in Japan?

It's most -- Japan is where we've got the largest -- or the least probability, probably, of moving in the near-foreseeable future into the dynamic program. Gabriel Dechaine - Crédit Suisse AG, Research Division: Got you. But then as far as the U.S. goes, is there any -- I mean, do you see the 10 year at 3% or something like that? Or is it more complicated than that obviously?

It's a multi-factor decision. I mean, we've got a number of criteria. We've actively monitored the blocks constantly in terms of when they may become hedgeable. But I can't really want to put it down to a single factor, a single point as to when we can move out of the macro and into the dynamic.

Our next question is from Joanne Smith of Scotiabank.

I actually can't believe that I actually have questions left to ask. But I'll try this one. It seems like -- you've been using treasuries, U.S. treasuries to bridge the duration gap on the portfolio. And I was wondering if you could just talk a little bit about what the trade-offs are for -- to that type of a strategy, if there are any at all. I have to make up my mind, but I'm not sure if you would confirm those, so if you could talk a little bit about that. And secondly, can you tell us where the duration mismatch stands today unless it's in one of the disclosures that I missed?

Joanne, I'll start and I'll see if Warren and Scott want to add. First, just to be clear, I would not characterize this as a duration mismatch. I think that's a misnomer. This is really, again, the difference between Canadian GAAP actuarial rules that will get applied to IFRS relative to U.S. GAAP. Again, in Canadian GAAP, it is different because we've literally, Joanne, got to take future premiums that we haven't even collected yet, project those out and make an assumption on how that money is going to be invested. That's wholly different from U.S. GAAP. So it really is not a duration mismatch the way I would think about it and I think the way you would think about it in the traditional U.S. company would think about it. This is really a strange artifact of the Canadian GAAP rules. In terms of what we've done to mitigate the interest rate sensitivity to the Canadian GAAP modeling, you mentioned U.S. treasuries, that's certainly true. It's also very important, though, to note, we've put on a substantial amount of forward-starting swaps, which increase then our sensitivity to corporate spreads in the future, but it's not just treasury. It's a combination of the treasuries and the forward-starting swaps. On your question on the treasuries, the main issue there is that we're giving up spread for the treasury. So we've priced this business in many cases, assuming normal spreads are conservative spreads in the future. You go up by a 30-year treasury, then all of a sudden the reserving assumes that we're not going to get the spread above treasuries for that period of time. So it is a substantial economic hit. As a result, we really would like, over time, to move more of those treasuries into corporates. On the other hand, we don't want to sacrifice our strong underwriting standards that served us so well. Let me see if Scott wants to add there.

Yes, what I would to add to that is it depends what you move from into those long treasuries and it was a combination -- part of it was cash and we've got the long treasuries so actually was an income pickup there between the -- because of the yield curve that you want to spread on the cash. But we did also sell some short corporates and moved that into long treasuries and that was maybe more of a push giving up spread by picking up the yield curve. And as Michael points out, there's real opportunity there now to add income going forward. Now we struggled to find appropriate long-term investments. So that will moderate a bit what we can do there. But as we talked about last quarter, one thing we are doing is adding some credit default swaps on, sort of create a synthetic bond with those treasuries where we're more comfortable in lending to companies to for 5 years and the 5-year CDS market. It also opens up a bigger set of names that we can invest in as well.

But just as a follow-up to that. I mean, with all of the speculation about the Volcker rule, with respect to the swap market, I'm just wondering what would happen to your ability to kind of write those credit swaps on the treasuries in the event that the corporate CDS market were to decline significantly because of the Volcker rule?

Well, I guess that's a risk. But I think we think the bigger risk is in the cash market. I think credit default swaps are much more liquid than the cash market including the financial crisis. We saw those continue to trade while the cash market did not. So the Volcker rule is it is concerning and that it will decrease liquidity everywhere, but probably more concerned about the cash market.

Okay. And just one last question on the treasuries. When should we think about you switching out of that strategy into more of a corporate bond strategy? I mean, is there like an interest rate level that you would begin to move away from that strategy?

No, I don't think so. I think we want the interest rate protection that gives us. So it's really a function of when can we find appropriate long corporates. And so what we're trying to do to add in, we would hope to make incremental progress over time, but it's not something I'd expect to have a big influence in any given quarter.

And Joanne, it's Mike. Just to reemphasize the, hopefully, the obvious, that is upside earnings opportunity for us. I mean, as we move those round numbers, $7 billion of treasuries to corporates, that would be incremental earnings. But as Scott said, this isn't going to be just the 2012 kind of item.

And our last question is from Sumit Malhotra of Macquarie Capital.

It's a hypothetical for Donald around the topic of acquisitions. Don, you've talked about your interest in growing Asia in the past and more recently, there's been some press reports that have spoken to it as well. Without getting too specific, I wanted to ask about what you've heard from your regulator? We haven't seen much capital deployment from the Canadian Life Insurance sector over the last number of years for obvious reasons. And the first part of my question would be what has your regulator communicated to you in terms of their willingness to see the company deploying material forms of capital? That's number one. And number two, as CEO, how would you feel? You've mentioned an earlier comment issuing capital or issuing stock on acquisitions with the stock trading where it is right now, would it be possible to make a transaction accretive in the near term? Obviously, I know it would depend on pricing, but just speaking generically here.

So just to be clear, I'll wrap it up here, as far as your discussions about your concern, if there was a transaction or an acquisition that you were looking at that diversified the risk profile of the company, even if it was a material-sized outlay, they're not averse to you going down that road at this point?

Thank you. This concludes today's question-and-answer session. I would like to return the meeting back to Mr. Ostler.

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

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