Q3 2023 Manulife Financial Corp Earnings Call
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This conference is being recorded.
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Please standby your meeting is ready to begin please be advised that this conference call is being recorded.
Good morning, ladies and gentlemen, welcome to the Manulife third quarter 2023 financial results Conference call.
I would like to turn the meeting over to Mr. Hong Kong. Please go ahead Mr go.
Thank you welcome to minimize earnings conference call to discuss our third quarter and year to date 2023 financial and operating results.
These materials, including the webcast slides for today's call are available on the Investor Relations section of our website. There are many ways dotcom turning to slide four we will begin today's presentation with an overview of our third quarter results and strategy update by wide Gori, President and Chief Executive Officer for.
Boring voice remarks, Colin Simpson, our Chief Financial Officer will discuss the company's financial and operating results.
After their prepared remarks, we moved to the live Q&A portion of the call. We ask each participant to here to a limit of two questions. A quick follow up questions. If you're happy to Jim questions. Please re queue and we do our best to respond to everyone. Before we start please refer to slide two for a caution on forward looking statements note that certain material factors or assumptions are applied to making forward looking.
Statements and actual results may differ materially from what is stated.
I'll also refer you to slide 35, when note on a non-GAAP and other financial measures used in this presentation, which includes an explanation of our use of transition the results for 2022 comparison.
With that I'd like to turn to go over to Roy Gori, Our President and Chief Executive Officer Roy.
Thanks, Sean and thank you everyone for joining us today.
Yesterday, we announced our third quarter 2023 financial results.
Let me first share with you some quick thoughts on the quarter.
We delivered growth across our global business, which is evidenced through the strong operating and new business results.
In the third quarter, we saw double digit growth in I T cells, and new business value compared with the prior year quarter.
We also generated solid growth in new business DSM of 6%, which contributed to an annualized organic growth of 5% on a year to date basis.
Since the adoption of <unk> for 17, we've been delivering steady year on year growth in core earnings over the past three quarters, including a 35% rise in core EPS this quarter.
We also reported core ROE of 16.8% hit about medium term target of 15% plus for the second consecutive quarter.
And we continue to focus on allocating capital to our high return businesses to drive Roe growth.
Despite the impacts of the challenging macroeconomic environment on our net income we grew our eye for a 17 adjusted book value by I'll go $1 per share in the third quarter, which translated to a 4% increase year on year.
And finally enabled by our strong capital position, we continued to deploy capital to further enhance returns to shareholders through dividends and share buybacks.
Turning to slide seven we are driving profitable growth, while focusing on the needs of our customers and returning capital to our shareholders, which contributed to our strong third quarter.
Asia continued to build on the momentum of the previous quarter capitalizing on the return of demand from mainland Chinese visitor customers and delivered strong new business results with IP sales and new business CSM growth of 20% and 16% year on year, respectively.
In Canada, we delivered impressive IP sales growth of 51% compared with the prior year quarter, driven by a large affinity market sale and it translated into an increase in new business value of 72% in the segment.
We're also making decisions easier for our customers, notably to accelerate the growth of our global high net worth business, we launched our unified Onboarding platform in the third quarter in Bermuda, Hong Kong, and Singapore to deliver a consistent high touch experience.
But distributors and customers.
I'm encouraged by the continued growth across our global franchise.
Now, let me speak to our continued journey of becoming a digital customer leader and highlight some of the key initiatives across our businesses.
Starting with Canada, we continued our digitization efforts to meet growing demand for more personalized digital health care experiences.
For our group benefits members with a strategic partnership with league, a leading healthcare technology provider.
This partnership will help our customers understand their health focus on prevention access care and better understand and optimize their benefits.
Global win we accelerated customer adoption of digital applications intended retirement through I'll say goodbye to pipe a campaign, which contributed to a 165% increase in members converting to E statements over the three month campaign period, and an increase in satisfaction in their digital experience over the <unk>.
Good quarter.
Moving to Asia, we further automating our claims handling process in Hong Kong to deliver a better customer experience and drive operational efficiency.
Through continued leveraging of data to enhance our auto adjudication engine. The initiative drove a nearly two fold increase in straight through processing claims year on year.
In the U S. We continued to optimize our digital capabilities to create a more seamless digital customer experience through various initiatives, including an enhancement of the interactive voice response authentication, enabling 31% all been bound calls to be completed with no human interaction during the quarter.
These are just a few recent examples of how we're making decisions easier for our customers and meeting their personalized digital needs.
And part of our investment of more than $1 billion since 2017 to digitize our business.
Looking ahead, we will continue to build on our strong digital platform, while accelerating our adoption of new technologies, such as generative AI.
We're already piloting a number of initiatives that we will look to scale as we uncover their potential to generate top and bottom line benefits.
Moving to capital management.
We continue to maintain a strong capital position supported by a higher like cat ratio in the quarter of 137%.
We also generated stable growth in adjusted book value per share with a 4% increase year on year in the third quarter.
Coupled with our financial leverage ratio that is close to our medium term target of 25%. We are in a position of strength to weather the macroeconomic uncertainties and continue returning capital to our shareholders.
In fact, we've returned approximately $7.7 billion of capital to our shareholders through dividends and share buybacks since we resumed our share buyback program in 2022.
And now a dividend per common share has grown an average of 10% annually since 2017.
In summary, I'm pleased with our strong results in the third quarter.
While we continue to operate in a tough and uncertain environment that presents challenges I see tremendous opportunities against the backdrop of higher rates and continued recovery in Asia.
Manulife is uniquely positioned to capture these opportunities given our financial strength business and geographic diversity and a leading insurance business that will continue to benefit from higher rates.
Thank you I'll now hand, it over to Colin to review the highlights of our financial results Colin.
Thanks, Alright, we are indeed delivered strong performance in the third quarter with growth in sales earnings book value and counsel all guns, a little more detail on our results before we move to Q&A.
I'll start with our top line on slide nine.
A P sales increased 21% from the prior quarter as we continued to capitalize on the return of demand across Asia in particular Hong Kong.
In Canada, we delivered APE sales growth of 51% driven by large synergy market sale.
The strong growth in sales translated into an increase in new business value of 15% and contributed solid growth in new business GSM O 6%.
This reflects increases in sales of Asia, and Canada offsetting a decrease in the U S, which experienced a slowdown in demand for accumulation products.
Global one saw net outflows of $800 million entirely due to a large case pension plan redemption in our U S retirement business year to date, we've generated net inflows of $5 8 billion.
I'm encouraged by the continued growth across our new business metrics compared to 2022, and the ice a relatively difficult economic conditions, a testament to the demographic tailwind in many of our markets, a broad product offering and our ability to execute.
Moving to slide 10, which shows the strong growths in our profit metrics core EPS increased 35% as we grew core earnings and bought back shares no. This growth was flattered by the hurricane related charge in our P&C reinsurance business in the prior year quarter, but normalizing for this core EPS still increased 12%.
Despite the significantly higher credit charge.
As Roy mentioned active capital allocation is a key priority for us and it is encouraging to see our third quarter core ROE increased to 16, 8% ahead of our medium term target of 15% plus for the second consecutive quarter.
Turning to slide 11, our net income was lower than core earnings this quarter caused by the challenging investment environment, but it is important to consider that some of this adverse result was offset by gains in other comprehensive income or ACI, which contributed to the increase in our book value.
Together with the contractual service margin, which also increased we reported an adjusted book value per share of $30 67 up 4% year on year.
But bringing back to our core earnings results Slide 12 shows our drivers of earnings analysis presented relative to the prior year quarters to give you a sense of our progress. The first point to note is the recovery in the core net insurance service results. This was driven by the non repeat of last year's $256 million Hurricane charge.
But also improved insurance express.
The second point is that higher interest rates continued to benefit our net investment result through both higher expected investment and high return small surface sources. These two factors were partially offset by higher debt costs included another core earnings along with higher performance related costs and investments in technology across our businesses.
Finally, the increase in expected credit loss or E. C. L. A this quarter was primarily related to certain electric utility bonds impacted by the Hawaii wildfires and a handful of private placement notes.
These factors drove a 28% year on year increase in all core earnings as shown in the next slide which I'll move to and discuss on noncore items.
The challenging macroeconomic environment led to a $1 billion market experience net charge in the third quarter. This included a $400 million charge from lower than expected returns on older.
$273 million charge due to lower than expected public equity returns during the quarter and the $266 million loss in derivatives and hedge accounting ineffectiveness driven by the significant increase in rights and Steepening of yield curve with a 10 and 30 year rates increased more than 70 basis points.
While the short rates between one and five years rose on average 30 basis points, we will continue to refine our hedge accounting programs to better align with economic hedges.
I will also note that given the interaction between the fair value through OCI option on our assets and liabilities and derivative hedge accounting it will be important to look at the impact on this line in conjunction with movements in OCI to see the full picture of interest rate impacts.
For this quarter the impact was net favorable.
While we reported a net charge in ALDA, reflecting lower than expected returns the portfolio continued to generate a positive return in the quarter.
Our long term track record supports our ALDA return assumptions, but we shouldn't expect some parents such as now where it may under perform the long term assumptions commercial real estate was again the biggest driver of all of the underperformance as higher long term risk free rates are pressuring valuations.
Although high capitalization rates used by third party appraisers lowered current valuations. These high rates also indicate higher returns going forward, which further increases our confidence in achieving our long term assumptions prospectively over time.
It is important to reiterate that we continue to view a diversified ALDA portfolio is well suited for insurance liabilities with attractive returns and low volatility relative to both credit and equity indices over the medium to long time horizon.
Outside of the market experiences all I would like to note that our annual review of actuarial methods and assumptions or basis change had a net neutral impact on net income attributed to shareholders.
This year's basis change resulted in a net favorable impact of $347 million pretax, reflecting a neutral impact on net income and increases in OCI in CSM.
Further information on the basis changes available in the appendix to the presentation.
Lastly, the $306 million gain and reinsurance transactions tax related items and other reflects a one off release of multiyear tax provisions.
The next few slides will cover the segment view of our results starting with Asia on Slide 14.
Both top and bottom line performances was strong.
A P sales increased 20% from the prior quarter, reflecting a return of demand from mainland Chinese visitor customers, which you can see in our Hong Kong results. As we've mentioned previously the pace of economic recovery in Asia is uneven and the strength of our diversified business in the region continued to shine through the.
The increase in sales contributed to a 16% and 7% growth in new business, CSM and new business value respectively.
We delivered strong core earnings growth in Asia of 33% year on year, primarily driven by higher investment yields and business growth as well as product actions, but I would add that core earnings also benefited from an increase in amortization of CSM and our Hong Kong business as a result of the basis change.
Moving out of its global one segment's results on slide 15.
Our global wine business recorded net outflows of $800 million. This was driven entirely by large case pension plan redemption U S retirement, which more than offset continued strong inflows in our institutional business. Excluding this large case pension fund net inflows were $4 billion for the quarter.
Retail net outflows in the quarter reflected low demand as investors continue to favor short term cash and money market instruments amid market volatility and higher interest rates.
Fight this backdrop, our U S retail net flows outperformed the industry average.
Our global wine business also delivered resilient Corning supported by high average <unk>, which increased 4% year on year and higher than usual institutional performance fees.
Our core EBITDA margin of $26, 9% has improved sequentially since the first quarter of 2023, driven by steady growth in average <unk> and higher institutional performance fees.
Hitting oversaw candidates segment on slide 16, which had another strong quarter AP sales increased 51% compared with the prior quarter, primarily due to a large affinity market sell which was the main contributor to our significant growth in new business value I would like to remind you that the majority of the affinity market.
<unk> are classified as premium allocation approach or P. A a contracts, which do not generate CSM.
Core earnings increased by 4% compared with prior year quarter, mostly driven by more favorable insurance express in our group benefits business.
Moving to slide 17, which illustrates our U S segment's results.
In the U S. Lower AP sales were driven by the backdrop of a continued high rates environment adversely impacting our accumulation insurance products in particular, especially for our affluent customers lower sales contributed to the lower new business results were.
We are actively broadening our product base to mitigate the headwinds, including the recent expansion into the employer market by introducing multi life products.
Our U S business delivered resilient core earnings, which decreased 2% compared to the prior year quarter, mainly reflecting the increase in ECL.
Insurance experience improved year on year from net favorable claims experience, which provided a partial offset to the credit impact.
Onto slide 18, we continue to maintain a strong balance sheet and capital position.
This underpins the commitment we make to our customers every policy sold it gives us financial flexibility.
At the end of the quarter, we had $22 billion of capital above all supervisory target ratio and I'll highlight that ratio of 137% remains strong.
Our financial leverage ratio declined by <unk> six percentage points year on year, largely driven by higher adjusted book value during the quarter and this continued to track closer to our medium term target of 25%.
Enabled by our strong capital position, we continue to return capital to shareholders.
We have returned approximately $7.7 billion of capital to shareholders through dividends and share buybacks. Since we resumed our buyback program in 2022 including approximately $420 million of buybacks or nearly 1% of our outstanding common shares during the third quarter.
And finally, moving to slide 19, which shows how we're tracking against our medium term targets.
Our CSM growth metrics are below our medium term targets, partly due to the impacts of market and foreign exchange movements, we continue to explore products and business enhancements to improve C. S M grid and I'll still optimizing our performance in a post eye for a 17 well.
Core EPS growth and core ROE, we have been strong in the first nine months 2023 and above our target ranges.
OLED, we've delivered strong oil pricing and new business results and echoing Roy's earlier remarks, as we continue to face an uncertain global macroeconomic and geopolitical environment I'm confident that we are well positioned to deliver for our customers shareholders and colleagues.
This concludes our prepared remarks before we move to the Q&A session I would like to remind each participant to adhere to a limit of two questions, including follow ups and to re queue. If they have additional questions.
Operator, we will now open the call to questions.
Thank you.
We will now take questions from the telephone lines. If you have a question and you are using a speaker phone. Please lift your handset before making your selection.
If you have a question. Please press star one on your devices keypad to cancel the question. Please press Star two please press star one at this time if you have a question there'll be a brief pause of participants register thank you for your patience.
And your first question is from many Feldman from Scotiabank. Please go ahead.
Hi, good morning.
Your web business benefited from higher than normal performance fees.
In the institutional business I was hoping you could provide us a little more color in terms of.
What was driving that and I was wondering if you could scale that in terms of dollars.
Yes, Thanks, Benny it's Paul here, Yeah in the quarter, we did have a strong performance fee was on our timber business. The performance fee was 23 million post tax this quarter and help contribute to the positive results, but if you look at the underlying core earnings they were strong without the performance fee. If your comparison to Q2, if I back out the performance fee completely.
Core earnings would have been 338 million up 6% from Q2 EBIT margin would have been 25, 6%, which is 100 basis points up from Q2, and that's relative to average a M may up 1% from Q2.
Now, having said that in our performance fees can be lumpy, but we would expect to generate a certain level on a regular basis historically for us that over the last four years, that's been between on average 10 to 15 million post tax.
On a 12 month month basis. This year year to date, we're sitting at 27 posted 27 million post tax a little bit higher than the normal, but if you're trying to get a sense of run rate. You should include some portion of our performance fees on an ongoing basis.
Thanks for that and then just wanted to talk about <unk>, new business and growth in CSM balanced growth both year to date coming in well below our medium term target. So I just wanted to revisit.
Right.
What's driving that and then trying to think through the implications.
Terms of <unk>.
Our earnings and book value growth going forward.
So.
Two questions on CSM.
Yeah, Yeah, Thanks, Manny and it's calling here. So we're actually really pleased with the new business ASM growth in the quarter, 80% is coming from Asia and Asia is up 16% year on year. So there's good momentum coming from Asia and that will feed through into the C. S and balanced growth. If you look at the CSM balanced growth in the quarter on an organic basis, it's up 5% annualized.
That's yet to date actually annualized 5%. So we have got momentum or CSM balanced growth it isn't quite at the 8% to 10% target that were going for but we were very focused on this because as you know this is a store of future earnings and this will drive through into future earnings.
Earnings So really nothing new to say on our target we continue to operate in and I for a 17 environment to there's only three quarters of reporting so are we.
We're still we're still getting used to that as a reporting regime, but remain very confident in our medium term targets email I might just add in as well I think collyn summarized it well, but we were still very much committed to our medium term targets for both new business C. S. M. N C. S. M. Obviously, we're still in the early days of April 17, and it's a challenging environment as Colin highlighted.
But there's a lot for us to be encouraged by particularly the fact that our E business see a temporary Asia was 16% in the quarter and 12% year to date and as Colin highlighted you know more than 70% in fact, 80% of our new business Csm's coming from Asia.
So we still feel very confident in our medium term targets, which are through the cycle and there's a lot to be optimistic about as we look to the next year and beyond.
And just a follow up in terms of.
Obviously, you are reacting to a market environment, but is there anything any levers that you can pull and trying to lead in order to.
Boost those those growth numbers. So curious about some actions that you can take or are taking to do that.
I think many you know for us, it's really about more customers through the door more sales and better margin. If we get that taken care of then everything else flows from there. So that's really what we're focused on.
Thanks, Paul.
Thank you. The next question is from Doug Young from de Sal Bank capital markets. Please go ahead.
Yeah.
Hi, Good morning, just maybe starting with Asia Asia.
It looks like there was last was an issue again in Vietnam I think that's been the case for a few quarters now I mean can you maybe delve into a bit of what the issue is and the reserves need to be adjusted.
That business and then I guess on the flip side you have in Asia. It also looks like there was some negative claims experience and taking this from just slide 25, if you can kind of dig into that a little bit.
What drove that.
Hello, Doug This is Phil I'll make a start and then hand over to Steve Finch, who may wish to comment further but to your first point on Vietnam. The market has been experiencing challenges and we've referenced this in previous quarters.
But it really is a reflection of the underlying challenging economic conditions in Vietnam, and we're seeing that translates into a lower new business volumes, but also lower levels of persistency and when you look at the movement in policyholder experience and the C. S. N. That's really a reflection.
And almost in its entirety and if the challenging persistency that the entire industry is seeing in Vietnam, and where we're seeing that as well in our business.
You also referenced a policyholder experience or experience elsewhere and in the P&L you do see a negative $20 million in Asia I do want to clarify that that exclusively relates to maintenance expenses. So our policyholder experience through <unk>.
Does it have some negatives across the region, but it all balances out to a net neutral position and when you look at the impact of expenses and compare the overall expense position relative to the third quarter of 2022, what you'll notice is as being a reallocation of unattributed.
Says to maintenance expenses, so that $20 million is actually geography, rather than a deterioration in the expense position, but I will hand over to Steve to see if he wants to comment further, particularly on the AR balance sheets impacts sure. Thanks, Bill and also adding that claims was neutral for Asia across there.
Region overall I see.
Specifically, our Doug with respect to your question on <unk> on reserving as still noted that persistency challenge across the industry in Vietnam that is expected to be short term in nature. We don't think it's a structural issue and we've got a strong position. There. So it's not really a long term assumption balance sheet issue and that's why it's not reflected in the basis change.
<unk>.
Okay, and then Steve while I've got you just on the long term care insurance I know it was a net modest positive exactly like last quarter little negative in the P&L a little positive in <unk>.
And the CSM can you unpack a bit about what's going on through that through the P&L to what do the CSM what youre seeing is it exactly the same as last quarter.
Is there something that we should expect to continue for this block of business, where we see a little drag on earnings, but a little bump in <unk>. So I'm just trying to understand how to think about the moving pieces with this business.
Yes, sure Doug I, yeah in on long term care in total which is really how I think we need to look at it at experience to understand the drivers I L. T. C was a modest positive. It's also been a modest positive since the assumption review in that in 2022 and.
You know just take the chance to to emphasize you know how we've been managing this business overtime regularly updating to reflect experience and we've been doing that.
You know for a couple of decades, whereas under the new U S. GAAP standards that sad news requirement. So we've been managing it that way for years in terms of specifically, what's you know what's going on in the quarter. We do see what goes through the through net income is a cash variances. So it's higher.
Asian for customers on claim, but that's more than offset by favorable incidents and termination experience and that particular trend is likely to continue over the short term, but again I look at the the.
<unk> in in aggregate, which has been positive.
It was just the termination when you say favorable termination is that Martin lapses that.
It's the combination of lapse and mortality.
Our active life and those on claim.
Okay perfect great. Thank you very much.
Thank you. The next question is from Tom Mackinnon from BMO capital markets. Please go ahead.
Yeah. Thanks, very much a two one quick question on the affinity sale.
Can you quantify the amount.
Yeah, Hi, Thomas it's Davita shot here. So this was our largest affinity sale ever it was the Ontario Medical Association of 36000, new customers, a 150 to 160 million of premium.
Alright, 150 260.
350, <unk> hundred 60 million of premium okay.
Okay. That's great. Thank you and.
With respect to the U S.
Like we're having some.
Some negative sales momentum here.
If I look back in the history of Manulife. It was you know is a second to die no lapse guarantee then moved into vitality.
You know the consumers changing here interest rate environment is changing.
Your sales are slipping here.
What is it that your debt.
What are you trying to do in order to revamp sales and what is your competitive advantage.
Sure Tom its Brook stangl. Thank you so much for the question over the past few years, we've really worked to significantly improve the new business profitability.
You know of the or the profitability of our new business franchise, and notably we've been able to grow sales during that period and that was really on the back of our unique differentiator vitality, which you mentioned.
So we've had a few years now steady and steadily increasing margins increasing sales. This year in Q3 in particular has definitely been a challenging market and Colin touched on it earlier if people buy life insurance in the U S. Generally for two reasons protection against loss of income or a state taxes what have you.
Or accumulation.
Particularly wealthy people that may have maxed out there for one K and so forth will put money into life insurance and accumulate it for retirement.
Higher interest rates, which you know obviously good for our business in a range of ways.
Challenge those accumulation sales, they're attractive alternatives for wealthy people to put cash right. Now so protection sales have held up pretty well, but our accumulation sales have really been hit hard and that's been a strength for us in the high end of the market.
I will say, we've maintained margins throughout all of that and we actually feel really good about our competitive position coming out of Covid vitality continues to be extremely popular boats with brokers and consumers and specifically in terms of what we're doing Colin touched on a notable action as we enhance and revamp our product lineup to reflect the current market.
We launched this multi life solution, which is a protection based solution.
With vitality integrated in it and we've seen a very very positive and strong market reaction to that and feel quite good about our ability to deliver profitable growth in our new business franchise in the U S. A tomo I might just also add that despite the challenging quarter N. B V for for our U S business year to date is up 4%.
Core earnings is up 6% year to date and as Brooks highlighted our vitality proposition actually is a significant differentiator for us and has allowed us to outperform the market over actually quite a number of years. So you know we feel really good about our U S business challenging market at the moment with higher rates as Brooks highlighted but we feel optimistic about the outlook there as well.
And if I could just a quick one with respect to the actuarial review laps continuing to be an issue in the U S. Did you do did you revisit the lapse assumptions for your.
No lapse guarantee or secondary guarantee products in the U S was that part of that review or is that come next year.
Thanks, Tom it's Steve So as the U S. Lapses were not part of the review this year. They are part of next year's review and let me give you a little context for you know what we're seeing IDE reminder, that before the pandemic you know our lapse assumptions were up to date experience was consistent.
With our assumptions prior to the pandemic.
Hi.
During the pandemic, we saw lapse rates on protection products drop in Canada, and the U S and that would include MLG and other protection oriented products.
What we what I expected to see over time is that those lapse rates would trend back to pre pandemic levels and indeed that is what has happened in a Canadian level.
Level cost of insurance UL products, which is quite similar to that the U S. No lapse guarantee it has happened in Sag funds in variable annuities and then in the U S. Well lapse rates remain low in the past couple of quarters, we have seen on some of our protection products those lapse rates side trying to go.
Up so.
So that you know all of this informs my expectation that over time, we do expect the lapse rates to return to pre pandemic levels and this type of phenomenon is also something that we observed in the global.
<unk> financial crisis, and coming out of the global financial crisis.
Okay. Thanks for the color Steve.
Thank you.
The next question Gabriel Deschaine from National Bank Financial. Please go ahead, Yeah I just got one question actually about the all the portfolio.
Other a.
Negative.
Performance period here, we get what's going on with CRE in particular.
My question is about the.
When would you start to review the expected investment income that thing to go through it.
The component that's tied to ALDA.
It looks like you're assuming 9%, 95% return going forward than historically, but that's fine and supported by that but those were ultra low interest rate period.
And you do give some sensitivities about 10% of them dropped my question is.
What if he brought that return down the 8% 9%.
Apply that declined to $40 billion alternative portfolio in.
Divide by four and that would be the reduction to your expected investment income.
Yeah, Gabriel Hi, it's Scott. Thank you for the question.
You know we over time expect the ALDA returns to be somewhat volatile, we're not going to hit our expected return of recorder.
And as you mentioned over time, we have it achieved those returns.
That we put into core.
We will have periods, however of underperformance in periods of over performance and if you look over history about half the time our performance is above about half the time that performance is below where in one of those periods right now where the performance is below the last five quarters, we've been a bit below now our gross returns are still positive. We just have not achieved the the long term.
Target returns the eight eighths sequential quarters before that returns, where we're above our long term targets. So we think those long term targets are still appropriate if any.
Hello.
Okay.
Sorry, I'm, sorry, something happened to my mic, but so so let me let me wrap this up a bad but the big driver in the last five quarters of the underperformance has been our real estate portfolio. As you mentioned, it's about two thirds of the underperformance and its whats driven that are a couple of things one office as we know has performed poorly but the second big dry.
Ever and the Big driver more recently has been rising cap rates, reflecting the higher interest rate environment.
And as as cap rates go up that does depress current returns, but it it portends higher returns into the future and to your point, we did benefit from lower cap rates historically over the last 10 years, but you may recall that in 2018, we did reduce those those.
Actions that we put through core to reflect even though we had hit the target returns we were less confident we would achieve them going forward given given the cap rates had come down we're actually now in the opposite situation and the underperformance excuse me in the last few quarters is due is largely due to these rising cap rates and and that.
That will lead to higher returns going forward. So as Colin mentioned in his introductory remarks, we're at we're more confident than ever of achieving those long term returns.
Dave if I could just yeah I get that.
If we are in a higher for longer rate environment. They are moving towards that.
Okay.
It would be the case today anyway.
Some of these asset classes, not just theory, it might or might not be able to generate the returns they have historically.
Investors wanted to take a more conservative view I'm, just trying to mechanically figure out.
Uh huh.
What would your.
That investment.
Income will look like.
You know that but I'll, let portfolio return was lowered from nine to eight is there any way you can ballpark that.
Yeah, Gabe, it's calling him we were very transparent about our oldest sensitivity you'll see the number and the and the and you actually pointed it out. So you can take a a rule of thumb and divide by 10% sensitivity by however, much you want to do to to analyze the impact of a reduction in expected long term returns on ALDA.
Only thing I would add Gabriel Gabriel is that you know an older portfolio is a diversified portfolio. We've got real estate. We've also got private equity timber agriculture infrastructure energy. So the diversification of our portfolio is very hopeful and yes higher rates suddenly providing a headwind from cap rate perspective on the commercial real estate portfolio, which as Scott highlighted should.
Actually give us more confidence around an hour return assumption in the future.
What about the other components of our older portfolio actually benefit from a higher rate environment and in fact, you know in 2005 and 2006, we saw higher rates as a as a as an environment and our older portfolio outperformed assumptions. So again I'll just remind you that older is a long term assumption it through the cycle.
We have strong conviction with our our assumption.
Alright, thank you.
Thank you.
Next question is from Paul Holden from CIBC. Please go ahead.
Sorry, Thank you good morning.
First question continuing with all of that is maybe you can give us a fence of how much cap rates have been revised whether it's year to date are sort of over the next 12 months just.
Just to give us I guess also a sense of how much further they may or may not change.
Sure Paul It's Scott again, yeah, so far year to date, we've seen and in North America cap rates rise about 60 basis points.
And we're now at nearly 6% on a go forward cap rates and if you think about the return on the portfolio. It should be the cap rate plus the growth and so with that sort of math, we are above our long term expectations. Our long term expectations for real estate or are among the lower ones. We have so they're below that 9% <unk>.
9% sort of on an average return that we have now going forward. It's a good question what our cap rate is going to do from hearing well I don't have a crystal ball I would say that if rates stay high we probably will see continued pressure on cap rates I think the appraisers sort of need to get confident that central banks are going to start to.
To reduce rates and once they get that I think you'll see the cap rates stabilize and at some point probably compress.
Got it okay.
And then just looking at the <unk>.
Core expected returns and then kind of comparing it to the investment income reported on the income statement, there's a pretty big difference in the year on year growth rate 24%.
On the the core per D O E versus a 5% increase in the income statement I, just I think about that and I look at the 24% and for what I think would be a long duration fixed income book. It seems high so I'm just wondering how I can reconcile the two and and really understand the.
Rapid or significant increase in core investment income year over year. Thank you.
Yeah, Paul as its Colin again, it's a good question. The if you'd look at interest rates. The actual interest rate impact coming through that line is only 43 million year on year. There is quite a large component from business growth.
And then there's a couple of ins and outs from as we adopt to die for a 17th so theres a lot of things going through that business line, but the combination of interest rates and growth is really driving that driving the overall increase.
And again.
Just adding that.
The go forward you know we're at a good jumping off point and that'll continue to grow as our business grows as the balance sheet grows.
Got it thank you for that.
Thank you.
Next question is from them on a per shot some cormack securities. Please go ahead.
Yeah. Thanks, I wanted to turn to the the credit losses would it be fair to suggest that you're adequately reserved for both the electric utility bonds and private placement loans or could there be additional losses on these exposures moving forward and then can you provide some additional color on the nature of these private placement loans like what's the size of the portfolio of provisioning.
And against that and you know any additional color would be helpful.
Sure Omar Scott.
For the question. So yeah E. C. I was it was a bit higher this quarter than we would normally would expect and I'll just remind you that when we look at ACL, where we're now looking at gross credit losses under <unk> four we looked at credit losses versus expectations. So you should expect to see credit losses on an ongoing basis, that's sort of why we put it into core it doesn't net to zero.
Oh I'm. So you should expect some credit losses. This quarter. It was a bit high and you pointed out the primary reason was Hawaii electric and its and its subsidiaries and so that was about half of half of the increase and.
That was due to Hawaii electric getting downgraded significantly and so move to stage two a lifetime reserve.
And is that enough.
Our experience with senior utility bonds, but I don't think we've ever had a loss on senior to the bonds went through a fairly similar experience with Pacific gas and electric and ended up with a complete recovery you know after they land and they actually filed for bankruptcy because of the wildfires. So I think with so we feel good about.
With that said you can never be sure as to what happens here, but we feel pretty adequately provisioned at this point the rest of the provisions I would say are on a variety of different none of them are extremely large and are kind of more in the normal course, and I would say.
Hey, you know we tend to be conservative when we put up provisions or downgrade securities. So I feel very comfortable with where we have the ECL at this point.
Okay and these type of placement answer they were kind of related to this electric utility bonds like is that.
Are these like separate exposures no. These days would be separate there'd be a bunch of different bonds, you know across the portfolio.
Okay Fair and then my next question is it plausible that we could go through 2024 and 2025 with all the continuing to drag down our reported EPS. So we should kind of think of the starting point for reported EPS to be below core are plausible for it to be below core for an extended period a period of time.
And then of course, you layer everything in on everything else that impacts all of the rest of the macro factors and in and above that starting point for an all of the charge is that the right way to think about the gap between reported and core.
Looking hard for the next couple of years.
So I would suggest that you know it's hard to forecast the future of course and in the shorter your time period. The harder. It is we feel very confident in the long term that reported and core will be the same with our ALDA experience.
I guess I would be a little concern for the next quarter or two that we we see cap rates go up and continue to weigh on the real estate portfolio beyond that you know my my my hope and expectation unless we see you know.
Recession or something like that that we would get back to our long term returns.
Thanks, that's it for me.
Thank you.
The next question is from Darko <unk> from RBC capital markets. Please go ahead.
Hi, Good morning, just a couple of questions on Asia, maybe if you could provide a little bit of color I. Just wanted to just ask more of a modeling question actually.
The basis change that debt.
We ended up.
Creating a higher C. L. CSM amortization, maybe if you could provide a little color on that and is this a new higher level sustainable and similarly, I believe you had some pricing action, but I just want to make I just want to confirm that.
Yeah.
Okay. Darko. This is Phil Thank you for the questions I'll make a start and then hand over to Steve with respect to the basis change.
I think what you're getting at is the very strong contribution to core earnings Colin referenced this in his remarks, we've seen a 33% growth in core earnings in Asia in the course of that 13% sequentially and one component of the growth that was the impact of changes in actuarial methods and assumptions, but I think it's really important.
To put that into context that off the 33 percentage points of growth. It was about seven percentage points of growth that was coming from basis change items. The remainder of the growth was coming from commercial factors and I think what we see in the third quarter is a very good foundation, that's a project project.
From for the future and when you reflect on a year to date core earnings growth for Asia, that's being 10% and I do think there is upside to that 10% rate of growth from factors such as you know the opportunity for a stronger productivity and our agency channel as well as the.
Continued emergence of the M C D channel post pandemic.
There are of course always headwinds.
We've talked about the ongoing challenges that the industry has seen in Vietnam, we've seen new regulations coming from.
The regulator in China, which we expect to impact short term banking momentum, but overall I see I do feel positive about the sustainability not just a Q3, but also growth from there Steve did you want to touch on the basis change factors sure. Thanks, Phil.
And thanks Darko the what we're seeing in Asia from the assumption review I falls in that bucket that we called other methods and assumptions and what this primarily relates to is.
Under after a 17, we'd been refining some of our models and in particular the cost of guarantee calculation on power, which is a new requirement under I've run 17, so wed through the year. We are we actually changed how we manage the business in terms of how we are past experience back through dividends to customers. We updated the models we reflected higher.
Interest rates and that resulted in a net release of liabilities a large portion of which is coming through the C. S. M. So as Phil noted the basis change is impacting positively the Asia earnings through higher C. S M balance and a slightly faster amortization of C. S. N that was more mechanical as opposed to anything.
That we did on the amortization.
Okay net sorry, Steve just to follow up on that so the faster amortization of CSM is a.
It is a.
Permanent thing or is it just did it just effect this quarter.
I know that would be an ongoing run rate okay perfect. Thank you.
Thank you.
The next question is from Nigel D'souza from Larry Thompson.
Please go ahead.
Thank you good morning, I wanted to dig into the actuarial review this quarter and I noticed that when.
It sounds too.
Aerion experienced since the COVID-19 pandemic.
I believe was excluded from.
From the review and I'm, just trying to get a sense of how.
You determine which experienced since 2020 was an outlier versus what could be more.
Post COVID-19 experience and how that factored into the review of this quarter.
Thanks, Nigel it's Steve died so how we dealt with Covid and the review is I for long term insurance products, where we felt that that they experienced during COVID-19 was not indicative of long with long term trends would be we excluded that experience and that's <unk>.
Consistent with industry practice and that I'd, just point to a comment that I made on one of the earlier questions for instance in Canada at the <unk>.
Level COI lap study that we did we did not include the Covid experience there, but as I noted experience has already trended back towards the pre pandemic levels, where we did reflect more recent experience was on certain morbidity assumptions, where we believe that the the experienced more recently.
He is indicative of future trends and not actually strengthened reserves on an NAV the morbidity side in in.
Nam and was partially offset in Japan. So that's the approach that we took and as I noted it is concerned it's consistent with that industry standards as well.
Any comments on mortality.
That's it.
And morbidity, but any thoughts on the mortality experience.
Okay.
Yeah sure I and in so they review that we did in our U S life, we updated mortality.
Versus mortality and we saw that through the pandemic with higher claims in life insurance fully offset by gains in our long term care in annuities from from the mortality trends. So just a reminder, that we're well matched I'm not mortality overall.
Maybe a slight adverse or favorable change from pre COVID-19 trends any sensor.
But the net impact might have been Christy just to gauge what.
The sensitivity would be to somebody's COVID-19.
Yeah, you know.
As I noted the mortality trends, we've got good offsets the lapse experience is generally trending back towards pre pandemic levels. So you know I.
I am not going to quote a number we do provide some sensitivities in.
In the MD&A on our on our liability assumptions I and as you know we you know we regularly and routinely update based on emerging experience and our view of the future. So we will continue to do that and be transparent about what judgments that we're that we're making.
Okay. That's really helpful. Thank you.
Thank you.
The next question is some Mario Mendonca from TD Securities. Please go ahead. Good morning quickly first on wealth management.
Obviously.
Among other things focus on the operating leverage in that segment.
It's been improving its also been negative now for some time because expense growth has been so high.
It's not the top line the top line looks pretty solid so could you speak to what these expenses are and is there a period. When we would expect expense growth to return to something more sort of normal in the mid single digits.
Yeah. Thanks for the question merits Paul here, Yeah, just just on the overall margin just relative to last year. Just a couple of things that we mentioned on last quarter's call that or just impacting the year over year. One is just a reduction of repatriation of seed capital and some private assets that brought down the core earnings and then they step up acquisition of our.
Of our China JV Fund management also.
Had an impact overall on the margin year over year.
The third impact was expense growth as you noted coming out of Covid. We did see an increase in expense growth to support the growth of our business, but we recognize that you know in Q1 of this year.
And just looking at the uncertain market started taking actions than internally here and you've seen that come through the expense growth since Senate was down from Q2 to Q1 and Q3 was.
Pretty flat with Q2, what I will say is that.
Expense growth is a continued focus for us in the business that's something that we're looking at how do we get leverage out of the global franchise and more importantly, you've heard where I talk about our digital ambition and the investments, we're making there and we expect that to pay dividends for us. So we are expecting to have more muted expense growth for go forward for our business based on those efficiencies.
That we see and then just looking forward from a margin perspective, you know, we can't control markets, obviously and that drives a lot of our fee income, but if you look at some of the other metrics you know the top line. As you mentioned has been very strong five 3 billion year to date 12 or 13 years.
And then the other thing I'd say is our our net interest fee yield has also been pretty stable. So when we look at that our focus on expenses and net flows we feel very optimistic that we'll continue to improve this margin over time.
Yes.
Again, it's a different kind of question.
How much your economist you speak T. We would expect.
<unk> start to come down.
Overnight ratings are coming down say around April or may.
Question is how soon after.
Rates start to drop the short end of the curve or the lineup of soon after.
Do you actually start to report some gains on the ALDA.
The returns that are above your long term expectations does that is that a reasonable expectation as rates start to fall.
Okay.
Yes, Mario Thanks.
So it's not all about interest rates, but interest rates, obviously have been pressuring our returns this year and to the extent the fed does start to lower rates that will certainly be helpful and I think appraisers will actually.
Reflect that pretty quickly.
Or even based on sort of market expectations. So yes, I would think on the on the real estate side, you should see that sort of reversal of course theres. Other factors at play has the general economy doing and so forth that will also have an impact.
Operator, do you have any further question.
And the next question is from Tom Mackinnon from BMO capital markets. Please go ahead.
Yeah. Thanks, just a follow.
Follow up on all the all the discussions I mean, we've been focusing here talking a lot on cap rates, but obviously the return on the portfolio is not just the cap rates the growth and as to the dynamics of sort of commercial real estate or changing how.
What are your thoughts on that growth I mean, it hasn't been.
It's a different world post Covid here now in terms of commercial real estate. So.
How does that factor in just your comments with respect to that.
Yeah, So as I talked about earlier for a FERC commercial real estate cap rates plus growth to your point or what what drive the total returns and.
You know our portfolio is.
His office industrial multi family and.
I would say on the office side I would say growth could be challenged it's it's hard to say for sure. This return to office is still not played out but that's something we're keeping a watching brief on but our office has become a pretty small part of our all of the portfolio. The U S office is only 5% of the overall.
All of the portfolio at this point, whereas I think the other the other property types really have pretty good tailwind behind them and industrial we've seen a lot of growth there would expect that to continue.
And then on multifamily there's there's certainly a shortage of housing, which I think bodes well in the long run so I'm feeling pretty positive on the growth of two of the three.
Sectors that we have and for office I think the jury's still out Hey, Tom Roy here I might just also chime in and add that add real estate portfolio is actually quite.
Globally diverse as well a 38% is in the U S, 33% in Canada, and 29% in Asia and we've seen on the point of valuations Asia hold up actually quite well. So the diversity of the portfolio is also another factor that just needs to be in the back of People's minds.
Thanks.
Thank you.
There are no further questions registered at this time I'd like to turn the meeting back over to Mr. Calm.
Thank you operator will be available after the call. If there are any for impressions have a good day everyone.
Yeah.
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Being recorded Seth go say listen at least over history.
Yeah.