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Great-West Lifeco Inc
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Good morning, and welcome, to the Great-West Lifeco's Third Quarter 2018 Results Conference Call. I would now like to turn the call over to Mr. Paul Mahon, President and Chief Executive Officer of Great-West Lifeco. Please go ahead, Mr. Mahon.
Thank you, Valarie. Good morning, and welcome to Great-West Lifeco's Third Quarter 2018 Conference Call. With me on the call today are Garry MacNicholas, Executive Vice President and Chief Financial Officer; Jeff Macoun, President and Chief Operating Officer, Canada; Bob Reynolds, President and Chief Executive Officer of Great-West Lifeco, U.S.; and Arshil Jamal, President and Chief Operating Officer, Europe.You will note there has been a change in our senior leadership team. Two weeks ago, we announced Stefan Kristjanson's decision to retire at the end of this calendar year. Coincident with that communication, we announced the appointment of our Canadian Deputy COO, Jeff Macoun, to the role of Canadian President and Chief Operating Officer.I want to thank and publicly recognize Stefan for his significant contribution to Lifeco over a career spanning 28 plus years. For much of his career, he was instrumental in building our Canadian group business. He also played a leadership role in our successful Irish Life integration, and most recently, he led our Canadian operations and was an architect of the business transformation that is currently underway.And while Stefan will be missed, I'm excited to work with Jeff Macoun in his new role, leading our Canadian operations. Jeff has over 30 years of experience in both group and individual. And given his most recent Deputy COO role, he is well positioned to take the reins from Stefan.So before we start, I'll draw your attention to our cautionary notes regarding forward-looking information and non-IFRS financial measures on Slide 2. These cautionary notes will apply to today's discussion as well as to the presentation materials.I will provide an overview of Lifeco's third quarter results, including headlines from our Canadian, U.S. and European businesses. Garry will then take you through a more detailed financial review. And after our prepared remarks, we'll open the line up to your questions.So I'll take you Slide 4 now. The company delivered solid results in the third quarter. Adjusted net earnings were $745 million, up 28% from the prior year, which included a $175 million hurricane loss provision.Sales growth was strong, particularly in the U.K. where 4 bulk annuity deals were completed in the quarter. Expenses remained stable with recent quarters, but were higher than a below-trend level in the prior year, reflecting ongoing strategic investments, recent tuck-in acquisitions and business growth.Adjusted earnings in the quarter excluding restructuring costs of $56 million in Europe. The Canadian segment reported earnings of $315 million, up 6% year-over-year. Strategic investments continued with new digital labs focused on product and process improvements for individual and group customers.SimpleProtect, our new online application for term life insurance and the first product to come out of our labs went into pilot in August and the results have been impressive. The average time to complete and approve the application has improved dramatically from weeks to hours and in some cases just 20 minutes. Advisor feedback has been very positive and we're expanding the pilot more broadly.We also have a Group Life and Health lab underway, creating a self-service tool for plan members to enroll electronically. It is designed to eliminate the current paper-heavy process, essentially allowing members to enroll and activate their benefits on the very same day. Other labs are in progress and we will share details of those in future quarters.Moving to the U.S. Empower earnings were up sharply, reflecting continued momentum in the business and lower taxes. Although Putnam slipped back to a small loss, the recent positive trend of sale and net flows continues.Mutual fund net inflows of USD 1.7 billion were the highest since the second quarter of 2014, supported by strong short-duration fixed income flows and strong overall Putnam investment performance. 82% of fund assets have performance above the Lipper median on both a 1 and 5-year basis.In Europe, operating performance was solid across geographies, although earnings were negatively impacted by a couple of larger items in the U.K. The first was a $56 million impact of a restructuring charge related to the integration of Retirement Advantage acquired earlier this year and the closed block sale we announced last quarter.The second was a $55 million loss on retail property related exposures. Garry will provide further details on both items later in the presentation.Finally, the company maintained its strong capital position and financial flexibility and is well positioned to both invest in the business for organic growth and act on M&A opportunities that may arise.Our priority remains -- our priorities remain a synergistic acquisition in the U.S. asset management space to add skill at Putnam and continue to grow -- and continuing to grow our power as the market consolidates.Please turn to Slide 5 now. As noted, adjusted net earnings this quarter were $745 million, up 28% year-over-year and up 25% on a constant-currency basis. Excluding last year's hurricane losses, adjusted net earnings were down modestly. Net earnings of $689 million were up 19% year-over-year and included the $56 million U.K. restructuring charge noted earlier.Great-West Life's LICAT ratio increased to 134% at September 30, above the company's internal target range of 110% to 120%. Lifeco cash was $900 million at the end of the third quarter and is not included in the LICAT ratio.Moving to Slide 6. Total sales growth was strong for Lifeco, increasing 17% year-over-year or 12% in constant currency. Canadian sales were relatively flat compared to the prior year with higher individual insurance sales offset by lower group customer sales.U.S. sales were up 15% or 9% in constant currency. Sales at Putnam increased 30% with mutual funds sales up 64%. Empower sales declined 10% due to lower large planned sales in period. However the pipeline remains very strong across all segments. Large planned sales tend to be lumpy and can impact peer-to-peer comparisons up or down.Turning to Europe, sales increased 35% or 30% in constant currency, primarily due to higher U.K. bulk annuity sales noted earlier. These also tend to be lumpy but were a positive factor this period. Equity release mortgages, a product we acquired with the Retirement Advantage acquisition in January also contributed to the U.K.'s sales growth.Turning to Slide 7. Fee income for Lifeco increased 6% year-over-year or 3% in constant currency. Canada's fee income was up 3% primarily due to higher asset, average assets and higher other related income related to Financial Horizons Group, which we acquired part way through the third quarter last year. In the U.S. fee income was up 8% or 3% in constant currency, reflecting asset and participant growth at Empower. While investment management fees increased year-over-year at Putnam, overall fee income growth was impacted by a nonrecurring fee of USD 12 million in last year's results. In Europe fee income increased 7% or 4% in constant currency, driven by higher asset management fees in Germany as well as in Ireland related to the Invesco Ireland acquisition, which closed on August 1.Referring to Slide 8. Adjusted expenses, excluding restructuring charges increased 13% year-over-year or 10% in constant currency. I would note in the chart that the top of this -- at the top of the slide that Lifeco's adjusted expenses have remained stable for the past 4 quarters at around $1.2 billion as additional strategic investments are being funded in part by efficiency gains.In Canada, expenses were up 10%, reflecting the inclusion of Financial Horizons Group and ongoing strategic investments and compared to a below-trend quarter the prior year. We have achieved $180 million of pre-tax annualized expense reductions and are on track to reach our $200 million target by Q1 2019.In the U.S., adjusted expenses were up 13% or 8% in constant currency due to business growth and IT initiatives at Empower partly offset by cost efficiencies. Year-over-year growth was also impacted by a onetime expense credit of USD 15 million in the prior year's result.In Europe, adjusted expenses increased 15% or 11% in constant currency, mainly due to the recent tuck-in acquisitions including Retirement Advantage, which we acquired in January and Invesco Ireland, which we acquired in August -- on August 1.I'm now going to turn the call over to, Garry. Garry?
Thank you, Paul. Starting with Slide 10. Adjusted net earnings in the quarter were $745 million or $0.75 per share, an increase of 28% year-over-year.In Canada, adjusted earnings increased 6% with favorable morbidity resulting group customer, higher base exchanges in individual customer, partly offset by lower investment gain. In the U.S., adjusted earnings were up 3% but down 2% in constant currency. Empower results were strong with earnings of USD 44 million compared to USD 31 million last year. While we continue to benefit from the lower corporate tax rate, earnings growth in U.S. was impacted by onetime items in the prior year that did not repeat though these items added USD 21 million to last year's earnings.Europe's adjusted earnings were up 72%, 66% in constant currency with last year's third quarter results, including a $175 million of hurricane related reinsurance loss. This quarter's adjusted earnings reflect the positive impact of longevity assumption changes, partially offset by investment losses related to the U.K. retail sector.Please turn to Slide 11 where we expand on this and add more color to the Europe results. There are 2 larger items that negatively impacted earnings in Europe in the quarter. We called those specifically and both items were in the U.K. We noted earlier the $56 million impact of the restructuring charge equivalent to about GBP 39 million pretax related to the integration of Retirement Advantage and the closed block sale.Charge includes the cost of systems decommissioning and migrating policies to the Retirement Advantage system, employee severance payments and other business transfer costs. We expect to realize annual run rate cost savings of GBP 20 million pretax by the end of 2020 related to transformation issues in our U.K. business. We expect these savings to be more back-ended giving the court approval process in the U.K.At the same time, we intend to make further investments in our U.K. retirement platform and product line up that will add some expense during the period. Europe's results also included losses of $55 million related to our U.K. retail and mortgage and property investments associated with 4 high street retailers. This reflects the challenges facing malls and department stores as online shopping continues to grow.I would note that our U.K. high street retail exposure is modest, standing at 0.4% of invested assets. With the March 2019 Brexit date looming and the outcome of negotiations between Britain and the EU still uncertain, I'd like to comment on our thinking around Brexit as it relates to our business.First, a reminder that we are domestic player in the U.K. and we do not pass port into Europe from the U.K. but rather do so from Ireland. Underlying fundamentals remain strong in our U.K. business as evidenced by the large bulk annuity deals completed in the quarter and the impacts from Brexit to date have largely been limited to currency movement.Our U.K. investment portfolio remains well positioned and we have added 3 slides in the appendix of our presentation by an additional disclosure around our U.K. property related[Audio Gap]exposure, expanding on our Brexit related disclosure from last year.Please turn to Slide 12. This table shows the segment and total Lifeco results from a source of earnings perspective. As a reminder, the source of earnings categories above the line are shown pretax. Third quarter results reflect healthy expected profit growth and a good contribution from management actions and changes in assumptions, partly offset by experienced losses in the quarter.Bank deposit increased 8% or $56 million, driven by business growth, increased margins in Group Life and Health in Canada and currency movement[Audio Gap]this quarter reflected gains on both annuity sales in the U.K. while last year included gains on longevity sales in reinsurance. Experience loss is up $32 million, included 64 million. And again, this is pretax, 64 million of investment losses related to 4 U.K. retailers as discussed on the previous slide. Insurance experience was probably neutral. Trading gains were lower than historical averages this quarter with a focus in Europe on sourcing assets for the significant bulk annuity sales.The benefit of that activity this quarter appears in new business gain. Management actions and changes in assumptions contributed $245 million, primarily due to update to the U.K. annuitant longevity assumptions as well as mortality and economic assumptions, partially offset by strengthening of policyholder behavior assumptions.Earnings on surplus of $1 million improved from Q3 2017, and recall last quarter included the large positive impact of a refinancing in the U.S. segment. In total, adjusted net earnings before tax of $922 million were up 29% year-over-year. The effective tax rate on shareholder earnings of 15% compares to 13% in third quarter last year.Turning to Slide 13. Lifeco's uncommitted cash position remains strong at $900 million. And this is not included in the Great-West Life LICAT ratio, but would be equivalent to about 4% on the ratio. Our book value per share was $21.25, up 7% year-over-year, driven primarily by higher retained earnings. As a reminder, return on equity is based on rolling 4 quarters. Adjusted return on equity was 14.7% in the third quarter and we continue to target a long-term ROE of[Audio Gap]Reported ROE of 12.8% reflects the U.K. restructuring charges as well as the charge for U.S. tax reform and a net charge on the disposal of this asset management investment in Q4 last year.Turning to Slide 14. Assets under administration were $1.4 trillion, up $147 billion or 11% year-over-year, driven by market performance and overall business[Audio Gap]That concludes my formal remarks. Back to you, Paul.
Thank you, Garry. All in all, it was a solid quarter marked by strong progress in sales and revenues. So with that Valerie we will now open the line for analyst questions.
[Operator Instructions] Our first question is from Steve Theriault with Eight Capital.
Few items for me, maybe starting in Canada. You talked about expenses here most of the way through $200 million of expense save target. I would have thought we'd start to see that more lifting expected profit but when I look back to last year expected profit has been pretty unchanged[Audio Gap]So why is that? Is it simply that it's offset by other investment spend? Or it is mechanically running through the SoE [indiscernible].
I'm going to let -- it's Paul speaking. And by the way, I'm going to ask analyst to direct questions to me and then I'll direct traffic. So Steve, I'll let Garry go to the mechanics. But if you look at the dynamics, we had an unusually low quarter a year ago. And if you look at Canadian expenses, they've been a bit steady over last 3 to 4 quarters, and we're expecting to see that expense moderate. So you will start to see some of those benefits begin to follow through. But Garry, maybe you can speak to the mechanics of where the expense would flow through.
Sure. There are -- there's a number of [ spot ] expenses to impact this. Some will be in impact to do business because there will be sales related expenses and distribution related expenses. Others will have an impact on the expected profit. I would also note that in Canada the expected profit was up 6% year-over-year and that will be from a variety of factors, but that would factor in. And again, the -- so will depend on the nature of the expenses story that show up.
Yes, but see just to reiterate, we have seen elevated investment, we've talked about those. Those investments are to drive both differentiation in top-line growth but also efficiencies. And when we refer to, for example, that new life insurance new business, as we move from multi-day paper-based process to automated process then your take-up rate occurs, we're going to start to see those benefit follow through. So that is really what our core target is, to see those expense -- that expense growth begin to moderate. And we look to that in future quarters.
Okay. Thanks for that. And then just to follow up on the U.K. retail mortgage issue. And I may have missed this to some extent in Garry's comments, but -- and - and I hear you that its 0.4% of investment asset, but it's still about -- looks like about an $800 million book. So maybe you could talk a little bit about how much concern there is that these types of $50 million hits could persist or get worse? What's the go-forward look there?
Yes. So I'm going to start out, Steve, by just sort of outlining, reiterating that what we're talking about here is what -- in the U.K. retail, U.K. high-street retail. So we're talking department stores. You've seen what happen with Sears obviously in the U.S, and this is similar actions that are happening where some sort of margin -- department stores are struggling under the weight of internet retail being a strong competitor, and that's really where those actions were taken related to a few of those. But I'm going to let Arshil to talk little bit more to that. And Arshil, you may want to turn it on to Raman if there’s further questions.
Just to give you a little bit of color on the in-quarter impact. They were related to some high-profile insolvencies that occurred in period. So we had some downgrades on the mortgage portfolio where the underlying tenant is not into administration. And we also had reductions in cash flows on our investment property, again where the key tenant has shortened through a court process through lease term and reduced the rents that they were paying on the properties that we own. I just wanted to take you a little bit to Page 26 in our supplemental disclosure where we have laid out the retail exposure for both mortgages and investment properties. And we see in our portfolios particular strength on the warehouse distribution side because that portion of the portfolio supports not just the high-speed retailers but also all the distribution requirements of internet retailers. So that segment has performed particularly strongly and we've seen previous quarter's uplifts in our portfolio and investment positive contribution. And the grocery segment has been very defensive and held up quite well and in fact in the most recent period the inflation flow through to grocery prices, so that segment has held up pretty well. So the majority of the damage we saw this quarter was related to particular insolvencies. So absent other insolvencies in the future, and we're not making any predictions, we feel sort of cautiously optimistic that we're appropriately provisioned and that the portfolio is bound and with particular strength in the warehouse distribution end.
Okay that's excellent. And then maybe last thing from me on Canada. Individual insurance sales in Canada up really nicely. It looks like this is largely driven by par. So can you talk a bit about what is driving your par business? So we're well aware that one of your large competitors has re-entered that market? Are you intern being more aggressive as there is something meaningful going on there?
Yes, so I am going to let Jeff Macoun go to that. But I would note this, over the last year there has been a real deafening of sales as we came out of the tax changes that impacted our overall participating, well cash-only relationships in Canada and those occurred through '17 -- pardon me, at the end of '16 and sort of they flat into '17 as well. So we had a lot of, I'd call it almost like market dislocation. We're seeing a lot of that dislocation passing. Now it is a question of how competitive and how active are you in the market. Jeff, do you want to make couple of comments on that?
Yes, thanks, Paul. I would just add a couple of comments that you are correct, Steve, we saw an increase of about 30% ahead of the prior year and 20% the prior quarter. Within that quarter, we did see a couple of larger sales come through in quarter. And we have seen a renewed focus from our end on with our work with the wholesalers and some minor changes we have made in product in the marketplace.
But Steve, I would just reiterate the fact that with this focused activity and -- we recognized that the market would soften out a bit and that it would start to come back and we see this coming back. And we are an important -- we are really important participant distributors in Canada and then somewhere we have our place at the table.
Our next question is from Gabriel Dechaine with National Bank.
And if I understood Arshil correctly, these losses in the U.K. retail portfolio were in the mortgages not investment properties, is that correct?
I'll turn that. it's actually a mix of 2. And Arshil, you want to?
Yes, on mortgage side we increased asset default, asset default provisions as the loan-to-value ratios have deteriorated and the tenant covenant quality has deteriorated, but the bigger impact was in the investment properties where we reduced the cash flows as the lease term as a number of retailers have gone into insolvency, lease terms through the court process have been amended. So we're now sitting on lower rent levels with shorter leases and we are working with new owners to work through or go through go-forward strategy. But at present, we're reflecting a lower level of rent and a lower lease term.
Yes. And Gabriel, that would be our typical approach. We take a conservative view to what -- here is where we are at current state, so we take a current -- a conservative view to current cash flows and we're obviously working hard to repurpose or get different tenants in place. So those opportunities will come and then will be reflected in future results.
Yes, I don’t want to make a huge deal about this, like a $60 million portfolio, but -- and you touched upon that. I am just wondering what -- are these short lease terms, meaning you can get a new tenant in there fairly like within a couple of years? Where are these properties located? Is it somewhere desirable[Audio Gap]new tenants because some big difference there within a strip mall in Birmingham and Central London.
I'll let Arshil. I mean, [indiscernible] I would encourage you to connect with our Investor Relations team to get detailed insights. But Arshil, maybe you can provide a bit of context.
Yes. We're generally comfortable with the location of our properties. They are in thriving towns, centers, near rail facilities and good public transport and other amenities. But I would caution that there is more retail space in the market with all of the other insolvencies, it's not a straight-forward task to get another retailer to come in. And in some of the properties we are going to have to work to repurpose some of the floors. So you are seeing in number of other markets parts of department stores getting converted into hotel or office usage or even shared office usage. So it's really those kinds of things that we have to do. So we're comfortable with the location that we have. But there isn't a 30-day, 90-day find another retailer, sign another long lease option available. This will take a little bit time to work through. And as Paul indicated, we have taken sort of a cautious view in terms of the cash flow to reflect the current situation. But we are optimistic on the underlying positioning of the portfolio.
And then I think this other U.K. trend that might be overshadowed here is you were able to offset those losses through some mortality reserve releases or I guess longevity reserve releases. That's a trend like we are seeing in a few western nations there where mortality rates are not improving anymore or as much as they used to. I want to try to get a sense for how much more conservatism there is in your longevity reserves in the U.K specifically given your payout annuity[Audio Gap]business benefits from declining mortality improvement.
Yes. So -- I think you said specifically and I don’t think we'll go there exactly. But as a general theme that we take a conservative approach as we setup liabilities on the balance sheet. We have a very, what I would say is a well-seasoned book of business. It's not scaled but it has been built over a long period of time. It was built over a long period of time with the same disciplines around underwriting but also around reserving. And so what we're seeing here is the impact of this. Garry, what other color can you provide to that?
Well, we certainly reflect both our own experience studies which we [ rebound ] this year as part of our thorough annual review. And then we've reflected latest industry studies. We are mindful to not get ahead of the trend. And so while we don’t see evidence at this stage of the trend turning around, we make sure we take a cautious view and not to get ahead of ourselves there. So we will see how it unfolds in the coming years. But we feel well positioned.
Yes, Gabriel, we don't want to get in a situation where we're getting aggressive recognizing a slowdown in results and then have some sort of a backlash. So we tend to take -- we take a conservative and cautious approach.
Great. And last one is on the Canadian group business. I just, reading the language around, group morbidity experience was strong this quarter yet your group, and I know that is in group insurance but also group pensions, earnings was down year-over-year. Can you give me a sense of scale of the morbidity improvement and then what offset that?
I am going to actually[Audio Gap]think to your point while Garry gets ready to respond to that. When we talk about group we're obviously talking about a broad business there that includes the lights -- the life -- the benefit side, the life and health side and obviously the group pension side as well. And so you've got lots of moving parts. The morbidity one we highlight because you will recall over the last couple of years it's been challenging for us. And that is one of the toughest ones to move in the change. On your health and dental benefit margins, those can -- you can sort of manage from period to period. But I think on the -- we highlight the disability because it's an area where we worked hard to get it into a healthy place and we see strong -- we see a real stability there. Garry, what would you add to that?
Yes, just a comment that we're -- in terms of morbidity experience in the -- in experienced gains and losses, it was just under $10 million, so there was a good contribution there. And now the gain is a positive sign given the trend a couple of years ago. And then, the overall earnings are down. That was more where the [indiscernible] the training, investment training activity was allocated. More of that went to the individual customer business this year on the group customer side. So that would have affected the group customer earnings just on a comparative basis.
Our next question is from Sumit Malhotra with Scotiabank.
Paul, I'm going to start with this U.K. real estate exposure as well. In the MD&A you gave us a bit more detail, you specifically call out the fact that there were 4 properties that experience financial difficulties. Just curious since you provided the number there. How many aggregate properties are there? And then maybe more mechanically, what's the trigger point that is required to be reached in order for you to start to take provisions against these portfolios? Is it the first default on the part or the first missed payment on the part of one of your borrowers? Is it an official filing that has to take place? Just wondering because it didn't look like in previous quarters there was any signs that -- and again, this was said earlier, I don't want to overstate this, but we didn't see anything that led us to believe that this was eminent previously.
Yes, so I'll let Arshil provide a little bit more context, but I'll start up with higher level. So we monitor properties there, and they're always -- they're moving in and out in terms of very healthy, maybe a little bit less healthy based on economic conditions and we always have properties anywhere in the portfolio that might be on watch or mortgages that might be on watch.
We rate our mortgages.
Yes, and we rate the mortgages. And I want to say that if you think about these 4, I mean there is pools of assets, large retailers with multiple locations, some of those locations performing very strongly, some that are easily repurposed, then others where you have greater concerns because of the challenge they would face. So the context is we're talking about 4 properties amongst many, many, many properties. I can't give you what the number is. But Arshil, maybe you can give a little context as to the methodology.
We can follow-up through Investor Relations to give you the exact number of underlying properties in the portfolio. I don't have that immediately at hand. The triggers in order were really the insolvency of the House of Fraser and a significant deterioration in the performance of [indiscernible]. So while we are constantly reviewing our portfolio, we do rely on the contractual rents that we've entered into with various retailers, and with the House of Fraser when they went into administration, the new purchaser took over running those stores and significantly reduced rents with a significant reduction in term and that went through a court process. So really that was the trigger in the quarter. So absent other high-profile insolvencies that impact our portfolio you’d see a more gradual reduction as we reflect financial underlying strength of that covenant. So it is a regular process. And a year ago we would have had a modest negative impact from British home stores that went into insolvency. So this is a regular part of that portfolio. And we also in this period had some offsetting gains, much more modest in the warehouse sector. So this is a continuous process where we're updating the ratings around the mortgages and updating the asset default provision and then updating the cash flows on the investor property side.
Yes. And Sumit, I would also add that we don't tend to sit from quarter to quarter waiting to see what happens. We're constantly looking at the overall mortgage and property book. And we're thinking about whether we want to proactively repurpose, whether we want to think about shifting. And Arshil made reference to the warehouse sector, that's been something that we've got very proactive on because that is, as we talk about Internet and retail, the warehouse sector is so fundamental to that, and that's been a large part of our focus. So the work would look quite different today than it would 5 years ago. So this was a constant activity as we try and manage the portfolio backing our liabilities.
And thank you for all that first of all. That's a good detailed review. And maybe the last part for me. Obviously we're talking about the U.K. specifically here, Paul, but you said off the top, you mentioned Sears and you mentioned the greater proportion of online retail. What about in other geographies, and I guess in your case specifically in Canada, what would be -- so you've given us a number here of about 0.5% is the total of invested assets that are in U.K. shopping centers and department stores. If we extend that to Canada, I don't think the U.S. is involved for you, but if we extend to other geographies, what would be the aggregate proportion? And are you seeing, since you're not waiting to -- for problems to occur, are you seeing any early signs of stress?
Yes. And so Sumit, I will direct you to the -- to Investor Relations area for more detail. I am going to turn it over to Raman Srivastava who is our global CIO. But we're active on monitoring retail across all of our book. So whether it's in Europe, Canada or U.S., and we're active on managing those books to move into -- a theme we've had would be shift to warehouse and shift to necessities. So in other words, you want malls where there is things like -- where there is drugstores and there's banks and there's liquor stores and those things, which stand up really, really well. And high-end fashions stands up very, very well and we like that. But when you're looking at other generic strip malls or lower-end malls, we really tend to move ourselves from out of those. So it's the constant management of the book to get yourself well positioned for where the puck is going. It's the way we think about it. But Raman, is there any additional insight you can provide now, recognizing that we can always have Investor Relations providing a little more of the detailed insight?
Sure. We can follow up with the detail. I guess, Sumit, I'll just add a couple of things. So we have obviously retail exposure across all geographies. I'd say I bucked into 3 main types. One is bonds. And I think, as you know, our book of fixed income securities is very high quality, 99% investment grade rated, and we're fairly comfortable with our exposure there. On the property side, it does tend to be dominated more by Europe as opposed to Canada or the U.S. We do have some in Canada but it's mostly exposure as we've talked about, is already is -- is through Europe. And then same goes on the mortgage side. We have exposures across all the regions, but again I'd echo the same comments in terms of fairly high quality. I guess the last point I'd raised which we haven't touched on yet, if you just go back to the supplemental slide Page 26. And it's a good indication of how we run this because not only have we made the shift more towards distribution but if you look at the retail space there, there's more exposure towards mortgages than properties. And if you look at our retail mortgage book, it's running at about 50% LTV. So I would characterize this quarter as idiosyncratic, there was 2 specific companies that had issues this quarter. Arshil mentioned one from last year. I think this is more of idiosyncratic issue than a systematic or thematic issue.
Okay. That's helpful. Obviously, it's been a long time since we've seen even a hint of any credit issue. So I think we're all very mindful when something pops up. So I appreciate the additional disclosure. And I'll follow-up with your drafter.
Our next question is from Scott Chan with Canaccord.
Just on U.S. Putnam, another strong result in a very tough environment. When I look at the mutual fund sales up 64% year-over-year, you talked about short-term fixed duration. Is there anything else that helps that incremental gross sales increase? And I'm trying to get -- a lot of it is coming from equities as well. Obviously since October we've seen a steep decline. So just a bit more color on the -- on maybe an asset class break, that would be helpful.
Yes, so I'll talk more generally and then I'll let Bob add some color to that. So as you know, if you look back over the last 4 to 5 years what we've seen is frankly all classes were in outflows, both -- all class of active management were in outflow. So we've had both fixed income and equity. What we've seen more recently would be a stronger fixed shift from some of the passive fixed income to active fixed income. And we think that will also happen on the equity side before too long. But the reality is we've been able to benefit from the general theme to active fixed income seeing positive flows. And we've actually been one of the stronger flowing companies. We've also seen some benefits notwithstanding a few equity funds that have been in strong growth was a couple of couple. We've also seen some waning of equity outflows and some strengthening there. But at the same time, the majority of the contribution here would be across the fixed income book. A lot of it in the shorter duration but even into medium duration. So I'll let Bob speak to sort of what you see is going on in the market right now. Bob?
Thank you, Paul. Yes, just to add on. In the industry itself there have been active fixed income flows. Active equity across the industry has been inn outflows. At Putnam we've had excellent performance across the board in all asset categories which has helped. And if you look at our top-flowing funds 3 are fixed income and 2 are equity. So we're seeing good across-the-board flow, but predominantly from the fixed income sector.
Okay, great. And then maybe just lastly, Paul, just on a consolidated basis expected profit was up 8% year-over-year this quarter. Now it looks like 2018 could close out at 10%. Is 8% to 10% sustainable heading into 2019?
Yes, that’s a good question. And obviously the core question is your underlying business and how are you going the business from what's happening with your revenues and your mix business. And I'm not going to make predictions to a particular percentage point. But we do like the momentum. We talk about whether its pipelines on Empower, whether it's Power book on the life insurance side whether it's group. We've been leading the market in group sales in Canada as well. So those are the things that are going to have -- drive that growth. But Garry, do you want to speak to -- anything else you'd add to that.
No, I think you did – really, the expected profit will come down to the business growth.
Our next question is from [ Tom Tannion ] with [ HMA Capital ].
Just wanted to start with Canada and just go back to the expense comments you made. Paul. And it sounds like you're expecting the expense growth to moderate, but I am open to get a just a bit of finer point on it because -- and maybe you can correct me if I'm wrong, if I adjust the expenses for the cost savings and for a financial horizon, I think the Canadian expenses it looks like it was up 13% to 14%, but maybe you can tell me if I'm in the ballpark. And you've talked a bit about your investments. What should the Canadian expenses grow by? Is this more in a 3% -- 5% range? Can you give us a little bit more detail on that?
Yes, so let me provide some context. So we've been [Audio Gap]in part. We -- I would characterize the year-over-year expense growth here as impacted by an unusually low quarter a year ago. So if I normalize for that, we were not under 13%, we're probably in the high-single digits. That high-single digits is really driven by three factors, an underlying discipline around our businesses as usual expenses that we've always had and we continue to have. But a focused investment on things that are going to drive real value creation. And value creation could be launching new capabilities that are going derive revenues that we're not capturing today. But the other part which is core is things that are going to improve customer outcomes in terms of faster turnaround, for instance, on life underwriting or group benefit setup, and those things have the double benefit of we end up with potential revenue uptick because we're ending up with a better mouse trap in terms of we're going to have a more competitive offering. But those things naturally will drive out productivity improvement because you're not handling paper. And that's where our core investments are. So I see 2 things happening. Number one, we ended up with an elevated level of expense in these labs and we're going to continue on with these labs. But these labs are -- we're not going to do considerably more of them, so it's like we're sort of at -- we're at this run rate of driving these labs forward. So I don't see adding a lot of increment with that. But I see us continuing to try and drive out high payback initiatives that are going to drive value in the business. So 10% year-over-year I think was -- is a bit of an overstatement relative to norm. I think you'll see it start to moderate more into that 5% range. And over time, as these things take hold, it'll come down below that. Well -- what we're really trying to do is get to a 3% or 4% expense growth, which would be reflective of a healthy growing business. That said, if we start to really drive the top line, which is our long-term goal, the next [ presses ] are going to tend to follow that to some extent. You get scaled benefits, but obviously expenses are going to be driven by how quick you're growing. So moderating back from the -- a bit elevated on a year-over-year basis right now but moderating back from -- moderating back from 10% or high-single digit into that 5% and ultimately we're targeting down below 5% into that 3% to 4%.
Perfect. I appreciate the color. The second, just on credit overall for the company, I think it hit earnings, the downgrades and the impairments hit above 31 million. The U.K. credit items hit earnings by 38 million. So I mean if we exclude the U.K. it looks like credit was a modest positive. I just want to make sure I'm kind of -- I've got that right. And maybe can you talk a bit about what you're see from a credit prospect because it's like outside of what you talked about with this particular idiosyncratic items in the U.K., it seems like it's pretty good.
Yes, so Garry, perhaps you can comment on whether the approximation of the 31 million versus the 38 million. But I think I would let maybe, for a moment I'll let Raman speak to his views on the credit market right now, because we've got -- as you outlined, we view that as idiosyncratic. We've got a strong diversified book. And we're actually -- notwithstanding there is a degree of buy and hold as you're thinking about long-term assets, long-term liabilities, we actively manage these credits. You have to actively manage them given what you see going on in the market and see what's going on with various cycles. So Garry, anything on before we turn it to Raman.
Yes, we do -- we did comment on the credit market impact in the MD&A. And again, it's -- like many of the prior quarters, just it was a very modest number, I think it was a negative $3 million -- I think it was compared to negative 1 last year. So [indiscernible] material on that and then we did call out that we had the change in our internal ratings on our mortgages that impacted. So I think other credit was actually slightly positive in the quarter but that was at the smaller impairments and then slightly positive credit moods in the other areas.
Yes, so Raman, anything else you'd add, perspectives on the credit market?
Sure Paul, so I'd say couple of things, so obviously been an extremely strong credit market post financial crises with only occasional belts of volatility. Even in October where you saw a very large sell-off in equities and in certain parts of the high-yield bond market investment grade spreads remain relatively stable. Now that's not to say that we expect this to continue for the foreseeable future, some point obviously the credit cycle will turn. And if you think about our book, we weren't impacted as much from the broader high-yield sell-off because 99% of our fixed income is investment grade. So our, as Paul mentioned, we have a history here at the company of very strong underwriting and credit being a huge focus. If you look at our portfolio, it's very highly rated with very little in low investment grade, very little in more risky parts of the credit market. So we feel very comfortable, although there always will be some idiosyncratic issues that pop up because we are taking risk. Overall, the book is fairly strong, and we think as the market turns and the cycle turns, we don't think we're there yet. But as we get into that cycle turning we should be able to hold up firm and look for opportunities to redeploy.
Okay. And then just lastly, Arshil, if I look at -- you obviously had very strong bulk annuity sales in the quarter that came through in the new business gain side. But if I look at -- back at the restructuring charge and the credit item and just last year for the CAT item. It looks like earnings were essentially flatter or down[Audio Gap]So I'm just not sure if that was a real tough comp last year? Or if there is other items that are, you can unpack there to kind of just give some color?
I'm going to turn that one to Garry first and then Arshil can add a little bit of color.
Yes, just loading on the comparison, you're right, we didn't have strong new business gain on the bulk annuities. But last year, interestingly, it was almost the exact same amount. We had a strong new business gain on a reinsurance transaction. And so the company is happy. So you're not getting that comp pickup on the new business gain year-over-year, it's about the same amount for those two sets of transactions. And then the other thing I noticed I commented on briefly is because we are obviously focused on sourcing the appropriate spread assets after our bulk annuities and we're well long enough, but we're working on that. We were not -- we were not able to do, use as the assets for trading gains on the in-force portfolio. So really wanted to focus on new business gains and we didn't see the trading gains on the in-force that we might have historically seen a bit more of.
Arshil, anything you'd add to that?
The only additional comment I'd make is, a lot of the focus and the discussion so far has been on the U.K. results. But in the Europe currencies, Ireland and Germany, we saw strong year-over-year growth in earnings. So that was a particular standout. As Garry indicated, in the U.K. it was a tough period for us with those investment losses this year and the lack of yield enhancement because we're focused on getting asset origination for new business. But for the Irish and German business this quarter was a very strong performance and strong year-over-year growth.
Yes. And I would just that part of the issue here is the bulk annuities are -- it's a lumpy business. And we've been active in this since last year. And all the opportunities kind of came in the same period. And while you are sourcing assets all the time you tend to do that at a study rate. These opportunities come along and we joke a little bit that it's like you're waiting for a business and then 3 busses show up at the same time. So you take advantage of that and we have.
Our next question is from Paul Holden with CIBC.
So just want to follow up on the conversation regarding operating expenses, and not necessarily particular to Canada but to the business overall because we have a lot of moving parts here, right, acquisitions, expense, efficiency, initiatives, et cetera. So how do you measure, how should we measure your progress on expense efficiency? Like is there a metric we can use based on your public financials to track the progress over time.
Yes, it's a good question, I mean obviously one would go to is there sort of an operating expense efficiency ratio that would work. And the challenge we've got is we've got very diverse businesses. Some of them are long tail liability businesses, lot of them are more cash businesses. So I think a measure, sort of a macro measure like that could be quite misleading. And the other reality is you would look at the relative maturity businesses. So in a Canadian business we can start to get at things like efficiency ratios and do those things because we are in a very organic growth mode. If you go to a business like Empower where we've got high growth going on, we're looking to do M&A, so that will be scaling that up. If you go to the U.K. and we've been in 2 transactions in the last year, we have done -- or in Europe 2 transactions in the last year. So it's tough to get a macro measure that you could look at. I think you have to look at the underlying dynamics of each of the businesses. Garry, is there anything you would add?
No, I think you described well. I think I'd reiterate what you mentioned earlier, that we have seen a leveling off and that Q3 2017 was actually a below trend number. If you look back, you can see Q4 '16, Q1 '17 were in and around that same $1.2 billion level. So we are seeing the benefits of some these moves we've made to increase efficiencies. But it's -- that when you look at across the whole[Audio Gap]each business is moving quite a bit in there because we've added some businesses and subtracted others.
Yes. And Paul, perhaps for context if you think about Empower, so you look at their -- what is happening with their expense growth, well we're seeing high -- fairly high growth in revenues, we're winning organically in the market. We plan to win inorganically in the market. We’re investing in automation. That automation causes [indiscernible] investment and expenses, that is building a better mouse trap. So we're going to be stronger on the revenue growth. And overall, our cost for participant is coming down in that business. So it's hard, you really have to get into each of the unique businesses to understand and we'll do our best to try and give you insights into those businesses. I wouldn't be inclined to try and give you a gross efficiency number because I think it would be misleading.
Got it, okay. One sort of smaller housekeeping type question on the reinsurance business. We typically don't see an income tax expense, but there was call it roughly a 10% effective tax rate this quarter. Has anything structurally changed there? Is that just kind of more of a one-off?
That is one that I will turn to Garry given he is the CFO and used to reinsurance.
Sure. The -- I think the main thing that would drive the reinsurance tax rate is really the jurisdiction in which the profits happen to rise in the period. So we have offices in Ireland, got business where we are[Audio Gap]entities in Ireland, in the U.S. and in Barbados. So the mix of earning emergence really depends [indiscernible] tax rate, which is nothing particularly unusual in the period.
Okay, so it has nothing to do with changes in U.S. tax structure or anything like that?
No.
[Operator instructions] Our next question is from Tom MacKinnon with BMO Capital.
I have some questions with respect to the changes you are doing to your U.K. retirement platform. Maybe first of all you can discuss the mix of the $3.3 billion bails you got in the U.K. and Isle of Man as it relates to bulk annuities and equity release mortgages? And what are you looking at that mix moving to as you revamp this retirement platform? And then, how does that impact your ability to get yield enhancements on this portfolio going forward? And then finally, if you could tell us what percentage of your earnings come from U.K. retirement?
Okay. I will start off maybe at a high level, Tom, and then I'm going to turn it to Arshil. If you think about that business, the business is evolving with the changes to pension, the pension requirement that went on where people are no longer compelled to acquire tailed annuities when they decide to shift from accumulation to decumilation. You see the market evolving. And the dynamics of that market would be individuals will look to a mix of different vehicles to fund their retirement. So that will be tailed annuities, could be a draw-down product like a RRIF in Canada or an IRA in the U.S. And then things like equity release which is a critically important product when you think about property as a major part of U.K. population's investment profile. So they are looking, how can they use their property as a vehicle. And there is tax advantages. So you got that dynamic. You also have the dynamic of a -- a rising interest rate environment with significant DB liabilities that companies are looking to move away from and off load. So that is fueling a bulk market that features quite strongly we see for many years to come. So we kind of see 2 dynamics there, the bulk opportunity which is would be fueling things like our yield enhancements but then you're also going to have the other opportunity where you see a bit of a shift away from fewer tailed to this mix of solutions. So Arshil, perhaps you can provide a bit of color on that.
So you're asking specifically about the $3.2 billion of U.K. sale that I am going to convert it over into Sterling, so that $3.2 billion, $3.3 billion that you quoted GBP 1.9 billion. And of that, close to GBP 1.5 billion is tailed annuities both bulk and retail. So we're still active in the retail market and that contributed to sales in the period. We also have our Isle of Man offshore and onshore investment bond business. And that contributed on the order of GBP 300 million of earnings. And then as Paul indicated, through retirement advantage we have our retirement account, that's a more flexible product where you can drop income over time and equity release mortgages that were originating, and that was over GBP 100 million. So that is sort of a rough breakdown of -- there is also small amounts of retirement solution sales on the Canada life side and small amount of group insurance sales around the group insurance side. It's more ongoing revenue premium. That's the key metric for us.
What are you doing in order to make changes to this product lineup? Which one of these should we see a more -- a bigger increase in going forward?
As Paul indicated, the key dynamic, we want to be continue to be active on the retail annuity side but in the broader retirement market more of the flows are going into draw down products sort of [indiscernible] like products. So the focus there is to try to make sure that our tailed annuity remains relevant and that we capture flows and that capital-light draw down retirement as well as increasing the amount of origination that we do on equity release mortgages. So we are expecting significant -- we are trying to drive a broken equity release and draw down products and we want to see recovery on the retail annuity side as the -- as the population ages. So I think you will see reasonable growth in all, but outsized growth we hope in equity release and in draw down products.
Tom, the one other -- it is Paul. The one other dynamic I would call to on the tailed annuity side is that we've been in a low-interest environment. So tailed annuities did not show well in a low-interest environment. As interest rates are rising, I think the tailed annuity product itself will begin to complete more favorably with draw down. So the individual who is kind of thinking about flexibility versus maximizing income, maximizing the certainty of income, probably tailed annuity we think we will begin to get better traction than over the last couple of years. But we actually think [ it will develop ]. This will not be going back to the tailed annuity market we saw, it will be diversified. And we're investing strategically, and that's why we did retirement advantage, we're again trying to look at where is this market going and how can we be a winner in the retirement income market place.
Okay, thanks. And then just as a quick follow up with respect to the U.K. annuitant mortality. In the first quarter you released reserves and that was as a result of an internal study. And in the second quarter you released reserves again in U.K. annuitant mortality, and that was a result of looking at the industry study. And now we're into the third quarter. So did you get a lot more data over the last 3 to 6 months to allow for another big release in terms of U.K. annuitant mortality?
I'll start off. And I'm not going to go into the specifics of studies and whether they're internal data or external data, but I will go back to my opening comment, was as we observe changes in mortality improvement, so we're seeing a slowing of this, we don't immediately go to exactly what happened in quarter, we look for thematically the direction of travel. And we want to be conservative in terms of the level that we recognize at any given point in time because we don't want to be whipsawed with ups and downs from quarter-to-quarter or even from year-to-year. So Garry, you want to provide a little context to that direction of travel and how it's influenced by internal versus external studies?
Yes. So a couple of things. You're right. Certainly this quarter a lot of the work was driven by our own experience studies where we actually have -- well we do updates and we can look at a specific. So a number of different parts of business, some around the reinsurance side, some around the direct side in various countries, but the vast majority being in UK. And so I don't recall off the top my head what Q1 -- what the Q1 change was. Well, we certainly had seen a direction of travel and we may have been reflecting a part of that because the studies were just coming out from the industry. But certainly in Q2 we were focused on the industry study that came out form the CMI. And then in Q3, we were combining that -- further work on that industry with our own experience, our own blocks of parts of business. That's what drove Q2 and Q3. And Q1, I just off the top of my head don’t recall. But we do keep it under review if we learn news. But a lot of the news in Q3 was our own studies and furthermore upon the public -- the public data that came out in Q2.
And Garry, it’s fair to say that this will be a constant for us. When you think about mortality improvement, so if you think through the 1990s, the early 2010, the early 2000s, there is improvement. And I guess the improvement expectations were kind of matched up with the reality of what we are seeing. We're seeing the shift now. But what we're trying to do is be cautious as we sort of change our thinking. And so we'll continue to monitor this and, well, it might not be a recorder, we're going to monitor this with the degree of challenge and skepticism to make sure that we're not sort of reacting, that we're consciously acting with thoughtfulness, So it will be a quarter-to-quarter thing. And in some quarters there may be recognition. But we have to be very careful to make sure that we're not overreacting [ on ] information and data.
Thank you. This is the end of the question-and-answer session. I would now like to turn the meeting back over to Mr. Paul Mahon.
Thank you very much, operator. So with that I would like to thank everyone for participating, for your thoughtful questions. I would please ask that you contact Investor Relations if you have any follow up questions. And we look forward to speaking with you again at the end of next quarter which will be actually into next year, so with that happy holidays when you get to them. Take care.
Thank you, everyone. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.