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Sun Life Financial Inc
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Good afternoon. My name is Carol, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sun Life Financial Q1 2018 Financial Results Conference Call. [Operator Instructions] Thank you. Greg Dilworth, Vice President of Investor Relations, you may begin your conference.
Thank you, Carol, and good afternoon, everyone. Welcome to Sun Life Financial's Earnings Conference Call for the First Quarter of 2018. Our earnings release and the slides for today's call are available on the Investor Relations section of our website at sunlife.com. We will begin today's presentation with an overview of our first quarter results by Dean Connor, President and Chief Executive Officer of Sun Life Financial. Following Dean's remarks, Kevin Strain, Executive Vice President and Chief Financial Officer, will present the financial results for the quarter. After the prepared remarks, we will move to the question-and-answer portion of the call. Other members of management will also be available to answer your questions on today's call. Turning to Slide 2. I draw your attention to the cautionary language regarding the use of forward-looking statements and non-IFRS financial measures, which form part of this afternoon's remarks. As noted in the slide, forward-looking statements may be rendered inaccurate by subsequent events. And with that, I'll now turn things over to Dean.
Thanks, Greg, and good afternoon, everyone. Turning to Slide 4. The company reported underlying earnings of $770 million and underlying return on equity of 15.1% for the quarter. Sun Life U.S., Asia and MFS each delivered strong earnings growth over last year, and Canada had a solid quarter. Yesterday, we announced the dividend increase of 4%, reflecting our continued earnings momentum. As you know, this quarter, we began reporting under a new capital regime, the Life Insurance Capital Adequacy Test, or LICAT framework. What was a strong capital position under MCCSR is even stronger under LICAT, as evidenced by the pro forma $1.2 billion increase in holdco cash at SLF to $2.9 billion that will occur post quarter, as we transfer up cash from SLA to SLF. This capital position, combined with a financial leverage ratio of 22%, provides both a strong defense as well as a strong offense in terms of the ability to take advantage of opportunities. Looking at sales, the value of new business or VNB was up 33% over prior year from a combination of higher sales volumes and favorable mix of business. Asia individual insurance sales grew 18%, Asia wealth sales grew 32% and U.S. group benefit sales grew 17%, all on a constant-currency basis. In Canada, our retail insurance sales were down relative to strong sales in the first quarter of 2017, including the lead up to tax changes. Asset Management sales grew 11% in constant currency. It was also a strong quarter in growth and expected profit, up 13% over prior year, 17% on a constant-currency basis with growth across all 4 pillars, with particularly strong growth in Asia and Asset Management. In Canada, we had a successful RRSP season. Retail sales of SLGI mutual funds were up 28%, and SLGI's assets under management increased by 24% year-over-year to end in the quarter at almost $22 billion. In our Client Solutions business, we grew in-plan deposits by 45% over prior year to $225 million for the quarter. This growth was driven by more targeted touch points with our clients from the increased profile and use of Ella, our Digital Benefits Assistant. In U.S. Group Benefits, we grew the after-tax profit margin from 5% at the end of 2017 to 5.6% on a trailing 12-month basis. Our success here reflects strong execution on the AEB integration, disciplined expense management and good progress on pricing and renewals. Asia results were strong with underlying net income higher by 32%, reflecting growth in in-force business, sales growth and improved product mix. In the first quarter, Asia delivered 17% of our global underlying net income, and we expect this percentage will continue to grow. Asia results reflected for the first time our International High Net Worth life insurance business, which was previously part of Sun Life U.S. Most of the clients, nearly 90% of these high net worth clients we serve in International Life insurance are in Asia, and we believe this change will help accelerate the development of high net worth business across our countries. In Asset Management, we delivered strong investment performance across the global platform and ended the quarter with $682 billion in assets under management. Sun Life Investment Management, our alternatives business, generated net flows of $335 million. At MFS, net outflows of USD 4.3 billion improved over the prior year. MFS' investment performance remained strong with 83%, 84% and 91% of MFS' retail mutual fund assets in the top half of their Lipper category over 3-, 5- and 10-year periods, respectively. In this year's Barron's ranking of U.S. mutual fund families, MFS earned the #2 spot for 10-year performance, a testament to their focus on delivering value for clients over longer horizons. And now remarkably, in 9 of the last 10 years, MFS has ranked in the top 10 of that Barron's list based on 10-year returns. The intensity of our efforts and pace of change around clients continued in the quarter. In Canada, we continued to improve and extend our mobile app, which is the #1 client-rated financial services app in Canada, and focused on helping Canadians live healthier lives. So this quarter, we launched Virtual doctor on demand where clients can access immediate care and peace of mind through a visit with a physician by live video, telephone or text. In the U.S., we continue to enhance the onboarding experience for clients by streamlining and automating our processes, taking administrative work off the shareholders of benefits administrators and improving our client education and touch points. Our survey show increased levels of client satisfaction with their Sun Life implementation experience. And this quarter, we installed more than 1,200 employer groups. Our group business-in-force grew to USD 3.9 billion of premium and other revenue. In Asia, our Hong Kong business launched our [ global ] client mobile app providing additional convenience and more personalized contact. The app leverages many of the same features we offer to our Canadian mobile users including fingerprint, ID login, policy and coverage summaries, account value updates and access to support through a Sun Life Advisor or a call center. Our Hong Kong Mandatory Provident Fund business was recognized as the MPF Plan of the Year in recognition of outstanding service in Sun's performance. Our MPF funds won another 9 awards, including consistent performer in the 1-, 5- and 10-year categories. We have the fifth largest MPF business in Hong Kong and have been the fastest growing in the MPF market over the past 10 years. So overall, we're off to a strong start in 2018. The move to LICAT shows the strength of our capital and risk story and gives us more financial flexibility. We have a lot of momentum, we're enhancing the client experience and we're executing on growth across the company. Putting it all together, we're excited about 2018, and we're making real progress toward our ambition to become one of the best Insurance and Asset Management companies in the world. And with that, I will now turn the call over to Kevin Strain, who will take us through the financials.
Thank you, Dean, and good afternoon to everybody on the call today. Turning to Slide 6, we take a look at the financial results from the first quarter of 2018. We saw strong results in profitability, growth and financial strength year-over-year. Underlying net income was $770 million, up from $573 million in the same quarter last year. We saw strong growth in underlying net income across all 4 pillars. Underlying results in the quarter reflects a 13% growth in expected profits, the contribution from interest on par seed capital and a lower tax rate due to U.S. tax reform. These results were achieved against the headwind of a strengthening Canadian dollar, which reduced underlying net income by $19 million relative to the same period a year ago. Interest on par seed capital, reflected in SLF Canada and SLF U.S. results, contributed $110 million to earnings this quarter. At the time of demutualization, shareholders of Sun Life and Clarica transferred seed capital to support new business in the participating policyholder account, and the seed capital with interest would be returned to shareholders when the capital in the par account was sufficiently large enough to support the business. Our success in growing the par business has allowed us to transfer the seed capital back to shareholders this quarter and to recognize the investment income. We saw the benefits from U.S. tax reform emerge this quarter as expected in MFS and in the U.S. Our reported net income for the quarter was $669 million, up from $551 million in the first quarter of 2017, including unfavorable market-related impact of $79 million. Our leverage ratio of 22.2% remains below our long-term target of 25%. We redeemed $400 million in subordinated debt in the quarter and repurchased and canceled 3.1 million common shares. Our capital position continues to be an area of strength under LICAT, with strong solvency ratios for both Sun Life Financial and Sun Life Assurance. Turning to Slide 7, we provide details of underlying net income by business group for the quarter. We saw year-over-year underlying earnings growth across each of our 4 pillars. In SLF Canada, underlying net income of $295 million was up 29% on growth in fee income on our wealth businesses and the benefit of the interest on par seed capital. The underlying return on equity for Canada was a strong 17.9%. Expected profit, the impact of new business and surplus income all grew in the quarter with a combined growth of almost 10%. In SLF U.S., underlying net income more than doubled from the first quarter of 2017 on favorable morbidity experience in the stop-loss business, gains from investing activities on insurance contract liabilities, the contribution from interest on par seed capital and U.S. tax reform. Our Group Benefits after-tax profit margin increased to 5.6% in the first quarter from 2.8% the prior year. SLF Asset Management had underlying earnings growth of 26% on higher average net assets at both MFS and Sun Life Investment Management and a lower tax rate due to U.S. tax reform. MFS' pretax net operating margin improved to 38% from 36% in the prior year. In Asia, underlying net income grew by 32% over last year, and our underlying return on equity was 10.7%. The improvement in SLF Asia's ROE this quarter reflects strong growth in net income, the addition of the High Net Worth International business as well as a change in our capital allocation model that saw us move our Asian business to a fully levered basis, consistent with our other business groups across Sun Life. Turning to Slide 8, we provide details on our sources of earnings presentation. Expected profit of $734 million increased by $83 million or 11% from the same period last year with growth across all 4 pillars. Expected profit was particularly strong in Asia and Asset Management, growing 23% and 11%, respectively. Excluding the impact of currency, the results of SLF Asset Management expected profit grew by 17%. We had new business during this quarter of $7 million, an improvement of $11 million over the same period last year from higher levels of new business gains in SLF Canada and SLF U.S. We reflected a methodology change in our source of earnings to better reflect the expected profit in new business strain in our U.S. stop-loss business. This does not impact our overall earnings but lowers the level of new business strain in SLF U.S. that is offset by an equal decrease in expected profit. As a result of this methodology change, we are revising our quarterly estimate for new business strain from minus $10 million to $20 million per quarter to a range of plus or minus $5 million. I remind you that this is a quarterly average which can fluctuate based on business mix, sales volumes, currency and changes in the level of interest rate. Experience items were largely offset this quarter as unfavorable net market-related impacts, lapse and policyholder behavior and mortality were offset by the interest on par seed capital, investment activity, favorable credit and morbidity experience. Other, which amounted to negative $50 million in our sources of earnings disclosure, includes the fair value adjustment on MFS share-based awards, acquisition and integration costs, and the impact of hedges in SLF Canada that do not qualify for hedge accounting. Earnings on surplus of $157 million was $25 million higher than the first quarter last year, reflecting higher levels of investment income and realized gains. Our effective tax rate on reported net income for the quarter was 16.4%. And on an underlying basis, the tax rate for the quarter was 15.8% and in line with our stated range of 15% to 20%. Turning to Slide 9. Let's look at the new LICAT capital framework and what it means for Sun Life. We ended the first quarter with a LICAT ratio for the holding company, SLF, of 149%. This, combined with a leverage ratio of 22.2%, places us in a very strong capital position at the holdco level. Our LICAT ratio for SLA was also a strong 139%. The higher ratio at SLF largely reflects the excess cash of $1.7 billion held by SLF Inc. Under the LICAT framework, the amount of capital required above the supervisory target in our operating company is lower, and we'll be -- and we will be transferring $1.2 billion from SLA to SLF in the second quarter. When added to the $1.7 billion of cash we already have at SLF, this will result in a pro forma excess cash level at SLF of $2.9 billion. While this will have no impact on the LICAT ratio at SLF, the transfer will reduce the LICAT ratio of SLA by approximately 7 points to 132% or 132.5% on a pro forma basis. On Slide 10, we illustrate the amount of capital above the supervisory target under both capital frameworks for SLA. Under LICAT, we have $7.1 billion above supervisory target of 100%. This compares to $5.2 billion above the supervisory target at 150% under MCCSR for an increase of almost $2 billion. This reflects a number of factors, including the efforts we've undertaken to -- over the past several years to reposition the company and improve our risk profile. On Slide 11, we show our market sensitivity to interest rates and equity market movements under LICAT. This sensitivity to changes in equity markets with a 10% change in either direction impacts our LICAT ratio by approximately 0.5 point. This impact of interest rate movements is countered to our earnings sensitivity where interest rate increases are a positive and interest rates declines are a negative. As interest rates decline 50 basis points, our LICAT ratio increases 3 points. Almost all of this sensitivity is due to the sensitivity of changes in interest rates in available capital and surplus allowance. This difference relates to the inclusion of unrealized gains and losses on AFS bonds and OCI and the change in insurance PfADs from interest rate changes. Slide 12 shows sales results across our insurance and wealth businesses. While total insurance sales were down 14% or 12% on a constant-currency basis, we grew our VNB by 33% over the prior year reflecting a positive mix of sales. This quarter, we began reporting VNB excluding our Asset Management pillar. We believe that VNB is a strong measure of future profitability and growth in the insurance business, but the other measures like AUM growth, fund performance and net deposits are better measures for the Asset Management business. SLF Canada sales were down 34% at the first quarter in 2017 and particularly strong sales driven by tax and product changes were introduced in January 1, 2017. Notably at $88 million, we continued to lead the Canadian industry for individual insurance sales. Sales in SLF U.S. grew by 17% from strong sales in Group Life and Disability and in stop-loss. Asia individual insurance sales were also quite strong, growing 18% over the prior year on double-digit growth in China, the Philippines, Vietnam, Indonesia, Malaysia and in India. Total wealth sales of $39.8 billion were up 6% over the prior year and 10% on a constant-currency basis. Asia wealth sales were up 32% compared to the same quarter in the prior year, supported by strong sales in our MPF business in Hong Kong and higher fund sales in India and the Philippines. Sun Life Asset Management sales were up 6%, as sales at MFS remained strong including U.S. retail mutual fund sales that reached an all-time high. Wealth sales in SLF Canada were down 13% as there were fewer large case sales in Group Retirement Services than in the prior year. Individual wealth sales in Canada were up 5% on continued growth from our wealth manufactured products, including Sun Life Global Investments Mutual Funds. So to conclude, we had a good first quarter. We saw strong growth in earnings, ROE and value of new business. Taken together with an even stronger capital position under LICAT, we are well positioned for the remainder of 2018. With that, I'll turn the call over to Greg to begin the Q&A portion of the call.
Thanks, Kevin. [Operator Instructions] With that, I'll now ask Carol to please poll the participants for questions.
[Operator Instructions] Our first question today comes from Steve Theriault from Eight Capital.
A couple questions. But first, Kevin, if I could just ask the upstreaming you did, the 1.2 -- or that you are planning on doing, I guess, or maybe it already occurred in Q2, but the $1.2 billion of the $1.9 billion bump you get on application of LICAT, should we expect you to take the additional $700 million up at some point? Or is that under discussion? Or is this the move that we should expect in its totality?
This is the first quarter for reporting LICAT, and it's still fairly new days under the LICAT regime. And so optimizing the capital under LICAT will be done on a measured basis going forward.
Okay. So possibly, more to come. On the U.S. business for Dean, wanted to circle back on the margin. You've talked about a target margin of 5% to 6% in Group Benefits. The last quarter you talked about a 75 basis point tailwind from the lower tax rate. So we see the margin this quarter, up nicely at 5.6%. Is that in the middle of a 5% to 6% range or at the low end of a -- more like a 5.75% to 6.75% range, including the lower tax rate? Just want to make sure I understand sort of where we are in that process.
Yes. I think, obviously, it's in the middle of the 5% to 6% range at this point. But you're right that we said we should get a tailwind from the lower tax rate. That will phase in gradually as this is a trailing 12-month measure. So we only saw a portion of that in the first quarter. So that's going to be an additional tailwind through the rest of the year. But certainly, we're nicely in the middle of that 5% to 6% range at this point and hoping to see that go higher.
Okay. And then last thing for me. The U.S. Employee Benefits business, the in-force has been consistently down but then I saw that sales were up year-on-year for the first time in quite a while. We can definitely see the turn in the stop-loss business and improved margin overall. Can you refresh us on your outlook for the Employee Benefits business looking out the rest of the year?
Sure. The reduction and dip to the same quarter last year is primarily related to 2 items. One was we had one large license disability client that lapped on January 1, and then we also last year converted the legacy Sun Life Dental business to the stronger legacy Assurance products. That was a block of business that needed quite a bit of rate action. Actually in both of those cases, the lapsation of that business was a positive for our margins because it was underperforming. But those are the primary drivers of the big decline in Employee Benefits. As you noted, we're seeing very nice growth on stop-loss. We've had a 20% year-over-year growth in the stop-loss BIF. Also, as you noted, sales are up year-over-year in the first quarter. So we think we've got good momentum and with the lack of those onetime-type items that occurred last year, we think we're on a good growth path. We should start to see growth in BIF in Employee Benefits and a continuation in growth in stop-loss.
Our next question comes from Humphrey Lee from Dowling & Partners.
Just related to the $2.9 billion cash at the holding company. I guess, what are you going to do with that? Because that's a really sizable war chest. How you look at it?
Humphrey, it's Dean Connor here. Thank you for your question. And you're right, it is a very strong capital position. It's not just the cash at the holdco, it's a 22% leverage ratio, which as Kevin noted is below our long-term target of 25% and a strong LICAT of 132% at SLA after we make that transfer. So it is a nice position to be in. We continue to focus on organic growth. We continue to focus on M&A activities, and as I've said before -- and I won't apologize for being consistent or boring on this, but as I've said before, we do take a disciplined approach. We're looking for opportunities that are on strategy or that will support our 4 pillars, and we're looking for opportunities where the economics makes sense and clear our hurdle rates. So we're clearly in the middle of lots of conversations across all 4 pillars on that front. And of course, buybacks have been part of the mix over the prior years, and we're in the middle of NCIB, whereas Kevin noted, we were active in the quarter and that will continue. I would note that we feel it's a very good time in the cycle to have a strong balance sheet. The stock market has been on a run for 9 years-plus. The credit cycle is in its later innings. So at this -- while we're looking for opportunities and we're looking to put that capital to work, we're also mindful that we're in later stages of this cycle, and I think we're -- it's a really good time in the cycle to have a strong balance sheet.
And then just to follow up on the kind of the strategy around -- surrounding the 4 pillars. So you've talked about kind of the -- all the different pieces. But I guess, in the U.S., you've always talked about being in the group business. But what about your appetite for Group Retirement, given your expertise in Canada and your expertise in Asia. Is that something that you contemplate, given your Asset Management business in Sun Life could be a strategic benefit?
We've looked at the U.S. Group Retirement business many years in the past. In fact at one point, we had a small 401k business, originally part of MFS and part of Sun Life and then we sold it back in 2010. That market has unfolded as we had expected when we sold the business. It has continued to consolidate. Margins have continued to come in. And we would much rather play in the manufacturing of alpha part of that retirement business through MFS and increasingly, through Sun Life Investment Management. So that's the path we've chosen. You're right to point out we've got a very strong GRS business here in Canada, where we have the leading position and the #1 share in a market that is consolidated and relatively fewer players. We see the U.S. market as a market where there is still more consolidation to come. And so we have been very deliberate as we picked our spots, and the U.S. retirement market is not one of them, and instead, we're focused on the group business where we see the opportunity to grow faster.
Got it. If I could sneak in one more. In MFS, you definitely have very strong gross sales in both mutual funds and managed funds in the quarter, but obviously redemptions were even higher. So I think you might have some management changes at MFS. So I was just wondering if you can talk about like which strategies you're getting inflows versus the strategies that you're getting outflows.
Okay. It's Mike Roberge. Gross sales, as you mentioned, we control gross sales, and we actually had record gross sales in U.S. retail and our best gross sales year across all channels for the last several years. And so gross continues to be strong. On the net side, yes, there's really no themes associated with that. We continue to see some of the same things I've talked about from an industry perspective that are impacting, which is move to passive, derisking, rebalancing by clients, and so there's really no theme to redemption, other than the fact that we think that redemption rates are going to have to come down in the industry because they're at very high levels now and -- as we've seen over the last couple of years. And the way to improve flows ultimately on a big assets basis is to have redemptions come down. And so our thought is we think that we'll see some normalization, we and the industry over the next couple of years, and that will obviously improve flows.
Our next question comes from Tom MacKinnon from BMO Capital Markets.
A question just on the notable items that are listed as other. If I take the $110 million seed capital gain out of that, that's a loss of $48 million. And from what the footnote suggests, it's partially due to short-term strategic spending. This $48 million negative is more than twice the negative $23 million in the first quarter last year and significantly larger than the negative $9 million from the prior quarter. So just trying to figure out what's going on here. Is this all sort of short-term strategic spending? Is there seasonality with respect to it? What's the outlook for that going forward? And I have a follow-up.
Okay. Well, Tom, I'll start with an answer and then maybe pass it to Kevin Morrissey. And the other notable line does include our strategic investments that were moved from the expense line, and this includes our investment to build out the retail wealth business in Canada and some of the distribution investments in Asia. But that's only part of what's in there, and there are some other sort of seasonable or onetime expenses like a charge related to the Affordable Care Act in the U.S. Group Benefits line and some seasonality around some comp expenses. Outside of that, there's just a number of smaller items that worked against us in the quarter and drove that down. But I would turn you to sort of think about the total notable items as a positive $94 million, which reflects the $110 million, right? So it just gives you a sense of what's there. I don't know if Kevin wants to build on that.
Tom, it's Kevin Morrissey. Just to add to what Kevin said, there isn't anything else really big that I would highlight there. It really was a bit of an odd quarter, in that there was just a lot of really small pieces that went against us. We see these as being kind of unusual, not things that would normally continue. And there is really nothing more that's notable. It was just a whole bunch of smaller things that added up.
What were those whole bunch of smaller things that added up? What do they amount to? And are they -- what should be our run rate for this other line, I guess?
Yes. If we look at the run rate in that over the last 8 quarters, Tom, it's about minus $15 million. And so I think that's probably -- it gives you a good sense. We did move our -- some of our strategic spending into that line. And I think that's probably a good benchmark to look at.
So you think that -- I calculated it to be negative $48 million, if you take out the seed capital gain. And you think negative $15 million run rate is better for that line going forward?
Yes.
Okay. And then just a question on the LICAT capital. Do you -- are you able to share with us what your target LICAT you've priced for? I assume you're pricing stuff for LICAT now. And what do you assume for a LICAT ratio when you do you're pricing?
So let me take a crack at that, Tom. And I think it's a -- we're not going to disclose our exact sort of pricing ratio at this time. But if you think about LICAT and MCCSR, they are different calculations. And LICAT is a more risk-fixed calculation, and the mechanics are different. But if you were just doing a -- and I know many of the investors have been looking at the 200% calculation under MCCSR. And if you looked at it on a mathematical calculation that looked at the equivalent excess capital over 100% LICAT number, you'd get roughly around 120%. But that's only one way to look at it. And if you look more specifically at Sun Life and our philosophy of capital is that we move the excess capital to SLF. Our philosophy of doing that, of moving the excess capital to SLF isn't going to change under LICAT and so that's why we're transferring the $1.2 billion excess of capital up. This brings SLA down to a LICAT ratio of 132.5%, and we've historically run in excess of our operating target at SLA. So maybe that gives you -- and I know it's not a perfect answer, but it gives you a sense that where -- how we're thinking about LICAT. But it is a very different calculation. So you can't just take the sort of mathematical excess and say, it's 120% and look at that because the risk inside of LICAT and the calculation of the ratio is quite different.
When you get to the 132% LICAT at SLA, are you carrying excess capital in your opinion at SLA?
So you would have seen -- just like our philosophy before, we are running on a level that's higher than our operating target.
Our next question comes from Meny Grauman from Cormark Securities.
I'm just wondering what proportion of the $110 million in accrued investment income can we expect going forward. How much do we expect on a run-rate basis?
I assume you're talking about the par seed capital transfer?
Yes.
Yes. So the transfer amount, including capital, was around $200 million. And that will be inside of the surplus account and we'll be earning investment income on that.
And Meny, it's Dean Connor. That's a onetime transaction.
Right. So what I'm trying to get is just more sort of on a run-rate basis, how much that extra capital do you expect to kind of help you? Is it part of the reason that sort of we're seeing an earnings on surplus look higher over time?
That didn't come through the surplus this quarter. But in future quarters, the investment income on the $200 million will come through surplus.
Okay. And I guess, it's a very small number, just from that additional capital from the par transfer?
Yes. The surplus account has been earning 3% to 3.5%.
Okay. And just following up on the capital deployment question, just to ask another way in terms of a large amount of dry powder. Does it change the way you look at capital deployment? Specifically, I guess on the M&A side, would it mean that you could look at bigger deals? Do you think of it that way as some changing something fundamentally in terms of your plans going forward?
Meny, it's Dean Connor. It doesn't change our view of the kinds of opportunities that we are considering. When you think about the cash at the holdco and Kevin answered -- in answer to Tom MacKinnon's question, he said, yes. Even at 132%, we have additional capital at that level. And then we've got a leverage ratio of 22%. And as you know, every point of leverage is worth about $300 million. So we've got lots of capacity in the balance sheet to make acquisitions. They -- so it doesn't change our view. We're more focused on fit, alignment and what could we bring to a transaction beyond the checkbook? What could we bring to that business to lift it up? And what can they bring to us to lift it up and how do we make the thing worth more than the sum of the parts? So that's -- that hasn't changed.
Our next question comes from Doug Young from Desjardins Capital Markets.
Yes. Just the first question on Canada. If I exclude the seed capital gains, it looked like underlying earnings declined year-over-year. And I think mortality was quite strong last year versus this year, and maybe you can elaborate and quantify that. But it also appears that there was unfavorable group morbidity experience, which is different than what we've seen with some of your competitors this quarter. So hoping to get a little bit more color on that, first off.
Yes. Thanks for the question. This is Jacques. Obviously, I can't speak to the specific experience of others in the industry. In our case, the morbidity experience was slightly unfavorable in the quarter. It was indeed driven by negative experience and visibility, which was partially offset by positive experience in extended health care. Overall morbidity experience can bounce around a bit from quarter-to-quarter. And as of this date, we're not concerned about it.
Was there anything else? Because morbidity was only slightly negative. Is there any other reason why the underlying earnings pulled back year-over-year? Is there -- was there additional expenses in there? Additional noise last year? Or -- what I'm trying to get at is what should we expect in terms of underlying earnings growth? And I think Dean has quantified it in the past, but it seems like it's different this quarter, so.
Sure. Yes, let me give you further views. We've seen growth in expected profit across both of the group businesses, GRS and GB as well as individual wealth business. We've seen growth in new business gains. Our assets under management are up. Our business in-force is up. So those are the things that we are pleased about in a way because they speak to, what I would call, key drivers of performance. As Kevin Strain mentioned, in the individual insurance business, our sales are actually #1 in terms of market share for the fourth consecutive quarter in a row. So overall, we think our underlying performance remains pretty solid. We've had, in Q1, a number of, what I would call, experience items like morbidity and policyholder behavior. None of them were large on a one-by-one basis, but on a cumulative basis, they did create a bit of a headwind. So overall, we feel good about the business from the start of 2018.
Okay. And just second question, adverse lapse experience popped up again this quarter. I guess, maybe for Kevin, the -- and I guess the biggest item here was the U.S. in-force Management business. I think that was called out in Q3 of last year as well as being an issue. Can you dig into this a little bit more? And I guess where I'm going with this, will this require a reserve boost to deal with? Or do you think this is just normal ebbs and flows? If you can maybe dig into that a little bit, that will be helpful.
Doug, it's Kevin Morrissey. The largest piece, about half of the total, was in the U.S. in-force Management closed block. This is a lapse supported in Universal Life block of policies. The experience in the quarter, we had fewer lapses in expected. And the lapses that we did see were skewed to less lapse-supported policies, and by this, I mean higher cash values and lower reserves. The second piece that -- has to do with about 30% of the total was in Canada. This was in the individual segregated fund guarantee. We view this piece as seasonal because the valuation assumptions really aren't calibrated to some of what we observed as seasonal policyholder behavior assumptions, in particular in regards to policyholder withdrawals and resets. And so we expect this to be a timing issue, and we think that we are going to recover that throughout the rest of the year. The final piece, it was rather smaller, but I would just highlight it for completion. It was in the International Life business. This is now reported in Asia. It was only a loss of about $7 million, and this is also a Universal Life block where lapses were a bit higher than expected. So your -- the second part of your question is more looking forward. It's still early days. It's only been 2 quarters since we made the update to the lapse assumptions. We'll continue to monitor the experience closely, and we'll see what the future unfolds.
Kevin, it doesn't sound like you're too concerned at what point. I mean, at what point in time do you get a little bit more concerned on the lapse side?
I'd say if the trend continues to build. If we see the quarters continue to stack up going against us, that would indicate that we might see a reserve strengthening coming. But as I said, at this point, it's a little too early to make that call, and we're just monitoring.
Our next question is from Gabriel Dechaine from National Bank Financial.
A couple of quick numbers questions here. First of all, AFS gains, was that a meaningful number in the earnings on surplus? And you did highlight the expenses as a bit of a deflationary item in the corporate segment and tied to IFRS 17. So are we going to see those costs rolling in over the next few years?
I'll start with the discussion on the corporate segment. On the corporate expenses, we did see a tick up in those with regards to LICAT and IFRS 17 and some other tax items in the quarter. IFRS 17 is starting to hit full flight now as a project, and we will see a higher run rate on expenses from IFRS 17.
Okay. Something you can earn -- work your way through though?
Yes, that's something we can earn our way through. We're certainly not changing our medium-term objectives.
Okay, good to know.
Gabriel, it's Randy Brown. With respect to AFS gains in surplus, no, they were not running high this quarter so then could not contribute to the earnings there.
All right. Then my real question, it's on the capital front and the inverse sensitivity to rates. So higher rates, bad for your LICAT ratio. I know it's not really a -- I mean, you're far from having a capital concern given your balance sheet positioning. But conceptually, how does that affect the way you manage and plan your capital or capital management in a rising rate environment? Are you willing to go much thinner on the LICAT ratio, knowing that your earnings is going to be -- your earnings generation is going to be improving over time? I'm just trying to get my head around that.
It is a bit counterintuitive because the earnings improve as the interest rates go up, and we can understand your questions on this front, Gabriel. I think if you -- one of the ways to think about it is this will likely change under IFRS 17 as well. So some of the sensitivity comes out of IFRS 17. We are at a very strong capital ratio overall. So I think that gives us the -- a protection around sensitivity of interest rates. But I think in terms of how you manage it, it's a balance around earnings versus capital.
And Gabriel, it's Kevin Morrissey here. Maybe I'll just to that a bit. At the beginning of the question, you're asking about the sensitivity. So I just want to elaborate a bit more about those components because they really are driven by the new components in LICAT that didn't exist under MCCSR. Kevin highlighted that at the beginning of his comments. We see about 55% of that sensitivity is driven by the PfADs, which are essentially mark-to-market and the discounting rate under comp reserving. And the other component is the surplus bonds that essentially get mark-to-market through the OCI adjustment in available capital. So that's really contributing about 90%, almost all of our sensitivity under LICAT. As Kevin mentioned, we do have a strong ratio. But when we think about how we're going to manage this, I'd say that we're really at early days in terms of optimization of capital under LICAT, and we have a very strong ratio. But we think we can do more, and you'll see more activity in the future as we look to rebalance our profile. And we think that we can do a bit more around those [ sensitivities ], so more to come on that.
I appreciate that. That's helpful. But just to paraphrase, Kevin, balancing earnings versus capital means, in theory, you'll sacrifice capital because of the mechanics and knowing the earnings is going to put you back on [ site ] over time, is that the idea?
Theoretically, we always look at making these calls on an economic basis, right? And unfortunately now, you get conflicting signals, right, when you look at from an earnings perspective or from a capital perspective. But there may be opportunities where those come together. So an example might be if we have a tactical outlook on rising interest rates, we could look to position some of our fixed income security shorter, right? So that would be a short-term drop in the run rate of earnings, but the yield curve is pretty flat, and tactically, that might be a good call. So that might be an example where those 2 could come together.
Our next question comes from Sumit Malhotra from Scotia Capital.
For Kevin Strain, go back to the seed capital transfer. So just so if I heard the previous answer right. So is $110 million -- it was the interest after-tax benefit in the quarter. And what was the total amount of capital? Was that the $200 million that you say got transferred back to the shareholder account?
Right, and that includes the $110 million. So the total transfer of capital and of the investment income was around $200 million.
And what was the reason for the timing coming through the quarter? I was speaking -- or coming through this quarter. I was speaking with Greg, it didn't seem like it was related to the LICAT change in any way. What was the -- was this -- did you have the option on this? Or was there something that triggered this event being -- taking place in this particular quarter?
Sumit, it's Kevin Morrissey. I'll take that one. As you know, we set up the seed capital at the time of demutualization. So this is going back about 18 years. The intention was to always return the seed capital plus interest once it was no longer needed to support the new business. What really triggered the timing was right now, we're in a position where the par open accounts no longer need the seed capital. We completed an internal review that came to that conclusion at the end of last year. We had an external actuarial opinion which collaborated that and we also -- the last step, which really triggered it was getting regulatory approval, and we did get regulatory approval from OSFI for the transferring in Q1.
And this next part, it really isn't -- I realize it's not an overly material factor, but I'm always just curious on how companies decide what gets included in their definition of operating or in your case, underlying earnings. So why would you view -- I mean, Dean did say this is pretty much a onetime pickup. Why was this included in your definition of underlying earnings since it's not something that we can expect to occur at this level going forward?
We have a number of places we have seed capital. We have seed capital in Asia. We have seed capital in SLIM. We have seed capital in MFS. In all the cases we have seed capital, we include the investment income as underlying net income. And so that's been our philosophy. And if you look at the criteria that determine underlying net income, this fits into that criteria. So we did make sure that we disclosed it. We are transparent in our disclosure because it is different, and it's sort of a lump sum onetime item. But we did feel that it was underlying net income.
Last one, Kevin, I just -- I feel like we go along with the -- with underlying or core or whatever metrics are for the various companies, but I'm always curious as to what your thought process is so thank you for that. Just move back to Canada for Jacques. And Kevin, it might be for you as well. I think Doug was getting at it, but if you kind of look at a few quarters' trend now and we take out the seed capital benefit, it is now 3 consecutive quarters of year-over-year decline. I fully understand that there can be experience back and forth at any particular period. But even when we look at the expected profit now having been pretty flat for the last 4 quarters, I guess, Jacques, you sounded more positive on the numbers than the trend has exhibited in the last few periods. What, in your view, is the key measure that we should be looking at here as to where you see the strength in the Canadian operations?
As I said earlier, I mean, we view the underlying performance as solid, and I pointed out a number of things. And there is -- experience headwind that has gone against us. I've looked at over the next -- last 3 months, sorry, and took some deep dive into various businesses and things are looking pretty good. I mean, I don't want to create expectations, but as Dean has mentioned in his remarks, our investment in digital are paying off very nicely. We're getting a lot of differentiation in the market from some of our tools. We've grown our assets under management. We're -- we've had great results in -- with Ella. So overall, I don't feel that there's anything that stands out as being a warning signal of any kind. I think things are looking pretty solid, as I said.
So -- and maybe, Kevin, this one might be numerically based for you. That flatter trend we've seen in expected profit over the last 4 quarters now in Canada, and I'm talking sequentially. In your -- maybe for both of you here, that is more of an aberration than anything stagnant in the business?
I might start with that and see if Kevin Morrissey wants to jump in. But if you look at Q1 '17 versus Q1 '18 and as Jacques had mentioned earlier, we saw expected profit growth in individual wealth, Group Benefits and GRS. And so those are 3 drivers of the expected profit going forward, and that's where we'd be looking to continue to drive that.
Yes. The only thing I would add to that is we did see a significant increase in individual insurance as a result of the repricing that happened with the tax changes in Canada. And we are seeing good year-over-year growth from expected profit in Canada from that.
Okay. I may be looking more at the -- not -- year-over-year, you're right. It was fine. I guess, I'm just looking at the last few quarters, but we'll monitor that going forward. The last one quickly for Dean. Obviously, very strong capital position. You did have a higher level of buybacks in Q1 that we'd seen previously. At least a portion of that was related to those third-party share agreements that seem to have stopped now for many companies. Does that change your view on allocating capital towards buybacks? I mean, obviously, there was a -- it was more favorable from a pricing perspective via those specific agreements. Do you still view the ROI of buybacks as attractively post those changes?
Yes. Sumit, thanks for the question. You'll recall, we did, under this NCIB, 3.5 million shares last year and that was without the benefit of the kind of purchase agreement that you referred to, the 3.1 million shares in the first quarter, partly with the benefit of that agreement that you referred to. So the agreement was an opportunity. We took advantage of it while we could. And we come back to kind of it is a normal course issuer bid, if I could put it that way. And we kind of view it at -- we still think at this share price, we still think it makes sense to continue on with the NCIB that we have open.
Our next question is from Paul Holden from CIBC World Markets.
So a couple follow-up questions on Canada. First is with respect to potential capital deployment, particularly as Dean mentioned, the focus will be on the 4 pillars and of course, one of them is Canada. Maybe to me, the M&A opportunities in Canada are a little less obvious than some of the other pillars. So maybe you can highlight to me what M&A could look like in Canada?
Well, I mean, I'll -- I don't want to get into that really. I'd refer back to what Dean said earlier. I mean, it has to be something that fits with our strategy, where we think we can bring some value. I think that you're probably right in saying that the list might be shorter in Canada than in other places. But at this stage, it's something that we're looking at.
Okay. Let me ask something a little bit more specific on that point then. We've seen a couple of your competitors get active on the NGA side in terms of M&A. Is there a competitive response you're thinking about, particularly as you're #1 in market share for individual insurance sales?
We like our model. As you know, we have our own sales force and we also distribute through third-party channels. We see that there's a need and we're investing in that to be in what we'd call omni-channels, and that's why we invest quite a bit in digital. So overall, I would say that we think we're in a good place. There are some opportunities. But we're -- as I said, we're pretty pleased with where we are.
Okay. Fair enough. And then last question and again, specific to Canada, another trend we're seeing across the industry is a focus on cost efficiencies and particularly with respect to headcount. Is there any kind of commentary you can provide around there in terms of Sun Life's strategy?
Look, specific to Canada, there was a springboard last year, and we're on track for that. We're looking across the business, as I said, the areas of the business that are high-growth where we need to continue to invest. I'll mention again, digital, an area that's very important. And generally, we're in the kind of environment where looking closely at expenses is important, and we're continuing that. That's part of good business management.
Our next question comes from Mario Mendonca from TD Securities.
First, if we could just think through the growth in expected profit in Asia, the sequential improvement obviously a lot greater than just the growth in the underlying business. We're using assets as my proxy for the growth in underlying business. Was there any recalibration of expected profit, as in looking at the pace with which you release those reserves? Did anything change in that respect?
Mario, it's Claude Accum. Yes, thank you for that question. The primary drivers of the recent improvements in expected profit is a result of -- we had -- and it's up $24 million this quarter from prior year is, number one, is we had strong business growth in our wealth businesses. It's very strong in the Hong Kong MPF channel, very strong in the India AMC, Asset Management Company channel and very strong in the Philippines. And then the second source was we had a strong pickup in expected profit in our Philippines insurance business. And you wouldn't have seen that before, but it picked up this quarter due to the strong insurance sales in Q4 and Q1 in the Philippines. So in a bit more detail, our growth wealth sales in Q1 were $3.7 billion. So that will get you a sense of the assets that are driving it. That's a 30% growth. And that level of sales gives us fees, and those fees shows up in expected profit. So you can triangulate to get that. And in the Philippines, our Q1 insurance sales, they accelerated. They were at 40%. And you saw that acceleration in Q4. And Q4 Philippines sales were up 20% on a constant-currency basis. And what happens in the Philippines, these products are strongly engineered. We don't get a gain of sale or strain when we issue the policy. But the immediate months thereafter, earnings start showing up. So that's what you're seeing in the Philippines, a lift in expected profits from the strong sales.
So why wouldn't this business growth that you're referring to also show up in the form of just stronger asset growth? Why the big disparity between asset growth and expected profit growth? Because all the things you highlighted would suggest to me that they would also fall into the asset side.
It does. If you look up total assets under management. It's up materially.
But far less than the expected profit, like sequentially, expected profit is up 11%. Assets are up 3%. Is there anything that you can think of that would cause that disparity?
So you're going Q4 to Q1? I think a better place to look is Q1 to Q1. So if you look at it Q1 this year to Q1 last year, you're comparing 2 comparable quarters.
Okay. I'll have a look at that. The -- secondarily, mortality. It was a weak quarter for mortality, probably for the first time in some time. Could you just speak to the segments that have played out in the products? And if there's anything in particular that would have driven it this quarter?
Mario, this is Kevin Morrissey. I'll take that one. We did have a weak quarter in mortality. We had a loss of $21 million pretax. It's not unusual for us to see seasonally higher mortality rates in Q1. So we wouldn't normally expect to see losses in the insurance business and then gains on our payout annuity. This year, we had more losses than gains with some insurance side. We lost $46 million on payout annuities with plus $25 million. The mortality rates were especially severe in the U.S., where we have life insurance but we don't have the payout annuity. So when we look at our first quarter last year, we had the reverse. We actually had a small net gain as a result of this. But maybe I'll turn it over to Dan Fishbein to comment a bit more on the mortality experience in U.S, okay?
Yes. Thanks, Kevin. In the first quarter, there was a very severe flu season. The U.S Centers for Disease Control actually tracked this as the worst flu season in at least 5 years, both for deaths and hospitalizations. And while it's always difficult for us to track this exactly because cause of death is not always listed as the flu. It's usually a secondary cause of death. We think that was the primary driver of the adverse mortality in the U.S. in the first quarter.
That's helpful. That's consistent with what we're hearing from others. Appreciate it, Dan.
And we have no further questions in queue at this time. I'll turn the call back to Mr. Dilworth for closing remarks.
Great. Thank you, Carol. I would like to thank all of our participants on today's call. If there are any additional questions, we will be available. Should you wish to listen to the rebroadcast, it will be available on our website later this afternoon. Thank you all, and have a good day.
This concludes today's conference. You may now disconnect.