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Sun Life Financial Inc
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Good morning, my name is Dan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sun Life Financial Q4 2017 Financial Results Conference Call. [Operator Instructions] Thank you. Greg Dilworth, Vice President of Investor Relations, you may begin your conference.
Thank you, Dan, and good morning, everyone. Welcome to Sun Life Financial's earnings conference call for the fourth quarter of 2017. 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 fourth quarter and full year 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 fourth quarter financial results. 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 morning'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 morning, everyone. Turning to Slide 4, the company reported underlying earnings of $641 million for the quarter, a strong finish to 2017, where we grew underlying earnings by 9% for the full year, 11% on a constant currency basis. Underlying ROE for the quarter and the year were also strong at 12.7%. Over the year, we increased the dividend by 8%, repurchased 3.5 million shares, reduced leverage and maintained a strong MCCSR ratio, including $2 billion of cash at the holding company. Sales results in the fourth quarter were mixed across our 4 pillars. Asia Insurance sales were up 3% and Wealth sales were up 21%, generating VNB growth of 19%, all on a constant currency basis. SLF U.S. sales were very strong. Individual insurance sales in Canada were down relative to very strong sales in Q4 of '16 from the lead up to tax changes. For the year, Insurance sales across the company were up 12% and Wealth sales were up 7% on a constant currency basis. And we finished the year with $975 billion of assets under management. Our results this quarter and for the year reflects strong execution on the drivers of profitable growth for Sun Life in the coming years. In Canada, we made good progress in building our wealth business. Sun Life Global Investments had positive net flows of approximately $600 million for the quarter, 3/4 of that in retail, and finished the year with over $20 billion in AUM. Following the quarter, we completed the acquisition of Excel Funds, a Canadian investment manager specializing in emerging market funds with nearly $800 million in AUM.Group Benefits in Canada also hit a milestone in the fourth quarter, reaching $10 billion of business in-force and extending our market leadership position in 2017. In U.S. Group Benefits, our continued focus on the AEB integration and good execution on pricing, renewals, claims management and expenses continued to pay off. We achieved an after-tax profit margin in U.S. group of 5% on a trailing 12-month basis, reaching our targeted 5% to 6% range 2 years earlier than we had previously indicated. U.S. finished the year with strong sales, particularly in stop-loss and international life.In Asia, Aditya Birla Sun Life Asset Management moved from #4 to #3 in the fast-growing Indian mutual fund market, ending the year with almost $50 billion of AUM, up from $30 billion just 2 years ago. We closed the acquisition of FWD's Mandatory Provident Fund business in Hong Kong and signed a 15-year distribution agreement. In Malaysia, we launched a distribution relationship with CIMB Principal Asset Management, allowing their network of 8,000 agents to offer our insurance solutions alongside their wealth solutions. And with this new partnership in Malaysia, we now have agency distribution in all 7 of our Asian markets.In asset management, we delivered strong investment performance across our global platform. Sun Life Investment Management, our alternatives business, generated net flows of $1.6 billion for the quarter and $6.1 billion for the year, driven by strong investment performance and improved distribution. SLIM's Canadian LDI and alternative fixed income team was named the fastest-growing asset money manager by Benefits Canada in the $1 billion to $10 billion of AUM category. At MFS, 84%, 79% and 92% of fund assets were in the top half of their Lipper categories over 3-, 5- and 10-year periods, respectively. We were pleased to see retail net flows turn positive in the fourth quarter. And overall, net outflows of U.S. $4 billion, improved over the same period last year. MFS continued to make progress on the buildout of international fixed income capabilities, increasing the number of fixed income portfolio managers by 40% over the past 2 years. Out of the 9 MFS U.S. retail mutual funds that had over $1 billion of sales in 2017, 4 of them were fixed income. We believe that MFS' ability to generate alpha, with carefully managed risk, will be particularly valuable to clients given the recent reappearance of volatility to equity markets around the globe.As you know, we have a relentless drive to make it easier for clients to do business with us, to resolve their problems better and faster, to be more personalized and proactive with them and to deliver value. Our net promoter and client index scores increased again last year and we are seeing that coming through in terms of clients doing more business with us, staying longer and referring more friends and family. And here are just a few examples of how we're making that happen. In Canada, our new interactive digital coach, Ella, has had nearly 2 million touch points with clients, resulting in engagement rates with group clients that have increased by more than 50%. Adding to her capabilities, Canadians can now talk to Ella through Google Home to search for top-rate health professionals, such as dentists, physiotherapists, chiropractors and so on, using over 3 million ratings provided by the patients who are our clients. This is one of the reasons our Group Benefits business is growing faster than the market. These capabilities help us win new clients, keep them with us longer and helps us to compete on a basis that goes well beyond price. In Client Solutions, our Digital Benefits Assistant is technology that nudges clients to engage with and get more from their pension and benefit plans. Last year, these digital nudges, in some cases aided by phone contact, generated over $700 million in additional GRS deposits. And that's in addition to the $2.5 billion of rollover sales. That's one of the reasons GRS AUM is growing at double-digit rates and one of the reasons GRS net income crested $200 million for the first time in 2017. Our Canadian business also announced a collaboration with Secure Key, a leading identity and authentication provider, to verify client information using blockchain technology, another step forward in ease of doing business. In the U.S., we've created a strategic partnership with Collective Health, a remarkable health tech firm that is transforming health care in the workplace for innovative employer clients and their employees. Their digital platform connects and administers the entire benefits ecosystem, health networks, benefit programs, spending accounts and employee support, and they are bending the cost curve for employers while generating Net Promoter Scores in excess of 70%. By integrating our leading stop-loss capabilities with Collective Health, clients and their employees will benefit from an even better experience. So to wrap and turning to Slide 5. 2017 was another year of strong growth and progress at Sun Life. Our financial performance was strong, with underlying earnings of $2.5 billion, and we continue to deliver on our medium-term financial objectives while investing for future growth.2017 was also a year where we saw the whole organization kick into a new gear on client obsession with a relentless focus centered on doing more for clients. We're really excited about 2018. We have terrific momentum, and we are making real progress towards our ambition to become one of the best insurance and asset management companies in the world. And with that, I'll turn the call over to Kevin Strain, who will take us through the financials.
Thank you, Dean, and good morning, everyone. Turning to Slide 7, we take a look at some of the financial results from the fourth quarter of 2017. Underlying net income was $641 million, up from $560 million in the same quarter last year. Underlying results in the quarter reflected strong growth in expected profit as well as favorable morbidity and mortality experience. These strong results were achieved against a backdrop of a strengthening Canadian dollar, which reduced underlying net income by $22 million relative to the same period a year ago. Our reported net income for the quarter was $207 million, down from $728 million in the fourth quarter of 2016. Fourth quarter 2017 reported results were largely impacted by a net charge of $251 million related to U.S. tax reform, the unfavorable impact of interest rate movements and a previously announced restructuring charge of $44 million after tax. We maintained a strong capital position with a Minimum Continuing Capital and Surplus Requirements ratio for Sun Life Assurance Company of Canada of 221%. Our SLA MCCSR margin ratio declined by 11 points from the third quarter, largely reflecting the recapture of a reinsurance treaty and lower reported net income. This was a unique treaty in place in our Canadian group business. This treaty was less effective under LICAT, and given our overall risk profile and the strength of our capital position, we believed we could create greater value through the recapture of this reinsurance arrangement.The MCCSR for the holding company, Sun Life Financial Inc., which is also strong at 246%. The higher ratio at the SLF level largely reflects the excess cash of $2 billion held by SLF Inc. Our leverage ratio of 23.6%, which includes preferred share capital, remains below our long-term target of 25%. We redeemed $400 million of subordinated debt in January of this year, and adjusting for this, our pro forma leverage for the Q4 '17 would be 22.4% and our excess cash position would be $1.6 billion. [indiscernible] released the final LICAT guideline on November 24, 2017, effective January 1, 2018, Sun Life will be measured under the new Life Insurance Capital Adequacy Test, LICAT capital regime. We have a strong capital position under MCCSR today, and we expect that strong capital position to continue under LICAT. We will provide more details on LICAT, including our initial disclosures, with our first quarter results in May of this year.Turning to Slide 8, we provide details for underlying net income by business group for the quarter. We saw double-digit year-over-year underlying earnings growth across 3 of our 4 pillars, SLF U.S., SLF Asia and Asset Management. In SLF Canada, underlying net income of $232 million reflected growth in fee income on our wealth businesses and favorable investment activity. The prior year's results included a net benefit from the release of a litigation provision. Results in SLF Canada continue to be strong, where we generated an ROE of 12.2% In SLF U.S., underlying net income was up 45% from the fourth quarter of 2016 as we have made strong progress on our Group Benefits business. Our Group Benefits after-tax profit margin increased from 3.5% in 2016 to 5% in 2017 on improved underwriting experience, pricing actions, investments in claims management, expense initiatives and the employee benefits business acquired in 2016.SLF Asset Management had underlying earnings growth of 20% from higher average net asset at MFS. MFS pretax operating profit margin improved to 40% from 35% in the prior year. MFS had net outflows of USD 4 billion as retail inflows of USD 0.5 billion were offset by institutional outflows of USD 4.5 billion. Sun Life Investment Management had inflows of $1.6 billion and generated net income of $6 million. In Asia, underlying net income grew by 29% over last year on strong growth in our wealth businesses and strong earnings contributions from our joint venture partnerships. Turning next to Slide 9, we provide details on our sources of earnings presentation. Expected profit of $758 million increased by $79 million from the same period last year, with business growth across all 4 pillars, particularly SLF Asset Management and SLF Canada. Excluding the impact of currency and the results of SLF Asset Management, expected profit grew by 10%. We had new business gains this quarter of $14 million, an improvement of $5 million over the same period last year. New business gains were driven by SLF Canada from improved product profitability in individual insurance and strong sales in our International business in SLF U.S. Experienced losses of $152 million for the quarter primarily reflect the net unfavorable impact of interest rates. Positive contributions from credit and investment activity, mortality and morbidity experience was offset by lapsed policyholder behavior and expense experience. Expense experience includes continued investment in our business, such as distribution expansion and strategic spend as well as annual incentive compensation costs from a strong performance in 2017. Assumption changes and management actions primarily reflect an increase in actuarial liabilities, including updates to lapse and policyholder behavior assumptions in SLF Canada. Other, which amounted to a negative $137 million in our sources of earnings disclosure, includes a restructuring charge announced in the third quarter to support our client strategy as well as acquisition and integration costs, fair value adjustments on FMS share-based compensation awards and the impact of hedges in SLF Canada that do not qualify for hedge accounting.Earnings on surplus of $128 million was $37 million higher than the fourth quarter last year, reflecting higher levels of investment income and mark-to-market on real estate. We have isolated the impact of U.S. tax reform in our sources of earnings disclosure on this slide. A net after-tax charge of $251 million reflects the impact of U.S. tax reform on actuarial liability, a onetime charge on deemed repatriation of foreign earnings, partially offset by the revaluation of deferred tax balances. Our effective tax rate on a reported net income basis was negative 36.7%.This tax rate was primarily reflective of the enactment of U.S. tax reform. On an underlying net income basis, which adjusts for these impacts, our effective tax rate was 21.5% and in line with our expected range of 18% to 22% in 2017. As a result of U.S. tax reform, we are revising the expected range of our effective tax rate to 15% to 20%. This new range is based on our current understanding of base broadening measures and U.S. tax interpretive guidance. This new range aligns with our previous disclosures on U.S. tax reform, whereby we expect the tax expense included in 2018 underlying net income to decrease by approximately $130 million.Slide 10 shows sales results across our insurance and wealth businesses. Total insurance sales were up 3% and 7% on a constant currency basis. The higher sales were primarily in SLF U.S. from strong sales in stop-loss and were partially offset by lower sales in individual insurance in SLF Canada, which benefited in the prior year ahead of product level tax changes. Canadian individual insurance sales have been strong in 2017. We achieved the #1 spot in life insurance sales for the past 3 quarters. Total wealth sales of $35.3 billion were down 5% and 1% on a constant currency basis over the prior year. The lower sales results were primarily in Group Retirement Services in SLF Canada, as a few large sales contributed to the prior year results. In SLF Asset Management, [ MFS ] sales rose 2% on a constant currency basis, however, were down 3% after the headwinds of currency. In Asia, we continued to see strong sales growth in our asset management company in the Philippines, our pensions business in Hong Kong and our Indian joint venture mutual fund company. So to conclude, we achieved strong results this quarter contributing to a strong year. And reported net income of $2.1 billion supported our strong capital position and book value growth. We saw double-digit underlying earnings growth across 3 of our 4 pillars. We generated 50 basis points of ROE improvement over the course of the year. And we deployed capital in a balanced and a diversified way. We enter 2018 from a position of strength as we continue to deliver on organic initiatives, execute well on acquisitions and leverage our robust capital position as we implement the LICAT capital framework this year. 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 Dan to please poll the participants for questions.
[Operator Instructions] Your first question comes from the line of Gabriel Dechaine with National Bank Financial.
I've got a quick numbers one and then one related to the U.S. tax reform. On the first one, the reinsurance recapture, I believe you've done this in 2 phases. When you originally reinsured that back in 2010, there was an earnings hit. So in recapturing it, you're getting some earnings back. Is that a decent sized number?
That's correct. We will have a positive impact on the earnings front after the recapture.
Of? In the amount of?
Roughly a few cents per share or just under a few cents per share.
Okay, nothing major then. Okay, then I guess the more thoughtful question on the tax reform. So what I've -- reading your discussion on the updated guidance, are you -- like the 15 to 20, are you being conservative there that maybe at the higher end of the range you might see some of the benefits dial back like the base erosion stuff? And then what I'm also hearing from U.S. companies, particularly on the group side, is that they're planning on passing on some of these benefits to their customers via lower premiums. I'm just wondering how that could affect the group business in the coming year? Do we eat into some of the repricing benefits we're starting to see now?
So I'll take the first part of the question and Dan will take the second part. The guidance of 15% to 20%, it reflects the positive impact of the tax reform, but the impact will -- of the overall range depends on the jurisdiction of our -- the geography of the income, right? So that will be an impact. And then there will be impact from base erosion measures, limitations to the interest expense reductions, FDII, those types of things will also have an impact on it. So we expect to be inside of that range, and we expect that the benefit of that is roughly the $130 million we talked about, which would put us inside of that range as well.
So you did contemplate some of the offsets that might be coming in that range then?
Sorry, there'll be some offsets in that range as well, yes.
This is Dan, I'll address the issue about competing away the benefit. We don't really expect to see much of that in the short- to medium-term. First of all, a lot of the group business is written on 3-year rates. So certainly any effect like that would take some time to play out. Also a number of the rates in the group business are filed with state insurance departments, so that would also take some time to play out. But probably more importantly, most of the insurers active in the group market today are not yet at their target margin. And we expect that most players will use tax reform as a way to get closer to their target margins in the short to medium term.
Your next question comes from the line of Doug Young with Desjardins Capital.
Sorry, I was mute there, sorry. Just a first question on Canada. Underlying earnings were down year-over-year, and, I think, Kevin you alluded to a litigation provision last year. And if I recall, it was $15 million to $20 million. But if I go in and I look at the market impact -- or if I look at experience, excluding the market impact, it looks like it was slightly positive last year, it looks like it was negative this year. So maybe that's expense, lapse. I'm just trying to get a sense of why the delta in experience, excluding market impact, last year versus this year, if can you kind of delve a little bit into that?
Yes, sure. I think the net provision last year, the legal provision, was about 28, so just as a benchmark. If you look at earnings, expected profit was up really nicely over year and new business came through very, very solid. In terms of the experience gains -- sorry, the actual experience, we saw some incidents push in the disability block. But most of that was offset by good overall health experience.
Was there any lapse items or issues from the experience side?
No.
Okay. And then just maybe turning to Asia. Hong Kong insurance sales were down 25% year-over-year. I know you're doing well in the Mandatory Provident Fund, but just wanted a little color. And I know expected profits was up 5% year-over-year this quarter. But it's been gravitating down over the last 2 years, I mean, I think, I went out 2 years ago, it was up -- it was growing about 20%. So just trying to get a sense of what's happening within expected profit growth in Asia and then sales in Hong Kong? But also the ROE, it seems range-bound in the mid-7% range. I thought the goal was to try to move this above 10% over time. So just wanted to get a bit of an update on that as well.
It's Claude Accum here. With regard to Hong Kong sales, on a composite basis, constant currency, it is down 15%. But you need to tease apart that business. They actually have 3 really good engines of growth. Two of them are doing very well. And so agency is up 16%. I believe that's the second-highest growth rate in the industry. The MPF business is also doing quite well. It ranks #5, moving to #4 by assets. But on net sales, it ranks #2. So one of the strongest MPF growing platforms in Hong Kong. And the slower spot is the MCV sales are off. And we haven't -- we haven't replaced that contribution. If you look at the whole contribution across Asia, our thesis is that these 7 countries combined should be able to produce a 15% to 20% growth rate. And so if you look at life sales, which are a bit soft, and combine that with wealth sales, which are very strong, showing 21% growth rates or 50% growth rates on a full year, on a constant currency basis. On a composite basis, we're seeing growth rates in Asia of 17%. And so that's in the middle of that thesis of a 15% to 20% growth rate. So we feel good about the growth trajectory in Asia, notwithstanding where Hong Kong is. If we look at all the other businesses combined, excluding Hong Kong, the other 6 businesses being Philippines, India, Indonesia, China, Vietnam, Malaysia, they're generating a 22% growth rate. So again, when you look across the whole book, we see some robustness in sales growth rate. If you look at expected profit, you really need to adjust for currency. So on expected profit, full year, it looks like it's up 4%. We'd like to see it grow faster than that. And we tend to manage it on a local currency basis. We don't hedge the [ synch up ], it's all in its natural local currency. So if we adjust for FX, it's another 6 points of growth. So expected profit is actually up 10 points and we think that's pretty decent. And if you look at where that's coming from, the 7 businesses, the 7 countries, are generating a 13% growth in expected profit. So we feel good about that on a constant currency basis. And then there is a bit of drag coming from the regional office, which takes about 3 percentage points off that growth rate, where we have some project expenses [ RO ] as special projects. If we come to the return on equity, we would normally expect to see the return on equity increase 50 bps per annum or more over a 3-, 4-, 5-year period. And we are carrying some extra capital in some of the subsidiaries, we did a capital injection in one of our subsidiaries and so that's tempered the growth in ROE this year.
And Doug, I would add that the ROE is based on 100% equity still in those numbers.
Your next question comes from the line of Nick Stogdill with Credit Suisse.
Just sticking with Asia to elaborate on that, I think earnings for the full year were up 18% on an FX adjusted basis. And last quarter, you did offer growth of maybe low double digits on earnings. Does that feel achievable for 2018? Just because we look at the core numbers throughout the year, they averaged about $80 million a quarter this year. So we didn't really see that trend up, but I'm just wondering if you feel confident that can grow in the double digits in 2018.
Yes, when we look at it on a constant currency basis, full year is at 17%. Q4 is quite strong, it's at 38% growth. And so looking forward, we think Asia's still on thesis that we can generate a 15% to 20% growth rate on earnings going forward.
Okay. My second question on MFS, just wanted to get some color on the sustainability of the margins this quarter. I know the asset growth has been important. Was there anything -- and I know there were fee gains in some items last quarter. [indiscernible] in there and maybe just your thoughts on the margins if asset growth is not as robust in 2018?
Yes, if you look at the quarter, and I'd say a couple of things. One is you've got to look at prior years, too. And what you'll see is seasonality in the first half versus the second half. So there are more fee days in the second half. We accelerate some of the vesting on compensation in Q1 and Q2. So you would expect the first half of the year, like we've seen in prior years, to be somewhat lower. So -- but when you get a big ramp in the market like we've seen in the last 6 months, you are going to see the market expand. That will be harder to sustain if we look -- as we look into next year. And we would expect the same headwinds, which we've talked about on prior calls, which is continued slight fee erosion over time to continue to weigh on results of asset managers.
And will MiFID II have a noticeable impact, I guess, in early 2018?
Yes, like we disclosed last quarter, it's not material. We don't think it's material to the financial results. It's clearly going to have some impact this year, but as it rolls up to Sun Life, it's, from our perspective and theirs, not material.
Your next question comes from the line of Meny Grauman from Cormark Securities.
You did the recapture of the reinsurance agreement to deal with LICAT. I'm wondering -- we're in Q1, but are there any other changes that you expect that are motivated by LICAT in Q1 or farther down the field?
This is Kevin, this was a unique agreement we had in our Group Benefits business in the U.S. so we don't see other similar types agreements -- sorry, in Canada, Group Benefits in Canada.
Okay. And then just wanted to ask on the employee benefits business in the U.S., it was touched on the sort of the impact of tax legislation at the top-of-the-house. But in terms of how you see the business unfolding in the U.S., employee benefits business, can you go into a bit more detail in terms of the impacts of the tax legislation on that business from a demand perspective in particular? And then, how that could impact your outlook in terms of after-tax margins? Does that give a little bit more upside to the 5% to 6% that you've been targeting?
Yes, thanks, Meny. In terms of demand, I think the overall U.S. economy is moving along quite nicely, and certainly tax reform is going to be another catalyst for that. So we are starting to see employment growth in the overall market, and we expect to start to see that as a contributor to our growth going forward. We're also starting to see some wage inflation in the U.S. and obviously that means multiples of salary with some of our coverages are based on also will increase. As far as the impacted margins, obviously, there will be an impact in after-tax margins from a lower tax rate. Give or take, we estimate that to be about 75 basis points going forward.
Your next question comes from the line of Humphrey Lee with Dowling & Partners.
Looking at your holding company excess cash position kind of adjusted for the debt repayments, the [ 1.6 ]. At the same time you have quite a bit of debt capacity, whether it is the 25% long-term target or the 30% kind of upper threshold that you feel comfortable to be, on an interim basis, hitting there. Like the last -- so you're kind of looking at maybe like close to $2 billion of capacity. And when I look back at the last time you had such flexibility, you went into a little bit of a shopping spree. So as I think about capital management, if you were to do some acquisitions, what would be on your wish list?
Humphrey, it's Dean here. Thanks for your question. I'll just say that the approach we've taken, which is kind of a really balanced, thoughtful, disciplined approach to allocating capital continues to apply. So that's share buybacks supporting -- first of all, supporting organic growth and acquisitions and share buybacks. As you know, we have a noncourse issuer bid in flight, 11.5 million shares. We've bought back 3.5 million of that piece, we've just announced the next leg of 3.2 million shares. In terms of acquisitions, our -- our approach remains the same. We are focused on acquisitions that build strategic capacity in each of our 4 pillars. So it's not 1 or 2, but we're looking for opportunities in all 4. Clearly, there are fewer of those in Canada of size, but the acquisition of the Excel business that we closed in January is an example of that. Looking for opportunities in all 4 pillars, opportunities that either bring us new capabilities or help us grow faster. In other words, we're bringing more than just a checkbook to the story, we're actually able to put the businesses together and accelerate growth beyond what would otherwise be possible. We continue to take a very disciplined approach to this. And clearly, a, it has to be on strategy, and b, it has to clear our long-term hurdle rates in terms of ROE, and that's challenging in this market given there's a lot of capital swimming around. So what I would say to you is that we're as aggressive as ever at talking with people about those opportunities. And as you note, we're in a very favorable position in terms of the firepower on our balance sheet for when we do find those opportunities.
I understand you have a balanced approach towards the 4 pillars. But I guess if you had to rank them like -- or if you -- if everything is on the table for your choosing, like what area would you like to invest first, if you had the choice?
I don't think there is any one preferred pillar in that sense. And as a more pragmatic answer, the reality is, it depends on what actually becomes available at prices that make sense economically. So we would like to -- so let me just take you around the company and this isn't in any particular order. But in asset management, Sun Life Investment Management has grown from 0 to $60 billion in the last 4 years. We are on a path to get that to $100 billion organically. We would like to find other opportunities to get SLIM even bigger than that. So that's one category. In the United States, we've, through the AEB acquisition, given ourselves terrific additional capability and heft and you see us executing really well on that. There are other capabilities that we are looking at and sizing up in the U.S. market as well, things that will accelerate our ability to grow. And then in Asia, there are so many different places to play. Job one is to get larger in the 7 markets in which we already operate. And -- because those 7 markets have something like 90% of the growth in Asia in the next decade. Those 7 markets have over 3 billion people in them. So job 1 is to get bigger in those markets. And that could mean looking at bancassurance opportunities, it could mean looking at wholesale acquisitions of other companies, it could mean buying up larger percentages of businesses we already own that we're in joint venture with, and you've seen us quite active in that space in the last few years. So I hope that answers your question.
Yes. And then I guess, specifically in Asia, there seems to be quite a bit of activities going on. There is a lot of divestiture by traditional players from foreign parents. I guess maybe at a high level, how would you think about the valuation of those properties or the Asia business in general? Do you feel like it's still a little frothy? Or do you feel like there maybe could be some interesting properties in the market?
Well, I think the price -- the starting point is that the prices for businesses in Asia look expensive on North American standards. But when you overlay the kind of growth you see in most of the markets that we're in Asia, and you overlay the kind of operational execution that we're capable of delivering, we see opportunities to make the economics work, not in every case, but in enough cases to make it interesting. So it is difficult to talk about specifics. But I think there continues to be some really interesting opportunities in Asia. And we're actively in the middle of all those discussions.
Your next question comes from the line of Stephen Theriault with Eight Capital.
I have a question on MFS. But first on Canada. I know it may not be a big deal, but I did want to talk about the SecureKey agreement for a couple of minutes, probably for Kevin Dougherty. Can you talk about which parts of the business will be touched by this? In particular wondering, will this be more facilitation of traditional agent sales by Sun Life agents? Or is this more a function of selling ancillary products to existing customers like through your mobile app? Is this a big enough deal that you could see meaningful productivity gains? Or is this more of an incremental, smaller project? I'd love to get a sense for what you envision with that.
Sure. Well with the SecureKey technology, it will enable very rapid, at some point, kind of instant validation of things like identity and credentials which will enable more to happen digitally, whether there's an adviser present or whether we are doing things through, for example, our mobile app. And so, there is a fair amount of friction in the current processes. And in the digital world, friction means drop-offs. So we think this has a tremendous amount of potential for us there. It'll take some time to roll out. And SecureKey has ambitions beyond just identity verification, perhaps into areas like health care, maybe eventually things like coordination of benefits, which will speed up a lot of Group Benefits processes. So there's quite a bit of potential, and we're quite excited about the investment and being involved with them.
And is the rollout -- is it first half of this year? First half of next year -- or sorry, first or second half of this year?
Yes. I think we'd start to see things happening in the second half of this year.
Okay. And then on MFS, a couple of things there. I can't remember seeing expenses over $550 million. I don't think there is Q4 seasonality. So Mike, can you give us a bit of insight on Q4 and a bit of an outlook for expenses next year? Are you -- did you take advantage of the very strong markets and maybe a bump in fees to front-end some expenses? Anything like that?
Nothing abnormal in the quarter from an expense perspective. What flexes -- what's going to flex is, with revenue growth, is compensation is going to flex, some of the asset-based fees that we pay some of the distributors, commissions that we pay based on sales. So there is nothing in there that would be anything abnormal relative to any other quarter. With the caution as I mentioned earlier, just think about seasonality that we'll have in the first quarter's compensation expenses higher, and you can see that if you go back to look at last year.
Okay. And then the last item was a small one again, but the U.S. GAAP net income, which I don't often notice, and it's normally higher than under IFRS, it's a lot lower this quarter. Is there any quirks there that you or Kevin could flag?
Maybe I'll leave that to Kevin, we focus on the GAAP number, not the IFRS. So Kevin, if you wanted to just cover maybe the reconciliation?
The only difference in the U.S. tax numbers was the U.S. tax reform impact on MFS, which was about USD 75 million.
Okay, so just the under -- that's not an adjusted number, so that's right.
Right, right.
Your next question comes from the line of Tom MacKinnon with BMO Capital.
Yes, question on Asia and then a quick one on strain in MFS. So Claude, just looking at Asia, the expected profit growth that we've seen in 2015 and 2016 was solid double-digit, but here in 2017 just 5%, but I think you're looking at maybe 10% excluding currency, but certainly lower than what we've seen in the past. Is this -- do you think this is due to extra spends in Hong Kong? And how should we be looking at that number going forward? And what are some of these extra spends you're having in Hong Kong? What are they trying to achieve?
Yes. So Tom, it's Claude here. If I look at the contribution from the 7 businesses, on a constant currency basis, their expected profit is up 13%. So I think that's the number you're looking for. And then if I roll in the regional office, it takes about 3 points off that. And that gets to the 10% that you noted. And so what's in the regional office are some special projects where we're trying to do things, not just in Hong Kong but across the whole Asia business group. It tends to be special projects more focused on developing growth in earnings over the long term. And so we think it will generate a lift in earnings in the future, but it does cause some drag in the short term.
Would you expect expected profit to be up higher than this 10% excluding currency going forward, more consistent with the 13% that you're getting in all the other offices?
We have some -- while we're carrying these special projects, we have opportunities to generate offsets elsewhere, and so we're seeing some strong growth in earnings on surplus. We are carrying some extra surplus in the businesses. And we have some opportunities in this environment to take some AFS gains. So we think, on a blended basis, expected profit, all these other things, looking at underlying earnings together, we think, we can drive underlying earnings growth in the 15% to 20% range per annum.
Then with respect to strain, I think the guidance was negative $10 million to $20 million a quarter, I think we're positive [ $14 million ] here. Not a lot in terms of help from DB sales. But is it just -- to what extent is this driven by higher interest rates? Would the higher interest rates allow this trend to continue? And to what extent has it helped maybe in each one of the countries?
So I'll start off, Tom, and then Kevin may -- Kevin Morrissey may dive in with some more detail. But the strain, of course, is going to depend on the level of the sales and the mix of the sales that we're seeing and the geographies that it's coming through, with Canada having gains and the U.S. and Asia having strain. So this year you saw a very good mix of business and good sales results in Canada, which drove the positive side of it. And so that's kind of the nature you're looking at, is it depends a lot on mix and geography and the overall results.
Tom, it's Kevin Morrissey here. Maybe I'll just add to that, we do expect to see seasonality, right, on that, so it does go up and down each quarter. For our 2017, we averaged about minus $5 million strain for the year. So that is still a bit improved versus that outlook that we gave. The other maybe key driver, though, I'll add to what Kevin said, is the quality assets backing the new business. And we did very well with some of the asset placements and got quite strong yields this year and that helped contribute to the reduced strain.
How should we look at it going forward? Are you going to stick with this guidance despite the fact that you crushed the guidance in 2017 and rates are higher?
At this point, we are still looking at the $10 million to $20 million of strain per quarter. But we will give you an update during the year next year.
Okay, that's great. And then the final one is on MFS. If we wanted to look at a tax rate specifically for MFS now in the new regime, how should we be looking at that rate? And finally, the income on the seed capital was generally just breaking even in several years ago and -- or in the last several years other than 2017, and it seems to be really high now. So how should we be looking at that one going forward?
I'll start on the seed capital, Kevin Strain can take the tax rate. As to seed capital, what's really going to drive that is a couple things. One is going to be the return that we generate relative to what we're hedging on that particular seed capital. There are times where with -- whatever we're hedging isn't naturally a perfect hedge. So you can get some slippage relative to benchmark. But if we perfectly hedged it and we have really strong performance, you're going to get seed capital gains. And last year was a very good performance year for us, and so there were some gains on seed capital. But that's certainly isn't anything I would look to try and project into the future.
Okay. So some gains but maybe not the same size as what we had in 2017?
Yes, again, I would try not to project gains or losses on that because you've got there are hedging issues that can impact that number and then there's just relative performance as well.
And for $130 million of tax benefit, Tom, that we see in 2018, it should be split roughly 2/3 to MFS and most of the rest goes to SLF U.S.
And what does put the tax rate at for MFS, if you wouldn't mind?
I think you can do a quick calculation on that if you take 2/3, but it's going to put it in the mid-20s.
Your next question comes from the line of Sumit Malhotra from Scotia Capital.
First question is likely going to be for Kevin Strain or Kevin Morrissey. Going back to the assumptions review last quarter. First, first part of it, obviously, last quarter you had moved to strengthen lapse and some of the other policyholder assumptions. Usually you take care of the bulk of that in Q3, but I did note you had a $30 million to $40 million strengthening for lapse again in Q4. Obviously, lapse has been an issue across the industry. So just wanted to get some color for (sic) [ from ] you as to what prompted you to have to step up on this one again this quarter? And somewhat related, I feel like we talk a lot about expense experience in Q4. It wasn't as big as we've seen in the past, but it was a negative drag. Does the adjustment you made last quarter, in your view, does this serve to make the negative expense experience less of a recurring issue in 2018?
Sumit, it's Kevin Morrissey here, I'll take the last question and then I'll hand it over to Kevin to talk about the expenses. So you're right, we do most of our changes in Q3, and that's where you observed that we had quite a bit of strengthening. In Q4, the total assumption method strengthening was $34 million. That was in total. We called out the last strengthening. It was a fairly modest piece, it was only about $10 million. We had a number of other smaller items, nothing I would call out. It was related to the segregated fund guarantee product in Canada and we used predictive modeling analytics to help inform new assumptions relating to withdrawal and partial surrenders. And I would say that this isn't necessarily addressing something from the past like we saw in Q3, where we were dealing with some negative experience. It's more of a case of just trying to make sure that our models remain robust and stay tightly aligned for future experience. So it's something that we do review and monitor each quarter throughout the year and as I said, this one was a fairly modest change.
And on the expense side, we did see experience that was higher in Q4. And as I said in my opening comments, it was -- there was a couple of things happening there. The impact of the annual performance pay cycle and the strong results of the company came through in the quarter. We also see some seasonality on some of our initiative spend in the fourth quarter. So we've seen that for a few years now, where some of those projects step up in the fourth quarter from a spend perspective. We are very focused on controlling expenses. But at the same time, investing in future growth and our leadership position on the technology front. And so sort of balancing -- the work we've did on the restructure charge will have a positive impact, but we will be continuing to invest in growth, in growth in the business at the same time.
But more specifically, I think we talked a little bit about this 3 months ago, does the adjustment that you made in the management -- or the assumptions for expenses, does that make the quarter-to-quarter experience drag less of an issue in 2018? Because that's what I would think the adjustment in that assumption would have done for Sun Life going forward?
Yes, Sumit, this is Kevin Morrissey again. Yes, that's right, the strengthening we did do, it will improve the run rate going forward. Though, we do -- just because of the sources that Kevin identified, we do expect to see some negative experience going forward. But it will be moderated based on the strengthening, yes.
All right. Let's move onto something else. Just on expected profit. And Kevin Strain, last quarter, you gave us some details as to maybe some of the behind-the-scenes factors that have held the total company growth rate back. And it certainly looked a lot better at the top of the house, in Q4. Specifically for the U.S. piece, that number, on paper anyway, still looks flat. Would you be able to tell me, in Q4, what the constant currency expected profit growth for the U.S. was? And then maybe more importantly, Sun Life, and this might be for Dan, you've talked about the repricing that you've been able to put forth in the group business. I think you had 1 round of it of this year, and there might be another round that came through in 2018. Has that started to benefit the expected profit yet? Or is that something that we're going to see in the coming year?
So I'll take the first part of the question and let Dan take the second part. So the expected profit on a constant currency basis for the U.S. grew by $2 million in the quarter.
Sorry, I missed that, it was.
$2 million.
It was up $2 million year-over-year?
In the quarter. Year-over-year, that's correct.
Yes, and on the repricing in the business, that's actually phasing in, in 3 different portions. So we started about 3, 3.5 years ago to reprice the disability business. We're largely done with that, we're -- more than 90% of the business has been repriced. The group life business began to be repriced more recently, we're probably about halfway done with that. The life and disability businesses are both generally done on 3-year contracts. And then our stop-loss business, we began repricing because we saw an underwriting cycle occurring there in the third quarter of 2016. Now that business is almost all annually renewable. So we've essentially completed that repricing as well. In terms of when you see that in expected profit, that's an element that we only reset annually. So you would start to see the impact, for example, of the very strong recent stop-loss renewal and new business results when we get into the first quarter of this year.
All right, that's helpful. Last one for me. Maybe a bit esoteric, so maybe I can tag in Dean here. You mentioned in your opening comments or you made referenced to some of the market volatility that we've experienced in the last couple of weeks. And I think a lot of it, at least, has been attributed to some of the upward move in bond yields. One of the questions that comes up for life [ co's ] and maybe, in this case, specifically to Sun Life is, we always think of these companies as being very interest rate sensitive, especially at the longer end of the curve. So as analysts or investors, when we see 10-year yields moving 50 basis points since the beginning of the year, if we turn it over to you, from a management perspective, how do you view that as -- in terms of a near-term impact for the company? Like we think it's positive, it doesn't seem like it's as positive as it used to be based on your disclosures. But from a specific product or line item perspective, what do you think the market should be focused on when the bond yield conversation with this sector comes up?
Thanks, Sumit. It's Dean here. There are first order effects and second order effects. The first order effects of higher yields show up in better strain. They show up in -- as well in terms of stronger earnings on surplus. And to the extent that those also show up in terms of equal spreads, corporate spreads or even wider spreads, in some cases, you might see even some lift in investing gains. But the first 2 in particular, strain and stronger earnings on investment income, would be features of living in a higher -- with a higher yield curve. The second order effects are demand for a number of our products. And the derisking of defined benefit pension plans, which we've talked about before, there are a number of employers who have been sitting on the sidelines waiting for 2 things to happen. One is for their DB plans to get better funded. And the equity markets we've just seen have really done a lot to help DB plans to get back on side in terms of their funding levels. And second of all, they've been waiting to see higher long-term interest rates. And so we would expect, all things being equal, to see higher demand for pension buyouts in our Canadian business. We would expect to see higher demand for individual payout annuities in our wealth business in Canada. And possibly even higher demand for some of our fixed interest products, like GICs and accumulation annuities.
And your next question comes from the line of Mario Mendonca with TD Securities.
This question might be best for Dean and Dan, as well, if you could offer some thoughts. There was a large transactions in U.S. Group Benefits, Liberty's business was sold. And as I read about it, it sounded -- frankly, it sounded perfect for Sun Life, particularly given your low leverage ratio and how this could, as you said before, Dean, improve your strategic capacity. So maybe without commenting specifically on Liberty, because that may not be appropriate, what is it about the Group Benefits business? Is this still a business that, Dean and Dan, you're eager to make acquisitions in? Or is there some specific criteria that you're after in that market that would really inform us about your intentions?
Well, Mario, it's Dean. I'll start and then Dan will, no doubt, want to add. As I said earlier, we have come a long way in the U.S. group business, and the Assurant acquisition has really helped us both in terms of capabilities and scale. And Dan and the team have done a fine job executing on that. We're not done yet, but it's gone very well and actually is ahead of our expectations. This is a very capital-intensive business. It's a very technology intensive business. You see that in our Canadian group business. You see that in the U.S. group business, major systems, technology. And that bar is just going up. You see it in this investment in digital and plan member interaction and proactivity. So scale does matter in this business. And I think we're investing in that scale. We think, given our current heft, we're big enough to succeed and compete in the U.S. group market. But nonetheless, there are other capabilities that we would be interested in adding, and maybe I'll turn it over to Dan and he can talk about some of those in terms of the areas where we want to round out and expand our business.
Yes. Mario, we certainly are interested in adding capabilities and growing scale. We like the business very much. We like the return profiles of it. And we like our position in it. Without commenting on any particular transaction, of course, what we also need is to have the economics work and work well for us. So that would be a key criteria to make sure that there is a price that we can get the right kind of return on. And we're certainly, as Dean said, seeing that on the Assurant transaction. We're very pleased, overall, with the results there. I would also point you to the announcement we made as part of our overall announcement of our new strategic partnership with Collective Health. We view that the business that we're a part of is the entire employee benefits ecosystem. We already play a significant part in the health space in the U.S. employee benefits world through our stop-loss business. And we have interest, really, in all parts of the benefits ecosystem beyond some of the products that we're in today.
Yes, please go ahead.
Sorry, just going to add, it's Dean here, I was just going to add one other comment. What you are seeing, and when you stand back from these recent transactions, is a consolidation of the market, which in the long run is a healthy thing, we think, in terms of competitive behavior.
Actually, that's exactly where I was going with my second part of this question. On that acquisition, the buyer talked about improving margins in the target company from 1% to 5% to 7% and suggested that it could happen over what seemed to me like a short period of time. Does that to speak to rather than a deterioration in competition but actually a more rational market to you? Like when I heard that, when I was reading that from the buyer, it did -- it struck me as something like the market is becoming more disciplined, not less disciplined. How do you view it, Dan or Dean?
Yes, I won't really comment on that particular competitor and what they're saying they're going to do. Obviously, increasing margins by a significant amount is not something that can happen very quickly. The market is clearly more rational now than it, perhaps, was a couple of years ago. And obviously, that's a good thing. But I would also say there's an opportunity right now in the market with 2 major transactions and the attendant consolidation and also disruption. We're making significant investments in national accounts, which at least 3 of those 4 players are very active in. And we think these transactions will also bring some of that business to market as opportunities for us.
Your next question comes from Paul Holden from CIBC.
Maybe to continue that conversation a bit. If we think about Collective Health and then your agreement with Pareto and we think about them in aggregate, can you give us a sense of how much scale that might add to your U.S. group business, whether it's on the top line or bottom line? What kind of potential should we be thinking about here?
Yes. At this point we're not ready to speculate on what the specific potential for increased business size with Collective Health would be. Pareto, we did get some sales in the fourth quarter. So we're off to a very good start there. I guess what I would say is, overall, our stop-loss business continues to be an area of great growth potential for us. We had a very strong year in stop-loss sales this past year, actually well above what our expectations were. We're seeing a more rational stop-loss market. We made the price adjustments we needed to make over a year ago. A lot of our competitors are still repricing their books of business right now. And we're seeing somewhat of a flight to quality with brokers bringing business to us and others like us who have scale and capabilities and stability. And then we think Collective Health and Pareto will be additional catalysts for growth, first in our stop-loss business and then, more broadly, across all of our group province.
Okay. And then as we think about everything you've just said and the margins you achieved in the U.S. group of 5% for 2017 with a very weak start to the year, like why shouldn't we think that margins will be somewhere at the top end of your guidance range of 5% to 6% or maybe even a little bit higher? Like is there a scenario where you can imagine -- a realistic scenario you can imagine where margins don't expand year-over-year?
Well, we're very pleased that we got to the margin range that we had targeted earlier than we expected. One caution on the way we're describing margins, we're doing that on a trailing 12-months basis. So each quarter, we drop a quarter. So if we dropped a weaker quarter, the margin will go up. If we drop a stronger quarter, the margins may temporarily go down. But with that said, we do have a lot of additional tailwind. As I've mentioned, the stop-loss business, we had a very good fourth quarter in terms of not just new business but the renewal increases that we were able to get. So we should see some lift in the future from that. While we're over 80% there on our acquisition integration synergies, there's still more room there, and obviously that will come into play. And then of course, tax reform. So we're optimistic that we will continue to see our margins grow in the group business.
Okay, great. And final quick question, probably for Kevin Dougherty. In terms of operating expenses in Canada, looks like they were up 8% in 2017. Does that pace of growth slow in 2018? And what should we expect for expense growth in Canada in 2018?
Yes. I think, in Canada, one of the things we saw in Q4, in particular, in Canada was incentive compensation accrual, which was in the range of about [ 20 ], I think. So that was significant and a couple of other one-off kind of items that are nonrecurring. So you can kind of -- should know about that. I would say, through the year, expenses improved -- the expense growth rate and we are -- and in spite of a significant investment in digital and new businesses and so on, I think it will moderate through 2018. We've done some expense work in Q4 and taken a provision for that. But we'll continue to invest in the business. So I think it will moderate over 2018.
Okay. So moderate maybe to a level where it's low single digits or close to 0? Is that a fair assumption?
I think low single digits is the right way to think about it.
Your next question comes from Darko Mihelic from RBC Capital Market.
Maybe in the interests of time, I'll just a one simple question and ask a bunch later of the IR folks. But just a question for Kevin Strain. Life insurance modeling is pretty difficult. And the corporate segment, the underlying, it was a loss again. What should we expect from corporate? Just if you can give us a hand with our expectations for corporate in 2018, that would be a real help.
As you know, Darko, there's a few things in the corporate segment, there's the U.K., the runoff-fee insurance and the Corporate Support. This quarter, the U.K. had a one-time tax charge as well. There was an autumn budget in the U.K. that impacted that corporate line by CAD 13 million and there was also some ACMA that came through the U.K. line. The --so if you are thinking about sort of this quarter versus prior quarters, you get some impact from that. I'm just looking, full year corporate segment this year was a negative [ 52 ] on an underlying basis. U.K. positive. And runoff positive. And then the corporate costs. The thing about the U.K., it's been running at a level around $100 million, maybe a little bit over $100 million. And you can expect that it will continue to be strong on the U.K. results. And we expect to continue to get lots of cash out of the U.K. The runoff has been a smaller piece. And then the corporate segment does bounce around quite a bit.
Okay. I guess that helps, Kevin.
You got a shot at the U.K. and the runoff, I think the corporate one is a harder to give sort of number where that would end up.
Yes, I know, I appreciate that. It's just from [ 7 ] to minus [ 52 ], it is just one more difficult part of the model I was hoping to get some color on. Thanks a lot. I appreciate it.
There are no further questions at this time, I'll turn the call back over to Greg Dilworth.
Thank you, Dan. I'd 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 on our website later this afternoon. Thank you, and have a good day.
This concludes today's conference call. You may now disconnect.