Earnings Call Transcript - MFC Q2 2023

Operator, Operator

Please be advised that this conference call is being recorded. Good morning, and welcome to the Manulife Financial Second Quarter 2023 Financial Results Conference Call. Your host for today will be Mr. Hung Ko. Please go ahead, Mr. Ko. Thank you. Welcome to Manulife's earnings conference call to discuss our second quarter and year-to-date 2023 financial operating results. Our press materials, including the webcast slides for today's call, are available on the Investor Relations section of our website at manulife.com. Turning to Slide 4. We will begin today's presentation with an overview of our second quarter results strategically by Roy Gori, our President and Chief Executive Officer. Following Roy's remarks, Colin Simpson, our Chief Financial Officer, will discuss the company's financial and operating results. After the prepared remarks, we'll move to the live Q&A portion of the call. Before we start, please refer to Slide 2 for a caution on forward-looking statements. No statement of material factors or assumptions applied in making forward-looking statements, and actual results may differ materially from what is stated. I would also refer you to Slide 38 for notes on the non-GAAP and other financial measures used in this presentation, which includes an explanation of transitional results for 2022 comparison. With that, I'd like to turn the call over to Roy Gori, our President and Chief Executive Officer. Roy?

Roy Gori, CEO

Thanks, Hung, and thank you, everyone, for joining us today. Yesterday, we announced our second quarter 2023 financial results. In our second quarterly reporting under IFRS 17, we delivered strong operating results, including core earnings of $1.6 billion, net income of $1 billion, strong growth in EPS and core EPS, and core ROE of 15.5%. I'm encouraged by the strong top-line momentum that we're building across our new business metrics, with double-digit growth in APE sales, NBV, and new business CSM compared with 2022. We also generated Global WAM net inflows of $2.2 billion. APE sales increased by 12% from the prior year quarter, led by Asia, where APE sales increased 26% year-on-year as we capitalize on the post-pandemic recovery in the region. The strong sales supported a 10% increase in NBV and a 15% increase in our new business CSM. The increase in new business CSM was in line with our medium-term target. The strong growth in new business CSM, particularly in Asia, gives us confidence in the future growth of our insurance service results. Our strong core earnings of $1.6 billion were up 4% from the prior-year quarter as growth across our insurance and corporate segments was partially offset by a decline in Global WAM. Our continued capital deployment through share buybacks contributed to our core EPS growing 6% from the prior-year quarter. Net income of $1 billion was impacted by lower-than-expected returns on our older portfolio. While some of the older classes are facing headwinds, we continue to generate overall positive return from the portfolio. We also delivered strong core ROE of 15.5%, which is in line with our medium-term target of 15% plus. We continue to maintain a strong capital position supported by a LICAT ratio of 136% and a leverage ratio of 25.8%. We also reported adjusted book value per share of $29.42, a 5% increase from the prior year quarter over a period that had sizable interest rate movements and during which we returned significant capital to shareholders. Overall, we have a very attractive business mix, including exposure to the emerging middle class in Asia and the developed North American economies, as well as the scaled global asset manager. And the three megatrends that underpin our business remain unchanged: a growing middle class in Asia, an aging population, and the digitization of the consumer. We are strongly positioned to capitalize on these opportunities, and the momentum that we generated in the quarter is an illustration of our growth potential. In Asia, the team is capturing the opportunity as the region continues to recover from the pandemic. I'm really excited that Phil Witherington, formerly our CFO, returned to Asia in July to lead the business. Phil has a deep appreciation of our Asia franchise, having previously served as Manulife Asia's Interim CEO as well as its CFO. In the short time that he's been there, we are seeing strong momentum building in our Asia businesses in the third quarter. Our top-line metrics bode well for the future earnings growth of the segment. I'm confident that Phil will lead our team and double down on our growth ambitions in the region, and he's here on the call with us today. I would also like to thank Damien Green for his leadership during the transition to the position of Chair of Manulife Financial Asia. In Global WAM, we delivered strong net inflows of $6.6 billion in the first half of 2023, supported by our unique business profile, which is diversified by geography and business line. We've maintained strong sales rankings in many of our key markets, including the number one spot in Canada's retirement market and number two in the U.S. mid-case retirement market. Core earnings were down from the prior year period, due in part to higher investments as we strive to continue building new business. However, I'm encouraged to see us building momentum, with our core earnings improving 12% and core EBITDA margin improving by 2.2 percentage points from the first quarter. As part of delivering value to shareholders, we're committed to helping our customers live longer, healthier, better lives. And we're executing against our ESG strategy and commitments. In Hong Kong, we launched enhanced health care coverage to better address the growing demand for health and protection services. In Canada, we further expanded our behavioral insurance program, making Manulife Vitality available on new Manulife Par individual insurance policies. And currently, our own timberland and agriculture properties have already removed more carbon from the atmosphere than our operations emit. We strengthened our commitment to reducing emissions by disclosing science-based targets, including an increased ambition to reduce absolute scope 1 and 2 emissions by 40% by 2035. This is all part of our commitment to helping make decisions easier and lives better, which will drive value for shareholders. And finally, since we resumed our share buyback program in 2022, our strong capital position has enabled us to return over $6.6 billion of capital to shareholders through dividends and share buybacks, including more than $440 million of buybacks during the second quarter. Overall, it was a very encouraging quarter with strong top-line momentum, and our strong sales performance leaves me optimistic for the future. With that, I'm happy to turn it over to Colin Simpson, who has succeeded Phil as our Group Chief Financial Officer. Colin brings a wealth of experience within the insurance industry. You'll get to know Colin very well as we intensify our focus to generate value for our shareholders and customers. With that, I'll hand it over to Colin.

Colin Simpson, CFO

Thanks, Roy. I wanted to start by saying I'm really excited to take on this role. I truly believe Manulife has an enviable portfolio of businesses and incredible potential. And as I get my feet under the desk, I look forward to connecting with the investment community. I'll start on Slide 11, which shows a snapshot of our financial KPIs in the second quarter of 2023. We delivered strong results. Core EPS increased 6%, and we generated strong momentum in our top-line metrics with APE sales, new business value, and new business CSM each up by double digits. We also delivered positive Global WAM net flows of $2.2 billion. Our balance sheet remains strong with 5% growth in adjusted book value per share, and our LICAT ratio of 136% provides ample financial flexibility. Moving to our top line and turning to Slide 12. We generated APE sales of $1.6 billion and new business value of $585 million. New business CSM of $592 million increased 15% from the prior year, which is a step-up from the first quarter 2023 growth rate and in line with our medium-term target. Asia-led APE sales growth was fueled by Hong Kong, where APE sales doubled primarily due to a return of demand from Mainland Chinese visitors. I will say the emergence from the pandemic has been uneven across our operating regions in Asia, but momentum is encouraging with 26% growth in new business CSM. In Canada, APE sales declined 11%, driven by lower group insurance sales as the prior year included very strong large case sales and segregated fund products, which was broadly consistent with the industry. Despite the decline in sales in Canada, new business CSM increased 21%. In the U.S., APE sales declined 15%. We continue to see higher short-term interest rates attract customers away from longer duration accumulation products, particularly for our high net worth customers, which is a target market for John Hancock. But we have maintained pricing discipline in a competitive environment, and we saw quarter-on-quarter growth in both new business value and new business CSM. Slide 13 illustrates the changes in contractual service margin balance, which is an important store of future profits under IFRS 17. During the first half of 2023, the contribution from new insurance business and expected CSM roll-forward exceeded the CSM recognized for service provided, which sets the foundation for organic CSM growth. This was partially offset by insurance experience reported through the CSM of $127 million. Unfavorable lapse experience in the U.S. and persistency in Asia emerging markets outweighed favorable long-term care experience. As a reminder, under IFRS 17, it's important to consider insurance experience through both core earnings and the CSM; a holistic view is available in the appendix of this presentation. I would add, because I know it is a focal point for some, that LTC experience was a modest net gain this quarter across core earnings and CSM combined. Putting this all together, organic growth in CSM was 3% during the first half of 2023, or 5% on an annualized basis. Inorganic CSM movement, which is influenced by market impacts, declined by $342 million over the same time period, largely driven by foreign exchange rate movements, which are not reflective of the fundamental business performance. Overall, the total CSM balance increased 4% in the first half of 2023 on a constant exchange rate basis, and we remain focused on achieving our medium-term CSM growth target of 8% to 10%. Moving to Slide 14. Our Global WAM business recorded net inflows of $2.2 billion, up from $1.7 billion in the prior year. We experienced lower mutual fund redemption rates, which improved retail fund flows. The prior year also benefited from a $1.9 billion institutional equity mandate. Overall, Global WAM's average assets under management and administration increased by 1%, driven by the acquisition of full ownership interest in Manulife Fund Management in Mainland China, which in itself is an exciting opportunity for us. Net fee income yield of 44 basis points increased modestly, reflecting higher fee spread and a change in business mix. We've been investing in our Global WAM business, resulting in higher expenses, and you can see that the core EBITDA margin decreased 350 basis points to 24.6%. This was also slightly impacted by lower earnings from seed capital as we repatriate funds. Moving to Slide 15, which shows our drivers of earnings analysis, which we are showing relative to the prior year and prior quarter, to give you a sense of our progress. The first area I'd like to focus on is how high interest rates are flowing core earnings. You will notice higher expected investment earnings driven by higher investment rates in fixed income securities as well as business growth. In addition, we earned more interest on surplus in the higher-yield environment. These two factors are partially offset by high debt costs, which you can see in other core earnings and slower CSM amortization on certain VFA, or variable fee approach contracts, impacting the overall insurance service result. The second point to draw out from this slide is on insurance experience, which shows a modest experience loss of $22 million. The prior year quarter had a significant benefit in U.S. Life during a period of volatile mortality related to COVID. Finally, you will notice that our expected credit loss is neutral this quarter, which is a significant improvement on the charge in the first quarter. Slide 16 shows our earnings reconciliation to net income attributed to shareholders for the second quarter. Despite the improvement from the prior year quarter transitional net income, there was a $570 million market experience net charge. This included a $478 million charge from lower-than-expected returns on ALDA, largely driven by real estate and energy-related private equity investments. The $141 million adverse other investment result mostly reflects a change in the Japanese yen currency rate, which saw a sizable movement during the quarter. Note that while we reported a net ALDA charge reflecting challenges faced by certain asset classes, the portfolio generated a positive return in the quarter, albeit below our long-term expectation. The commercial real estate market continues to be difficult. And in recent quarters, we've seen capitalization rates rise as interest rates have increased, adversely impacting valuations. It is worth reiterating that the vast majority of our real estate portfolio is independently appraised on a quarterly basis. So while difficult issues persist in the office commercial real estate market, we believe our valuations are current. For example, our most recent valuations on our U.S. office portfolio reflect an approximately 30% reduction from peak. I would also note that over the past decade, our North American office exposure has decreased from over 40% of ALDA in 2013 to close to 10% today. Turning to Slide 17 and our ALDA portfolio. Returns have been lower in the recent quarters, but we invest in asset classes that are well-suited for insurance liabilities and generate attractive returns, with lower volatility relative to both equity and credit indices over a medium to long time period. In 2020, for example, our ALDA portfolio generated a $1.4 million loss relative to expectations, but we more than recovered that loss in 2021. And in the 5 years preceding 2023, the portfolio outperformed our assumed returns on a net basis during a volatile period that included the pandemic. Over the years, Manulife has built up strong asset origination and management capabilities, which I view as a competitive advantage. The historic return profile, which we show on this slide, gives us confidence in achieving our expected long-term returns. We have also added a slide in the appendix to show ALDA performance over the past 5 years. Moving to Slide 18. We delivered core ROE of 15.5%, in line with our medium-term target of 15% plus. And when you consider our current valuation, I believe a mid-teens ROE, coupled with improved stability of earnings and book value, offers investors significant value. This is a key factor in our decision to remain active in our share buyback program. And during the quarter, we purchased for cancellation nearly 1% of our outstanding common shares for over $440 million. And you can see we've steadily returned capital to shareholders over the past five quarters. This has contributed to the expansion of our core ROE. On to Slide 19. We continue to maintain a strong balance sheet and capital position. This underpins our commitment we make to our customers with every policy sold and gives us financial flexibility. At the end of the quarter, we had $21 billion of capital above our supervisory target ratio, a LICAT ratio of 136% remains robust. The 2 percentage point decrease in our LICAT ratio in the second quarter was primarily driven by the redemption of subordinated debt and share buybacks, which also drove a net 0.2 percentage point reduction in our financial leverage ratio. And finally, moving to Slide 21, which shows how we're tracking against our medium-term targets. Our core EPS growth has been solid in the first half of the year, though slightly below our target. Core ROE of 15.2% year-to-date is in line with our medium-term target. And although our CSM metrics have performed below target in the first half, we built strong momentum in the second quarter, including new business CSM growth of 15%. All in, we've delivered strong results in the first half of 2023 and are well positioned to deliver for our customers, shareholders, and colleagues. This concludes our prepared remarks. Before we move to the Q&A session, we'll now open the call to questions.

Operator, Operator

Our first question is from Meny Grauman from Scotiabank.

Meny Grauman, Analyst

First question, I wanted to ask about expected investment earnings. We're seeing a big improvement sequentially and then very strong growth year-over-year. Just trying to understand the sustainability and the potential variability in that number going forward. I guess the first question is what we're seeing from a year-over-year basis, really just a function of the higher rate environment? Or are there some other key factors that we should keep in mind? And as we look forward, if we assume that the rate environment maybe has peaked to some extent, what does that mean about the trajectory of this line item going forward?

Colin Simpson, CFO

Meny, it's Colin here. I'll kick off and others can join in. I mean, what you're seeing is, absolutely as you intimated, high yields. We're looking at and through core earnings; to the extent that yields stay where they are, we would expect this to persist. So absolutely sustainable; if yields go up even further, then we would expect to earn more through that line item.

Scott Hartz, Executive

Sorry, it's Scott, to add a bit to that. What's driving it is the higher rate environment. And as Colin said, if rates stay where they are, we would expect it to be sustainable, and, in fact, even grow a bit. As the portfolio turns over, we will be turning it over at higher yields.

Meny Grauman, Analyst

And how does the inversion of the yield curve, is that playing a factor here in terms of how this line item behaves? And so how should we think about sort of the shape of the yield curve in terms of what the impact is on this line item?

Scott Hartz, Executive

I think while the yield curve is inverted, all yields are higher that exist on the current portfolio, so that's all positive.

Operator, Operator

Our following question is from Paul Holden of CIBC.

Paul Holden, Analyst

So strong results out of Hong Kong sales, as you highlighted. And then, Roy, you also mentioned continued positive momentum in Q3. I guess what I want to understand there better is just everything we read here talks about sort of the stall of the consumer recovery in China. So wondering how we square those two factors. And then I also want to understand, was Q2 like an abnormally strong quarter because it's a little bit of a catch-up based on pent-up demand? Or do you think there is momentum based off sort of that run rate?

Philip Witherington, Executive

Paul, it's Phil. Thank you for the question. And can I just start by saying how fantastic it's been to be back on the ground in Hong Kong and in this role representing our Asia segment. And Paul, that leads me into your question. There is a lot of media talking down the conditions in Hong Kong and China. But the reality is being on the ground, there's a tremendous amount of activity, and it feels to me very much like it did pre-pandemic. And I think you're seeing that in our performance in the second quarter. That 26% growth in APE across Asia, translating to a 26% growth in new business CSM, I think that's very encouraging. And of course, as we've said before, that SAM growth will translate to future core earnings growth as well. So I remain very optimistic about the prospects for Hong Kong, China, and Asia. And I will point out that actually, in China, we hear about the potential stalls to the recovery in China, but our second quarter was the strongest second quarter on record in China. I think that does demonstrate the robust emergence from the pandemic. You referenced in the second component of your question whether Q2 should be seen as abnormal. I don't see it as abnormal at all. I see what we've experienced in the second quarter as a continuation of the momentum across Asia from the first quarter. And as Colin mentioned, there is an uneven recovery from the pandemic across markets, but that's the benefit that we have of a diversified portfolio. And of course, an important driver of our growth in the second quarter is the Mainland Chinese visitor customer segment to Hong Kong. That has been very notable. It's consistent with our strategy to capture a greater share of the MCV flows, but I don't want that to overshadow a strong domestic business, a strong domestic performance in Hong Kong and across Asia. And the same statistic is true if we strip out the benefit that we've seen from Mainland Chinese visitors, which I believe is sustainable. But if we strip that out, we're still seeing high single-digit growth rates in APE in the second quarter. So a strong domestic business in Hong Kong, supplemented by incremental growth in Mainland Chinese visitors that I believe is sustainable; I don't think we'll see the same levels of growth that we've seen in the first and second quarters, but I think this is something that will continue to be in the run rate, reflecting the fact that the underlying customer needs remain in place.

Roy Gori, CEO

Paul, Roy here. Just a couple of adds. Two of the core strengths of our Asia franchise are, a, that we are at scale. In fact, we're the third largest Pan-Asian player. That makes a big difference in terms of the ability to defray costs and actually continue to deliver momentum. And then the second big advantage of our franchise is that we're incredibly diverse, both from a geographic perspective, but also from a channel perspective, with good contributions from agency bankers as well as direct mail. So that really does fill us with confidence, as Phil highlighted.

Paul Holden, Analyst

And then my second question is on commercial real estate. Obviously, higher cap rates, as you highlighted, have been a drag on returns. I guess what to understand better is if cap rates stop increasing and just kind of level out from here, would you be able to meet your long-term return assumption? Do you think at this point real estate will be in for a longer period of below-normal returns?

Scott Hartz, Executive

Yes. Paul, it's Scott. Thank you for the question. And to your point, there's been a couple of factors driving the underperformance in real estate versus assumptions. One has been, obviously, the stress in the office with a lot of the work from home reducing demand, which it's hard to say where that's going to go. Although we do see positive signs with companies like Zoom coming back to the office. But the other one, which is probably more in recent quarters, has been the rise in cap rates. And there may be a little bit of continued pressure on that in the short run, but I'll remind you that rising cap rates mean that we're discounting at higher interest rates, the future cash flow off of those properties. So higher cap rates actually imply higher future returns. So I'm very confident over the long term, we'll be able to achieve those assumptions. In the short term, it's obviously hard to predict.

Operator, Operator

The following question is from Tom MacKinnon from BMO Capital Markets.

Tom MacKinnon, Analyst

I have a question regarding the sales in Asia. The 25% year-over-year increase in Asia APE corresponds to a 25% rise in the new business CSM, as indicated on Page 22 of your SIP. However, it seems you're reporting only a 3% year-over-year increase in your Asia new business value. Can you clarify the reasons for this discrepancy? I understand that CSM is influenced by sales, but what accounts for the difference in how new business value is calculated? Is there any capital included in this calculation? I would appreciate your insights on why the growth in new business value is significantly lower than the growth in CSM.

Philip Witherington, Executive

Tom, this is Phil. And you're right to point out the growth in APE and new business CSM, both growing 26% across the region with 3% new business value growth. And I'll hand over to Steve to comment further, but one thing that I will highlight is that new business CSM and NBV are both good metrics to look at as indications of the value that we generate from the growth that we deliver. But there may be variations quarter-to-quarter. And one thing to highlight with respect to 2023 versus 2022 is product mix. And you may recall that a year ago, the voluntary health insurance scheme in Hong Kong was introduced, which drove quite a lot of interest in health products in Hong Kong. That's an annually repriceable short-term product that for IFRS 17, therefore, doesn't impact the CSM because it goes through the premium allocation approach model. But it was something that was reflected in new business value. So that's one thing that reflects the divergence in growth rate in 2023 and between the two metrics. But Steve, you may wish to comment further on the methodology.

Steven Finch, Executive

Yes. And Tom, I call your attention to the fact that total company level, we saw a broad alignment between new business CSM growth at 15%, APE growth at 12%, and NBV growth at 10%. So just as under IFRS 4, you'll recall, we would see some variability between the new business gains and the NBV. And similarly, under IFRS 17, we'll see some variability between new business CSM and NBV. But over time, they will be directionally consistent, and that's what you should expect to see in all of our business. Just want to add to Phil's point that we also, from higher interest rates, increased risk discount rates in Asia, which was a slight headwind to NBV.

Tom MacKinnon, Analyst

And then just as a follow-up, the NBV margins in Hong Kong were running like 80%, and now they're 50%. Is there a business mix issue there? And it hasn't really moved quarter-over-quarter despite the big jump in the sales.

Philip Witherington, Executive

Thanks for the question, Tom. You highlighted an important point. The total NBV margin in Hong Kong is around 50%, slightly above that. We have experienced a shift in business mix, with the volume doubling in Q2 2023 compared to the same quarter in 2022, largely driven by the MCV customer segment. It's important to note that while the MCV business is high-quality and profitable, it has lower margins than the rest of our business in Hong Kong. Like the rest of the industry, we are seeing MCV customer demand leaning towards lower-margin savings products, which contrasts with the pre-pandemic period when there was higher demand for protection and health products from this segment. We believe there is an opportunity to enhance our product mix, enabling us to meet a broader range of customer needs, which could positively impact our margins in the future. Additionally, our domestic business in Hong Kong continues to be vital and has grown steadily during the pandemic. In fact, we have gained market share in this high-margin domestic sector. Compared to the second quarter of 2019, our domestic business has grown by 11%, while the overall domestic market has shrunk by over 20%. This reflects the quality of our underlying business, which is our highest-margin operation in the region. I'll stop here, Tom, and I'm open to any further questions.

Roy Gori, CEO

Tom, I might just add as well that 50% NBV margin is incredibly high. That's really solid and strong. We’re really very happy with our margins out of Hong Kong, quite frankly, out of Asia. And the 80% margin that you referred to is slightly elevated versus our more average medium-term NBV margin coming out of Hong Kong. So there is a bit of a comparison year-on-year that makes that look more dramatic than it actually is. And as Phil highlights, our focus is on growing NBV. Obviously, we want to do that at high margins, and we think there's more opportunity to continue to grow our margin, as we have over the years.

Tom MacKinnon, Analyst

Is the distribution of the MCV business, is that more broker-related or more of career agent-related?

Philip Witherington, Executive

Yes. Thanks for the follow-up, Tom. Brokers are an important part of it, but agency is an important point as well. We have made some specific investments over the course of the pandemic in order to take a greater share of the MCV customer segment. And we feel that's appropriate given that really the legitimization of the segment through government policies that have been put in place over the course of the pandemic and the important role that Hong Kong has to play in the development of the Greater Bay Area. So some of the things that we've been doing, we've opened customer service centers in places that are convenient for Mainland Chinese customers, as well as that we've been developing our hospital network in Mainland China. In fact, we're a leader in that regard. We've been enhancing the customer materials that we have into multilingual materials. So not just traditional Chinese for the Hong Kong domestic market, but also simplified Chinese as used in Mainland China. So lots of things that we've been doing, and in particular, in agency, which is a really important channel for us in Hong Kong, we've been really looking at hiring a greater proportion of Mandarin-speaking agents that will be able to interact more comfortably with Mainland Chinese visitor customers.

Operator, Operator

The following question is from Gabriel Dechaine from National Bank Financial.

Gabriel Dechaine, Analyst

I have a question about the strategy and another about the numbers. I'll begin with the numbers. Your Slide 25 is quite useful in illustrating the balance between experience items that impact P&L and those that go through CSM. Could we delve into some of the key components? Can you quantify the larger elements? I'm interested in understanding how the negative LTC experience affected P&L positively through CSM. Additionally, it seems that individual life experience was a more significant negative for the CSM. Could we break down some of the major elements represented in that graph?

Steven Finch, Executive

Sure, thanks, Gabriel. I'll address that; it's Steve. Starting with long-term care (LTC), overall, I look at the total experience, which reflects in both the profit and loss statement (P&L) and customer service management (CSM) figures. In this quarter, total LTC experience showed a modest gain. However, there were cash payments made during the quarter, which negatively impacted P&L. Although we had higher cash benefit reimbursements than anticipated, this was more than balanced out by favorable incidence and lapse experiences, slightly countered by lower mortality levels. When looking at the broader drivers between the two sections, we saw a total pretax impact of $110 million in relation to what's going through the P&L. For LTC, we experienced positive claims across various areas, including continued favorable results in Canadian group benefits, although these results were offset by certain expenses. Moving to the CSM, two major factors affected the experience: adverse persistency, mainly from Vietnam, and ongoing low lapse rates in the U.S. Both trends are not what we expect in the long term. I'm happy to provide more details if needed.

Gabriel Dechaine, Analyst

Well, I mean, what I was hoping for was some numbers. But you got the numbers for me?

Steven Finch, Executive

I think I mentioned the biggest drivers there.

Gabriel Dechaine, Analyst

Okay. Now the strategy question, your one of your peers in Hong Kong, Canadian domiciled one with operations in Hong Kong. Similar to you in the sense that you want to increase your Mainland Chinese sales or sales to Mainland Chinese customers in Hong Kong compared to what you did in prior years. I'm wondering what the motivation is there, just to get a better sense of why that strategy makes sense now, whereas it didn't pre-COVID.

Roy Gori, CEO

Let me start, Gabriel, and I'll hand over to Phil. The first thing I'd say is that MCV sales have always been part of our strategy. We've been focused on the Chinese consumer that's been moving to Hong Kong or tapping into Hong Kong for their insurance and health needs. And again, a core competency of our franchise is that we are diverse. But we also have a strong presence both in Hong Kong and in China, which lends itself to capturing that segment. And I would highlight that for us, the key differentiators on why we think we can win and why we quite frankly have won in the MCV space is a strong brand. And having a strong brand in Asia makes a massive difference. Obviously, being there for more than 127 years and having established a credibility with consumers and all other stakeholders really matters because people can trust us. We also aspire to have the best products in the market, and we have the best people. So I think those combinations are why we will continue to outperform in Asia and, quite frankly, in the MCV space. So it's always been a part of our focus. And now with the reopening, given that, that market had gone away for some time, we're just doubling down on it is the way I would position it. But Phil, you might want to supplement that.

Philip Witherington, Executive

Sure. Happy to. And Gabe, thanks for the question. A couple of supplements to what Roy has said. The first thing, and I referenced this a few minutes ago, is really over the course of the pandemic, the formalization of the Greater Bay Area framework puts Hong Kong right at the center of the GBA. And I think that is something for us that provides us with confidence this is a good market for us to capture strategically. I think the second thing is that looking on at the underlying customer needs that exist within our Chinese Mainland customer segment, those needs are there greater than ever before; the need for long-term savings for retirement, the need for health care, the need for critical illness. And it absolutely makes sense that that's an appropriate market for us to capture. And then the final point that I'll make is that given our scale position in Hong Kong, we have the capabilities; we have the products. It just makes strategic sense for us to scale that with the flows that are coming into Hong Kong through MCV visitors. What I will say is that we've seen a big surge in the first and second quarter. I do expect that to be maintained, but I don't expect those rates of growth to continue. I think that rate of growth reflects a bounce-back. But as we've seen pre-pandemic, there can be variation in quarter-to-quarter in MCV volumes, but it's there over a long period of time; I expect the customer segment demand to continue.

Operator, Operator

Following question is from Mario Mendonca from TD Securities.

Mario Mendonca, Analyst

First, going back to Asia for a moment. The addition to the CSM from new business was obviously very strong this quarter. And when I try to connect that to something like insurance sales, it would appear that the contribution this quarter was far greater than the increase in insurance sales. So my question is am I missing something? Should I also be considering the revenues from sales in annuities? Or is it appropriate to just compare that to the increase in insurance sales?

Philip Witherington, Executive

Mario, it's Phil. Thanks for the question. I would encourage you to look at total APE sales, which include both insurance and annuity sales. The annuity sales shown in the SIP are absolute dollar figures, not APE, so they can be influenced by the mix of single premium and regular premium. We consider APE sales as the primary metric, and as Steve mentioned earlier, there is a strong correlation between new business CSM and APE.

Mario Mendonca, Analyst

But would you agree this, Phil, that this quarter the increase in new business CSM was outsized relative to the increase in APE? It just appears that way. I can see APE this quarter, very similar to last quarter, yet the increase in the CSM was far greater.

Philip Witherington, Executive

Yes. I'll answer with respect to Asia and then hand over to Steve to answer. There is a higher new business CSM this quarter. We have made some refinements to our methodology, which have had a benefit. But specifically for Asia, if we strip out the impacts of those refinements, we'd still be seeing growth of approximately 20% in new business CSM, which is a strong demonstration of the value that we're driving. So I agree with you, Mario, it's a little elevated this quarter, but I do expect to see strong business CSM growth in the quarters to come. Steve, if you want.

Steven Finch, Executive

No, nothing to add. That's...

Mario Mendonca, Analyst

Steve, just so we're clear, does that mean there was like a one-time catch-up this quarter? Or is this the new sort of sustainable CSM if APE were to be the same?

Steven Finch, Executive

There was a modest catch-up, year-to-date catch-up in the quarter on some power methodology. But as Phil said, it was still a very strong quarter of growth. So the year-over-year growth instead of 26% still would have been approximately or north of 20%. So fairly sustainable.

Operator, Operator

The following question is from Lemar Persaud from Cormark Securities.

Lemar Persaud, Analyst

I want to stick on that line of questioning on the ALDA portfolio. I understand the point you're trying to make on that ALDA slide in the appendix suggesting that the returns are solid over the past three and five years so over the longer term. But it has been below the expectation for a full year now. So I guess, is there like a line in the sand that we can draw suggesting that expected actual returns are below the expected for, say, two years, then you guys have to revisit the return assumptions? Or could that persist for two to three years before you guys have to revisit those assumptions? I'll leave it there and then I have a follow-up.

Scott Hartz, Executive

Sure, Lemar. Scott again, thanks for the question. We revisit those assumptions every year. So every year, my team works with Steve's team to look at historical returns, to look at what the market is expecting on these things going forward. And it is a very long-term assumption. So looking at any quarter or any given year, is not really the right way to look at it. And I would tell you, I have more confidence in achieving those returns now after having underperformed there over the last year. A lot of that underperformance is driven by higher discount rates on these assets, which does weigh on valuations now. But higher discount rates imply higher returns in the future. So frankly, in periods of underperformance, I have more confidence going forward. It's almost the reverse. If we outperform for a while because discount rates are down, that's when we start to ask ourselves should we be bringing down the long-term returns. But in this environment, I'm very confident in achieving those long-term returns.

Steven Finch, Executive

And Lemar, it's Steve. I'll chime in. In the past, a lot of these questions came to me because if there was a change in assumptions, that went through reserves. But I wanted to add as well that these assumptions are important for our product pricing, et cetera. And just reinforcing Scott's point, it's a very thorough process that we go through each year to validate long-term return assumptions. And I won't repeat what Scott said, but I also have conviction in these assumptions that they're appropriate over the long term.

Operator, Operator

Following question is from Darko Mihelic from RBC Capital Markets.

Darko Mihelic, Analyst

I promise I do have a long-term view on stuff, but I'm going to focus a little bit on the short term today. And I thought I heard somewhere in prepared remarks that my first question is around commercial real estate values dropping by about 30% in the U.S. I think I heard that correctly. The trouble is I'm not an expert, so I'm looking for a little bit of color around that. In other words, you also just mentioned it was 95% externally appraised. So is 30% kind of in line with what we're seeing at most other places? Is there any benchmarks you could provide? Even internally, how does that compare to your Canada, Asia portfolio of commercial real estate? And maybe lastly, a little bit of color around that would be, would that mark also include own-use commercial real estate? So just looking for some color that tells me you are conservative on the CRE portfolio would be helpful.

Scott Hartz, Executive

Sure. Yes, you heard correctly. Colin's opening remarks highlighted that our U.S. real estate portfolio, specifically the U.S. office real estate segment, constitutes only 5% of the overall outlet portfolio, which used to be a much higher percentage. After the global financial crisis, we sold over $3.5 billion in North American office properties in the last five years, significantly reducing our exposure. However, with a 30% drop, it will inevitably impact our income. We do have over 95% of the portfolio appraised externally each quarter, and we believe the valuations are current. Nevertheless, this doesn’t rule out the possibility of additional pressure in the future. As I mentioned earlier, the current pressure seems to be more widespread due to increasing cap rates rather than being tied to an asset class facing concerns about rising vacancies, which has certainly been the case for U.S. office properties. We have a diversified portfolio, with 28% located in Asia and the remainder in the U.S. and Canada. In Asia, there aren't the same pressures on office spaces as people continue to go to work. Consequently, we haven't observed significant valuation declines in Asia and do not expect to in the future. In fact, certain markets like Singapore have actually seen increased appraisals due to favorable dynamics. The 5% of our U.S. portfolio includes properties that we occupy, which likely has experienced a smaller decline since we do not anticipate large vacancies there going forward. However, rental levels have decreased as vacancies have risen, and our businesses will benefit from this. We will charge lower rents as they decrease, which will be reflected in the value of the real estate. This includes the home office real estate. Additionally, we utilize external appraisals and believe that overall U.S. office values are expected to decline by about 30%. Some competitors may show a decline of slightly less than 30%, but it's unclear if they have used external appraisers and if their valuations are current. We feel confident that our appraisals are up to date, although there is potential for further weakness.

Colin Simpson, CFO

Just to add a point here, Darko. Commercial mortgages are only 7% of our overall portfolio, and office is only 2%. So our exposure, while it's of concern, is not a significant proportion of our overall portfolio, and we maintain a conservative approach to lending.

Operator, Operator

Following question is from Doug Young from Desjardin Capital Markets.

Doug Young, Analyst

Just to kind of maybe follow-up questions to earlier questions. But first is, Steve, on the unfavorable lapse experience in the U.S. that went through the CSM, can you kind of dig a little bit more into that? Can you quantify it? And where I'm going with this, obviously, secondary guarantee UL block has been a hot topic, been an area of some pressure for some of your peers in the U.S. Is that where we're seeing the pressure? And why wouldn't that be a concern for us and investors?

Steven Finch, Executive

Sure, Doug. I can elaborate on that. Let me take you back to just before the pandemic. As you know, we frequently update our assumptions as more experience becomes available. Before the pandemic, we had already updated our U.S. lapse assumptions and strengthened our reserves over the years. However, during the pandemic, particularly in 2020, we immediately noticed discrepancies in lapse rates for some of our products. Protection products in the U.S. saw a decline of about 20%. Canada experienced a similar trend with some products, specifically variable annuities, reflecting lower lapse rates. Recently, especially in the last couple of quarters, we've observed a return to pre-pandemic lapse rates in Canada for products like Level COI, UL, and SEC funds. My perspective is also informed by the global financial crisis, where we saw similar disruptions in lapse rates across various products, and over time, those lapse rates returned to pre-crisis levels. Therefore, I expect a similar trend in the U.S., with lapse rates moving back to pre-pandemic levels over time.

Doug Young, Analyst

And so just to confirm, this was related to the no-lapse guarantee UL block. Am I correct in that?

Steven Finch, Executive

It would include the no-lapse guarantee block as well, but we also have other protection products where we've seen some similar trends. So, and that was included.

Doug Young, Analyst

And can you quantify like, is it just an immaterial amount? Like...

Steven Finch, Executive

This is the key driver in terms of the CSM experience in the quarter for the U.S. that you can see in the results. I want to remind you that on these protection products, lapse rates are very low. We are not discussing a change from 5% annual lapse rates to 3%. For example, the expected lapse rates for the NLG product are below 1%. While these changes in lapse rates are small, when capitalized over a long period, they can have an impact. However, I firmly believe that those rates will trend back over time.

Operator, Operator

We have no further questions at this time. I would now like to turn the meeting over to Mr. Hung Ko.

Operator, Operator

Thank you, operator. We'll be available after the call if there are any follow-up questions. Have a good day, everyone.

Operator, Operator

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