Thank you for standing by. This is the conference operator. Welcome to the Great-West Lifeco third quarter 2022 results conference call. I would now like to turn the conference over to Mr. Paul Mahon, President and CEO of Great-West Lifeco. Please go ahead.
Thank you, Ariel. Good morning and welcome to Great-West Lifeco's third quarter 2022 conference call. Joining me on today's call is Garry MacNicholas, Executive Vice President and Chief Financial Officer, and together we will deliver today's formal presentation. Also joining us on the call and available to answer your questions are David Harney, President and Chief Operating Officer, Europe, Arshil Jamal, President and Group Head, Strategy Investments and Reinsurance, Jeff Macoun, President and Chief Operating Officer, Canada, Ed Murphy, President and Chief Executive Officer of Empower, and Andra Bolotin, Executive Vice President and Chief Financial Officer, Great-West Lifeco U.S. Andra will be filling in for Bob Reynolds, who's unable to be on today's call. Before we start, I'll draw your attention to our cautionary notes regarding forward-looking information and non-GAAP financial measures and ratios on slide two. These apply to today's discussion and presentation materials.
Please turn to slide four. Great-West Lifeco delivered a solid performance in the third quarter despite a still challenging and volatile macro environment. Like the second quarter, weakness in equity and fixed income markets negatively impacted asset levels and reduced fee income in our wealth and asset management businesses. Currency movements, particularly the notable strengthening of the Canadian dollar against the sterling and euro, also had a negative impact on results. Base earnings per share of CAD 0.74 included a reinsurance claims provision of CAD 128 million or CAD 0.14 per share related to Hurricane Ian, which we announced on October 19. Our thoughts remain with the families, businesses and communities impacted by the devastation caused by Ian. Through our partners, our reinsurance business supports people at times like this in helping rebuild their lives.
Excluding the reinsurance provision, base EPS of CAD 0.88 was comparable to last quarter and down 5% year-over-year, a solid quarter considering the headwinds of weaker markets and weaker European currencies. The quarter included a solid contribution from Prudential, a sequential improvement in Empower's underlying earnings excluding Prudential, steady results in our life and health insurance businesses, and excellent investment and credit performance. This resiliency in earnings reflects our strength and diversification across business types and geographies. Coupled with discipline and a conservative management philosophy, it supports the company's steady performance in volatile times. We will highlight some examples of the benefits of diversification as we go through today's presentation. We made strong progress against our strategic priorities in the quarter. I'm pleased to share that we completed the transition of MassMutual clients to the Empower platform just in the last few days.
This final wave, migrating over 900,000 participants from MassMutual, is an important milestone for Empower. We're set to meet our cost synergy targets by the end of the fourth quarter. As we close out this MassMutual acquisition, I'm pleased to share that Empower has achieved participant retention of 92%, asset retention of 89%, and revenue retention of 87%, well ahead of our original expectations. We're using this same disciplined approach with the Prudential integration. Planning is well underway. The teams are working closely with this important customer base and client migrations are set to begin in the first quarter of 2023. In addition to the strategic benefits of scale and synergies, these acquisitions have strengthened Empower's value proposition for new clients.
Momentum in the defined contribution business is strong, with request for proposal activity higher in the last year than any previous year across all plan types. Beyond Empower, we're confident in the strength and resilience of our businesses and strategies in the current environment. While major economies grapple with the challenges of inflation, interest rates, and the potential for recession, we will continue to operate with discipline. This includes discipline in managing our high quality investment portfolio, underwriting and deploying capital on new business, and managing expenses. Please turn to slide five. This slide shows our medium-term financial objectives, 8%-10% base EPS growth, a base ROE of 14%-15%, and a target dividend payout ratio of 45%-55% of base earnings.
While year-to-date base EPS growth is below our 8%-10% objective, these are medium-term objectives, and looking ahead, we're confident in meeting them over the medium term. Please turn to slide six. Our Canadian business saw stable insurance sales in the quarter, with individual broadly in line with last year and group growing 15%, partly due to the addition of ClaimSecure. In wealth, group sales saw modest growth year-over-year and positive net cash flows with strong momentum in our NextStep asset rollover program. Individual wealth sales declined on lower segregated fund and mutual fund sales in line with industry results. The sales results in Canada this quarter highlight the benefits of our diversification with softer individual wealth sales offset by stronger group insurance and group wealth sales. Given the inflationary environment, Canada Life is positioning the business through strong expense discipline.
We're managing expenses through a sharp focus on priorities and productivity improvement supported by the ongoing modernization of our technology platform. Please turn to slide seven. In Europe, business performance was steady with last year despite the economic headwinds and turmoil in U.K. financial markets towards the end of the quarter. Insurance and annuity sales were solid but lower compared to last year when the U.K. booked a $1.3 billion bulk annuity sale. Strong momentum continued in equity release mortgage sales until we temporarily suspended new originations in late September in response to heightened market volatility. ERM is an important business for us as it adds breadth to our retirement income solutions for our clients and is an attractive asset backing long-term liabilities. We remain committed to the ERM market and expect to resume originations as the U.K. interest rate environment stabilizes.
Excluding currency impacts, Europe had a steady performance, including in wealth, where sales declined to a modest 3% year-over-year in constant currency. Base earnings were also resilient, which Garry will discuss shortly. This reflects the diversified nature of our European businesses, including a product set focused on financial necessities like pension savings, retirement income solutions, and group protection. Please turn to slide eight. Putnam's AUM was impacted by market declines and ended the quarter at $158 billion. Net outflows of $2 billion improved considerably from the prior quarter and were primarily in Putnam's lower fee fixed income products. Flows in higher fee equity products were positive year-to-date.
Putnam's investment performance remains strong as demonstrated by four or five-star Morningstar ratings on 30 funds and just under 80% of fund assets performing at levels above the Lipper median on a 3-year basis. Additionally, 80% of assets across all asset classes and 96% of all assets in equity are in Morningstar four or five-star rated funds. Please turn to slide nine. At Empower, sales increased 37% year-over-year, with DC sales up 42%, driven by a large $5 billion government plan sales. As noted, the DC business is experiencing strong momentum. We're also pleased with the momentum we're seeing in retail, where IRA sales grew 10% year-over-year. Retail wealth management is a significant long-term opportunity for us as we work to serve the broader financial wellness needs of Empower's DC plan participants.
To this end, we're leveraging Personal Capital's hybrid digital advice capabilities in the Empower environment. As of the end of the third quarter, the new experience was made available to 11 million of the Empower participants. Turning to our integration programs, MassMutual is now complete with the final wave of the plan conversions happening earlier this week. It was our largest conversion with 900,000 participants migrating. I would like to thank the integration team for their hard work and resilience throughout the MassMutual migration journey. We have achieved $101 million of pre-tax cost synergies and are on track to reach our $160 million target by year-end. As noted earlier, asset, participant, and revenue retention have outperformed our original expectations.
The Prudential integration is on track with $43 million of the $180 million pre-tax cost synergy target realized, and client migration is set to begin in the first quarter of 2023. Please turn to slide 10. CRS expected profit was down 4% year-over-year. Strong overall growth mostly offset lower actuarial PFAD releases, while other margins and fees were up 18%, reflecting growth in structured reinsurance and improved margins for the P&C business. The new business pipeline remains healthy in both structured and longevity reinsurance portfolios. We remain focused on the core U.S. business in the U.S. and Europe as we continue to pursue expansion in new markets.
While the reinsurance claims provision in the quarter is included in experience gains and losses, and thus not referenced on the slide, I would like to touch on the benefits to Lifeco of participating in the P&C retrocession business. While we're exposed to losses during major catastrophic events like Hurricane Ian, we like the diversification and the non-correlated risk exposure it provides with the strong returns it generates through the cycle. We're a disciplined underwriter with annually renewable contracts, and the business is governed by strict exposure limits and return targets. With that, I'll now turn the call over to Garry to review the financial results. Garry?
Thank you, Paul. Please turn to slide 12. Base and net earnings per share are both CAD 0.74 this quarter, which includes the previously announced hurricane provision representing CAD 0.14 per share. Before this provision, base EPS of CAD 0.88 was generally in line with Q2 and similarly delivered against a challenging economic and market backdrop. The results are 5% below last year, which primarily reflects lower asset-based fee revenues and European currency translation headwinds, partially offset by the addition of earnings from the acquired Prudential retirement business. Overall, a solid result in a difficult environment. In Canada, base earnings of CAD 283 million were down 9% from last year due to market-related fee income pressure and lower yield enhancement contributions, along with lower gains from mortality and disability this quarter. This was partially offset by a CAD 20 million tax settlement gain.
In the U.S., Empower base earnings of $171 million included $47 million from the addition of the Prudential retirement business, and that included a $6 million catch up from the initial reporting for Pru last quarter. As a reminder, over 50% of net revenues at Empower are asset-based. The impacts of lower markets on asset-based fee revenues continues to be a headwind, although business fundamentals such as top-line sales, customer retention, and retail expansion remain strong. As noted earlier, we have recently completed the last wave of conversions for the MassMutual business, which is an important milestone and great accomplishment by the team. Through the integration, as Paul noted, we have exceeded the original customer revenue retention targets.
When looking at period-to-period comparisons during integration, there is a lag between deal closing and the impact of any client terminations, given that it takes time for clients to go to market. Most of the impacts of the expected attrition on MassMutual has actually been felt in 2022. Very little was in the comparative quarters last year. Somewhat offsetting this, we are on track to meet our original run rate synergy target of CAD 160 million by the end of Q4, and the benefits of those synergies will fully emerge in the Q1 2023 results. A similar pattern is expected on the Prudential business. There has been very little attrition to date, which is good. However, some attrition is expected in 2023 as part of the acquisition process, and that will impact year-over-year comparisons in 2023.
On the positive side, the benefit of full expense synergies will begin to emerge once the integration is complete early in 2024. Expense synergies tend to be more pronounced at the start and at the end of the program. Early savings come from eliminating duplicate overhead costs, while later savings arise when prior admin systems and service agreements are discontinued post-conversion to Empower's platform. We are seeing this play out on MassMutual with the final conversions completing earlier this week, and we expect to see a similar pattern for Prudential with early savings noted this quarter and most cost synergies coming towards the end of integration. Turning to Putnam, earnings were down from Q3 last year, largely impacted by lower asset-based fees as expected, given the assets under administration decline, plus mark-to-market losses on seed capital as of September 30.
The Europe segment posted another very strong quarter in Q3. Currency was clearly a headwind, with both euro and sterling down over 11% from last year. In constant currency, base earnings were down just 1% from Q3 2021, which as a reminder, was an outsized result for Europe last year since it included a large pension settlement gain in Ireland. Strong yield enhancer results in the U.K. were a key contributor this quarter. The Capital and Risk Solutions segment, which is primarily the reinsurance business unit, saw earnings significantly impacted by Hurricane Ian. While there have been some larger experience and new business gain items in recent quarters, both positive and negative, a steady trend of steady transaction success in reinsurance continues to underpin base earnings growth. Aside from the hurricane impact, life mortality results improved considerably from a very challenging Q3 2021.
This was partly offset by a decline in longevity experience. Based on the results of the last two quarters, though, mortality results and longevity appear to be normalizing following a two-year period of pandemic related impacts. Turning to slide 13. This table shows the impact of various items excluded from base earnings. There were a number of larger items this quarter, but in total, there was no overall impact. Base and net earnings were the same. Actuarial assumption updates were a net positive, and I'll cover these on a later slide. Market related impacts and liabilities were a negative, and that's partly due to hedge ineffectiveness given continued market volatility, and partly a tempering of future growth expectations for U.K. real estate assets backing liabilities.
The remaining items are predominantly acquisition related, including transaction and restructuring costs, plus ongoing integration costs with respect to Personal Capital and the retirement businesses acquired from MassMutual and Prudential. Transaction costs were actually a net positive due to the release of the contingent consideration provision for Personal Capital, given the impact markets have had on the ability to achieve asset-based growth targets. Note the release of the CAD 54 million pre-tax is largely a non-taxable item which added to some of the tax rate distortion this period. Turning to slides 14 and 15, sources of earnings displays. These next two slides highlight the source of earnings first from a base earnings perspective and then net earnings. I'll focus comments on slide 15, the net earnings perspective, with a reminder that the amounts above the line are pre-tax. Expected profit was down 7% year-over-year.
The decrease is primarily attributable to lower expected fee income given the decline in assets due to market downturns in each of the regions as well as currency headwinds, particularly impacting Europe. The decrease was partially offset by the addition of Prudential's business and improved margins in Canada Group business and the Empower general account business. Moving to new business impacts. The results were more typical this quarter than Q3 2021, which had included a large gain on an asset-based reinsurance transaction. The majority of impact is the U.S. new business strain, which represents non-deferrable upfront sales costs on investment contracts. It was higher than last year, largely due to the addition of Prudential along with continued strong organic business growth at Empower. Experience gains contributed positively again this quarter, and I'll cover these in more detail in the next slide.
Earnings on surplus of CAD -8 million improved CAD 10 million from last year, with the benefit of higher interest rates partially offset by the impact of additional financing costs as a result of the Prudential acquisition. The effective tax rate this quarter was 6.5% on base shareholder earnings. While the tax rate reflects the jurisdictional mix of earnings and certain non-taxable investment income, this quarter there were also settlements of outstanding tax matters in Canada and the U.S., and a tax pickup on inflation-linked U.K. gilts, which combined lowered the tax rate by about 5%. The net earnings tax rate of -3% benefited from those same items, but in addition was affected by the jurisdictional mix of basis change, actuarial basis changes, as well as the non-taxable Personal Capital contingent consideration release noted earlier.
Turning to slide 16, these tables expand on the experience results as well as management actions and basis changes to highlight various items in the quarter, some of which we've touched on already. As shown in the chart on the left, yield enhancement continued to contribute positively, primarily in the U.K. this quarter. The net impact of mortality, longevity, and morbidity was a modest negative this period for only the second time since the pandemic began, although perhaps this balances out against the strong experience gains we saw last quarter across most insurance risk categories and geographies. Life mortality and disability results in the U.K. and annuitant longevity results in reinsurance were the main contributors to the overall experience result this quarter. Credit-related impacts were positive again this quarter, driven by upgrades in the bond and mortgage portfolios as our high-quality investment portfolio continues to perform well.
The table on the right highlights there were a number of larger basis changes this quarter. Policyholder behavior experience is influenced by a variety of factors, including interest rates, underwriting, product designs, and the availability of competing products. Based on the trends we've been seeing in our block and the results of a wider industry experience study, we reviewed and strengthened the assumptions for our Canadian universal life business. Other notable assumption change this quarter was a positive contribution from updates to U.K. annuitant longevity assumptions based on the more recent pre-pre-COVID trends. This is not picking up the distortions during the pandemic, and we will continue to monitor emerging experience and research regarding the potential longer term impacts of COVID-19 on annuitant mortality. There were also smaller positive contributions from assumption updates and refinements this quarter. Moving to slide 17. This slide highlights operating expenses by segment.
Expenses are up year-over-year as expected, given the increase in business both organically and through M&A. Excluding Prudential and the one-time Irish pension gain last year, Lifeco expenses were up 4% year-over-year. Recognizing there will likely be some inflationary pressures in labor and other costs emerging in the future, this is an area we'll monitor closely, increasing our focus on achieving productivity gains in our operations and adjusting pricing if appropriate. Looking at the segments, in Canada, expenses are relatively flat, up 2% year-over-year, and that includes the acquisition of ClaimSecure. In the U.S., expenses were up 28% year-over-year on a constant currency basis. At Empower, excluding Prudential, expenses were up 3%, again, in U.S. dollars, with a similar increase at Putnam.
Empower's DC business was up just 1%, which primarily reflects the 5% organic growth in DC plan participants, largely offset by the synergies realized from the MassMutual integration. The overall 3% increase reflects recent investments in retail wealth strategy build out. In Europe, the headline expense growth is being heavily impacted by the Irish pension settlement gain last year, currency movements, and the impact of the RL Life acquisition. Within Europe, the local business units are striving for low single-digit expense growth outside of any unusual items given the pressure on revenues from lower markets. In Capital and Risk Solutions, the expense growth is off a very small base and is aligned with the growth in the business, including the continued expansion into newer markets. Please turn to slide 18.
The Q3 book value per share of CAD 25.61 was up 5% year-over-year, primarily driven by strong retained earnings given the solid results over the last four quarters. Currency translation in other comprehensive income was a positive this quarter as a stronger U.S. dollar more than offset the weaker European currencies. The rise in interest rates this year has lowered fair values on available for sale securities. However, there is a partially offsetting gain in pension OCI. As disclosed at our information session in June, we expect shareholder equity to be reduced in the range of 10%-15% upon transition to IFRS 17, primarily due to the creation of the contractual service margin liability.
The LICAT ratio at Canada Life remains strong at 118% at the upper end of our target range of 110%-120%. The ratio was up one point compared to last quarter. Earnings net of dividends and the continued smoothing in of the scenario switch benefit were partially offset by the increase in interest rates, particularly U.K. gilt rates. As noted in prior quarters this year, we have described the negative impact on LICAT from higher interest rates, more as a formulaic issue rather than an economic one, since in general, our business benefits from higher interest rates. As a reminder, under LICAT, a portion of the available capital is calculated at fair value, which declined again this quarter as interest rates rose further.
The required capital, however, is largely calculated at fixed rates as defined by OSFI, and so does not move in the same manner. OSFI released its 2023 LICAT guideline in Q3, setting out the adjustments to accommodate the transition to IFRS 17. The first LICAT ratio under the new guideline were reported as part of the Q1 2023 results, and we expect a positive impact on transition. As an indication of the impact, we have estimated a pro forma LICAT for September 30 would be in the mid-120s. Note the actual impact on transition will be dependent on market conditions at the time, including the level of interest rates given the different sensitivities between IFRS 4 and IFRS 17. Lastly, Lifeco cash, which is not included in LICAT ratio, ended the quarter at CAD 0.3 billion. Back to you, Paul.
Thanks, Garry. Please turn to slide 19. We're pleased with Lifeco's results in the third quarter, where the strength and diversification of our business underpinned a resilient performance. Looking ahead, we will continue to advance our business strategies with the same operational discipline that has served us well in the past in periods of economic volatility. This will include striking an appropriate balance between carefully managing our expenses and investing for growth while maintaining a firm commitment to our conservative risk disciplines and continuing to deliver for our clients in these uncertain times. That concludes my formal remarks, Ariel. Please open the line for questions.
Thank you. We will now begin the question-and-answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question comes from Tom MacKinnon of BMO Capital Markets. Please go ahead.
Yeah, thanks very much. Just on the decision to stop writing the equity release mortgages, I think you're a major player in this marketplace with about a 12% market share. I'm wondering what you see as an impact in terms of your U.K. sales going forward as a result of this decision. Are there any other issues with respect to the value that you ascribe to those equity release mortgages on your balance sheet? Is the fact that you're not writing business, does that new business given the environment, does that suggest that you're gonna take a closer look at that asset on your balance sheet? Are we in any danger of any potential write-down of that asset? Thanks.
Great question, Tom. It's Paul. I'm gonna sort of, I'll first make a comment that our decision to actually step away from that market was temporary in nature. It was given the very volatile interest rate environment. As the interest rate environment stabilizes, which we're seeing in the U.K., our intention would be to be back in that market. Having said that, there's kind of two parts. One is the balance sheet impact. One is our perspective on that business in the U.K. market and what it means to us. Maybe what I'll ask is Garry to comment on the balance sheet side.
I'm gonna turn it over to David, maybe to talk about ERMs in the context of our perspectives on the U.K. environment, you know, how it plays out for our business, but also maybe a bit of broadening perspective on the U.K. environment and the opportunities there. Why don't you start out, Garry?
Yeah, sure. I think just quickly on the balance sheet side, the decision really was not about the in-force book. We feel it's a high quality portfolio of equity release mortgages. This was entirely an ability to price effectively given the continual up and down movement of U.K. gilts in September. Really, we think it's got a high quality portfolio and had nothing to do with the balance sheet.
Okay. Maybe David, you could talk about that product, you know, what it means to our business there and your perspectives on sort of maybe more broadly on opportunities for growth in the U.K.
Yeah. I suppose just to repeat, like, the withdrawal from the market was to do with the interest rate volatility. Like borrowers of this product to have a lifetime fixed rate, and usually when you make the loan offer, they have a period of time to close. For lenders, that's they're just left with an exposure while people have that period, which is dangerous in a very volatile market. Interest rates have stabilized again now, most people are coming back into the market and we expect to be back in shortly as well. Like, I think we still see strong demand for the product. I think it'll be tempered a little bit because it will be more expensive for people to borrow.
I think lenders will be careful then on loan-to-value ratios as well. They will be a little bit lower going forward, but still we see strong demand for the product. Again, just to emphasize on the balance sheet, we don't really see issues there. The loan-to-value ratios are low and, you know, historic borrowers that are on the balance sheet, like they've all borrowed at lower rates than are there at the moment, and those rates are fixed. I suppose other factors in the market then as well, just to relate it to the higher interest rates, like I think it will dampen demand a little bit for equity release mortgages, but counter to that, I suppose on the sales side, we do see higher demand for both communities going forward.
Because of the higher interest rates. Like overall, we'd be pretty optimistic on the sales outlook within the U.K.
Thanks, David.
What percentage of your sales in 2021 were equity release mortgages? I mean, these were originations, I assume, so they probably come in, I don't know, were they like 15% or 20% of your sales in the U.K.?
Just let me check.
Tom, I think someone's tracking that number down, but it would be in that lower 10, I think that 10% + range. So from the standpoint of materiality, I mean, we've got a pretty diversified business group is important to us. It's a good profit engine. We've got a leadership position. The annuity market, while you know, it's lumpy relative to bulk annuities, and we pointed out that we had a you know, a large sale in Q3 last year, not this year. We think that'll continue to feature as a good contributor. David, did you find that percentage for us?
Yeah. We split it out on slide seven, so we saw the equity release mortgage sales against the annuity sale. For Q3 last year, you know, there were, you can see CAD 287 million equity release mortgages out of a total of just less than CAD 2 billion. We had the large bulk annuity sale there. Q3 2022, it's more balanced between equity release mortgages and annuity. You know, I do expect equity release mortgage sales to be lower in 2023, but we probably expect annuity sales to be higher as compensation.
That 10-15% is probably about right, Tom. You know-
Okay.
You've got to normalize for the volatility on bulk annuity sales, which will be more lumpy.
Okay. If I get one last one in here, the CAD 20 million tax settlement gain, was that in the base earnings? The other CAD 54 million that Garry alluded to, I don't believe that was in base. That's just in the reported earnings. Is that correct?
That's correct, Tom.
Okay, thanks.
Okay, thank you.
Our next question comes from Meny Grauman of Scotiabank. Please go ahead.
Hi. Just a few questions on expenses. One, I noticed there was a reference in the press release to some back office operations that were moved to India and talking about efficiency benefits. I'm just wondering how significant that was. Are there other sort of initiatives like this at Canada Life or across the enterprise? I'll start there.
Thanks, Manny. It's Paul. I will begin maybe at a high level and just remind listeners that we actually do have a pretty meaningful operation in India that has been built out originally in support of the Empower operations. The core focus there as a starting point is to provide, you know, a broader around-the-clock service and around-the-clock ability to you know drive the operations. There's also obviously the benefits of efficiencies of being able to operate in different markets. The key is, you know, technology. It's being able to leverage that technology to make it happen. As we think about overall opportunities across the group, for sure some opportunities will be the ability to, you know, leverage some capabilities like the India capability.
The other part, though, is to make sure that we are focused on increasing automation. You'll see that theme increasing right across the group. It's a continued focus. The other one is to make sure that in periods like this, as we look at certainly as we look at, you know, some compression of fee income, that we're making sure that we're seeking out all the process improvements we can, productivity initiatives. I think you'll see that as a theme and a discipline in our operations as we move forward. It's always been a theme, but I would say it'll be a bit of an elevated theme moving forward, and we'll speak to it about in future quarters as we harvest opportunities.
I will turn to Jeff, who can maybe speak to the benefits to Canada of this. This is just a starting point for you, right, Jeff?
Yeah. Thanks, Paul. Meny, thanks for asking that. Maybe just to build on Paul's comments. We're seeing some real explosive growth, particularly on the Group Life and Health side in Canada. This is about a couple of things. One, enhancing our service 24/7, where this is a really good move for us. Second of all, to move to 24/7, it also gives us an opportunity on our cost structure, on our unit cost to continue to look at reducing that. So we are up and running, and we will see those numbers increase in 2023 as we move along.
It's really a couple of things, enhanced service, getting after unit costs, and to deal with our explosive growth that we've got in Canada, particularly on the Group Life and Health side.
Are there still benefits to this that are likely to flow through into sort of the run rate earnings picture in Canada? Like, is that something we're still gonna see come in to earnings over the next few quarters?
Yeah, you know, I'd say over the next few quarters and years, though, really, because you have to think about it from the standpoint of, you know, this is a first move. It's looking at certain services that group has in Canada. We're actually looking at this more broadly. As I said, it's a combination of things we can do for automation, process improvement just on the ground here in Canada and our domestic markets, but also leveraging some of this offshore capability. By the way, this is not, you know, an outsource capability. This is something that we manage and that we're leveraging, and we're seeing great benefits. Yes, you would begin to see some of these things flow through, but I think this is a multi-year opportunity for Canada and frankly, for our other businesses.
That's a good segue I wanted to follow up just in terms of the U.S. asset management business. Paul, you referenced some of the fee pressure. We can see that in that business, but when I look at the expenses, the operating expenses up year-over-year in the quarter and year to date. I'm wondering how much of an opportunity do you have there to change that picture? Are there certain sort of expense initiatives in that business that you could highlight for us?
Yeah. I'll start off with that one, Meny, and then I'm gonna turn it over to Andra Bolotin. Putnam has actually had good expense discipline over the last number of years, and they've done that through a number of things, both you know just good discipline around headcount, but also things like fund consolidations, which can really create a lot more efficiency in your systems. You know, when I say systems, I mean the overall business system, whether it's your back office, you know, managing assets and the like. I'll let Andra speak to sort of actions taken to date and her perspectives on going forward. Andra?
Yeah. Thank you, Paul. First I would also remind folks that there was a reduction in distribution expenses that is not showing in that number, and I think there's a footnote on the page that says it's down CAD 10 million year-over-year. In addition, I think as you highlighted, we've done a lot with product consolidation and expense discipline. We're gonna continue to focus on that. I would say that, you know, most of what we're seeing is market driven, both on the P&L and on the net flows. We would expect that to recover rapidly as market conditions improve. This is something we just continue to focus on with expense discipline, and, you know, we're keeping. We look at this every day.
Thank you.
Thanks, Andra. Thanks, Meny.
Our next question comes from Doug Young of Desjardins Capital Markets. Please go ahead.
Hi. Good morning. Good afternoon. Just starting with Empower. You know, if we just do the simple math and we take out the contribution from Pru, you know, earnings were down U.S. dollar basis about 14% year-over-year. Can you talk a little bit about how much of that related to the market decline year-over-year? Because obviously, you say 50% of your revenue is market driven. How much of that related to the deteriorations that kind of are front-loaded? I'm just surprised that it wasn't, you know, less given some of the expense synergies to come through. I'm just curious as to when you look forward, because you've got the Pru deal coming through, when should we see a pivot in this from an organic growth perspective?
Doug, let me start off at the top. One of the things that we see, I think we highlighted in quarter, was, you know, relative expense growth relative to growth in our participant count and our revenues was well in line if you actually carve out the impact of Pru in quarter. When I think about the quarter, I think there's been good expense discipline in quarter, but there's a lot of moving parts. As you pointed out, you've got, you know, the tail end of any client retention or client losses related to MassMutual. At the same time, we're seeing actually very strong growth in pure organic terms.
I think as we pointed out before, when we have organic growth, one of the things is we have the onboarding costs of those customers as we bring them on. We don't defer all those costs. So you're always gonna have those multiple dynamics going on. Maybe I'll let Garry provide a little bit of context, and then you could turn it over to Ed to provide some context on his view on the forward-looking in terms of what the prospects are for Empower. Garry, do you wanna go?
Yeah. I think I'd just comment on a couple of things. When we talk about the lower equity markets, you also have to bear in mind that fixed income is also well down because of the rising rates. Those two combined, you know, the impact on asset-based fees was quite a good chunk of that decline year-over-year. We haven't spent a lot of time, but last year, we did comment in Q3 last year on very high surplus income gains at Empower, just a number of some of the alternative investments had good returns in Q3 last year. We had good returns this year, but they were probably CAD 10 million down from last year as well.
You've got the fee-based pressures in that. We've talked about the last year had almost none of the MassMutual attrition in. This year had more, and on the other hand, we picked up those expense synergies from MassMutual, so there's some offset there. I think a lot of it is the markets, and I just call out that surplus income drag as another factor. I think the business is really well positioned, great expense control. Maybe Ed can-
Yeah. Ed, maybe you can speak about the expense control in the context of organic growth. You know, it's almost trying to strip out a bit of the Pru noise and the remaining MassMutual noise and provide some context around that. Ed?
Thanks, Paul. Yeah, I don't have much to add with respect to the comments that Garry made and where the revenue pressure is coming from. I think that's pretty obvious. If you look at what's happening, let's just look at the defined contribution business for a moment. We had, if you adjust for MassMutual, we had 8% organic growth, just in organic growth year-over-year, and our DC business had 1% expense growth. We actually see pretty good operating leverage. We continue to invest a lot in distribution and growth, both on the defined contribution side and on the retail side of our business.
We're adding people to support the opportunities that we have. If you look at our pipeline right now, it's $1.7 trillion on the defined contribution side. It's the highest in our history. We're seeing really strong RFP growth and traction across the business. Even if you adjust for the MassMutual participant deconversions that ran through the business, you know, you're still looking at net participant growth from the DC side of 5.5%, which is roughly 2x-2.5 x the rate of the industry average. You know, we're taking share away from the competition, and we're growing faster than the market, 2x the market on the defined contribution side.
I think the market will continue to consolidate. I think the growth opportunities for Empower, both on the DC side and the retail side are immense. It's important that we continue to maintain discipline on the expense side while investing for growth.
Thanks, Ed.
Yeah. Thanks. Just a follow-up. I guess I understand the participant growth and organic side. It's just looking at how it trickles down to the bottom line, and it sounds like, you know, this quarter market, you know, was the biggest driver of the year-over-year decline. We could face some further pressures over the next few quarters, you know, as the pre-business terminations flow through and the lag effect from the expense synergies, you know, obviously depending on what market conditions do. Is that a right way to think about it?
You know, Doug, I do think that's the right way to think about it, and obviously, we therefore have to be cognizant of that and manage against market conditions. It's finding that right balance between expense discipline, but making sure that we don't take our eyes off the long-term, medium to long-term prize when, for example, on the retail side. You know, we do not want to as we've now deployed, for example, the new Personal Capital enabled participant experience, including for managed accounts and, you know, IRA rollover. We wanna make sure that we are taking advantage of that capture opportunity, and that takes, you know, trained and licensed people able to support clients, and we're seeing growth there.
We're gonna actually manage that balance, but we have to make sure that we're cognizant of the market environment, and we are very much that way, and we will be disciplined.
It takes me to my second question, Paul. It's just on Personal Capital. Like, it sounds like things are going well, but you wrote off contingent consideration $41 million, which tells me it's not, you know, it hasn't tracked, you know, in line with your expectations, but worse than expected. I guess that could be market driven. I'm just hoping you can maybe, you know, in light of this discussion, you know, talk a bit about what drove that.
Yeah. You captured it, Doug, and I'm gonna turn it over to Ed to provide a little more context, but it's market driven. The actual business has done very well from the standpoint of executing, serving clients, you know, continuing to actually retain clients, client conversions going reasonably well. The big challenge is really the significant fall in equity markets. The reality is that contingent consideration was a function of, you know, asset-based consideration. I'll turn it over to Ed to provide a little bit more color if there's anything I've missed, Ed.
Yeah. I would say, again, if you look year to date, gross sales are up 10%, revenue's up 14%. Where we've seen real momentum is on the client retention side. We're seeing a lot of adds to existing accounts. The challenge has been at the top of the funnel. Sales have been challenged a little bit. We continue to invest in growth, but that's also leading to higher customer acquisition costs. You're seeing that play out through the P&L. Definitely fees have been impacted, as Paul said, by lower markets and lower asset levels. We've started to temper some of the acquisition spending. We started doing that two quarters ago in light of the challenging markets.
Obviously, you got to maintain a sustained presence, when you're out there in the marketplace. This is also not a time where you're seeing individual retail customers move relationships. When you experience this level of market volatility in the downturn we're seeing, we're seeing slower sales conversions at the top of the funnel.
Yeah. Ed, I think that's a good call out. Doug, I would say that's sort of a consistent theme we see across retail wealth management. You're just not seeing money in motion in the same way. There's a lot of people that are sitting and not moving. You see that play out, for instance, in our retail seg and mutual fund sales here in Canada. It's a dynamic that's a little bit more market driven than our business model driven.
Garry, can I just get one?
Well, I would just add on.
Sorry, go ahead.
I'm just going to add on the retail side. I was just gonna say on our retail IRA rollover business, I just wanted to comment there that, you know, we've seen similar challenges. If you look at sales, you know, sales are up 32%, year to date. Revenue is up 78%. There's just a lot of opportunity here. With the market conditions the way they are, the top of the funnel, the conversion around new accounts has slowed a bit.
Okay. Just quick on Garry. Cash at the holdco, CAD 300 million, was CAD 800 million last quarter. I think historically you've said you wanted to keep CAD 500 million-CAD 700 million. Did you move cash down to the Canada Life OpCo? And if so, how much?
Yeah. We did not actually move the cash down. It's more that we didn't dividend as much cash up as we might normally do. Again, that's just being mindful of
The LICAT ratio and any potential volatility in the U.K., because it has that anomaly in LICAT where those higher U.K. gilt rates because those are backing some of our actual margins account for capital. It was just, you know, being a little cautious on that front with the LICAT ratio. We kept a little more money at Canada Life and didn't dividend up. We did not put any down, we just didn't send it up.
I would say, Doug, we've got lots of financial flexibility in the system. We're not concerned about that. That was frankly, as we transitioned through these last two quarters on our journey to IFRS 17, we're managing the non-economic aspects of LICAT during that period. We will have that behind us and frankly, a quarter from now when we do parallel reporting of both IFRS 17 and IFRS 4.
Thank you.
Our next question comes from Gabriel Dechaine of National Bank Financial. Please go ahead.
Hi, I've got a few numbers questions. Hopefully you can answer them. One, what is the size of the equity release mortgage portfolio on your balance sheet and the LTVs associated with that exposure? As far as the catastrophic reinsurance business goes, what's a normalized annual earnings contribution from that business? Thanks.
Okay, so there's two questions there. Gabriel, I'll remind you that as we're thinking about the impact of interest rates on the in-force liability of the equity release mortgages, that's not really an area of concern or focus for us. The reality is those were mortgages written at low rates, and it's not a number that we sort of are worried about, but maybe Garry can comment on that. I'm gonna ask Arshil to speak to perspectives on the P&C Cat business, the size of that business, its profit contribution.
For reference, Gabriel, we do show the equity release mortgages. I think they're in the slides back on page 34, and they'll be in the MD&A as well. They're CAD 2.6 billion.
Yeah. It's a relatively small portfolio in the big scheme of things. Early days for us with that business, but very well managed, low LTV. We like that asset on the books right now backing liabilities. It continues to be. It'll be a positive contributor, continue to be so. Arshil, maybe you can speak to the P&C Cat business and the attractiveness both from a diversification.
The LTVs are below 50% on that type of business.
Oh, yeah.
Yeah, no. These tend to be more below 30, Gabriel.
Yeah, yeah. Okay. Yeah.
Yeah. Okay. Do you wanna speak to how P&C Cat fits into both our profit profile and our diversification profile, Arshil?
Just to remind you that the P&C Cat portfolio reprices every year, and the market conditions do change based on that experience. We don't generally break out what the annual profit contribution is. What I would say is over the last five years and over the last 10 years, despite the losses, including the loss that we just reported, that portfolio has contributed to the return on and meets its return expectation targets, contributes really well from a diversification perspective, and is the smallest of our business lines within the reinsurance business unit. I think that's sort of a historic scene setting.
As we look forward into this renewal season, we're expecting significant increases in margin, and we're gonna see very little of that flow through to our bottom line in margins because we're gonna prioritize risk reduction and maintaining our underwriting discipline. We're gonna write the same limits going forward, but we're gonna reduce the risk in that portfolio, so that we avoid secondary perils, and continue to provide very valuable coverage to our clients, in the face of very, very large events, including events like Hurricane Ian. Again, over a 5- and 10-year period, this business line contributes very strongly to our overall profitability, is a diversified risk, and we expect stronger margins going into this renewal season compared to the previous years.
Yeah. Gabe, I would just add that this is something that is always front and center around this time of year, as we have discussions with our reinsurance committee of the board and at the board. We're kind of all over looking at the profitability over time. You know, the reality is we've got a very expert team that is well on top of this. The key for us is to think about the way we think about this is that we have this sized and level where our exposure is capped. It's annually renewable, so we've got a decision we can make each and every year.
We focus on making sure that we're playing way out, you know, further out on the risk spectrum relative to when you see things going on in the market that we really only wanna be, you know, there for clients on the major catastrophic events like Ian. That's what's happened. Actually, we're there for that. The reality is that there's customers that now of P&C insurers that now have to rebuild their lives, and we're a part of that system helping them rebuild. At the end of the day, it's a good diversifier from a risk perspective, but it's also a good profit contributor, and we're very comfortable with the business.
Yeah, Arshil gave the numbers there. It doesn't not one of those you have a bad year, wipes out ten years of profits. That's pretty much what I was after.
Thank you.
Thanks, Gabe.
Our next question comes from Paul Holden of CIBC. Please go ahead.
All right. Thank you. Two questions. First one is relating to earnings on surplus, and maybe you can give us a sense of how quickly you can turn over that portfolio to capture the benefit of higher yields.
Okay. Maybe I'll start off with Raman, who can provide a bit of perspective on, you know, our surplus and the opportunities that exist within it. You know, the key is, you've gotta be confident in those steps in an environment with lots of volatility. Raman, why don't you sort of take it up, maybe start off at a high level overall our perspectives on the portfolio and the surplus opportunity?
Yeah, sure. I think, well, maybe just starting at the high level, you know, our starting point on the surplus and on the assets in general is one of high quality. I think in terms of the ability to rotate, as markets move both in rates and in spreads, we will have, I think, over the coming quarters, a lot of opportunity to rotate into higher, not just higher rate, but also higher spread product without sacrificing credit quality. That's the first point. I think we're starting from a place that allows us to move. Our surplus portfolio tends to be shorter, so there's a natural maturity and roll-off that occurs with the governments, whether it's, you know, U.K. gilts or other governments that we have. There's not a lot of trading per se.
I think there's natural maturities and there'll be natural ability for us to reinvest those maturities into higher spread assets. It tends to be a shorter portfolio, and I'd say, you know, the market environment should be friendly for us to reinvest both in fixed income and some of the non-fixed income parts of the market.
Garry, did you wanna add something?
Yeah. Just quickly to note that in the earnings on surplus line, you also see the debt costs. Now, the good news there is a lot of our debt is actually long term, and it doesn't roll over as much. There will be, you know, some maturities, but a lot of it is very long term. The debt costs are the other side of that.
Just wanna clarify one part of the answer, just to make sure I understand. It sounds like as the portfolio naturally rolls over, you'll be able to take advantage of that, but you won't actively sell existing fixed income holdings in order to capture higher yield. Is that correct?
Raman?
I mean, we could do both, but I'd say just, there's just a natural ability for us to do it without having to sell fixed income. We have the opportunity to do both, but there's a lot that rolls over just naturally given that's inside of five years on average.
I think what Raman is getting at, Paul, is that, you know, we're limited in part by market capacity and market opportunity. He said our first opportunity for deployment will be the natural rollover. If there's more opportunities than that, than what that takes, then we'll certainly be looking at developing the portfolio.
That's helpful. Okay, thank you. Second question is with respect to the pension risk transfer market. Obviously, what transpired in the U.K. LDI market in Q3 was well covered by the media. I'm just wondering if there's any kind of implications for Great-West and that market, sort of more on a, I don't wanna call it structural type basis. Like, does this change the way you think about structuring your pension risk transfer business? Does it change the way your clients think about engaging in that market? Does it open up more opportunities for you? Does it close down some opportunities for you? Just trying to wrap my head around all of that.
Yeah. Good question, Paul, and it certainly achieved a lot of angst in the media and obviously a lot of attention. I'm gonna let David Harney start on that one because we don't use some of the LDI strategies that have been highlighted. That doesn't feature in the way we manage this. We'll start off with providing some context around that and whether we think it's gonna reshape the market in any way. Why don't you start on that, David?
It's just on LDI, like we have a very small portion, so we do run some out of Ireland, but it's quite a low leverage product. Most of our product into this market, into the pension risk transfer is to bulk annuities. I think what's happened the last few weeks, the impact of that, I think, will. It doesn't change our view of the market on what we supply in, but I think it will change the mindset of clients. Like, obviously, the two options to have for managing these liabilities are LDI or you transfer the risk to an insurance company through bulk annuities. Like, I think the outcome of all of this is going to be, pension schemes will lean more now to bulk annuities rather than LDI solutions.
Most people are expecting strong growth in the bulk annuity market next year as a result of it.
Yeah. Maybe you can speak to your perspectives on the growth that could emerge into the bulk annuity market. Why would it happen now?
Like, I suppose one of the issues in the U.K. is companies that have defined benefit liabilities that have to sort of hold that as a liability on their company balance sheet. That's a big motivation then for pension schemes to de-risk and transfer these liabilities to insurance companies, and that's not the same in other economies. You know, the long-term strategy of most companies is to exit these liabilities at some point. You know, we see very sort of strong demand for bulk annuities as a result of that over the next 10 years at least.
Thanks. Any other questions on that?
That was it. That's all from me. Thank you. Thank you very much.
Good. Thank you.
Our next question comes from Nigel D'Souza of Veritas Investment Research. Please go ahead.
Good afternoon. Thanks for taking my question. I wanted to follow up on the Europe segment and on risk-based product premiums in the U.K. When I look at that, you know, year-over-year, quarter-over-quarter, it's down, but there's a bit of noise there. You had the bulk annuity sale last year. You had a currency headwind this year. Just trying to get a sense of how do you expect or your expectations for risk-based product premiums in the U.K. going forward, how should we expect that to trend?
Yeah. Nigel, I'll go back to sort of from a strategic perspective, we're positioned in product sets in Europe that are very much financial necessities. We're in pension savings, we're in retirement income, you know, we're in group risk. And obviously, we think about bulk annuities as an opportunity. We view those product sets in a rising rate environment with some of the other risks that emerge as products that will remain resilient or may be pushing to opportunistic. If you think about the bulk annuity space, David made reference to the equity release mortgages where, you know, we may see a bit of softening in demand there just because of higher rates.
We do think that the market itself, that our product set, sits well in that market and that, you know, the return characteristics are attractive. David, I'll let you add to that.
Yeah. Like, if you go to slide seven, it just shows the display of insurance-related sales. Like, obviously, we don't publish targets or anything like that. I'd say in Q3, just the level of annuity sales that's there, like that's a little below what we'd expect in a quarter. You know, like probably a more reasonable number to expect there is 500 or 600 million, but it obviously just depends on the timing of winning those cases. The equity release mortgages sales then we do expect to moderate next year because borrowing costs will be higher for people and we'll be lending at lower loan-to-value ratios. The insurance sales there in that segment are, like they're low relative to the other sales.
That's just bulk annuities are large single premium sales. The ERMs are loans. I'd say the sales number there for insurance and group risk probably underrepresents the importance of the product. Like it's a much stronger contributor profit-wise, you know. The key profit contributors within the U.K. are the annuities and the group risk. The group risk book we expect to perform well, like even though there are recessionary pressures in the economies, the premiums there are related to employment and salaries, and we're seeing strong salary growth. Employment levels are very high in the U.K. Our group risk book is performing very well at the moment.
Thanks, David.
Okay, great. It sounds like you expect that to move higher on group and annuities on a constant currency basis. The last question I had was on the dividend payout ratio that you outlined 45%-55%. You're currently sitting closer to 60%. Do you wanna see that payout ratio fall to the midpoint, 50%, before you reconsider increases? Just trying to get a sense of the timing of future dividend increases going forward.
Yeah. No, no. What I would say, Nigel, is we made a decision to move forward on a dividend increase in Q3 last year because at the time we had lifted the restrictions and we'd been held off from that for a while. Our explicit decision this quarter was to actually go back to our normal cycle of Q4 when we do our reporting in early February. That's when we'll take up that discussion with the board. I would say that our view on dividends is not a function of what's happened in a particular quarter. It's really our medium-term outlook. We remain confident in our medium-term outlook of 8%-10% growth in earnings.
Obviously, we're gonna see some you know volatility in periods like this. We remain confident in our overall business, and we will use that confidence to guide our decision-making, our dividend decision-making next quarter. It'll be our outlook for longer term growth, not any particular quarter. We use that range of 45%-55% as a bit of a guide around sort of where we would view it over the long term if you were to measure it on an average over a longer term period. It's not a guardrail. It's not something where we're trying to get back to get back to the midpoint, 50%. Getting to 60% doesn't fuss me in any way. It's more a function of what is our long-term outlook and our confidence in that.
Okay. That's helpful. Thank you.
This concludes the question and answer session. I would like to turn the conference back over to Mr. Mahon for any closing remarks.
Thank you, Ariel. Well, listen, I'd like to thank all participants today for joining us. I'd like to thank the analysts for their questions. It's always a good exchange. Actually, we look forward to getting back together with you in the new year as we report our Q4 results. I think it'll be early February or maybe a little bit later. Is it early February, Garry? Early February. We'll be back with you then. In the meantime, I hope everybody has a safe fourth quarter holiday season and look forward to talking in the new year. Take care.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.