EX-99.1 2 d489903dex991.htm EX-99.1 EX-99.1

Exhibit 99.1

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Manulife Financial Corporation

Consolidated Financial Statements

For the year ended December 31, 2017


Responsibility for Financial Reporting

The accompanying consolidated financial statements of Manulife Financial Corporation are the responsibility of management and have been approved by the Board of Directors. It is also the responsibility of management to ensure that all information in the annual report to shareholders is consistent with these consolidated financial statements.

The consolidated financial statements have been prepared by management in accordance with International Financial Reporting Standards and the accounting requirements of the Office of the Superintendent of Financial Institutions, Canada. When alternative accounting methods exist, or when estimates and judgment are required, management has selected those amounts that present the Company’s financial position and results of operations in a manner most appropriate to the circumstances.

Appropriate systems of internal control, policies and procedures have been maintained to ensure that financial information is both relevant and reliable. The systems of internal control are assessed on an ongoing basis by management and the Company’s internal audit department.

The actuary appointed by the Board of Directors (the “Appointed Actuary”) is responsible for ensuring that assumptions and methods used in the determination of policy liabilities are appropriate to the circumstances and that reserves will be adequate to meet the Company’s future obligations under insurance and annuity contracts.

The Board of Directors is responsible for ensuring that management fulfills its responsibility for financial reporting and is ultimately responsible for reviewing and approving the consolidated financial statements. These responsibilities are carried out primarily through an Audit Committee of unrelated and independent directors appointed by the Board of Directors.

The Audit Committee meets periodically with management, the internal auditors, the external auditors and the Appointed Actuary to discuss internal control over the financial reporting process, auditing matters and financial reporting issues. The Audit Committee reviews the consolidated financial statements prepared by management and then recommends them to the Board of Directors for approval. The Audit Committee also recommends to the Board of Directors and shareholders the appointment of external auditors and approval of their fees.

The consolidated financial statements have been audited by the Company’s external auditors, Ernst & Young LLP, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Ernst & Young LLP has full and free access to management and the Audit Committee.

 

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Roy Gori

President and Chief Executive Officer

  

Philip Witherington

Chief Financial Officer

Toronto, Canada

February 7, 2018

Appointed Actuary’s Report to the Shareholders

I have valued the policy liabilities and reinsurance recoverables of Manulife Financial Corporation for its Consolidated Statements of Financial Position as at December 31, 2017 and 2016 and their change in the Consolidated Statements of Income for the years then ended in accordance with actuarial practice generally accepted in Canada, including selection of appropriate assumptions and methods.

In my opinion, the amount of policy liabilities net of reinsurance recoverables makes appropriate provision for all policyholder obligations and the consolidated financial statements fairly present the results of the valuation.

 

 

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Steven Finch

Appointed Actuary

Toronto, Canada

February 7, 2018

 

Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        105


Independent Auditors’ Report of Registered Public Accounting Firm

To the Shareholders of Manulife Financial Corporation

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated financial statements of Manulife Financial Corporation, which comprise the Consolidated Statements of Financial Position as at December 31, 2017 and 2016, the Consolidated Statements of Income, Comprehensive Income, Changes in Equity and Cash Flows for the years then ended, and the related notes, comprising a summary of significant accounting policies and other explanatory information (collectively referred to as the “consolidated financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Manulife Financial Corporation as at December 31, 2017 and 2016, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.

Report on Internal Control over Financial Reporting

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), Manulife Financial Corporation’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 7, 2018 expressed an unqualified opinion on the effectiveness of Manulife Financial Corporation’s internal control over financial reporting.

Basis for Opinion

Management’s Responsibility for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement, whether due to error or fraud. Those standards also require that we comply with ethical requirements, including independence. We are required to be independent with respect to Manulife Financial Corporation in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We are a public accounting firm registered with the PCAOB.

An audit includes performing procedures to assess the risks of material misstatements of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures include obtaining and examining, on a test basis, audit evidence regarding the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to error or fraud. In making those risk assessments, we consider internal control relevant to Manulife Financial Corporation’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances.

An audit also includes evaluating the appropriateness of accounting policies and principles used and the reasonableness of accounting estimates made by management as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a reasonable basis for our audit opinion.

We have served as Manulife Financial Corporation’s auditors since 1905.

 

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Chartered Professional Accountants

Licensed Public Accountants

Toronto, Canada

February 7, 2018

 

106        Manulife  Financial Corporation  |  2017 Annual Report  |  Consolidated Financial Statements


Independent Auditors’ Report of Registered Public Accounting Firm on Internal Control Under Standards of the Public Company Accounting Oversight Board (United States)

To the Shareholders of Manulife Financial Corporation

Opinion on Internal Control over Financial Reporting

We have audited Manulife Financial Corporation’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Manulife Financial Corporation (the “Company”) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.

We also have audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Consolidated Statements of Financial Position as at December 31, 2017 and 2016, and the Consolidated Statements of Income, Comprehensive Income, Changes in Equity and Cash Flows for the years then ended of Manulife Financial Corporation, and our report dated February 7, 2018, expressed an unqualified opinion thereon.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Report on Internal Control Over Financial Reporting contained in the Management’s Discussion and Analysis. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.

Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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Chartered Professional Accountants

Licensed Public Accountants

Toronto, Canada

February 7, 2018

 

Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        107


Consolidated Statements of Financial Position

 

As at December 31,

(Canadian $ in millions)

   2017              2016         

Assets

          

Cash and short-term securities

   $ 15,965         $ 15,151    

Debt securities

     174,000           168,622    

Public equities

     21,545           19,496    

Mortgages

     44,742           44,193    

Private placements

     32,132           29,729    

Policy loans

     5,808           6,041    

Loans to bank clients

     1,737           1,745    

Real estate

     13,810           14,132    

Other invested assets

     24,483                 22,760          

Total invested assets (note 4)

     334,222                 321,869          

Other assets

          

Accrued investment income

     2,182           2,260    

Outstanding premiums

     1,148           845    

Derivatives (note 5)

     15,569           23,672    

Reinsurance assets (note 8)

     30,359           34,952    

Deferred tax assets (note 6)

     4,569           4,439    

Goodwill and intangible assets (note 7)

     9,840           10,107    

Miscellaneous

     7,337                 7,360          

Total other assets

     71,004                 83,635          

Segregated funds net assets (note 22)

     324,307                 315,177          

Total assets

   $   729,533               $   720,681          

Liabilities and Equity

          

Liabilities

          

Insurance contract liabilities (note 8)

   $ 304,605         $ 297,505    

Investment contract liabilities (note 9)

     3,126           3,275    

Deposits from bank clients

     18,131           17,919    

Derivatives (note 5)

     7,822           14,151    

Deferred tax liabilities (note 6)

     1,281           1,359    

Other liabilities

     14,926                 15,596          
     349,891           349,805    

Long-term debt (note 11)

     4,785           5,696    

Capital instruments (note 12)

     8,387           7,180    

Segregated funds net liabilities (note 22)

     324,307                 315,177          

Total liabilities

     687,370                 677,858          

Equity

          

Preferred shares (note 13)

     3,577           3,577    

Common shares (note 13)

     22,989           22,865    

Contributed surplus

     277           284    

Shareholders’ retained earnings

     10,083           9,759    

Shareholders’ accumulated other comprehensive income (loss):

          

Pension and other post-employment plans

     (364         (417  

Available-for-sale securities

     179           (394  

Cash flow hedges

     (109         (232  

Translation of foreign operations and real estate revaluation surplus

     4,381                 6,390          

Total shareholders’ equity

     41,013           41,832    

Participating policyholders’ equity

     221           248    

Non-controlling interests

     929                 743          

Total equity

     42,163                 42,823          

Total liabilities and equity

   $ 729,533               $ 720,681          

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Roy Gori

President and Chief Executive Officer

  

Richard B. DeWolfe

Chairman of the Board of Directors

 

108        Manulife  Financial Corporation  |  2017 Annual Report  |  Consolidated Financial Statements


Consolidated Statements of Income

 

For the years ended December 31,

(Canadian $ in millions except per share amounts)

   2017              2016         

Revenue

          

Premium income

          

Gross premiums

   $   36,361         $   36,659    

Premiums ceded to reinsurers

     (8,151               (9,027        

Net premiums

     28,210                 27,632          

Investment income (note 4)

          

Investment income

     13,649           13,390    

Realized and unrealized gains on assets supporting insurance and investment contract liabilities and on the macro hedge program

     5,718                 1,134          

Net investment income

     19,367                 14,524          

Other revenue

     10,746                 11,181          

Total revenue

     58,323                 53,337          

Contract benefits and expenses

          

To contract holders and beneficiaries

          

Gross claims and benefits (note 8)

     24,994           25,059    

Change in insurance contract liabilities

     20,023           18,014    

Change in investment contract liabilities

     173              

Benefits and expenses ceded to reinsurers

     (8,158         (8,097  

Change in reinsurance assets (note 8)

     2,269                 (842        

Net benefits and claims

     39,301           34,134    

General expenses

     7,233           6,995    

Investment expenses (note 4)

     1,673           1,646    

Commissions

     6,116           5,818    

Interest expense

     1,139           1,013    

Net premium taxes

     360                 402          

Total contract benefits and expenses

     55,822                 50,008          

Income before income taxes

     2,501           3,329    

Income tax expense (note 6)

     (239               (196        

Net income

   $ 2,262               $ 3,133          

Net income (loss) attributed to:

          

Non-controlling interests

   $ 194         $ 143    

Participating policyholders

     (36         61    

Shareholders

     2,104                 2,929          
     $ 2,262               $ 3,133          

Net income attributed to shareholders

     2,104           2,929    

Preferred share dividends

     (159               (133        

Common shareholders’ net income

   $ 1,945               $ 2,796          

Earnings per share

          

Basic earnings per common share (note 13)

   $ 0.98         $ 1.42    

Diluted earnings per common share (note 13)

     0.98           1.41    

Dividends per common share

     0.82                 0.74          

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        109


Consolidated Statements of Comprehensive Income

 

For the years ended December 31,

(Canadian $ in millions)

   2017              2016         

Net income

   $    2,262               $    3,133          

Other comprehensive income (loss) (“OCI”), net of tax:

          

Items that may be subsequently reclassified to net income:

          

Foreign exchange gains (losses) on:

          

Translation of foreign operations

     (2,256         (1,044  

Net investment hedges

     227           2    

Available-for-sale financial securities:

          

Unrealized gains (losses) arising during the year

     601           (218  

Reclassification of net realized gains and impairments to net income

     (32         (523  

Cash flow hedges:

          

Unrealized gains arising during the year

     110           21    

Reclassification of realized losses to net income

     13           11    

Share of other comprehensive income of associates

     1                          

Total items that may be subsequently reclassified to net income

     (1,336               (1,751        

Items that will not be reclassified to net income:

          

Change in pension and other post-employment plans

     53           104    

Real estate revaluation reserve

     30                          

Total items that will not be reclassified to net income

     83                 104          

Other comprehensive loss, net of tax

     (1,253               (1,647        

Total comprehensive income, net of tax

   $ 1,009               $ 1,486          

Total comprehensive income (loss) attributed to:

          

Non-controlling interests

   $ 192         $ 141    

Participating policyholders

     (27         61    

Shareholders

     844                 1,284          

Income Taxes included in Other Comprehensive Income

 

For the years ended December 31,

(Canadian $ in millions)

   2017              2016         

Income tax expense (recovery) on:

          

Unrealized foreign exchange gains/losses on translation of foreign operations

   $ (1       $         1    

Unrealized foreign exchange gains/losses on net investment hedges

     48           22    

Unrealized gains/losses on available-for-sale financial securities

         284           (15  

Reclassification of realized gains/losses and recoveries/impairments to net income on available-for-sale financial securities

     7           (183  

Unrealized gains/losses on cash flow hedges

     49           15    

Reclassification of realized gains/losses to net income on cash flow hedges

     3           6    

Change in pension and other post-employment plans

     37           57    

Real estate revaluation reserve

     9                          

Total income tax expense (recovery)

   $ 436               $ (97        

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

110        Manulife  Financial Corporation  |  2017 Annual Report  |  Consolidated Financial Statements


Consolidated Statements of Changes in Equity

 

For the years ended December 31,

(Canadian $ in millions)

   2017              2016         

Preferred shares

          

Balance, beginning of year

   $ 3,577         $ 2,693    

Issued (note 13)

               900    

Issuance costs, net of tax

                     (16        

Balance, end of year

     3,577                 3,577          

Common shares

          

Balance, beginning of year

     22,865           22,799    

Issued on exercise of stock options

     124                 66          

Balance, end of year

     22,989                 22,865          

Contributed surplus

          

Balance, beginning of year

     284           277    

Exercise of stock options and deferred share units

     (22         (12  

Stock option expense

     15                 19          

Balance, end of year

     277                 284          

Shareholders’ retained earnings

          

Balance, beginning of year

     9,759           8,398    

Net income attributed to shareholders

     2,104           2,929    

Preferred share dividends

     (159         (133  

Common share dividends

     (1,621               (1,435        

Balance, end of year

     10,083                 9,759          

Shareholders’ accumulated other comprehensive income (loss) (“AOCI”)

          

Balance, beginning of year

     5,347           6,992    

Change in unrealized foreign exchange gains (losses) of net foreign operations

     (2,029         (1,042  

Change in actuarial gains (losses) on pension and other post-employment plans

     53           104    

Change in unrealized gains (losses) on available-for-sale financial securities

     572           (739  

Change in unrealized gains (losses) on derivative instruments designated as cash flow hedges

     123           32    

Change in real estate revaluation reserve

     20              

Share of other comprehensive income of associates

     1                          

Balance, end of year

     4,087                 5,347          

Total shareholders’ equity, end of year

     41,013                 41,832          

Participating policyholders’ equity

          

Balance, beginning of year

     248           187    

Net income (loss) attributed to participating policyholders

     (36         61    

Other comprehensive income attributed to policyholders

     9                          

Balance, end of year

     221                 248          

Non-controlling interests

          

Balance, beginning of year

     743           592    

Net income attributed to non-controlling interests

     194           143    

Other comprehensive loss attributed to non-controlling interests

     (2         (2  

Contributions (distributions), net

     (6               10          

Balance, end of year

     929                 743          

Total equity, end of year

   $  42,163               $  42,823          

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        111


Consolidated Statements of Cash Flows

 

For the years ended December 31,

(Canadian $ in millions)

   2017              2016         

Operating activities

          

Net income

   $ 2,262         $ 3,133    

Adjustments:

          

Increase in insurance contract liabilities

     20,023           18,014    

Increase in investment contract liabilities

     173              

(Increase) decrease in reinsurance assets

     2,269           (842  

Amortization of (premium) discount on invested assets

     230           78    

Other amortization

     560           693    

Net realized and unrealized (gains) losses and impairment on assets

     (7,188         (2,804  

Deferred income tax recovery

     (331         (235  

Stock option expense

     15                 19          

Cash provided by operating activities before undernoted items

     18,013           18,056    

Changes in policy related and operating receivables and payables

     (222               (1,039        

Cash provided by operating activities

     17,791                 17,017          

Investing activities

          

Purchases and mortgage advances

     (87,224         (104,059  

Disposals and repayments

     70,720           82,001    

Change in investment broker net receivables and payables

     227           (186  

Net cash decrease from sale and purchase of subsidiaries and businesses

     (10               (495        

Cash used in investing activities

     (16,287               (22,739        

Financing activities

          

Decrease in repurchase agreements and securities sold but not yet purchased

     (29         (23  

Issue of long-term debt, net (note 11)

               3,899    

Redemption of long-term debt (note 11)

     (607         (158  

Issue of capital instruments, net (note 12)

     2,209           479    

Redemption of capital instruments (note 12)

     (899         (949  

Secured borrowing from securitization transactions

     741           847    

Changes in deposits from Bank clients, net

     261           (157  

Shareholders’ dividends paid in cash

     (1,780         (1,593  

Contributions from (distributions to) non-controlling interests, net

     (6         10    

Common shares issued, net (note 13)

     124           66    

Preferred shares issued, net (note 13)

                     884          

Cash provided by financing activities

     14                 3,305          

Cash and short-term securities

          

Increase (decrease) during the year

     1,518           (2,417  

Effect of foreign exchange rate changes on cash and short-term securities

     (658         (347  

Balance, beginning of year

     14,238                 17,002          

Balance, December 31

     15,098                 14,238          

Cash and short-term securities

          

Beginning of year

          

Gross cash and short-term securities

     15,151           17,885    

Net payments in transit, included in other liabilities

     (913               (883        

Net cash and short-term securities, January 1

     14,238                 17,002          

End of year

          

Gross cash and short-term securities

     15,965           15,151    

Net payments in transit, included in other liabilities

     (867               (913        

Net cash and short-term securities, December 31

   $ 15,098               $ 14,238          

Supplemental disclosures on cash flow information

          

Interest received

   $ 10,596         $ 10,550    

Interest paid

     1,118           983    

Income taxes paid

     1,360                 841          

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

112        Manulife  Financial Corporation  |  2017 Annual Report  |  Consolidated Financial Statements


Notes to Consolidated Financial Statements

 

Page Number   Note     

114

 

Note 1

  Nature of Operations and Significant Accounting Policies

121

 

Note 2

  Accounting and Reporting Changes

123

 

Note 3

  Acquisition and Distribution Agreements

124

 

Note 4

  Invested Assets and Investment Income

131

 

Note 5

  Derivative and Hedging Instruments

137

 

Note 6

  Income Taxes

139

 

Note 7

  Goodwill and Intangible Assets

141

 

Note 8

  Insurance Contract Liabilities and Reinsurance Assets

149

 

Note 9

  Investment Contract Liabilities

150

 

Note 10

  Risk Management

157

 

Note 11

  Long-Term Debt

158

 

Note 12

  Capital Instruments

158

 

Note 13

  Share Capital and Earnings Per Share

160

 

Note 14

  Capital Management

161

 

Note 15

  Stock-Based Compensation

163

 

Note 16

  Employee Future Benefits

167

 

Note 17

  Interests in Structured Entities

169

 

Note 18

  Commitments and Contingencies

171

 

Note 19

  Segmented Information

173

 

Note 20

  Related Parties

173

 

Note 21

  Subsidiaries

175

 

Note 22

  Segregated Funds

176

 

Note 23

  Information Provided in Connection with Investments in Deferred Annuity Contracts and SignatureNotes Issued or Assumed by John Hancock Life Insurance Company (U.S.A.)

182

 

Note 24

 

Comparatives

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        113


Notes to Consolidated Financial Statements

(Canadian $ in millions except per share amounts or unless otherwise stated)

Note 1    Nature of Operations and Significant Accounting Policies

(a) Reporting entity

Manulife Financial Corporation (“MFC”) is a publicly traded company and the holding company of The Manufacturers Life Insurance Company (“MLI”), a Canadian life insurance company. MFC and its subsidiaries (collectively, “Manulife” or the “Company”) is a leading financial services group with principal operations in Asia, Canada and the United States. Manulife’s international network of employees, agents and distribution partners offers financial protection and wealth management products and services to personal and business clients as well as asset management services to institutional customers. The Company operates as Manulife in Canada and Asia and as John Hancock in the United States.

MFC is domiciled in Canada and incorporated under the Insurance Companies Act (Canada) (“ICA”). These Consolidated Financial Statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”).

These Consolidated Financial Statements should be read in conjunction with “Risk Management” in the 2017 Management’s Discussion and Analysis (“MD&A”) dealing with IFRS 7 “Financial Instruments: Disclosures” as the discussion on market risk and liquidity risk includes certain disclosures that are considered an integral part of these Consolidated Financial Statements.

These Consolidated Financial Statements as at and for the year ended December 31, 2017 were authorized for issue by MFC’s Board of Directors on February 7, 2018.

(b) Basis of preparation

The preparation of Consolidated Financial Statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities as at the date of the Consolidated Financial Statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from these estimates. The most significant estimation processes relate to assumptions used in measuring insurance and investment contract liabilities, assessing assets for impairment, determining of pension and other post-employment benefit obligation and expense assumptions, determining income taxes and uncertain tax positions and fair valuation of certain invested assets. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the year in which the estimates are revised and in any future years affected. Although some variability is inherent in these estimates, management believes that the amounts recorded are appropriate. The significant accounting policies used and the most significant judgments made by management in applying these accounting policies in the preparation of these Consolidated Financial Statements are summarized below.

(c) Fair value measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (not a forced liquidation or distress sale) between market participants at the measurement date, that is, an exit value.

When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is typically based upon alternative valuation techniques such as discounted cash flows, matrix pricing, consensus pricing services and other techniques. Broker quotes are generally used when external public vendor prices are not available.

The Company has a process in place that includes a review of price movements relative to the market, a comparison of prices between vendors, and a comparison to internal matrix pricing which uses predominately external observable data. Judgment is applied in adjusting external observable data for items including liquidity and credit factors.

The Company categorizes its fair value measurements according to a three-level hierarchy. The hierarchy prioritizes the inputs used by the Company’s valuation techniques. A level is assigned to each fair value measurement based on the lowest level input significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are defined as follows:

Level 1 – Fair value measurements that reflect unadjusted, quoted prices in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date reflecting market transactions.

Level 2 – Fair value measurements using inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets, inputs that are observable that are not prices (such as interest rates, credit risks, etc.) and inputs that are derived from or corroborated by observable market data. Most debt securities are classified within Level 2. Also, included in the Level 2 category are derivative instruments that are priced using models with observable market inputs, including interest rate swaps, equity swaps, and foreign currency forward contracts.

Level 3 – Fair value measurements using significant non-market observable inputs. These include valuations for assets and liabilities that are derived using data, some or all of which is not market observable, including assumptions about risk. Level 3 securities include less liquid securities such as structured asset-backed securities, commercial mortgage-backed securities (“CMBS”), certain long-duration bonds and other securities that have little or no price transparency. Embedded and complex derivative financial instruments as well as real estate classified as investment property are also included in Level 3.

 

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(d) Basis of consolidation

MFC consolidates the financial statements of all entities, including certain structured entities that it controls. Subsidiaries are entities controlled by the Company. The Company has control over an entity when the Company has the power to govern the financial and operating policies of the entity, is exposed to variable returns from its activities which are significant in relation to the total variable returns of the entity and the Company is able to use its power over the entity to affect its share of variable returns. In assessing control, significant judgment is applied while considering all relevant facts and circumstances. When assessing decision-making power, the Company considers the extent of its rights relative to the management of an entity, the level of voting rights held in an entity which are potentially or presently exercisable, the existence of any contractual management agreements which may provide the Company with power over an entity’s financial and operating policies and to the extent of other parties’ ownership in an entity, if any, the possibility for de facto control being present. When assessing returns, the Company considers the significance of direct and indirect financial and non-financial variable returns to the Company from an entity’s activities in addition to the proportionate significance of such returns. The Company also considers the degree to which its interests are aligned with those of other parties investing in an entity and the degree to which it may act in its own interest.

The financial statements of subsidiaries are included in the MFC’s consolidated results from the date control is established and are excluded from consolidation from the date control ceases. The initial control assessment is performed at inception of the Company’s involvement with the entity and is reconsidered at a later date if the Company acquires or loses power over key operating and financial policies of the entity; acquires additional interests or disposes of interests in the entity; the contractual arrangements of the entity are amended such that the Company’s proportionate exposure to variable returns changes; or if the Company’s ability to use its power to affect its variable returns from the entity changes.

The Company’s Consolidated Financial Statements have been prepared using uniform accounting policies for like transactions and events in similar circumstances. Intercompany balances, and income and expenses arising from intercompany transactions, have been eliminated in preparing the Consolidated Financial Statements.

Non-controlling interests are interests of other parties in the equity of MFC’s subsidiaries and are presented within total equity, separate from the equity of MFC’s shareholders. Non-controlling interests in the net income and other comprehensive income (“OCI”) of MFC’s subsidiaries are included in total net income and total OCI, respectively. An exception to this occurs where the subsidiary’s shares are required to be redeemed for cash on a fixed or determinable date, in which case other parties’ interests in the subsidiary’s capital are presented as liabilities of the Company and other parties’ non-controlling interests in the subsidiary’s income and OCI are recorded as expenses of the Company.

The equity method of accounting is used to account for entities over which the Company has significant influence (“associates”), whereby the Company records its share of the associate’s net assets and financial results using uniform accounting policies for similar transactions and events. Significant judgment is used to determine whether voting rights, contractual management and other relationships with the entity, if any, provide the Company with significant influence over the entity. Gains and losses on the sale of associates are included in income when realized, while impairment losses are recognized immediately when there is objective evidence of impairment. Gains and losses on commercial transactions with associates are eliminated to the extent of the Company’s interest in the associate. Investments in associates are included in other invested assets on the Company’s Consolidated Statements of Financial Position.

(e) Invested assets

Invested assets that are considered financial instruments are classified as fair value through profit or loss (“FVTPL”), loans and receivables, or as available-for-sale (“AFS”) financial assets. The Company determines the classification of its financial assets at initial recognition. Invested assets are recognized initially at fair value plus, in the case of investments not at FVTPL, directly attributable transaction costs. Invested assets are classified as financial instruments at FVTPL if they are held for trading, if they are designated by management under the fair value option, or if they are designated by management when they include one or more embedded derivatives. Invested assets classified as AFS are non-derivative financial assets that do not fall into any of the other categories described above.

Valuation methods for the Company’s invested assets are described above. All fair value valuations are performed in accordance with IFRS 13 “Fair Value Measurement”. Disclosure of financial instruments carried at fair value with the three levels of the fair value hierarchy and the disclosure of the fair value for financial instruments not carried at fair value on the Consolidated Statements of Financial Position are presented in note 4. Fair value valuations are performed by the Company and by third-party service providers. When third-party service providers are engaged, the Company performs a variety of procedures to corroborate pricing information. These procedures may include, but are not limited to, inquiry and review of valuation techniques, inputs to the valuation and vendor controls reports.

Cash and short-term securities comprise cash, current operating accounts, overnight bank and term deposits, and fixed income securities held for the purpose of meeting short-term cash commitments. Short-term securities are carried at fair value. Short-term securities are comprised of investments due to mature within one year of the date of purchase. Commercial paper and discount notes are classified as Level 2 because these securities are typically not actively traded. Net payments in transit and overdraft bank balances are included in other liabilities.

Debt securities are carried at fair value. Debt securities are generally valued by independent pricing vendors using proprietary pricing models incorporating current market inputs for similar instruments with comparable terms and credit quality (matrix pricing). The

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        115


significant inputs include, but are not limited to, yield curves, credit risks and spreads, measures of volatility and prepayment rates. These debt securities are classified as Level 2, but can be Level 3 if the significant inputs are market unobservable. Realized gains and losses on sale of debt securities and unrealized gains and losses on debt securities designated as FVTPL are recognized in investment income immediately. Unrealized gains and losses on AFS debt securities are recorded in OCI, with the exception of unrealized gains and losses on foreign currency translation which are included in income. Impairment losses on AFS debt securities are recognized in income on an individual security basis when there is objective evidence of impairment. Impairment is considered to have occurred, based on management’s judgment, when it is deemed probable that the Company will not be able to collect all amounts due according to the debt security’s contractual terms.

Equities are comprised of common and preferred equities and are carried at fair value. Equities are generally classified as Level 1, as fair values are normally based on quoted market prices. Realized gains and losses on sale of equities and unrealized gains and losses on equities designated as FVTPL are recognized in investment income immediately. Unrealized gains and losses on AFS equities are recorded in OCI. Impairment losses on AFS equities are recognized in income on an individual security basis when there is objective evidence of impairment. Impairment is considered to have occurred when fair value has declined below cost by significant amounts or for prolonged periods of time. Judgment is applied in determining whether the decline is significant or prolonged.

Mortgages are carried at amortized cost, and are classified as Level 3 for fair value purposes due to the lack of market observability of certain significant valuation inputs. Realized gains and losses are recorded in investment income immediately. Impairment losses are recorded on mortgages when there is no longer reasonable assurance as to the timely collection of the full amount of principal and interest and are measured based on the discounted value of expected future cash flows at the original effective interest rates inherent in the mortgage. Expected future cash flows of impaired mortgages are typically determined in reference to the fair value of collateral security underlying the mortgage, net of expected costs of realization and any applicable insurance recoveries. Significant judgment is applied in the determination of impairment including the timing and amount of future collections.

The Company accounts for insured and uninsured mortgage securitizations as secured financing transactions since the criteria for sale accounting are not met. For these transactions, the Company continues to recognize the mortgages and records a liability in other liabilities for the amounts owed at maturity. Interest income from these mortgages and interest expense on the borrowings are recorded using the effective interest rate method.

Private placements, which include corporate loans for which there is no active market, are carried at amortized cost and are generally classified as Level 2 for fair value disclosure purposes, but can be classified as Level 3 if significant inputs are market unobservable. Realized gains and losses are recorded in income immediately. Impairment losses are recorded on private placements when there is no longer assurance as to the timely collection of the full amount of principal and interest. Impairment is measured based on the discounted value of expected future cash flows at the original effective interest rate inherent in the loan. Significant judgment is applied in the determination of impairment including the timing and amount of future collections.

Policy loans are carried at an amount equal to their unpaid balances and are classified as Level 2 for fair value disclosure purposes. Policy loans are fully collateralized by the cash surrender value of the underlying policies.

Loans to Manulife Bank of Canada (“Manulife Bank” or “Bank”) clients are carried at unpaid principal balances less allowance for credit losses, if any, and are classified as Level 2 for fair value disclosure purposes. A loan to a Bank client is considered impaired when there is objective evidence of impairment as a result of one or more loss events that have occurred after initial recognition, with a negative impact on the estimated future cash flows of the loan.

Once established, allowances for impairment of mortgages, private placements and loans to Bank clients are reversed only if the conditions that caused the impairment no longer exist. Reversals of impairment charges on AFS debt securities are only recognized in income to the extent that increases in fair value can be attributed to events subsequent to the impairment loss being recorded. Impairment losses for AFS equity instruments are not reversed through income. On disposition of an impaired asset, any allowance for impairment is released.

In addition to impairments and provisions for loan losses (recoveries) reported in investment income, the measurement of insurance contract liabilities via investment return assumptions, includes expected future credit losses on fixed income investments. Refer to note 8(d).

Interest income is recognized on debt securities, mortgages, private placements, policy loans and loans to Bank clients as it accrues and is calculated using the effective interest rate method. Premiums, discounts and transaction costs are amortized over the life of the underlying investment using the effective yield method for all debt securities as well as mortgages and private placements measured at amortized cost.

The Company records purchases and sales of invested assets on a trade date basis, except for loans originated by the Company, which are recognized on a settlement date basis.

Real estate consists of both own use and investment property. Own use property is carried at cost less accumulated depreciation and any accumulated impairment losses. Depreciation is calculated based on the cost of an asset less its residual value and is recognized in income on a straight-line basis over the estimated useful life ranging from 30 to 60 years. Impairment losses are recorded in income to the extent the recoverable amount is less than the carrying amount. Where own use property is included in assets backing insurance contract liabilities, the fair value of the property is used in the valuation of insurance contract liabilities. Own use property is classified as Level 3 for fair value disclosure purposes.

 

116        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


An investment property is a property held to earn rental income, for capital appreciation, or both. Investment properties are measured at fair value, with changes in fair value recognized in income. Fair value is determined using external appraisals that are based on the highest and best use of the property. The valuation techniques used include discounted cash flows, the direct capitalization method as well as comparable sales analysis and include both observable and unobservable inputs. Inputs include existing and assumed tenancies, market data from recent comparable transactions, future economic outlook and market risk assumptions, capitalization rates and internal rates of return. Investment properties are classified as Level 3 for fair value disclosure purposes.

When a property changes from own use to investment property, any gain arising on the remeasurement of the property to fair value at the date of transfer is recognized in OCI, to the extent that it is not reversing a previous impairment loss. Reversals of impairment losses are recognized in income.

Other invested assets include private equity and property investments held in power and infrastructure and timber, as well as in agriculture and oil and gas sectors. Private equity investments are accounted for as associates using the equity method (as described in note 1(d) above) or are classified as FVTPL or AFS and carried at fair value. Investments in oil and gas exploration and evaluation activities are measured on the cost basis using the “successful efforts” method. Timber and agriculture properties are measured at fair value with changes in fair value recognized in income, with the exception of buildings, equipment and bearer plants which are measured at amortized cost. The fair value of other invested assets is determined using a variety of valuation techniques as described in note 4. Other invested assets that are measured or disclosed at fair value are classified as Level 3.

Other invested assets also include investments in leveraged leases, which are accounted for using the equity method. The carrying value under the equity method reflects the amortized cost of the lease receivable and related non-recourse debt using the effective yield method.

(f) Goodwill and intangible assets

Goodwill represents the difference between the purchase consideration of an acquired business and the Company’s proportionate share of the net identifiable assets acquired. It is initially recorded at cost and subsequently measured at cost less any accumulated impairment.

Goodwill is tested for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable at the cash generating unit (“CGU”) or group of CGUs level. The Company allocates goodwill to CGUs or groups of CGUs for the purpose of impairment testing based on the lowest level within the entity in which the goodwill is monitored for internal management purposes. The allocation is made to those CGUs or groups of CGUs that are expected to benefit from the business combination in which the goodwill arose. Any potential impairment of goodwill is identified by comparing the recoverable amount of a CGU or group of CGUs to its carrying value. Goodwill is reduced by the amount of deficiency, if any. If the deficiency exceeds the carrying amount of goodwill, the carrying values of the remaining assets in the CGU or group of CGUs are subject to being reduced by the excess on a pro-rata basis.

The recoverable amount of a CGU is the higher of the estimated fair value less costs to sell or the value-in-use of the CGU. In assessing value-in-use, estimated future cash flows are discounted using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. In some cases, the most recent detailed calculation made in a prior period of the recoverable amount of a CGU is used in the testing of impairment of goodwill in the current period. This is the case only if there are no significant changes to the CGU, the likelihood of impairment is remote based on the analysis of current events and circumstances, and the most recent recoverable amount substantially exceeds the carrying amount of the CGU.

Intangible assets with indefinite useful lives include the John Hancock brand name and certain investment management contracts. The indefinite useful life assessment for brand is based on the brand name being protected in markets where branded products are sold by trademarks, which are renewable indefinitely, and for certain investment management contracts due to the ability to renew these contracts indefinitely. In addition, there are no legal, regulatory or contractual provisions that limit the useful lives of these intangible assets. An intangible asset with an indefinite useful life is not amortized but is subject to an annual impairment test which is performed more frequently if there is an indication that it is not recoverable.

Intangible assets with finite useful lives include acquired distribution networks, customer relationships, capitalized software, certain investment management contracts and other contractual rights. Distribution networks, customer relationships, and other finite life intangible assets are amortized over their estimated useful lives, six to 68 years, either based on straight-line or in relation to other asset consumption metrics. Software intangible assets are amortized on a straight-line basis over their estimated useful lives of three to five years. Finite life intangible assets are assessed for indicators of impairment at each reporting period. If any indication of impairment exists, these assets are subject to an impairment test.

(g) Miscellaneous assets

Miscellaneous assets include assets held in a rabbi trust with respect to unfunded defined benefit obligations, defined benefit assets, if any (refer to note 1(o)), deferred acquisition costs and capital assets. Deferred acquisition costs are carried at cost less accumulated amortization. These costs are recognized over the period where redemption fees may be charged or over the period revenue is earned. Capital assets are carried at cost less accumulated amortization computed on a straight-line basis over their estimated useful lives, which vary from two to 10 years.

(h) Segregated funds

The Company manages a number of segregated funds on behalf of policyholders. The investment returns on these funds are passed directly to policyholders. In some cases, the Company has provided guarantees associated with these funds.

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        117


Segregated funds net assets are measured at fair value and primarily include investments in mutual funds, debt securities, equities, real estate, short-term investments and cash and cash equivalents. With respect to the consolidation requirement of IFRS, in assessing the Company’s degree of control over the underlying investments, the Company considers the scope of its decision-making rights, the rights held by other parties, its remuneration as an investment manager and its exposure to variability of returns. The Company has determined that it does not have control over the underlying investments as it acts as an agent on behalf of segregated fund policyholders.

The methodology applied to determine the fair value of investments held in segregated funds is consistent with that applied to invested assets held by the general fund, as described above in note 1(e). Segregated funds liabilities are measured based on the value of the segregated funds net assets. Investment returns on segregated funds assets belong to policyholders and the Company does not bear the risk associated with these assets outside of guarantees offered on certain variable life and annuity products, for which the underlying investments are held within segregated funds. Accordingly, investment income earned by segregated funds and expenses incurred by segregated funds are offset and are not separately presented in the Consolidated Statements of Income. Fee income earned by the Company for managing the segregated funds is included in other revenue. Refer to note 22.

Liabilities related to guarantees associated with certain segregated funds, as a result of certain variable life and annuity contracts, are recorded within the Company’s insurance contract liabilities. The Company holds assets supporting these guarantees which are recognized in invested assets according to their investment type.

(i) Insurance and investment contract liabilities

Most contracts issued by the Company are considered insurance, investment or service contracts. Contracts under which the Company accepts significant insurance risk from a policyholder are classified as insurance contracts in the Consolidated Financial Statements. A contract is considered to have significant insurance risk if, and only if, an insured event could cause an insurer to make significant additional payments in any scenario, excluding scenarios that lack commercial substance at the inception of the contract. Contracts under which the Company does not accept significant insurance risk are either classified as investment contracts or considered service contracts and are accounted for in accordance with IAS 39Financial Instruments: Recognition and Measurement or IAS 18 “Revenue”, respectively.

Once a contract has been classified as an insurance contract it remains an insurance contract even if the insurance risk reduces significantly. Investment contracts can be reclassified as insurance contracts if insurance risk subsequently becomes significant.

Insurance contract liabilities, net of reinsurance assets, represent the amount which, together with estimated future premiums and net investment income, will be sufficient to pay estimated future benefits, policyholder dividends and refunds, taxes (other than income taxes) and expenses on policies in-force. Insurance contract liabilities are presented gross of reinsurance assets on the Consolidated Statements of Financial Position. The Company’s Appointed Actuary is responsible for determining the amount of insurance contract liabilities in accordance with standards established by the Canadian Institute of Actuaries. Insurance contract liabilities, net of reinsurance assets, have been determined using the Canadian Asset Liability Method (“CALM”) as permitted by IFRS 4 “Insurance Contracts”. Refer to note 8.

Investment contract liabilities include contracts issued to retail and institutional investors that do not contain significant insurance risk. Investment contract liabilities and deposits are measured at amortized cost or at fair value by election. The election reduces accounting mismatches between assets supporting these contracts and the related policy liabilities. Investment contract liabilities are derecognized when the contract expires, is discharged or is cancelled.

Derivatives embedded within insurance contracts are separated if they are not considered to be closely related to the host insurance contract and do not meet the definition of an insurance contract. These embedded derivatives are presented separately in other assets or other liabilities and are measured at fair value with changes in fair value recognized in income.

(j) Reinsurance assets

The Company uses reinsurance in the normal course of business to manage its risk exposure. Insurance ceded to a reinsurer does not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet its obligations for reinsurance ceded to it under a reinsurance agreement.

Reinsurance assets represent the benefit derived from reinsurance agreements in-force at the reporting date, taking into account the financial condition of the reinsurer. Amounts recoverable from reinsurers are estimated in accordance with the terms of the relevant reinsurance contract.

Gains or losses on reinsurance transactions are recognized in income immediately on the transaction date and are not amortized. Premiums ceded and claims reimbursed are presented on a gross basis on the Consolidated Statements of Income. Reinsurance assets are not offset against the related insurance contract liabilities and are presented separately on the Consolidated Statements of Financial Position. Refer to note 8(a).

(k) Other financial instruments accounted for as liabilities

The Company issues a variety of other financial instruments classified as liabilities, including notes payable, term notes, senior notes, senior debentures, subordinated notes, surplus notes, subscription receipts and preferred shares.

These financial liabilities are measured at amortized cost, with issuance costs deferred and amortized using the effective interest rate method.

 

118        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


(l) Income taxes

The provision for income taxes is calculated based on income tax laws and income tax rates substantively enacted as at the date of the Consolidated Statements of Financial Position. The income tax provision is comprised of current income taxes and deferred income taxes. Current and deferred income taxes relating to items recognized in OCI and directly in equity are similarly recognized in OCI and directly in equity, respectively.

Current income taxes are amounts expected to be payable or recoverable as a result of operations in the current year and any adjustments to taxes payable in respect of previous years.

Deferred income taxes are provided for using the liability method and result from temporary differences between the carrying values of assets and liabilities and their respective tax bases. Deferred income taxes are measured at the substantively enacted tax rates that are expected to be applied to temporary differences when they reverse.

A deferred tax asset is recognized to the extent that future realization of the tax benefit is probable. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the tax benefit will be realized. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets and they relate to income taxes levied by the same tax authority on the same taxable entity.

Deferred tax liabilities are recognized for all taxable temporary differences, except in respect of taxable temporary differences associated with investments in subsidiaries and associates, where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future.

The Company records provisions for uncertain tax positions if it is probable that the Company will make a payment on tax positions as a result of examinations by tax authorities. These provisions are measured at the Company’s best estimate of the amount expected to be paid. Provisions are reversed to income in the period in which management assesses they are no longer required or determined by statute.

The Company is subject to income tax laws in various jurisdictions. Tax laws are complex and potentially subject to different interpretations by the taxpayer and the relevant tax authority. The provision for income taxes and deferred income taxes represents management’s interpretation of the relevant tax laws and its estimate of current and future income tax implications of the transactions and events during the year. The Company may be required to change its provision for income taxes or deferred income tax balances when the ultimate deductibility of certain items is successfully challenged by taxing authorities, or if estimates used in determining the amount of deferred tax asset to recognize change significantly, or when receipt of new information indicates the need for adjustment in the amount of deferred income taxes to be recognized. Additionally, future events, such as changes in tax laws, tax regulations, or interpretations of such laws or regulations, could have an impact on the provision for income taxes, deferred tax balances and the effective tax rate. Any such changes could materially affect the amounts reported in the Consolidated Financial Statements in the period these changes occur.

(m) Foreign currency translation

Items included in the financial statements of each of the Company’s subsidiaries are measured by each subsidiary using the currency of the primary economic environment in which the entity operates (the “functional currency”).

Transactions in a foreign currency are translated to the functional currency at the exchange rate prevailing at the date of the transaction. Assets and liabilities denominated in foreign currencies are translated to the functional currency at the exchange rate in effect at the reporting date. Revenue and expenses denominated in foreign currencies are translated at the average exchange rate prevailing during the quarter reported. Exchange gains and losses are recognized in income with the exception of translation of net investments in foreign operations and the results of hedging these positions.

These foreign exchange gains and losses are recognized in OCI until such time that the foreign operation is disposed of or control or significant influence over it is lost.

(n) Stock-based compensation

The Company provides stock-based compensation to certain employees and directors as described in note 15. Compensation expense of equity instruments is accrued based on the best estimate of the number of instruments expected to vest, with revisions made to that estimate if subsequent information indicates that actual forfeitures are likely to differ from initial estimates, unless forfeitures are due to market-based conditions.

Stock options are expensed with a corresponding increase in contributed surplus. Restricted share units and deferred share units are expensed with a corresponding liability accrued based on the market value of MFC’s common shares at the end of each quarter. Performance share units are expensed with a corresponding liability accrued based on specific performance conditions and the market value of MFC’s common shares at the end of each quarter. The change in the value of the awards resulting from changes in the market value of MFC’s common shares or changes in the specific performance conditions and credited dividends is recognized in income, offset by the impact of total return swaps used to manage the variability of the related liability.

Stock-based compensation cost is recognized over the applicable vesting period, except if the employee is eligible to retire at the time of grant or will be eligible to retire during the vesting period. Compensation cost, attributable to stock options, restricted share units, and performance share units granted to employees who are eligible to retire on the grant date or who will become eligible to retire during the vesting period, is recognized at the grant date or over the period from the grant date to the date of retirement eligibility, respectively.

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        119


The Company’s contributions to the Global Share Ownership Plan (“GSOP”) (refer to note 15(d)), are expensed as incurred. Under the GSOP, subject to certain conditions, the Company will match a percentage of an employee’s eligible contributions to certain maximums. All contributions are used by the plan’s trustee to purchase MFC common shares in the open market.

(o) Employee future benefits

The Company maintains defined contribution and defined benefit pension plans and other post-employment plans for employees and agents including registered (tax qualified) pension plans that are typically funded as well as supplemental non-registered (non-qualified) pension plans for executives, retiree welfare plans and disability welfare plans that are typically not funded.

The Company’s obligation in respect of defined benefit pension and other post-employment benefits is calculated for each plan as the estimated present value of future benefits that eligible employees have earned in return for their service up to the reporting date using the projected benefit method. The discount rate used is based on the yield, as at the reporting date, of high quality corporate debt securities that have approximately the same term as the obligations and that are denominated in the same currency in which the benefits are expected to be paid.

To determine the Company’s net defined benefit asset or liability, the fair value of plan assets is deducted from the defined benefit obligations. When this calculation results in a surplus, the asset that can be recognized is limited to the present value of future economic benefit available in the form of future refunds from the plan or reductions in future contributions to the plan (the asset limit). Defined benefit assets are included in other assets and defined benefit liabilities are included in other liabilities.

Changes in the net defined benefit asset or liability due to re-measurement of pension and retiree welfare plans are recorded in OCI in the period in which they occur and are not reclassified to income in subsequent periods. They consist of actuarial gains and losses, the impact of the asset limit, if any, and the return on plan assets, excluding amounts included in net interest income or expense. Changes in the net defined benefit asset or liability due to re-measurement of disability welfare plans are recorded in income in the period in which they occur.

The cost of defined benefit pension plans is recognized over the employee’s years of service to retirement while the cost of retiree welfare plans is recognized over the employee’s years of service to their date of full eligibility. The net benefit cost for the year is recorded in income and is calculated as the sum of the service cost in respect of the fiscal year, the net interest income or expense and any applicable administration expenses, plus past service costs or credits resulting from plan amendments or curtailments. The net interest income or expense is determined by applying the discount rate to the net defined benefit asset or liability. The current year cost of disability welfare plans is the year-over-year change in the defined benefit obligation, including any actuarial gains or losses.

The cost of defined contribution plans is the contribution provided by the Company and is recorded in income in the periods during which services are rendered by employees.

(p) Derivative and hedging instruments

The Company uses derivative financial instruments (“derivatives”) including swaps, forward and futures agreements, and options to manage current and anticipated exposures to changes in interest rates, foreign exchange rates, commodity prices and equity market prices, and to replicate permissible investments. Derivatives embedded in other financial instruments (“host instruments”) are separately recorded as derivatives when their economic characteristics and risks are not closely related to those of the host instrument, the terms of the embedded derivative are the same as those of a standalone derivative and the host instrument itself is not recorded at FVTPL. Derivatives are recorded at fair value. Derivatives with unrealized gains are reported as derivative assets and derivatives with unrealized losses are reported as derivative liabilities.

A determination is made for each derivative as to whether to apply hedge accounting. Where hedge accounting is not applied, changes in the fair value of derivatives are recorded in investment income. Refer to note 4(c).

Where the Company has elected to apply hedge accounting, a hedging relationship is designated and documented at inception. Hedge effectiveness is evaluated at inception and throughout the term of the hedge and hedge accounting is only applied when the Company expects that the hedging relationship will be highly effective in achieving offsetting changes in fair value or changes in cash flows attributable to the risk being hedged. The assessment of hedge effectiveness is performed at the end of each reporting period both prospectively and retrospectively. When it is determined that a hedging relationship is no longer effective, or the hedging instrument or the hedged item has been sold or terminated, the Company discontinues hedge accounting prospectively. In such cases, if the derivatives are not sold or terminated, any subsequent changes in fair value of the derivatives are recognized in investment income.

For derivatives that are designated as hedging instruments, changes in fair value are recognized according to the nature of the risks being hedged, as discussed below.

In a fair value hedging relationship, changes in fair value of the hedging instruments are recorded in investment income, offsetting changes in fair value of the hedged items, which would otherwise not be carried at fair value. Hedge ineffectiveness is recognized in investment income and arises from differences between changes in the fair values of hedging instruments and hedged items. When hedge accounting is discontinued, the carrying value of the hedged item is no longer adjusted and the cumulative fair value adjustments are amortized to investment income over the remaining term of the hedged item unless the hedged item is sold, at which time the balance is recognized immediately in investment income.

 

120        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


In a cash flow hedging relationship, the effective portion of the change in the fair value of the hedging instrument is recorded in OCI while the ineffective portion is recognized in investment income. Gains and losses in accumulated other comprehensive income (“AOCI”) are recognized in income during the same periods as the variability in the hedged cash flows or the hedged forecasted transactions are recognized in income. The reclassifications from accumulated other comprehensive income (“AOCI”) are made to investment income, with the exception of total return swaps that hedge restricted share units, which are reclassified to general expenses.

Gains and losses on cash flow hedges in AOCI are reclassified immediately to investment income when the hedged item is sold or the forecasted transaction is no longer expected to occur. When a hedge is discontinued, but the hedged forecasted transaction remains highly probable to occur, the amounts in AOCI are reclassified to investment income in the periods during which variability in the cash flows hedged or the hedged forecasted transaction is recognized in income.

In a net investment in foreign operations hedging relationship, the gains and losses relating to the effective portion of the hedge are recorded in OCI. Gains and losses in AOCI are recognized in income during the periods when gains or losses on the underlying hedged net investment in foreign operations are recognized in income.

(q) Premium income and related expenses

Gross premiums for all types of insurance contracts, and contracts with limited mortality or morbidity risk, are generally recognized as revenue when due. Premiums are reported gross of reinsurance ceded (refer to note 8). Revenue on service contracts is recognized as services are rendered.

Note 2    Accounting and Reporting Changes

(a) Changes in accounting policy

(I) Annual improvements to IFRS Standards 2014 – 2016 Cycle

Effective January 1, 2017, the Company adopted certain amendments issued within the Annual Improvements to IFRS Standards 2014-2016 Cycle, as issued by the IASB in December 2016. There are various minor amendments which are effective in 2017, with other amendments being effective January 1, 2018. The currently effective amendments were applied retrospectively. Adoption of these amendments did not have a significant impact on the Company’s Consolidated Financial Statements.

(II) Amendments to IAS 12 “Income Taxes”

Effective January 1, 2017, the Company adopted the amendments issued in January 2016 to IAS 12 “Income Taxes”. These amendments were applied retrospectively. The amendments clarify recognition of deferred tax assets relating to unrealized losses on debt instruments measured at fair value. A deductible temporary difference arises when the carrying amount of the debt instrument measured at fair value is less than the cost for tax purposes, irrespective of whether the debt instrument is held for sale or held to maturity. The recognition of the deferred tax asset that arises from this deductible temporary difference is considered in combination with other deferred taxes applying local tax law restrictions where applicable. In addition, when estimating future taxable profits, consideration can be given to recovering more than the asset’s carrying amount where probable. Adoption of these amendments did not have a significant impact on the Company’s Consolidated Financial Statements.

(III) Amendments to IAS 7 “Statement of Cash Flows”

Effective January 1, 2017, the Company adopted the amendments issued in January 2016 to IAS 7 “Statement of Cash Flows”. These amendments were applied prospectively. These amendments require companies to provide information about changes in their financing liabilities. Adoption of these amendments did not have a significant impact on the Company’s Consolidated Financial Statements.

(b) Future accounting and reporting changes

(I) IFRS 15 “Revenue from Contracts with Customers”

IFRS 15 “Revenue from Contracts with Customers” was issued in May 2014, and replaces IAS 11 “Construction Contracts” IAS 18 “Revenue” and several interpretations. Amendments to IFRS 15 were issued in April 2016. IFRS 15 as amended is effective for annual periods beginning on or after January 1, 2018. The Company will adopt IFRS 15 effective January 1, 2018, using the modified retrospective method with no restatement of comparative information.

IFRS 15 clarifies revenue recognition principles, provides a robust framework for recognizing revenue and cash flows arising from contracts with customers and enhances qualitative and quantitative disclosure requirements. IFRS 15 does not apply to insurance contracts, financial instruments and lease contracts.

The Company’s service arrangements are generally satisfied over time, with revenue measured and collected from customers within a short term, as services are rendered.

Adoption of IFRS 15 is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

(II) IFRS Interpretation Committee (“IFRIC”) Interpretation 22 “Foreign Currency Transactions and Advance Consideration”

IFRIC 22 “Foreign Currency Transactions and Advance Consideration” was issued in December 2016 and is effective for annual periods beginning on or after January 1, 2018 and may be applied retrospectively or prospectively. IFRIC 22 addresses which foreign

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        121


exchange rate to use to measure a foreign currency transaction when advance payments are made or received and non-monetary assets or liabilities are recognized prior to recognition of the underlying transaction. IFRIC 22 does not relate to goods or services accounted for at fair value or at the fair value of consideration paid or received at a date other than the date of initial recognition of the non-monetary asset or liability, or to income taxes, insurance contracts or reinsurance contracts. The foreign exchange rate on the day of the advance payment is used to measure the foreign currency transaction. If multiple advance payments are made or received, each payment is measured separately. The Company is assessing the impact of this standard. Adoption of IFRIC 22 is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

(III) Amendments to IFRS 2 “Share-Based Payment”

Amendments to IFRS 2 “Share-Based Payment” were issued in June 2016 and are effective for annual periods beginning on or after January 1, 2018, to be applied prospectively. The amendments clarify the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments; provide guidance on the classification of share-based payment transactions with net settlement features for withholding tax obligations; and clarify accounting for modification to the terms and conditions of a share-based payment that changes the classification of the transaction from cash-settled to equity-settled. Adoption of these amendments is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

(IV) IFRS 9 “Financial Instruments”

IFRS 9 “Financial Instruments” was issued in November 2009 and amended in October 2010, November 2013 and July 2014, and is effective for years beginning on or after January 1, 2018, to be applied retrospectively, or on a modified retrospective basis. Additionally, the IASB issued amendments in October 2017 that are effective for annual periods beginning on or after January 1, 2019. The standard is intended to replace IAS 39 “Financial Instruments: Recognition and Measurement”.

The project has been divided into three phases: classification and measurement, impairment of financial assets, and hedge accounting. IFRS 9’s current classification and measurement methodology provides that financial assets are measured at either amortized cost or fair value on the basis of the entity’s business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. The classification and measurement for financial liabilities remains generally unchanged; however, for a financial liability designated as at fair value through profit or loss, revisions have been made in the accounting for changes in fair value attributable to changes in the credit risk of that liability. Gains or losses caused by changes in an entity’s own credit risk on such liabilities are no longer recognized in profit or loss but instead are reflected in OCI.

Revisions to hedge accounting were issued in November 2013 as part of the overall IFRS 9 project. The amendment introduces a new hedge accounting model, together with corresponding disclosures about risk management activities for those applying hedge accounting. The new model represents a substantial overhaul of hedge accounting that will enable entities to better reflect their risk management activities in their financial statements.

Revisions issued in July 2014 replace the existing incurred loss model used for measuring the allowance for credit losses with an expected credit loss model. Changes were also made to the existing classification and measurement model designed primarily to address specific application issues raised by early adopters of the standard. The revision also addresses the income statement accounting mismatches and short-term volatility issues which have been identified as a result of the insurance contracts project.

Revisions issued in October 2017 allow financial assets to be measured at amortized cost or fair value through OCI even if the lender is required to pay a reasonable compensation in the event of an early termination of the contract by the borrower (also referred to as prepayment features with negative compensation).

The Company expects to defer IFRS 9 until January 1, 2021 as allowed under the amendments to IFRS 4 “Insurance Contracts” outlined below. The Company is assessing the impact of this standard.

(V) Amendments to IFRS 4 “Insurance Contracts”

Amendments to IFRS 4 “Insurance Contracts” were issued in September 2016, which are effective for annual periods beginning on or after January 1, 2018. The amendments introduce two approaches to address concerns about the differing effective dates of IFRS 9 “Financial Instruments” and IFRS 17 “Insurance Contracts”: the overlay approach and the deferral approach. The overlay approach provides an option for all issuers of insurance contracts to adjust profit or loss for eligible financial assets by removing any additional accounting volatility that may arise from applying IFRS 9 before IFRS 17 is implemented. The deferral approach provides companies whose activities are predominantly related to insurance an optional temporary exemption from applying IFRS 9 until January 1, 2021. The Company qualifies for the exemption and intends to defer IFRS 9 until January 1, 2021.

(VI) IFRS 17 “Insurance Contracts”

IFRS 17 was issued in May 2017 and is effective for years beginning on January 1, 2021, and to be applied retrospectively. If full retrospective application to a group of contracts is impractical, the modified retrospective or fair value methods may be used. The standard will replace IFRS 4 “Insurance Contracts” and will materially change the recognition and measurement of insurance contracts and the corresponding presentation and disclosures in the Company’s Financial Statements and MD&A. The Company is assessing the implications of this standard and expects that it will have a significant impact on the Company’s Consolidated Financial Statements. In addition, in certain jurisdictions, including Canada, it could have a material effect on tax and regulatory capital positions that are dependent upon IFRS accounting values.

 

122        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


For life insurance companies, such as Manulife, that have long-duration products and/or regulatory and tax regimes dependent upon IFRS accounting values, the Company believes that an effective date of January 1, 2021 is aggressive. Therefore, while the Company’s implementation project is well underway, the Company and others in the life insurance industry are encouraging the IASB to defer the effective date.

(VII) IFRS 16 “Leases”

IFRS 16 “Leases” was issued in January 2016 and is effective for years beginning on or after January 1, 2019, to be applied retrospectively or on a modified retrospective basis. It will replace IAS 17 “Leases” and IFRIC 4 “Determining whether an arrangement contains a lease”. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, the customer (“lessee”) and the supplier (“lessor”). The standard brings most leases on-balance sheet for lessees under a single model, eliminating the previous classifications of operating and finance leases. Exemptions to this treatment are for lease contracts with low value assets or leases with duration of less than one year. The on-balance sheet treatment will result in the grossing up of the balance sheet due to right-of-use assets being recognized with offsetting liabilities. Lessor accounting will remain largely unchanged with previous classifications of operating and finance leases being maintained. The Company is assessing the impact of this standard.

(VIII) IFRS Interpretation Committee (“IFRIC”) Interpretation 23 “Uncertainty over Income Tax Treatments”

IFRIC 23 “Uncertainty over Income Tax Treatments” was issued in June 2017 and is effective for years beginning on or after January 1, 2019, to be applied retrospectively. IFRIC 23 provides guidance on applying the recognition and measurement requirements in IAS 12 when there is uncertainty over income tax treatments including whether uncertain tax treatments should be considered together or separately based on which approach better predicts resolution of the uncertainty. Adoption of IFRIC 23 is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

(IX) Amendments to IAS 28 “Investments in Associates and Joint Ventures”

Amendments to IAS 28 “Investments in Associates and Joint Ventures” were issued in October 2017 and are effective for annual periods beginning on or after January 1, 2019, to be applied retrospectively. The amendments clarify that an entity applies IFRS 9 “Financial Instruments” to financial interests in an associate or joint venture to which the equity method is not applied. IAS 39 is being applied to these interests until IFRS 9 is adopted in 2021. Adoption of these amendments is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

(X) Annual Improvements 2015 – 2017 Cycle

Annual Improvements 2015 – 2017 Cycle was issued in December 2017 and is effective for years beginning on or after January 1, 2019. The IASB issued three minor amendments to different standards as part of the Annual Improvements process, with the amendments to be applied prospectively. Adoption of these amendments is not expected to have significant impact on the Company’s Consolidated Financial Statements.

Note 3    Acquisition and Distribution Agreements

(a) Mandatory Provident Fund business of Standard Chartered

On November 1, 2016, the Company completed its acquisition of Standard Chartered’s Mandatory Provident Fund (“MPF”) and Occupational Retirement Schemes Ordinance (“ORSO”) businesses in Hong Kong, and the related investment management entity. In addition, on November 1, 2016, the Company commenced its 15-year exclusive distribution partnership with Standard Chartered. These arrangements significantly expand Manulife’s retirement business in Hong Kong. Total consideration of $392 was paid in cash.

(b) Distribution agreement with DBS Bank Ltd (“DBS”)

Effective January 1, 2016, the Company entered into a 15-year regional distribution agreement with DBS covering Singapore, Hong Kong, mainland China and Indonesia. The arrangement expands the Company’s strategy for growth in Asia. The Company recognized $536 of distribution network intangible assets on the agreement’s effective date.

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        123


Note 4     Invested Assets and Investment Income

(a) Carrying values and fair values of invested assets

 

As at December 31, 2017    FVTPL(1)      AFS(2)      Other(3)      Total carrying
value
     Total fair
value(9)
 

Cash and short-term securities(4)

   $ 439      $ 11,429      $ 4,097      $ 15,965      $ 15,965  

Debt securities(5)

              

Canadian government and agency

     17,886        4,892               22,778        22,778  

U.S. government and agency

     12,497        13,472               25,969        25,969  

Other government and agency

     16,838        2,988               19,826        19,826  

Corporate

     96,785        5,366               102,151        102,151  

Mortgage/asset-backed securities

     3,018        258               3,276        3,276  

Public equities

     18,473        3,072               21,545        21,545  

Mortgages

                   44,742        44,742        46,065  

Private placements

                   32,132        32,132        34,581  

Policy loans

                   5,808        5,808        5,808  

Loans to Bank clients

                   1,737        1,737        1,742  

Real estate

              

Own use property(6)

                   1,281        1,281        2,448  

Investment property

                   12,529        12,529        12,529  

Other invested assets

              

Alternative long-duration assets(7)

     12,018        88        8,624        20,730        21,053  

Various other (8)

     142               3,611        3,753        3,752  

Total invested assets

   $   178,096      $   41,565      $   114,561      $   334,222      $   339,488  
As at December 31, 2016      FVTPL(1)        AFS(2)        Other(3)       
Total carrying
value
 
 
    
Total fair
value(9)
 
 

Cash and short-term securities(4)

   $ 269      $ 11,705      $ 3,177      $ 15,151      $ 15,151  

Debt securities(5)

              

Canadian government and agency

     18,030        6,715               24,745        24,745  

U.S. government and agency

     13,971        13,333               27,304        27,304  

Other government and agency

     18,629        2,312               20,941        20,941  

Corporate

     87,374        5,041               92,415        92,415  

Mortgage/asset-backed securities

     2,886        331               3,217        3,217  

Public equities

     16,531        2,965               19,496        19,496  

Mortgages

                   44,193        44,193        45,665  

Private placements

                   29,729        29,729        31,459  

Policy loans

                   6,041        6,041        6,041  

Loans to Bank clients

                   1,745        1,745        1,746  

Real estate

              

Own use property(6)

                   1,376        1,376        2,524  

Investment property

                   12,756        12,756        12,756  

Other invested assets

              

Alternative long-duration assets(7)

     10,707        96        8,048        18,851        19,193  

Various other (8)

     164               3,745        3,909        3,910  

Total invested assets

   $ 168,561      $ 42,498      $ 110,810      $ 321,869      $ 326,563  

 

(1) The FVTPL classification was elected for securities backing insurance contract liabilities to substantially reduce any accounting mismatch arising from changes in the fair value of these assets and changes in the value of the related insurance contract liabilities. If this election had not been made and instead the available-for-sale (“AFS”) classification was selected, there would be an accounting mismatch because changes in insurance contract liabilities are recognized in net income rather than in OCI.
(2) Securities that are designated as AFS are not actively traded by the Company but sales do occur as circumstances warrant. Such sales result in a reclassification of any accumulated unrealized gain (loss) in AOCI to net income as a realized gain (loss).
(3) Primarily includes assets classified as loans and carried at amortized cost, own use properties, investment properties, equity method accounted investments, oil and gas investments, and leveraged leases. Refer to note 1(e) for further details regarding accounting policy.
(4) Includes short-term securities with maturities of less than one year at acquisition amounting to $2,737 (2016 – $3,111), cash equivalents with maturities of less than 90 days at acquisition amounting to $9,131 (2016 – $8,863) and cash of $4,097 (2016 – $3,177).
(5) Debt securities include securities which were acquired with maturities of less than one year and less than 90 days of $1,768 and $161, respectively (2016 – $893 and $192, respectively).
(6) Includes accumulated depreciation of $389 (2016 – $404).
(7) Alternative long-duration assets (“ALDA”) include investments in private equity of $4,959, power and infrastructure of $7,355, oil and gas of $2,813, timber and agriculture of $5,033 and various other invested assets of $570 (2016 – $4,619, $6,679, $2,093, $4,972 and $488, respectively).
(8) Includes $3,273 (2016 – $3,369) of leveraged leases. Refer to note 1(e) regarding accounting policy.
(9) The methodologies used in determining fair values of invested assets are described in note 1 and note 4(g).

 

124        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


(b) Equity method accounted invested assets

Other invested assets include investments in associates and joint ventures which are accounted for using the equity method of accounting as follows.

 

     2017            2016  
As at December 31,    Carrying
value
     % of total            Carrying
value
    % of total  

Leveraged leases

   $   3,273        56        $   3,369       58  

Timber and agriculture

     451        8          430       8  

Real estate

     498        9          419       7  

Other

     1,535        27          1,562       27  

Total

   $ 5,757        100        $ 5,780       100  

The Company’s share of profit and dividends from these investments for the year ended December 31, 2017 were $291 and $14, respectively (2016 – $252 and $17, respectively).

(c) Investment income

 

For the year ended December 31, 2017    FVTPL      AFS      Other(1)      Total      Yields(2)  

Cash and short-term securities

                 0.9%  

Interest income

   $ 7      $ 153      $      $ 160     

Gains (losses)(3)

     22        (47             (25   

Debt securities

                 5.4%  

Interest income

        5,102        577               5,679     

Gains (losses)(3)

     3,690        (205             3,485     

Recovery (impairment loss), net

     16        (1             15     

Public equities

                 16.6%  

Dividend income

     524        79               603     

Gains(3)

     2,372        226               2,598     

Impairment loss

            (14             (14   

Mortgages

                 3.9%  

Interest income

                   1,685        1,685     

Gains(3)

                   69        69     

Provision, net

                   (32      (32   

Private placements

                 5.3%  

Interest income

                   1,553        1,553     

Gains(3)

                   43        43     

Impairment loss, net

                   10        10     

Policy loans

                   365        365        6.1%  

Loans to Bank clients

                 4.0%  

Interest income

                   68        68     

Real estate

                 6.2%  

Rental income, net of depreciation(4)

                   517        517     

Gains(3)

                   341        341     

Impairment loss

                   (4      (4   

Derivatives

                 n/a  

Interest income, net

     809               84        893     

Gains (losses)(3)

     (1,029             84        (945   

Other invested assets

                 10.3%  

Interest income

                   174        174     

Oil and gas, timber, agriculture and other income

                   1,690        1,690     

Gains (losses)(3)

     441        (7      50        484     

Impairment loss, net

                   (45      (45         

Total investment income

   $   11,954      $ 761      $ 6,652      $ 19,367        6.0%  

Investment income

              

Interest income

   $ 5,918      $ 730      $ 3,929      $ 10,577        3.3%  

Dividend, rental and other income

     524        79        2,207        2,810        0.9%  

Impairments, provisions and recoveries, net

     16        (15      (71      (70      0.0%  

Other

     460        (51      (77      332        0.1%  
       6,918        743        5,988        13,649     

Realized and unrealized gains (losses) on assets supporting insurance and investment contract liabilities and on macro equity hedges

              

Debt securities

     3,694        (8             3,686        1.1%  

Public equities

     2,200        35               2,235        0.7%  

Mortgages

                   69        69        0.0%  

Private placements

                   40        40        0.0%  

Real estate

                   350        350        0.1%  

Other invested assets

     329        (9      121        441        0.1%  

Derivatives, including macro equity hedging program

     (1,187             84        (1,103      (0.3%
       5,036        18        664        5,718           

Total investment income

   $ 11,954      $   761      $   6,652      $   19,367        6.0%  

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        125


For the year ended December 31, 2016    FVTPL      AFS      Other(1)      Total      Yields(2)  

Cash and short-term securities

                 0.7%  

Interest income

   $ 7      $ 117      $      $ 124     

Gains (losses)(3)

     18        (18                 

Debt securities

                 4.7%  

Interest income

     5,051        588               5,639     

Gains(3)

     1,658        548               2,206     

Recovery (impairment loss), net

     (18                    (18   

Public equities

                 10.6%  

Dividend income

     534        58               592     

Gains(3)

     1,008        201               1,209     

Impairment loss

            (48             (48   

Mortgages

                 4.1%  

Interest income

                   1,667        1,667     

Gains (losses)(3)

                   81        81     

Provision, net

                   (7      (7   

Private placements

                 5.4%  

Interest income

                   1,494        1,494     

Gains(3)

                   17        17     

Impairment loss, net

                   (50      (50   

Policy loans

                   358        358        6.1%  

Loans to Bank clients

                 3.9%  

Interest income

                   68        68     

Real estate

                 4.9%  

Rental income, net of depreciation(4)

                   523        523     

Gains(3)

                   160        160     

Derivatives

                 n/a  

Interest income, net

     1,115               (33      1,082     

Losses(3)

     (2,597                    (2,597   

Other invested assets

                 10.3%  

Interest income

                   103        103     

Oil and gas, timber, agriculture and other income

                   1,162        1,162     

Gains(3)

     634        1        207        842     

Impairment loss, net

                   (83      (83         

Total investment income

   $ 7,410      $ 1,447      $ 5,667      $ 14,524        4.7%  

Investment income

              

Interest income

   $ 6,173      $ 703      $ 3,657      $ 10,533        3.4%  

Dividend, rental and other income

     534        58        1,685        2,277        0.7%  

Impairments and provisions

     (18      (48      (140      (206      (0.1%

Other

     (6      707        85        786        0.2%  
       6,683        1,420        5,287        13,390     

Realized and unrealized gains (losses) on assets supporting insurance and investment contract liabilities and on macro equity hedges

              

Debt securities

     1,657        5               1,662        0.5%  

Public equities

     963        22               985        0.3%  

Mortgages

                   80        80        0.0%  

Private placements

                   12        12        0.0%  

Real estate

                   128        128        0.0%  

Other invested assets

     688               160        848        0.3%  

Derivatives, including macro equity hedging program

     (2,581                    (2,581      (0.8%
       727        27        380        1,134           

Total investment income

   $ 7,410      $ 1,447      $ 5,667      $ 14,524        4.7%  

 

(1) Primarily includes loans carried at amortized cost, own use properties, investment properties, derivative and hedging instruments in cash flow hedging relationships, equity method accounted investments, oil and gas investments, and leveraged leases.
(2) Yields are based on income and are calculated using the geometric average of the carrying value of assets held during the reporting year.
(3) Includes net realized gains (losses) as well as net unrealized gains (losses) for financial instruments at FVTPL, real estate investment properties, and other invested assets measured at fair value. Also includes net realized gains (losses) for financial instruments at AFS and other invested assets carried at amortized cost.
(4) Rental income from investment properties is net of direct operating expenses.

 

126        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


(d) Investment expenses

The following table presents the Company’s total investment expenses.

 

For the years ended December 31,    2017      2016  

Related to invested assets

   $ 625      $ 581  

Related to segregated, mutual and other funds

     1,048        1,065  

Total investment expenses

   $   1,673      $    1,646  

(e) Investment properties

The following table presents rental income and direct operating expenses of investment properties.

 

For the years ended December 31,    2017      2016  

Rental income from investment properties

   $   1,120      $    1,204  

Direct operating expenses of investment properties that generated rental income

     (694      (764

Total

   $ 426      $ 440  

(f) Mortgage securitization

The Company securitizes certain insured and uninsured fixed and variable rate residential mortgages and Home Equity Lines of Credit (“HELOC”) through creation of mortgage-backed securities under the Canadian Mortgage Bond Program (“CMB”), and the HELOC securitization program.

Benefits received from the securitization include interest spread between the asset and associated liability. There are no expected credit losses on securitized mortgages under the Canada Mortgage and Housing Corporation (“CMHC”) sponsored CMB and the Platinum Canadian Mortgage Trust (“PCMT”) HELOC securitization programs as they are insured by CMHC and other third-party insurance programs against borrowers’ default. Mortgages securitized in the Platinum Canadian Mortgage Trust II (“PCMT II”) program are uninsured.

Cash flows received from the underlying securitized assets/mortgages are used to settle the related secured borrowing liability. For CMB transactions, receipts of principal are deposited into a trust account for settlement of the liability at time of maturity. These transferred assets and related cash flows cannot be transferred or used for other purposes. For the HELOC transactions, investors are entitled to periodic interest payments, and the remaining cash receipts of principal are allocated to the Company (the “Seller”) during the revolving period of the deal and are accumulated for settlement during an accumulation period, or repaid to the investor monthly during a reduction period, based on the terms of the note.

The following table presents the carrying amount of securitized assets and secured borrowing liabilities.

 

As at December 31, 2017    Securitized assets         
Securitization program    Securitized
mortgages
     Restricted cash and
short-term securities
     Total      Secured borrowing
liabilities(2)
 

HELOC securitization(1)

   $ 2,024      $ 8      $ 2,032      $ 2,000  

CMB securitization

     1,480               1,480        1,523  

Total

   $ 3,504      $ 8      $ 3,512      $ 3,523  
As at December 31, 2016    Securitized assets         
Securitization program    Securitized
mortgages
     Restricted cash and
short-term securities
     Total      Secured borrowing
liabilities(2)
 

HELOC securitization(1)

   $   1,762      $   8      $   1,770      $   1,750  

CMB securitization

     1,018               1,018        1,032  

Total

   $ 2,780      $ 8      $ 2,788      $ 2,782  

 

(1) Manulife Bank, a MFC subsidiary, securitizes a portion of its HELOC receivables through Platinum Canadian Mortgage Trust (“PCMT”), and Platinum Canadian Mortgage Trust II (“PCMT II”). PCMT funds the purchase of the co-ownership interests from Manulife Bank by issuing term notes collateralized by an underlying pool of CMHC insured HELOCs to institutional investors. PCMT II funds the purchase of the co-ownership interests from Manulife Bank by issuing term notes collateralized by an underlying pool of uninsured HELOCs to institutional investors. The restricted cash balance for the HELOC securitization reflects a cash reserve fund established in relation to the transactions. The reserve will be drawn upon only in the event of insufficient cash flows from the underlying HELOCs to satisfy the secured borrowing liability.
(2) Secured borrowing liabilities primarily comprise of Series 2011-1 notes with a floating rate which are expected to mature on December 15, 2021, and the Series 2016-1 notes with a floating rate which are expected to mature on May 15, 2022. Manulife Bank also securitizes insured amortizing mortgages under the National Housing Act Mortgage-Backed Securities (“NHA MBS”) program sponsored by CMHC. Manulife Bank participates in CMB programs by selling NHA MBS securities to Canada Housing Trust (“CHT”), as a source of fixed rate funding.

Fair value of the securitized assets as at December 31, 2017 was $3,533 (2016 – $2,821) and the fair value of the associated liabilities was $3,503 (2016 – $2,776).

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        127


(g) Fair value measurement

The following table presents fair values and the fair value hierarchy of invested assets and segregated funds net assets measured at fair value in the Consolidated Statements of Financial Position.

 

As at December 31, 2017    Total fair
value
     Level 1      Level 2      Level 3  

Cash and short-term securities

           

FVTPL

   $ 439      $      $ 439      $  

AFS

     11,429               11,429         

Other

     4,097        4,097                

Debt securities

           

FVTPL

           

Canadian government and agency

     17,886               17,886         

U.S. government and agency

     12,497               12,497         

Other government and agency

     16,838               16,599        239  

Corporate

     96,785        2        96,073        710  

Residential mortgage/asset-backed securities

     8               7        1  

Commercial mortgage/asset-backed securities

     1,099               1,099         

Other securitized assets

     1,911               1,886        25  

AFS

           

Canadian government and agency

     4,892               4,892         

U.S. government and agency

     13,472               13,472         

Other government and agency

     2,988               2,941        47  

Corporate

     5,366               5,278        88  

Residential mortgage/asset-backed securities

     37               37         

Commercial mortgage/asset-backed securities

     138               138         

Other securitized assets

     83               82        1  

Public equities

           

FVTPL

     18,473        18,470               3  

AFS

     3,072        3,069        3         

Real estate – investment property(1)

     12,529                      12,529  

Other invested assets(2)

     16,203                      16,203  

Segregated funds net assets(3)

     324,307        286,490        33,562        4,255  

Total

   $   564,549      $   312,128      $   218,320      $   34,101  
As at December 31, 2016    Total fair
value
     Level 1      Level 2      Level 3  

Cash and short-term securities

           

FVTPL

   $ 269      $      $ 269      $  

AFS

     11,705               11,705         

Other

     3,177        3,177                

Debt securities

           

FVTPL

           

Canadian government and agency

     18,030               18,030         

U.S. government and agency

     13,971               13,971         

Other government and agency

     18,629               18,357        272  

Corporate

     87,374        2        86,721        651  

Residential mortgage/asset-backed securities

     10               8        2  

Commercial mortgage/asset-backed securities

     680               674        6  

Other securitized assets

     2,196               2,161        35  

AFS

           

Canadian government and agency

     6,715               6,715         

U.S. government and agency

     13,333               13,333         

Other government and agency

     2,312               2,261        51  

Corporate

     5,041               4,967        74  

Residential mortgage/asset-backed securities

     65               64        1  

Commercial mortgage/asset-backed securities

     123               121        2  

Other securitized assets

     143               141        2  

Public equities

           

FVTPL

     16,531        16,524               7  

AFS

     2,965        2,963        2         

Real estate – investment property(1)

     12,756                      12,756  

Other invested assets(2)

     14,849                      14,849  

Segregated funds net assets(3)

     315,177        278,066        32,537        4,574  

Total

   $ 546,051      $ 300,732      $ 212,037      $ 33,282  

 

(1) For investment properties, the significant unobservable inputs are capitalization rates (ranging from 3.50% to 9.00% during the year and ranging from 3.75% to 9.75% during the year 2016) and terminal capitalization rates (ranging from 4.0% to 9.25% during the year and ranging from 4.1% to 10.0% during the year 2016). Holding other factors constant, a lower capitalization or terminal capitalization rate will tend to increase the fair value of an investment property. Changes in fair value based on variations in unobservable inputs generally cannot be extrapolated because the relationship between the directional changes of each input is not usually linear.

 

128        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


(2) Other invested assets measured at fair value are held primarily in power and infrastructure and timber sectors. The significant inputs used in the valuation of the Company’s power and infrastructure investments are primarily future distributable cash flows, terminal values and discount rates. Holding other factors constant, an increase to future distributable cash flows or terminal values would tend to increase the fair value of a power and infrastructure investment, while an increase in the discount rate would have the opposite effect. Discount rates during the year ranged from 9.20% to 16.5% (2016 – ranged from 9.63% to 16.0%). Disclosure of distributable cash flow and terminal value ranges are not meaningful given the disparity in estimates by project. The significant inputs used in the valuation of the Company’s investments in timberland are timber prices and discount rates. Holding other factors constant, an increase to timber prices would tend to increase the fair value of a timberland investment, while an increase in the discount rates would have the opposite effect. Discount rates during the year ranged from 5.0% to 7.5% (2016 – ranged from 5.0% to 7.5%). A range of prices for timber is not meaningful as the market price depends on factors such as property location and proximity to markets and export yards.
(3) Segregated funds net assets are measured at fair value. The Company’s Level 3 segregated funds assets are predominantly invested in timberland properties valued as described above.

For invested assets not measured at fair value in the Consolidated Statements of Financial Position, the following table presents their fair values categorized by the fair value hierarchy.

 

As at December 31, 2017    Carrying
value
     Fair value      Level 1      Level 2      Level 3  

Mortgages(1)

   $ 44,742      $ 46,065      $      $      $ 46,065  

Private placements(2)

     32,132        34,581               28,514        6,067  

Policy loans(3)

     5,808        5,808               5,808         

Loans to Bank clients(4)

     1,737        1,742               1,742         

Real estate – own use property(5)

     1,281        2,448                      2,448  

Other invested assets(6)

     8,280        8,602        88               8,514  

Total invested assets disclosed at fair value

   $   93,980      $   99,246      $ 88      $   36,064      $   63,094  
As at December 31, 2016     
Carrying
value
 
 
     Fair value        Level 1        Level 2        Level 3  

Mortgages(1)

   $ 44,193      $ 45,665      $      $      $ 45,665  

Private placements(2)

     29,729        31,459               26,073        5,386  

Policy loans(3)

     6,041        6,041               6,041         

Loans to Bank clients(4)

     1,745        1,746               1,746         

Real estate – own use property(5)

     1,376        2,524                      2,524  

Other invested assets(6)

     7,911        8,254        54               8,200  

Total invested assets disclosed at fair value

   $ 90,995      $ 95,689      $ 54      $ 33,860      $ 61,775  

 

(1) Fair value of commercial mortgages is determined through an internal valuation methodology using both observable and unobservable inputs. Unobservable inputs include credit assumptions and liquidity spread adjustments. Fair value of fixed-rate residential mortgages is determined using the discounted cash flow method. Inputs used for valuation are primarily comprised of prevailing interest rates and prepayment rates, if applicable. Fair value of variable-rate residential mortgages is assumed to be their carrying value.
(2) Fair value of private placements is determined through an internal valuation methodology using both observable and unobservable inputs. Unobservable inputs include credit assumptions and liquidity spread adjustments. Private placements are classified within Level 2 unless the liquidity adjustment constitutes a significant price impact, in which case the securities are classified as Level 3.
(3) Fair value of policy loans is equal to their unpaid principal balances.
(4) Fair value of fixed-rate loans to Bank clients is determined using the discounted cash flow method. Inputs used for valuation are primarily comprised of current interest rates. Fair value of variable-rate loans is assumed to be their carrying value.
(5) Fair value of own use real estate and the fair value hierarchy are determined in accordance with the methodologies described for real estate – investment property in note 1.
(6) Primarily include leveraged leases, oil and gas properties and equity method accounted other invested assets. Fair value of leveraged leases is disclosed at their carrying values as fair value is not routinely calculated on these investments. Fair value for oil and gas properties is determined using external appraisals based on discounted cash flow methodology. Inputs used in valuation are primarily comprised of forecasted price curves, planned production, as well as capital expenditures, and operating costs. Fair value of equity method accounted other invested assets is determined using a variety of valuation techniques including discounted cash flows and market comparable approaches. Inputs vary based on the specific investment.

Transfers between Level 1 and Level 2

The Company records transfers of assets and liabilities between Level 1 and Level 2 at their fair values as at the end of each reporting period. Assets are transferred out of Level 1 when they are no longer transacted with sufficient frequency and volume in an active market. During the year ended December 31, 2017, the Company transferred $nil (2016 – $nil) of assets measured at fair value from Level 1 to Level 2. Conversely, assets are transferred from Level 2 to Level 1 when transaction volume and frequency are indicative of an active market. The Company transferred $nil (2016 – $nil) of assets from Level 2 to Level 1 during the year ended December 31, 2017.

For segregated funds net assets, the Company had $nil transfers from Level 1 to Level 2 for the year ended December 31, 2017 (2016 – $8). The Company had $5 transfers from Level 2 to Level 1 for the year ended December 31, 2017 (2016 – $nil).

Invested assets and segregated funds net assets measured at fair value using significant unobservable inputs (Level 3)

The Company classifies fair values of the invested assets and segregated funds net assets as Level 3 if there are no observable markets for these assets or, in the absence of active markets, the majority of the inputs used to determine fair value are based on the Company’s own assumptions about market participant assumptions. The Company prioritizes the use of market-based inputs over entity-based assumptions in determining Level 3 fair values and, therefore, the gains and losses in the tables below include changes in fair value due to both observable and unobservable factors.

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        129


The following table presents a roll forward of invested assets and segregated funds net assets measured at fair value using significant unobservable inputs (Level 3) for the years ended December 31, 2017 and 2016.

 

For the year ended
December 31, 2017
  Balance,
January 1,
2017
    Net
realized/
unrealized
gains
(losses)
included
in net
income(1)
    Net
realized/
unrealized
gains
(losses)
included
in AOCI(2)
    Purchases     Sales(3)     Settlements    

Transfer

into

Level 3(4)

   

Transfer

out of

Level 3(4)

    Currency
movement
    Balance,
December 31,
2017
    Change in
unrealized
gains
(losses) on
assets still
held
 

Debt securities

                     

FVTPL

                     

Other government & agency

  $ 272     $ (3   $     –     $ 26     $ (58   $ (6   $     $     $ 8     $ 239     $ (3

Corporate

    651       19             105       (34     (29     24       (21     (5     710       10  

Residential mortgage/asset-backed securities

    2                                                 (1     1       (1

Commercial mortgage/asset-backed securities

    6                         (5     (1                              

Other securitized assets

    35       (1                       (7                 (2     25       (1
      966       15             131       (97     (43     24       (21           975       5  

AFS

                     

Other government & agency

    51       (1     (2     14       (15     (2     1             1       47        

Corporate

    74             4       22       (10     (4                 2       88        

Residential mortgage/asset-backed securities

    1             (1                                                

Commercial mortgage/asset-backed securities

    2                         (1     (1                              

Other securitized assets

    2                               (1                       1        
      130       (1     1       36       (26     (8     1             3       136        

Public equities

                     

FVTPL

    7                         (4                             3        
      7                         (4                             3        

Real estate – investment property

    12,756       301             1,257       (1,267                       (518     12,529       264  

Other invested assets

    14,849       395             3,022       (435     (837                 (791     16,203       244  
      27,605       696             4,279       (1,702     (837                 (1,309     28,732       508  

Segregated funds net assets

    4,574       60             261       (248     (54           (184     (154     4,255       45  

Total

  $   33,282     $   770     $ 1     $   4,707     $   (2,077   $   (942   $   25     $   (205   $   (1,460   $   34,101     $   558  

 

130        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


For the year ended December 31, 2016   Balance,
January 1,
2016
    Net
realized/
unrealized
gains
(losses)
included
in net
income(1)
    Net
realized/
unrealized
gains
(losses)
included
in AOCI(2)
    Purchases     Sales(3)     Settlements    

Transfer

into

Level 3(4)

   

Transfer

out of

Level 3(4)

    Currency
movement
    Balance,
December 31,
2016
    Change in
unrealized
gains
(losses) on
assets still
held
 

Debt securities

                     

FVTPL

                     

Other government & agency

  $ 310     $ 3     $     $ 50     $ (41   $ (30   $     $     $ (20   $ 272     $ 1  

Corporate

    903       (29           83       (84     (134     58       (124     (22     651       (4

Residential mortgage/asset-backed securities

    15                         (11     (1                 (1     2       1  

Commercial mortgage/asset-backed securities

    70                         (56     (4                 (4     6       (3

Other securitized assets

    48                         (1     (7           (4     (1     35        
      1,346       (26           133       (193     (176     58       (128     (48     966       (5

AFS

                     

Other government & agency

    42                   18       (6                       (3     51        

Corporate

    90             (2     29       (32     (3           (5     (3     74        

Residential mortgage/asset-backed securities

    8       (1     1             (6                       (1     1        

Commercial mortgage/asset-backed securities

    4                               (1                 (1     2        

Other securitized assets

    5             2                   (1           (4           2        
      149       (1     1       47       (44     (5           (9     (8     130        

Public equities

                     

FVTPL

                      7                                     7        
                        7                                     7        

Real estate –investment property

    13,968       163             681       (1,782                       (274     12,756       197  

Other invested assets

    12,977       786       9       2,171       (76     (685                 (333     14,849       847  
      26,945       949       9       2,852       (1,858     (685                 (607     27,605       1,044  

Segregated funds net assets

    4,656       92             356       (312     (19     (12     (105     (82     4,574       93  

Total

  $   33,096     $   1,014     $   10     $   3,395     $   (2,407   $   (885   $   46     $   (242   $   (745   $   33,282     $   1,132  

 

(1) These amounts, except for the amount related to segregated funds net assets, are included in net investment income on the Consolidated Statements of Income.
(2) These amounts are included in AOCI on the Consolidated Statements of Financial Position.
(3) Sales in 2017 include $619 of U.S. commercial real estate sold to the Hancock US Real Estate Fund, L.P., an associate of the Company which is a structured entity based on partnership voting rights. The Company provides management services to the fund and owns approximately 11.7% of its partnership interests. Also in 2017, sales include US$313 (2016 – $1,011) of U.S. commercial real estate sold to the Manulife US Real Estate Investment Trust in Singapore, an associate of the Company which is a structured entity based on unitholder voting rights. The Company provides management services to the trust and owns approximately 9.5% of its units.
(4) For assets transferred into and out of Level 3, the Company uses fair values of the assets at the beginning of the year.

Transfers into Level 3 primarily result from securities that were impaired during the year or securities where a lack of observable market data (versus the previous period) resulted in reclassifying assets into Level 3. Transfers from Level 3 primarily result from observable market data now being available for the entire term structure of the debt security.

Note 5    Derivative and Hedging Instruments

Derivatives are financial contracts, the value of which is derived from underlying interest rates, foreign exchange rates, other financial instruments, commodity prices or indices. The Company uses derivatives including swaps, forward and futures agreements, and options to manage current and anticipated exposures to changes in interest rates, foreign exchange rates, commodity prices and equity market prices, and to replicate permissible investments.

Swaps are over-the-counter (“OTC”) contractual agreements between the Company and a third party to exchange a series of cash flows based upon rates applied to a notional amount. For interest rate swaps, counterparties generally exchange fixed or floating interest rate payments based on a notional value in a single currency. Cross currency swaps involve the exchange of principal amounts between parties as well as the exchange of interest payments in one currency for the receipt of interest payments in another currency. Total return swaps are contracts that involve the exchange of payments based on changes in the values of a reference asset, including any returns such as interest earned on these assets, in return for amounts based on reference rates specified in the contract.

Forward and futures agreements are contractual obligations to buy or sell a financial instrument, foreign currency or other underlying commodity on a predetermined future date at a specified price. Forward contracts are OTC contracts negotiated between counterparties, whereas futures agreements are contracts with standard amounts and settlement dates that are traded on regulated exchanges.

Options are contractual agreements whereby the holder has the right, but not the obligation, to buy (call option) or sell (put option) a security, exchange rate, interest rate, or other financial instrument at a predetermined price/rate within a specified time.

See variable annuity dynamic hedging strategy in the “Risk Management” section of the Company’s 2017 MD&A for an explanation of the Company’s dynamic hedging strategy for its variable annuity product guarantees.

 

Notes to Consolidated Financial Statements   |  Manulife Financial Corporation  |  2017 Annual  Report        131


(a) Fair value of derivatives

The pricing models used to value OTC derivatives are based on market standard valuation methodologies and the inputs to these models are consistent with what a market participant would use when pricing the instruments. Derivative valuations can be affected by changes in interest rates, currency exchange rates, financial indices, credit spreads, default risk (including the counterparties to the contract), and market volatility. The significant inputs to the pricing models for most OTC derivatives are inputs that are observable or can be corroborated by observable market data and are classified as Level 2. Inputs that are observable generally include interest rates, foreign currency exchange rates and interest rate curves. However, certain OTC derivatives may rely on inputs that are significant to the fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data and these derivatives are classified as Level 3. Inputs that are unobservable generally include broker quotes, volatilities and inputs that are outside of the observable portion of the interest rate curve or other relevant market measures. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and consistent with what market participants would use when pricing such instruments. The Company’s use of unobservable inputs is limited and the impact on derivative fair values does not represent a material amount as evidenced by the limited amount of Level 3 derivatives. The credit risk of both the counterparty and the Company are considered in determining the fair value for all OTC derivatives after considering the effects of netting agreements and collateral arrangements.

The following table presents the gross notional amount and fair value of derivative contracts by the underlying risk exposure for derivatives in qualifying hedging and derivatives not designated in qualifying hedging relationships.

 

As at December 31,    2017             2016  
         Notional
amount
     Fair value             Notional
amount
     Fair value  
Type of hedge   Instrument type       Assets      Liabilities                Assets      Liabilities  

Qualifying hedge accounting relationships

                                                        

Fair value hedges

 

Interest rate swaps

   $ 548      $      $ 20         $ 2,158      $      $ 477  
 

Foreign currency swaps

     84        1        4           91        1        3  

Cash flow hedges

 

Foreign currency swaps

     1,757        20        333           1,285               447  
 

Forward contracts

     165               4           255               23  
   

Equity contracts

     125        16        1           126        21        1  

Total derivatives in qualifying hedge accounting relationships

     2,679        37        362           3,915        22        951  

Derivatives not designated in qualifying hedge

accounting relationships

                    
 

Interest rate swaps

     246,270        12,984        6,251           281,188        21,900        10,878  
 

Interest rate futures

     11,551                         11,616                
 

Interest rate options

     10,093        312                  9,390        376         
 

Foreign currency swaps

     16,321        494        1,122           12,226        347        1,645  
 

Currency rate futures

     3,157                         4,729                
 

Forward contracts

     20,341        915        65           15,411        340        644  
 

Equity contracts

     13,597        813        22           14,989        669        33  
 

Credit default swaps

     606        14                  662        18         
   

Equity futures

     12,158                         16,072                

Total derivatives not designated in qualifying hedge accounting relationships

     334,094        15,532        7,460           366,283        23,650        13,200  

Total derivatives

   $   336,773      $   15,569      $   7,822         $   370,198      $   23,672      $   14,151  

The following table presents fair value of derivative instruments by remaining term to maturity. Fair values disclosed below do not incorporate the impact of master netting agreements. Refer to note 10.

 

     Remaining term to maturity         
As at December 31, 2017   

Less than

1 year

    

1 to 3

years

    

3 to 5

years

    

Over 5

years

     Total      

Derivative assets

   $ 605      $ 822      $ 889      $ 13,253      $ 15,569      

Derivative liabilities

     224        149        168        7,281        7,822      
     Remaining term to maturity     
As at December 31, 2016     

Less than

1 year

 

 

    

1 to 3

years

 

 

    

3 to 5

years

 

 

    

Over 5

years

 

 

     Total      

Derivative assets

   $   467      $   680      $   719      $   21,806      $   23,672      

Derivative liabilities

     593        595        511        12,452        14,151      

 

132        Manulife  Financial Corporation  |  2017 Annual Report  |  Notes to Consolidated Financial Statements


The following table presents gross notional amount by remaining term to maturity, total fair value (including accrued interest), credit risk equivalent and risk-weighted amount by contract type.

 

     Remaining term to maturity (notional amounts)            Fair value                     
As at December 31, 2017   

Under 1

year

    

1 to 5

years

    

Over

5 years

     Total             Positive      Negative      Net            

Credit risk

equivalent(1)

          

Risk-    

weighted    

amount(2)    

 

Interest rate contracts

                               

OTC swap contracts

   $ 7,161      $ 19,141      $ 112,412      $ 138,714        $ 13,379      $ (6,867    $ 6,512        $ 6,588       $ 809      

Cleared swap contracts

     1,615        12,928        93,561        108,104          245        (206      39                  –      

Forward contracts

     6,036        10,614        675        17,325          903        (38      865          285         35      

Futures

     11,551                      11,551                                         –      

Options purchased

     816        3,856        5,421        10,093                312               312                471               61      

Subtotal

     27,179        46,539        212,069        285,787          14,839        (7,111      7,728          7,344         905      

Foreign exchange

                               

Swap contracts

     999        4,481        12,682        18,162          510        (1,483      (973        1,874         200      

Forward contracts

     3,046        135               3,181          12        (31      (19        101         12      

Futures

     3,157                      3,157                                         –      

Credit derivatives

     38        568               606          14               14                  –      

Equity contracts

                               

Swap contracts

     2,612        169               2,781          60        (14      46          337         35      

Futures

     12,158                      12,158                                         –      

Options purchased

     4,693        6,148        100        10,941                769        (10      759                2,606               305      

Subtotal including accrued interest

     53,882        58,040        224,851        336,773          16,204        (8,649      7,555          12,262         1,457      

Less accrued interest

                                         635        (827      (192                            –      

Total

   $ 53,882      $ 58,040      $ 224,851      $ 336,773              $ 15,569      $ (7,822    $ 7,747              $ 12,262             $ 1,457      
     Remaining term to maturity (notional amounts)            Fair value                     
As at December 31, 2016   

Under 1

year

    

1 to 5

years

    

Over

5 years

     Total             Positive      Negative      Net            

Credit risk

equivalent(1)

          

Risk-    

weighted    

amount(2)    

 

Interest rate contracts

                               

OTC swap contracts

   $ 13,244      $ 37,395      $ 164,252